Aaon Inc (AAON) 2006 Q3 法說會逐字稿

Good day, and welcome to today's AAON Incorporated third quarter earnings release conference call. Just as a reminder, this call is being recorded. At this time, I would like to turn the call over to Mr. Norman Asbjornson. Please go ahead, sir.

Good afternoon. Prior to moving forward, I want 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 Securities and 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, or the quarterly report on form 10-Q. I would like now to introduce Kathy Sheffield, our CFO.

Kathy?

Good afternoon. Welcome to our conference call today. We appreciate your attendance. We will first review the third quarter results. The third quarter results ending 9/30 of '06.

The Company had an outstanding sales quarter, with revenues increasing $16 million, from $48.136 million, to $64.153 million. Our gross profit margin increased from 18% in 2005, compared to 21.2% at September 30, 2006. That increase was aided by improved pricing and Norm will discuss the margins in further detail here in a moment. Operating profit was 11.9% of sales, compared to 8.8% for the same period in 2005. And that was a change despite an increase of $1.5 million in SG&A expense. Our pre-tax earnings increased $3.3 million, from $4.4 million, to $7.7 million. Net income increased $2.6 million, from $2.8 million, to $5.4 million, or $0.21, from $0.22 per share, to $0.43 per share for the quarter.

The results for the nine months ending 9/30 of '06, revenues increased $40.6 million, from $136,310 [sic - see press release], to $176.910 million. Gross profit was 19.3% for the nine months ended 9/30 of '06, compared to 19.9% for the same period in 2005. Our operating profit was 10.6% of sales, compared to 10.3% for the same period in 2005. Our pre-tax earnings increased $4.6 million, from $14.5 million, to $19.1 million. Our net income increased for the nine months, $3.4 million, from $9.2 million to $12.6 million, or it increased $0.28 per share, from $0.72 to $1.00 per share.

Our balance sheet continues to remain strong. Our current assets were $81.1 million, and our current liabilities were $47.3 million. At the end of September, we had $6.5 million on our revolving line of credit. Primarily due to the increase in receivables, our inventory, and our capital expenditures. We do expect most if not all of our debt to be eliminated by the end of the year.

I would now like to turn the call over to Norm who will discuss the quarter and nine month results in further detail.

Okay. Sales were, as Cathy said, largely influenced by a very healthy economy, as well as new product lines that we have introduced, as well as the fact that we have had price increases. At this point in time, it looks promising that the balance of the year will be pretty much just influenced by the seasonality of our business, which is always that our second and third quarters are strong quarters, and the fourth and first quarters are a little weaker due to the colder climates, curtailing building activity in the northern part of the United States.

Gross profit has finally reversed. We have been having very regular price increases, so has all of our material costs and component costs been going up very regularly, too. We had a hard time getting ahead of it with our price increases outrunning the cost increases, but we have finally managed to achieve that. On that regard, the last price increase we had was at the end of June, and some of that started shipping during the third quarter, but not all of it. So the bulk of what is shipped in the third quarter was due to price increases that occurred earlier, either in November last year, or in April of this year. So we still have some increase in price increase to be reflected yet forward, going into the fourth quarter, which should at least balance off and possibly gain us a little bit over the cost increases we anticipate happening in the fourth quarter. How does this sustain it? Well, no big secrets, we've got to be doing what we're doing right now in the third quarter to keep the profitability improving, and the volume going up.

We're doing a lot of training of our sales force because we believe that our weakest part of our operation right now, even though it is a wonderful group of representatives, we believe our capabilities internal to the factory have now gotten ahead of our sales efforts, so we're putting more efforts into training our sales force, and managing the sales force better so that we can sustain the growth that we're heading into. 30% is as you probably know if you're following this industry quite a remarkable number and is not really long-term sustainable on a regular basis. However, as I've indicated before, we do believe we've got a 15 or possibly a little bit more going, some years and some quarters, we will exceed it, as we have this year, and some times we will not do so well, as we have in more recent years. But at this point in time, we don't see a lot of the clouds on the horizon to slow it down.

There are three indicators that we kind of follow to see what we think is happening. One of them, the first one is somewhat negative. And that is housing starts. The next one has to do with the activity level we believe is occurring at the specifier level, which is in our case the consulting engineer. That seems to be very strong. It does not appear to be weakening at this point in time. The third thing is the closure rate on contracts so that you can get orders. We have seen some slowdown in that. But I think most of it is what the merchandise people would call sticker shock.

