Aaon Inc (AAON) 2006 Q1 法說會逐字稿

Good day and welcome to today's AAON Inc. 1st quarter revenue an earnings release conference call.

At this time I would like to turn the call over to Mr. Norman Asbjornson. Please go ahead, sir.

Good afternoon, Norman Asbjornson here with AAON. I'd like to introduce Kathy Sheffield, our CFO.

Good afternoon, welcome to our 1st Quarter conference call.

Before proceeding, I'd like to read our disclaimer. To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward looking and made pursuant to the Safe Harbor Provisions of the Securities Litigation Reform Act of 1995. As such, it is subject to the occurrence of many events outside 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 SEC filings, including the annual report on form 10K and the quarterly report on form 10Q.

We're ready to proceed with the review of the 1st quarter financials. The volume of sales were pretty much as were anticipated by some of the analysts following our Company. The profitability was higher than what they had anticipated. The reasons for the improvement in the volume of sales were as stated in the release this morning. Improvement in the commercial and industrial construction industry, the way in which our new and redesigned product are being received by our customers and, of course, price increases which occurred during the year 2005.

Canada contributed in the quarter, 3.3 million in sales. Compared to 2006 when they contributed approximately 2 million. Must note at this point because of the substantial increase in sales that you shouldn't extrapolate the percentage increase into the future quarters. It may not be a very indicative of the type of increased performance we anticipate for the rest of the year. We do anticipate sales to be over 210 million or in the 210 million area. So that as you can see will give you some idea of what kind of further improvements we expect.

The cost of sales going down through our financial sheets, the cost of sales, you'll note are relatively high compared to 2005. There are numerous reasons for that. Steel has still been proceeding up, copper has been going up rather dramatically. And there's been an increase in manufacturing expenses related to the following items. We've had increased costs on refrigerate, substantial increases there, insulation has gone up fairly dramatically, and shipping supplies, due to the increased in sales. We've also had a fairly substantial increase in depreciation due to the additional equipment we have been buying. Employee wages and benefits have materially gone up this year, this past quarter. And we, of course, have because of the increased volume we've had increased material handling and labor which has been reflected in there as well as a fairly substantial utility increase.

The gross profit as a percent of sales, you'll note is less than it was in 2005. Some of those decreases in the growth margin were due do the above items which I just named, our increased manufacturing expense and other things, but are significantly affected by continued problems in our Canadian operation. Both the low margin jobs and our labor inefficiencies of ramping up production. It should be noted that the last month of the quarter was a significantly improved month, but it did not overcome the significantly bad first two months. If we had removed Canada out of our profit picture all together, our contribution rather than at 19.4 would have approximated 21%.

On SG&A expenses, you note that we had a decline in that area. Most all of that decline is due to a decline in our warranty reserve. And most of that is due to the fact that we have a formula that was established with this--with our auditing firm to determine what a reasonable warranty was. And because of a diminishing of our warranty costs, it was determined that we were over warrantied in our reserve based upon our most recent history of actual warranty costs. So therefore, there was a decrease of approximately $198,000 in the warranty reserve.

In the form of the assets, we've had a fairly substantial increase in that of about 5.4 million, which was due to the purchase of sheet metal fabricating equipment. We are ramping up the equipment around here throughout the Company because we believe we have for the next foreseeable few years, a rather optimistic view of what we think we can accomplish and we don't want to be hampered by the fact that the machinery necessary to build product sometimes has a lead time of approximately 1 year, and therefore, we can find ourselves in a position of being able to build -- or to sell equipment that we can't build. So we have bought quite a bit of equipment and most all of that equipment is coming into the first half of this year and a substantial portion of it already came in the 1st quarter.

Accounts receivable, you'll note has increased, but that's pretty much related strictly to the volume. So nothing unusual to report there. Our liabilities accounts payable, increased again due to increase in our sales and the timing of payment to the vendors, no real significant thing to talk about there. Accrued liabilities increased 2.1 million, primarily due to the following. The sales, even though we had a diminishing of our warranty reserve, there we still did have some additional reserve put aside because of the increased volume of sales, but as a proportion it went down. We had a increase in our income tax accrual. We increased our payroll tax accrual. And that pretty much covers the accrued liabilities issues.

