Aaon Inc (AAON) 2012 Q2 法說會逐字稿

Good afternoon. Ladies and gentlemen, I would like to welcome you to the AAON, Incorporated, second quarter sales and earnings call. Mr. Asbjornson, you may begin your call.

Thank you. Thank you, ladies and gentlemen, for attending our call. Without going forward at this point in time, I need to go through this 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.

I thank you again, and I'd like to introduce you to our Chief Financial Officer, Kathy Sheffield, who will give us the first part of the report.

Good afternoon. Welcome to our conference call. Thank you for joining us today for the review of AAON's financial performance for the second quarter and six months of 2012. Please note that in making comparisons today, it's important to remember that 25,000 square feet of our manufacturing facility roof did not fall in on us this year. So I'd now like to begin by discussing the comparative results of the three months ended June 30, 2012, compared to June 30, 2011.

We're very pleased to announce that our revenues were up 21% to $83.3 million from $69.1 million. Revenues increased primarily as a result in gains in market share and new commercial and industrial construction, as well as the replacement markets and the favorable reception to our new and redesigned products.

Gross profit increased 79.8% to $21.1 million from $11.7 million. Gross profit was 25.3% of sales compared to 17% of sales last year. The increase in gross profit is attributable to improved productivity from our new sheet metal fabrication equipment and our revamped production line.

Selling, general and administrative expenses increased 20.8% to $6.9 million from $5.7 million. As a percent of sales, SG&A remained constant at 8.3% of sales for the three months ended both June 30, 2012, and 2011.

Operating income increased approximately 135% to $14.2 million, or 17% of sales, from $6 million, or 8.7% of sales. Net income increased 142.2% to $9.3 million, or 11.2% of sales, from $3.8 million, or 5.6% of sales. Diluted earnings per share was $0.38 per share versus $0.15 per share in the same period a year ago. Earnings per shares were calculated on 24,728,000 shares versus 24,923,000 shares.

The results of the six months ended June 30, revenues were up 15% to $148.3 million from $129 million. Gross profit increased 48.1% to $34.6 million from $23.4 million. Gross profit was 23.3% of sales compared to 18.1% of sales. Selling, general, and administrative expenses increased 14.5% to $12.9 million, or 8.7% of sales in both periods. Operating income increased 7.3% to $21.8 million, or 14.7% of sales from $12.1 million, or 9.4% of sales.

Net income increased 85.1% to $13.9 million, or 9.2% of sales, from $7.5 million, or 5.8% of sales. Diluted earnings per share was $0.56 per share versus $0.30 per share. Earnings per share were based on 24,750,000 shares versus 24,931,000 shares.

Moving to the balance sheet, we see that we have no long-term debt. We have a working capital balance of $48.3 million. Our current asset ratio was 1.9 to 2, which was affected by an increase that we had in inventories of about $4.2 million due to purchasing additional inventory to accommodate the increase that we had in our backlog and also due to an increase in accounts receivable of approximately $17.9 million, which was due to our increase in revenue. Shareholders' equity per share was $5.38 compared to $4.87.

I would 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?

Okay. We basically, in order to give a better understanding of what is occurring for AAON, I have to, I think, break it down and talk about what the marketplace is doing. And then after that I'll enter in and talk about what AAON is doing, and then we'll try to combine the two together as best we can.

In the marketplace, there's really two segments to our market. There's the new construction market; then there's the renovation market. The new construction market is best typified and predicted by what is called the Architectural Billing Index, and if you work with that, you know that 50% line is the neutral point. Above 50%, they are billing more work than they have in the preceding year. If they're below the 50%, they're billing less work.

This is a beginning point for all of our new construction, because if somebody doesn't design the building, nothing else happens, so this is an important index to watch, and it's normally the way that we try and predict what's going on. As stated by those people, when they bill that billing, it actually ends up in construction contracts approximately nine to twelve months later, so it's always a good forward-looking index to look at.

