Aaon Inc (AAON) 2010 Q3 法說會逐字稿

Welcome to AAON, Inc.'s third-quarter sales and earnings report conference call. I will now turn it over to your host, Norman Asbjornson.

Good afternoon. Thank you for joining us in AAON's third-quarter investors conference call. I'd like to read a forward-looking disclaimer before proceeding.

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 occurrences of many events outside of 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.

And with that, I would like to introduce Kathy Sheffield, our CFO. Kathy?

Thank you, Norm. Good afternoon. Welcome to our conference call and thank you for joining us this afternoon. I'd like to begin by discussing the results of the three months ended September 30.

We're pleased to announce that our revenues were up 10.9% to $64.9 million from $58.5 million. Revenues increased due to the positive response to our new products and to gaining additional market share. Gross profit decreased 29.4% to $12.5 million from $17.5 million.(Sic-see press release) Gross profit was 19.3% of sales during 2010 compared to 30.3% of sales during 2009. The gross margin percentages were narrowed by higher raw material and manufacturing costs, increased labor expenses, and our inability to implement price increases, given the economic environment. Also, the third quarter a year ago benefited from a $1 million reduction in cost of sales resulting from our hedging of copper.

Selling, general and administrative expenses decreased 1.9% to $5.2 million or 8% of sales from $5.3 million or 9.1% of sales. The decrease was due to lower bad debt and warranty expense, a decrease in sales-related expenses, and a decrease in profit-sharing expense due to lower net income.

Operating income decreased 41.1% to $7.3 million or 11.3% of sales from $12.4 million or 21.2% of sales. Our effective tax rate remains at 35%. However, we did receive a tax benefit in the third quarter due to an increase in the domestic production activity tax credit from 6% to 9%; higher R&D tax credits than expected with the filing of our 2009 income tax return and bonus depreciation, which was reinstated in September of this year.

Net income decreased 32.5% to $5.2 million or 8% of sales from $7.7 million or 13.2% of sales. Diluted EPS was $0.31 per share versus $0.45 per share. Earnings per share were based on 16,647,000 shares versus 17,304,000 shares in the same quarter a year ago. In addition, related to the quarter comparison, our 2009 net income benefited $600,000 or $0.04 per share due to the copper derivative mentioned in the gross profit discussion.

The results of the nine months, our revenues were down 6.5% to $178.7 million from $191.1 million. Gross profit decreased 22.3% to $41 million from $52.8 million. Gross profit was 22.9% for the nine months of 2010 compared to 27.6% in 2009.

Selling, general and administrative expenses decreased 11% to $16.6 million or 9.2% of sales from $18.6 million or 9.7% of sales. Operating income decreased 28.5% to $24.4 million or 13.7% of sales from $34.1 million or 17.9% of sales. Net income decreased 25.5% to $16.1 million or 9% of sales from $21.6 million or 11.3% of sales. Diluted EPS for the year was $0.95 per share compared to $1.25 per share a year ago. EPS was based on 16,981,000 shares versus 17,318,000 shares.

Moving to the balance sheet, we see that we continue to have a strong liquidity position of $4.1 million in cash, which aids our goal to stay as liquid as possible during today's uncertain economic times. Our current asset ratio was 2-to-1. Capital expenditures were $13.1 million related to the completion of our Tulsa building expansion and for equipment purchases to set up additional manufacturing lines in that expansion.

Shareholders equity per share is $6.94 compared to $6.85 in 2009. We paid cash dividends of $3.1 million, both in January and July of 2010.

I'd like now to turn the call back over to Norm, who will discuss our results in further detail, along with the new products and the outlook for the remainder of the year. Norm?

Thank you, Kathy. Our sales, as was noted, were up almost 11% for the quarter but down 6% for the nine months. Now we've had a lot of turmoil, as we're all aware, but let me tell you what we see in AAON's analysis of all this.

We have been embarked upon a very significant change in our product design. We've invested considerable effort and money into new products. We watch and monitor what occurs as we introduce those products to see whether we're hitting our targets, as far as improving our market position with the new products over the old products.

The first major one that we were watching was what we call our C Box, which was a 16-ton through 30-ton box introduced in the fall of 2008. We watched that to see, and it showed surprisingly good acceptance and increased relative efficiency of sales compared to our other product lines in the previous product line.

