Aaon Inc (AAON) 2012 Q1 法說會逐字稿

Welcome to AAON first quarter's earnings report for 2012 conference call. I will now turn the call over to Mr. Norman Asbjornson.

Good afternoon. Thanks for joining us this afternoon. Before going on, I'd like to read a disclaimer. To the extent any statement presented herein deals with information that's not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act of 1995. As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ materially from those anticipated.

Please see the risk factors contained in our most recent Securities and Exchange Commission filings, including the annual report on Form 10-K and the quarterly report on 10-Q. Thank you. Now, I'd like to introduce our Vice President of Finance, Kathy Sheffield, who will go over some of the statistics with us.

Good afternoon. Welcome to our conference call. Thank you for joining us for this review of AAON's financial performance for the first quarter of 2012. I'd like to begin by discussing the comparative results of the three months ended March 31, 2012 to March 31, 2011. Our revenues were up 8.4% to $64.9 million from $59.9 million. The increase in our revenues is the result of our continuation of gains in market share due to the favorable reception of our new products. Gross profit increased 16.2% to $13.5 million from $11.6 million. As a percentage of sales, gross profit for the quarter was 20.8%, compared to 19.4% a year ago. The increase in gross profit is attributable to the improved productivity from our new sheet metal fabrication equipment that we put into service at the end of last year and our revamped production lines.

Selling, general, and administrative expenses increased 8% to $5.9 million from $5.5 million for the same period a year ago. As a percentage of sales, SG&A remained constant at 9.2% of sales. Operating income increased approximately 24% to $7.6 million, or 11.6% of sales, from $6.1 million, or 10.2% of sales. Net income increased 25.1% to $4.6 million, or 6.9% of sales, from $3.7 million, or 6.1% of sales. Diluted earnings per share was $0.18 per share versus $0.15 per share in the same period a year ago. Earnings per share were based on 24.772 million shares versus 24.939 million shares.

Moving to the balance sheet, we see that we ended the quarter with a cash balance of $3.2 million, and we had no long-term debt. We had a working capital balance of $48.1 million. Our current asset ratio was 2 to 1. Our capital expenditures were approximately $3 million, related to new equipment and the continuation of a building addition. Our shareholders' equity per share was $5.13 compared to $4.85 a year ago. I'd now like to turn the call back over to Norm, who will discuss our results in further detail, along with our new products and the outlook for the remainder of the year. Norm?

Yes, we'd like to talk a little bit about basically the differences in the two major places where we get our orders, namely new construction and the second one being replacement market. We had, coming into this year, quite a different situation due to things which occurred last year, most namely the replacement market. The replacement market last year was distorted toward the first part of the year on orders entered, due to the 100% write-off that was given to certain capital products, such as heating air-conditioning equipment, by the federal government. Therefore, the first part of last year was a very good bookings year. The last half was a very poor one, which reason I bring that up is that set the stage for what has happened in the first quarter this year.

We namely came into this first quarter this year with a pretty low backlog, due to the fact that we had shipped everything to the people who were buying it, because they wanted it badly last year to get into that tax break for many of them. They were not giving us a lot of orders. So it didn't look really too promising coming out of last year relative to the backlog. In the first 10 days of January, it continued that way, and then the world changed at a remarkable way.

Orders started coming in very rapidly and continued to do so and still continue to do so. They're coming in not at the same rapid rate that they have at various times during the past few months, but consistently been good booking months. January turned out to be a very good booking month, even though it started out very slow for 10 days. The net result of all that was that of course, in January, because we came into it with a low backlog, and it does take time to ramp up your manufacturing and have the people and everything going, so January was kind of a slow shipment month. February was a much improved one, and March was even more improved, getting the total for the three months to within $500,000 of the best first quarter we've ever had.

Now because of the tightness of the marketplace, we were not doing very much in pricing last year at the end of last year as far as raising prices, because we didn't want to -- we were having a hard time basically getting enough volume to keep everything the way we wanted it to do, and we didn't want to endanger it with a price increase. However, once the orders started flowing well in January, we started increasing prices. They did not seem to have a noticeable effect on what went in, but we were making marginal, small price increases in a number of different areas that we felt we could do that. And it did not slow the orders down appreciably.

