Aaon Inc (AAON) 2003 Q4 法說會逐字稿

Welcome to the AAON Inc. fourth-quarter and full-year December 31, 2003 earnings conference call. At this time, all lines are in a listen-only mode. There will be an opportunity to ask questions at the end of today's conference and instructions for asking questions will be given at that time. I thank you for your attention. Now, I'd like to turn the conference over to your host, Mr. Norm Asbjornson.

Thank you. Good afternoon to all who are on the phone call. I would like into our Chief Financial Officer, Kathy Sheffield, who is here with me today.

Good afternoon, ladies and gentlemen. Welcome.

Before beginning, I would like to read the safe Harbor statement, a forward-looking disclaimer. 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. As such, it is subject to the occurrence of many events outside of 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 Commission filings, including the annual report on Form 10-K and the quarterly report on Form 10-Q.

I believe now we will go forward, discuss the fourth-quarter results and the full year of 2003.

As was noted in our release this morning, our sales declined approximately 4 percent to 148.9 million in 2003, compared to 155.1 million in 2002. The net income declined 3 percent to 4.2 million, compared to 4.6 million in 2002.

Sales in the fourth quarter, as was noted, increased to 37.8 million from 37.2 million, and net income increased to 3.7 million compared to 3.1 million a year ago. The majority of the difference being the income tax provision in the fourth quarter of 2003 was 700,000 less than a year ago.

Just going down through our statement of operations, if you look down through there, you will see that it was very, very much similar all the way down to the income before taxes line, when we compared 2003 to 2002. There was only a $73,000 difference at that level and then we found the income tax provision changed rather significantly.

So, what are the reasons for the income tax provision changing? The income tax issue primarily results to from two issues. Almost half of the difference in the income tax provision for the year is due to the fact that we had increased depreciation of almost half of that difference. The other major portion was, of course, because of our reduction in sales volumes. All other issues were fairly minor and not worthy of going into individually.

The other issues that stands out, in looking through the SG&A portion of the year, or the quarter really, you'll see that we had almost 1,400,000 difference between 2002 and 2003 and the three months ended at the end of the year. That comes down to a depreciation differential of $882,500, an increase in property insurance of 78,000, an increase for more timing reasons than anything else of $350,000 in state and local taxes, and our Board of Directors hired an outside consulting firm to review our salary structure in the Company this past year. It was determined that all of the salaries were pretty much in line except for the top-level management, myself and some seven other people. Those salaries were adjusted at the beginning of the quarter, resulting in $343,000 more cost over the three months.

We had a national sales meeting to bring our sales force up-to-date on all the numerous changes due to the new products which we were introducing, and that was put into the fourth quarter at a cost of $288,504. We became more aggressive in our collection efforts on our receivables and our expenses in that area were $85,000 more. Including (indiscernible) to some degree and other costs, our professional (indiscernible) for legal and accounting fees were up $66,200, resulting in the difference between a year ago and this year.

That pretty much brings all the discussion points up-to-date, which obviously if we hadn't had these SG&A expenses, our standard margin, or our gross margin would have been fairly increased in the fourth quarter of this year.

Now, the reductions in sales that we experienced were for numerous reasons. One of the reasons, obviously, is the economy has still had troubles and according to industry statistics, we had a down quarter, or a down year, in available business. That available business varied between a number of different products.

If we look at the industry as a whole as to where the down business was, in commercial, which includes retail, according to industry statistics, that was down 1.2 percent. Another one of our major markets is the office building market, and that was down 11.1 percent. Educational structures, which is another major thing for us, was up 1.2 percent, and manufacturing, our fourth major category, was down 17.3 percent.

I did not try and do a weighted average, only used the statement of the industry as a whole for nonresidential construction, which according to these statistics, including some other buildings that we are not too active in, was down a little over 2 percent. So, that was part of our problem.

What also occurred during the time is we lost a significant amount of business from Target stores this past year compared to the previous year. We made up the majority of it in business to other accounts, namely a lot of the other ones; the educational market did well for us, and then the other markets -- which were down but which we improved our position in those markets. So, that was the result of changing the mix of our product and also not growing the Company as we have in past years.

