Aaon Inc (AAON) 2005 Q2 法說會逐字稿

OPERATOR INSTRUCTIONS I would now like to introduce you to to your moderator, Mr. Norman Asbjornson. Sir, you may begin.

Good afternoon. Norman Asbjornson here. I have with me Kathy Sheffield, our CFO.

Good afternoon. Welcome to our conference call.

Prior to proceeding any further, I would like to read 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 Security Litigation Reform Act of 1995. As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ materially from those anticipated. Please see the risk factors contained in our most recent Security Exchange Commission filings, including the annual report on form 10K and the quarterly report on form 10Q.

I'll proceed now and review the discussion -- or review the results of the second quarter and the first six months of 2005. The sales were as projected -- or as shown slightly less than what we had anticipated for the year.

That result is primarily due to anticipation of results from new products being stronger than they were, as well as the results of the sale of products from our Canadian operation. So in specific, the Canadian operation was below the budget. Our residential product that we are introducing was below budget. And a new 2 to 5 ton rooftop went below budget, as did the new air handling unit which we are in the process of introducing. The rest of the product lines pretty much were on or above budget. So there is where our revenue short fall occurred. Along with that corresponding number, we had a penny lower earnings in share which kind of went along with the drop off of the sales.

The gross margin, when compared to a year ago, were up substantially both for the three months and the six months. The gross margin, however, did decline from the first quarter to the second quarter.

That decline was largely attributable to the variety of affects -- things that we were booking from Sarbanes-Oxley results. Some of them were in the area of our computer related, wherein we are doing a great deal of things to advance our computer operation. Others were professional fees and additional accounting costs that we incurred.

The purchase variances, a higher increase in the steel --

Yeah, we had also the variances in increased cost in the steel, but even though it began falling in the first quarter, it was still higher than what we had anticipated. The other one that has gone up considerably this year and has affected us has been copper, which began the year at about $1.12, and is presently at about $1.65. So that has had a variance problem for us.

The Canadian operation revenues is what noted were below expectations. Both the revenue and the bottom line were correspondingly affected.

The latter part of the second quarter, the last month of the quarter, we saw a fairly significant improvement, both in sales and in bottom line. It's starting to come around now to a point which we anticipated it doing earlier this year, but because we were spending time on getting our 404 compliant and other things compliant, we didn't get all the work done on that operation that we expected last fall and early this year. And we just finished that part of the work to allow us to run it better in the second quarter of this year.

As that -- since I'm on that subject, we do anticipate the Canadian operation to do much better on both revenue and bottom line for the balance of the year. The first half losses up there were a combination of both the revenue shortfall, as well as the fact that we had underpriced some of the business and we didn't have real good control yet over our cost of purchase materials. All those issues have been addressed, and as I mentioned, will have a significant effect on the operation of the Canadian operation for the balance of the year.

The problem with our residential in sales and corresponding other issues, came about primarily because of what occurred in our planned marketing effort of marketing over the internet. We found that there were two issues in that area.

One was that it was much more complicated than what we had originally anticipated and complications come about from a variety of things, such as the fact that we must -- on-line we must compute all the sales taxes and everything for wherever it is the product is to be shipped, so that if it has a city tax, a state tax, and whatever other taxes, we quote those taxes in there. We had some difficulty getting a workable software system, which we now have, to allow us to do that. The other part of it was quoting proper freight, and again, finding a methodology to calculate and quote freight immediately was somewhat difficult.

However, the other thing was of our own choosing, which was the fact that we realized that it was going to be so beneficial that we decided to include our part sales in our internet capabilities. And consequently, we added a considerable amount of work to the people that had to do the software and get everything ready to go so that we could also sell our parts over the internet. And both of those things right now are in the final Beta test area. We anticipate the latter part of this month having all of them functional and out there working. So that is where we stand on the marketing end of the product.

The product itself is being built. It is ready to go. It's a marketing problem that we're having to deal with.

The other thing I mentioned was that we brought out a new 2 to 5 ton rooftop unit, and there were a number of little issues that cropped up in our introduction of that. That is sold through our normal established selling methodology, so it's not a marketing issue so much as it is just getting everything lined up and ready to go.