Our capital expenditures as mentioned earlier, we've spent nearly $6 million so far on sheet metal equipment. And as mentioned earlier, we will do a substantial amount more in the 2nd quarter. So the 12 to 14 million that we have announced we expect to spend in this year, most of it will get spent in the first 6 months of the year.

Contributing to the volume improvement we mentioned the fact that it was new products as well as redesigned existing products. So I'll talk about a little bit about that. We haven't had a lot of sales in some of these areas, but we do have expectations that they will become substantial sales source for us. We have designed a lower cost, small tonnage rooftop unit. The small tonnage rooftop unit as defined by ourselves is 2 tons through 5 tons. A very immense market with a variety of quality of products in it.

And we in the past have always sat on the top end of the quality and capabilities of that 2 to 5 ton market, and what we've done in this new product called an HB, we just moved a product in a little lower cost than what we've had in the past, so we've gone down into the higher volume part of that market a little further. We are a long ways from being down at the bottom of the market, which is the lowest cost products in that market. But we now have a bigger entrance into that market, which is a very large market.

The redesign had some issues which we brought in that we believe are state of the art and that are going to be a requirement by federal mandate, state mandate, and customer requirement. One of the most significant is the fact that this type of equipment, the rooftop of which I'm speaking and the air handlers, anything moving air has not had any requirement for the insulating value of the cabinet. And the industry has had very poor, poorly insulated cabinets. And we have chosen to think that there are -- there is a market out there and that the regulators are going to come in and force an improvement of the insulation value of their moving products, and we want to be there before that starts occuring so that we can participate for those people who are concerned about it, as well as not get caught by some regulatory demand that it be improved.

So toward that line, we have designed a foamed panel, which has an insulating value, roughly twice as much per inch of thickness as does fiberglass. And that's a-- in some cases, we have product that is not just a few percentage points or something better than the competitors, but we may be talking 4 or 500% better than some of the equipment that's on the market. So it's a significant thing. As I say, we're anticipating that this is going to be a requirement, not only by the customers, but by regulations, as well. We are there on a significant percentage of our product and we are in the process of getting the rest of our product to meet that same code.

The other issue has to do with energy efficiency of manufacturing of the heating and the cooling and the moving of the air. If you think about it for a one moment, you'll realize most air conditioners only run at maximum capacity for a very brief time of the year. When it's maximum load on the unit and the rest of the time they're operating at a reduced capacity. The net result of that is, is that the air moving device movement of air is pretty constant on most equipment and so it's consuming the same amount of energy whether it's producing a lot of cooling or just moving air.

The net result of all of that is is the air moving device becomes in many cases, many parts of the United States the dominant energy consumer is the air moving device and not the cooling device. And the way our energy is measured in this product, it's measured at maximum cooling with the cooling all on and it has to perform at a certain level of efficiency. It doesn't really measure what the thing is going to do throughout the whole year because if the air moving portion which when it's fully loaded is a relativity small value. If that is a significantly larger value for some people than it is for us, our unit will have a significant advantage in total energy consumed even though at the full load condition it may have a less of a percentage improvement.

So this is geared toward total energy consumption, not just a single point which the industry is measured at the present time, which is maximum cooling. So, again, we're trying to be in the forefront of where we believe the industry is going and things that are going to happen to it, and we want to be there and done. And in that area, of course, we know for sure that environmentally safe, refrigerants are going to have to happen in our industry, and it is already been agreed to by our government and rules and regulations are inexistence that tells us the phaseout of various refrigerants.

The refrigerant which is used in the air-conditioning industry is typically one which is designated by a nomenclature of R22. And that is not a terribly bad refrigerant, but it still does have a negative aspect to the environment. And therefore, will be removed from new products in the year 2010, and will be removed by the chemical companies from manufacturing in the year 2020. It has already been mandated that it be 35% less beginning the first of last year, from the benchmark year of 1999, so it is already in the phaseout mode.