If we look at the most recent one I have available to me, which is June of this year, and try and decipher how much of the line was above the 50% and how much was below in the two preceding things, here's the analysis that I've arrived at and try and best judge their comparative values in 2010, which basically affected 2011, and then 2011, which basically is affecting 2012. And trying to determine the difference between those two to tell us whether we can anticipate more or less business from new construction this year is what the use of the value that has.

And if I try and make that comparison to the best of my ability without having a lot of numbers, just looking at the graphs, I would say that there's a very close, identical amount of work was done by the architects in 2010 for 2011 and '11 for 2012. And so no real noticeable trend is occurring that I can determine.

The timing in it is a little bit different, depending on where to tell in there, so the timing of when we get that available business, it could be different. But that is only the beginning point of our new construction. After the drawings are done and their construction documents and everything are completed, the owner has to make the determination about when to enter into a contract and put it out for bid, et cetera. So it's still distorted even further. So at that point, we lose control of our ability to view it.

That being said, my belief is that at best, we're neutral in the amount of work that's available to us for this year compared to the amount of work that was available last year. So last year's results give a good picture of what's likely to occur in this year.

Now, let's switch a little bit and go to the remodeling and renovation market. There are no statistics, really, to tell me anything that I'm aware of in that realm, and that's something more that we just get by working with it.

However, there was an event that occurred in December of 2010 which influenced both 2011 and 2012, and that was the budget reconciliation, a bill that was passed in December of 2010. And contained within it was 100% write-off of qualified capital investments for the year 2011 on anything that was entered into on a contract and completed and put into operation during the year 2011 that had 100% write-off of it.

It also contained a provision that anything that was entered into contract, shipped, installed, or whatever, and used in 2012 would get a 50% write-off if you wish to choose for it. So it had an effect upon both years.

Now, the effect that it had was because in 2010, December was very late, so everyone being put on notice that you could get a 100% write-off in 2011 didn't give anyone much time to figure out what they wanted to do or could do, and consequently, everyone, and my take on it, did not get into 2011 because of the timing and the thing that they had to do.

The net result was we saw an upswing in new orders, a large upswing. In the first seven months of 2011, we booked 19% more business than we did in 2010. And then, in the last five months, in August, it fell below what we did in 2010 and continued below through the rest of 2011 in bookings, new orders. And so we went from a 19% positive comparison to 2010 to a 9% negative comparison. So that kind of established what we had in order flow for us to build and ship. And now you can look at our 2011 results and see how that all worked out.

Going into 2012, because these people who didn't get to participate in 2011 were all set up to participate in 2012, and what occurred in 2012 was that all of the orders, or a large percentage of the orders that people wanted to have billed and shipped and take the 50% depreciation allowance, were given to us in the first three months. We got an abnormally high, roughly a 30% increase or less, 25%, somewhere in there, depending upon how you looked at it, the increase in the first three months.

However, they slipped back and they didn't increase quite so much in the second quarter compared to the previous one. The net result, if you go to the net result and take a look at it, it was roughly, we got about a 15% increase in 2012 over -- well, actually 14.9% -- over 2011 for the first six months. So you can see that 30% slipped drastically in the next three months. And it has continued to somewhat reflect what it did before.

Now, that kind of comes off a little bit negative, which it is what it is, in that a lot of the replacement market was pushed into the first half of the year. So we ended up shipping a lot, particularly in the month of June, when all that was wanted by the customers. And we had a tremendous second quarter.

The third quarter, now, does have some carryover from that increase in it. As you'll note, our $62 million in backlog was a little higher than it was the preceding year, in 2011. But that being said, the marketplace has absorbed, or the order desk has absorbed, I think, the majority of the replacement market that people really wanted to push forward. So we're going to be getting a lighter booking for the balance of this year out of the replacement market.

So if you look at the marketplace, it's not a real winner for us in the construction industry. At best, in the total for the year, in my opinion, it's somewhat, as I discussed earlier about the new construction, it's somewhat going to be a balance for the renovation market, too, with it skewed a little bit toward the first part of the year.

