Aaon Inc (AAON) 2021 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to AAON, Inc [Second] Quarter Sales and Earnings Call. (Operator Instructions) This call will last approximately 45 minutes to an hour. I would like to turn the meeting over to Mr. Gary Fields. Please go ahead, sir.

Good afternoon. Thank you for joining us. I'd like to read a forward-looking disclaimer to begin with. A reminder to the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995, the Securities Act of 1933 and the Securities and Exchange Act of 1934, each as amended. As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ materially from those anticipated. Please see the risk factors contained in our most recent SEC filings, including the annual report on Form 10-K and the quarterly report on Form 10-Q.

Joining me today on the call is Rebecca Thompson, our Chief Financial Officer and treasurer. Rebecca will open by reviewing our financial performance.

Thank you, Gary. I'd like to begin by discussing the comparative results of the 3 months ended September 30, 2021 versus September 30, 2020. Net sales increased 2.8% to $138.6 million from $134.8 million. The year-over-year increase was fully driven by price increases and a favorable product mix, partially offset by unit volumes, which were down approximately 11.2%. The decline in unit volumes is mainly a result of a very tight labor market that limited the company's ability to ramp up production.

Our gross profit decreased 11.8% to $36 million from $40.8 million. As a percentage of sales, gross profit was 26% compared to 30.3% in the third quarter of 2020. The decline in gross profit was related to increases in material costs and wages rising quicker than our price increases could counter act. Inefficiencies caused by minor supply chain disruptions and COVID-19 absenteeism in the quarter, which reduced our production of coil.

Selling, general and administrative expenses increased 8% to $15.9 million from $14.7 million in 2020. As a percentage of sales, SG&A increased to 11.5% of total sales from 10.9% in the third quarter of 2020.

SG&A as a percent of sales increased primarily due to the lower unit volumes. Income from operations decreased 22.9% to $20.1 million or 14.5% of sales from $26.1 million or 19.4% of sales in 2020. Our effective tax rate increased 22.5% from 21.8%.

Net income decreased to $15.6 million or 11.2% of sales compared to $20.5 million or 15.2% of sales in the third quarter of 2020. Diluted earnings per share decreased by 23.7% to $0.29 per diluted share from $0.38 per diluted share in 2020.

Turning to the balance sheet. You'll see that we had a working capital balance of $196.4 million versus $161.2 million at December 31, 2020.

Cash and cash equivalents totaled $101.8 million at September 30, 2021, up from $79 million at the end of 2020. Our current ratio is approximately 3.6:1. Our capital expenditures were $42.6 million for the 9 months ended September 30, 2021. We expect capital expenditures for the year to be approximately $60 million. The company had stock repurchases of $15 million during the 9 months ended September 30, 2021. Shareholders' equity per diluted share is $7.46 at September 30, 2021, compared to $6.61 at December 31, 2020.

I'd now like to turn the call back over to Gary Fields, our CEO and President.

Well, overall, as far as sales and earnings go, 3Q performance was disappointing. Labor shortages, supply chain constraints both restricted our ability to ramp up production as much as we would have liked. This resulted in lower unit volumes and inefficient leverage of our fixed cost. Material inflation also challenged our margins, but the production constraints really magnified the effect of the higher cost.

All in, the top line was softer than expected due to various production constraints, which resulted in the weaker-than-expected margins. Backlog at September 30 of $181.8 million was up year-over-year, 114% and up 32% from the end of the second quarter. What's really astounding is orders up year-over-year 60% in third quarter. This is really impressive, especially when considering our orders were up year-over-year 18% in third quarter of 2020. Most of the industry saw much easier comps than we did. We see no sign of the demand slowing. The replacement market demand is very strong.

New construction actually has hit the lowest point of its -- since the pandemic started in this quarter. But on the positive outlook is Architecture Billing Index, Dodge Index, Construction Starts, all the various indexes we look at are all very, very positive. And we're looking at the new construction market to rebound. But we have gained a tremendous amount of market share as the year has gone on here.

We're seeing this fairly well distributed across all of our traditional markets. We've seen a little more strength in medical and health care and in growth facilities than we have in the previous past year or so. We want to give you an update on the sales channel and talk to you about some product introductions.