So as we came through the quarter, we came out of it with a very nice backlog, right up among the best backlogs we've ever had at any time in the year. We ended up having it at the end of the first quarter, which is quite unusual. So that all looks very good to AAON. Now, looking around and trying to figure out what was happening and trying to be able to define it so we understood it ourselves, as well as being able to tell you what we think went on. We look at what happened in the two areas I mentioned. One which is the replacement market, which did not do very much the last half of last year, because they had to have the product in and installed in order to qualify for the 100% depreciation.

However, this year has a 50% depreciation, and we believe that there were some people who could not move fast enough to get the equipment ordered and produced and shipped and installed last year, since that bill was not passed until December 17 of 2010. Therefore, there was not a lot of time to take action. We believe that there's some of those people decided to move forward and go ahead and let it come into this year, because there's still a 50% instant depreciation allowance. So we believe there's some -- even though there was some sucked out of this year because of the 100% last year, we think it might be being offset by the fact the 50% is in there this year.

That being said, we're of the opinion that the replacement market is normalized, because anything that went forward last year has been offset by something that's being bought this year, which wouldn't be bought if it weren't for the 50% thing. If I look at the new construction and go into Architecture Billing Index, I find that they've upgraded their graphics and made it much easier to discern what has been taking place.

According to their analysis, and one I would believe in, their Billing Index precedes the actual spending on the building by some 9 to 12 months. So in order to see what's happening today, you drop back somewhere between 9 and 12 months, and you can see in the Architecture Billing Index whether it was growth market as far as how much work the architects were doing, or whether it was a declining market. If I look at last year from, say, March through the end of October, with one very small exception, it was a declining market throughout that entire time period.

On an average, if I tried to average the graph they give us, I would say it was a 2% to 3% decline month-over-month throughout that time interval. It passed over at the end of October into the positive arena and has stayed positive since March -- or October of last year through till March 12 of this year, which is the latest date on the graph. But it has been something less than 1% positive. So if you look at that and you wash that through, a negative 2% or 3% that we're in right now, but going into a positive less than 1%, then the total is negative. So, the industry, from statistics, doesn't look very bright.

But then let's take a look at one other place to see what is actually happening in the arena of what we're doing on the types of buildings that we're involved in. For that we go to one put out by the Census Bureau, a thing which shows what the bookings, or the actual dollars spent by month are, a year-to-date compared to a year ago, and we find a little more positive image at that point. For instance, the only one in the negative column there is, at this point in time, which March is, again, the most recent thing that they give us, was religious buildings, which were negative 8.2%. The others were in the low single-digits for the most part, with the exception of commercial space, which was 11.5% improvement from a year ago. The most notable one in the improvement area, which it portends well, is manufacturing was up 42.5%.

So that would explain, for whatever reason, that discrepancy is to the Architecture Billing Index, or apparently a small discrepancy there. It would explain some of the growth that we're seeing. However, it doesn't explain the totality of it, because we have had substantially more growth than that. So, the only other thing to which we can attribute that is the improved relationship that we have created with our customers. Both through the new products which we've brought out that have been well received, as well as all the other things which make up a relationship between a supplier and a customer. We apparently are doing a better job across the board, and that basically what's going on.

That is a very good sign from my -- our perspective, because it says we're not totally connected to what's going on in our industry. We're rising above what's happening to the industry to some degree. We believe that there's nothing that we're doing at the present time to change that course of direction. We're anticipating that, that will stay with us for a long time to come, far beyond this year, and therefore will give us a better year.

Consequently, we're pretty optimistic, much more so, as I said in my news release, about the middle of the news release. I said that the new products, improved manufacturing equipment, and facilities have given us more advantages. As well as the improvement we have gotten from training, and in some cases, replacing our sales outlets and trying to improve our responsiveness to our customers in our communications and in all other areas. So at this point in time, we're pretty confident that, that 's going forward.

