Aaon Inc (AAON) 2003 Q2 法說會逐字稿

Thank you for holding, ladies and gentlemen. Welcome to the AAON, Inc. second quarter earnings call. During the conference, all lines will be in a listen-only mode. You will have an opportunity to ask questions at the end of the presentation. Instructions for asking questions will be given at that time. I thank you for your attention and I turn it over to our host, Mr. Norman Asbjornson.

--Our Chief Financial Officer, Kathy Sheffield, who is here with me today.

Good afternoon, ladies and gentlemen. Welcome.

Before beginning, we'll go over the disclaimer, forward-looking disclaimer. To the extent any statement presented herein deals with information that is not historical, including the for outlook for the remainder of this year, such statement is necessarily forward-looking and made pursuant to the Safe Harbor provisions of the security litigation reform act of 1995.

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 securities and exchange filings, including the annual report on Form 10-K and the quarterly report on Form 10-Q. Thank you.

We'll now go ahead and have a review of our financial statements. First quarter, as reported -- I mean the second quarter, as reported, resulted in net sales of $37,222,000 compared to a year ago, $40,181,000. The other side of that story is the inventory -- I mean the backlog position. As reported in our annual and 10-K, on March 1st, our backlog was $24,972,000. It has gone up approximately $10 million since that time till today, which results in approximately a 40% increase in our backlog.

So while our sales are down, our backlog has been climbing. The way our business runs, we would normally expect that at this time of the year because it is somewhat seasonal. However, the amount of increase in the backlog and the fact that our sales increased each month during the past quarter, as well as did the backlog, at a rate faster than what we would attribute to purely a seasonality factor, we are of the opinion that either our penetration of the market improved during those three months or the economy improved.

The net result is, it has given us a more optimistic view for the last half of this year. Going down through the P&L statement, very little differential on the gross profit percentage. It's down about half a percent for the quarter and about 4/10ths of a percent for the year to date.

The big change comes about in the SG&A. SG&A is noticeably down for the year. Again, as a percentage, it's small; but as dollars go, it's fairly big. The income from operations, I should say, is noticeably affected, to the point that the income is now better than it was a year ago. Most of that comes about in the form of a diminishing warranty cost, and that is primarily the result of the fact that a year ago we were in the process of introducing a lot of new product, and we had some associated warranty issues with that introduction. The other thing that has diminished again relative to that same issue is our agency cost has gone down, that being the agencies that certify our product, is down considerably.

On the opposite side of that, we did have a major sales meeting about 30 days ago that was fairly expensive, and we had to produce a lot of literature and sales aids for all that new product, and that offset some of our savings in the warranty and the agency cost. But the net reduction was substantial in our SG&A. Interest is not an issue, being that we're basically debt-free, with the exception of revolver, we use just to balance our accounts off a little.

Income, before taxes, is again down marginally, and basically, because we did buy back a fair amount of stock during this time period, it didn't impact our earnings per share as much as it did as a percentage, as much as it did our earnings in dollars. Going into the buy-back of stock, last year we began buying stock back on October 17th and through then until the end of the year we bought back approximately 216,000 shares at approximately $4 million cost. From the first of this year until the end of June, we bought back another 427,000 at an approximate cost of $6.8 million, and since June 30th we've bought back another 34,800 shares at about $679,000 cost.

So thus far to date, we've bought back 677,764 shares out of the announced intention last fall of buying back approximately 10% or 1.3 million shares. To do that, we have spent $11,478,474, which has basically come out of cash flow and somewhat out of our cash position over the past six and a half months. Looking over on to our balance sheet, the biggest issue there that I can see is accounts receivable, and that's primarily of the following nature.

In December, we're in a downturn in that October is stronger than November, which is stronger than December, so we're slowing down during the last quarter of the year when our December 31st numbers are; and in June of this year, again reflecting what I mentioned earlier, we're in an upswing each quarter, each month being stronger; and therefore, that attributes most of it and most all of that differential is in the less than 60-day column. So it's fairly current receivables.