So then what does that say to us about where AAON is and what AAON is going to do? So we'll switch our conversation now from talking about the marketplace and go into talking about what changes have occurred in AAON and what we can expect from AAON.

Well, those of you who have been with us for a while know that we have pursued an aggressive posture in creating new products for the past three or four years. And we did not slow down during the recession at all; we went right ahead. It's been a very fruitful thing for us, because we've been able to improve our ability to take market share.

Now, what am I talking about? Well, if we drop back to the year 2003 and view 2003 up through 2008, we were gaining market share at somewhere around 5% to 6% per year. And then, if you subtracted the inflationary factor from it, it was 5% or 6% market share gain during that timeframe.

And then from 2008 through 2011, we went, market-wise, if you look at our numbers, we went down by 5% in business. However, if you go into the governmental statistics on the types of buildings that we are selling product into, and they publish information on various types of buildings as far as the dollars that have been expended on every month throughout the year. And if you tabulate those seven different building markets that we primarily support, such as retail, commercial, educational, hospital, et cetera, and compare 2008 to 2011, you'll come up with about a 37% reduction.

And if you look at our performance over that time, you'll see we reduced about 5%. And take the inflation or deflation out of those numbers, that's somewhere around 11%. So that new production, or that new product that we've produced enhanced, in my opinion, and other things we were doing of improving our sales operations and everything, improved our takeaway market share. In other words, what we're removing from the marketplace more than we normally would, up to about 11% per year rather than the 5% per year. So that tells us that we've been hitting the target we set for the product doing what it's doing.

Now, let's talk a little bit about what we're all about. Ever since we started out 24 years ago, we've had a business plan that set us two things that we're going to attempt to do. Number one, we were going to attempt to be the technological leader in the industry, sell upscale, sell more to owners, sell a product which was the best value product for the dollar, and pursue that part of the marketplace. Now, what is that compared to?

Well, the majority of the marketplace and the majority of the people supplying that marketplace are pursuing the cost market, first cost market. That is not what we're pursuing. The first cost market is what they are pursuing more than we are. They obviously try and pursue what we do, to some degree, and we to theirs, to some degree. But fundamentally, we're pursuing the value-added market, which means energy efficiency, it means mantainability, it means life cycle. And also, of course, first cost is mixed into it.

But a heavy influence on efficiency, life cycle, maintainability, all the other things which cost you to own it. So we're geared up for more the owner and the person who's got to pay the bills long term, whereas the first cost is more geared up toward the speculative builder and the speculative buildings.

So you have to understand that a little bit, in my mind, because what happened in the recession, I believe, is the speculative market took a bigger beating than did the owner market. In other words, the owners continued on and built the buildings they needed. The speculative-type construction suffered more of that recession at 37% fallback. So that has to be weighed in, also, into why we went from 5% to 11% of market share gain per year.

As you can see, it's a pretty complex thought process, at least in my mind, and I run through here trying to figure out what's going on. But the net result is I believe we've enhanced our ability to take market share quite considerably over what we had before. And we have, ever since we began this process 24 years ago, we've been taking market share fairly consistently -- not always, but over the long term, we have.

The net result, then, in trying to put a projection for you people to try and figure out where AAON's going and what it's going to do, you have to think about the two things -- the marketplace and how AAON is addressing the challenge. And that's where I'm trying to get you to.

The other part of this, of course, has been the necessity to improve our sales force and to improve our support of the customers and all the supporting functions to our sales force. And when we started out, we started out fairly heavily leveraged with no money, and we were not able to do as well in those functions as we are today. Today we are not suffering for a lack of money; we're suffering for, maybe, that we don't address something as fast or as well as we can. But our ability to support those functions is much better than it has ever been, so that has added to it.

All of these things are still with us and are going to be with us going forward. We're gaining strength in all these arenas every year, every day. And so even with a flat marketplace, which is what I believe we're facing, we still expect to have some growth. And as you can see from last quarter, it might even be fairly substantial.

