Aaon Inc (AAON) 2008 Q1 法說會逐字稿

Good day, and welcome to today's AAON, Inc., first quarter conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to your host, Norm Asbjornson.

Good afternoon. Prior to embarking 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 SEC filings including the annual report on Form 10-K and the quarterly report on Form 10-Q. Thank you. I would like to introduce Kathy Sheffield, our CFO.

Good afternoon. Welcome to our conference call. I would like to begin by discussing the results of the three months that just ended March 31, and those results of which we are quite proud. Revenues were up 11.8% to $65.5 million from $58.6 million. This increase is primarily due to an increase in both market share and pricing. Gross margin stayed constant for the two years at $15.7 million. The gross margin percentage was 23.9% of sales for the first quarter in '08, compared to 26.8% of sales for the same quarter in '07. Although the margin percentage was less this quarter compared to the same quarter a year ago it was still a very good margins, and the margin being at 23.9% is really a better respectable representation of what we would expect our margins to be.

Selling, general, administrative expenses increased for the first quarter by 3.5% to $5.9 million or 9% of sales from $5.7 million or 9.8% of sales. The increase in SG&A is primarily due to an increase in sales related expenses and then just overall general and administrative expense increases. Operating income decreased slightly by 2% to $9.8 million or 14.9% of sales, from $10 million or 17% of sales. Net income increased by 1.6% to $6.4 million, or 9.8% of sales from $6.3 million or 10.8% of sales for the same period last year. Diluted earnings per share was $0.35 per share this quarter compared to $0.33 per share the same quarter a year ago. EPS was based on 18.311 million shares compared to 18.902 million shares for the same quarter in 2007.

Moving to the balance sheet, our current asset ratio increased slightly to approximately 2.3% primarily due to an increase in current assets. Capital expenditures for the quarter were right at $1 million, and those expenditures were related to equipment purchases which would increase our production efficiencies. Shareholders' equity per share was $5.58 compared to $5.29 last year. During first quarter, in 2008, we paid cash dividends of $2.9 million and also bought back stock from retirement incentive plans and through the open market as well, and paid $1.8 million in total. I would now like to turn the call back over to Norm who will discuss our results in further detail, along with discussion about new products and the outlook for the remainder of the year. Norm.

Yes, we had record-break sales performance, primarily due to having come into the year with a larger backlog than we did in 2007. We had a negative order input in that we did not book quite as much as we did in 2007, and, therefore, we pretty much stayed constant with our manpowering. Then coming into the second quarter now, into April this year, there's been indication that the order is on the upswing. It's been very strong bookings and as a matter of fact, weakness in the first quarter in bookings was in the first two months, January and February, and we had a strong March, stronger than it was a year ago. So it looks like we're gaining strength in the booking department at the present time.

Our second quarter actual shipments is pretty well covered with orders which we presently have in the backlog. We still have a little opening for new orders, and that is rapidly being taken up. So our problem in the second quarter is not going to be orders. Our challenge is in producing product. In that respect, we sit with kind of the proverbial good and bad situation. The good part of it is that we've got plenty of work to put out the door. The bad part is we're having a difficult time hiring additional personnel, so we're going to be somewhat limited by personnel, and that's due to unemployment rate in our Metropolitan area of 3.2%. Doesn't give you very many people to pick from. So second quarter results on shipment are not going to be limited by orders. They are going to be limited by our ability to get out the door.

As I spoke earlier, order input looks very good. Based upon all the signs and everything we see it looks like a very promising year. However, I also read the paper and listen to news broadcasts and everything, and there are, as we all know, several negative things out there in the marketplace, and there's a lot of negative discussion. But I did see some signs of that there in the first two months of this year but since that point in time it doesn't look like it's happening in the construction market, at least for us. So that's kind of the going on situation in that respect.

Now, on gross margins we are seeing a more inflationary environment than we were seeing last year, and that is reflected in the results that we obtained for the first quarter. We are at the present time going to have another price increase which is occurring at the end of this month. So that will help us, and on what we've got in the backlog right now, basically we had a price increase on the first of December of last year, and that didn't get worked through our backlog until the very last part of the last month of last quarter. So what -- what happened last quarter was that the cost increase for material did come through and the price increases weren't effective. The price increase will be effective for obviously most everything for this quarter, and the question mark is are material costs going to continue to increase faster than our cost increases are going to improve it. Time will tell on that, but it is an inflationary environment which we're in.

