Aaon Inc (AAON) 2004 Q4 法說會逐字稿

Good day, everyone, and welcome to the AAON fourth quarter and year end 2004 earnings call. As a reminder today's call is being recorded. At this time, I'd like to turn the call over to Mr. Norm Asbjornson. Please go ahead, Sir.

Good afternoon. Before proceeding, I'd like to introduce you to Kathy Sheffield, our CFO.

Good afternoon; welcome to our conference call.

Prior to proceeding, I would like to read the 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 of AAON's control that could cause AAON's results to differ markedly 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 to begin with a review of the fourth quarter and our year-end financial statements. For the fourth quarter, in summary, our sales were up from the preceding year and our profit was down. In precise numbers, our sales were up 16 percent and our profit was down 24 percent or 21 percent for the quarter.

The story is as it has been throughout the entire year. All of the problems which we've experienced has been in variances. The majority of the variances are related to material cost increases. Some of the variances, a small portion of them, are related to overhead and labor factors. The overhead ones are many times related to other inflationary things which exceeded expectations such as our natural gas costs and electrical costs.

Selling, general and administrative costs turned out to be, for the fourth quarter, less than the preceding year by approximately $290,000. Income from operations were, as stated before, down from the preceding year. Our interest expense was nonexistent. Our interest income was pretty much nonexistent. Other types of expenses or income were nonexistent.

Therefore when we get down to the bottom of the entire amount, our profit net income for the quarter was down by 44 percent from the preceding year's fourth quarter.

Earnings per share diluted were 16 cents compared to the year ago 29 cents. Weighted shares outstanding on a diluted basis were 12,831,000; on a basics status they were 12,382,000, which was down very slightly on a diluted from the preceding year although on a basics basis, it was down about 150,000.

Looking at the 12 months, you'll see that our volume was approximately up, should have standed (ph) in the fourth quarter it was up 19 percent -- 16 percent for year-to-date. So our fourth quarter, our volume was up greater than our year-to-date by a ratio of 19 percent in the fourth quarter, 16 percent for the total year.

Our cost of sales in the fourth quarter was up to 32 percent versus 29 percent for the year to date, indicating that we continue to receive cost increases. However, our gross standard product for the year was up -- was 24 compared or down 24 percent compared to down 21 percent for the quarter. Which, when we go down through everything else which was pretty much the nonexistent interest, etc., you will find that in the fourth quarter, our profit was down 44 percent. In the year-to-date our profit was down 47 percent, indicating that we have started to turn the corner at least in the fourth quarter toward becoming more profitable.

For the year-to-date our earnings per share on a diluted basis were 58 cents for the year. On our number of shares outstanding for the year on a basic basis, they were 12,435,000. On a diluted basis, they were 12,923,000.

Summarizing all of that, net sales for the year increased by 24,400,000. Breaking that down a little bit, there was $3.3 million of that in our Canadian acquisition so on a comparable basis comparison of our existing businesses as of a year ago, our increase in sales was $21,100,000.

Cost of sales was up by 33.2 million, which indicates the reason for the downfall in the profit, obviously. Looking at the problems that we had in that, again, most of it was in raw material and purchased material cost increases exceeding expectations, with a little bit of labor and some overhead also being up.

The other thing on gross margins was associated with a couple of additional changes which we made. As mentioned in the first quarter, we had some cost increases significant on -- cost increases during our startup with our new coil product line in the first and second quarters. Those went away in the third quarter and the fourth quarter they were not unexpected. There were no specific additional costs associated with the coil line. We had gone through our learning curve.

We had two unusual things happen to us this past year. We had a shutdown of our plants for four days due to electrical malfunctions caused by storms and an unusual computer outage which affected all three locations, our mainframe computer for the first time in all of our history caused us some problems. We are in the process of changing over to a new machine, which will be in effect by the end of the first quarter of this year.