We also are sitting at this point, as I mentioned, with a $58.7 million backlog at the end of March. And you say well, how has that gone on since that point? I will tell you that it is larger now than it was at that point in time. So things are looking positive. We are hiring personnel. We're gearing up for a higher level of sales. Of course, while we're doing that, we've been implementing some price increases at both of our facilities on virtually all of our product line. However, there's a bad side to that, because with this $58 million backlog we had at the end of March, before the price increases that weren't already built in to that a little bit earlier. In other words, some of that market -- some of that $58 million had price increase in it.

Some of it did not. That which did not, of course, has to be produced in order to get us into some of the better-priced product. That has been occurring, and additional price increases have gone in since the end of March. The net result is that we are improving our selling price, which will relate to bottom line as it gets moved through the system. Just because the back-log is moving, we don't immediately realize that on the bottom line for a whole host of reasons. One of which, to start out with, a lot of the customers that give us an order don't want it for some period of time.

But also, we don't have the capability of instantaneously turn it around and ship it because we do not have built in stock. We build to order, and therefore, we have to build the product. Therefore, we will be accelerating our sales throughout this quarter. And the second quarter will definitely be an upswing over the first quarter, because we already have all the backlog. All the dollars that we're going to ship are already in the backlog. So we know where the orders are. We're building up a nice reserve of orders for the third quarter, and it has a promising look at this point as well.

So I would say that we're optimistic about the balance of the year, not because we think the marketplace is going to be good. We do not believe that. We believe it will be mediocre at best. It will probably be a little better than going negative, but it's not going to be very positive from anything that we can see, because if you don't design -- if the architects don't design buildings, there's no building going to be built for the most part. Now there are some exceptions, but percentage-wise, it's pretty small. If the architects are not designing them 9 months to 12 months before you expect to see them on the bottom line, they're not going to be there.

Right now, we're basically far enough along that we can look at the Architecture Billing Index and we can see what the rest of the year is likely to be on new buildings. Since it only turned positive in the end of October of last year, if you go by the 12-month thing that says that we won't be getting anything out there until November of this year, but to make additional volume possible. If you back it off three months, that's the most optimistic. So, it will only be in the fourth quarter or the very late part of the third quarter that any improved volume might even begin to appear. Since it's not even 1%, it's not going to be dramatic. Everything that we have to look at has to do with -- it's either replacement market or taking market share. Of those two, we believe that taking of market share is where our ball game is going to be played.

Consequently, we're going to give you pretty optimistic view of what's going on in that arena. Now, one of the things which we've within doing for the past several years has been building buildings, buying machinery, and redesigning equipment. The vast bulk of our dollars are coming off from equipment that has been recently redesigned. The smaller part, which is on the products which haven't been recently redesigned, are in the process of being redesigned now. But the impact they will have on the short term, even after they're out there, is less than the ones which we have just done, because the volume isn't as high. But it will give us, going forward, an entirely new product line for both the Longview and the Tulsa facility. They have been being received very well by the customers. They are obviously pleased with what we're doing, as is evidenced by our upswing in orders.

So that's the picture that we see and hear at this point in time. We have no big issues out there that we're aware of. As far as our marketing of the product, we know of no issues out there. We know of no big warranty issues. We've stumbled a little bit internally on our internal reporting systems, and we'll be noting that. But it's not of consequence, and it has not had, and will not have, any big effect on us. We have it resolved. We had a mistake made in the way that required that we notify you of it, which we will do. But it was not one that is going to have any long-term or very much short-term effect on us. So that being said, I'd like to open the conversation for questions now, if we may have them.

(Operator Instructions)

Jon Braatz, Kansas City Capital.

Can you talk a little bit more about the price increase in the first quarter, and what you're expecting in the second quarter -- the size of the price increase? And do that in the context of what you're also seeing in terms of some, let's say, component cost increases or steel cost increases? Whatever. And will you be able to fully offset some of those cost increases, if indeed there are some?