Everything about building a building has gone up very rapidly here for the past few years, and I'm sure there is a lot of people that anticipated the building costing them less than they're finding out that it is going to cost. We do believe from what we're seeing that if they make maybe some adjustments to the building, maybe some adjustments in some other fashion to their budget, but we believe most of those buildings are going forward, so we don't believe that it is a real detriment to our ability to sustain good business environment in the commercial and industrial market.

The thing that we're seeing on raw materials is a stabilization at a very high -- much higher level than it was a few years ago, but it seems to be balancing out now with the steel not having any noticeable trend, either up or down and the same thing for copper and aluminum. They might go down a little bit, and then they come back up again, or vice versa. But we can't see any noticeable trend. The only noticeable cost increase we do continue to see is the fact that a lot of component manufacturers who were like we were, caught behind the curve on raising prices are still trying to raise prices for components. So they're is some inflation in the marketplace, and like I said, part of our price increase is still to be reflected in our sales and so we think that we got enough to balance out any cost increases we are going to experience in the fourth quarter. And possibly we will improve our margin a little bit more yet.

Looking forward, as I said, we are going into the slower time of the year, and we will experience a modest slow down from the third quarter. We will, however, look very good compared to year ago, we believe. So no -- nothing big or traumatic to indicate to us that I should tell you anything else in that respect. Net income for the year in total, because we believe we will be maintaining the margin that we did in the third quarter, or possibly increasing it, will continue to draw our year to date percentages up with that. So we believe that we're hitting back somewhat toward where we have been back before all of the inflation started catching up with us.

We believe that the management that we're employing right now will make that happen over a period of the next couple of years. It is not going to quick, but we are on the road now to doing it. From the standpoint of where we're getting our sales, we have anyone who has followed us for a long time, remembers we started out with very, very few customers, namely on our origin, we started out with two customers, both big national account firms, and we gained a lot of other national accounts, because we concentrated on them to get our growth going and get our volume up, and we were very successful at that. However, there is two aspects of that which are in the positive obviously, as there is a great deal of business in the national accounts.

The payment is usually pretty solid. The negatives are, because they buy a lot of product, the price level is pretty tough, and the second thing is usually you enter into one or two-year agreements on pricing, and in an environment like we have just been going through, you would sit there with a commitment at a price level that would be very unattractive by the time you got through your commitment. Therefore, it puts you under a lot of financial pressure by the time you are in the latter part of your commitment with them.

On the other side, going through to the world in general, which is what we've been doing, we've been switching over our business to schoolhouses, office building, manufacturing facilities, health facilities, all of the other types of buildings that are out there, and getting more of that, and in some cases, giving up some national account business. The net result is whereas we started out with two national accounts in our formative years, we are now basically doing somewhere less than 10% of our business with all of our national accounts, and the other 90% of the business is with the other types of accounts of the business is with the other types of accounts which I named. So our customer base is much broader.

And the company is in much better position to weather problems and doesn't have heavy dependence upon any single customer. The manufacturers' reps, as I mentioned, are the thing we're concentrating on at this point, because we have spent a lot of capital, we have done a lot on the inside of the company to prepare it to be able to sustain 30% growth, if that is fortunate enough to happen, and w e basically had that growth with minimal problems, with minimal overtime.

We just more or less handled it very smoothly and without much trauma at all. Our biggest trauma that we had was that because business is very good, a lot of our suppliers had problems supplying us with product. And therefore, we did have some issues to deal with, not because of our inhouse capability, but with some of our supplier capabilities.

There are basically several major business segments we deal with and I will just briefly give you my comments on what I feel on those. Retail, a little bit soft. Office buildings, fairly firm. Manufacturing construction after a long downturn seems to be regaining some health in that area. But from a much lower base level. Education and medical are both quite strong. Other commercial type activities are in good shape. And miscellaneous business is in quite good shape. Are we getting other new businesses that I want to talk about? Well, more of just what I spoke of. A wide breadth of customers, and yes, we are getting a lot more customers. And as we grow the business, our customer base is expanding.

A few people would wonder what happened on our backlog over the quarter. We went from about 67.8 to 67.9 backlog at the end of June, which was kind of inflated because when you put out a price increase, you bring in a lot of business that wouldn't normally come in until the following month or two, because they're given 30 days in which to close on business that they bid, so it tends to get front-loaded to protect their pricing. And that gave us a $67.9 million backlog. At the end of the quarter, we are running about $58.4 million, and so we did go down almost $10 million, but one has to remember that we booked at least 10 or $15 million more business at the end of June than what we anticipated bidding. So it really didn't change our general business climate, nor the direction of it. It just changed the timing of when we got the orders. Capital expenditures.

