Aaon Inc (AAON) 2006 Q4 法說會逐字稿

Good day and welcome to today's AAON Incorporated fourth quarter and full year revenue and earnings report for year end 12-31-06. Just 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.

Thank you. Good afternoon. Norman Asbjornson speaking. Before going forward, I would like to read a forward-looking disclaimer. To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the Safe Harbor provisions of the 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 Securities and Exchange Commission filings, including the annual report on Form 10-K and the quarterly report on Form 10-Q.

I would like to introduce our Chief Financial Officer, Kathy Sheffield, who will go forward with some of the numbers at this point in time. Kathy?

Good afternoon. Welcome to our conference call. We will first discuss fourth quarter results. Beginning with revenues; in the fourth quarter we're up 12% to $54.6 million from $48.9 million. Gross profit increased 19% to $9.8 million or 18% of sales, from $8.2 million or 17% of sales. SG&A for the quarter decreased 40% to $2.7 million or 5% of sales, from $4.5 million or 9% of sales.

Our operating income increased 90% to $7.1 million or 13% of sales, from $3.7 million or 9% of sales. Net income increased to $4.4 million or 8% of sales, from $2.3 million or 5% of sales. The diluted earnings per share were $0.35 per share versus $0.18 per share for the fourth quarter in 2005. Our earnings per shares were based on 12,649,700 shares versus the 12,679,300 -- million shares, excuse me, million shares in the same quarter a year ago.

Now looking at the full year results, revenues were up 25% to $231.5 million from $185.2 million. Gross profit increased 24% to $43.9 million or 19% of sales, from $35.3 million or 9.1% of sales. Our SG&A increased 3.3% to $18.1 million or 8% of sales, from $7.5 million or 9% of sales.

Our operating income for the same period increased 45% to $25.8 million or 11% of sales, from $17.8 million or 10% of sales. Net income increased to $17.1 million or 7% of sales, from $11.5 million or 6% of sales. Our diluted EPS for the year was $1.35 per share versus $0.90 per share for 2005. Our earnings per shares were based on 12,352,400 shares in 2006 compared to 12,749,800 shares a year ago. We do have millions of shares, not thousands of shares.

Norm is going to discuss a few important points concerning the balance sheet right now before we go on to the balance sheet -- he will discuss the income statement.

Okay, we basically did have a nice revenue increase. Primarily, that came out of two things. Number one, our industry had a very healthy year this year -- or in '06, and we benefited from that. We also were still putting price increases through from 2004, 2005, all of which added approximately 8% to 2006, simply due to price increases, which occurred in '06 versus '05. And then we had some new products which were well received by the industry, as well as continued growth in our existing product lines.

The gross profit improvement was primarily due to timing of our price increases verses cost increases which we got. They are all in somewhat of a state of flux. And the fourth quarter gross profit of 18% largely also reflected that, in that we had put through a price increase back in July of '06 of almost 6%. It had not really flow -- managed to flow through for very much of the fourth quarter. And consequently, while we had the cost increases there, we didn't have all of the price increases showing up at that point in time.

The other factor that really negatively impacted us -- well, there are two sides to it. We had more shut-downs last year, largely in the fourth quarter, than we ever had in the history of the Company. Two of them were the results of a pretty severe ice storm which came through here and closed most all businesses down for a couple days. And the other thing is that, although we had ordered our materials in plenty of time and everything, there was a very big problem with shortage of materials last year. It was pretty broad spectrum-type shortage. We ran out virtually -- ran out of galvanized metal, the type we buy. At one point, we ran out of copper tubing. All of which were ordered in more than adequate time -- just that the industry was overloaded.

And to give you an idea how much adequate time was and what problems were, one of our most persistent problems was condenser fab motors and we have four suppliers of those motors. We have two major suppliers and two minor suppliers. We ordered all -- from all four of those we ordered in January of 2006 a major portion, almost all of what we thought we would need, figuring we would supplement it as we went. And we told them that was the way we were ordering it and all. And we gave them released purchase orders in January of '06. Come June of '06, they were starting to miss shipping dates. That continued all the way through until September. We didn't get all of our June shipment requirements that had been released in January until the latter part of August.

