Aaon Inc (AAON) 2007 Q1 法說會逐字稿

Good day, everyone, and welcome to today's AAON Incorporated first quarter 2007 earnings conference call. As a reminder, today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Norman Asbjornson. Please go ahead.

Good afternoon. Prior to getting under way, I would like to read a forward-looking disclaimer. To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the Safe Harbor provisions of the Security Litigation Reform Act of 1995. As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ materially from those anticipated. Please see the risk factors contained in the most recent SEC filings, including the annual report on form 10-K and the quarterly report on form 10-Q.

Prior to going further, I would like to introduce Kathy Sheffield, our Vice President and Chief Financial Officer. Kathy?

Good afternoon, I'd like to welcome you to our first quarter conference call. Discussing, first of all, the income statement. Revenues in the first quarter were up 9% to 58.6 million from 53.6 million. Gross profit increased 51% to 15.7 million, or 27% of sales from 10.4 million or 9% of sales for the same time last year. SG&A expenses increased for the first quarter of 2007 by 24% to 5.7 million or 10% of sales from 4.6 million or 9% of sales. Our operating income increased 72%, to 10 million or 17% of sales from 5.8 million or 11% of sales. Net income increased to 6.3 million or 11% of sales, from 3.7 million or 7% of sales in 2006. Diluted EPS was $0.50 per share for the first quarter of 2007 versus $0.30 per share for the first quarter of 2006. Earnings were calculated based on the earnings per share of 12.611537 million shares versus 12.633797 million shares in the same quarter a year ago.

Going to the balance sheet. Our current asset ratio increased slightly, approximately [2 to 2] due primarily to not having any current debt, and increased current assets such as our cash receivables and inventory. Our capital expenditures for the three months ended March 31st were 4.5 million, our expenditures related to some new equipment for facilities and certain renovations that we had both in the Long View and the Tulsa facilities. We paid cash dividends in January of 2007 of 2.5 million, and also bought back stock for certain retirement and incentive plans in the amount of 1.6 million. Our shareholders equity per share as of March 31st of 2007 was $7.80 compared to $7.25 for the same period a year ago.

I would now like to turn the conference call back to Norm.

Okay. Addressing the sales issue, first of all, a large share of the increase in sales came about by virtue of price increases implemented in 2006. The market was strong. Our biggest, we did miss some analysts' projections by $2 million. The majority of that miss was in our Canadian operation. And I'll touch on that briefly for a moment. That, we've had a change in management of that facility as of the first of April. And, based upon what has happened there since that time, we have picked up the production very considerably and we expect that, there will be significant changes in, for sure, the top line and we also believe strongly in the bottom line going forward. The backlog in the Canadian facility will more than support a substantial increase in sales volume. We were falling behind because we didn't produce well in the first quarter.

Moving forward from that, we had pretty uniform good sales input, primarily from our representatives, but also we had pretty strong national account sales, as well. We had anticipated our national account sales being a little weaker than they were. That is on the new orders as opposed to the shipment. The new orders, I should say, were strong across and more on the national accounts than what we'd thought. Not particularly a large amount, but enough to make a comment about it.

The generation of the sales came pretty uniformly across all of our various market segments. We didn't notice any particular weakness, nor any particular strength. During the quarter we did have an increase in our backlog over what we started the quarter with. So we actually booked more business than what we sold, or shipped. A lot of our contribution was coming from products which we've been talking about the redesign of, which is mainly our bigger tonnaged equipment, that has become a larger percentage of our sales this year than last year. That includes chillers, large tonnage rooftops and large tonnage condensing units.

We are entering into a much more serious endeavor in the air handling market, which is a market roughly approximating the size of our rooftop market. So it's got potential for being a very significant aspect of our business. Up to date, we have been in a portion of the air handling market, but only a small part of it, because we introduced it basically into our Long View facility because they did not have any experience in that product line. We have been using the past four or five years of them building small tonnage air handlers to get their learning curve behind them. And at the same time getting ready up here to undertake building larger tonnage units. And the difference for the two locations is the suitability of the facility for large products versus small products. The Long View facility is an ideal location, but it is not an ideal facility for the larger sizes, the larger sizes will be built in the Tulsa facility.

We also are doing very well in order input on custom air handling units which are for our Canadian facility. So with the introduction of the air handlers, we've entered a new and different phase of our growth and one with which we are not as familiar as being able to forecast as accurately, but we have great expectations of what we will be able to accomplish in that. But only time will tell whether reality and our expectations are on the same wavelength.