If we look at the balance sheet for the end of the year, we will see that our balance sheet has gotten healthier and looks very good; it's in a very strong position. The first notable thing is we have no debt of significance, only our normal month-to-month operating kind of cost. We have over $10 million in cash and cash equivalents. We have no long-term debt, as I spoke earlier, and it's only a short-term debt that we're having right now, money on a month-to-date basis when we're balancing books.

Looking down through our current assets has increased (sic) considerably over the year, primarily in area of cash and Accounts Receivable is virtually flat from year-to-year. The inventories, however, are up over $5 million from a year ago. That is primarily the result of a change which we are undergoing right now of some of our customers are starting to go to the new green refrigerant, which is a refrigerant called R-410 (ph), as opposed to the old refrigerant, which was R-22. In that change, we have to build a different coil because the new refrigerant has a higher operating pressure and therefore requires different construction on the coil. We were having some difficulty getting all of our coils built at the end of last year and we have several jobs requiring the coils. All the other componentry came in but the coils weren't coming in, so we were a little late in shipping some product -- also helped, obviously, lowering our total sales by a fairly significant amount. Those issues have been resolved and at the present time, all that shipment is behind us and we are running along well in the building of R-410 refrigerant equipment. So, the conversion to the green refrigerant is on at AAON and is accelerating as we speak, and we are, I think, through the majority of our major hurdles of ramping up the volume in that.

Going on down through that, (indiscernible) is our prepaid expenses are up the roughly $2 million, and that is because we have prepaid on some machinery for delivery this year. You have to make a down payment on some of that expensive machinery, and that represents a down payment on approximately 7 or $8 million worth of equipment.

The final issue is deferred income tax, which went down slightly.

Looking down at our plant, property and equipment end of it, nothing of major significance there. We have a few more buildings; we have some more machinery and the furniture and fixtures is primarily computers -- have increased over the years. So, you're seeing about little over $6 million in CapEx increase there, and you're seeing, of course, more depreciation. So, our total net on that is a little bit over $2 million increase on property, plant and equipment, resulting in our total assets for the first time ever being over the $100 million mark at 102 million.

Our current liabilities are up slightly. Revolver is up a little bit; our Accounts Payable is up a little bit. Most all of this is related to the increase in inventory, and our accrued liabilities are down slightly, thereby affecting a little less than a $4 million increase in our current liabilities.

Deferred tax is up a little bit, and when we get down to the bottom line, you'll see that our stockholders' equity has gone up approximately 5 million-plus, and that is after having bought back considerable stock. As noted in our release, we are on an ongoing program of buying back stock. In the fall of 2002, we announced that we were going to buy back 10 percent of our stock, which is approximately 1.3 million shares of stock. During the year, 2002 and 2003, we bought back 812,964 shares for $13,911,000. Since then, we have bought back some additional stock, another roughly 100,000 shares of stock. So, we have about 1,300,000 shares that we announced we were going to buy back in the fall of 2002. We have bought back 913,964 shares of stock at a cost of $16,086,712. So, even though we spent approximately $9,928,464 of that during 2003, we still managed to increase our stockholders' equity by the previously mentioned $5 million-plus.

So, at the present time, looking with our cash flow analysis, you'll see that we have less positive cash flow in 2003 than we did in 2002 by approximately $6 million, or $5 million. If we look up at that, a little bit of it is in net income; some of it is -- over $.5 million of it is due to increased depreciation, which I mentioned before. That, of course, lowers our tax burden.

Accounts Receivable -- nothing else of significance until we get down to deferred taxes is up a little bit and our Accounts Receivables have gone down a little, as have prepaid expenses and Accounts Receivable.

Accrued liabilities has changed a little bit there by lowering our net operating activities.

On the investing side, we spent less money this year, which brings us to the question of what our CapEx is for the year 2004. We are speeding up that because we do believe the economy is speeding up. Therefore, we are preparing for not just this coming year's growth but we're getting prepared for the following year's growth, and it takes quite a while to do that, and so we're going to spending approximately 10 to $11 million in CapEx in 2004.

If we look down at our financing activities, you'll see that most of it is from repurchases of stock is (sic) most of the differential between this year and last year. Our cash position has increased slightly but not greatly.