Now, I would not want to give you the idea you should extrapolate that, because that would be a total misnomer. But we definitely believe that we've got the ability to continue to gain market share.

We are, on dollar-wise of new products, approximately 70% of our dollars' shipment are in these new products that we've created over the past three or four years. We still have about 30% of our products to go through and upgrade, and we're in the process of doing that at the present time. The timetable for doing that, I would guess, mostly it will get done within the next year to year and a half. There will be some of it will drag out much longer than that, but the vast majority of that 30% will be operable some time over the next year to year and a half. So we are continually improving our ability to move forward.

Now, I've got to -- in order for you to get any kind of feel for what I just talked about, you've got to understand that our industry is not a rapidly changing industry, although it has been recently much more rapidly changing than it ever has in the past. But needless to say, there are still some products that we're competing against that I can think of that's a formidable competitor, that the basic product was designed back in the late 1960s. So that's a long time. That product manufacturer has been upgrading the details, but it's kind of like an automobile that was designed back then and has had numerous facelifts and other things. It's really still fundamentally a 1960 design concept and with a lot of modifications to it.

And so our industry doesn't change fast, and new ideas are not received well. The owners and the consulting engineers they employ many times will tell you, "That sounds like a wonderful idea. Yes, I see on paper that it's going to save a lot of money, and yes, I see all those things. But why don't you come back after you've been in market for about a year, and then we'll talk about it." So even though we may be doing some things that are justifying moving faster, there is a kind of a bulldog anchor hook to us as far as how fast we can change.

And so that's what we're faced with in the marketplace. I basically have both a negative and a positive view. I have a negative view of the economic situation we're in. I have a negative view of it coming out. I don't see that where we're going right now is going to change our marketplace in the near future. I have a very positive view of what we're doing and what it's going to do for us, but putting those two together, it's going to be a challenge for the balance of the year, without a question.

And without any more to do on my part, I'd like to open it up for questions.

(Operator Instructions.) Jon Braatz, Kansas City Capital.

Norm, can you talk a little bit about the price environment at the moment and cost pressures? I know sometimes you get hit by some component cost increases and you need to pass those on. But can you give me a little update on that?

Surely. The commodity portion of the marketplace has gone nowhere. If anything, it might almost be a little bit gone negative. It's a mixture between the copper, aluminum, and steel and their percentage use, but basically, that's a non-story.

The story is all over in purchase of the manufacturing components. And we've gotten a little bit of discounts in some places, but they're not enough to overcome those which are increasing. And the increases were happening more to us last year than they are this year, the bigger ones, but there is a consistent pressure from those people. Just like everything else, they're trying to improve their operation, pushing forward.

If I had to say what we're doing and everything, I think we've had somewhere around a 3% average cost increase over the past year. And somewhere around that is what we've been able to pass through on our pricing. So we have more or less just had an offsetting pricing structure going forward.

And because of the very competitiveness of the market, that's about all we felt that we could make happen. And so we've worked more on the cost structure of our Company. With last year, I basically moved the Company, in my mind, forward in many areas about three years of what I would normally have done. I pushed it all into last year, which did cause us some issues as far as over-challenging ourselves. And the equipment that we bought, the new sheet metal and the building we did and the remodeling of our production facilities and everything, did have a negative on us last year, without a question.

Those are behind us, so basically, what most of our forward going right now has to do with cost reductions and productivity improvements. I think we will be able to maintain price increases equal to our cost increases, but neither of them are a very big thing in life right now.

Okay. Norm, looking back at all the manufacturing enhancements you've made, new sheet milling equipment and so on, do you think you, like this quarter, did you capture the full benefit of those investments, or are you still moving up the learning curve?

The bulk of them were captured this past quarter. They weren't the first quarter, but the second quarter, most of them were. There's still a gradual increase now, but it's a diminishing one from here on out.

Thank you, Norm.

Joe Mondillo, Sidoti and Company.