In 2006, we have had approximately 16, maybe starting to crowd 17 million in capital expenditures. Most all of which were for machinery to allow us to grow the business. A little bit was on building, but the bulk of it was in machinery area. What we're doing at the present time is starting to forward buy on our machinery. And in the past, most of our buying was to fill a need that was upon us. We are now starting to buy and put a little bit of safety in the manufacturing arena a little bit more than we've had in the past. And therefore, have, like we did in the third quarter, the ability to crank up when we have the orders, crank up a few more millions of dollars out the door, without any great amount of trauma. For 2007, we think that is going to drop back down to something under $10 million in capital expenditures.

With that, I'd like to open it to questions and answers, so Lisa, if you'd take over and start the question and answer section, please.

Thank you. [OPERATOR INSTRUCTIONS]. And we will pause for just a moment. Our first question comes from James Gentile with BB&T Capital Markets.

Hi, guys. How is it going?

Wonderful, James. How are you?

So you're jacking CapEx down to under $10 million in '07 from $16 million or so in 2006. What are you expecting to do with the extra free cash flow at this juncture?

Well, as you see, we've got a modest amount of debt right now, and that -- and as Kathy said, we expect that to be pretty well curtailed. We're going to get back into the same routine that we were in before, trying to decide what to do, and we haven't had real serious discussions about that yet. We did have a little bit of authorized stock to buy back, and we undoubtedly will continue that and finish that. And then it comes down to, do we go back to more of a stock buyback, or do we go in and raise our dividend a little bit?

Great.

So we will be doing something. The exact nature of what we do is undetermined at this time.

And was there some language earlier in your prepared remarks, Norm, that said that you were going to grow revenue organically, targeted at about 15% per year. Did I hear that right?

That's correct.

What would be driving that organic growth?

All of the new products which we have, plus the growth of our existing products. We have been building this company up to have a product line that would -- when it is fully matured, allow this company to be up toward $1 billion in sales. So we -- you might say we got too many products for our present size but it is what you have to do if you're going to grow. You have to prepare yourself. And we are preparing ourselves.

Great. Thank you.

And our next question will come from Frank Magdlen with with The Robins Group.

Good afternoon, Norm. And congratulations on a good quarter.

Well, thank you.

In that growth area, could you update us on what percent of your shipments are with the new refrigerant and maybe what percent of shipments are coming from your foam product?

Okay. I sure can. On the refrigerant issue, that is probably about 20% of our shipments right now, maybe a little over that. Maybe somewhere between 20 and 30% is going out that way. It is starting to happen much more regularly all the time. Most -- a lot of the national accounts have converted over to it. A lot of more knowledgeable builders of say school districts, or whatever, have converted over.

It has a little price premium, but from a standpoint of the economics of it, I would, if it were my building, be buying it, because refrigerant, the existing refrigerant 22 is going up in price, and three and 410 which is the new green refrigerant is going down in price. The 22 will become virtually unobtainable in another 15 years, or 10-15 years, other than just on refined -- re-refined refrigerant, which means it is going to be enormously expensive before the product that we put out the door today is worn out. So I think it is a wise move on anybody's part to move to R410.

On the foaming issue, probably at the present time we're running somewhere in the 30-some percent of our sales dollars are going out in foamed product. By this time next year, that is probably going to be doubled. So we're moving forward rather aggressively in the foaming process. And for those of you who may be unaware of why we're doing this, it is an energy issue, where by federal authorities, state authorities, city authorities have mandated the amount of insulation that must be put in a building, and the single pane glass being no longer acceptable, double pane, et cetera, et cetera.

The one thing that has not been mandated is how well in the case of a rooftop unit, how well it is insulated, and the industry as a total, including our old product, was terrible, and we believe that it is a marketable thing, that people just like the concern now with insulating their building properly, are going to be insulating -- concerned with buying a heating air conditioning unit that is much better -- I'm not talking about a percentage. I'm talking in percentages really 4 to 600% better. It is a huge step forward we're making. So that is what is occurring in those two areas.

All right. Could you touch on Canada a little bit and tell us what is going on with that division?

Yes, we, as you probably know, bought that company out of bankruptcy, in May of '04. And basically, our analysis said that there were some good people in the company, they had good engineering, and they had good quality controls, so the customers of the company thought it was a great company. Unfortunately, it had operational problems, which put it in bankruptcy. The main one being system, lack of systems. And since we believe we have very strong systems, we felt that it was a readily correctible situation, and that made it worth doing, because it filled out and extended our product line, gave us more complete product line, and so that we were able to do all of the rooftop units and not have some that we couldn't do on some jobs. So we purchased it and have converted the systems over.