SG&A expenses, as was noted by Kathy are up in total but they are down as a percent of sales. They are down from 9.8% to 9% even though they are up in total dollar volume. I expect 9% to be reasonable estimate for the rest of the year on SG&A. The operating margins at 14 .9% are extremely good for this industry. And very happy about it. That's better than our margin last year of 13.6%. This is our best performance in the past four years on operating margin. So that portion of it looks very strong. And, of course, it comes around to the net income line which was a record that we had this year.

The CapEx, as Kathy noted, we've only spent $1 million so far for basically equipment, and we've been giving guidance that we will be spending 7 million to $10 million. That still is an accurate number to be contemplating. We are embarking upon some rework in addition to the building which we'll -- the work is going to be done on the Tulsa facility. That will consume the majority of the balance in that 7 to 10. We believe we have adequate equipment to get ourselves not only through this year but through next year with a reasonable amount of growth in it, too, and what we're setting up in the way of what we're doing on the building portion is not so much what we need this year, it is not, it is for future years. What it will do for us, however, as we get the building done, it will improve our ability to run some portions of our building a little -- or our production a little more efficiently than we would have without this. It will relieve a little tightness we have on a couple production lines.

It will provide us what we need for several years in the future in building capacity, so the capital needs in that area will disappear for some time to come, and the -- as I said, the machinery side of it, we're quite good in, so the Company is sitting in extremely good condition and getting better as far as what capital needs we have in the Company for substantial growth. Canada has as you know, had problems ever since we bought it out of bankruptcy we haven't been making money up there. Continues to be the case.

In the first quarter this year we just had a very minor loss compared to previous months and previous years and quarters and we're sitting at a real unpredictable situation because those of you who follow the exchange rate between the Canadian dollar and the U.S. dollar know that we had to implement nearly a 30% price increase on any of the Canadian product which was sold into the United States due to the change in the exchange rate with the Canadian dollar becoming much stronger compared to the U.S. dollar. That, of course, was a hard price increase to sell through to our U.S. customers and it diminished our order input very severely and we've been working off backlog on that operating and the big catch now is because about 80% of our business has historically come out of the U.S. customers for the Canadian operation is our ability to get orders to maintain that. Our present backlog and our present pricing of our backlog is certainly adequate to make profit. Our problem is when more in personnel, getting the personnel trained and working properly, and getting more orders for the facility. We are, as noted, because of the precariousness of the profitability of that Company that portion of our Company still analyzing its future very significantly.

On new products, the air handlers and chillers which are to varying degrees new products with us are coming on strongly, and the addition that we're putting on to the Tulsa facility has a it lot to do with the air handler and chiller portion of our business, because that is one of the areas that we're squeezed on for space. We have gotten into, after several years of telling you we're heading into it, we have basically gotten into the residential on a very minimal scale and have anticipations that we will be working out the problems of actually making it functional as a marketing system over this year. We are entering one new area of product.

There's a system which is many times referred to as a floor by floor unit or a self-contained variable volume system. It's the type of system which is prevalent in New York City with the high-rise market and in other cities for high-rise market. It is very dominant product line for the New York City market. A little less dominant in some of the other high-rise markets. So it has fairly good volume capabilities depending largely upon high-rise office buildings, of course, for the market.

We have another thing which is being introduced and has been introduced by us and by our compressor supplier called a digital scroll compressor which effectively makes small tonnage compressors variable capacity devices. And this has a huge opportunity for a number of reasons, among which is its ability to save energy. It's a very energy efficient way of improving production. Many of you may be aware of some of our common terminology in our industry called SEER, in other words seasonal energy efficient ratio. Or plain EER for larger equipment which is just energy efficient ratio.

That number is one which is at a fixed point. One point of measurement. It doesn't cover the full spectrum of the varying loads that occur due to the varying temperatures and varying internal loads of a building. And so it's a good measurement of the overall capability of a machine to save energy, but it is a very poor measure of its ability to totally do that. What I'm trying to say there is if you were running it always at that one design point and comparing it, it's a great measure. But that's not the real world. The real world is that it the's always varying, your load is and this digital compressor has a very, very pronounced positive effect upon doing that. It's a new technology. We are in a leadership position of implementing that technology, and we think it will be a very pronounced effect upon our ability to compete and also address the energy issue that we're so involved in, in our industry.

