Aaon Inc (AAON) 2004 Q2 法說會逐字稿

Thank you for holding, ladies and gentlemen, and welcome to the AAON conference call. (Operator instructions) I thank you for your attention and now I will turn the conference over to your host, the CEO of the company, Mr. Norm Asbjornson. Go ahead, please.

Good afternoon. I'd like to introduce Kathy Sheffield, our CFO who is here with me.

Good afternoon. Welcome to our conference call.

Prior to getting started I \would like to read our safe harbor statement.

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 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 would like now to review our second quarter results. As you note, the revenue is an all-time high, but a very disappointing bottom line. Going down to see what occurred in there, as we had projected before, we had a major problem with our copper and steel, steel being the primary one there. That cost us roughly about a variance over standards approximately $2m for that, and that is still ongoing, so we are looking at about a 4 percent hit on the bottom line ongoing.

The other things, there was a little continuation of a coil start up problem with the 7mm, but that was not a big issue with the other problems. The big issue there came about, probably the biggest one, was some equipment failures we had on expanders down at our Longview facilities. We had two very large machines, both about 40 feet tall and weigh 2,000 to 3,000 pounds a piece, and they are six to seven year old machines with a life expectancy of 30 years or so. Both of those machines have been very reliable, we’ve only had minor problems with them over the past few years.

However, in both cases we had significant problems with both of them this quarter. One of the units, in addition to being down having the problem, it was out of commission for about two weeks, and the second one was out of commission for about three weeks. That really hit our bottom line. That collectively, with the coil thing, were in the high $9m area is what it impacted our bottom line.

I should say the pretax one. The earlier issue that we had was we had a very severe windstorm here in Tulsa which affected not only Tulsa because it took out our electricity for two days, but because our mainframe computer went down it had a negative effect on our earnings facilities.

In addition to which, we had it seemed like no end of problems this quarter, and our mainframe computer which has backups built into it had one of the discs fail and the computer manufacturer and our computer people decided they’d replace the disk over a noon hour on Wednesday afternoon, going to be down for approximately 45 minutes to an hour, and when they tried to bring it back up, they couldn’t bring it back up. To put it into simple terms, and watching and listening to the computer people, they claimed and I would guess they probably were right, they’ve never had a problem like this before.

For whatever reason they fiddled with it the rest of Wednesday and then they shipped in a major part of a new computer into us overnight on Wednesday night, did the same thing on Thursday. They put that in, it didn’t work. So they fiddled with it again and on Thursday night again shipped in another major portion of the mainframe computer, and on Wednesday morning that part was here as well as their most-expert troubleshooter. And finally, in the early afternoon, the Friday afternoon, what was to have been a one hour down after 2.5 days we finally got the computer back up. That had a real bad impact on all of our facilities.

So we just seemed to have had no end of bad luck. The positive, if you can say that there is a positive of all of this is that in spite of all of these problems we still managed to generate the record performance on the top line, if it hadn’t been for that we would have had a bang up quarter, which unfortunately we didn’t get.

The net result of that is that we are still sitting with about a $52m backlog, which is a very, very high backlog for us and now that all of those problems hopefully are behind us, we can start shifting at a higher rate than we did this second quarter as well.

On the other side of it, those presumably will be all history and we won’t have all of this significant product problems or manufacturing problems, and we are only left with the one problem which is continuing which is the steel and copper price that will hit us for a couple million dollars.

On the plus side of that, we did initiate a price increase of 3 percent in March which didn’t fully become applicable until April and we then had over $50m also of backlog that was the lower price, pre-price increase price and we have been working our way through that. As you can see, we have not gotten through $52m worth of backlog since April 15th.

We have gotten through probably a little over two-thirds of it, and at the present time we are starting to get new price business coming through, and we are getting rid of the last of the old price business which will be out of here, mostly it will be out of here in the first two weeks of next month.

I mentioned a 3 percent price increase, but we also had one other issue that had an effect on the cost. We had given out some special pricing to all of our sales people who attended a sales meeting last October. This special pricing gave them the right to have a discount on each of the product lines between October and April of this year. So in addition to the 3 percent increase, we are also getting rid of that discount. The discount individually was about a 10 percent discount that they had one of. So we had quite a bit of that discounted business in there as well. That also is in the process of being flushed out.