We had thought we could do that much faster than we were able to do so, and while we now have that being sold and it is functioning and everything is going forward, we had anticipated going into the second quarter of having that pretty well ready, and as it turned out, it wasn't until about the first part of June to midpart of June that we really got it running the way we wanted it to. So we didn't get the benefit from the sales of that product.

Similar situation occurred on our new air handling unit, of which is coming out of our Longview, Texas facility. We had thought that we would be marketing it a little faster than what we ended up actually having it ready to market. But at this point in time, that has also been on the market now since early part of June, and is progressing very well.

So, all of the things which slowed our revenue growth in the first half and the second quarter primarily were related to those issues, which have been pretty much resolved.

The marketing of our -- our 410 refrigerant, our green refrigerant, or our environmentally friendly refrigerant has been proceeding very nicely. Quite a few customers have chosen to go with the green refrigerant. It looks like we've made a wise decision in getting in that early on. This is a refrigerant which doesn't actually have to be totally converted to until the year 2010. But we chose to move forward at an earlier date, and do our engineering and get it ready for market, and our manufacturing capabilities up, and we have been now for some period of time ready to market our 410 refrigerant, which is the environmentally friendly refrigerant, that is the refrigerant of the future.

And so it's been proceeding very nicely and looks like a lot of the customers are going to create enough demand for it so that it is certainly going to be running very strongly long before 2010.

On the new cabineting items, we are proceeding with improving the energy efficiency of our cabineting by converting from a fiberglass insulation to a foam insulation. Our two largest rooftop product lines have been converted for some time now. The largest product was converted approximately one year ago, and the mixed size down of product line was converted earlier this year.

We're in the process of converting other products. The new 2 to 5 ton rooftop that I mentioned we had some difficulty getting into production has been designed with the foam insulation. The new air handler, which I also mentioned as having been somewhat difficult for us, is also being produced with the new foam insulation.

The benefit to that is it's roughly twice as good an insulator as is the fiberglass insulation that is obsoleting. And this has two very big benefits. Number one is an energy savings benefit. The second one on our rooftop products, is that in the very humid climates it's been not unlikely to have on an extremely humid day, having some condensate form on the outside of the cabinets of the fiberglass units. Needless to say customers don't like that. It also adds to the deterioration of the cabinet by having moisture on the outside of it. And this advance in insulation should either eliminate that entirely, or certainly greatly minimize any possibility of that.

Thus, we think that as it becomes promoted by ourselves and we think some others will get on board with it, I believe it is another major advance in technology for our industry. We are, to our knowledge, the only one in the rooftop end of it doing that type of product. There are a few other products in the air conditioning industry being converted by other manufacturers, but no one has yet done rooftops, to our knowledge. So we're a leading edge technology, again in another area.

There's continued either softness or slight decline in our national account sales. The national account business this year and last has been extremely competitive, with cost increases occurring and some of the -- and the national accounts often times operating with fixed pricing. The net result of that being that on the national count business where we have long-term fixed pricing, of course, the additional cost is giving us some of the problem on our bottom line as well.

Manufacturer's sales has offset any decline we've had in the national account and given us a pretty good improvement in the first quarter, but not such good improvement in the second quarter.

Looking forward into the balance of the year, we're anticipating improved growth in the revenue, primarily attributable to our manufacturer's rep sales. We feel comfortable that our revenue is going to be approximating that which has been put out by Sidoti and other people giving the forecast.

The five major business segments that we normally deal with -- retail, I discussed briefly because that's largely your national account, but not all of it, is kind of stable, and in our case is either stable or a little declined in.

Manufacturing construction group-- like manufacturing facilities, has seen an improvement this year after a number of years of decline. It is obviously not back up to where it was, say five years ago but it's definitely reversed from where it was going down every year. It has made a modest come back.

Educational and medical facilities have been one of the strong points, continue to be one of the strong points, and we believe from what we can determine, will continue in the future to be a strong point.

Other types of commercial businesses and office buildings have shown modest improvement this year and have some signs of getting better.

Miscellaneous business, which is just anything not covered in the others, we believe is going to continue to show an improvement as it has in the past couple years.