Looking at the various kinds of business segments that we involve ourselves in, let's talk about some of the ones that we're into. Probably the strongest one we're into is our education, and that's largely first grade through 12th grade building structures. That market is quite strong, doing very well. We are doing very well in it, and it's doing well for us. Our next strong one has been and at one time was our primary one, the retail market. The retail market is a little bit on the weak side at the present time, and has, in fact, some people are cutting back, others are not, but it's not a real strong part of the market and so in one respect we're fortunate that we've redirected our efforts over the past few years, more into the educational structure, which is a stronger market at the present time.

The other part that has still shown some strength compared to some previous years and was one that was pretty weak for a long time is the office building market. That's not doing badly. And the other part of that which also was having problems in the past and seems to be somewhat stronger now is the manufacturing buildings market. The medical and healthcare portion of the market which is a smaller market but is a very healthy market at this time, as one would expect as our population ages and grows, that market is likewise growing. And then there's our general unqualified type of building which is not covered by one of the aboves, and that portion of the business looks pretty strong. So as I mentioned before, if I didn't read the newspaper, didn't listen to the newspaper, I'd think business was quite good.

The outlook for the balance of 2008, therefore, is questionable, because there is other news out there that would lend to you believe that you should be concerned. But what I'm seeing on the order desk and what I see in the immediate future would tell me that it's going to be strong at least for awhile. We have been active in our stock repurchase program. The new program, which began in November of '07, and blacked out most of the time, because of the end of the year, will be reentered by thus Friday. The remaining shares we have yet to purchase on that is 1,028,900 shares. As Kathy noted earlier we have already purchased some this past quarter. Some of our initial authorization out of that. With that, I will open it to question and answers.

Thank you. (OPERATOR INSTRUCTIONS) We'll go first to Frank Magdlen with The Robins Group.

Afternoon, Norm, and congratulations on a very good quarter. Could you quantify a little bit as to what the loss in Canada was, and also could you quantify your backlog?

Total backlog for the Company is right at $50 million. The loss in Canada was about $62,000 in the quarter.

And what were the revenues in Canada? Canadian revenues, one moment here. Maybe Kathy could look up for us the shares that were actually repurchased in the quarter.

Surely. Kathy, would you do that. The Canadian sales for the year -- let's see. 2,821,000.

Since you've added so much to your plant and equipment in the last few years, what would be a good maintenance CapEx number to look at going forward?

Depends upon our growth, Frank. What we're embarked upon right now in the building program is we've spent the past two years trying to analyze how we should build this building out and what effect it would have on our abilities and various things, and by our abilities, the I'm saying our efficiencies what effect it would have on our efficiencies so we know how it would affect our P&L statement and everything. And we've done quite a lot of work in that area, and we've decided that this is an appropriate time to move forward. And the reason we're moving forward with it right now is twofold. We were first of all going to move forward with what plan A, and then our tenant, who has been renting from us told us that they were shutting down a plant here and wouldn't need our place for a distribution center, so we were going to get back the building that we have rented out, and that changed our approach to the whole thing, and made it such that when we analyzed how to do all this with that in mind, we decided to go forward and basically set this thing up for a portion of the building anyways, it's going to be set up to go to what we think the ultimate capacity in today's dollars would be of approximately 900 million to $1 billion out of this facility in Tulsa. So a portion of that building that would be necessary to do that will be completed by the end of this year.

All right. But, Norm, on a regular reoccurring basis you need to replace so much plant and equipment. What is that now?

Well, basically we're running between 9 million and $10 million on depreciation, and that's probably a reasonable number to use for that purpose. The only deviation from that will be if the business grows faster or slower than what we anticipate. Either way it will affect that number.

All right. And then Kathy, do you have the shares repurchased?

Yes. For the first quarter, Frank, we purchased 103,040 shares, and that was at a total price of $1.8 million for an average price of $17.72.

All right. Thank you very much.

You're welcome.

Norm, can you give us a little bit of history on price increases, say over the last two years? And I know you said you have one coming out at the end of this month. Just general terms.

In general terms, we've been increasing price over the past two years probably somewhere in the high single digits. In other words, 8 or 9% a year, even though the inflation would tell you that that's too high. It is high for the cost we incurred because we're tied more strongly to the commodity industry -- index of steel, copper and iron -- or aluminum which has been going up faster, let's just talk about that for a moment. Copper during 2007 ranged in price from $2.42 a pound to $3.65 a pound. In the first quarter of 2008, it has ranged from $3.80 to $3.90 per pound. We're locked in on about 80% of our copper for 2008 ranging in prices from $3 .55 to $3.60. We estimate that second quarter copper is going to see copper at $4.30 to $4.50 a pound. So we're going to be benefiting by our lock in of 80% of it but 20% of it we are going to be paying that kind of price for.