Okay, in all of this change that we are doing, we have produced a new product this year, approximately $33 million of our sales in new products. That has lent itself to some production start-up problems of some new (indiscernible) equipment and has had some negative effect on our bottom line. I had mentioned earlier also that going into the (indiscernible) 4-10 (ph) has given us some difficulty -- not a great deal, but some. We are probably going to see a little bit of it carrying over into the first quarter, but pretty negligible at this point. Largely, we've got the startup of the new products behind us; the learning curve is probably 80 percent behind us.

Looking also down the road into what might we expect, I mentioned that our backlog is at a very high rate. Our backlog is up approximately $10 million higher than it was a year ago at this time, and it's just in the hard $30 million area, close to $40 million, so we're sitting on a good backlog position; we're sitting in what we believe to be an expanding economy, and we are sitting with a lot of new products with a lot of positive sales improvements potentials in these new products.

So, it's easy for me to sit here and be optimistic, but I also have been around long enough to recognize that at all times, the economy doesn't go like you think it should and sometimes new products aren't as well-received as we expect them to be. So, we are looking at somewhat of a mixed bag but basically, if you believe, as I do, that the economy is on the upswing and that people are going to buy the new products, we should be pretty optimistic, going forward.

The other major issues are at what risk are we with any of our major customers? We only really have one that's really out there that needs to be talked about, which would be Wal-Mart. Wal-Mart's business with us last year was up; their order input rate with us was up. They are in the process of getting ready to bid for the next couple of years and have told us that that will be coming -- that that will be happening in the near-term. We know of no reason why we should anticipate getting any reduction of any significance. Likewise, we don't really see the likelihood, at this point in time, from what we know, that we're going to get a great deal of increase. So it appears to us likely, as far as we can see, to have maybe some modest adjustment up or down, but nothing of major importance.

They have not -- since we have not bid it yet, they have not said how long this next bid is good for and we really won't know until they put a bid for them in our hands.

The other issue which I had mentioned earlier is R-410 refrigerant. The new bid -- we have been asked by Wal-Mart to change over to R-410, and we have also been doing business with a furniture retailer called IKEA, who has gone 100 percent to R-410 and some of our other customers are likewise going to R-410.

Since we are prepared and have gotten through the beginning learning curve of going to R-410, we think this is a positive because we don't believe most of the industry is nearly as far advanced in making the conversion to a green refrigerant as what we are -- green meaning to me environmentally safe or environmentally-friendly refrigerant. We believe we are on the leading edge of that, compared to all of our competition, so if the industry, if the customers' demand changes to that quickly, it should be beneficial to us.

On some of the innovation which we are doing that has significance, the thing that I think we should emphasize here is, in addition to the R-410, we have devised methodologies several ways to control the humidity. Even when cooling is not required, we can make the unit become a dehumidifing machine, even when cooling is not required. In fact, it can actually dehumidify and do a modest amount of heat simultaneously.

So, with mold becoming an increasing issue to the point that the insurance companies are eliminating it from their policies and lawsuits and other conflicts over mold are increasing, we think that our ability to control humidity, which is a requirement for mold to grow, is very positive. We look on that as being something which is going to continue to become more beneficial to us. We are already selling a lot of equipment with this ability to control humidity, and we anticipate that is going to continue to increase as a percentage of our business and increase our ability to get orders.

So those are two large issues that we think are significant at this time. We have been talking and are on the verge and will be introducing a residential replacement condensing unit. That does not mean we are into the residential business across the board; we do not have furnaces (indiscernible) handling devices, but over half of the residential business is in the replacement market and that part of the market we're going to be prepared to deal with. The first half of this year, we will be starting in that market. Because we are a newcomer and because we are just getting started and we will have our normal start-up problems, it's not going to have probably a significant impact on our performance in 2004 but definitely by 2005, it should be a big player for us volume-wise on that product.

As I mentioned earlier, we've redone a lot of products. As a matter-of-fact, everything has from 2 tons -- all the rooftop units have had some degree of change done to them, changing their model number all the way from two tons up through 230 tons. I know on all units 16 tons and larger, it's been a ground-up total revision. The ones 15 tons and down have been less dramatic, they've been minor revisions, but above that, it's a major revision -- ground-up starting with a new, clean sheet of paper and redesigning the product line.