Certainly. If I had to give you a percentage -- because what we've done, we've done a number of things. Where we were thinking that we had some things which were under-priced, we priced them up a little bit. We did a lot of spot pricing, just trying to correct some problems we felt we had in our pricing structure. Then we also went in and did a pretty much a generalized price increase. So we had a variety of small, incremental price increases going on.

When it's all into the system -- and recognize that with the backlog we have right now, it's not all going to come out in the second quarter. Some of it is going to drift into the third quarter before it gets out of the backlog. But it's probably somewhere in the vicinity of a 5% price increase.

As far as what's going on in the commodity business, that's a non-issue. For the first time in a long time, steel is up very modestly. Copper and aluminum are down modestly. Net result -- nothing. In other words, I don't see that as being an issue to be discussed on commodities.

There is price increases coming through from component manufacturers. Some of them have been fairly substantial. The biggest probably has been about an 8% one. But most of them are down in the low single digits, meaning the 2%, 3%, 4%, 5% area. Since the component part of the material cost is just a portion of the material cost, not includes the commodity part, the net result of that is probably around 3%. We got probably somewhere around a 5% increase. We'll be improving our margin for that reason, if no other reason.

Along with this, all the work we've done and all the money we spent on new machinery and rearranging the factory is paying off in improved productivity, both in our sheet metal fabrication as well as our assembly areas. So we don't see that as being a negative. All in all, we have probability at this point in time, everything we can see of any, a modestly increasing gross margin coming all the way to the bottom line.

Okay. Going back to the new machinery that you installed most recently -- how far along are you in, let's say, reaping the entire benefits of that -- the improved productivity? You mentioned that you're seeing some of it. But will we see additional gains throughout the year from this new equipment?

What we did -- because as we were doing this, we had to take out some old machinery before we could put in the new machinery -- so we had a problem of, how do you do that and not affect your production last year?

The way you do it is, we had excess building on the west side of the street here in Tulsa. We put in some of the machinery over here so that we could take it out on the east side and not lose our ability to satisfy our customers. By doing that and then by refilling the east side back up, what we have done is, we didn't just replace the machinery that we got rid of, we actually increased our capacities rather significantly.

So we are at the present time realizing virtually all the benefit of the new machinery on the production we're doing. However, we're not realizing all of its future, because we're not using all of it. As we get more volume, we will continue to be benefiting from that new machinery.

Okay. Thank you very much, Norm.

Joe Mondillo.

I was wondering if you had any idea on how the mild temperatures affected the first quarter at all?

I thought that they affected it in a very positive manner. However, we have a newspaper that's called the Air Conditioning News, and I was just reading in the most recent April issue that in the third quarter, that in the non-residential construction by the Association of Contractors, that their business was down 3.24%. And the most recent month was into January, and it was down another 0.8%. They were trying to figure that out in this article. Like I say, received that news magazine here recently.

And the general consensus was that they couldn't figure out why it wasn't there. That's what they say in there, and they have a pretty broad visibility into it. I don't think that was true, totally. Maybe it didn't get going until further along in the year, namely, February or March. But I truly believe we had some people start building buildings much sooner than they normally would have. Some of them in January probably didn't think the weather could really be that good, and they probably just sat there waiting for the big snowstorm, which never occurred. Eventually, they got to believing, well, we just will get going and start building the building, and they did so, I'm quite certain.

Okay. In terms of the orders and what you saw throughout the quarter -- February, I believe you said, second half of January, February were extremely strong. And I believe you said on the last call that things settled a little bit from the -- such a strong February, in March. Did things stabilize from the March levels into April? Or how did the order trend look throughout the quarter and into April?

We distorted it to the point that I have a hard time giving you a good answer to that, because that's when we put the price increases into effect -- in April. And whenever you do that, you bring in some orders prematurely, because people don't want to pay that extra money. We give them 30 days from the time we announce the price increase until it becomes effective that they can't order anything anymore. It gives them time to cover the orders that they've made bids on to their contractors or to the customers, so that they can go out and clean those up, because they bid it based on the premise of our old pricing.