So I was wondering if you could talk about what kind of end markets you're seeing the strength in the first half of the year.

Yes, our biggest market that we pursue is the educational market, and it's taken a pretty big hit over the past few years. It lost -- a lot of the states and everything are having their financial problems, whatever, and they've backed off on building first grade through twelfth grade buildings, which is our biggest marketplace. So that's taken a big hit.

There's been a surprising, a little bit more activity over in manufacturing, particularly in that area of the arena, but it had really deteriorated very badly, and it is showing some surprising strength. And then the rest of our marketplace is modestly going. Health, of course, is doing pretty well. And the retail and office is somewhere in between the rest of them. So that's kind of where I think I see the marketplace working.

Do you have an idea what the current breakout in the first half of the year was for new construction demand versus replacement as a percent of sales?

I think we're still running somewhere in the upper 50% area on replacement compared to new construction. I believe that's still occurring. We've done a few things that, really, I don't know that they're going to have a big impact, but I'll mention one to you that we did embark upon.

There's a considerable concern in certain geographical areas in the United States over making buildings as earthquake-proof as they can make them. And therefore, they are setting standards about the ability of the equipment to operate after it's been subjected to an earthquake shake. And there's various levels of standards, the most severe one being a shaker test in which you put your product on a shaker table and it shakes it very hard for 30 seconds -- very hard. It shakes it every direction you can imagine. If you watch a video of it, it looks like it's shaking the machine apart.

We have gone through that. We've put about $1 million into doing that in all of our products up through 70-ton and the rooftop line, and several of our split systems and some air handlings have also been done. So we're kind of in one of the leadership positions of getting ready for that.

I wasn't sure what the payoff is going to be -- how fast, in other words, that this was going to be demanded. But we did, in July of this year, ship to a major manufacturer of both defense and commercial products, about over $1.5 million worth of the replacement units for a factory. And that was one of the considerations. That was one of the big considerations that got us the job, was all of our product had been over the shaker test.

So there are things like that that are coming into play in the renovation market that kind of distort even our ability to say, "Well, we're going to parallel that market," or whatever. Because if that, for instance, becomes a more important thing to people, where we have a decided advantage because we're already qualified with our product line in that regard. I don't know if that gives you any flavor of what's going on, but it's a definite game-changer in the replacement market, things of that nature.

And of course, the energy thing is playing a huge benefit in that. And we are right up, either in the lead or right up with the leaders, in the energy segment of all of our product line.

All right. And then in terms of your gross margin, is there any way that you could quantify how much the gross margin was driven related to productivity improvements versus just the increased volume?

You're right. The over-absorption of our fixed cost definitely played a part in that improved margin that we had. I'd say that was -- this is really searching. Maybe Kathy can give me a better idea. Do you have a better one? I'm going to say that 80% of it was due to improved productivity, and 20% -- and I'm searching a little here, Joe -- about 20%, maybe, from the over-absorption, 20% of that improvement.

Okay, that's helpful. And then lastly, could you just address or talk about the geothermal opportunities that you guys have been tapping into over the last year or two?

Yes, the geothermal ran up really quickly. It's moderated a little bit, but it's a very viable market, and it's going to continue to be a very viable market. But I think one of the things that's happened that has changed the geothermal, and the other part of our market that has had a noticeable change is air source heat pumps. In other words, those technologies which we're trying to extract heat from the air through an air source heat pump, or extract heat out of the earth, a geothermal, or dump the heat into the earth, that part is still there.

But the extracting of the heat has had a negative thing happen to it, and that's called fracking. Namely, the cost of gas has gone down considerably. And therefore, any other source of energy has, that could be displaced by gas, is having a tough competitive situation because the gas price available to you and I is considerably less than it was just a couple of years ago. And so your decision-making toward geothermal or air source heat pumps is very noticeable.

And the one that you can see it in is air source heat pumps, which have historically been growing at a faster rate than air conditioning equipment as a whole, have now gone the other way. They went into a negative position, a bigger one than the air conditioning industry in the whole. And the only thing I can think of for that, why that's happening, is the price of natural gas.