Inventory is down slightly, simply because we've been able to tighten up on our inventory control a little. We have only spent $2.7 million cap out of what we intended to this year, which was an announced cap of about $6 million, and we're pretty much online to be in that general area by the end of the year. Accounts payable, not a big issue, and most of that's due to the upswing we're experiencing now compared to the end of last year when we were in a slowdown. The accrued liabilities, virtually all of that is in commission payable to our representatives. So not much of a story to be told there.

Cash flow position continues to be strong for the company, and I think we're on line to buy back the balance of our stock probably by sometime the first quarter next year. The recent events which have occurred -- late May, we had a sales meeting, which was by far the largest sales meeting we have ever had. We had in excess of 400 salespeople who attended. The salespeople contribute their money to come to the meeting. We pay the bills while they're at the meeting as far as hotels and meals and lodging. So that, as I mentioned before, was our big amount of money that we spent in that area, or a large part of it was in that. It was an extremely positive meeting. We introduced a lot of new product, we gave them a tremendous amount of new sales aids.

They went back out and did a superb job in June of taking us to an all-time high booking month for the company in any month in our preceding history. It has slowed down a little bit in July but is still strong. The new products are coming on well. They're largely responsible for some of the upswing. So everything is pretty much heading the way we think it should there.

The markets, as I mentioned, I believe are stronger, and not just for us because of new products and things we're doing, but I believe there is more market out there. I believe there is an economic upturn beginning to appear in the products that we sell. Maybe not across the board, but in the types of products we're involved in, it appears that there is. Again, our major markets are the retail market, which is looking strong at this point. The medical community, that is a strong market. And the educational market, which is primarily schoolhouses, first grade through to 12th grade, has been very strong.

Two weak markets which continue to be weak are in the manufacturing facilities, industrial construction, and the office building market. Neither of them are showing any signs of strength at this point in time, so that's a continuation of what we've been reporting for some long period of time. Our business has been switching over more toward manufacturer's representative business, away from the national accounts, not so much intent but we have, since the beginning of this Company's start, been gaining more strength in the rep business.

The rep business is largely in all other kinds of businesses, in other words, the medical, the educational, the plant and construction and the office building as opposed to retail, where most of our national account business is. The outlook for the rest of the year at this point is very guarded optimism. 2004, again, a guarded optimism, somewhat reinforced by some of the new products which we're in the process of introducing now. I mentioned that we had introduced a lot of them last year.

The products we're selling this year at this moment in time, probably over half of them were new to us since the beginning of the year 2002, and we're in the process of adding more new products, redesigned products, but differing in some respect from what we had as recently as the beginning of last year. So we think that that is going to, in addition to anything that happens in the economy, create a more favorable opportunity for us to continue to grow and improve our bottom line. With that, I'll open it to question and answers.

Thank you. To ask a question, please press the 1, followed by the 4, on your touch-tone phone. If you would like to re-ask your question, press 1, followed by 3. The questions will be taken in the order they are received.

+++q-and-a.

There appear to be no questions at this time. Again, if you would like to ask a question, please press the 1, followed by a 4. Our first question is from Mr. James Gentile.

Hi, James. How are you?

Fine, thank you. Your backlog is about 24 million or is that 34 million, and it was up $10 million?

Yeah, it was 24 million -- essentially 25 million and right now it's essentially 35 million.

35 million. Now, of that, how much I guess is the rough versus the new component airers and chillers and is there any residential business in there?

There is no residential business in there? I don't have a breakdown immediately in front of me here on that, but I'm going to guess that the chillers and the air handlers constitute -- yeah, just a moment here. I have some numbers. Chillers and air handlers probably constitute a couple million -- between $2 million and $3 million of that backlog. In other words, probably 7%, 8% of it.

Fair enough. Fair enough. And I guess much of the SG&A leverage was obviously your warranties allowances decreasing, which you guys definitely went over nicely. And that's about it. In your opinion, just looking at it 2004, given the fact that you are entering the residential replacement market and the fact that -- if, in fact, you have your manufacturing capability on time for the replacement season, how much do you think that could potentially be?

