Aaon Inc (AAON) 2006 Q2 法說會逐字稿

Good day. Welcome to today's AAON Incorporated second quarter 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. Welcome to second quarter report AAON financial statements. My name is Norman Asbjornson, the President. I have with me Kathy Sheffield, our Vice President and Chief Financial Officer and I'm going to have Kathy go through the numbers with you and then I will spend some time discussing the ramifications of those numbers. Before we get started, however, I would like to read you a forward-looking disclaimer.

To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the Safe Harbor Provisions of the Securities Litigation Reform Act of 1995. As such, it is subject to the occurrence of many events outside 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 10-K and the quarterly report on Form 10-Q. Thank you.

Kathy?

Good afternoon. We appreciate your attendance at our call, conference call this afternoon. I would like to go over the three months ended 6-30-06 compared to the three months ended 06-30-05.

I want to begin with the sales. Our sales increased $13.7 million, which was up 30.3% to $59.1 million compared to $45.4 million a year ago. Primarily that increase had to do with an increase in our commercial and industrial construction activity. Some of the Company's redesigned products that have been favorably received by our customer base and then also it includes some price increases that were imputed in 2006.

Our cost of sales increased $12 million to $45 million from $37 million, which was an increase of 32.4%, and was 82.9% of sales for the quarter that ended in '06 and 81.6% for the quarter that ended '05. Gross profit increased $1.7 million, or 20.9% to $10.1 million from $8.4 million. Gross margins were 17.1% at 6-30-06 compared to 18.4% at 6-30-05. The Company does continue to experience higher commodity and component costs and more recently, we've been impacted by transportation costs related to an increase in fuel costs, and Norm will discuss the gross profit in further detail a little bit later in the call.

SG&A increased $1 million, or 27.4% to $4.9 million, which was $3.8 million due to an increase in warranty reserve related to an increase in our sales, and then also an increase in sales expense. Operating income was 8.9% of sales, and then net income increased 10.6% to $3.5 million, or $0.27 per share compared to $3 million, or $0.24 per diluted share in 2005.

For the sixth months ended June 30 of '06 compared to the six months ended June 30, '05, sales increased for the six months, they were up 27.9% to $112.8 million compared to $88.2 million in 2005. Our cost of sales increased $22.5 million to $92.2 million from $69.8 million, which is an increase of 32.3% and is 81.8% of sales for the six months ended June 30, '06 and 79.1% for the six months ended June 30, '05.

Gross profit increased $2.1 million or 11.3% to $20.5 million from $18.4 million. Gross margins were 18.2% compared to 20.9% in 2005. SG&A increased to $9.4 million, or 8.4% of sales. This was an improvement of 9.9% of sales in the previous year. Operating income was 9.8% of sales for the six months ended June 30, '06. Net income increased 12.3% to $7.2 million, or $0.57 per share compared to$ 6.4 million, or $0.50 per diluted share in 2005. As we move to the balance sheet, you'll notice that accounts receivable increased $5.2 million to $37.6 million from $32.5 million at 12-31-05 due to our increase in sales.

Capital expenditures were $12.3 million and in earlier discussions on our conference calls, we've estimated our CapEx for 2006 to be between 14 and $15 million and the majority of that, we said would be expended in the first half of this year and it has been. We continue to believe that that estimate is an accurate one. You'll notice that on the revolver, we had a $2.2 million balance on our revolver due to heavy capital expenditures and the cash dividend payment. This will change considerably the last half of the year due to the reduction of capital expenditures. Accounts payable increased $4.8 million due to an increase in expenses related to the increased volume and timing of payments to vendors.

I would like to turn the call back over to Norm, who will discuss our results in further detail and discuss new products, our outlook for the remainder of the year and answer any questions you might have. Norm?

Okay. First of all, a little note on sales. Sales, you see, was considerably above our estimates and the estimates that were out on the Street.

That's largely attributable, as stated earlier, due to a very positive construction activity out there, but also not to be neglected at all is the fact that our two largest products, namely our RL series and RN series, which have been totally reconstructed into some of the new technology, led the way in that volume increase, meaning that it wasn't strictly a result of the market situation, but it was also a direct result of the things we did to redesign those two large products. On the other products, they were much more compatible with being growth about like the industry's growth was.

As we've said earlier, we maintained a pretty steady state on our Canadian operation and did not go out for additional volume. We have said all along that we were going to be in the mid 15 millions area, 15, 16 million, 14 million for the year, and that's the market we're running at.