A new business, we did get a commitment from Kroger stores to do their air conditioning -- incidentally, they are doing it with our 410 green refrigerant -- for the coming two years. And they have a number of different stores run under names other than Kroger that will also be included in that national account agreement.

No other major national account business that we are talking about at this point, although we are doing business with Toyota now of which has come about in both our Tulsa facility, as well as our Canadian facility. We just shipped a large replacement job for them and we received word back from them that they were very pleased with the quality of the product that they received, so we think that that shows promise for us.

That incidentally, is one of the areas which the buying of our Canadian operation and the capabilities of that are going to greatly help us, because their strength is so largely in the heavy industrial, and so consequently, having their product alone with the product we have out of Tulsa, gives us a great deal better chance of getting heavy industrial-type facilities than we had in the past. I mentioned that we believe that our revenue is going to continue to grow, and we have some hopes of it getting back up to a much higher rate of growth than this last quarter. And I believe that is going to be possible in the 3rd quarter, and 4th quarter is a little too soon to give you any feel for, but there's good signs that 4th quarter, likewise, will be strong.

At this point in time, looking further out into the year 2006, we have put a lot of new product in place. We have a lot of new things going on. If the economy of the country stays reasonably strong, we are looking for good growth into 2006. We're not going to discuss any specifics on it, but it just is one of the things which we have been planning on in all of the new products we have evolved and everything. We've had substantial improvement in market or additional markets we've never penetrated before, all of which will add up to a growing company for AAON.

I thank you for listening to us at this point in time. I do have one last issue to talk about, which is the stock repurchase which we've been on. We have almost completed -- we still have a little -- about 100, 000 shares of stock to be repurchased, and we are with blackout periods such as right now, still repurchasing as soon as the blackout period is over.

So we are also looking at whether to do more stock repurchase or do something else to enhance stockholder value and we're doing a fairly -- we're going to do a fairly heavy investigation as to what the best way to enhance stockholder value is, as we continue on, and at such time that we make a determination, we will be letting all of you know what direction we're going as far as how we think we can grow stockholder value most intelligently.

And with that I'd open it to question and answers.

Thank you. OPERATOR INSTRUCTIONS Our first question comes from James Gentile with the Sidoti Company.

Good afternoon, how are you?

Good, James. And yourself?

Fantastic. I have several questions. I guess, could we just start with the backlog? You gave vague-ish guidance for the second half with regard to revenue and earnings growth. I was wondering if you could comment. You suggested that June was a bit stronger in terms of order accumulation. I noticed inventory popping up a little bit by a couple million dollars. Could you kind of give us a little bit more of a sense of the percentage growth expected in the second half on the top line?

Yes, I think in the third quarter I feel fairly comfortable in thinking we're going to go back up into the, something approaching the 15% growth.

4th quarter is a little more distant, a little more difficult to determine. I know of no reason we shouldn't do it in the 4th quarter, but I don't have it in house, so it is a little more nebulous. But market place seems to be reasonably good, and the product is doing well in the market place. So I'm still optimistic on the 4th quarter as well.

Great.

And you kind of outlined a couple of problematic product areas for you in the second quarter. The one that really struck a cord with me was the residential product as you described, the internet distribution platform.

In previous public transmissions you suggested that the residential product probably would not be gaining any sort of critical mass until 2006, yet you claim there was a bit of expectation in the second quarter revenue number with regard to the sale of the product.

So I was just wondering if you could kind of give us more detail on what exactly you are expecting for that particular product, because this is a very new effort for you all. I guess for the remainder of next year -- for the remainder of this year, and more importantly in 2006.

Okay. Yeah. I lumped it into the problem areas that we had, James. And you are correct in that we didn't have much expectation for it and it didn't give us much for this year.

But people being aware of it, they wonder, well, what happened to it? So I did include it even though as a part of that number it was a very, very small amount and really was kind of almost negligible, but it did have a problem for us.