We have also begun, but we're just in formative part of it, on the split system residential product line. And we're just trying to work out the details and some of the problems of actually implementing more serious ordering procedure over the internet for that product line. That one has, again, a large potential for it. It's actually a much larger market than any of the things we're in today as an individual market, and basically, comes close somewhere around having the same market potential as all of our other product lines combined. However, it is also an effort with which we have even less experience and we're entering it by going over the internet in a way that is not being done presently by the marketplace. So we're trying a new marketing technique, and I guess you could best compare us to Dell computer, who also in the computer industry did the same thing we are doing, which is going direct to the customer and eliminating one step of the distribution that is normally a accustomed to being there in this product line.

What is the big difference in our thing? A big difference obviously is in bottom line. And the bottom line is a composite of a lot of different things. And I guess, seriously, whenever you're forecasting or trying to see what you're likely to do, you always contemplate a certain number of positive events and a certain number of negative events. And how well you evaluate that depends on how well you hit your goals. And occasionally, a lot of things run against you that you don't expect and you come up on the short end. This was one of those occasions when virtually everything other than our Canadian operation ran for us. Productivity ran for us, the fact that we have added a couple new Salvagnini sheet metal machines that have capabilities we didn't have before that eliminated some more of our labor in our sheet metal fabrication of parts, a significant amount of the small parts helped our efficiencies along and we had very good efficiencies in all the other areas. So our materials didn't get as bad as we thought and our efficiencies were better than we thought.

Added to that, the price increase we put in play last, the end of June of last year, was all in effect during the quarter. And there were no other real nasty surprises, and thus, the bottom line came along very nicely.

The question to all of that, of course, is how sustainable is that production? We believe that in different ways, it probably is sustainable. And what are the different ways in which I'm talking about? Well, the bottom line as a percent of sales is, we believe the highest that any company in this industry has experienced in the past 40 years or so on a quarters basis, or if it's not the highest, it's certainly one of the very highest. And so it's a hard thing to say that our sales bottom line as a percent of sales will remain where it is. In all probability, that will go down a little bit because, of course, we are going to have some price increases going forward. And we're existing on price increase on the pricing side that was put into place last year. We do have a new price increase that's going into effect on new orders, come the end of this month. But that will refill our backlog with new price business, but that backlog will not start sliding out in the very best condition for four weeks and most of it won't start going out the door until 8 or 10 weeks down the road. So, we will be existing basically on the old pricing. And thus it's likely to slip a little bit.

On the positive side of things, and absolute bottom line dollars, we have great expectations of having better numbers possible. And that is due to a couple things. One, we historically always have better sales in the summertime than we do in the first quarter. First quarter is normally our weak quarter. So, on historical basis, we would expect our volume to go up across the board, across virtually all of our product lines. In addition to that, we're adding certain other products, primarily the one that will be most effective will be the new air handling units. And the other side of that is the fact that based upon what has occurred since we put the new management in place in Canada, and the fact that we have plenty of orders up there, it will make a material change in our volume, and we expect also some major, fairly major, change in the bottom line. So there's a lot of positive things going forward that would indicate we have a good chance of holding this performance in absolute dollars on the bottom line, if not the percentage of profit per dollar of sale. So that may slip, but it will be offset, we think, and maybe some more by the sales going up significantly.

The material cost increases, we need to discuss a little bit. Like I said, we're somewhat surprised, because our copper price, which had fluctuated into $3 plus per pound last year, slipped all the way into the low $2.40-some during the first quarter. We thought it would continue to slip on down, primarily our analysis was based upon the slowdown of the U.S. housing market. Unfortunately, China really determines what happens in the market. And their usage of copper and India's use and other-world countries' uses of copper didn't go down proportionately. And copper went back up again and it's back up into the mid and upper $3 again. So that's a significant negative to us, that has occurred, the positive occurred in the first quarter and the negative has been slowly occurring to us in the second quarter. And back in the last month or so of the first quarter. So, that is kind of a negative.

On the larger one of commodity, steel still continues to be, in galvanized form, continues to be pretty stable. And we think it has every likelihood of remaining stable. Everything we read about the world's supply and usage and everything would indicate that should hold. We did not forward contract or do any hedging on copper because, as I said, we expected further deterioration, which did not occur. On aluminum, it had been pretty stable for quite some time and we were concerned and we did hedge about 80% of our expected usage of our aluminum during the balance of the year. So, we're thoroughly well protected on aluminum for the balance of this year.