The next product that we introduced was what we call our B Box, which goes from 8 tons through 15 tons, introduced in the late fall of 2009. During the second quarter, we saw that also doing a similar move forward in claiming more market share than our previous product would have claimed.

The last two, which were introduced as our A Box, introduced in the mid-second quarter and our RQ Box introduced at the very end of the second quarter.

What we were seeing was fulfilling our expectations of what we were hoping from the new product and was starting to give us increased marketability of our product line. And therefore, at the end of the second quarter, we started reversing some of what we were doing at that time, which was heavy stock buyback. And we said, we are going to have to start getting ready for when the market turns. And our penetration of the market had already turned on us, and we anticipated the A Box and the RQ Box would perform similarly to what the C and D Box had.

And at this point in time, I'm pleased to tell you that that that does appear to be occurring. Therefore, we started considering how we were going to handle this.

We were faced with a couple of other interesting aspects, one of which was the fact that some of our machinery in our East facility -- our East facility handles approximately one-third of our production business in the Tulsa area -- was when we originally began work and was sort of obsolete and maybe a little unplanned in the way we organized that building, because we'd had a couple of additions onto it, and we had, during our growth, started out very much smaller than we were now.

And so it's not a very efficient building, plus the equipment that we were manufacturing in was getting old and worn-out, so we were going to have to do something in the not-too-distant future in the downturned economy, as long as we had the capital to do so. And we felt it was advisable to effect a lot of this redesign of the facility and refitting of the facility as soon as possible.

In order to accomplish that and not lose productivity of our product, we were going to have to overstock the west side with machinery. So we did. We changed our plans a little bit. We bought, committed to quite a few millions of dollars' worth of the additional equipment, which will not be delivered until the end of this year and the first part of next year, but on which we have to make a down payment of approximately $5 million, which is included in our capital expenditures year-to-date.

So that is really future -- that $5 million is basically new product that we -- or new equipment we haven't yet received. That will then allow us to dismember some of the old equipment and begin replacing it on the Eastside facility of the Tulsa facility.

In addition to which, the products which we had brought out new back in 2008 and first part of 2009 out of our Longview facility were also doing extremely well all year, and they were starting, even though we had done quite a bit of renovation and expansion of that facility in recent years, we started out running our sheet-metal capability down there and needed more sheet-metal capability down there. So we included in that machinery purchase some more equipment for that facility to be delivered in the first quarter of next year.

So all of these things changed our game plan a little bit; added a lot of capital expenditure, which we hadn't originally planned on, plus some of the equipment that was available now was better than the equipment which we had anticipated being available when we did choose to buy new equipment.

The market, however, has continued to be soft and softening. There's a good leading index called the architectural billing index, that mapped a billing index any time it's below 50%, indicates a continued downturn in the amount of hours and dollars billed by the architectural firms of the United States, which would say that we're going to have fewer architects design buildings available for selling equipment.

That, however, had been moderating during the year and not going down quite as quickly as it was earlier in the year. And has, in fact, finally at long last, gotten up to the neutral point of 50% and just barely over it in September.

So, things are turning, but the building industry index only talks about what they are doing in the way of designing buildings. And that always has a lag effect before we get to pick up an order for it, of somewhere up toward one year from the time that they start increasing their production of buildings, simply due to the time lag of issuing those proposed building improvements or new buildings out into the trade, the bidding of them, and us finally getting an order and getting ready to build the product.

So it's not a quick thing, but it is a very welcome thing that we're observing. So that was turning -- our market share was going forward, so we had to accelerate even more the preparation we had to make internally so that we could handle it, as it really gets going.

Now we have always had an excess of capacity, but the other good thing about a lot of these things that we're talking about right now is they come with an improvement in productivity. And our productivity has always been a very high thing for us. And so not only are we preparing for future business and being able to handle our present business more efficiently, but we're also doing it at a time when we're not being pressed quite so much to increase our production. And therefore, we have more time available to handle it in a more efficient manner, and do a better job of buying equipment and planning on our forward movement.