Now what does that do? Well, we can't build units without motors. Furthermore, we couldn't ship replacement motors to some of our customers who'd had failed motors when we should have shipped. So we really caused ourselves a terrible amount of grief by being in that position.

And one of the issues you might, in going through the financials that are on the Street right now, note that our backlogged inventory is higher than it normally is at this point. And one of the most major part of that extra inventory is my frustration and anger with the people not being able to get me parts last year when I needed them. And consequently, where as normally we would carry a $2.5 million backlog of coils in order to have a workable amount of backlog, we right now are between$5 and $6 million in backlog of coils we built for ourselves that we know we have the copper tubing because they are already built into coils, we know we have the aluminum, it's already built into coils and same thing with steel. I also have a large percentage of the condenser fan motors I need for next year, as well as a few other hot button items. I'm overloaded with inventory in certain areas by intention.

Fortunately, in several of these cases, not only is that inventory going to offset our possibility of further problems this coming year, but it is also inventory which, for the most part, has had price increases since we bought and built it. And the price increases will more than carry the inventory cost of carrying the materials. It is a good and bad story that you can see on our balance sheet at the present time and you can see on last year's P&L statement as well.

So we had three days of plant shut-down due to simply not having what we needed to run the place properly. We had two days of shut-down due to ice storms. Total of five days of shut-down. We hardly ever have a day of shut-down, let alone five days. And each one of those days peeled about $800,000 out of our shipments. So we knocked about $4 million out of our shipment. And of course, that reflects itself all the way up and down the P&L statement. So that was probably the most significant thing which happened to us, was unintended and unplanned plant shut-downs.

The purchased material and raw materials varied all over the place. They still are. As for instance, in the fourth quarter of last year, copper went down by about $0.20 a pound. So far this year, it's gone back up $0.40 a pound. Galvanized steel, which is another significant commodity product, has fortunately got some stability to it and remained somewhat stable for the past year. Aluminum has had a slight price increase.

But when we get over into stainless steel -- and fortunately, we don't use too much of it, but we do use a fair amount. Stainless steel has, from the third quarter of last year, gone up approximately 25% at this point in time, and is indicating -- probability, it hasn't finished going up. Component prices were somewhat level in characterizing them, but they did have an inflation throughout the year for us.

So those -- those are some of the things that did occur. Most of which, with the exception of the unexpected shut-down and perhaps all missing on the magnitude of some of the price changes, they were pretty much normalized factors that we are accustomed to. We also did forward buy on some expense items for the year 2007.

There is another noticeable thing in our price sheet -- in our P&L statement; namely that our SG&A went down considerably in the fourth quarter. And the reason for that is we have been gradually improving our warranty situation. In other words, our warranty costs as a percent of sales have diminished now for four years in a row. And we always want to be cautious in that because warranty is one of those areas where unexpected things sometimes happen and they can be pretty expensive unexpected things. So we always try to stay on the safe side in our warranty reserve.

As we went into the fourth quarter last year, it was obvious that with the diminishing warranty -- actual warranty costs that we were charging against the reserve versus what we were putting into reserve, we were going to have to lower our reserve account. And so we did so in the fourth quarter of last year. And that caused a fair amount of movement of money in the fourth quarter. Most of that money was money which would have normally gotten reported in the first three quarters, so it didn't change our year-to-date, particularly. It just kind of swayed the fourth quarter versus the first three quarters.

We had nothing that really did much to our current ratio or our long-term or current debt. We basically have no debt. And we basically bought a lot of base -- capitalized material, approximately $17.8 million last year. And most of that was not so much in need of what we had -- a need for last year to run last year, that was largely buying for the future. By that I mean we built some buildings that are going to be needed in '07 and going forward. And we bought machinery for a similar reason. And those were the two big capital expenditure items that we had in there. They were largely confined to our Tulsa and Longview facilities with some to our Canadian facilities.