On components, the components primarily use all those commodities, and depending upon the vendors and how they handled it, they are going to be, without question, forced to raise prices as time goes on, as they have been here in the past few years. And so we'll get hit by some component cost increases that will occur periodically for the balance of the year.

On labor efficiencies, we think that we're doing things pretty much like we have for a long time. We have been increasing our labor efficiency for many years and we don't believe that we've come to the conclusion of that. And I'll give two examples of where that is most likely to occur in a significant way. One, in our Canadian operation, with which I've talked already. And the other, I mentioned very briefly, that we bought an automated some automated sheet metal equipment, which has capabilities of doing things that the manufacturers previous machines were unable to do. And that's quite a bit of labor that was involved in doing small parts of sheet metal in a more labor intensive fashion than we now have the capability of doing. So those two things will have a significant, very identifiable impact on us. And like I said, all across the board, we have been increasing our labor efficiency. And I believe that will continue.

We do not have sheet metal bottlenecks. For the first time, possibly, that we haven't had something occur that kind of gave us a hiccup, minor hiccups for the most part, in recent years and earlier years gave us major hiccups. We, very much are on top of our sheet metal issues. And we can move very rapidly and we can increase our volume very quickly. So it has gone from being one of our nemesis to one of our strengths now. And I don't see us having a problem there for the foreseeable future, because we've spent the capital necessary to assure ourselves of being able to stay ahead of the issue.

Again, on the gross margin, it's going to be awfully hard to say that's going to stay where it is, but it's going to definitely stay up in the higher range than what it is been in the past few years. As I spoke earlier, the end of this month, another price increase goes into effect, which won't be seen on the bottom line until at the earliest, four weeks after the end of this month. And most of it won't be seen until 8 to 10 weeks after the end of the month.

The SG&A expenses, you might have noticed, did go up. The very-- the primary thing that went up in the SG&A expense arena is profit sharing with our employees. They share in 10% of the pretax profit, equally, every one of them gets the same as I do in the profit sharing. And it gets distributed quarterly. So, over $0.5 million of that increase was increase in profit sharing.

The other things which did occur, we did have some increase in our professional fees. We did have, because of the increased volume, we had an increase in our accrual for bad debt expense. We had an increase in our sales and marketing expenditures, due to the fact we had a significant annual meeting and other things that we have done to introduce our new products and getting them under way and everything. So we spent some additional effort there and spent about $0.25 million in that effort, in that arena. The rest of them were primarily smaller, and you could group about a little less than $200,000 together in smaller things such as increased warranty cost because of the increase in sales volume and the reserve we had to put into it. And so that basically covered what occurred in the SG&A arena.

There is one other thing that you may notice if you study it hard. And that is, that there's been a dropoff in our retained earnings of about $396,000. And that comes about by the fact that there is a new accounting rule called thin 88-- FIN 48, which has the people who dealt with it says it's a very complex issue. Basically, summarizing it for a nonaccountant person such as myself, they said it requires that you handle certain assumptions in your figuring of the income tax in a different manner than what was done before.

And so we did that and it did have $396,000 impact on our retained earnings, not on our present-day earnings, but on retained, because this changes some of the assumptions made in previous years-- or previous quarters. That 396 isn't necessarily gone, however, because the assumptions we made back there prove to be the correct assumptions, that 396 or some percentage of it will come back into the bottom line at a future time. We did not have any issues with any assumptions we had made on the federal income tax. We did have some issues of assumptions we've made on the state level on income tax. So that's where the money was additionally allocated to.

I think that pretty well covers my issues that I have. And so I'd like to open it up for questions and answers.

Thank you very much. (OPERATOR INSTRUCTIONS) We'll pause for a second as we assemble our roster. Our first question of the day will come from Frank Magdlen with The Robins Group.

Good afternoon, Norm, and congratulations on, I guess, a record quarter for you.

Well, thank you, Frank.

A lot of hard work getting there with the capital expenditures and the work with the employees, but can you give a little more light two things. One is, the actual backlog number? And what was the shortfall in Canada, will it be profitable this year? And help -- flesh that out a little bit for us, if you could.