Well, we believe the part that we have a shot at of the residential market is somewhere between a billion and a half and $1,700 million. It won't take much of a piece of that to keep us as busy as we possibly can be. I'm going to suggest in our first year, if we manage to get somewhere in the $5 million area, we'll be fortunate, and that's probably going to be due to the fact that we have to start up a business, basically, and there shouldn't be a lot of problems trying to make that all happen.

Sure. And how much of the $37 million in quarterly revenue was new products versus -- and not the refurbished legacy -- the refurbishments made to your Legacy roof product, but the new product introductions, such as the chillers and the air handlers and the smaller units, etc.?

Well, as a percentage of the new rooftop units, the large tonnage that we didn't have before --

And the large tonnage --

The extension, we probably got about $2 million to $3 million in product we didn't have in that area before, and then we picked up several million dollars of product which basically replaced the former offering in the large tonnage.

Okay. Would you say that your replacement business for the commercial air-conditioning units is higher than the newer constructions at the moment?

No, but because we were running probably a 60/40 ratio, but I would say we definitely have gone up in that relationship. We're probably in the mid 40s on replacement and the mid 50s on new construction. A lot of our business this year has been in the very small orders, what we'd call small orders, stuff -- a lot of it fairly -- quite a bit below $100,000. I kind of considered anything below $100,000 to be a very small order, and that's where the bulk of our business has been. Whereas in the past, a higher percentage of it was in, say, 500,000, $300,000 orders, something in that area. We haven't been getting the business in those large orders this year.

Excellent. Well, good job repurchasing shares and, as usual, we look for your new products to gain traction.

I think that they will, and as we get some of these launched and get some market identity, I think we'll do real well with them.

Fantastic. Thank you, Norm, very much.

Thank you, James.

The next question is from Mr. Cody Paulette. Go ahead, please.

Can you give us an idea -- I assume you're talking about a total of $6 million in capital expenditures this year. What's actually property and plant and what's actually equipment? And could you give us an idea of what next year may look like?

Yeah, sure can. Just a moment here. The buildings that we spent so far have -- has amounted to about $800,000 on our are building, and mainly computers in another category, we've spent a little over $100,000 in that, and all the rest of that $2.7 million that we spent was in machinery and equipment.

Okay.

So we've been -- we've been replacing older pieces of equipment as well as adding new things we haven't had in the past. Really getting our equipment in first-class condition.

Are you talking about $6 million total for the year, so what do you expect the next six months to come from --

It's going to be a repeat of the first six months, pretty much, it's going to be heavy on machinery and equipment, and light on computers and light on building.

Okay. And 2004?

2004 might reverse a little bit, because with the prospects which we have right now, we will probably go ahead with an addition for a sheet metal manufacturing facility at this location, and that'll probably cost us a couple million dollars. So we'll have a reasonable building expenditure in there. I don't look for anything other than that in a major amount, but there will be a few hundred thousand dollars of miscellaneous type building issues, I'm sure. And then on that will depend on how optimistic we are about going forward on the economy. If we are quite optimistic, we can spend money in a hurry on machinery, because we know what we want, and so it's not a matter of having to make those decisions, it's a matter of spending the money and deciding when it's wisely spent. So it can go, again, based upon the economy, anywhere from probably $5 million or $6 million worth of machinery to maybe twice that much if things really got booming.

Good. Thank you.

Thank you. The next question is from Mr. Brian Bears. Go ahead, please.

The question about your residential initiative. It seems to me like that's a -- pretty much a commodity market compared to the sort of differentiation you can achieve in your more expensive, larger units. Could you kind of explain your competitive positioning there and sort of how you see that evolving?

Well, we're not going to build any product with the present refrigerants, R-22 for the market. We're only going to build product for the refridge rant in the future, the green refrigerant, or how you want to describe it, which is R 4-TNA. So that will give us somewhat -- a little bit of traction, but the rest of the residential people are likewise moving in that direction, but they haven't honed their skills as much there as they have in the other area, so there are a few places where, because of the nature of this new refrigerant, primarily the fact that it's a much higher pressure refrigerant, and there are some places where we might have an opportunity to take advantage of the competitive situation there where our competitors don't have their situation as well in hand.