The Company is in excellent shape. Balance-wise, on our balance sheet, we are in extraordinarily good condition. We are introducing new products. And we are expanding sales of some of our existing ones. One of the larger areas of expanding sales has to do with our chillers, which had been introduced a few years ago, and our air handlers, which we began introducing several years ago. And we are just now in the final stages of getting, what I would call, a complete line of air handlers. That is in the final stages of occurring this quarter and will change the complexion of the Company quite a bit as we go forward with those. We have had some products in those areas, but it's been less than a full compliment of necessary products.

We also are going forward, as we discussed in the past, with minimalized residential offering. That is beginning to move for us. And our custom products are moving forward. Last year, in the purely custom products, we were doing a little over $11 million in those areas. We expect to be doing somewhere around $20 million in that area this year. We have eliminated a lot of the problems which were causing us bottom line problems. And expect that the bottom line should continue as it has for the past year or so to improve and gradually get more and more healthy.

The business segments that we are in, by and large, were similar to what I said early on. Most all of them were reasonably healthy; obviously, some more than others. They all were quite healthy markets last year. As a net result, our backlog that we went out of last year with was little over $56 million. We are going into fourth quarter -- or I mean the second quarter, excuse me, probably with a little over $60 million. And so we are still growing. And we are expecting that this year will be a good year because the same conditions that were in effect last year still appear to be viable for this year; in other words, growth in the commercial and the industrial building markets. First quarter is shaping up to be a strong quarter. And like I said, the balance of '07, as far as we can see at this point, looks to be a strong quarter.

So that's kind of what has been occurring in the Company. The problems are largely gone from the Company, I guess I would have to say. Problems now have become more -- the Company is now 19 years old and we have gone from being a highly leveraged, very, very small company to being a non-leveraged small company. And we have gone from being in a totally unknown company to being a very respected company, not only because of the health of our balance sheet and our income statement, but also because of the high technology products and high quality products that we are building. We have built a very good reputation of being somebody to look at when they want high quality and they want high technology.

As has been mentioned in the past, we have been totally capable of building units with refrigerant that is environmentally friendly and that part of our business continues to grow. It's to the point where on the larger equipment, which is kind of what one would expect, the year that is mandated by the Montreal protocol and what our federal laws state, is that we will cease building equipment with the R-22, which is the old refrigerant, and build only with environmentally-friendly refrigerants, beginning in January of 2010. And we have been capable of doing that now for about four years. And we would expect it within the next year, that some of our products are going to go virtually, totally into the new refrigerant. And we will drop the production of the old refrigerant units.

As is the case many times, a lot of people don't welcome change and therefore, they are prolonging the situation longer than it should be. But we are ready for it. We continue to redesign our products, bring out new products that are leading edge technology, primarily in energy savings and also in quality and longevity. So we probably have approximately two years of that left to go through and we will have gone through our entire product and upgraded them to those types of products.

So the Company is in, not just really good shape on the P&L statement and the balance sheet; but it's, frankly, in very good shape across the board. And as has been mentioned, we've have four years of diminishing warranty cost and our products are very good.

I thank you, and I open it for discussion.

Thank you very much. [OPERATOR INSTRUCTIONS] First we will go to James Gentile with BB&T Capital Markets.

Hey, Norm. How is it going?

Very well, James. How are you?

Very good. SG&A for 2007; what could we expect as a percentage of revenue, moving forward?

I would say it's not going to change appreciatably from the year 2006. There is no real likelihood that anything is going to go up that we see. Two big components in it are warranty costs and bad debt reserve, and in both cases, we have been getting better. I didn't talk about it, but warranty -- bad debt situation has been improving consistently, too. That should hold in. From the standpoint of other expenditure of other personnel, they will go up, approximately, with our revenue growth.

Okay. And then capital expenditures in 2007; clearly not as high as '06.