So, the bulk of our sizes have been redone. Now, the major part of the market is in the smaller sizes, and a major part of our sales are there. But as I mentioned before, we've done about 32, $33 million on our new products already last year, and this year, of course, including across the spectrum, the vast majority of our sales will be in new products. A major portion of that will be in totally new products, so we are kind of cutting-edge in all of our product lines; we don't have a lot of old products that were designed several years ago that we are relying for on our business. they are all new products that we are relying on for our business. It's a very positive thing in that we are state-of-the-art pretty much across the line on our product line.

Towards that end and what I mentioned earlier about our CapEx, what we would be spending money on, we have decided that even though we are leasing out 360,000 square feet of building here in Tulsa to an outside company, it made more sense to us to build a new building for our sheet metal department because so much of the sheet metal department is reliant upon doing special things in the ground. To take our old building and tear up all the concrete in order to do that and throw our tenant out, it makes really more financial sense to build another section on the building for the sheet metal. Then, if we grow into it at some point in the future, that other building will make an ideal assembly area. So, we're building about a 105,000 square foot plant that we have started clearing the ground; we haven't really gone up really gone up in the air with any building yet. We're still in the groundwork stage but by midsummer, we should have that building in and operating.

As mentioned before, we have a deposit in our prepaid on some machinery, the majority of which will go inside that new building. All of that machinery will be totally automated. Therefore, it will improve our efficiency of manufacturing sheet metal and increase the efficiency of our total operation.

I believe, at that point, I've pretty well covered those issues. The other question probably in your minds is, what is our percentage of national account business to our rent business? As you who have maybe followed us for many years remember, when we started out some 15 years ago, over 90 percent of our business was basically with a couple of accounts -- national accounts. So, we've gone from over 90 percent down to, at the present time, approximately 20 percent with the national accounts and 80 percent with all kinds of other customers. So, our customer base has expanded very considerably and the reliance on any single customer has dramatically reduced itself. Therefore, the Company, from a customer standpoint, is in the best shape it's ever been in.

That pretty well wraps up my part of this discussion. I'd like to open it now to questions and answers.

(OPERATOR INSTRUCTIONS). Mr. Mark Robbins.

Good afternoon there, Norm. You were discussing how you had done quite a bit of redesign and rebuild of your larger systems and some rebuilding and design work on your smaller systems. I guess the question I'd like answered regarding this is, given current pricing, would we expect to see a little better margins from this redesign, or is it just to maintain margins by cutting costs of componentry and so forth?

Long-range, it's going to improve our margins. What has happened, the bigger tonnage units tend to be more for office buildings, manufacturing and large retail. That's the weakest part of the marketplace the past year. And so, we didn't gain as much of it out this past year as one would have hoped we would because we really introduced products that were in a weak part of the market. Of course, the weak part of the market probably has the best potential, as the economy improves, to rebound more strongly.

Lets go to the next one, and that was, when you were explaining what your residential units were going to include, you said condensers. Help a layman out here. To me, that means the coil or heat exchanger in your furnace that you would use for conditioning and the coil and system that might be outside of your house to remove heat from your house -- you know, that kind of a thing. Is that correct, or am I --?

That's a correct statement.

So it's both ends of that system?

Yes. We have the coil that would go in with your furnace or your air-handling device would be included (sic) in our offering for sale, as well as the box that sits outside the coil and compressor and what you might call the air conditioner.

Don't you really need just reversing valves and then you could have a heat pump?

We will have a heat pump.

Okay, so the condenser is a heat pump then?

It can be either a cooling only or a heat pump.

I'm with you, okay. You were going through the SG&A and some of the items that added expense this year. You've got to forgive me. I only caught a few things. I got the -- you had the professional come in and re-gauge some of the top people's salaries; you had a national sales meeting; you had a -- collections of Accounts Receivable were up and then you had legal costs were up. There were a couple of other things that were up in SG&A that I didn't catch that made that million dollar figure.

State and local taxes were up $350,000, and that was primarily a timing issue more than an increase in taxes, although there was some of that there. Property insurance went up 78,000. Depreciation -- and this is primarily because we bought more stuff -- was up 182,500.