The other item was that we also had some unexpected large quantities of equipment failures at our Longview plant which affected our ability to build coils which thereby affected our Tulsa facility, also. So we had a couple of quite unusual -- three actually -- three unusual events that we haven't had particular problems with before. In addition to which, we bought the Canadian operation out of the bankruptcy sale and after starting it up and getting it going, we had a pre-tax loss of $900,000 on our Canadian operation. Part of that had to do with the fact that we started without, basically, coming out of bankruptcy, had to build our backlog, had to get it functioning again at better level. It was functioning at a very low level at the time of bankruptcy. We've converted then totally into our software systems because one of their problems was their systems had failed them and contributed to their downfall and so we put them into our systems which we have great faith in and which fit their type of operation very, very well. We had very little adjusting to do to fit their company into the software.

And the other thing is, we bought a building up there and we moved the company from their previously leased space to our Company-owned space with all the risk security of things that were happening to us on our cost of sales.

All of the above were non-recurring costs, which we don't anticipate to see again with the exception of raw material costs. I might mention that Sarbanes-Oxley didn't cost us too badly last year but promises to have a more definitive impact on us this year. The other area such as warranty, warranty was well within expectation at just over 2.2 percent.

Our bad debt. We wrote off or improved our bad debt position and, therefore, have a lower reserve for bad debt going into this year than we had going into last year.

Looking at our balance sheets, our capital expenditures were up greater than what we had planned primarily to the requirement that in addition to the ones which we had received all we were required to go ahead and capitalize some of the things which normally will -- are units equipment type expenditures which we are just receiving now but they were so close to being received that it was decided we needed to capitalize them. So our total capital expenditures were an all-time high of $17.5 million for the year 2004.

This is due to the fact that, with all the work we have been doing in getting our product line ready, improving our marketing, adding new products and everything we had to do some also in equipment and in facilities for years to come. So we are setting the Company up very rapidly for a growth period.

As to how that relates, the Tulsa plant expansion improvement was approximately 6 million of that 17.5, for physical plant as well as equipment. The equipment portion of that was also another 3.2 million for automated equipment and about another .5 million for a variety of other items.

I mentioned earlier that we have a new computer system waiting. That's an additional .5 million that we invested in. In our Longview facility, we bought land adjacent to our existing facility for a future addition not at this point in time but for some future time for $470,000. We did do a building addition and renovation down there for $655,000. Longview equipment. We had a variety of equipment pieces which totaled approximately $1,300,000.

On our Air Wise, our Canadian purchase of the Air Wise company, the asset purchase part of that was equipment for just under $500,000. The property that we purchased in Canada for that facility was $1,300,000.

We did have a continuation of our stock buyback. The amount of stock which we purchased last year was 265,100 shares for $4,978,517, leaving the number of shares authorized to be repurchased at 246,936 shares. We have so far repurchased 1,780,064 pardon me 780,000 64,064 (ph) shares for a total purchase price of $18,889,534.

The income and order rate has been respectable. Everything we read and everything we are hearing indicates that we have expectations of a good year coming up. I think the biggest thing that I am aware of that could upset that is that we did have very significant steel prices increases last year which have moderated slightly but not very much. We had large copper increases, large aluminum increases, all of which in addition to affecting our ability to control cost had an impact on the rest of the building industry as well. So how much all of the good indications we have reflect the cost of the building itself, building a building which went up significantly last year due to material cost increases. I don't know.

So I think there is a little bit of a question mark bear and then of course the general tenor of the economy which seems based upon what I've read to be a positive for the year 2005.

Incoming order rate has kept our backlog at a high of about 39 million plus shares at the present time. We've not had a great deal higher backlog than that. It's almost 40 million shares, not quite. So we are starting the year, this year in very good condition.

We had a national sales meeting of all of our sales force, our representatives and all got together here on November 5th through the 7th of last year. We introduced a lot of new products and a lot of changes to them. They are prepared to go out and serve the market better than they were prior to coming off that.

Looking at individual business segments. The retail segment and our participation into it would appear to be a modest growth part of our market for the year 2005. Medical, again, a modest growth in that. I think a little bit stronger than modest in educational. We believe we will do a little bit better in that particular area.

Industrial buildings, plants, and those types of facilities, which is one of the more depressed ones. Depressed about four years ago and continues to remain depressed, does not look to us to be something that is coming back at this point but more of a flat and depressed market. Office buildings, somewhat like plants. They depressed with dotcom bust back in the year 2000 and they continue to be on the soft side. So we have got two of our five identifiable marketplaces, namely plants, industrial construction and office buildings that we think will be flat.