And then the way in which we're going to market the product, we won't be going through the traditional distribution system, and we'll be able to cut considerable cost out of the way we're going to take it to market. So the two things that we believe will give us an edge in the product is the -- some advances we're making in how we build the product and then the reduction in the distribution cost, plus there are a couple of things we're going to do that are not being done in the market today that we think will be warmly received by the residential market, and I'm not in a position that I want to announce them at this time.

Okay, great.

But we do have something more than what I've talked about.

And the -- do you think that the margins sort of ball parking -- I don't know, it's really early to tell -- but do you think the margins would be comparable to what you see in your other lines of business?

Well, we hope with the fact that we'll be able to cut money out of the distribution cost and one part of the manufacturing process which we're also going to do somewhat differently, we think we'll be able to keep the margins somewhat close to where we are. But recognize that our margins are quite -- are bottom line, I should say, our bottom line is quite different than what historically has been in our industry. We run about twice as high a bottom line return as our industry historically is doing, since we're running up and around 9 right now. So I would say it's going to be hard for us to pull it much above the 5% and 6% after tax, but we're committed to try and do that, just like we've done it on the commercial side.

Great. Thanks a lot. Keep up the good work.

Thank you.

Thank you. The next question is from Mr. Mark Robbins. Go ahead, please.

Norm, thank you. I guess I missed a little bit of the presentation. Would you be so kind as to help me better understand the residential rollout? What size units are you going to be manufacturing and selling, Norm?

Well, the residential predominantly runs from two tons through five tons, and that is what we're set to do. There are, like I mentioned, a few things that aren't being done in the industry that we're going to be doing.

And then, as I was trying to catch up, you mentioned that you were strong in medical and schoolhouse, and then I did miss the three categories that you were weak in. What are you strong in and what are you weak in again?

Well, retail -- retail is probably our strongest suit and retail is doing respectably well right now. Our second one that probably is our second strongest is the educational market, and it's doing respectably well. Medical is strong, and we do reasonably in that market. The weak markets that we have are manufacturing facilities and industrial buildings, and we, as a company, are not weak in that market, but the market is very weak. And the same thing in office buildings. We have a good product line for it, but the market just isn't there right now --

And, I'm sorry, what was that last category?

Office building.

Office building, okay.

Basically the office building market started falling apart with the high-tech and the dotcom debacle which began in the spring of 2000 and it's continued right on until today. And the plant and industrial construction began its downward trend about the same time, and it still remains in a bad state.

Okay. I think I've caught up. Thanks very much, Norm.

You're welcome.

Thank you. Our next question is from Mr. Eric Wenger. Go ahead.

Eric Wenger, Wenger Investment Management here. How are you?

Great. Congratulations on all the great new initiatives. I think I got my questions answered already.

The next question is from Mr. Greg Weaver. Please go ahead.

Hi, Norm. Won't this new residential product rollout allot more for the warranty, or do you wait to see how things perform?

Well, the way in which we're going to take it to market, we're incentivizing our market in trying to be selective on the dealers which we establish, and from the standpoint of difficulty of the product or the application it is not, it is quite a simple application, really, so it's really highly contingent upon our ability to work with competent installers, and we're putting a lot of emphasis on competent installers. So we're hopeful that we're not going to experience a lot of cost there. It won't be because of a bad product, if we have much, I don't think, it will be primarily because we've perhaps gotten in bed with somebody who we shouldn't have as an installer.

So the warranty issues that you referenced in regards to your new products that you were having last year is more of an issue with how they were installed as opposed to manufacturing defects?

No, in last year it was both, because there we were in some really high-tech products. We were doing things that, in some cases, nobody had done before; and in other cases, they were very challenging applications for what we're doing. I'll give you a for instance. The industry basically does not have -- the other people do not have a really viable 100% makeup air unit. We do have. But it's pretty sophisticated to make it work when you're trying to take 100% outside air and bring it to a controllable temperature that you want to introduce into the building, and we had some issues in that. We were very successful because there were a lot of people that wanted that application, but also it had a lot of potential for downside on it, and we did have some downside problems there.