Looking at our see the, prices were pretty level at about $0.45 a pound for the first 10 months of 2007, then it increased in November and December up to about $0.50 to $0.51 a pound. Ever since then it's been going up month by month. We're up now running in the upper $0.50s and the lower $0.60s a pound. In other words, coming up from November at $0.45, now we're playing with $0.60 a pound. So where's that going? I don't know. That's a pretty big number. And those two elements, of course, make up a lot of what we buy to fabricate with and they make up a lot of material that our vendors of componentry use. So we're in kind of a higher inflationary environment than what the country as a whole is experiencing.

Aluminum is one of the beneficial ones in that it's experienced about a 4% increase. So it's not running wild. Stainless steel is running $2.45, $2.48 a pound. We think it's going to be pretty stable there. Component prices, as I said, are connected very tightly to those first two. And so we expect them to run some where in the 5 to 8% -- or 7%.

All right. Well, thank you very much. I'll jump bake queue, Norm. Thanks for the good quarter.

Thank you.

We'll go next to [Joe Mondilo] with Sidoti & Company.

Good afternoon, Norm.

Hi, Joe. How are you?

Good. First can you -- I know you mentioned the end markets there. Could you maybe quantify or just give a rough estimate or just some color on how much exposure maybe to education and to the rest of the markets there?

I don't have some really good numbers to give you, so they're going to be seat of the pants sort of numbers at this moment in time. I'm going to say that the education market probably running 25% of our business, or maybe 30%. Retail probably is in the low 20s. Office buildings, 15, 18, and the rest of them probably break down to balance of that, 30% or whatever.

All right, that's fine. Thank you. And then on to the steel. How often are you buying steel and what's your procedure there in keeping inventory of steel?

Well, my procedure right now is over inventory, because of the price -- constant price up-swing we've got, and I have various places within the Company here where we can store steel. Some of it is stored in the flat, in the (inaudible) machines we have what we call warehouses that we store steel in preparatory to using it. We have in that area somewhere in the 600,000 pounds of capabilities, all of those things being filled, and we try and maintain a full situation on that, and we probably have in rolled up unprocessed steel, we have the capability of carrying probably 800,000 pounds of steel and I'm trying to keep that all filled and beyond that we try and make commitments to our steel suppliers for as far as they would commit to us at a price that we think is worth committing to and we're doing that. So steel is not a hedgable item, and therefore we're doing everything we know to hedge it.

Would you say you have like a somewhat of a schedule on how often you're buying it, like every two months, every three months?

We bought it every time, every day that we get a good chance, because we're going to use 30-some million pounds, and at that volume, we are getting many truckloads. A truckload is somewhere between the high 30,000 to 50,000 pounds, and we have several of them come in every day. So we're constantly buying and shopping for steel.

Great. Okay. And regarding your gross profit margins, with this dramatic increase and it doesn't look like it's dropping any time soon, what do you think your -- could you give some color on what your gross margins and what you expect them to be like and if you can hold them at all and such going forward in 2008?

Well, as Kathy mentioned to you, we ran 23.9 in the first quarter, down from a year ago 26. The 26, if you will recall back then, I told you that kind of was where all the stars align themselves, one of the few times in my life when they did, but they did last year. So the number we have this year is a very good number. Last year was kind of an abnormality. The ability for us to keep that there is going to depend upon our ability to guess where this price increase of commodities and things is going, as well as our ability to pass on the price increase to the users. As you know, it's always difficult to convince people they should pay more money than they have been, and their expectations are somewhat based upon their own experiences with our economy as a whole. Of course, right at this moment in time there's getting to be quite a bit of expectation for inflation in food and in energy use, particularly at the gas pump. So it's being easier for them to understand our needs to pass it through, and we're able to pass through our price increases. We always do have that lag effect, however, of our backlog being priced at one price and end up being built at a new cost. So to answer your question directly, I think we can hold it up in the 20s, somewhere around where we are right now.

How much of a 2 to 3% decline from last quarter would you say is due to increased raw material prices in this first quarter?

The vast majority.