The refrigerant which has been more or less agreed that -- between the chemical companies and the manufacturers is going [surplant], most if not all, of the R22 is a refrigerant category, categorized as R410. We have as we've reported before, totally redesigned all our products to accept R410 in approximately 25% of our business at the present time is going R410. We anticipate that even though the deadline for us to cease manufacturing equipment is 2010, that consumers and others are going to demand a quicker phaseout of R22 and we're ready to go at any time, we could convert over with very little notification to 100% of R410. So that's just to point out something we started doing way back in the 90s. Getting ready for that conversion, and we were totally done and ready for it in 2004. Well, we're doing the same thing on the phone panels and on the direct drive more efficient air-moving device.

In the sales event area, we have had a series of years, which has ended about 2005 maybe started to end in 2004, but we had some from 2000 on, that were kind of flat years for the commercial and industrial heating and air-conditioning industry, primarily due to two things which occurred. The first of which, was the failure of the.coms in the year 2000. Which meant when they failed they emptied out a lot of office space and therefore the office building market dried up. That was a very significant market for the commercial heating and air-conditioning industry.

The second one has been the movement offshore of manufacturing facilities, factories. And that occurred somewhere about in the same time element. So of the five or six major categories of commercial and industrial buildings, two of them had a significant downturn, starting in about 2000. And it affected the market up until about 2004 pretty, pretty seriously.

Along with that, everybody became more competitive and particularly after any large volume type business, which national accounts are the predominant source. So national accounts have been a pretty vicious price market for the past several years. And when it got too vicious, we have backed away from that and let somebody else have it when the -- when there was no profit to be made. And therefore, where as in our initial beginning as a Company, we were relying with 90 almost 100% on national accounts, we're down now to where we're relying on them for around 10% of our business. So we broadened our customer base immensely, and while we still want national accounts very badly, we're not seriously dependent upon them.

Our source of our growth to offset this change in customer base has been our manufacturers representatives, and independent commissioned sales force throughout the United States and some distribution nationally-- internationally. But most of it has been domestic. And they have come to the floor very nicely, and given us growth through this time period. We feel we're a much better balanced Company that we have ever been in the past, and we feel we have our sales operation in very much better condition, going forward than we have ever had it in the past. And we're now prepared to go forward.

To kind of wrap up some of those categories of major customers, the retail is kind of flat, I would say, and it's very, very competitive. Manufacturing construction has, after going backwards for a number of years has reversed direction and has started a modest improvement from a much lower base than it used to be at.

Educational and medical, both of those have had considerable growth throughout this time frame and continue to have good growth. The office building market has started rebounding, so it has come around quite a bit. And then there's a category of just other, which is anything not fitting in the above categories, and that has been a pretty strong market for the past several years. So in total, the sick ones have either stopped going backwards, or have in fact, began improving. And the other ones that had been good all along continue to be good. So our market outlook is pretty good at this point in time.

Current backlog as of December-- as of March 31st, was 47.6 million. The outlook for the remainder of 2006, well, I told you what we were doing in the buying of equipment and nobody around here ever tells me I buy something just to sit and look at it. So I expect the machinery is going to go to work, and the only way it's going to go to work is that we get enough orders to make it functional. And so I would say we're optimistic for the balance of 2006. I thank you for listening to me. I'm opening it to questions and answers. Rachel, if you'll open it up, please.

Yes, thank you Mr. Asbjornson. [OPERATOR INSTRUCTIONS] We'll take our first question from [James Gentile] from BB & T Capital Markets.

Hello, [James Gentilia] BB & T Capital Markets. How are you doing, Norm?

Hi, James, good to talk with you again.

Definitely. Was wondering, I have a couple of questions. Could you split the revenue growth, it was about 25% in Q1. Could you split that out between price increases and volume increases?

Yes, just as a rough number, I don't have real hard numbers, probably about 11% of it was cost increases and the rest of it was in volume increases.