Retail, medical, and educational we think will be up and then, we have a lump sum called 'other and others'. We expect that could be up slightly too.

We did have price increases last year. We announced price increases that went from 7 percent to about 11 percent varied in there, depending upon the product. It sounds like a lot in a noninflationary time. But it wasn't significant enough to cover our cost increases and therein is the reason for our falloff in our profitability.

So we were unusually -- we were hit with unusually strong inflationary things and material cost increases and while we passed on price increases that were much higher than the consumer price index or anything else, they were still inadequate. We think that the cost increase run-up has run its course. We don't look for it to back off a great deal. Primarily because the United States is not controlling elementary commodity prices. Those are world wide commodity prices. And they are controlled by the effect of the economy throughout the world and everything we see indicates that the world is going to have a good year in 2005, and continue to run the demand portion of the supply demand curve on these products up and keep the price at a high level.

However we don't expect that the price will go up more, because we think that production is increasing adequately to stop that.

In new products we made an immense change in our product. We've done some very fundamental changes. The two fundamental changes are that our entire product line is now available in a refrigerant called R4-10 which is an environmentally friendly refrigerant and so any one of our customers on any one of our products can choose to go to an environmentally friendly refrigerant and away from R 22 which has a life that says beginning at the year 2004, the chemical companies had to reduce their production of that from the base year 1999 by 35 percent. Most of that reduction was taken up by the fact that the foaming industry also used that refrigerant very heavily and they transferred out to an environmentally safe refrigerant; and leaving most of that market that our 22 serves being the heating and air conditioning market.

So while we didn't get hit with the totality of the reduction that the chemical companies had to make, nevertheless the price of R 22 has began an upward climb and the transfer to the new, environmentally safe refrigerant has begun and we are totally ready for it.

The other very fundamental change we made in products and we are in the midst of this one. We are not finished with it. We have done some products. We are doing some other products and we will, within the next twelve months, pretty well be done with doing all products -- and that is changing the method of insulating the cabinets on our units.

Historically, we -- and all other manufacturers -- have used fiberglass as the insulating material. The industry has begun its change to foam panels similar to what the refrigeration industry did long ago on refrigeration cases and things of that nature. The benefit of foam is that it is twice as good an insulator on a per inch basis as compared to fiberglass for the most part. Not precisely but close.

In addition to which foam adheres to both the metals that are containing it, and in this case we have a metal on the inside as well as on the outside, and when the foam goes in and clings to both surfaces, it converts that into a composite construction. And the composite construction is much stronger than the strength of the individual componentry and, therefore, we are making our product stronger and we can also change some of the structures so we actually can lighten the product.

So we are getting the best of all worlds in that we are getting a stronger, lighter, more energy-efficient cabinet on our products and we think that will be a very sought-after thing in the market as we introduce it. Again, we have taken leadership position in one portion of the air conditioning industry. The air conditioning industry that is converting to foam is largely doing so on indoor air handlers, which we are converting also. And to our knowledge they have not begun to convert on rooftop units which we are also converting.

So in the rooftop segment of it, we have got a lead on all of the rest of the industry to our knowledge.

The other aspect of it is that we continue to add new products. We have last year discussed the residential air conditioning. Residential has gotten -- we have completed and we've begun the marketing. We're just in the very very formative stages of getting that moving. We expect to make it a significant event here within the next 30 days and start going much stronger.

As to its effect on our bottom line since we are starting at ground zero on it, even if it has tremendous percentage growth, it is still not going to have a material effect upon our bottom line for the year 2005. Other product lines which had been changed are really revolving around products which we have already had in existence; and we are offering an upgraded technically more advanced product. And in that area, we have a number of products that we had introduced prior to last year that are gaining strength very rapidly. Our big tonnage rooftops, our chillers, our air handling units and as we go to small, we are moving down the scale in rooftops; and they are also improving our ability to gain orders on our regular rooftops.