We hosted a national sales meeting in October. Feedback from the sales channel was, it was the most appreciated and best sales meeting that AAON had ever conducted. I think this tells you a whole lot about the marketing tools that we have been building to strengthen our marketing efforts.

One of those, we displayed our new mobile marketing unit, which is an 18-wheeler-style truck and trailer, very much in alignment with what you'd see at, say, a NASCAR event in their merchandising. The trailer expands on both sides. It will accommodate about 40 people inside in an air conditioned environment. It's got a 26-foot long touch screen in there that we display videos. We did extensive work with a company to develop videos that will display both our -- well, multiple things, but our manufacturing style and manufacturing facilities. But most impressively, our Norman Asbjornson Innovation Center. That is our R&D laboratory that we're quite proud of, and it displays all of that.

Aftermarket parts and services continue to strengthen. That's another tool that we have worked with our sales channel. And our training programs are very much appreciated and they're gaining momentum, and we're seeing a lot of benefit from the training programs we've had in place for now 5 years. As far as new product introductions, we've spoken quite a lot about the next generation of water-source heat pump. Now this is not to replace the original generation. This is to supplement it. So now we have 2 complete lines of water-source heat pumps.

One, our original one, we have named [Ecofit] because it has the best performance in the industry for its type of unit. This new series that we introduced, we call [Pro fit] because it fits in a retrofit environment like a Pro. It's a drop-in replacement for the vast majority of units that are out there. Our sales channel partners were introduced to that at the sales meeting we had last month. And they said that we hit the bull's eye with it. They're very, very excited about it.

The other thing that we've been working on extensively, we've talked about a little bit in the past is our air source heat pumps in package rooftop configuration. We have accomplished 2 tons through 60 tons packaged rooftop units that are capable of satisfying the load and the energy requirements in cold climates, down to 0 degrees Fahrenheit at this particular time. We're very excited about that. We have development going to expand this all the way to 240 tons and will be complete with that development by the end of '22. We have prototypes in testing now.

So some of the operations at both Tulsa and Longview, we've had some productivity issues, as you can see from the numbers in the third quarter. Headcount was still slightly down in Tulsa. It has grown in Longview. We've been able to attract more people there. But we're turning the tide on that. We've made some changes in our hiring processes, our wage rates. We've revamped our HR department entirely with new leadership and brought in some fresh views on how to get people, and we're beginning to see an improvement in that. We had some supply chain issues that actually continued into and through October. We have resolution for most of these, and we're hopeful we're going to see improvement going forward. but there remain uncertainties out there.

One of them that caught us recently, they had been giving us all greenlights on everything telling us we were fine. And then suddenly 1 day they called and said, we're not fine. So we're finding other vendors to fill that gap. We've already secured those, and so it was a temporary problem, but it really affected our coil production.

The COVID instances that we had, while on a company-wide basis, the absenteeism was not a high percentage like we experienced back in 2020 at the peak of this problem. However, it was -- ever been burdensome because it was focused in a particular area of the company that made components internally that are distributed both for Longview and Tulsa. And so we ended up with a shortage of those components for a period of time, and that's why we struggle to get more units out. This has been resolved. The absenteeism right now is back to historic normals. So we're in real good shape.

Sales for network -- sales rep network is strengthening quite a lot. They're getting market share gains. I will say that not only did the innovation of our products have become more attractive, in addition to that, our lead times are the most attractive in the industry.

So people that would traditionally think of us as a niche player may be at a premium cost are now looking at us because we can satisfy their delivery requirements. Even with the little production constraints that we've had, we've been able to meet our commitments on these, and we've been able to deliver projects that many of our competitors just did not have the ability to get anywhere close.

Another interesting aspect of our business is parts sales are up year-over-year 15%. That was an all-time quarterly record for the second straight quarter in a row. Now in 2020, parts sales were a little down from the fact that there were a lot of buildings that were not accessible. But if you look at it in absolute dollar volume, these are still record numbers for parts sales. So all the efforts we've put into strengthening this aftermarket aspect of our business are beginning to show -- manifest themselves nicely.