Okay. And on the residential product, when is the actual production schedule to begin?

Well, we're in the testing mode at the present time. We've designed the product. We're doing our laboratory and about to begin on our field testing, and then we have to get ourselves organized from a marketing standpoint. So we're going to be able to start doing something right around the first of the year with sales. Some of that will be just a beginning kind of a foray because the real market that we're after, the replacement market, is more of a late spring and summer market, and we're trying to get ourselves ready for that, which basically begins in the March or April time frame.

Of next year. So have you slowed that down? My sense was that you were trying to pursue at least limited opportunities in the Southern market this year?

Well, we hoped to get a little bit of it, but it's not going to have a material effect on our P&L statement, because a lot of it will be trying to get ourselves established and work all the kinks out of our manufacturing and our marketing methodologists.

Okay. Do you have any dealers signed up at this point?

No, we do not.

On the retail front, are there any large bids where you are an incumbent or potential new player up for renewal?

Well, we have just landed one new one, which is Ikea, it's a furniture retailer out of Sweden, and they build very large buildings for furniture retail, and we have been given a contract to do that with them. However, it's not a large dollar volume, even though each store is very high cost. They're only going to build five to ten stores a year. That's about the only really significant one that we have recently gotten a commitment from. We're always working on others, but none of them are at this point such that I would want to comment on it.

Great. Thank you.

Thank you. Your next question is from Mr. Tony Bowes. Go ahead, please.

I wonder if you can refine your guidance for the second half a little bit. It seemed that during the first half, on a year over year basis, sales are roughly $3 million shy of what you did on a quarterly basis in '02. Do you expect that gap to narrow in the second half of '03?

Yes, I do. In fact, I expect to eliminate it. How much beyond that is still questionable, but it looks like we're getting back to where, if the second half -- if the orders continue to flow the way they are presently and the way it looks like they're going to flow, we should be back maybe positive year to year.

And when you look at this quarter, how much of the September quarter is actually done in the month of September?

We're into the pretty heavy months, all three months. I wouldn't say there's a significant difference historically and I don't see it happening right now. The month we're in right now will be one of our best months, and August and September will likewise be very similar to this month. So we're in our strongest three -- three of our strongest months out of the year will be in this quarter.

And is July actually a stronger -- and is July actually stronger than June?

Historically it's a little bit stronger, and I'd say that's primarily due to the educational market, which tends to award contracts in the late spring, award orders in the June time frame, and as I mentioned earlier, we had a tremendously good June, and want shipment by the beginning of school. And so you get in a crunch primarily in July and the first part of August on schools. Some of those will drag over. And then the rest of the building market likewise is pretty strong throughout this time of the year.

Has Wal-Mart made a decision regarding future business?

No, they -- as I've told you a couple years ago, they were talking about coming out and asking for a rebid on their business. That never materialized, as I mentioned then. Generally speaking, unless they have some major change they want to implement, they don't initiate that kind of a thing, and it only gets initiated when they have a desire for some kind of change or when their suppliers go to them and start talking price increases. And with the lack of inflation that's been out there, our competition, our competitor, and neither one apparently have gone to them pushing for a price increase, so they have not done, as they said a couple years ago, and gone out for a rebid. They are back in the point of talking about doing it this fall, and they have put out some preliminary specifications, and there are some significant changes which they're considering, and that's probably going to be the motivation that will cause it to happen, if it does happen, this fall.

Also, what's your capacity utilization?

It varies. On building per se, on our building, we're way, way down. We've got a major share of our building -- of one of our buildings is leased out for quite a large sum every month, and so we've got a lot of building utilization with the exception that the building that's leased out is basically really for assembly-type operation. I mentioned earlier we might build a building for sheet metal. It's actually more advisable for us to keep our tenant in the building and build another building because the sheet metal manufacturing is so specific a kind of building that to reuse the existing building that we have leased out would not make good sense for doing that. That's why we might build while we're still leasing out. I'm giving you a long run-around here, but the net result is we're probably only at 20% utilization of our buildings right now totally.

And what about on an equipment basis?