Great. And you commented on the -- on the lower tonnage, I think it's going to be called the HB product, am I right with that?

That is correct.

And in it -- it seems like that's, kind of a deviation from your larger tonnage semi-custom expertise, could you kind of give us an idea of A the size of the market, B, when we expect to start shipping some of those smaller tonnage products?

We began shipping the product last summer, and it was beginning shipping because we had to establish a new production line, we had a whole new product, and we didn't want to go in real fast in case we had some remedial things that we might have to take care of. And fortunately, they were minimal, so we really didn't really have a big issue, and as we've cranked up the volume our concern about warranty problems has been diminishing rather rapidly.

The market is probably an additional close to--in the rooftop business, close to -- it's pushing up toward $1 billion of additional volume that we were really not in position to take care of with our previous product line. Now, we're not going to take all of that and include that into what I'm saying that we're geared toward, as I said, we moved down further into it. How far down into it did we move? Good question, I don't really have a good answer.

I have a feeling I think we picked up a potential marketplace of maybe 300 or $400,000 worth of it, depending upon how well we can sell some of the ideas and some of the innovations that we have in that new product. Which incidentally is a foamed product, it's a much better cabinet than what they're accustomed to in that product line. But we're still pretty competitively priced. And we also have a number of other innovations in that product which will do things like humidity control, energy management, and things that are not possible with a lot of the product that's out there today.

And how -- are you using your independent distribution channel for the sale of this, I imagine some of the -- your core customers wouldn't be, uh, appropriate for this type of product.

We're using the same people. Here is what was happening many times. And let's say that we're looking at a schoolhouse. Because of our ability to control humidity, they would buy some of our product to control the humidity for the whole job, and they would feed the whole building all from our units, because we have the ability to control the humidity, and then they would buy some of this less expensive equipment to control the temperature. And so we basically had part of the order, but we didn't get all of the order. And so we think that now we have a much better chance of getting a larger percentage of that business, which we were just basically having to forego because of the cost. And we think we've got enough cost out of our product to avail of ourselves in some of that market.

Great. And what's the average cost of a 2 to 5 ton unit?

Oh, somewhere in the 1,000 to $3,000 range depending upon what options you put on it.

So we're still talking like 2, $300 a ton of cooling, right?

Yes, really more like 3 or $400, and if you add some stuff onto it, it might go to 500. But it's, it's less than our previous product line was in that tonnage range.

Okay. And then just one other question with regard to some of your other product lines that were quote unquote new over the past couple of years, air-handlers and water chillers. How much of the $53 million in quarterly revenue was derived from those types of products?

Well, air-handlers, these-- I don't have good solid numbers, but I have a pretty good feel for it. The air-handler portion of the business in the last quarter probably amounted to somewhere around 4 to 5 million of it. And the chiller market probably was in the vicinity of $1.5 million of it.

Are those faster growing as a percentage of a larger tonnage unit if you look at your entire portfolio today?

No, those are more mature markets.

Okay.

And so they're not growing really fast, it's just that our product line that was a part of the marketplace we were kind of ignoring, we didn't have product for it. And the way we build product it was an easy deviation to go off into the air-handler or the chiller market because, for instance, in the chiller market, we basically used part of-- the major part of the rooftop product and just added a different type of heat exchanger, and we had a chiller. So it wasn't like we had a lot of the development work or anything to do to get there.

Got you.

And consequently, we did some things that are different than the rest of the people did. We offer pumping packages, which maybe permit them not to have a mechanical equipment room in the building, so their 1 or $200 a square foot building doesn't have to be used up with mechanical equipment. We can put it in a less expensive container with the chiller outside, and we can also put boilers in there. So now your mechanical equipment room in the building is nonexistent. We can prepackage the mechanical equipment room at a less cost, and we believe a better product than what you could put it together in the field. So we give them both the product that we think is an improved product, at a lower cost. So it's not something that hasn't been done by the industry before, it has by the custom manufacturers, but none of the production manufacturer have done this. So we're set up in a production line environment to do it, which drives our cost down, and to the extent that there's a market there that is looking for that, we're in place to supply that market.