Clearly not as high. Somewhere -- and this is going to depend upon -- there is one fly in the ointment, if you want to call it that, and that is how successful we are going to be with this air handling expansion that we are introducing this quarter. If that turns out to be very, very successful, it's going to put us in a problem of handling the material out the back door. And it's going to be very time consuming and costly, if I don't do something about it. I would start building a building on the very south end of this plant to accommodate the shipment of things. So it would be a very non-technical construction project, just basically a big building shell. And if we don't have booming acceptance of that product line, that will not occur. If we do have a booming acceptance of it, it will occur.

Is $12 million a good number to start with?

$10 is a better number to start with.

Cool.

$12 would be very top number. So I would say somewhere between $8 and $12, and primarily contingent upon what happens on the building projects.

And then a final question; with the March quarter almost coming to an end, do you -- you suggested a $60 million backlog going into Q2? Did I hear that correctly?

You did.

All right. And then gross margins, could you -- I mean, we saw a peak in '01 of 24.7%. Clearly, the complexion of the business has changed dramatically; more components, larger tonnage units, different raw material cost situation. What could we expect for gross margins in '07?

They should gradually improve as we go along. You'll note that we didn't have any great improvement during last year. We were basically keeping track -- keeping up with but not really improving as much as I would like. I think we will probably, for the year in total, gain a couple points.

Okay. Thank you very much, Norm.

You're welcome.

And moving on, we will hear with Andrea Sharkey with Sidoti & Company.

Hi, Norm. Hi, Kathy.

Hi, Andrea.

Hi, Andrea.

Kathy, I have a question for you. Just looking at the tax rate, what do you think would be a good go-forward rate for '07? Would it be 36%, 37%?

We were looking at 37.5% for 2007, Andrea.

Okay. And then next question would be; on the custom business, I was just curious, I know it started to turn back to a modestly profitable level throughout the year. Could you give us what the gain or the loss was from that business for the full year?

Well, it was much less than it has been in the past, but we were still in a loss position with it. One moment here. Yes, we were down less than $1 million in it for the year.

Okay. And then looking forward, you said $20 million on the top line for '07. Do you have any sense of what kind of profitability you might be at for '07?

Well, if you ever been around a manufacturing facility that's coming out of bankruptcy, you will know how frustrating and unpredictable sometimes things are.

Sure.

And here is where we stand. The Company, when we bought it out of bankruptcy, had the reputation for well-engineered product and good quality. So the product was well-received in the industry. It was well thought of. The operational part of the Company was where the sadness occurred. And basically, the Company was still structured, as I would say, I would have expected to look at a company in 1960 or 1970. And was way behind times, as far as systems and technology.

And we spent the first little while putting the software in place so we could tell what was going on and to communicate properly within the Company. We put it into a new building because it was in a -- not a very good building for building product. And we went to work on systems up the inside of the Company to run the Company better, beyond the financial running of it. And we are in very good condition on the software to know what the costs are and to predict what we should sell stuff for and all those things which we didn't know early on. So that part of it is in good shape. When we take an order, we know where our profitability is, and it is working really well in that part of it.

Where the real trouble is right now is processing the order through to the manufacturing part of the Company. The manufacturing part of the Company, once it gets a hold of it, is doing a respectable job. It's strictly that front end, front office part. And we are putting a lot of things in place technologically to get there. The biggest unknown and the big question mark and the big frustration is people and cultures are hard to change. And how fast they are going to change and accept some of this and take advantage of it is going to have a big to-do with how profitable the Company is.

So we are bringing the orders in the door at a level that should be profitable. We are starting to construct them at a level that should be profitable, if we just don't foul ourselves up in between there.

Okay. So looking at '07, somewhere -- certainly lower than your overall base business but should be modestly profitable?