Now, to talk about gross margin, first of all, we did not say anything about the Canadian operation because there's no real story to be told. It is, as we said, up in marginally profitable, so it's right at the break-even, make a little bit of money frame. It should continue along that way as we go forward. It's not going to be as dramatic an improvement on the go-forward as it has been in the past because we basically corrected a lot of fundamental issues and now it's more of a fine tuning, so it will become a more profitable entity as every month goes on.

On the other products, we had a price increase, as we told you back in November of 2005, and basically that entire price increase for the most part started rolling through in the second quarter. The first quarter it was not involved there at all and it started-- well, it barely got into the first quarter and it started showing up in the end of the first quarter, the beginning of the first quarter. By the end of the second quarter, of course, that price increase was virtually all present in--

In that time period, however, we had some really wild and dramatic cost increases on our copper. For instance, we entered the year with copper in the high $1 a pound area and in the first week or so of May, it hit an all time record high of $4.07. You say, well what's a dollar of copper mean to you? Well, it means that we use about 300,000 pounds of copper per month, so that dollar, 30, 40 cents it went up over the period of the first five months of the year meant that every month that we went by, we were costing ourselves 3 or $400,000, just due to copper alone. So commodities and component price increases still are bedeviling us.

They slightly outran our price increase of April-- I mean December 1st, end of November, December 1st of '05, and we put in another price increase in April, the end of April of '06. But that price increase just began coming into effect at the last part of the second quarter. If you were to say what took place in the second quarter, you would say our first month of the second quarter was a lousy month. The second month of the quarter was a so-so month. The third quarter-- or the third month of the quarter, second quarter was a pretty good month. Both on volume and on the bottom line.

It didn't all-- it didn't correct all the problem of the first month where we weren't seeing as much of the price increase, we weren't seeing a lot of the things we saw by the time we got to the third month. So we see the price increase falling through, moving into the picture, but it didn't move as fast as cost increases. Now, then, we did have another price increase beyond the April price increase. We had one in June of this year, and that one will not, unfortunately, roll through all the way to the bottom until probably October as our calculation about the second week of October we'll see it becoming a factor.

Why is that? Well, that's because we've added a stupendous order input and of course when you have a backlog, it's priced at the price it was whenever you took that order and our order backlog is moved up to where our total backlog at the beginning of this month and its working its way down now, but was approaching $70 million, which was by far an all time high backlog. It's not up that high right now, it's moving down because our order input has diminished as the price increases.

That's partially due to two things. When you get a price increase, people prebook orders to you, so you aren't going to get that at a later date because you already got it so they could protect their pricing, and the second thing is that we're getting into that part of the year and possibly the possibility of marginal slowdown in the very, very high activity rate in the commercial building market. But the net result is we are now building more than we're taking in in orders, so our backlog is starting to be reduced.

We do look for the second-- third quarter to be a very, very good revenue quarter, and we do look for the, all of the April price increase to be working its way through early on in this quarter. It should-- it was already showing up, as I indicated, in the last part of the second quarter, and it will probably be totally into the quarter pretty much totally into the quarter approximately right as we speak today. So the April price increase is going to start having an effect for most of the quarter.

The-- as I've mentioned earlier, however, the price increase that we had in June will not show up this quarter. It will show up in the first part of the fourth quarter. So that is kind of what is taking place. We've been raising prices. We've been getting acceptance on our price increases. Unfortunately, we're running behind the cost increases we're receiving.

We believe we've passed over that point about the second month of the second quarter. We think that somewhere in that timeframe our price increases started out running our cost increases. Time will only tell whether or judgment is correct in that aspect. If it is, and nothing wild happens in the last few months of the year, we definitely will see an improvement, not only in compared to last year, comparing revenue, but also the comparison on the bottom line should also start looking favorable.

Where is that going as far as what products do we have that are new and what's happening? Well, let me run down through that very quickly. We have an HB product, which is new. It's selling okay, but it's not significant on our bottom line. We have a CA product, residential thing. We've kind of let that sit by the side because we've been so overwhelmed with the other business, so it hasn't sold very heavily at all. The RN, which is our 26 through 70-ton product and the 45 through 230-ton rooftop and chiller from 35 to 365-ton has been where a lot of the increased volume as a percent compared to last year has been occurring.

We are seeing a faster and faster turnover into environmentally safe refrigerants, which we're totally ready to handle. We have got our internet sales up and working, the part that's working the best for us is our parts sales. We're selling parts on the internet, too. It is working for us better than the condensing units at this point, which are just being played with really on it.