Water-source heat pump sales were down 23%. We really believe that, that was fueled by 2 things. First off, the new construction being down in that product that we had available at that time, not being particularly attractive for retrofit. The next thing was is people that would begin stocking units were waiting for that ideal retrofit unit so they may have hit the pause button on restocking some of their warehouses, waiting on this more attractive product. Air handlers and condensing units were up 8%. And again, a high percentage of those are air source heat pump. And we build these for light commercial and small industrial applications, and that's been a really strong growth opportunity for us.

Our CapEx investments, as you saw, we're a little behind the spend that we thought we were going to spend. We were forecasting spending a little over $70 million this year, and it's looking like it's going to be $60 million. This was constrained by the supply chain as well. I mean people just can't get materials to us to build some of the things we were going to build or some of the things that we wanted to put in place. None of this really puts us in a bind. Some of it was for additional marketing tools, and they would -- it'd be nice to have, but they're not slowing us down. The sustainability of AAON is a really interesting story that we're just now beginning to learn how to tell the story.

I've been here running this company for 5 years now. And I saw plenty of evidence of great sustainability, ESG, things going on, but we were doing a very poor job of communicating. We added some very key staff that this was absolutely in the wheelhouse to be able to create that communication and learn how we gather the information in a very objective manner. So we just produced our second sustainability ESG report. That should have been out on the wire in the last couple or 3 weeks, as I recall.

A lot of companies are talking about innovation of energy-efficient equipment, but that is the backbone of AAON. It's our unique semi-custom production that's allowed us to lead in energy efficiency. Our marketing department recently did a comparative analysis of all of our key competitors, rooftop units, their best effort offerings next to our best effort offerings. We won that battle in every comparative instance, everyone. We have the absolute highest energy-efficient rooftop units on the market. And these are all AHRI certified. So this is certified data.

We have a very diverse and inclusive workforce. We were just recently awarded multiple awards actually by the state of Oklahoma, Tulsa County, the City of Tulsa. So we're being recognized for this. So ESG is something we focus on a lot, and we intend to share more going forward to help all of you investors fully understand what we do. But I encourage anyone who's interested in is yet to do so to read the report that we just put on our website.

Now outlook. Orders and backlog trends are strong as we move closer to the end of the year. Historically, we see a drop off in orders somewhere towards the end of the second quarter entering the third quarter. We have not seen that. The near-term biggest concern is going to be with production. The positives are that headcount is improving. Price cost should improve as we work through the backlog because the backlog has an improving margin profile due to the previously announced and effective price increases.

Some of the production inefficiencies will go away as we solve these minor irritants of supply chain interruption, which they have not manifest themselves into a major disarray. They've just been here at -- some of them last for a few days. Some of them have lasted for a week or 2, but nothing has been extensive. But as those go away, we have the manufacturing infrastructure, we have the headcount capable of producing in excess of expectations. But some of these production constraints did carry into October. We're seeing them resolved at this point and being resolved with further resolution later this month.

So our fourth quarter and early 2022 outlook is, compared to the third quarter, we anticipate the fourth quarter sales to be slightly down and expect gross margins to be modestly up. But I want to mention that we had a sales meeting in 2020 and we had this one here in 2021. So we're going to have probably $1 million plus SG&A burden in the fourth quarter. That won't reoccur in '22. We only have a major sales meeting every year or so. So I'm just stated that we did not have one in '20. This was the one that we had last month. So as we move through the first half of the year, we anticipate production to accelerate. We have a higher headcount, and we're gaining on that. We believe that our supply chain issues are being resolved. There's still unpredictability, but we believe that we've got a pretty good outlook on that.

So with the rising production rates and the price increases we implemented, including we have another one coming up on January 1, it's already been announced, but it's effective January 1. We did anticipate the gross margins to expand on the improvement that we expect in the fourth quarter.