The general tone of business, however, like I say, while the futures are starting to look good, none of the buildings, other than medical and healthcare and education are about the strongest ones, along with general governmental type buildings -- those are really the three strong ones at this point in time. The rest -- all the rest of the buildings -- commercial, retail, office, manufacturing, lodging, municipalities, are fairly good but a lot of the rest are still looking pretty poor.

But with our improvement in sales and our substantial improvement in backlog, most of which has been building here in the last few months -- in other words, most of that we were still going down all the balance of last year; from September on through the rest of the year, we were reducing our backlog. And the backlog did not start improving until the first quarter got a little bit better but not much, and the second quarter gained speed. The third quarter, it gained significant additional speed. And that's why the backlog is going up substantially, but our sales haven't gone up so much because most of it is a fairly recent time of change into backlog.

So, the fourth quarter, as you can well appreciate, does look much better on the volume standpoint. However, it needs to be remembered that that backlog is going in there at basically 2008 price levels. It might even be a little bit on the weak side of that, because we have added some standard features to our product at no additional cost over these past two years.

The incoming order rate continues to be much solider than it has been and we have initiated somewhat of a price increase down into our Longview facility, which has gotten the most healthy part of that increased backlog. And so we have decided that we can afford to take a chance on losing a little bit of volume and going for some more margin.

And we have effective as, basically, virtually today while we're talking, it's in the process of occurring on new orders coming into house, which, of course, will be somewhere two to three months before they ship; but we have been able to at least affect a little bit of improvement down there. I don't see that -- the improvement in the near future in the Tulsa product line, but undoubtedly some point down the road here, I believe we will see the time when we can start improving our margins with pricing.

In the interim, we are improving margins by improved productivity as we wrap up the Westside manufacturing facility in Tulsa, which we're still spending considerable money on doing. We are increasing our volume capabilities in that facility, which in turn, is improving the productivity of those product lines built in that area. As I said earlier, about two-thirds of the Tulsa facility output comes out of the West building and one-third is coming out of the East building. So longer-term, you can look for us to be going with the East building.

Now one of the other things that has pushed us to accelerate things has been an increase in the depreciation schedule on capital equipment, because of course, getting -- being able to take the depreciation faster means you're not putting a long-term loan out to the federal government at no interest, which is what happens when you stretch your depreciation out over many years. So it's beneficial to us, even though it kind of upsets our P&L status and the balance sheet and everything, because of the increased capital expenditures and everything the way it handles.

It's going to be very beneficial to us. And you can see quite a significant amount more -- oh, $3 million or so that will start happening between now and the end of the year because we've tried to accelerate the delivery of all capital items that we can into this year.

The SG&A sales, as Kathy mentioned, were pretty good for the quarter. They were down compared to the previous year due to the things which she mentioned, which indicates the fact that we've been able to maintain all relative issues within our SG&A at a very good rate. Even though we've increased our volume, we haven't had a corresponding upswing in SG&A.

Most everything else on the negative side of it has come about by virtue of cost increases, pretty much led by commodity price increases, which also relates to some increases in purchased finished goods parts like motors and things of that nature, which because they are also heavily impacted by commodities, have started to come through with price increases on those items as well. So that's been hammering us on our bottom-line.

At this point in time, I don't know what more to tell you about for this year. We're going to stay as liquid as we can. Our stock buyback has been suspended in the third quarter, as I mentioned earlier, when we decided to put the emphasis on sales on the capital expenditures.

Just to summarize, we finished off an old stock buyback plan plus dipped into a new stock buyback plan. Our total purchases of stock during the year-to-date have been 780,939 shares for $18,457,694.

The other thing that -- which we have done and what we have is dipped into the new authorization, which was 850,000 shares authorized, and we have still remaining open on that 371,507 shares. Our cash position will remain pretty liquid, and we're feeling good about where we are and how we're managing that, and how we're getting ready for what we hope will be a much healthier economic situation and a much higher growth pattern for the Company, is our outlook and hope.

Our sales for 2010 fourth-quarter is going to be better, obviously, than 2009, due to the healthy backlog. And as I mentioned, our capital expenditures when we finish will be in the $16 million, maybe a little bit more, for the year in total.

I'd like to open it up now for questions regarding what we've been discussing.

(Operator Instructions). Joe Mondillo, Sidoti & Company.