So in effect we will have two price increases. One the 3 percent official price increase, and the other one the elimination of the discounted pricing. So we have more than enough price increase to cover what appears to be the cost increases that we would have to cover. The net result of all of that is that as we clean out the last of that low price business, we will return over time, over the balance of this year to approximately the same gross margin that we have been experiencing up until this year.

That, coupled with the fact that we have a heavy backlog, does give some promise to the second half of this year, doing some substantially better things for our bottom line than we have experienced in the first half.

The sales increase, for those who watch that, for the six months was 15.6 on the second quarter and 13.9 for the six months. The percentages, as you might have noticed, have dropped on the bottom line in the second quarter by 53.2 percent on profitability, and that is in the process of turning around as we speak.

The other issues that probably need to be roughly discussed is warranty issue and the bad debt issue. We did, along with this, we cleaned out some of our questionable accounts on bad debts. We also have been doing considerable work cleaning up some of our warranty problems so those were slightly higher than what we had anticipated, and they are both gone now. So really, the only thing on the ongoing that we have to worry about is again, the steel and copper costs.

Going on to looking at our balance sheet, if you’ll notice our current ratio is still excellent at 2.4 to 1. On capital expenditures, as we announced when we said we would be in the $11m maybe $12m capital expenditure this year, we have done over $8m of it so far. The things that we have done, we have purchased some additional land in Longview for $380,000, so that if we continue to grow we have the land available to grow into that. Bought us about 14 acres of land.

The Tulsa plant expansion is well underway, so far we have spent about $2.1m. It will, when finalized, be close to $3m. We have spent $5.5m for equipment, of which we have paid cash on $3.8m of the total $6m purchase for two new automated sheet metal machines. And then we had an acquisition which we did not know whether we would be able to do it or not, we basically bought a company called [Air Lives] in Canada, in Mississauga, a suburb of Toronto, which is a custom manufacturer of rooftop units and air handling units. Our cash outlay on that was approximately $1.8m. It had a negligible effect on us in the second quarter because, of course, in bankruptcy they had pretty well gotten rid of the backlog and all their business, and it is causing us a little bit of loss as well as giving us a little bit of revenue at the present time. Roughly $100,000 a month on cost on loss of you will.

We have picked up considerable business now. We’ve got the backlog up to where before, I’d say in this quarter we’ll be doubling possibly, depending possibly on how it works, tripling volume from that facility that we have in the two months that we’ve owned it now. My expectations are that we will lose money through most of the balance of this year in a diminishing amount with that acquisition, and then we will start picking up positive results.

That has all the indications of something which will give us at least as good as we’re doing, possibly better, bottom line in about a year, year-and-a-half when we finish cleaning up the problems that caused them their problems.

The things that they had, they had a good product line, good quality, but they had system problems and operational problems, all of which did us very well. We have already put them into our system, into our computer system, and we are getting the operational problems resolved as we speak. All of their problems were ones which we understood very well and which we knew what we had to do to correct their problems, and therefore made it a very appealing purchase to us because it expands our product offering, it gives us quite a few people with very good skills in many areas and the problems which they had a deficiency in were ones we understand how to fix rather readily, so it will do very well for us on an ongoing basis.

Changing the subject slightly, we are still buying back stock and year to date in 2004 we bought back 141,800 shares. The total we have bought back in the program to date is 954,764 shares. The year to date expenditure on stock buyback is $2,976,833. Our total buyback to date is $12,905,297. We still have approximately 370,000 shares to buy back. Buy back will not start for another week after this and then we will be back in the market again.

At the rate we’ve been buying back since basically November of 2002 and so we will probably be, all of the balance of this year and possibly into next year in a buyback mode still before we use up all of our authorized buyback.

Incoming orders are still strong. As I mentioned, we have $52m in backlog at the present time, roughly. The price increase to all of our customers went through very well. We have introduced and are actively building product with the new refrigerant, so we’ve overcome one of the questionable items about what our startup costs will be the what our getting going costs, whatever you want will be on going to the new environmentally friendly refrigerator.