Okay. Backlog on April 30th was $61 million. The Canada situation, as you know, we bought that out of bankruptcy, and the gentleman who was running it had a lot of positives. One of them was not his ability to run certain parts of the business, and we thought we could bring him around and bring him up to speed and we failed to accomplish that. It became more and more evident as time went by, and we spent a lot of effort trying to get it to come around with him. And we were unsuccessful, and so then we had to prepare ourselves for a transition which we have been under -- preparing for, for quite some time. In case it did happen, and when it finally became obvious, the first quarter that we had to, then we went ahead.

We put in place first of all, a person who is very capable and very knowledgeable in that business and that particular segment of the business, namely the custom air handler and that custom market, this individual. And we also during that time, of preparation, brought in the new head of our engineering department here in Tulsa, who also had tremendous knowledge in that arena. And we have both of those individuals up there right now overseeing that operation. And it has done a remarkable turnaround in the way of production. We had in the previous years, been able to get the pricing correct on it. And we had been able to get our purchasing correct on it. What we were still fighting with was labor efficiencies. And based upon the first five to six weeks, which these people had been running it up there and based upon the performance they've been getting, our labor efficiency has had a remarkable improvement. And there's no reason for us to suspect it won't stay improved and get better as time goes on. So that covers those two issues, I hope, by the way, that answers your question.

Are you willing to give us a revenue guesstimate for Canada for this year?

Something around 20 million or better. And in the first quarter, it was less than 2 million.

That was a big hit, okay. All right. I'll just jump back in queue. It was a nice quarter, again.

Thank you.

Next we'll hear from Andrea Sharkey with Sidoti & Company.

Kathy, how are you?

Good, thank you, Andrea. How are you?

I'm doing well. Just a quick question on the margin on the gross margin. I know, Norm, you really fleshed out a lot of different things, both positive and negative that you'll be (Inaudible), and I was just wondering, if I look at it for the rest of the year, obviously this 27% was incredible and not necessarily sustainable. Would maybe a 22% range be something that you'd be more comfortable with?

I'd feel very comfortable with that, Andrea.

Okay, great. And then, I guess, I think you mentioned, and correct me if I misheard you, that you're going into the second quarter seasonally, you would expect to see the sales go up as normal. But the earnings would be roughly the same as the first quarter. So, is that fair to assume, EPS bottom line would be somewhere in the range of where it is this quarter?

I'd hate to give you a plus or minus from where we are, but has a chance to be plus about as much as it has a chance to be minus, I would say. Because I have some expectation of slippage and the gross margin as you're indicating. But I also know for sure we're going to produce more products. So the bottom, absolute number I think has as great a chance to increase as it does to decrease.

Okay. That's fair enough. And then you mentioned the price increase that you're going to take at the end of May. Could you tell us what the magnitude of that is? And is it across the board all products or is it only specific products that you're doing?

It is specific products. It varies from no price increase, on some that we've been able to do cost reductions or do something else that have made them look very good without price increases. So that the price increases vary from 0 to 7%.

Okay, great. And then, just as a general range, would you say 50% have some form of price increase versus others, or is that percentage, more heavily weighted for price increases?

I would say 80% have at least some price increase. 80% to 90% have some price increase.

Okay. I think that's all I had, thank you very much.

You're welcome.

(OPERATOR INSTRUCTIONS) Our next question will come from Jim Bradshaw with Bares Capital Management.

Could you speak a little bit more about the new chillers and air handlers and how they've been accepted so far?

Well, the chiller has been out there for a while, but it's kind of like -- it wasn't a complete system without air handlers and we only had a partial offering of air handlers. So it's been a little bit at a handicap you might say. But the other thing is that we took a very different approach on chillers. Rather than go into the strictly vanilla market, you might say, and just produce something that chilled water, we said that's not going to give us the margin we need. And, therefore, we have to offer the customer something that we can do that will be cheaper for us to do than it is for him to do it any other way. And there are there are two issues that we added to make that happen. Number one, we put the pumps, to pump the water throughout the building in our package as an option that they could choose to do. And we can do it cheaper than what they can do it in the field. So that gave us a little difference from the way the industry does it.

And the next thing we did was we added boilers. And so basically what we can do is build up an entire mechanical equipment room. And ship it on a truck. Now, this is going to be good for typically buildings up to, say, 0.5 million square feet or something like that. So it won't be something that you will see on a huge, huge building, but it will be up to -- it could be up to a pretty good size building. And both of those things made us more price competitive, and gave us a better chance of having margin and took us out of the rink of fighting with everyone who has already been there.