We still anticipate it being a very good product for us in 2006. As I said we're in business as far as the manufacturing, it's our marketing thing that is causing us the problem. And I might have given you a little bit of positive in that we chose to put the parts in there because the thing looked so great that when we get it ready to go, we think, and parts are a big dollar -- a fairly big dollar sale for us, and it's a pretty decent margin business for us.

So the fact that we have chosen to implement it right away at this point in time should tell you that the -- we think very highly of the software that we're going to take out into the market with the internet sales.

Got you. And then in Canada, in the first quarter from the last conference call, you said that it generated probably around $2 million in revenue from Canada. Is that correct? Am I correct for that?

That's -- that's -- my memory is correct. Kathy is looking it up right now here for me.

And then I guess --

Yeah, that 2 million is a correct first quarter number.

Okay, and so year to date is it proper for us to suggest a $2 million revenue run rate per quarter for 2005?

That's correct. Second quarter we didn't do any better than we did the first quarter. We basically did about the same in run rate and that wasn't expected. We thought we would have it turned up faster but, as I mentioned some of the problems we didn't get. It is at the present time definitely running much better, and we are anticipating that it is going to produce revenue and bottom line improvement considerably in the third quarter and probably the fourth quarter.

Sure. Then you have the -- what about the -- from a gross margin perspective coming out of Canada or perhaps, directly down to the net margin, I suppose, coming -- what should be -- have we reached an inflection point where -- I guess the question is, have we reached break even in Canada yet? Because I think there are numbers --

It is kind of questionable because a lot of the problems, as we told you, is a lack of a good business system so that you knew what was going on. And while we put all that in place, there is still a little question in the mind about a few issues in there.

But by and large I can tell you this, that it , in June of this year it came real close. It is right at the break even. Maybe by a little fluke, we're not too sure whether-- because we have been raising prices and so we might have had some good price business in June, and then we might fall off and get some of the less price business in July. So we're in that transition wherein we're getting price increases starting to fall in. But we're not able to track all of it, the price increases, what one has got better price and what one doesn't.

And the other part is that we have different product lines and we're just now getting a real good handle on what each one of them is costing us. So we might get more volume, but it might be in one of the lesser revenue product lines -- or the revenues there, but the bottom line is slow. So we're getting a little bit of difficulty in being absolutely -- we can be very comfortable here when we look at our numbers. We're not quite as comfortable up there.

But our belief, and we just reviewed this with the manager who is down here today, and went over it with him, and the top line there is absolutely no question is going to do considerably better in the 3rd quarter and the 4th quarter. The bottom line has been improving at a very rapid rate, and we're all anticipating that it will be in the black or very close to it in the third quarter.

And then one final question in the first quarter with the 23 plus percent gross margin that you put up in the first quarter, you did suggest properly that there was going to be a sequential decline in that metric. Are you still standing by a 20%ish gross margin for 2005 full year?

I believe so.

Great. Thank you very much.

Uh-huh.

Our next question comes from Frank Maglen with The Robins Group.

Good afternoon, Norm.

Good afternoon.

Can you quantify Canada a little bit more. In the last conference call you reduced our expectations to maybe 15 million for the year, and a break even in the second half. And now I'm hearing that it is going to be -- third quarter is going to be close to break even on something approaching 2 million in revenue. Did I hear that right?

No. No. The revenue up there in U.S. dollars now, not in Canadian dollars, the revenue up there is probably going to be 3 plus --

All right.

-- million, somewhere in that vicinity for the third quarter. And the likelihood is that we're going to break even, or possibly make a little money.

All right. And then you -- in the first quarter you lost about 700,000. Are you willing to break that out a little bit for us as to what you lost in the second quarter up there?

Yeah, just one moment.

And that was on about 2 million in revenue?

That's correct.

Maybe Kathy could --

Do we have that handy here?

(inaudible) I've got the 6 month but not the 3 month.

The sheets that you made up for me, maybe we can go get one of those for Canada, for the second quarter? I'll give you -- I'll come back to that question and answer it in a little bit. Kathy is going to go get a sheet so we can give you a correct answer.

Okay. And maybe Kathy has this too, the tax rate going forward?

It's returned to about 36%.

Because it was 32 something in the 4th.