So geothermal, back to your question, geothermal, I think, is because it still does have a real virtue of being able to dump heat into the ground and do it in a very energy-saving fashion, that part of the equation still exists, which is an electrical-driven cost that is saving on your electricity as opposed to saving on gas, natural gas costs, which you could have done with heating with natural gas.

So on the air source heat pump, of course, you don't get that same benefit. You don't gain anything on the cooling side. But in the geothermal, you do. So it is probably on more the southern part of the United States is probably holding its own better against this lower-cost gas than it is in the more northern climates, where you were trying to gain on the heating side.

How much does that make up of your sales at this point?

Oh, probably between 5% and 10%.

All the geothermal, or the air source as well?

The air source as well.

Okay. All right, thanks a lot, Norm.

DeForest Hinman, Walt Hausen and Company.

Just one question, and I apologize if you've answered this already, but I got on the call a little bit late. Can you talk about the capital allocation strategy going forward? You've moved past the heavy investment period, and we had a nice sale number and we got some receivables that are probably flowing through in the third quarter. So can you update us on your thoughts for the cash?

Yes. Basically, new capital commitments -- I've got to separate this out, because you're going to see things that will dispute the numbers I'm going to tell you here. So I've got to explain the number a little bit.

Capital commitments that we're making this year, we think we're going to be -- we started out and told you between $8 million and $10 million. That's a conservative number. I think it's going to be less than that on new capital commitments. However, when you look at our financial sheets, you'll see it's already up to $8 million. Well, if you look over and see how much I've really committed, it's just a little over $4 million. So what's the discrepancy?

Well, that's something maybe I'd better turn over to the wiser one of the two of us here and let Kathy talk about where that differential is.

It's just a classification on the cash flow statement between operating and investing income based upon capital expenditures that are sitting in accounts payable, some that were sitting there at the end of June and some that were sitting there at the end of the year.

So basically, the difference between how much we're committing to cap versus the capital expenditures that show up is a carryover from last year that was on our accounts payable portion in some fashion and is actually showing up as a capital expenditure. So from a cash flow standpoint, it's going to be impacted by some of what we did last year as well as what we'll be doing this year. And, of course, some of what we do this year may carry into next year.

However, I'll tell you that even though we're just a little over $4 million so far this year in new commitments, that's diminishing. And so I'm going to be, like I said, conservative, because I'm pretty sure about the $8 million. That probably is my high point for the balance of the new commitments.

And it's diminishing until the picture changes in the economy and tells me I've got to do something else. Because in so many areas now, whether it be the equipment or the buildings or anything else where I would normally spend capital money, it's going to require that we have a bigger marketplace and more sales before I'm going to be going forward. So my capital expenditure is going down this year, and at this present time, I would say it will continue down into next year.

So should we, as shareholders, anticipate continued buyback activity, or should we anticipate some cash buildup?

At this point in time, I'm looking at cash buildup because of the uncertainty of what's going to happen with -- whatever you want to call it -- the fiscal cliff we're facing in the first part of next year and how that gets handled. You can't see where they're going, and I don't feel very good about any of it. And so I want to keep some cash available, so I'm going to be sitting on the cash that we build up for a while until I see some direction in the thing.

Obviously, we're starting to throw off a lot of cash. And I think, barring anything that I can see right now, we're going to continue to build up cash fairly well. So until, say, the first part of next year, I'm not really likely to make any commitment to use that cash for anything other than putting it out there at that wonderful interest rate we're getting right now.

Okay, thank you, Norm.

And at this time, there are no more questions in queue.

Thank you for attending our second quarter profit and loss and business meeting, whatever role we want to call it, but I hope that it was beneficial to you, and I'd welcome any more calls after we get done with this meeting. If you want to call me directly, feel free to do so. Thank you, and talk to you at the end of next quarter. 'Bye.

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