Long term, we've never been more optimistic. With all the initiatives we've taken with our product portfolio and strengthening of our sales channel, we're positioning the company from being a niche player to a mainstream player. So we're very confident in what we're doing, had some struggles but I think pretty much the whole industry dealt with in the third quarter, maybe burdened us a little bit more than we thought. But if we look back to 2019 and see what our performance was then, you'll notice that 2021 Q3 is 22% better than '19. Now it wasn't a whole lot better than '20, but it was 22% better than '19. I think if you look at the industry as a whole, you'll find that the majority of the industry, if you compare Q3 '21 to Q3 '19, you'll find something closer to 11% or 12% difference, maybe 14%, but you won't find '22.

So with that, I'm going to open the call up to questions.

(Operator Instructions) First question from the line of Julio Romero.

So just to start on the labor front. At Tulsa last quarter, I think you mentioned you were down 30 to 40 employees year-over-year. Where do you stand today in terms of year-over-year headcount at Tulsa?

Exactly flat in Tulsa. So we've gained those 30 or 40, and we're plus 12% in Longview.

Okay. Great. Great. And on the price increases, I think year-to-date, you had January, June and September 1. Did you have another increase post September 1 take effect?

No. You're correct. They were January 11, June 1, September 1, taking effect. We announced 1 in late September that takes effect January 1 of '22.

Got it. Understood. And I guess it looks like your lead times extended somewhat, but on a relative basis, it looks like the delta between your lead times and your competitors had widened since last quarter. Is that a fair characterization?

Absolutely fair. So a couple of things to bear in mind. If you look at the production rate and you looked at the absolute backlog right now, our lead times would reflect a little longer than what we're actually doing. The reason for that is, some of the projects can't receive the equipment in accordance with our lead time. We're quicker than the projects. There's a lot of trouble out there in the world right now getting projects to a point where they can accept the units. So we do our best to accommodate that. So it spreads our backlog out a little more than -- you just can't take the backlog, divide it by the production number and come up with the actual lead time.

But we are running 10 weeks on a lot of units, 12 weeks on some more units. I'd say probably 12 weeks categorizes the majority of our production for rooftop units. We're probably closer to 10, maybe 8 to 10 weeks on our Longview products. This compares to some of our competitors, all of them are well into the 20s and 30s, and we've even heard 50 weeks from some.

Got it. That's good color there. And I guess just last one for me here is, the orders have continued to be strong and that's kind of in line with last quarter's commentary that you expected orders to trend steady. And it sounds like the outlook isn't really unchanged. So I guess how long do you think you can continue this trend of really robust orders?

Well, we had the sales meeting, as I spoke to you about earlier here or so to the group earlier. We had 500 sales channel partners attend that meeting, and the consensus amongst them was, it's never been better. The pipeline is absolutely robust. The fact that we have products that are now attractive for the cold climate that are decarbonized, 100% electric, that is a motivating factor. This new water-source heat pump that addresses the replacement market was a motivating factor. The support that we've given, the marketing tools that we give them are all motivating factors. And they said their pipeline is very robust and they expect a high percentage of closure rate on that pipeline.

So given that, we're forecasting things to stay really strong. So our total bookings year-over-year are up about 66%.

(Operator Instructions) Next question from the line of Brent Thielman.

Gary, I guess just following up on that. Given I'm trying to think about this in a sense that given the sort of the shorter-term challenges that you're dealing with and everybody else is dealing with. I guess when does this cause you to pull the reins in at all, at least temporarily in terms of orders? Or is it just the fact that the lead times in the industry are so far out you can still capture market share and continue to take orders at the pace you are? I just wanted some more color there.

I don't have any tendency to pull back on the reins. I have a tendency to figure out how to -- using the horse analogy, which you know I'm a horseman. I have a tendency to lay the spurs to the production facility and get it to catch up. We've made a lot of strides in that regard. The one critical thing was back in '18 and starting into '19 when we had these similar issues where we had a large backlog and we had production that was not meeting expectations, it was generated by infrastructure issues. We didn't have enough salinity machines. We didn't have a lot of organizational things. We spent a lot of time correcting that. You saw that in Q4 of '19, where we rebounded. We came all the way through '20 very nicely. So our infrastructure still has surplus capacity beyond what our backlog is with ideal lead times.

So we have the manufacturing capacity. We've had a change in recruiting practices. We've had a change in leadership of the HR Department with some fresh new ideas. And we're making headway with that.