That 30 days gives them the time to put a lot in. And they did -- they gave us a lot of orders in April. Then what you normally expect is that there's a little bit of a drought that will follow that. Since we've just closed April and we're just getting well into May, we're looking for the drought. And so far, it doesn't appear to be very bad.

We had a fantastic April in bookings due to the price increases, and so far, it doesn't look like we're going to pay too big a penalty for it in May. If we don't pay a very big penalty for it in May, then we're just going to be talking more optimistically than I am right now.

Okay. In terms of the price increases -- I'm not sure if I heard you wrong or what, but I thought you said that you had a problem with price increases last year, or some sort of issue with price increases? Did I hear that wrong?

No. What happened last year -- the first seven months of last year, we were up 19% on orders. We thought we had a great year going, and we put some price increases in. But then out there in the eighth month, it seemed as though the world changed dramatically. From there on till the end of the year, the average for those last five months was down 9% compared to the previous year.

So we went from having a plus 19% to a negative 9%. During that negative 9%, we thought the bottom was falling out of the marketplace, except we had it pretty well figured that it was the replacement portion of it that was doing so. We didn't want to raise prices in a severely declining market, because that would've only lost us more volume. The loss to the volume would have been more than the gain we would have realized from a price increase.

So we did that throughout the last half of last year and into the first 10 days of this year before the orders started flowing the way they did. That's what I was saying is, that we didn't have price increases very much in the last half of last year because of the downturn we were experiencing.

Okay. Got you.

I don't know if you could talk about a little bit more color on the demand that you're seeing right now? What kind of size products are you seeing? What regions in the country are heavier than others? And also, end markets in terms of where the demand is coming from?

Okay. But the majority of our growth, and the best part of our growth, has been in our larger tonnage units that we redesigned. I can't say that's because of a market condition necessarily, because that's where we started our redesign efforts, was in the largest ones and we worked to the bottom ones. So they had had more time out in the marketplace to develop a positive image and more of a customer following than the smaller ones. But the bigger ones have led our price -- our order input. The small ones have come along very well, but I would still say that it's been larger tonnages where we've done the best. At this point, that's what we think we're seeing.

As far as parts of the country -- in general, I would say it's a pretty uniform thing. I would say the western part of the country may be suffering more than the rest of the country is. But really, California is suffering quite a bit. To some degree, I think Oregon and Washington state are, also. But those would be the only ones that I would say might noticeably be showing problems with growth as a region. Now, in the other parts of the areas, there probably are individual states that are having problems for whatever reason. But in general, it's just a western issue.

Any color on end markets, such as education, healthcare, where you're seeing the demand?

If I'm to believe the Census Bureau here, the strongest demand of all is in manufacturing, and it's pretty spectacular. The next strongest demand is in commercial, which is your retail, your office -- your retail and stores and things of that nature. And then the next one down from that is -- the healthcare is the next.

I'll give you some numbers. The manufacturing -- this is on a March to March basis, 42.5% up -- spectacular. Commercial, 11.5%. Healthcare, 7.1%. Educational, 3.4%. Religious, negative 8.2%. Office building, 1.8%. Lodging, 1.3%.

So those are the buildings that we furnish equipment to, and that's what they are. That's why I say, if you added all of that up, it's not a bad growth from these things. Now, these are buildings, normally speaking, that could have been started at any point in time, because this is the dollars that are spent on those buildings. Some of them are in the final stages of completion, and they're spending the money on it. Some of them are in the beginning stages of building. But that's where they were spending money in March of this year.

Okay. Last question.

It may have to do with your comments on the larger tonnage, potentially the mix. But if you could address the gross margin here. You obviously saw close to 21% this quarter. You think that's sustainable? Or what are you looking at the gross margin?

I'll be very disappointed if it doesn't grow bigger than that. I think we've got everything in place to see a continuation. Not a huge continuation, but the modest continuation of improving gross margin.

Okay. All right. Thank you.

Jon Braatz.

Just a follow-up. Kathy, I see that your tax rate went up, as you weren't able to take advantage of some tax credits. And also, you didn't qualify for the production activity tax credit. Is that the accelerated depreciation that you missed out on?