It will definitely continue to be a less profitable business. It is, as I expressed before, I believe, because I came from that kind of an environment before I got here; it is my belief that ultimately that will not only be equal to but possibly superior in profit -- profitability to what we have been accustomed to. It's a matter now of people making change and us doing a few more minor things to changing things internally to the Company. Most of the tough things are already done, other than the people. And that will gradually change as the people realize the benefits with what we are trying to do. Which they are, but not as fast as I would like.

Sure, sure. Great. And then just last question. I know the foam insulation in your product is pretty exciting. And I just was curious, is that on all of your products now? And how is the acceptance of that going?

On the foaming?

Yes.

It's being very well-received. And it's on about -- right now, probably somewhere in the 40-some percent of the dollars of our products going out the door. It is on the largest equipment we've got, the most sophisticated and most demanding customers and everything -- we are supplying that to. So as we are going down right now, when we get done this quarter with introducing the air handling equipment, which is also foamed and direct-drive blowered, we will probably be in -- by the next time I have a quarterly conference call, we will probably be in the 50-some percent of our product will be getting foamed. A year from now, we probably will be talking in the 75% to 80% of it will be getting foamed.

Great. Thank you very much.

You're welcome.

And our next question comes from Graeme Rein with Bares Capital Management.

Hi, Norm.

Hi.

Could you talk -- I know in the past, I think you said the RN or the medium-sized rooftop unit was roughly 25% of your dollar shipments. Can you give a revenue composition break-down across, like rooftop units, chillers, air handlers; kind of general percentage of how that breaks down right now?

I don't have precise information here, so I would be doing a lot of hip shooting to give you a break-down. Just a moment, let us do a little bit of comparison of some numbers here and see if we can't do something. Could I get back to you on that -- on the break-down? Because I don't see that we've got the ability to quickly give you anywhere near what I would consider a decent answer.

I can call you offline. Could you talk a little about the small ton units? I know you were at about 5% production -- or five units coming off a day a couple, six months ago. Could you talk about how that's ramped up?

It hasn't ramped up as fast as we had expected it to. It is running -- maybe 25% faster than that at the present time.

And then lastly, have you seen any changes in the competitive environment? Are your competitors doing anything different or more similar to you guys, in terms of automation or moving into the semi-custom niche that you guys are in? Or could you talk generally about competitive environment?

Well, yes. There is always -- everybody is always doing something that they feel will give them a better position in the marketplace. So that's, without any question, occurring. Are they coming after the custom? In one sense, no. And in another sense, yes. What do I mean by that? Well, a semi-custom market, as the industry knows it, is evolving into a more of a actual semi-custom market. And therefore, what would have been customer or semi-custom three or four years ago is now not considered semi-custom. And so there are quite a few of the high-volume people who have introduced things into their product line, which five years ago I would have said were very -- going into the semi-custom very big. Today they are in that market but I wouldn't classify that because the industry has evolved more into a -- more technologically advanced industry. So, yes, it is growing. And yes, they are growing into it. Are they growing into it faster than we are growing in it? No, I don't believe that is occurring.

Okay. Thanks for your time. Keep up the great work.

Thank you.

[OPERATOR INSTRUCTIONS] At this point, there appear to be no further questions in the queue. I will turn the call back over to Mr. Asbjornson for any additional or closing remarks.

Okay. I would like to thank all of you for your time of tuning in to us. I hope that it has been beneficial. I hope that I've answered your questions as to why, perhaps, we didn't hit a couple of the analyst's numbers quite on -- exact. I would clarify one aspect of it. If the fourth quarter had been a stand-alone quarter, it would have been a $0.36 quarter, because it fell just a little bit short of being totally up to a $0.36, and would have rounded up to $0.36. But when you do the end-of-the-year and you have to go back and put everything together -- the first three quarters and they all had rounded up before, and when you add all the rounding-ups together, you had to round it down for the fourth quarter. And we are slightly under the $1.36 for the year, because it, likewise, just barely missed the rounding-up portion of the number.

With that, I leave you and thank you for your time and look forward to talking to you in another 90 days. Thank you.

Once again, this does conclude today's conference call. Thank you for your participation, and have a great day.