Equipment basis, we're probably in the 80% area. So as we go forward, that's why I mentioned that we are spending money on machinery now and would be spending money next year on machinery, because if we start getting significant growth, we will need more machinery to accomplish it.

And lastly, do you have a breakout by percentage of revenue for each market?

In what respect do you mean? Retail and those --

Precisely.

No, we do not.

Okay. Thank you.

Mm-hmm.

You have no further questions at this time. I apologize. We do have one more question from Mr. Mark Robbins. Go ahead, please.

Norm, just a couple more questions regarding the residential business, the new residential units. You said that that was going to be high pressure or higher pressure refrigerant. In higher pressure usually means the need for better tolerances and tighter manufacturing capabilities. Doesn't that lead you to believe that you may have a higher warranty problem?

Well, we have been working with that new refrigerant that we will be using for eight years now, and we have a few thousand tons of it out there running on air-conditioning with commercial units, and we've had a very, very low warranty cost on it.

So while it has the potential for having problems for the reasons you've talked about, we think we've addressed it very well, and we have a fair amount of history now that would attribute that to us, that we are not going to have a lot of problems with it. And we are doing some things different than the industry is in it, I think. From what we've been able to learn, we will be doing a few things different that I don't want to talk about right now, but I think that's part of the reason that our success ratio has been very high so far.

With a higher pressure, that implies a more efficient unit. Does that also mean that your air-conditioning units could be sold on an efficiency and energy savings standpoint over and above some of the other units that are available?

Yes, it certainly does. The pressure runs roughly 50 to 60% higher than the R-22 that's presently a popular refrigerant, and the volume of the refrigerant that moves goes down by a corresponding amount, down by 50 or 60%, so it changes a whole lot of the parameters of the design of the unit, and it is -- unlike most of the refrigerants that have been used to replace environmentally unfriendly refrigerants, they've all had negatives. Like, there's an efficiency that attaches itself to all refrigerants, and there are many different refrigerants, and all of them that they've replaced to date were more efficient refrigerants than the new refrigerant. That is not true with R-410 and R-22. It is a more efficient refrigerant. So it has a positive aspect in that respect that hasn't been in there and some of the other trades that have been done so far.

Does this indicate that the new units that you'll be shipping also have heat pump capabilities rather than just air-conditioning capabilities, heating abilities rather than just air-conditioning?

They definitely will.

Okay. I guess I missed this part of the discussion, so I do apologize to my colleagues who are listening in. What was the thought process that led you to go into the residential business, Norm? I mean, as we've discussed in the past, that was almost taboo.

That is correct. If I had to enter strictly on the market as it has existed in the past, it's a very competitive commodity-type market, and there are some things which I've been alluding to but not talking about that have come up that we have learned in our commercial business that will give us an edge and then the way in which we've finally decided to take it into the market as far as our distribution methodology, we're going to pick up some money there, and so now it has an attractiveness that it didn't have before.

Okay.

Because there have been things that have occurred which may have changed the picture, so to speak.

And then, I apologize, 'cause I asked you this just not too long ago, but we might as well get it down on the record, any thought on a change in dividend policy?

Obviously, with the change in the laws, we are looking at that as to determine the practicality of it. In the past, it was not a smart move because you made people pay on a regular income basis the money that they got. Well, they've eliminated that. Now it works just like capital gains. So that part of it, the negative part to the stockholders, that portion is gone. The only other part that we have to take a look at and decide is what image we want to project, what our stockholder base is looking for, and then the cost of distribution of a dividend if we were to choose to do that.

Okay. Thank you very much, and, you know, good luck on the latter half of the year.

Thank you.

Thank you. There are no further questions.

All right. No further questions. I'd like to thank everybody for attending our get-together today. I hope that I've answered all the questions you have. If not, I'm always available to you to get back to me, so feel free to contact me if you do have something else you'd like to discuss. Without anything else ...

We just look forward to seeing you at our next conference call in October where we'll discuss the third quarter results and review the remaining part of the year.

And thank you for attending.

This concludes the AAON, Inc. second quarter earnings call. Thank you for your participation.