Thank you.

Brian Behrs (ph).

Hi, Norm. What portion of total sales were Wal-Mart?

They were just under 19 percent.

Just under 19 percent for the year?

Yes.

Sort of switching gears, back to the $5 million increase in inventory that I think you said had been sort of worked through the system, has that been totally worked through the system to where inventories currently are kind of back to what you would call normal?

Not totally but quite a bit of it because, as I explained, it just happened to catch us right at the end of the year when we got a lot of orders for the new R-410 equipment. We couldn't produce the coils quite as fast as we wanted to because we were on a learning curve of ramping up the coil production. So, we ended up having the compressors received, the motors received, all the other things received that we had ordered from outside vendors, but our coils that we manufactured ourselves weren't ready, so we didn't build the units and ship everything out the door, which impacted our sales and impacted our inventory.

Thanks. The last question is that I know, on the last call, you had mentioned revisiting the issue of dividends with the Board. With the ramp-up in CapEx, has there been any rescinding of that -- your propensity to pay a dividend?

We reviewed the idea of paying dividends and the cost of writing checks and distributing dividend checks. It appeared to us, after we got done doing a fairly in-depth analysis of it, that the better way to redistribute the money to the shareholders and also allow them to choose as to whether to take it in more equity or in cash is to continue the stock buyback program. So, that's what we've elected to do as opposed to a cash dividend.

Sounds great. Thanks.

Bob Sullivan (ph).

I was wondering if you could go back to the new machines and the reworking of what you're doing with your product line and maybe address a little bit -- there's been some environmental issues and also even terrorist issues out there that we've had to deal with. If you could maybe walk through some of the more exciting things on the new product. If I am a buyer, what would kind of excite me about getting into some of the new products?

Then if you could also talk a little bit about the industry in terms of where it sits at in the cycle. It looks like the shipments are probably at a trough. Outside of sort of nonresidential construction, what are some of the other data points that we might want to take a look at to see shipments pick up?

Well, you know, just to take an optimist (sic), one of the things which I use as a gauge for what's likely to happen is a outside predictor of what they think is going to happen. There's one which we are using that was based upon Reed Business information. If we were to believe what their optimism says as far as the nonresidential part of the market where they said we were down 2 percent this year in 2003 -- their estimation is the market will be up 6.3 percent in 2004 and it will be up 12.5 percent more in 2005, so they are awfully optimistic.

Now, other people won't be quite that optimistic, but coming off from three to four years of negative and down things, it's quite a dramatic turnaround. That is anticipated by a lot of forecasters. So that's on the very positive scale. We are sitting here with all new equipment now.

Back to the earlier part of your question, the R-410 issue I think is a major issue, from an environmental standpoint. I think there's a lot of people, a lot of customers are going to get on that rather quickly. The fact that we are already prepared and in business on it I think is going to be to our benefit.

Some of the other things that we did to the product -- we increased the insulation value of the wall, which means less heat loss through the (inaudible) cabinet. We improved the cabineting considerably so that their cabinets are much, much better built than they were in our previous product that we obsoleted.

One very, very dramatic thing that we have done that I think is going to be well received as people realize its virtue is we've gone from having a main air-moving device, a main air blower, fan, or whatever you want to call it, which has been driven by a D-belt (ph) driven-motor. We eliminated the D-belt drive and we went direct drive, and we used a backwardly-inclined (indiscernible) fan wheel, both of which lessen the amount of energy; there's no energy loss in the drive and in the bearings because there are none. The noise level has gone down considerably, so we've improved that. Because of the way we've built the thing, our air-moving costs in general went down, so there's a dramatic reduction in the brake horsepower to move a given amount of air. Of course, because we have no V-belt drives, there's no maintenance. We have no bearings on the shafts; we have no shafts. There's the elimination of the maintenance costs. These are fundamental, dramatic, major changes that, as customers become more aware of them and get on board with them, I think are going to be extraordinarily well received. To our knowledge, we are the only ones doing it and that is something which we've included in all of our products -- 26 tons and larger, so 26 tons through 230 tons are all what I described there.