The biggest one, probably, is the fact that we attacked the very bottom end of the rooftop market which is a huge market, huge dollar volume market of about $1 billion that we weren't really too seriously into before and all of our numbers that we have used before we didn't include them, because we weren't really designed into it. And while we are not at the clear down at the bottom low-cost bottom of that marketplace, we did move into the product -- into that marketplace much more seriously with an offering which we are in the process of taking orders on now and just about ready to start shipping on with a lower cost 2 to 5 ton rooftop product.

So we have entered a huge additional part of the rooftop market that we really weren't playing in before and entered it with a good product.

We have one catch in the way we entered it. We -- that part of the marketplace has, by federal law, had a 30 percent improvement in energy-efficiency mandated to occur in January 2006. So we are about approximately one year ahead of ourselves in that we have this higher efficiency product available now; and of course, all of that increase in energy-efficiency doesn't come without a cost.

So we have a cost problem still but a year from now, that large segment of that cost problem will disappear as all the other manufacturers have to rise to that higher efficiency. They will, I'm sure, be doing so over the coming twelve months. So we will gradually get stronger in that. We do expect to have that give us a bottom-line impact in our P&L.

Net result of all that I've talked about is that we anticipate a growth year for the Company in 2005 over 2004. We don't expect that we are going to improve our ratio of profitability. In other words, our dollar profit per dollar of sales we don't expect to improve very much. Because we are still going to be contending with the material cost increases. We are going to be contending with other cost increases that are going to be difficult to pass on to customers. So we don't think we are going to make a significant gain in that area.

With that, I have pretty well concluded going through my review of it; and I would like to open it for questions and answers.

(OPERATOR INSTRUCTIONS) James Gentile with Sidoti & Company.

I have several questions. I guess we'll start with Canada. That's a more customized product offering, correct?

That is correct.

Could you give us some insight into -- you said in the conference call you booked 3.3 million in sales coming out of Air Wise or whatever you call it now. Was that for the total year 2004 or just for the quarter?

That was for the total year.

What do you have earmarked for Canada to produce in 2005?

In the upper teens, 17, 18 million.

And at what margin?

We think it will be a margin -- negative margin for the first three to four months of the year. We think by the end of the year somewhere in the latter part of the year its margin will be approximately the same as the rest of our operations.

So you figure 4 percent or so net?

Net 4 percent would seem reasonable.

What is the maximum potential of, if you were to operate the Canadian facility at 100 percent capacity? What would be the maximum utilization there in terms of revenue?

With the facility as it stands today, we are believing that we can be somewhere in the $40 to $50 million out of the facility. The property itself has additional expansion capability. We haven't gone to the local people to find out what their codes would allow us to do as far as the building expansion. But just looking at it and thinking what is reasonable, I think it is reasonable we could expand the plant and this means not the offices but just the production part of the plant. Enough to get somewhere in the high 100 or high up toward 100 million of that plant.

That's a ways to go, obviously.

But that is a while. That is some future date. As far as our ability to sell it, we think we have got the ability to sell it today. Our problem, then, is one of making all this happen. Getting our act together in marketing, and getting our act together in manufacturing and all the other things necessary to grow the Company. So we think the market is available. We think the Company's got the nucleus for it, but we have got a long ways between potential and actuality to clean up.

Would you say that this 17, 18 million is more of an optimistic --?

No, I think that's realistic, (MULTIPLE SPEAKERS)

Giving your backlogs today?

Again we are not having problems getting orders for it. Problems doing is getting them speeded up to that volume.

I'd say midway through last year, you started to comment on certain competitors' pricing disciplines and the relative loss of say your national (ph) accounts business as a result of these lack of price increases, if you will. Could you comment on the state of the industry?

There is always a lag between the cost increase and a price increase in this industry. I think that is not unusual for a lot of industries. The amount of lag in this industry seems to be unduly long and I don't know if whether that is attributable to a thought process or a reporting process on their part of knowing what they should do and taking action on it, I really couldn't tell you.

But for whatever reason, price increases that should have started happening early in the year last year did not start happening until mid to latter part of the year. By the end of the year, there had been reported in our trade newspaper, where most people make an announcement, price increases that would indicate that everybody pretty well got on board but it took them all year to get on board. Now if we don't have big cost increases this year, that means at least that we are back on more of a playing field that should be there.