The last thing that added up is that we put all this inside of an enclosed box, an insulated and closed box. There are two issues there. Three, I would say. The first one being that it contains the biggest noise aspect of the chiller inside the box and eliminates, basically, eliminates the noise problem. And since a lot of these chillers are sold in a pretty well developed parts of the city, where noise is many times a real problem, it gave us a very distinct advantage in that.

The next aspect is, of course, that it basically made everything that they had to do working on that an inside job. So if it's raining or some other way, miserable outside, they basically are inside and that inside condition can be conditioned with heating and cooling. So that it's just like another part of the building. So that, again, gave us a distinct advantage in that respect. So not to eliminate the possibility that the unit's going to last longer because all the functioning operating components virtually are inside out of the weather as opposed to the way they typically are on chillers. So we have a very different approach on chillers.

On air handlers, we also are approaching the air handler market in a little different fashion, because, go back to our basic business premise, which is, we look for areas of the industry that are poorly served and can be served better and see if we can't serve them better. And that's what our whole philosophy has been about throughout our entire existence. And it's worked very well for us. Air handler market is just beginning to start to use some foam for the construction of the cabinet. And basically, an air handler is a pretty simple device. It's a cabinet with a coil or coils to heat or cool a building by using typically chilled water and hot water. And that's where in the chiller and the boiler operation come in. They provide that chill water and hot water, and then a pumping systems to pump it around into the air handlers, and that's where the pumping portion of our chiller operation comes into effect.

And so the foam has already started to appear from other companies. But they seem to be having difficulty mastering the foaming process, even though foaming has been around in many industries for a long time, all your refrigerators are foamed and all the refrigeration stuff at the supermarket is all foamed. But nevertheless, it does require a learning process in how to do it. We have pretty well mastered that on our large tonnage rooftop equipment. We have read about it in correct way and we've really addressed the issues and consequently we pretty well mastered the art of foaming products. And so entering into a foaming world on the air handlers does the same thing as it does in the rooftop. It gives us a much better insulated product. Yet, because of the way foam acts, makes composite construction between the metal and the foam, it also allows us to lighten the middle up a little bit, save some metal cost. Lighten the product up from the standpoint of how hard it is to handle and how hard it is to mount in the building. But at the same time, increase the strength of the unit because composite construction is done correctly, stronger than all this metal that typically is used. So that's one of the issues.

The other issue is something we are employing in our large rooftops, which is direct drive blowers. This eliminates the v-belt drive and all of its noise, it's all of its inefficiencies and all of its maintenance cost are eliminated. So we have great expectations for going out there with a state of the art product into a very well established market that's been around for a long, long, long time. And going out there with a name of AAON, which is now very well established as being an innovative high-quality manufacturers, so we do have great expectations for what we might be able to do. With the air hammer and adding to it the chiller, which give us the complete package now to go after a market and a building.

I appreciate that. It was very comprehensive. What percentage of the units shipped had foam insulation this quarter?

Well, of the units, it would be small, as a count goes, because recognize we started doing it on the biggest units. And the biggest unit is a unit that's up to 12 feet wide and 9 feet tall and 60 feet long. And the smallest unit is 70 inches by 60 inches by 43 inches. So as you can see, the dollars are very disproportionate. On a dollar basis, the foam units probably constituted around 20% of our sales. That includes the fact that, of course, none of our Canadian sales are foamed products. However, both the Long View, Texas, and the Tulsa, Oklahoma, markets are producing foamed equipment.

Okay. I appreciate your time. Thank you.

Andrew DeAngelis with KeyBanc Capital has a question.

Hi, Norm.

Hi.

Question on, and I'm sorry, because I joined late if you already answered this. Of the 9% growth that you saw in the quarter, how much was price and how much was units?

That's always a little bit of an estimate, but we think 67% of it was probably price-driven and the rest of it was growth driven.

Okay. And book-to-bill in the quarter?

Book what?

Book-to-bill?

We booked more than we built.

Okay.

So our sales were less than what our bookings were.

So you built backlog, great.

Right. And we are, the end of April, we were 61 million in bookings in the backlog.

I guess just more generally, could you speak to the state of the market right now? And your outlook for the commercial market?