That sounds like a terrific incentive. I'm a buyer. It sounds like, in general, it lowers my cost to produce what I need to produce. Do you also -- there's a lot of systems out there that -- software/hardware that folks can buy to actually monitor buildings and things like that. Do you hook into those standards? There's a couple of standards out there. Do you build your product to those so that they can kind of plug and play into these different systems?

Yes. Basically, you're bigger ones are systems called BackMit (ph) and one called Lawn (ph). Our systems are compatible with both of those. I didn't get into that to a great deal but we have made very major steps forward in our control systems so that they will play into all of those things. You can literally sit and analyze our unit. We have been able to do this for a long time is why I didn't beat on it too much -- because we have been able to take any of the control companies that are out there and integrate their controls into our unit for the customer so that they can take advantage of whoever is in the forefront in the controls industry, whatever they've come out with to allow them to better monitor their equipment or to run it more energy efficiently. We've always been in the forefront of that and we've made some major progress in that area this past year as well.

Thank you. I will go back in the queue.

Stephen Bramlette (ph). Your line is live.

It's Steve Bramlette (ph) from Medianomics (ph). One question -- I'm curious if you can speak a little bit towards, you know, when you have an increase cost of power generally in the country, or an increase in the intensity of a summer, let's say an increase in the number of cooling-degree days, do you see those phenomena driving your commercial buyers into the market to upgrade their units and increase their efficiency?

I don't think there's any doubt. The customers I think are lagging what is taking place in many areas, one of them being the power-generation issue. One of the major things in the power-generation issue has to do with peak demand at any one given time on a given system in some city. The effort of the power-generation people to reduce that demand to more or less level the (indiscernible) out a little bit. Towards that end, the control issue that we just spoke about is going to play a big part on that so that as the demand goes up, the power company will offer -- I think as time goes on -- will offer large users certain benefits if they don't exceed a certain amount in the peak-demand time of the year. In order to do that, they are going to have to get much smarter in how they run their equipment so that they still get acceptable air-conditioning but don't exceed that demand charge or that demand amount.

All of these things are playing into it, as well as this refrigerant issue. To just give you a quick idea on that, most people don't think about a refrigerant as having an energy factor to it, but it does. Different refrigerants have different energy efficiencies. This new R-410 refrigerant, which is mandated by Montreal protocol and by our federal laws to become a green refrigerant of some sort (inaudible) R-410 has more or less risen to the top of the list of what the chemical companies and everybody else is thinking is the future to replace R-22.

There was quite a study done by governmental agencies and everything on the efficiency of that refrigerant because it is slightly more efficient than the more detrimental refrigerant which it is replacing. So I think that's going to precipitate the movement towards the environmentally friendly refrigerant, because it is also more energy efficient. There are analyses that I read about -- did a seasonal analysis for how much better is it compared to the old refrigerant on a total year basis. Regardless, even though it's more efficient at lower temperatures than it is at higher temperatures, on a seasonal basis, no matter where you are in the United States, you will get more efficiency out of the new refrigerant.

So, all of those things are going to come to play as people become aware of them and start reflecting them in their buying habits.

Thank you very much, Norm.

Tommy Pollack (ph).

I just wanted an idea if you could give us, on these extra SG&A, how much of that is going to be recurring in each quarter, going forward, and how much are really just one-time, fourth-quarter charges?

Towards that end, I think I'll let my CFO speak to that. She's probably a little bit more knowledgeable than I, so I will Kathy Sheffield answer that question.

We will see depreciation continue at that level. In the first and second quarter, we will see the property insurance because that's just how the payments are going to lay out. The salaries will stay the same. We anticipate the advertising -- we're not sure about that. That could stay the same; that could lower or it could increase. We just don't know because we do that when the need arises.

The collection and professional expenses and fees will probably remain approximately the same.

Okay, legal and accounting -- I guess that would just be a one-time?

Well, that it's possible that it's one-time but we can also see, with some things on the horizon, that there will be continued professional fees that we will incur.

You talked about a national sales meeting of almost 300,000. Is that to your advertising what you're talking about, or is that different? The.

That's correct; it's the rep meeting.