As I mentioned, the new technology that we've employed in the larger tonnage units seems to be quite appealing to customers. The air handling units, which we haven't spoken a lot about, we're moving forward in that area, which will be a very large potential market for us and we have now pretty well prototyped all of the product which we have to to start moving forward and getting serious about getting ready for actually taking orders and producing orders. We would expect that by the end of the third quarter, we will be well into getting those things ready to go and in the fourth quarter, we should see some results of the air handling unit sales.

As mentioned earlier, the Canadian situation is now in a breakeven to make-money mode and we'll be continuing, we believe, to move forward. As far as where we're getting our orders, our continued effort with manufacturers reps has continued to pay off. They are now over 90% of our business as opposed to our direct sales to national accounts, which are less than 10% now.

The types of market that we're serving, the retail market, which was always been a very, very heavy market for us, particularly for the national accounts, has become lesser important percentage of our business. The office market, which had dried up in 2000 with the dot-com collapse, has made a reasonable comeback, and we are doing pretty well in the office building market. Manufacturing buildings, which had collapsed in the late 1990s seemed to have stabilized and made a modest recovery and we're doing pretty well there. Educational has been a very good market for us. That's probably our strongest market at this point and the bulk of the educational is kindergarten through twelfth grade or through high school. Medical continues to be a strong market. The rest of commercial business has been strong and then miscellaneous has been strong.

So we aren't seeing, as we were a few years ago when we were talking about the weakness in office buildings and the weakness in manufacturing, we're not talking about particular weakness now. If you made a comparison to many years ago, yes, you could still say manufacturing is weak, office maybe hasn't come back totally, but they are both looking brighter than they have before. As mentioned, we approached at the end of last quarter, we were approaching $70 million in backlog and we've worked that down a little bit, but it is definitely an all-time high and it is one of the reasons why it takes us a long time to implement our price increases because we've got all that pre-price increase business in the backlog.

That pretty well covers what I think needs to be covered. I'll open it up now for question and answers.

Thank you. [OPERATOR INSTRUCTIONS]. Our first question will come from James Gentile with BB&T Capital Markets.

Hey, how's it going?

Pretty good, James, and yourself?

Very good. It was nice to hear Kathy on the line giving the financials. The warranty allowance in the quarter, as a result of the higher sales, how much was that, Kathy?

Hang on just a minute, James. That was basically a little over $0.5 million.

Okay, and then with regard to the backlog, Norm, you mentioned it being around $70 million. That's almost 50% higher sequentially from the first quarter. I was wondering if you can perhaps give us insight into how much of that is price increase in terms of that 50% sequential growth and how much of that is volume.

Compared to last year's, it's probably somewhere in the 10 to 12, maybe 15% due to price.

Okay.

And the balance of it is due to volume.

And we're seeing, again, the larger tonnage R-series products making the larger-- making up the larger of the mix there?

Yeah, the percentage increase has been highest on the biggest tonnaged equipment.

And then your air handlers and chillers business?

Chiller business has been real good. What air handling business we've been in has been growing, but it's been a fairly modest part of our total sales and what I'm talking about now is we're going into the air handling business in a very serious way by the end of this year. We've, we've done-- established ourselves with what we have been doing for the past several years in the small tonnages. What we are establishing ourselves with now is all the way up through the larger units and we believe very strongly that we're going to assume a fairly significant market position.

If you take into account a stabilization of, $3.50 to $4 copper for the balance of the year, take into account the price, the June price increase taking effect into the second half, could you give us a sense perhaps of the level of gross margin that could be attained on this book of business?

If, if, there's a lot of if's.

Of course, but--

We got to keep saying if a couple times. But if the commodities stay stable and if our component pricings from other people, the motors and compressors and all don't get out of control, we could improve our margin into the low 20s very easily with what we've got in backlog.

So you were to argue the sizable variance, if copper wasn't already-- was already known, the bigger variance was the componentry, the compressors, the motors, et cetera?

That's correct.

Okay.

Everyone who is dealing with those is dealing with the same problem we are and just kind of like we are, they are pushing their prices through a little after the fact and so consequently that has become a major part of our cost increases, is the component manufacturers trying to get themselves back again and where they want to be.

Great. Thank you very much, Norm.

Okay.

[OPERATOR INSTRUCTIONS].

And next we'll hear from Frank Magdlen with the Robins Group.

Good afternoon, Norm.

Hi, Frank. How are you today?

I'm fine, and it's cool out here on the West Coast, at least for the time being.

Not here, it's not.

Well, I guess that prompts the question, does the hot weather stress out some of the older units and the replacement cycle picks up a little faster?