Our systems are working very well. And as a net result, we are now making a modest amount of profit. It is entirely possible in any given month for it to go into the negative, but very slightly, so we're basically running a little bit on the plus side of break-even, for the last four or five months, although we had prior to that during this year, we had losing months. So it has come along well.

And now, what we're doing is correcting the way in which they get orders in, by converting their cataloguing, and their pricing, and everything, into an electronic method. And we are straightening out the front end of the business. The internal of the business is in pretty good shape. And we're starting to buy machinery to bring it into a more up to date manufacturing methodology.

What is revenues year for date, the estimate for the year, and what might would expect next year?

Were up there?

Yes.

Just a moment. Do you have the number there handy, Kathy?

Maybe while you're looking for that, could you comment on SG&A expense and the tax rate?

So far, up there, we've done $9,031,315.81. We would anticipate we're going to finish the year up there about $12 million. The tax rate, we got a one-time tax benefit for our manufacturing that was around a half a million dollars. And that kind of distorted what you're seeing there in ongoing tax rate. But our ongoing tax rate probably is still in the 37 area.

All right. Then what -- what should we expect in SG&A going forward?

Well, SG&A is very tightly tied to volume. So if you're talking about percentage, we shouldn't be on long-term going up appreciably, we run anywhere from the eights to the 10%. And that is what I would expect us to do, for the most part, although we are beefing up our marketing group, as I mentioned, to go out and get our sales organization moving faster, so we can sustain a faster growth rate. So we've added a little bit of cost in there.

But the rest of it is that we have a formula by which we must put money in reserves, for two aspects. One is bad debts. And one is warranty. And that gets reviewed on a quarterly basis, by both ourselves as well as our auditors to determine if we have got the right percentage going into it.

And then on warranty, it was more volume related than it was any particular problem?

Oh, yes. We basically don't have any particular problem. It is all, almost all volume-related. Same thing with the bad debt. We're really not having a lot of bad debt problem but it is volume-related.

Well, thank you, Norm, and congratulations again on a nice quarter.

Thank you, Frank.

And our next question will come from Andrea Sharkey with Sidoti & Company.

Hi, good afternoon, everyone.

Hi, Andrea.

Most of my questions have been covered already but maybe if you could just talk a little bit about the accounts receivable and the inventory that was up this quarter. Was that also just a volume issue? Or is there something more going on there?

Most totally it was volume-related. In fact, our bad debt and our warranty both slightly, not major, as a percent of sales, actually slackened a little bit. So virtually all of the change in the increase was due to volume.

Okay. And that was also the case for the accounts receivable and the inventory?

That's correct.

Okay. And then I guess maybe could you just talk a little bit about the HB and the CB units that you guys began producing? Have you done much with that? Or is that kind of taking a backseat given maybe higher volume in your other larger units, or the residential market not being that strong right now?

Well, it really doesn't have much to do with either the markets. It has to do with our ability to do the things we need to do to get the market -- or our marketing moving a little faster. In the HB product line, we've been building that now for a year, a little over a year. And it is gradually growing in acceptability and we haven't pushed it hard because we wanted to make sure we didn't have any warranty issues start appearing, which we have not, and we have not done all of the marketing things we know we have to do to accelerate its sales. In the case of the CB, that was very heavily dependent on two things.

One, we are building it for commercial use right now, because the residential version other than the voltage might be different, but other than that, it is very -- but other than that, it is very similar, if not identical to a commercial unit. And we have just begun to start trying to do something on the residential side of that. Because what we did, when we got the software up and running, for the Internet, and we're able to calculate sales tax and offer all of the different freight rates and everything, we said, you know we already have a $0.5 million parts business or thereabouts, and that is very seasonal, and so when the busy part of the season, whether it be winter or summer, we're always short on personnel to answer the telephone and create the orders for the customers calling in, and the rest of the year, we always have surplus people.

Let's balance it out by putting it into the computer system, and therefore, nobody has to sit around waiting for someone to be free on the telephone in order to enter an order. So we did that. We put -- we reprioritized how we use that, and we got the parts on it. The parts are -- the system on it is working wonderfully well. Just like we hoped it would and now we're starting to get serious, more serious on the residential aspect.

And then I don't know, could you tell me maybe how much as a percentage of your sales right now are coming through that Web site?

It is a very small percent because like I say, on parts, we got $0.5 million worth of it, and some people don't want to deal with a computer, or they have a need to talk to a person for some additional help. The computer system allows them to get an immense amount of help and information, but sometimes, people don't feel that that is adequate, and they want to talk to someone. So probably at the present time about two-thirds of our sales are coming through there. In other words, somewhere in the $300,000 a month probably starting to come through the Web site, and the rest of them are still coming through the telephone line.