We generally will have one of those approximately, not always every year, and it will fall in some quarter and it's no consistency, based upon when we think we've got enough things that we need to make a communication to our rep force. That amount of money is likely to happen this year. In all probability, like last year, if it does happen this year, it will probably be in the fourth quarter.

What about the timing on the state and local taxes, which was a big chunk also?

We will probably see that -- a little bit of that each quarter, but not that amount.

Okay, thank you.

Chris Kodowitz (ph).

Hi, gentlemen. A question for you on the tax rate -- do you guys see that going back to the levels that you've seen it at the past?

I'll let Kathy answer that.

Yes, we do.

Okay. You mentioned that Wal-Mart is up to about 19 percent of your sales. Is the Target thing pretty much behind you, or are you going to continue to see some new work from them?

We have seven people from Target in our shop today talking with -- (Multiple Speakers) -- this meeting we're having today with them might have some influence. I don't know. They haven't stated. They wanted to come down and talk with us.

So basically, we lost the business that we lost because of price, and I don't know whether the competitor who has it is happy with the price level they have it at, or whether they are happy with the performance of that competitor -- I don't know.

Okay. You talked a little bit about share buybacks during your discussion. Do you continue to see some more share buybacks this year?

Definitely. We have suspended them as of about a week ago and up until then, we had bought back about 100,000 shares this year. That's this year. We are out of the market for another 48 hours and then we will be back in the market.

Okay. I know, with a lot of CapEx this year, I didn't know if you would continue to do that.

I think we can handle the CapEx and the share buyback. I think we will finish off the 1.3 million sometime this year and we will do the CapEx as well. As I explained earlier, we believe that the share buyback is a form of a dividend to our stockholders.

It looks like you guys had a pretty big drop in your diluted share base from the third quarter to the fourth.

I'll let Kathy deal with that.

I guess I was just wondering if there was an explanation. Is that anti-dilutive shares being pulled out for this quarter? What is that?

Yes. It is affected by the diluted shares, yes.

Is that something that's permanently gone or just temporarily gone?

Part of it is temporarily gone and part of it permanently gone.

Okay. I going to assume that options?

That's correct.

Are you guys seeing an increase in material costs in leadtimes for any of the raw materials that you guys use? I've talked to some other people in the industry and heat-transfer in general, not to specifically HVAC. They've been complaining about like (indiscernible) materials, which you guys may not use, but different materials are really going out with more demand. You may not see it out of China, but I know some of these other companies are complaining about that -- (multiple speakers).

What we're seeing is the basic commodities, copper, steel and aluminum, are all going up and in some cases, fairly significantly. What is not happening, because of the competition situation, is that the processed components' price increase has not started happening very much. In fact, there's still some downside in that. So, the manufacturers are being squeezed between raw material costs and what they can sell their product for. So, our net cost is not getting hurt so badly but to the extent that we buy the copper or the steel or the aluminum to all by itself, which we do a lot of, yes, we are seeing a definite cost increase.

Okay.

But like I said, from things we buy from somebody that takes those raw materials and puts them into a product, we're not seeing much cost increase.

Yes, it's a little surprising but good deal if you can get it! How about leadtimes? Is that a problem? Are you guys finding that everything you need you can get pretty much when you need it?

Leadtime is not a problem right now. That's probably why price is not so much of a problem, because there's plenty of material out there.

You were talking about the R-410 being more efficient. Is that just inherent in the fluid, or is that situation where do you run that at higher pressures or do different things with it?

No. If you take an identical system, which is what this governmental study did, and ran the exact same system from the standpoint of componentry, it is a more efficient refrigerant. The lower the temperature -- in other words, at 80 degrees outside temperature, it is more efficient -- a greater percentage efficiency there than it is at, say, 90 or 100. Somewhere up around 100, it goes the other way and the old refrigerant is more efficient. But if you take a yearly usage factor, because you don't have too many days of real high temperature, and you run it across the entire spectrum of the operating (indiscernible) envelope, you'll find that it's a fair amount more efficient in even Phoenix, Arizona, for instance, than is the older refrigerant.

As far as the product redesign goes, are you designing those (indiscernible) at different pressure levels than the previous units that you designed? Is that part of it?