On the air-handlers, the air-handlers really is just a portion of our rooftop unit, only just configured with different sheet metal. So we are a sheet metal fabricator, that's basically what we're all about for a large part of it. And so it, again, was a very natural deviation to -- into that market.

Would you be interested in growing your air-handler chiller market through acquisition?

For the right acquisition, yes we would.

Okay. Great, thanks.

We'll take our next question from Frank Magdlen from the Robins Group.

Good afternoon, Norm.

Hi, Frank, how are you today?

Very well, and a very nice quarter. I have a couple of questions. The real simple one is what should the tax rate be going forward?

I'll deviate to Kathy on that one.

It will be somewhere between 37.5 to 38, Frank.

For the balance of the year?

Yes.

Alright. And then Norm, in Canada, if I understood you right, that that cost you about 850,000 to 860,000 of gross margin? Or does that just, you said it would be--?

No, we had 400 and some of bottom line, 423,000 of pretax loss up there, and basically that loss occurred in January and February. We've been telling you that we're heading for a turn around and in March it pretty well turned around. It -- pretty well quit the loss. And looking forward as near as we can see, it isn't going to be a solid profit center at this point in time, but the loss days look to be pretty likely to be behind us for the most part.

It isn't to say we might not have a lost month or something, but in total we're optimistic about the rest of the year of having it out of a loss column, and hopefully, we some--have some reason to believe that we might have a profitable year for the balance of the year up there. Recognize we had to bring that thing a long ways from when we bought it. And it's been a painful journey, and so we're not feeling real comfortable with where we are, but we're very optimistic about where we are, if you can understand what I'm saying there. We think that we got it cured but I'm not going to bet my bottom dollar that I got it cured.

All right. But you--say you had about 3.3 million in the 1st quarter of revenue.

Right.

And going -- for the year you're looking at maybe 15?

That's correct. We're trying to hold a monthly revenue in about the 1.3 million, 1.4 million Canadian, maybe 1.5 million on an upside. And as we get a comfort feeling that all of the things that we've been doing and all of the people in the education that they've received is -- are pretty solid and in place. We can turn the volume up rather quickly. But as you know, if you're losing money, all you're doing is turning the loss up. Which is not my desire, so I want to make sure I'm turning the profit up, and not the loss.

So you think alike with most investors that's good, Norm. But on the--your comment earlier about the-- your gross margin was about 19.4, and you said Canada cost you and it would have been approximately 21%, does that mean without Canada or what did--?

If I had removed Canada from the equation we'd had been about 21%.

Okay. All right. And then, can you help us a little bit in the backlog. How much of that now has the new pricing and I think you raised prices about 11% last year and another approximately 5% was announced for this year. I'm assuming that price increases are sticking, I see a lot of other people in the industry following your lead or you're following them, whoever wants to be the bad guy, it doesn't matter, but how much of that -- where are you in working the price increases through the backlog?

Okay, I've got 11% that I told you about last year. Approximately 4 to 5 of it, about 4-- yes, somewhere around 4 probably of it was initiated in the latter part of November and early December. And that didn't get shipped out last year, it just went into the backlog. And so it's -- didn't even get out of here in January and February. Basically, most of it got out of here in March, although there was some go-- went out earlier, and most of it is out of here now, so that what I'm saying is most of that last price increase in the latter part of last year is now happening in all of the product that we're shipping today or did in March, actually. And there may be a little bit of lingering old price business that we're shipping in April, but it's very minimal.

We have inaugurated another 3 to 5%, which they have 30 days after we announce the price increase to get their orders in because we give that much protection to a quotation to the customer. And that time element on that runs out on the 29th of this month. So we are still taking last -- that price increase that we put in in November of last year, it's still what's coming in the door at this point in time and will until the 29th of this month at which point the new 3 to 5% increase will start coming in the door at that point.

So that means our backlog will basically be at the price level of the last price of last year and that's for the most part, what we're going to ship in the 2nd quarter. And what the price increase that we just announced for this month is really going to be the end of the 2nd quarter and the beginning of the 3rd quarter. And so it goes.