Vast majority. Okay. And then just one more thing. In terms of the replacement market, can we look at -- is it valid to look at it as if the U.S. economy begins to turn? Is that the replacement market is that going to increase as well just because companies are going to have more capital spending? Is that a good way to look at that?

I think it is, and then you have to think about what precipitates various types of sales, and new construction is an easy one for our industry to run at, whether you're in the engineering business, in the contracting business, or whatever segment of it. It's a little harder to run after the replacement market, but when the new market -- if the new market is not available, these people have to find something to run after, and, therefore, they put more pressure on selling into the replacement market, and it tends to grow if the economy isn't real sick. Going out, talking to someone who kind of knows they need to replace their equipment, and if somebody is in there doing a good selling job on them, it's more likely to result in an order, and therefore the replacement market seems to get healthier when the other market gets a little sicker.

All right. Thanks a lot.

Yes.

And we'll go with Jon Braatz with Kansas City Capital.

Good afternoon, Norman, Kathy. Couple questions. You mentioned, Norm, what your revenues from Canada were this quarter. What was it last year in the loss?

I've got it right here, Kathy. Sales last year in the quarter were 1.922 million. So it's up quite a bit from last year, because as we mentioned to you, or we done previous quarters, we had quite an influx of orders last year which turned out to be a very detrimental thing to have happen, because a large quantity of them are in the United States, and we got caught in that exchange rate problem. We had all these orders in house at one price, and we ended up, when we collected the money in U.S. dollars and converting it to Canadian dollars, taking a real bath on it.

Right. I think you had said in earlier calls that you thought the revenues would be down sharply this he year.

They are from here on out. We've gone through the backlog. Now we're more dependent upon new orders.

Okay. Good. Did you mention -- I was distracted for a second here. Did you mention what the price increase was going to be for the end of this month?

Roughly 3%.

3%. All right, fine. And that's across the board?

Yes, across the board.

Okay. Let's see. What else do I have? I think that was it for now. If I have anything else, I'll get back in the queue.

Good talking with you.

We'll go next to Graeme Rein with Bares Capital.

Hi, Norm.

How are you?

Doing well. Could you talk about two things for me. One, national accounts. Have you made any progress in getting into the large national account? Then also the 410-A refrigerant, are you seeing a change in the market in terms of acceptance and demand for that aspect of the product yet?

Okay. We haven't pursued the national accounts too aggressively for a couple reasons, one of which is we've been very busy with the other direction that we've been in pursuit, which was expanding our customer base. And the second one being that in times of volatility of commodity prices, it's really hard and very risky to go making long-term commitments, which is what you do with national accounts. You make long-term financial commitments, and if commodities are volatile, you really rolling the dice a lot more risky than you are on the short term order by order basis. So we've been very busy on the other front, and we've not been giving out as competitive of bids when we have a chance on a national account as some of our competitors have been willing to do.

Okay. Then the 410-A?

The 410-A is rapidly in process of changing. It's one of those areas which is, from my perspective, not understandable about why anybody would buy the old style refrigerant, because you're buying a piece of equipment which minimally in the worst case condition is going to have a ten-year life, and in most cases is going to have a 20 or 30-year life. And on January 1, of next year -- not next year, the year after, 2010, there will no longer be -- you will no longer legally be able to sell an R-22 machine in the United States, and the amount of refrigerant that the chemical companies can build of the old R-22, it drops dramatically again, by federal law, and so you're selling a product today that is going to have a hard time having refrigerant available for it because it's going to rapidly become dependent upon recycled refrigerant, and at some point you are going to have to replace the unit probably not because it wears out but because you can't get the refrigerant at a reasonable price. So it's kind of nonsensical, but there are still a lot of people buying the old equipment, but it's dawning on a lot of them how foolish that is, and we're happy to have that happen because, as you know, we've been using -- had all of our equipment available at R-410 for several years now, so it's beneficial to us when that dawning happens to potential customers because some of our competitors are not nearly as far along as we are in converting.

That's what I was going to follow up with. Have you seen a change in the competitive offerings?

They're gradually moving that way. We have heard some people who supply componentry which is refrigerant-type determined, making concerned statements about why the industry isn't moving as fast as they think it should, and they're quite concerned that there's going to be a lot of confusion and a lot of trying to get variances from the government and the whole lot, anything and everything sometime next year about this time, because, the chaos that's going to exist where somebody hasn't gotten themselves properly prepared to go 410 is going to be pretty substantial for some of these very large names in our industry, I think.