At the present time we are probably building somewhere in the vicinity of 25 percent of our business with R-410, which is the new refrigerant. We are way ahead of the industry in that respect, we are leading the industry. A lot of the industry has seriously started doing this in the residential end, but they have not seriously gotten into it on the commercial end, so whether those questions as far as what impact it will have on us, it will have negligible impact and it is all behind us.

The other things that we have done in this past quarter or last six months is we have converted our very largest equipment, which is more our industrial or heavy commercial product line and our chillers all over to a full panel construction. The benefit to that is that it lessened our need for so much steel and it approximately doubled the insulation value of our cabinet compared to what it was before and compared to what all of our competitors are doing today. So we got a strong product, a lighter product, a little less costly product for steel and a much better product for the customer. The customer realizes a lot of benefits from it and we managed to do it at basically the same price.

Most of our cost, of course, was in capital necessary to do that as well as the redesign of the cabinetry. That we expect to be a very positive sales feature as we go forward, and compared to other products to foam construction, we would anticipate that it would be very well-received by our customers.

[Writ] business has been very strong, the national account business that we’ve had this year has been steady but not as strong as the [writ] business has been. The net result of all of that is that of all of our business segments, retail has been fairly strong, medical has been very strong, educational has been very strong. Industrial construction is starting to show some signs of coming back, as are our office buildings. The net result is that we are doing quite well now on new orders.

As I mentioned, we spent about $8.5m of probably somewhere around $11m or $12m in capital expenditures, so we still have approximately $3m, plus or minus to go in capital expenditures. The other issues we have, the big major other one in question would probably be the residential product line. The residential product line, unfortunately, has had two issues that have caused us to fall behind on that. One of the issues is a disagreement which has been accruing between our industry association, Air Conditioning and Refrigeration Institute, which represents all manufacturers, and the federal government.

The federal government, in the preceding administration, regulated SER-13 and our industry chose to challenge that in court. We’ve gone through that earlier this year, because the present administration rescinded, or tried to rescind that SER-13 and make it 12, and the industry was kind of thinking that was what was going to happen with the lawsuit, and it did not. The judge ruled that the SER-13 stood and therefore the industry chose not to fit that but get on with it. That kind of slowed us down because we were thinking we were dealing with a probable on 12 rather than 13, so we had to do a little bit of adjusting there.

And then all of our problems with the coil issue was the other thing which slowed us. We are now building some of the units, we haven’t really gotten serious about selling them yet, but we are building and putting some units into the field at the present time.

The other large issue that we have been talking about has been the mold retardation due to a methodology to convert an air conditioner into a dehumidifier when it has not been needed for air conditioning. We are doing very well in that and that has become more and more popular. There have been some of our competitors enter into that now. We have been doing that since 1988 so it is not a new one for us but we have never really promoted it heavily like we have the past couple of years, and a lot of our business does have that option with it.

The more efficient equipment that is mandated by an SER change as well as any other regulations, we are well ahead of. We are not behind in that area so we don’t have any more money to spend on meeting any future regulations that are closed at the present time.

The net result of all of that is that the company is in exceptionally good condition for products, for efficiencies and all other respects. All of our facilities are in very good shape and getting better. We have a problem with cost increases which we are dealing with and will plague us for a while, because that steel cost increase, in addition to our raw steel, is causing our suppliers to raise their prices where steel and copper are involved in the product, which is most of the things we buy. So the inflation is ongoing and as far as I can see will continue to be ongoing. Most of it is generated according to what we understand by the prosperity that the rest of the world, and most particularly China is enjoying. China is using over 2.5 times as much steel last year as what the United States used, and is at the present time, according to what I’ve read, using in excess of 30 percent of the steel in the world, the same thing for copper and aluminum. And on concrete, which we are not involved in but it kind of gives you a flavor for what might happen, we are using over 40 percent of the concrete in the world according to what I’ve read.

So I think the inflation we are experiencing is going to continue, and I don’t think much is going to happen that is going to change that commodity problem that we are experiencing. With that, I am opening it to questions and answers.