Then it would be -- are we looking at then gross margins now, closer to 21% for the 2nd quarter?

I think that's a reasonable expectation.

Okay. And then hopefully, the price increases going forward are enough to maintain that margin as we see copper up a little bit and everybody else trying to get their margins, up as well.

Yes, we're all faced with the same kind of a problem, certain cost increases are still pretty rampant, particularly in the world of copper right now. And so we are not in a noninflationary market, we are having to overcome that inflationary aspect and try and improve yourself beyond that. And so it gradually is going to creep up, but it's not all going to fall to the bottom line for sure.

Okay. And then one last question, in SG&A and the warranty reserves, and you explained how you're down about $189,000 in the reserve and that flowed through, is most of that improvement over with then?

Well, I hope not.

Okay.

We have been, we're on a three year reduction in our most costly item, which is--we give a five year warranty on our compressors, and we have been diminishing our warranty as a percent of our sales for three years now, consistently. And I don't know how far down I can go because right now whether it's due to our supplier doing a much better job of building the compressor or our doing a better job of applying the compressor, I'm tending to believe a little bit of both. We are now having failure rates that are at levels that a few years ago were unthinkable to get to that low of a level. And -- but it seems like we're still able to go down, so I'm hopeful that's going to continue down.

The other thing is, every year we've improved our capability, people capability around here of doing things correctly and not making mistakes that cost us. And I believe we're still improving our capability and will for some time to come. So the mistake type warranty cost and our biggest single component failure cost, both are improving, and I look forward to further improvement in both areas.

All right. And what's happening to your head count as you add the new equipment?

Well, it's not going up proportionally. It is going up, but the -- there's two things happening. One, the equipment that fabricates sheet metal is more efficient than it was, and it was already very efficient equipment that we were buying. And so the cost of constructing a sheet metal part is minimal, or minimized because of the capital we've put into the equipment.

The assembly and the rest of the labor throughout the Company, we have gotten smarter, the longer we've been here and I wouldn't say the people are working so much harder as they are working smarter. And we think that we still know how to improve ourselves in that arena. So we have not been increasing our labor content directly with our sales, I guess is what I'm saying.

All right. Thank you very much. And that was a nice quarter.

Thank you.

[OPERATOR INSTRUCTIONS] And we'll take our next question from [Unidentified Speaker] from [Bears] Capital Management.

Hey, Norm.

Hi.

How's it going?

Good.

Quick question, I was hoping you could provide a little bit more detail on the Canada operation as far as what kind of problems you're still running into and if you've kind of resolved a -- the cost analysis for your sales approach, if you're going to go through distributors or use your own people?

Okay, well let's take Canada first of all. As you probably are aware we bought that operation out of bankruptcy and it had a very low backlog, so we had to get orders in house, we had to hire people, ramp up, and we-- because one of their problems was their facility, a leased facility, we moved them into a facility that we purchased, we had to renovate that and everything. So there are a lot of issues that we've had to deal with. Basically the strong part of their company in our estimation was the fact that they had a very good reputation of building a quality product that was a good product.

So we did not have to deal with product problems, what we had to deal with was business functional problems. And the biggest one we could see was the fact that because they were quite a small company, they didn't have much in the way of reporting systems, they didn't have very good informational systems, and they didn't really have a good way to tell what was hurting them and what wasn't and so on and so forth. So we had to put our software systems in place. Which we thought we would do much faster than we did, but we got kind of waylaid by Sarbains Oxley that made us stop doing anything to run the business and concentrate strictly on meeting Sarbains Oxley requirements as opposed to running the business. And so that put us at a deficit of about six to nine months before we -- that we didn't anticipate having to spend doing that. To the extent at least that we did.