Yes. It's really a funny, funny situation that I'm looking at. Because historically what everybody in the industry took as the gospel was that the commercial market basically was building buildings to serve the residential construction and, therefore, as residential went so went commercial followed by some lag effect. That completely got pulled apart when the dot com thing fell apart because the office building market fell apart with the demise of the dot com people in the year 2000. And then the second thing that hit us was the factories moving offshore, took away a second major market, and therefore caused some real problems with the commercial part of the market. The residential, on the other hand, went barely forward with low-priced interest and had a bangup several years. So we were kind of disconnected from that. Now, because it appears there's been an over-building and a little bit of speculation and whatever else, the housing market is heading down the tube and the commercial looks very sound right now. It's doing very well.

And, as a matter of fact, the biggest problem we face, in for sure the Tulsa market, to a little bit less, not too much less in the Texas market, and a little bit less in the Canada market, is that the industry, or that the economy is so strong, that there aren't any people available. And that's causing us probably the single biggest problem we're having is hiring people. And from what we hear around the country, that is not an unusual situation. So, the economy, contrary to the political people who just talk to hear themselves talk, as far as I'm concerned, they, they will say whatever they think will elect them. But the reality of the market is that there aren't many employable people in most parts of the industry -- or most parts of the country, I don't believe. And, therefore, the commercial market looks like it's going to boom right along because it's serving a need to fill buildings for all these various places that are putting these jobs together for all these people.

Great. And then my last question relates to your [cost of] business, the Canadian business. It sounds like you have a $20 million revenue target for the year. I was just wondering about the profitability of that revenue? And then, I guess, just along those same lines, it's sounded like last time we had talked that you were looking at kind of building your presence in the [custom market] a little bit more substantially, maybe looking at some other properties there. Just wondering where that stands stands?

Well, because of the fact that we had a lot of problems with that purchase, and getting it up and running, but everything, and I have 10 years of experience in running that type of an operation, everything I know from my history, and the people that I got hired who also have histories in that product or in that type of market, concur, we all pretty much agree, we all have the same general guidelines and rules of thumb, if you will, of what we have to accomplish. We have accomplished it in the pricing, and the price of the product that we've been booking for quite some time now. We have not accomplished it in the labor efficiencies, and now, with the new management we put in place up there, it appears we haven't even closed last month yet. So I can't say definitely where I am. But it appears from everything we can see that we probably have turned the corner on hitting it where it should be, and I would say further that it has the potential for being every bit as good on the bottom line as profitability per dollar sales as anything we have. And we have some very talented people up there running it, and I would be very shocked if I don't get a good bottom line performance.

So, our biggest issue there will be cleaning up smaller issues and getting ready to grow beyond 20 million per year. But that's not going to be hard on the order side, because our sales force, all we have to do is breathe a little bit in their ear that we'd like more business and it seems to appear. So, right at this point in time, the last measure I took, which was about a month ago, only 17% of our rep force was even actively selling the product line. So, it's not a product line that will always get sold by 100% of the rep force. But 70 or 80% of the rep force starts selling it, you can see what the upside could be and the ones who are selling it aren't trying as hard as they could. So it's got a huge potential for us. But it would require buildings and it would require equipment and it would require a lot of the normal things associated with growth.

And then I guess just to the second part of my question, in organically growing that business, potentially a [3 and 0] acquisition, what, what's the outlook there? Have you guys been progressing on that front?

We try and look for acquisitions, but at the same time, a lot of acquisitions are kind of maybe not to the extent that the two that we've experienced, which is our Long View facility, and our Canadian facility, which both of which have major problems. But generally when you buy somebody, they do always have some kind of problems. And depending upon how much money you have to pay for them, that's one aspect of it. The other part of it is, how much intellectual expenditure do you have to go through to get them to where they produce like you expect them to? And sometimes that intellectual experience can be a lot more difficult than the financial one. So, you have to be very careful when you think you're going to buy something and get a benefit from it. Whereas, if you develop it like we did the air handling unit, and the chiller in-house, we know where we are. We're not getting a big marketplace right away, but we're getting a marketplace that we want with the product we want.

Perfect. Thanks a lot, Norm. Congratulations.

Thank you.

At this time, we'll take a follow-up question from Frank Magdlen with The Robins Group.

Thank you. Hey, Norm, could you give us a feel for what your headcount is right now?

Just a moment here.

And then, while you looking that up, what percentage of your units are being sold now or shipped with the new R-410?