That's correct. That had to do with some of the tax questions we had on the purchase and the loss that we had up in Canada last year. And what we ended up doing up there on taxes , it helped us out a little bit in the first quarter and it won't help us out again, so we're back to the 36% which has been our historical.

That's for the next two quarters.

Correct.

Are you hedged on copper?

Yes, we are to a degree. We're hedged to about at the 80% level at $1.35. And the number I gave you on what has happened to copper is right now affecting about 20% of our purchases. By the end of the year, it will be affecting all of our purchases, whatever it is at that point in time.

Well, let's go back to the first quarter when you had a nice margin improvement. And if I remember right, you had collectively maybe 11% price increase year over year to get to that 23.5%. And now we're looking at about 18-4 something in gross margin. What do you need in the way of price increases to get back to your 22ish gross margin level?

Well, it's kind of a mixture. What our problem is is that a lot of our product -- our old line product and we're probably getting as much money as we can get and still not have a real adverse affect on our ability to get orders. And that's not hurting our bottom line so much as the situation in Canada is, where we have the loss. That, and some of the other costs that we're incurring in new products is really what's hurting us.

So, it's really rather than getting a price increase in our existing product, which we will try and get some of, but that is not really the thing we have to focus on. It is getting rid of the losses in Canada, and getting rid of some of these other problems. And that will get our gross margin back up where it needs to be.

These problems you've talked about, one not having enough revenue or slowness in coming out of the chute or the launch site, if you will, but also is there some efficiencies yet to be gained in the production side?

Yeah, no question, particularly on those new products because we have the man power, in many cases, working that should be producing more product out the door than they are. Our efficiencies aren't really good. And that's the things that we're addressing. We are moving the company yet higher technology very quickly. And sometimes we get ourselves a little over loaded and it just takes us a little bit longer to work through it.

Like, for instance, the new air handling unit, we also in addition to bringing in the new air handling, it is the first time we built foam product down in our Longview, Texas plant. So we not only challenged them with a new product, but we challenged them with a new methodology for building the sheet metal on it.

And some of the same situation occurs up here, even though that we're in business, we've got two plants here. One on one side of the street and one on the other side. And we're now moving foam technology this quarter, this last quarter we moved foam technology over in to the western -- west plant as well as the east plant and so we had a start up situation occurring there.

Like I say, all of these things now are behind us. I won't say we've mastered them and we're up where we should be. But we've mastered them to the extent that we're running and we're working on improving the efficiency at this point in time.

When you look at your product sales, what percent are out of the new product category?

Oh, the percent is pretty low. What it is is the fact that we had counted on them in our talk with you and other people. We counted on them being something in this past quarter and they didn't turn out to be as much.

Back to your previous question about loss on Canada, we had about a 700,000 in the first quarter. We had 850 in the second quarter.

Okay. And you have three -- you're expecting, to the best of your knowledge, 3 plus million in revenue in third quarter and close to break even.

That's correct. So approximately $850,000 on the bottom -- or on the pretax line should reverse just by getting us back break even up there.

It would be nice. A little bit more on the backlog. Last time you have been willing to quantify it. Are you willing to do so at this time?

Yeah. Backlog has been holding very steadily in the low to mid-30-some million.

All right. And then, what's left in the way of CapEx for this year?

Well, so far our CapEx expenditures -- just one moment -- so far this year we spent 5,471,000 in CapEx and we've got probably another 4 million -- 3 to 4 million to spend in there.

All right. I guess that takes care of it for now, Norm, I guess. We wish you well. And to make sure we understand ourselves, you expect about a 15% growth in the top line third quarter -- over third quarter of '04 and possibly, if they shape up the same, for '05.

Right. The third quarter I feel pretty comfortable with that and the 4th quarter I feel a little less comfortable. But there's no reason not to expect it. It's just that in the third quarter I pretty well know it's there and the 4th quarter, I don't have that in hand yet.

All right. And does Kroger start shipping this quarter or --

We actually shipped a couple units. Didn't amount to a lot of dollars, but we have made a couple shipments to them last quarter. And so they told us when we were awarded the contract that they wouldn't get really serious with us until the latter part of the third quarter and that's probably true.