Okay. Thanks for your time.

(OPERATOR INSTRUCTIONS) We'll go next with [Cory McCullum] with GMP Capital.

Good afternoon, Norm and Kathy. How are you? Just fine.

Good afternoon.

I had one question. As you think about the education build-out of schools here across the country, are those replacement schools, replacing existing school, or are those building out in response to the housing growth in the past few years? How do you see the drivers of that piece of your business?

Well, most of it is due to just population growth. If you're like I am, I've been around here a little while. At one time when I was growing up I remember that the population of the United States was about 160, 170, 180 million. And now it's somewhere close to 300 million. And to handle that, you're talking 5 million buildings you have in existence in the United States to handle as much as we've got right now. If you project that number on, depending upon which of the projections you wish to believe in, in another 20 years you may be looking at, instead of $300 million, you may beep in the $500 million area, or certainly in the 400. And realize that that's going to -- if we've got that many million buildings today, we are going to have lot of millions of buildings to handle that population, and that's probably the biggest driver.

But also what happens is as our cities grow, the internal part of the city at one time was the center of the city, then it moved to the urban areas, and some of the central cities lost a lot of population but the general area of that town or city doesn't decline, it just moves into the suburbs. So there's a lot of movement just within an area that creates new schools for these new areas where the new families with the children are going. And then as is happening in some places, they're coming back into the central city now and they're going back in and renovating some of these old schools and putting air conditioning into them and bringing them up to speed. So there's a whole host of things that work -- at work here that I believe will continue to happen. Particularly there's some effort to slow down our immigration in the United States, but the number of children per family I think is reversed itself and started growing a little bit. So it looks to me like we're still in a growth mode in that area.

Thanks. Just one quick housekeeping issue. The tax rate in this quarter versus the first quarter of '07 seems to be a little bit different. How should we think about that going forward?

That -- going forward, it is presently at 35%. That's what we expect it to be going forward. There were three things that actually affected the tax rate between this quarter and the quarter a year ago. That had to do with an R&D tax credit and a domestic production activities tax credit and some apportionment factors in various states based upon our new FIN 48 requirement. So all those things said we're look at 35% through the end of the year.

Thank you.

And our next question will come from [Robert Marquardt] with [Thermonetics].

I have a question on the new compressors. What sizes are those available in, and how soon are you going to I want great them into your equipment?

Well, the manufacturer of those compressors introduced them to the U.S. market in the mid-1990s and nobody accepted them because they were a little more expensive, and the manufacturer happens to be a worldwide manufacturer and found a ready market for it in the Asian market, put it into production over in their Asian plant and sold into it that market, and when we, in the early 2000s were looking for ways to address energy as well as some other problems that needed a variable volume compressor, remembered our foolish statement that we didn't want it back in the mid-90s, and we called them up and said, are you still wanting to sell in the United States? And we cut a deal with them to bring it in for us in 2002. And it was a very limited offering. It was only available in very small -- in the area of where normally you have variable volume compressors in large sizes but you don't have in small sizes. These were available in limited range in the four to seven ton area which is typical to, say, a normal size house in most parts of the United States.

So we brought that in and we used it as well as we could but it was, as I say, a very limited ability to do much with it. We've been after them to expand the size of the compressor and make it more available in the United States, both of which they have been doing, and also because the Far East market is unencumbered in Asia -- or in China, India, and Indonesia by the environmental concerns. They are not under any obligation to go to the new refrigerant because the Kyoto and the Montreal protocol did not address that for developing countries. So they only had it available in the old refrigerant over in the Far East market. So the manufacturers had to evolve that compressor into the new 410 market and also expand it. So they've had a considerable challenge doing that but they're doing it very well and we're able now to offer it in much more sizes but small sizes so far, and just very recently are we starting to go into larger sizes. So it's a funny thing. We've got a variable volume compressor in small sizes and there are some out there in large sizes, and there's a big gulf in between that is not available.

Thank you.

And we'll go back with Jon Braatz.

Norm, I think in your text of your commentary you mentioned that SG&A costs came in at 9% for the first quarter, and you thought 9% was sort of the going rate going for the remainder of the year. Just doing some calculations, it would look like if I did that your SG&A cost for the year would be up about 20%. Did I misunderstand your comment?