There are exceptions in the case of national accounts. Because national accounts by their very nature are large and they are hard buyers, tough buyers. And they do not give into price increases easily, so in the national account arena, it is going to be harder to pass through price increases that it is in the day-to-day type business.

Would you say, then, that your percentage of national accounts business -- could you just comment on the number there?

From our existing accounts, we do not believe we are going to grow and as a matter of fact we have seen some deterioration in a couple of cases. However there is other national accounts business that we are pursuing right now which might offset anything that we might lose elsewhere. Our net belief in where AAON is going to find its strength in the coming year, however, is more in the educational market than it is in the retail market.

So we think we're going to have a hard time passing on cost increases. We don't think -- we're not going to pursue volume that is of questionable margin that is as hard in the retail as we are in some of the places where we might be able to get a margin proper.

I will just ask you straight up. What was Wal-Mart in terms of the dollar sales 2004?

About 25 million.

Frank Magdalen with Robbins Group.

Couple of questions. What is going to happen with SG&A? It was up in the fourth quarter a bit. But you're saying that the Sarbanes-Oxley portion of say 404 is going to hit you more in the first quarter of '05?

Yes. A lot of the money that we spent in the fourth quarter didn't find its way onto the accounts payable books until January. Because a lot of it came in, a lot of the work they did happened in November and December and we didn't get billed and have bills that were due until January or February. So, some of it slipped over that way and I see what happened last year and, basically, Sarbanes-Oxley didn't get started until the middle of the year at the earliest. And this year it's going to be in effect for the whole twelve months. So we didn't look and have a lot of expense out-of-pocket as a percent of our total sales, although what we had was in excess of what our normal pre Sarbanes-Oxley's total auditing cost was.

We did have that much that happened in last year from Sarbanes-Oxley, but that is just the tip of the iceberg. That a Company like ours, our Sarbanes Oxley, cost of ongoing as I see it, is going to be several times -- several times I said -- what our auditing cost used to be. So it is going to become a significant thing to us.

Does that mean that SG&A is like it was 9 percent of revenues in the fourth quarter? Is that number more realistic for '05?

One moment and I will tell you.

How much of that Sarbanes Oxley is one time or is it just complete maintenance -- at a higher level?

Some of it I'd rather Kathy talk about the one time first ongoing. Kathy?

In midyear, we started the assessment and documentation of internal controls and procedures. We had, of course, many controls and procedures in place but they weren't documented to the extent that Sarbanes Oxley 404 required it. The documentation was done in the last half of the year. Some testing was done in the last half of the year; but due to the time line with the year in closing and so forth, testing will also be done in the first quarter for the year end. We will then go on to documentation in 2005. It's done. It will just have to be updated as any changes are made. But testing will occur in 2005.

Going forward, testing will occur and also revisions and documentation will occur.

The net result is the total dollars expended on a regular year are going to be greater, starting in 2005 rather than what we spent in 2004. There are going to be significantly more money to be spent in 2005 than we actually spent in 2004.

Two other questions then. What are you going to do for CapEx in '05 and what should we use as a tax rate?

CapEx. Because of what we ended up doing and which, as I said earlier, because some of this stuff was due to come in very quickly after the first of the year, we had to put that in last year's CapEx number. So it did have an effect on it that went down on us what we anticipated before. So I am a little more vague about where I'm going to be this year but it will be in the 7 to 10 million as opposed to the 17.5 million last year. The effective tax rate, 38.15.

Greg Hillman with First Wilshire.

Could you talk about the home air conditioner replacement market? The one you are just starting to enter? And could you talk about what your strategy is to go to market and what you are going to do? Basically just talk about your marketing strategy a little bit more and go into a little bit more depth?

Sure will. Basically there's a lot of things happening in that market. The biggest of which is the mandated energy improvement that I mentioned earlier. That covers all of your residential products which had what they call -- there's a measurement called SEER which is Seasonal Energy Efficiency Ratio. And that is an index of how much energy it costs to do a given amount of cooling. The federal law was, and is, for this year 10. The federal law on -- I think it is the 26th of January of next year, 2006, becomes 13. And this requires not only a complete redesign of your air-conditioning apparatus, but it requires a significant addition of copper and aluminum; and to a lesser extent steel in order to make the unit bigger because the only thing, really, that is dramatically different that's available to make this happen is just putting more coil in the machine which means more copper, aluminum, and steel.