These probably are not what you would call their normal run, because they have to re-- they have to design around us . And so what we're getting is probably warranty type units or remodeling type units, repair type units or whatever you want to call them. Replacement units. That's probably what we are seeing right at this point in time.

All right. Well thank you very much.

You're welcome.

Our next question comes from Brian Baris with Baris capital management.

Hey, Norm.

Hi, how are you?

Great. On your CapEx just to follow up on that last question, how much of that this year is sort of one time for Sarbanes Oxley versus kind of an ongoing run rate?

I don't know that -- there's a little bit of software we're having to buy for Sarbanes Oxley, but Sarbanes Oxley I don't think is affecting much else of our CapEx.

Okay.

Just a moment, Kathy, do you know of anything else?

CapEx as far as Sarbanes Oxley is probably around 50,000.

Okay. So it is not material.

No, it is not a big number.

Okay. And then just to clarify, you had mentioned that you're moving your parts sales on to the internet. I guess just to clarify is that just the parts sales for your residential division, or are you moving all parts sales under the internet?

All parts sales.

All parts sales.

One of the biggest problems you have with part sales is they are very seasonal, and so when you get into the season like we're in right now, you're always having a problem staffing enough telephones and getting enough things to happen to give good customer service and then in the -- in the off season you end up with too many people.

Whereas putting it on the internet, it basically goes right past the order desk, if you will. The order desk is the computer -- is the internet and it goes directly down to the shipping department. It is much easier to staff a shipping department than it is an order desk.

Yeah, That's great. How much of your top line is part sales?

Well, we do about a half a million dollars a month.

Okay. Great. That's all I had. Thanks, Norm.

M-hm.

Again, ladies and gentlemen, if you would like to ask a question, please press star 1 on your touch tone phone. We have a follow-up question from Frank Maglen with The Robins Group.

Norm?

Yes, Frank.

Is there much left in the way of variation in your SG&A expense? You had a nice reduction from the first quarter, and I'm assuming that a lot of that was Sarbanes Oxley related.

Not really. Most of the reduction in the SG&A came about due to reduction in our warranty costs. We have had a very substantial improvement in our -- diminishing, or however you want to word it, in our warranty costs.

Okay. So that's moving very nicely in a good direction.

Yes, it is. Very -- it is one which we are all very pleased with. Sarbanes Oxley is -- there is only one way to say it. It is a burden, a big financial burden, that is going to be with us to some degree forever and ever as far as I can see. It is definitely going to be a significant cost adder to all companies, all public companies. And it certainly is a big cost adder to this company.

However, going forward then would SG&A of around 4 million be more in line for per quarter with that reduction in your warranty costs ?

We're hoping it will be. Two of the big things that we end up with out there are warranty costs and bad debt. And the bad debt has been more or less stable, and the warranty cost, everything that we know says it should go down because the biggest item in our warranty cost is compressor failures.

Compressors -- we warranty a compressor for five years from the time that the product goes into operation. And our percentage failure rate has been diminishing now for five years and it made a significant reduction this past year indicating two things. Indicating that we're applying the product particularly well, and the vendor from whom we're buying the compressor is doing a good job on keeping their quality up. And between the two items we just are having very very low compressor failures.

All right. Thank you, Norm.

M-hm.

Our next question comes from Greg Weaver with Kern Capital.

This has been covered, but did you give a sense on where we're going with the gross margin front on a go forward basis?

I did, Greg. The question was asked was long-term by Sidoti as to did I still expect 20 for the year in total, and I gave him an affirmative on that. I still believe that's a reasonable expectation.

So low 20s for the back half of the year is doable, but not -- pretty low 20s, basically right?

Yes, I would say that.

Okay. Thank you. M-hm.

Again, ladies and gentlemen, if you would like to ask a question, please press star 1 on your touch tone phone. Thank you. Sir, there are no further questions at this time. Please continue.

Okay. I'd like to thank you for listening. If there are anymore questions, please ask immediately, otherwise I'll be looking forward to talking to you again at the end of the third quarter, and believe that as I have stated here that we will have a pretty decent quarter to report at that time. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference call. At this time you may all disconnect.