First question I had, Norm, given the strong backlog that you do have and it was up sequentially compared to June, could the fourth quarter be stronger than the third quarter here on the top-line?

Yes, it's entirely possible. The big catch in the fourth quarter being, of course, the Thanksgiving and Christmas vacations, which kick quite a few days out of the manufacturing schedule.

And because we're going into the slower part of the year, we don't want to hire a lot of people, because the first quarter is normally kind of a weaker quarter, and so we don't want a lot of people on. And our ability to turn on overtime because of the way we're running in place now, which is basically 12 hours a day on assembly and 24 hours on the sheet metal, is somewhat limited. So we're going to be limited really by our ability to produce rather than we are by our order backlog.

Okay. So you're probably going to have a pretty strong first half of the quarter and then second half is probably a little uncertain at this point in time?

That's correct. That is correct. And it depends upon how fast -- how much we can manage to move that along. But it's going to be strong -- it's going to be a strong quarter.

Okay. And then just in terms of the gross margins, where do you think those are going to go in, say, the fourth quarter and then just looking out to 2011? They fell to 19% in the third here from 24% in the second, which I thought was a pretty big drop. So where are you seeing --?

Okay. One of the things that has hit us in the third quarter -- as I mentioned, that A Box and the RQ Box -- the A Box was introduced in the latter part of the second quarter and it was really almost at the beginning of the third quarter when the RQ was.

Both of those cost us some inefficiencies because of teaching the people and getting the things organized on new products. And they had a related cost to them -- all of the parts that were obsoleted out of our inventory, those old parts for the old products were scrapped out. So we had a high scrap rate also of the old product that we were getting rid of. And those things are behind us.

So that's going to help our bottom-line. How much more damaged commodities and price increases will have is anybody's guess at this point. I don't think they're going to be substantial, but we could be fooled. So we've got a good thing going that could give us a little boost in the fourth quarter compared to the third quarter, or it could at least minimize any damage that product cost increases might have to us.

So, my belief is [19] is probably a low point and it might be better than that for the fourth quarter.

Okay. And then just talking about price increases, given the green shoots that we're seeing, do you think your customers are more willing to take a price increase? And do you see any more put in place down the line?

You know, there's a -- it's a double -- it's a many-edged sword price increase. You're always going to lose some volume when you do it and you're going to gain some gross margin; but the bottom-line may or may not be enhanced by the loss of volume by whatever your price increase is.

But there's another one that we are faced with right now, in that these new products, we want to get as broad an acceptance they can, as we can, so we do like to get more of them out there so people can see why they should give us more money for them. So cutting off a little bit of the volume is more than just what happens to the bottom-line; it's also what happens to our introduction of the new product into the world.

You don't have that if you have a product that's been out there several years or something; you know, there's no gain there. But with a brand-new product and an extremely -- I can't emphasize extremely, big differential that the product has, with three things -- one, energy efficiency; number two, two-inch cabinet that is like 10% -- not 10%; 10 times as good of our value or resistance to heat transfer or insulator, however you want to say it, as our old product line; and the very much higher efficiency direct drive airflow blower that we have in the product.

We've got some really strong sales features there that we want to get into the market as strongly as we can early on, so that we gain market recognition of these wonderful things we've brought into this new product line.

Okay. How much does your new products make up of your total sales base right now? Say, like two, three-year, just introduced products?

This is going to be a seat of the pants answer; it won't be from something I'm looking at down there. But as I said, the east side of the street is on Tulsa product -- it's maybe 30% of our sales, and that is where the B Box, the A Box and the RFQ all reside, in that side of the street, and that's about 30% of our dollars.

And then the C Box, which is probably another 10% to 15% of our dollars, is on the west side. So they're all somewhat new products. So we're talking upwards of 40% of our dollars are new in Tulsa -- in our total. And then if we go down to Longview, where we've got another 15% of our dollars virtually all in new product in the last two years. So, something in excess of 50% of our dollars is two years old or newer in product lines.

Okay. And then in terms of investing in the machinery, what are you looking at for CapEx in the fourth quarter? And do you have any idea of what the budget is going to look like in 2011?