I don't think so. The 20% would sound a little high just doing a quick mental calculation because we've come down from 9.8% to 9%, then what that would have to -- most of that 9% would be directly into our growth. Now, if you're anticipating a 20% growth for us, then you'd be right on the nose, I think.

Right.

It's going to be very closely tied to our growth.

Sure. I understand. Then the second question is if I came to you and said I'm looking for a piece of your equipment, I need you to bid on it and I'm looking for delivery in January of next year or something like that, given the volatility in the commodity prices, how would you quote me? If you could give sort of a real life walk through on that? How would you quote me knowing that, you don't know what steel price are going to do? Can you walk me through that a little bit?

Sure can. There's two ways I can approach you. I can give you a firm price, and I can do a speculation on my part about what the cost will be. Then if you say, that sounds like it's going to be very high, I could then give you a price which if you took delivery today, and we have evolved and I think it's our own evolution of what we've done, but we've taken the percentage of material that's steel, copper, people, and all those things, and we've written a formula, which is not a very complex formula to take governmental statistics which are available on the Internet for each of those commodities, and calculate a price for the thing. In other words, we can take today's price and say okay, we'll sell it to you for today's price adjusted by all these factors which -- and here's the formula and you can go on the Internet and you can make the adjustment to the price and you can tell us what we're going to charge you, and we will be happy to sell it to you for that.

Okay.

So one way is a speculation on our part, and the other one is a speculation on your part, and you just take whatever the governmental statistics say each of those commodities has gone up, put it in the formula, crank out the percentage increase to give us and give it to us. We use that when we deal with national accounts if we can convince them to go that way, and it seems to be that they go that way because they can calculate how much price increase they should give us just like we can and they feel comfortable in that because they're using governmental readily available numbers to do the calculation.

How -- what percentage of your backlog or your orders that come in, how would you say what percent is quoted the first way versus the latter way?

Well, the only way -- the only people really that use it very much are national accounts.

Okay.

Because most people, once they give us an order for a job, it's usually a pretty short-term order. In other words, they want it delivered for the most part within next two to three months.

Thank you very much.

You're welcome.

We have a follow-up from Joe Mondilo.

One question. It's actually regarding the SG&A there. I just want to clarify. The first quarter of last year was 9.8 and the first quarter this year was 9 but the last three quarters of last year were around 7 to 8. So are you expecting the last three-quarters of this year to increase from that 7 to 8 to 9? Or to be roughly in line?

Kathy is more familiar with all the intricacies of that. I'd rather she address that. So I'll turn it to her.

Yes, Joe, it's going to be more in the 8.5 to 9% in the SG&A is warranty. As our sales increase, there's -- we're going to be reserving a certain percent of warranty that will go into the SG&A and increase it.

One of the things that you see in the slow down in that is our warranty costs tend to peak in the summer during the air conditioning time because the most costly and the most problematic portion of our unit is a cooling portion, not the heating portion. And, therefore, we, as the year goes on, we can kind of gauge if we're not having as many problems as we anticipated because we always have to put an end to this reserve, and if we're not taking it out of the reserve as fast as we thought we were going to, then we have a formula that we've agreed upon with our auditors as to how much reserve we should have, and we crank in there, and if it's starting to over reserve then we start backing it off. Of course, when you back it off it backs right down to the P&L statement. So that's why last year, for instance, our warranty costs -- there's two warranty things that are at issue here. Warranty for -- warranty cost and bad debt reserves. And neither one of them were quite as high as we thought they would be. So that gave us a shot in the arm in the latter part of last year.

Thanks.

And with no further questions, I'd like to turn it back to our speakers for any remarks or closing statements. Please go ahead.

I'd like to thank all of you for joining us. We are very pleased to have had what we consider to be a very good first quarter, and we think we're going to have a very respectable second quarter, like I say is it's not limited, not going to be limited by dollars of sales. It's going to have two things that are going to affect it. One, our ability to increase the volume by how many people we can hire and how much overtime we choose to work. And the other side of it, the bottom side of it being what cost increases we do or do not receive, but other than that, there's not much question in our mind about the total dollars. It then comes down to the question in our mind about what costs are going to do to us.

Looking longer range, as I said, if I read the paper and the news, television and all that, and guessed on that I would be scared to death most of the time. If I look at the order desk and what I'm being told, I'm happy as can be. So take your pick. Thank you. We'll talk to you again the end of the next quarter. Talk to others of you in between. Thanks.

And that does conclude today's presentation. Thank you for your participation, and have a great day, everyone.