In those big units, which are booming along better than anything else, approximately 30 to 40% at least are in our R-410, and with this price increase that we're implementing right now, it's starting to make that changeover. Some of our suppliers, mainly the compressor people, and the cost of refrigerant has gotten to where, on those big units, the price will be equal with the R-410, equal to R-22. And that's going to have an impact on the market and on the changeover. Because if you buy one of those units, it's going to have a life expectancy far beyond when the old refrigerant is no longer available from the manufacturers, all that will be available will be refined reconstituted refrigerant. It will be at a horrendous price.

So I look for the change to occur very rapidly for us in those big tonnage units over the balance of this year and next year. At which point it wouldn't surprise me at all by this time next year to be 90-some percentage R-410 in those sizes. The smaller size units are also making a transition, but not quite as rapidly as the big ones. And that's probably understandable because when you get to the smallest size units, people look at them kind of like they do residential. They're not a lifetime unit. They thought of as something they're going to change out in some predetermined number of years down the road. And so they don't get as excited about the fact that refrigerant won't be available.

All right. And while you're still looking for headcount, where are you in the repositioning of the Company? Do you think you're 95% where you want to be?

Oh, yes. We're not doing a whole lot of repositioning now. We're fine-tuning the Company now. The biggest you could call repositioning would be the fact that we're entering the historical older line of the marketplace, which is referred to as the client equipment or the central station, or, it has a variety of names, but it is consisting of boilers, chillers, and air handling devices of some nature. And we're going into that much more seriously. It represents roughly the same size market as the one we've been in. So, we are repositioning ourselves to the degree that we're going to shortly be probably as dependent upon that part of the market as we are presently in the rooftop market. Kathy's done a real quick one on there. And we're real close to 1,500 people in total. Approximately close to 1,000 of them are here in Tulsa. Something over 300 of them are down in Texas and over 100 are up in Canada.

All right. Thank you very much.

Yes.

Andrea Sharkey with Sidoti & Company has a follow-up question.

Just a quick follow-up question on the air handlers. I just wanted to ask, are they also being sold through your regular channels through the manufacturers rep?

Oh, yes. That's, that's as common as, how could I say that, an automobile dealer who handles more expensive car and less expensive car. Sells into the same marketplace, it sold the same people, it sold in the same manner. Everything is very similar except the fact that it's a different product. So, our present sales force is very capable of handling this.

Okay, great. And then, in terms of, because it's a new product, do you think you're going to have a little bit higher warranty expense that you'll have to accrue for? I think typically you usually did 3% of sales if I'm not mistaken? Do you think it would be about that or maybe --

Well, let me back up just a little bit here, yes, we were running as high as 3% or very close to that. Probably a little on the light side a little while ago. But right now, what we're reserving of sales is 1.75% of sales. And we are reserving more than what we're actually spending. And if you recall, at the end of last year, one of the reasons that we had a good final to last year is we reduced our reserve because the auditors said we were over reserving in warranty. And so we rescheduled how much we put into reserve, as well as -- and lowered it down to the 1.75. But being cautious, people, the auditors have us over reserving a little bit now, which is what we've always been along with them in that caution. So it wasn't unusual for us. And so it's going down. Air handlers should have us lower warranty cost by about 1/2, 1/2 the amount of what the business we've been in. Because it doesn't have compressors. Now, the chiller part of it will be roughly comparable, but we've been in that now for a few years. Chiller part is pretty comparable to the rooftop part, but the air handler part should be substantially less.

Okay, great. Thank you.

(OPERATOR INSTRUCTIONS) At this time, there are no further questions. I will now turn the conference back over to Mr. Norman Asbjornson for any closing or additional remarks.

Okay. I'd like to thank everybody for participating and for your support. I kind of like to sum it up by saying that, we have for a few years now, been well in control of our destiny with our financial performance. And right now, we have gone a long ways toward completing the product line that we need to have for significant amount of growth for a lot of years to come. And if we didn't develop any new products but just refined the ones that we've been talking about, the Company is capable of growing immensely with the products that we already have in house.

So, the thrust of the Company has been slowly changing and it's going to be changing even more away from product development, away from worrying about how to get more efficient in manufacturing, and toward marketing the product. Because that's really where our problem is going to be faced. That's what's going to be our growth limiter. The product line itself is not going to be and our ability to build product is not going to be. Notably, you always have some times that it will happen to you, but in general, making a generalized statement, this Company now is entering a somewhat new phase, more seriously of a marketing challenge. I thank you again, look forward to talking with you the next time.

And that does conclude our conference call. Thank you for joining us today.