Rough idea -- this is going to depend upon the health of the economy totally, because we have long-range plans in this place where we could spend quite a lot of money rather easily, because we've already done, for instance, an addition on some buildings -- the architectural work is already done; it's ready to go. We can pull -- so to speak, pull the trigger and start building the buildings at any moment in time. We don't have to do any planning; that's been going on for years and is completed and all ready. So, that's a big one.

The other one is, as I mentioned, which will go on, is replacing some of the machinery in the east side of the building in addition to what we've already got on order. I'd mentioned we'd spent about $5 million on what is approximately $13 million worth of things on order right now, so we've got another $8 million that's going to be hitting the capital line between now and about the end of the first quarter or early the second quarter next year.

And we will probably be looking at the -- in just machinery alone, another $6 million or $7 million going forward for the new -- for new machinery on the east side. And then it's going to depend on whether we pull the trigger on some buildings additions. The building additions could be another $5 million. And then you're going to have, in addition, $2 million or $3 million worth of just miscellaneous stuff.

Okay, so if I got that correctly, may be somewhere's around $4 million to $5 million this quarter and then $15 million to $20 million next year?

That's probably correct. That could happen if the economy looks like it's going to -- [if it were to reset], that's entirely correct numbers.

Okay. And then last question I just wanted to ask you to get your thoughts on -- governmental buildings have been quite strong for you. You've talked about how that's been going well over the last several quarters. How are you -- how does that look going forward?

Well, I don't know -- you know, they've spent a lot of the money that -- the exceptionally high spending rate that the government has been doing, has been largely spent. So I would say that that's going to diminish, because I don't think that the excessive increase in our debt level at the federal level is going to go on for very much longer. And so the building program is probably going to diminish.

But that probably is not going to be such a bad deal if the private industry, which it appears is starting to pick up the slack, goes forward, that the governmental [side has been] backing off, it's not a bad thing because private sector, when it gets healthy, is substantially bigger than the government could ever be.

Okay, great. Thanks a lot, Norm, Kathy.

DeForest Hinman, Walthausen & Company.

Just some follow-ups on the questions from the last caller. It sounds like we had some scrap costs or moved around a lot of equipment at the East facility in Tulsa -- is there any dollar amounts that you can put around those numbers on the scrap costs and the costs to move that equipment around that are in the third quarter?

Yes, the scrap I'll give to Kathy; she's better on that than I. She's doing a little paper --

Scrambling, yes.

-- digging right now.

Based upon the scrap, I don't have it for the quarter but year-to-date, we're looking at around $2 million. We also had manufacturing expense increases and additional manufacturing expense increases, plus the raw material increases.

Those -- at least a fair share of those were related to the cost of moving people around and equipment around. So I would guess the third quarter out of that $2 million, it certainly was more than one-third of the $2 million. And some of that scrapping was stuff that was going on from that B Box which was introduced the end of last year, so we've had a very heavy scrapping thing as we got rid of old products and went into the new products.

That's pretty well-done. So, say you're going forward, let's assume -- and that's all I'm doing right now for the third quarter -- let's assume that, out of that $2 million, $800,000 of it was in the third quarter; I would guess that probably half of that will disappear in the fourth quarter.

Okay. And just to be clear, it sounds like you're not inclined to increase headcount at this point because we missed some production days because of the holidays. So are we going to just kind of maintain headcount, at least in the fourth quarter, and have more overtime costs and then reevaluate next year?

That's what we're doing at the present time. That is our game plan going forward. And if the orders keep coming in as we get into the first quarter next year, then we will go back to increasing headcount again.

Okay. And my last question is, what is the headcount at this time?

The last one I saw for Longview was about 370 people and for here was about 1,062.

Alright, thank you.

We might tell you on that headcount that during the year, we have added personnel in both facilities, a fairly substantial amount of personnel in both facilities. I'm just going to guess, a couple hundred people or so.

(Operator Instructions). We have no further questions in queue at this time.

Alright. Well, very much appreciated your attending our third-quarter report. I thank you and, hopefully, we're on an upswing and going to be able to give a more optimistic forecast for the future, and a much better report of the past in our next quarterly get-together. Thank you.

We'll see you in March of next year. Bye.

That concludes this afternoon's teleconference. You may now disconnect your lines.