Okay. So still pretty small amount.

Yes, it is still small. And that as a percent of our sales is not a big meaningful thing. What it is, is a satisfaction thing to our customers, they no longer get mad when they've got a broken down unit and all of our phone lines are busy and they can't get a part ordered. Now they can get a part ordered. And it just -- the customer relationships are much better now.

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

You're welcome.

And next we will hear from Graeme Rein with Bares Capital.

Hi, Norm. Congratulations.

Well, thank you.

A couple of questions for you. As far as going back to the foam insulation briefly, if you kind of refine that process down to where you like it, as far as it not being as labor intensive, or are you still waiting to make improvements in that process before you kind of ramp it up?

No, we've got it ramped up and we feel that we know how to foam well now because we've been at it long enough that we think we understand what we are having to do. It is, as you're indicating, more labor intensive thing than is fiberglass, to make a foam panel, as opposed to having a fiberglass insulated one. In some cases, depending upon which part you're doing, it gives you a return, or a discount in your assembly labor, because in some parts, it makes it easier to assemble the units. So we haven't sat down to see where we are, but we think we are not hurting ourselves too much by foaming in the labor area. It might be a little bit, but it isn't a big significant amount.

Okay. And how are the air handlers and chillers contribute to your revenue? How is the air handler market going?

The air handling market is coming along well. Most of it is either down in Long View, in which we're probably -- oh, probably -- we're probably running, of our total sales, some three or 4% of our -- 5% of our sales are in the air handlers. Chillers are probably somewhere in that same vicinity. And condensing units are somewhere in that same vicinity. So those are the three things. We are probably in the 15, maybe 20% into those three products that we hadn't had here a few years ago. We are expecting, because we're -- right now, we're somewhat limited in our offering. We don't have a complete line of what product is what I'm saying, and we're in the final stages of filling that gap, and once that is filled, we expect that to start moving forward much more rapidly. And at some point in time, it goes -- those orders for those item, we just talked about, could start approaching half of our business.

Okay. And then last thing, do you anticipate any -- are you getting any future price increases in the works or is that going to kind of cool off?

Well, one would hope that it will cool off, because I think you know, what is happening is making it very difficult for a lot of customers to afford buildings, and that is not going to do our society any good when we get to have too many high-priced things in our society. So I would hope that it would cool down. And not make the United States uncompetitive any more so than we are at this point in time. My belief is that it is largely run its course. The big rapid increase. And primarily it is due to the fact that now we're in the world economy, and China is the big consumer of most products, steel, copper, aluminum, what you want to name it, concrete, whatever, their consumption of it has created somewhat of a world shortage of those components which has driven the prices up.

Okay. All right. Well, thanks for your time.

[OPERATOR INSTRUCTIONS]. And we will now take a question from David Martin with SPA.

Has there been any -- anybody inquire about a buyout of AAON? There has been a lot of acquisitions of this type of business by the larger groups.

Over the years, we have been at various times contacted by the larger manufacturers, as you would delegate them, and they have an expressed interest to varying degrees. At this point in time, nothing serious is in the offing. And they never got really what I would call serious when they were talking to us. Anything is possible. Because they understand what we do that is a little bit different than what they do. And if in their business plan they saw the necessity for having the capabilities we have, it is entirely possible that they would come in here and make an offer that would be appropriate to making a sale.

Thank you.

And next we will take a question from Andrew DeAngelis with KeyBanc Capital Markets.

Norm, good afternoon.

Hello.

Just a quick question on the competitive landscape as you see it. I mean as you look at the competitive landscape out there right now, what gives you pause and what kind of heartens you as you look forward?

Well, the only thing that gives me pause is a concern that everybody recognize what is happening to their costs and that they don't ignore their cost structure. What is making me feel good is that doesn't seem to be the case. It seems like at this point in time most of them are what I would call intelligent management going on in our industry. Which from my perspective is a welcome change, because usually that was not the case. You would wonder why someone would do something that they did, because it didn't make any logical sense on the outside. And I don't see that so much any more.

Great. That's all I had.

[OPERATOR INSTRUCTIONS]. And it does appear we have no further questions at this time. I would like to turn the call back over to you Mr. Norman Asbjornson.

Okay. Well, I would like to thank everyone who participated in our conference call. I will remind you that we will be doing another one at the end of the fourth quarter. Hopefully with very positive things to talk about, and at this point in time, that's what we believe will be the case. So without more, I'm going to thank you for those of here at AAON and your interest in us, and look forward to talking to you later. Thank you.

And that does conclude the conference. We thank you for your participation. And have a wonderful day.