(Operator instructions) Our first question comes from Mr. James Gentile. Go ahead, please.

Good afternoon, Norm.

Good afternoon, James.

I just wanted to clarify the beginning of the call, you said the machine problems and the coil delay impacted the pretax earnings by $9m in the quarter, is that correct?

That’s about what we think we lost in the year, really.

Oh, annual. I just wanted to clarify that. Thank you. That’s all.

Our next question comes from Mr. Greg Weaver. Go ahead, please.

Hi, Norm.

Hi, Greg.

On the R410, you said about 25 percent of your business was related to that. Is that flat sequentially? Any reason why?

Is it what?

It is the same number as it was last quarter, I am surprised it hasn’t gone up.

We haven’t gone out and really started to move it forward, and a large reason that it is there is that about 20 percent of Wal-Mart stores have converted to R410 and the rest of it, the 5 percent or 6 percent is other customers and we haven’t gone ahead with the end promotion of it yet because we are going to be a little cautious to make sure there is nothing that we have missed in that that might come back and get us.

But before the year is up, we will be promoting it. Now how much people will want to convert remains to be seen.

So this is more an issue of you want to see how the units perform in the field before you want to go?

You know, we’ve put a few thousand tons out there over the past few years and we’ve not experienced any problems, so it is not so much equipment problems that we are looking at, but our in-house problems that might get us. One of the big ones has to do with this coil equipment which we started up which is totally related, that new coil equipment, to R410. We want to keep a little reserve and we are buying more of that equipment as we speak. Right now, we are using a pretty sizeable percentage of the equipment we had, and if we push it right to 100 percent and then we have a problem, we have a real problem because we are going to miss ship dates for our customers, and we can’t have that.

So we are sitting here until we get some more equipment that will support a higher volume before we accelerate our R410 sales.

Okay, understood. And on the topic of gross margin then, so it is kind of – you took a lot of the hits already, but you figure by December quarter you are back in the low to mid-20’s?

Yes, that’s what I think.

Okay, that’s all for me. Thanks.

Our next question comes from Mr. Chris Kodawitz. Please go ahead.

Hi, Norm, hi Kathy. I wanted to touch base with you guys, get a little more color maybe on the sales program. Did you guys expand on what kind of dollar volume that you saw there? Do you guys know that?

You mean projected forward?

Well actually, what did you guys think was associated with the total program after you guys kicked that thing off in October.

Well you can kind of see it there in that we are up essentially 15.6 last quarter and 14.9 for the year to date. We would have been up more if we hadn’t have had all the breakdowns, and we expect that it is going to be very strong in the last half of the year, so we our sales, all of our efforts seem to be resulting in true growth.

Now the industry has had a pretty decent year too, so we are getting some of the growth just from industry growth and some of the growth from getting a more, bigger percentage in the marketplace.

Okay, I am following you there, but I was wondering if you guys had broken down in accordance with the coupon plan that you guys had set up for your various sales distributors or dealers, did you guys have a way of breaking down, you know, 20 percent of the sales you did in some time period by dollar volume, for instance, were directly a result of that program?

We have the ability to do that, I don’t have any breakdown. I’ve watched it on a day-to-day basis as we put it together, but I haven’t summarized it over any given time period to see how that changed. I had a general feel for it and we got a heavy amount of it this spring, so compared to last fall, but right now it is mixed in with all the other business that we are putting out the door.

The net result, if you are driving at what the positive will be, the program had a built-in automatic ability for the people to use it because we gave the coupon. It does not eliminate the fact that there will be some jobs that we will take at less than full price going forward. The net result of what the coupon had an effect on the total sales, I think it probably affected about 3 percent to 4 percent.

So you think it increased your sales about 3 percent to 4 percent?

No, it had a negative impact on our bottom line of 3 percent to 4 percent, but that doesn’t automatically come in and come back, because we will have to continue to be cost competitive with some jobs in the future. We will have the ability to decide how much we do so we can either eliminate it totally and suffer the loss of some potential business we might think we should take or we could cut our price sometimes and get more volumes.

Sure, that’s always part of the game.

That is always part of the game, there is nothing new there.