Yeah, it, does but it's probably not a real noticeable thing to us because basically we are structured more to the new construction and the planned replacement market than we are to the emergency replacement market, and couple of our competitors are more gearing themselves to the unplanned replacement market and not so much to the planned and not so much to the new construction. So they probably do better in this-- in that part than we do.

However, what it does do is it certainly points out the flaws of the wornness of their equipment and most of that equipment, when it goes down, is repairable and they put it back into operation. But they also say I've got to replace that before next summer. I can't have this happen again. So on that market, we will benefit from that market as we go through the balance of the year and into next year.

All right.

We did have, we did have some very significant ones where we have replaced entire shopping malls, walk-in, enclosed malls, with in excess of $1 million worth of equipment. We have done that this past quarter. So it has become a bigger thing to us, but it's a planned replacement, not an emergency replacement.

Okay. Three other questions. One, on the tax rate, it was a little lower I think than I was expecting. What's your guidance for the balance of the year?

It would be between 37 and 38%, Frank.

For the next two quarters. All right. Norm, what percent of your products that you're shipping now is with the new refrigerant.

I'm going to say something slightly over 20%.

Okay.

Most-- a high percent of our national account-type business, and these are people who sit down, as I think they do anyway, and study out the total ownership cost of a product that they buy, and a new one with the new refrigerant does cost slightly more, but they recognize they are going to own that 20 years from now and they still believe that thing is going to be up there running, which it surely should be if they take any care of it at all. And the cost of refrigerant, the R22 that's being phased out is going to be extraordinarily high probably in 20 years and so they may end up down the road there, if they bought an R22 unit, they may get to the point where they just decide to change the unit rather than put the refrigerant into it because it becomes more practical to do so.

And they may end up having to throw away, or may decide to throw away a unit that still isn't in bad condition simply because its operational maintenance is just too high to worry about any longer. So when you get to somebody who looks at it that way, they tend to change and so the national account people have largely changed and some of the smarter, more detailed lookers of the schoolhouse market or office building or whatever also are doing that change.

All right. Could you recap your price increases, and when I look at a 30% revenue increase for the quarter, how much of that was price versus volume?

Compared to a year ago, as I said earlier there, it's probably in the 10, 12, might be stretching it to get to 15% of that. I think it's more, without giving a good analysis, I think it's probably about 12%.

All right.

Compared to a year ago.

Prices are up 12, balance of the volume?

Balance is strictly volume.

And then, again, on the gross margin question, if we used your July, that gross margin, everything else staying stable, whether it's fuel or copper, seals, et cetera, components, then your gross margin approaches the low 20s?

Yes. If you just look at, as I mentioned earlier in the talk, if you look at the first month of the quarter, the second and the third, there's a noticeable improvement as we went through the quarter, because we started kicking in some of that price increase that started coming through, some of that April price increase.

We were totally, pretty much totally into the November price increase and the April price increase started happening and you could see it as a percentage of profit, any way you want to look at it on the profit side of it, you could see it improving as we went through the quarter. Needless to say, the first month of the quarter was not one I want to ever have again too much. I didn't lose money, but I sure wasn't proud of the bottom line.

And then, Norm, what is the cumulative price increase? If I take the November, the April and the June-- is that around 15?

Well, it somewhat depends upon the product mix because we price to where we were hurting the most and took a lot of things into consideration. If I had to guess what the mixture of the price increases that we've had, just this year, not counting the last November one, but just counting the April one and the one which we had in June, I'm going to say we were somewhere around 9, 9%.

Okay.

Maybe 10, somewhere in that vicinity.

Okay.

So we had a fairly significant percentage. If you look at the inflation index for the economy as a whole, we looked like we were just in a wildly inflationary pricing thing, but so were our costs, and so this industry at least has really got hit by cost increases and price increases as the year's gone on.

Okay. Thank you very much, Norm.

You're welcome.

And Andrea Sharkey with Sidoti & Company has our next question.

Good afternoon, Norm and Kathy. How are you?

Oh, fine, Andrea. How are you?

I'm doing well. Most of my questions have already been addressed, but just to continue on all the price, cost increases that you've seen, the component and-- copper and everything, I believe in your press release you mentioned a moderating environment of costs and I just wanted to see if that was correct to assume that as it stands today, things are at least kind of staying pretty steady or are you seeing things continue to tick up a little bit-- other cost increases?