So last year, just about this time, we finally got the software up to where we could see pretty clearly, some of the problems were. And up until that point, there was always debate going on between the people who were working there and our people and even within between everybody, as to where the problems were, because we didn't have a firm handle on costs of everything. We got a lot of parts that go around and so, unless you've got a good system, you can kind of gut feel where your problems are and everybody's gut felt a little different, I guess. And so we didn't really attack the problem as intelligently as we could. And like I say about this time last year, we started getting a good clear picture of it, and then we knew what we had to do.

But between knowing what you have to do and getting it done, was what took up until about the third month of this year. And the biggest problem there is that we took a lot of business at prices we shouldn't have taken it at. And consequently, we had a backlog that was priced lower than it should have been priced. And the net result of of all of that is we had the choice of either trying to get rid of the backlog, which would have been very offensive to our customers, we didn't care really to anger them. So we went ahead and built the product out even though we did have a good price product to build. And that went on through February of this year, and in March we pretty well were out of that badly priced product. So this time last year, we pretty well knew where our problem was and it took us until 1st of March roughly to get rid of the problem.

And now, the pricing of our backlog we feel is in pretty decent shape, it's not as high as we would like it, but it's it's reasonable. It's at a level that should make us some money. We spent most of our effort on the material and the pricing and now what we're spending our effort on is educating and getting the people to work more efficiently. And we still have a long ways to go in that area. The good thing about this is the fact that we believe we're pulling it into profitability, and we don't believe it's run well right now. We think we've got a long ways to go to really get that thing running well. What the good thing of that is, it says that once we get there, we should be making good money at it. And that's the positive. The negative is the fact that we still have a ways to go.

Earlier you mentioned the polyurethane foam insulation products would soon be almost a requirement by your customers in a regulatory environment. Do you have a time frame of when that might start being phased in?

Would you repeat the first part of that again?

The polyurethane --

Oh, okay. Yes. It's, you mean, the foam --

Insulation.

Insulation.

Yes.

We phased it in about a year and a half ago into our very biggest product line, about a year ago -- not quite a year ago, we phased it into our next biggest product line, last summer we phased it into the new HB product line, starting last fall we started phasing it into the air-handler product line. Probably sometime this summer we will have all new product line in air-handlers that we have never had before, and it will all be foamed sometime between now and fall. And then we've got three more boxes to do and the first one of those will be done probably about a year from now. And the other two by the end of 2007.

Okay. And it looks like in this quarter you bought back a fair number of shares, is that going to continue going forward?

No. When we announced the dividend policy, we suspended, we didn't curtail, and we didn't say we wouldn't buy shares, but as a policy, we are not right now buying shares. We are now buying capital goods and we are getting ready to pay dividends.

Okay. Thanks a lot.

It's our expectation that at some point in time we will go back to buying shares.

Okay. Thank you.

And we'll take our next question from [Scott Sullivan] from Smith Barney.

Hi, congratulations on a good quarter.

Thank you.

Quick question. And I apologize if you've already gone over this. But did you talk about expenses related to [Sarbuck's] compliance?

No, I didn't talk about that. There's a lot of ways to look at that. And in our annual report, which is in the process of getting mailed out at the present time, we will give you a number of 1.4 million that we've spent over and above what we would normally have spent on auditing fees, on hiring people to help us change some of our software, on additional people in our department to perform the functions that we're required to perform now. It basically is a pretty broad brush thing, it requires you really to put more personnel on in your company. To perform all of these functions and as well as basically hire at substantially more money, auditors to do substantially more than they were doing in the past. So these numbers that 1.4 million is not going to disappear, it's going to diminish somewhat, but not hugely.

The other side of that, if you got into it, which is one that's much harder to quantify, I told you earlier that we quit running the Company in some respects for about six to nine months, that had a cost, that had a big cost on Canada. We lost a lot of money up in Canada because we couldn't address the problems when we should have addressed them. It had some effect on some of our other things, how much was that? You could, you could sit here and speculate but I can tell you it was big numbers. And that will not happen again, hopefully they don't change something that puts us in that predicament again, but it's been a very costly endeavor.

I can respect that. Going forward for the next couple of years, what areas do you see the most leverage for your business going forward?