Okay, so the 3 percent to 4 percent impact, that is an after-tax, estimated overall in the quarter, or overall in the program?

Yes, before tax. That is what I think that it has hit us for in the quarter.

Okay, and that is on all sales?

Yes. Okay.

Yes that makes sense, because it wasn’t 100 percent of your sales that got involved in that –

No, that’s correct.

It was a percentage, so it is a little bit dilutive. You guys talked a little bit about the Wal-Mart business, can you guys give us an update on that? It sounds like you said it was steady, but any more color there?

Wal-Mart plays their cards very close to the vest, and so they are continuing to talk about re-bid and haven’t yet done anything to give us any definitive time schedule, and so we don’t know on that. But we have had good business from them and continue to enjoy good business.

That being said, like I say, they don’t tell us everything so we don’t know everything that is going on. But we will have to pull this to a head because Wal-Mart business has not had a price increase.

That’s kind of what I figured, I mean you guys were probably going to be under pressure, giving discounts to other people, right? Do they know that?

Oh I am sure they do, they know really well what the cost increases do, and there is no question that they understand what is going on. We will have to go to them before long and get a cost increase, because of course the steel and copper has hit us, it has hit our competitor as well, so I can’t help but to think they are sitting in the same position we are.

Okay. Speaking of steel and copper, you guys mentioned $2m, is that – you said variance. Is that just in the quarter, is that an annual run rate?

That’s in the quarter.

And you said that was just for steel, or is that steel and copper, everything?

Well it is everything but it is predominantly steel and copper.

Okay, and then finally I will get off and let someone else go, tax rate floated up a bit. Any comment on that?

I’ll let Kathy comment on that, I don’t have –

Basically it is just to do with some rounding month by month, a provision is made based upon a 38 percent, basically, and on a 36 on Longview. So when it is rounded basically it just edged up a little bit, no real story there.

Okay, so you say 38 percent on AAON, 36 percent on Longview?

Correct.

Okay, that’s all I’ve got for now. Thanks.

You’re welcome.

Our next question will come from Mr. Mark Rothen. Go ahead please.

Norm, I’m okay right now. I’ll call you afterwards.

Okay, Mark. Good talking with you.

Good talking to you. Thanks.

The next question is from Mr. Joe Kinnithen. Go ahead, please.

Yes, hi. I just wanted to ask if there would be, what possibilities there were for insurance recoveries from storm related damages or the equipment outages, if you get recoveries and when you think you might?

We did not have insurance which would cover those issues. We do have some outage insurance, but it wasn’t enough that we could collect on it in the way that we are insured. So there will be no recovery on any of that.

Okay, thank you.

The next question will come from Mr. Frank Macland. Go ahead, please.

Good afternoon, Norm. On the last quarter you just had, did the production problems cause you to miss shipment dates?

Yes they did.

That’s one reason for the increase in the backlog. Do you have any idea about how much you did not sell because you didn’t have it to ship?

I would say that if we could have done it, we could have added about another probably $3m, maybe $4m to our shipments.

That is to your top line.

Top line.

And then with the capacity additions, what are you capable of doing now on an annual basis, with the 3 percent price increase or thereabouts, what can you do on an annual basis, and two, what percent of your capacity utilization are you really at?

Well what we are really capable of doing right now is somewhere around the mid-$200m on an annual basis. The low to mid-$200m. It varies by what you are talking about. Equipment-wise, by what I just told you, that is our equipment limitation. Our facility limitation is substantially higher than that and it depends again on which portion of it we are discussing. The assembly operation in Tulsa is probably running in the 50 some percent right now, that area, 40, maybe 50, right in there. The sheet metal facility, that is part of what we are building in Tulsa and it is pretty well completed as I indicated earlier, that we are probably running in the – when that facility is completed, we are probably running in the 30 percent range on that. We had the need to do it so we built 106,000 square feet which was a little bit [inaudible] building, but the way we have to put the building together and the cost, it was the only way it made sense. So we are way oversized on our facility for that.