Yes, it is, Jon.

Okay. All right.

Secondly, I assume tax rate goes back to normal in the remaining three quarters, which is -- what? Right around 37%, or something to that effect?

That's correct. We're anticipating it would be around 37% and then always looking, waiting for government to possibly approve the R&D credit, which could lower that to 36%.

Okay. All right. Thank you.

The mix, however, will have to include what we just furnished, which is right at 40%. So the net -- the mix for the year is probably going to be more like 38% or 37.5%.

(Operator Instructions)

Joe Mondillo.

Norm, I had one quick question. First off, do you have the backlog at the end of 2011?

Yes, I do. One moment here. Backlog at the end of 2011 was $43,993,763.

Okay. Looking at the backlog -- so the backlog was up 20% year-over-year, and that's roughly -- you should realize all of that backlog within the quarter. Having said that, and the fact that you continue to seem to receive solid orders continued through April, which is essentially, would be the entire second quarter, are we expecting -- could we be expecting a 20% year-over-year top-line growth in the second quarter?

That's pretty big growth.

Essentially, if the --

Here's the only problem. I've got to hire people to do that. And I am hiring people as fast as we can. However, our unemployment in Oklahoma right now is sitting at 5.4%. So you're getting down into a group of people that aren't very much enthusiastic about working, and some cases, aren't really qualified to work.

And so we're not able to just hire people, because we're trying to hire them. We're having some difficulty. Not big difficulty. I'm not saying that. But we cannot just ramp the place up as fast as we might. That would be the primary reason we wouldn't be able to do 20% over.

The other thing is, I don't want to take a bubble and squash it real quickly if it isn't going to be followed on by additional orders. That's not to say I don't think the additional orders are coming. I just don't feel real comfortable in this economic environment to say that they definitely are. But if it's because we're taking the business from other people, I see no reason why we shouldn't continue to do so.

Okay. One more question.

In terms of the first quarter -- the operating leverage that you saw, it seemed a little weak considering you saw the improvement in the gross margin, and the top line grew by 8%. But SG&A seemed very bloated, and compared to last year as a percent of sales, the SG&A was very comparable. So you didn't get the leverage fully down to the bottom line. You saw top line grow 8%, EPS grow just 2%.

Could you comment on that, and should that improve throughout the year? And why didn't you get the leverage there?

To some degree, that will improve. One of the things that we had was profit-sharing expenses went up on it. The other thing is that we have replenished some of our warranty things that we had, and the warranty and everything. We've improved some of our reserves and everything, too.

Okay. So compared to -- you do that on an annual basis, though, right? Was that warranty expense higher than last year for some reason?

Yes, it was. What happened to us -- with new products, you always take your chance that you're going to have some problems, and we did have two problems. And to that, you might say that we did a recall. We sent people out in vehicles to go to those job sites and do some work. One of them was a manufacturing design, a manufacturing problem -- a quality issue, if you will.

On one side of the street, the people doing the work built the product correctly. On the other side, they did not. We had to correct that. The other thing was a minor engineering error that we didn't want to leave out there. Both of these were connected to heating. And we didn't want to leave somebody having problems with their heating system.

So we did spend an unusual amount of money. Those things are all behind us now. The product is basically -- considering that we redesigned all the product, it was pretty trouble-free. It's kind of like, when they tell you don't buy a brand-new -- the first of the new cars because it's going to have some problems. That holds true in air conditioners, too. There are some potential problems on a brand-new product as manufacturing gets everything underway. And so we did have a little bit more on warranty costs than would be normal.

Okay, great. Thanks.

There are no more questions in queue.

Okay. I thank you for coming with us on talking about the first quarter of 2012. We're looking forward to, as we've said, an even more promising call when we have it in August for the second quarter. We're optimistic that we'll bring you even better news. And I thank you for help staying with us and being our stockholders and being part of our operation. Thanks. Goodbye.

That concludes today's conference call. You may now disconnect your lines.