I mean when you say, well, we were down 30 or 40 people and now we're just up flush with a year ago, we got those 30 or 40 but I promise you I have friends in other manufacturing industries that would love to be flushed with how many people they had a year ago or 2 years ago. So we're making headway with that. And we believe that we'll have adequate head count.

Our concerns for -- that impacted Q3 and will impact Q4 just slightly were supply chain. And they were last-minute notifications of supply chain issues, but given the effort of the purchasing department, coupled with the engineering department to qualify some additional vendors, those were resolved. So it's a matter of those new vendors that we attained spooling up.

Now they've all sent sample materials in here to be tested, and that was part of the qualification. So that's all completed now. So we have small shipments coming but accelerating. So throughout Q4, we'll accelerate that supply of things that were interrupted and will be fully recovered on that by the end of the year. So that's why we're saying, first off, Q4 has a few last production days due to all the holidays than does Q3. And then October was somewhat impacted by this supply chain, little interruption. And so Q4 is probably going to look pretty close to Q3 on revenue, plus or minus a little bit. And -- but the margin will be better because the backlog had better priced equipment in it. So going into Q1, I'm very, very happy with what's going on. And we're thinking that Q1 will be back in our target range plus on margins, and we'll be back to increasing revenue. And so we're pretty bullish on it.

Well, that was my next question. So you got that one. I guess -- just so I understand it, I mean I think you talked about steel in 1 component of this. What are some of the big ticket items that have been challenging from a supply chain standpoint?

Well, copper tubing. That's the one that did it. So we manufacture our own coils, and we manufacture those in Longview. And we have a copper supplier that stub their toe. And we used a different copper supplier for our Tulsa facility. And when we presented them the opportunity to also supply our Longview facility, they stepped up and said, yes. And so then we found a couple of additional suppliers beyond them so that we had back up to the backup, if you will. So there was a backup plan there. It's just that we would have appreciated a little notice that they were going to have trouble delivering, not the day it's supposed to be here, say, oh, it's not coming.

Okay. What about trucking and freight?

I'm not hearing anything that's problematic. I think they would let me know if it was. We have -- the vast majority of what we ship, we ship on -- we contract for the freight, and we add it to the invoice for the product we ship. We ship nearly everything truckload, probably a small percentage of less than truckload. Normally, it's mixed. It's not a dedicated truck. It will all be AAON units, but it might be 2 or 3 locations that it's going to -- so that company, we've had a 20-plus year relationship with, and they have performed marvelously for us.

Same thing, we send them to pick up a lot of our materials. So we use -- actually, it's 2 trucking companies, but 1 is more predominant than the other one. We have controlled that very well, long relationship. I don't know how they're treating their other customers. They're a very, very high character, high integrity company. So I bet their treatment is all the same. But they've told us, we have to pay a lot more for truck drivers now than we did. So this really goes back to early 2020. They had to raise their rates to truck drivers. I don't want to be quoted for sure on it, but I think it was in the relative order of 25% that they had to increase their rates that they were paying their drivers. And of course, that passed on to us, and we were able to pass it on, but we're not having any issues that I've been made aware of.

Yes. Okay. Maybe the last one. I mean I know you've got the new introduction on the water-source heat pump side, which is pretty exciting. Any -- I mean, any qualitative or if you want to -- quantitative thoughts and targets for '22 for the business? How you think about that?

It's too early to talk about what that's going to do. Now that we have it out there, I'd really like a quarter to see how that soaks in. This is a real good time right now to have them -- I mean it was key that we had this thing ready to go here right away. And so we'll probably be better prepared to talk about how those orders are coming in. So I know that our backlog is up 30% year-over-year on water-source heat pumps. So something is already trending in the right direction. And I don't know that there was that many days that we made that product available that, that could impact it. But I'd really like to hold off on forecast and not -- because I don't want to miss the mark and right now, the target is too blurry.

(Operator Instructions) I see there are no further questions at this time. Please continue.

All right. Well, I want to thank all of you for joining us on the call. We'll talk to you again in February with our fourth quarter results. Have a great day. Bye-bye.

That concludes today's conference. Thank you, everyone, for participating. You may now all disconnect.