Our Longview facility, I had mentioned we had bought some more land down there and we are running closer down there and we are probably running in the 60, maybe 70 percent utilization of our facility down there. In our Canadian operation, we will buy we are in the process right now on an environmental study to buy a facility because that is a leased facility where the company which we bought was in, and that when we get into that facility, we will be probably running somewhere in the 50 percent on that facility. That facility is going to cost us between $1.5m and $2m by the time we get in it and get everything going.

All right. Thank you.

The next question will be from Mr. Brian Bears. Go ahead, please.

Hi Norm, good afternoon. Going back to the Wal-Mart business real quickly, it would seem to me that with your innovations in your coils, copper prices increasing may be a good thing for you from a competitive standpoint? Would that be a fair statement?

You know, we are not absolutely sure what all of our competition is doing, but to our knowledge they have not done what we have done which is change the diameter of our tubing.

Have you gotten any feedback from your sales force in terms of pricing, what your competition is doing?

We basically are only looking at only a very limited part on R410, and we don’t have a real good picture of what they are doing on 410.

So at this point, your advantage in copper prices is relatively immaterial?

That’s correct. It is hard to say exactly what they have done until we see what the results are. They had two choices, they could have increased their copper considerably to maintain their safety margin in their copper because the new refrigerant runs 60 to 70 percent more pressure than the old refrigerant, which we are going away from, or they could have take a risk and not increase quite so much and put themselves more at risk for having coil failures. Until we see what they are doing, we really don’t know.

On the cost to the refrigerant and the compressors and all the other items, there is no question they had to spend the money for those items. It will be a little while before we really have a clear picture of what they are doing.

Okay, you had mentioned earlier in your prepared comments about your converting the chillers and your larger area units to a different kind of construction, that lessens your reliance on steel?

That is correct.

I kind of missed those comments, can you describe that?

The old way of building those units was with two pieces of sheet metal, an inner wall and an outer wall with fiberglass insulation between the two. In that kind of construction you are dependent upon each of those pieces of steel for your structure. What we have gone to is a foamed panel where we foam in between two pieces of metal, and when you do that that makes a composite construction such as you probably read about the aircraft industry uses a lot of components of construction. It gives you a lot more strength with less material, so we have been able to reduce the material content in the product, mainly the steel content, because of the composite construction affected by the foam construction.

And can that be applied through more of your product line?

It will be applied almost totally on almost all of our products. There are a few products which don’t have any insulation requirement, but anything that has an insulation requirement, it could be applicable.

Thank you.

(Operator instructions) The next question will be from Mr. Rick Weaver. Go ahead, please.

Hi, Norm. Can you just remind me again what is typically your biggest booking quarter?

Second or third, depends upon the year. So we are right in the middle of the best booking time of our year. The weakest time would go between the fourth quarter and the first quarter, and that again will depend upon the climate more than anything I think, and the business economics situation.

So what do you think, with industrial and office which has been weak for quite a while now, picking up steam, do you think it is more likely to help smooth some of this seasonality or give you an even stronger third quarter?

The third quarter we anticipate to be very strong, the fourth quarter is a little bit more in question. Hopefully those two come back to life a little bit more because they are ones that would support fourth quarter and first quarter better than what education or some of the other markets we go after.

Education is particularly strong in the second quarter and the third quarter, and that is basically because for the most part they are trying to get the schools open for school in the fall.

Right, understood. Thank you.

The next question will come from Mr. Chris Kodawitz. Go ahead, please.

Hi folks, just a follow up. Can you guys flush out the warranty and bad debt expenses that you took in the quarter?

I will let Kathy touch base with you on that.

Basically I don’t have that here, Chris, by the quarter. For the six months, basically between the two it was about $383,000. This was what the actual bad debt was. The warranty was actually about $800,000.

About $800,000 for warranty, about $383,000 for bad debt. Bad debt, you had that deal with the overseas job in the first quarter, right?

That’s correct.

So that’s included in that?

Yes.

Okay, that’s all I’ve got. Thanks.

You’re welcome.

It appears that we have no further questions.

I would like to thank all of you for your attendance and look forward to the next conference call in October to discuss the third quarter results and take another look at the full year. Thank you again, talk with you then. Bye.

That concludes today’s conference. Thank you for your participation, you may now disconnect.