Yes, very differently because this new refrigerant operates about 60 percent higher pressure. In other words, on the suction side, in the cooling coil, you're used to look at about 80 pounds. Now, you're looking at about 130 pounds. On the condensing side, you were looking at the 200 and some into the 300s. Now, you're looking at 300s into the 500s. So, you definitely have a set of design parameters on your refrigeration circuit.

That makes sense. Part of the reason for the question obviously is the R-410 helps everybody, as opposed to maybe your specific design being an advantage for you.

Yes. Any manufacturer is going to realize the same thing. The only we advantage we might have is if we have done our work and spent our money and don't our learning before they have. That's where we believe we are ahead of a lot of the other people at this point.

Thanks a lot, folks!

Greg Weaver (ph).

Norm, could you quantify the lost revenue or push-out revenue from Q4 due to the coils?

It's probably somewhere in about the 3 million, 4 million maybe.

Okay, and your backlog -- that number that you gave, the high 30s number, was that as of the end of the year, or is that today?

That is both. It hasn't gone down. In fact, it's probably about the same as it was. It was in the high 30s at the end of the year and it's still in the high 30s.

Okay, so that's up again sequentially, right?

Approximately 10 million, compared to, say, the same time frame a year ago.

Right? I'm saying since the prior quarter though, it's up sequentially, like 3 million?

Since you mean like the third quarter?

Yes.

Yes, that's correct.

So in light of the revenue push-forward here, as well as your increasing backlog, is it safe to assume that your revenue should be up sequentially?

Well, that's what we believe is going to occur, yes! We think we are in a growth mode, but we are a little cautious because there still seems to be quite a little bit of question mark about is this growth in the economy really for real or not. Beyond that, we think that the product is more attractive to our customers, so that's going to help us. So, we are guardedly optimistic I guess I would say.

On the gross margin front, you had real nice gross margins, especially with the coil situation. Was there scrap involved with the coil, or was it just you couldn't get tubing or what?

No. What it was was we basically changed the design of our coils to accommodate this higher pressure. By that I mean we are using a smaller tube on our coils, so we bought all new equipment to manufacture those new coils, and we had a learning curve in operating the pieces of equipment. A learning curve means that if you don't run it just right, it does what's called a crash; it's kind of like on your computer, everything goes down the tube on you and you have to then repair the machine and fix it back, whatever it did damage to itself when you had that occur. So far, most all of it you could be attributed to operator error (sic). In other words we don't know what we're doing as well as we should, and we are getting better. We are making fewer mistakes and so now we are over that hurdle pretty well.

So that was more of a direct material hit than anything else? (multiple speakers).

We wrecked a lot of material; we wrecked some parts of the machinery and we had to buy parts, but it's a one-time kind of thing; it's not an ongoing kind of thing. Once we learn what we're doing and stop doing foolish things, we won't do that to it.

With that in mind then, you said you have licked most of these problems now, right, in the current quarter?

That's correct.

Is it safe to assume that your gross margins should be sustainable then?

Yes. As far as I can see, that would be a reasonable expectation.

The last question for me was on the R-410. What percentage of your units were shipped with that? Do you have a sense of how much of your backlog is at R-410?

No. On the 410, this problem that I'm describing cuts across quick, because what we've done is where we've designed a coil for R-410, in some instances -- not across the board but in some instances -- in order to minimize our inventory and to minimize the number of (indiscernible) different coils we are using, we have started using that same coil in R-22 systems. Therefore, all of the problems we had with coils didn't all relate directly to R-410 systems; it related somewhat also to R-22 systems.

Our R-410 sales right now are still a pretty small percentage. If I had to guess, I would guess down in the 5 percent area. I would guess that, by this time next year, at the rate it's going, it's going to be probably something less than 50 percent but I would guess it might be 30 or 40 percent, the way it sounds like from the customers. I think there's a lot of demand to make the switch but a lot of people are just waiting for the other guy to do it first.

It appears there are no further questions at this time.

Okay. Well, thank you very much for listening to us. Like I said earlier, there is a lot of unanswered questions (sic) about how well will do this year, but we personally in here are pretty optimistic that we are back into a growth mode. So, thank you for the time. We will talk to you at the end of the next quarter.

This includes today's conference call. Thank you for your participation.