Well, let's start just with copper and then with aluminum and then with steel, the basic commodities. The copper probably hit a high in May, I'm going to guess, of this year, somewhere in that vicinity. And then it went up over $4 and now it's back into the mid $3. And steel went up to the upper $0.50 a pound and now it's back down to $0.50 cents a pound. Aluminum, likewise, jumped up and it's back down a little bit. So the basic commodities have backed off.

Unfortunately, as I mentioned earlier, all the people that use those commodities are kind of like we are. Their pricing of their product is running behind their cost increases and so they are out there hammering on us with component, like motors, like blower wheels, like contactors, like wiring, like all the things that are someone's done something, value-added to it to change it from a commodity into a product. Those are the things we're having problems with in price increases at the present time.

But as a percentage, as a total percentage of our sell price, it appears to us that it's not as bad as it was in the first half. It looks like it's moderating and getting to be a less of a factor. And with the price increases that we have already put in and that are sitting in the backlog to be built yet, we believe those will cover all the cost increases which we think are going to happen to us while we build those units out and therefore we expect to see an improvement in margin.

Okay. That makes sense. And one last question. I was wondering if you could just maybe talk about your Wal-Mart business a little bit. Seems like, national accounts are certainly becoming a much smaller part of your business, but just wanted to get a sense of what's been happening there.

Wal-Mart is definitely a smaller part of our business. It, it was when we started the business, it was maybe 70% of our business, 16, 17, 18 years ago, and it is down to 7 or 8% of our business now.

Okay, and I believe on maybe last quarter or maybe the quarter before talking about you had gone to Wal-Mart with the price increases and I was just wondering if they had accepted that and what maybe their response was to that, if you have been able to get that through.

Wal-Mart is a tough buyer, first of all, and they are very fair people, very-- we have a great deal of respect for them, but they are difficult to get price increases from. We have gotten some improvement in pricing. It's much like it always is. It's not what we would like it to be, but it's to an acceptable level now. And that's perhaps hurt us a little bit with them in their volume. I'm not sure, because I don't know what they're paying other people for the product, but we have gotten a modest price increase out of them.

Okay. That's all I had. Thank you very much.

Okay.

[OPERATOR INSTRUCTIONS]. We'll now hear from [Gramie Rain] with Bears Capital Management.

Hi, Norm and Kathy.

Hi, how are you?

Hi.

Doing well. As far as CapEx goes, seems like last years have been pretty heavy investing in new machinery. Do you see that leveling off in the next three to five years, or is 12 to $14 million sort of a number that we should project for?

Depends upon what happens to our business. Last year we gave you a number that I thought was going to be very easily contained that we were going to do 13 to 15 million in CapEx this year and we still believe that to be true, and we said that we were going to front load that capital expenditure in the first half and we did do that. We expect it to moderate, but the one caveat we put with all of that is if we continue to have, in other words, subtract out the price increase and go strictly to the volume increase part of our increase in sales, if we continue to have real strong, total absolute sales improvement in the number of units, we will maybe go back up, but at this point in time, we think with what we have bought that it will be at least a year before we have to really get serious about that decision. So our CapEx will be a smaller thing next year and it will definitely be a much smaller thing for the balance of this year than it was for the first part of this year, and as I say, we spent 12 million and we still think 15 million is adequate for the year.

Okay, and with the addition of the smaller ton unit and also, the air wise up in Canada, is there any-- I mean do you anticipate sort of developing any more products, or does the product line you have seem to be mature enough to meet all the customer demands right now?

We don't see a significant need for a lot of products that we don't have. What we do see is that we could do a smarter job of making our present product line more attractive to our customers and perhaps a little more economical for us to build and still keep our quality up where it is. In other words, we think that some of our product line, the A, B and C box, which was the core of this company for a number of years, is basically been modified slightly for several times, but is still fairly much the product line it was when we brought it into the market in 1989.

So it's now 17 years old with some cosmetic and some functional changes occurring along the way. We think that we can go in and make a significant improvement technologically in that product line and make it more salable and more buildable, more everything, and so we will be redoing those kinds of products.

Okay.

But that won't change the basic product concept or where we're going. It's just going to give you an up to date product that we're selling there.

Okay. Thanks a lot.

[OPERATOR INSTRUCTIONS]. And it appears we have no further questions. Mr. Asbjornson, I'll turn the call back over to you for any closing remarks or comments.

Okay. We appreciate all of your interest. We hope that we've satisfied what you were expecting of us and going to work very hard to make sure we do as we go forward. And I want to thank you for tuning in and listening to us talk with you at the end of the next quarter. Good-bye.

That does conclude today's AAON Incorporated second quarter earnings release conference call. Thank you, everyone, for your participation. We wish you a great day.