This is -- I will give you just a real short briefing to show you why it's a little bit questionable about what is going on. This law was one that President Clinton signed in the final days of his administration and kind of a hot potato that he passed over to the Bush administration. The Bush administration tried to go back to what the industry had been planning which was an SEER (ph) 12 and he passed revision. The industry our industry, ARI, of which we and all the other manufacturers are a member of voted to challenge the 13 law. The federal law of 13. And did so in federal court and lost.

And than we had another get-together and decided that we weren't going to prevail and we had better go for the 13 and get on with it. Well we wasted a lot of time. We didn't. AAON didn't. We voted for the 13. We were continuing on the 13. Others had to make a significant change in their plans to get their 13 by January of next year.

And the reason that this is kind of a thing that I would talk that long about is I don't really know what it is going to do to the whole competitive situation and the residential market. Because there's a lot of people going to have to spend a lot of money and it may change their competitive structure entirely. I don't really know at this point.

But what we are planning in our marketing approach is that more than half of the residential equipment, the air-conditioning portion, is replacement market. And the replacement market does not require that you be in the furnace business, although there is a portion of it that is tied to that but the bulk of it does not require the changing of furnaces. It requires the changing of the cooling coil and of the condensing unit or the air conditioner that sits outside the house.

Those items, we have available. We use the condensing unit in commercial and so it is just the same thing we are using in commercial with a different voltage on it. The A coil. We have built A coils for the residential market in our past. That is not a big thing for us to do.

So we basically have the componentry to do that portion of the residential market. We are going after this in a different marketing fashion that is going to cut significant costs out of our way of going to business because we are going to eliminate the normal way which is through a distributor and we are going to go direct to the customer.

Now going to direct to the customer does have a freight disadvantage; and it does have a disadvantage in that the customer doesn't have immediate availability of the product. He has to wait for it to be shipped from the factory. But in return for that, we get all of that one layer distribution cost to allow us to make a profit and will also allow us to pass a significant portion of that on to the customer and, thereby, give them a better value forth their money than if we had that distribution cost included in our product.

So that basically is how we are going to market. We are trying something that is not being done in the marketplace today for the most part. Most people are not going through direct to the customer and by I say to the customer I don't mean the houseowner. I mean the dealer, the individual who actually deals with the houseowner who installs it in the house. That dealer, normally, has a distributor between he and the factory and we are taking a distributor portion out of the picture.

Are your coils going to fit all the existing units? I take it you just leave most of a lot of the air-conditioning unit intact and you are just replacing coils or condensing unit. Is that correct?

That is correct and the coil -- you are right in that there are some discrepancies in the dimensions of the coils sitting on the furnace. However a whole large amount of that market has the coil sitting in a sheet metal plant and built by the contractor. And that is the way we are designing our coil is to fit into that plenum (ph) rather than match the top of the furnace precisely. So that is a very viable way of doing it. It is done all the time today. So we are not having to cultivate new ground in that area.

Is this for individual residences or is this more like apartments or is this bigger units?

Individual residences.

What are your things going to cost? Your coils and the things you are going to be selling?

I'm not going to quote.

I mean, not what it's going to cost. What are you going to sell it for?

Relatively speaking, we think we are going to be able to take about the better part of 20 percent of the distribution cost out of the picture. And, therefore, compared to how we would sell it if we had to go through that methodology, we are going to have that much more money to play up with back to the customer as well as ourselves.

Have you tested this new model, this way to go to market? Has this been, have you had any success in any kind of market test you've done with it?

We have not.

When are you going to test it?

We are in the final stages of putting the methodology in place as we speak. And I would say that we are within 30 days of starting to test.

(OPERATOR INSTRUCTIONS) It appears we have no further questions at this time. I'd like to turn the conference back over to our moderator for any closing comments.

Thank you for attending our conference today. We appreciate your attendance. We look forward to our next conference call in April to discuss the first quarter. At that time, we will be prepared to talk to you with more vision of what the balance in the year will be. Again, thank you for attending and we will talk to you next quarter.

That will conclude our conference. Thank you all for your participation.