The fact that basically one of my, as you're probably well aware, I'm not a youngster anymore, and I know that father time is going to take care of me over time here, and one of the benefits that I have is the fact that I am of an age with a lot of experience, and so what I'm doing is I'm setting this Company up for a long term, hopefully, not necessary to have a lot of vision of the future because a vision will be already implemented, and that's what we're doing. We're implementing vision with new products with foam cabinets, with more efficient air-moving devices, with more efficient cooling systems, with better control systems, with the state of the art sheet metal fabrication, with putting the buildings together the way they should be, with setting up our production lines, all of these things have been ongoing now for the past few years. And that's what I'm more or less has set as a target for myself is when time does say it's time for me to be gone, I don't have to walk out thinking I leave a job half finished.

I want to go out knowing that I've set the wheels in motion so if they just do a reasonable job of management, the Company will progress and will grow simply without any great vision or any great new products or anything like that. All of the products and everything will be in place and everything will be more of a general management challenge rather than knowing where to go to make the world work. And so that's what's undergoing right now. And we're probably at somewhere the two thirds to probably close to three fourths of the way there at this point in time.

That's terrific. And one last quick question, you may not be able to answer this, but given some of the constraints being a smaller company when the new cost structures hindrances of the [Sarbucks] and the like, would you be better suited as a private company in your opinion?

Well, that was a question that we all had, the Directors I say we the Directors, had that as among other alternatives and so we went out searching and had that as an issue here here about a year ago now. That we went out finding an investment banking house type of organization that wasn't really an investment banking house. But was consisting of people who thought in that fashion and would give us good analysis of our Company and what would be the best place for us to be.

And they came in, studied us, gave us the pros and cons of going private, of selling out, of buying other companies, everything we could imagine and they could imagine we discussed the pros and cons of. Definitely going private had some possibilities, somebody would have to lead that issue. And if you did that, you were going to give up this getting ready for the future, because you were going to spend your money on going private rather than getting ready for the future. And from my perspective, I thought we better stay where we are, we can afford it even though it's hard. It's not something that's good, I think it's very detrimental thing to our society, I think they could have done a much better job in law-- by doing a few things differently, but I'm not the one who wrote the law. And consequently, in looking at it, it looked like it was better for us to will live with it and stay where we are for this Company at this point in time.

Terrific, and again congratulations on a job well done.

Thank you.

[OPERATOR INSTRUCTIONS] And we'll take our next question from [Brian Bears] .

Hey, Norm.

Hi.

I know it's not something you probably like to dwell on too much. But going back to your last comments about sort of the succession planning, do you have a lot of confidence in the managers that report to you and can you talk a little bit about how those issues are approached within the Company?

Okay. Yes I have a lot of confidence in the people here. I think the Board of Directors has had a lot of concern with what's going to happen when I'm no longer here for whatever reason. And so there's been a lot of studies and a lot of planning and a lot of discussions, and the Board has been involved with looking at the people who are here and seeing what the capabilities of those people are and being able to evaluate them. So at this point in time, my belief is that pure management to this Company is already in place.

If I were not to get out of my chair right now, the Company would not be in bad stead from a pure management standpoint. And I think most everyone, because we do this in a very open environment, as far as talking about where we're going and how we're going to get there and what we're going to do. They understand where we're going, and they probably would fill out that last 25% to whatever it was I mentioned here that isn't yet done, and maybe they wouldn't be as aggressive and everything as I have been, but I think that Management would carry this Company on very capably if I didn't get out of this chair right now.

Well, thank you, Norman, we--

So I feel very comfortable in thinking that we've done a good job in that area.

We appreciate your candor, thanks, Norm.

And Mr. Asbjornson it appears we have no more questions at this time, sir. I'd like to turn things back over to you.

Okay. Thank you very much for participating in our discussion, I hope it's been informative, and that I've satisfactorily answered your questions. If you do have any others, feel free to call me, I'll be glad to talk with you about it whatever they may be. Have a good day, and talk to you next time here in about three more months, bye.

That does conclude today's conference call, thank you very much for your participation and have a wonderful day.