Aaon Inc (AAON) 2017 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

Welcome to the AAON, Inc.

Fourth Quarter Full Year 2017 Sales and Earnings Call.

(Operator Instructions) This call will last approximately 45 minutes to an hour.

I would like to turn the meeting over to Mr. Gary Fields.

Please go ahead, Mr. Fields.

Good afternoon.

Thank you for joining us.

Today is February 27.

We're going to be doing the annual and fourth quarter coverage.

So I want to start with reading a forward-looking disclaimer.

To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995.

As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ materially from those anticipated.

Please see the risk factors contained in our most recent SEC filings, including the annual report on Form 10-K and the quarterly report on Form 10-Q.

So now I'd like to introduce Scott Asbjornson, CFO, to go over fourth quarter numbers.

Thank you, Gary.

Welcome to our conference call.

I'd like to begin by discussing the comparative results of the 3 months ended December 31, 2017, to December 31, 2016.

Net sales were up 13.6% to $104.2 million from $91.7 million.

The increase in net sales was the result of increases in our production, slightly offset by changes in our product mix.

Gross profit increased 17.2% to $31.1 million from $26.5 million.

As a percentage of sales, gross profit was 29.8% in the quarter just ended compared to 28.9% in 2016.

Selling, general and administrative expenses increased 58.9% to $13.7 million from $8.6 million in 2015.

As a percentage of sales, SG&A was 13.2% of total sales in the quarter just ended compared to 9.4% in 2016.

The increase in SG&A was due to increases in our warranty costs, along with smaller increases in our salaries and benefits compared to the same period in 2016.

Income from operations decreased 2.9% to $17.4 million or 16.7% of sales from $17.9 million or 19.5% of sales.

Our effective tax rate decreased to 9.6% from 36.3%.

The Tax Cuts and Jobs Act enacted on December 22, 2017, lowered the corporate income tax rate from 35% to 21% in 2018.

Due to this change, the company remeasured its deferred tax assets and liabilities on the enactment date, which resulted in a $4.4 million benefit to our income tax provision.

Net income increased 38.1% to $15.8 million or 15.1% of sales from $11.4 million or 12.5% of sales.

Diluted earnings per share increased by 39.4% to $0.30 per share from 21 -- $0.21 per share.

Diluted earnings per share were based on 52,932,000 shares versus 53,420,000 shares in the same quarter a year ago.

The results of the year ended December 31, 2017, versus December 31, 2016.

Net sales were up 5.5% to $405.2 million from $384 million.

The increase in net sales was primarily due to increased volume as compared to the prior year, offset by changes in product mix.

Gross profit increased $5.3 million to $123.4 million from $118.1 million.

As a percentage of sales, gross profit was 30.5% in the year just ended compared to 30.8% in 2016.

Selling, general and administrative expenses increased 27.9% to $49.2 million from $38.5 million in 2016.

As a percentage of sales, SG&A increased to 12.2% of total sales in the year just ended from 10.0% in 2016.

The increase in SG&A is primarily due to increases in warranty expenses.

Income from operations decreased 6.9% to $74.1 million or 18.3% of sales from $79.6 million or 20.7% of sales.

Our effective tax rate decreased to 26.8% from 33.3%.

As already mentioned, this decrease was the result of the changes from the Tax Cuts and Jobs Act.

Net income increased 2.1% to $54.5 million or 13.4% of sales from $53.4 million or 13.9% of sales.

Diluted earnings per share increased by 3% to $1.03 per share from $1 per share.

Diluted earnings per share were based on 53,079,000 shares versus 53,450,000 shares in the same period a year ago.

At this time, I will turn it over to our Treasurer and Chief Accounting Officer, Rebecca Thompson.

Thank you, Scott.

Looking at the balance sheet, you'll see that we had working capital balance of $103.7 million versus $101.9 million at December 31, 2016.

Cash and investments totaled $30.4 million at December 31, 2017.

The investments of maturities ranging from less than 1 month to 5 months.

Our current ratio is approximately 3.1:1.

Our capital expenditures for the year were $41.7 million.

We expect capital expenditures for 2018 to be approximately $53.2 million.

The increase in capital expenditures is primarily due to construction projects related to our new research and development lab, water-source heat pump production line as well as other internal developmental projects.

Shareholder's equity per diluted share is $4.47 at December 31, 2017, compared to $3.85 at December 31, 2016.

I'd now like to turn the call back over to Gary Fields, our President.

Good afternoon.

So let's talk about the upcoming year 2018.

So in 2017, we had the retirement of significant management of manufacturing and the plant.

And it took pretty much the third quarter, things started accelerating for those young folks that took over.

Fourth quarter you obviously see the results that are published today.

And you see that they got on firm footing.

They got some profitability headed their direction.

They did quite a lot with getting the production back in line.

One of the key things is that we got a handle on our warranty expenses.

And this was due to, we cleared out -- in the first part of the year, we cleared out some old things that for whatever reason hadn't come to the surface.

And then we also had a couple of issues with vendors and a process that through the middle part of the year.

We cleaned all of that up, and our warranty is now trending back closer to historic values.

So I think in the upcoming quarters, you're going to see where we made the statement that we believe SG&A will get back on reasonable footing towards historic values, warranty being the biggest adversary to that having happened last year.

So we definitely got that taken care of trending in the right direction.

The next thing is, we went into 2018 with a very bloated backlog.

It was $81.2 million.

That backlog was caused by a couple of things.

One was, we had a price increase on November 15.

While those people didn't want delivery until 2018 and by our standard lead times, that was in line with it.

So the huge swell, a fair amount of it was because people got the orders in really a little earlier than they wanted to have them in.

So you'll see in the first quarter that we'll be building that backlog out and getting back in line with a reasonable backlog number.

The only reason that I have any concern about backlog is if it's too high, that tells me that we're not delivering in accordance with our customer's request.

And so right now, the vast majority of what we're delivering is on time.

We continue to have one of our manufacturing lines that runs a bit later than what they're requesting.

But I've got a little more story to tell on that here in a minute.

All right.

So water-source heat pumps.

We've discussed water-source heat pumps extensively for the last -- nearly 2 years now.

The water-source heat pumps that we're talking about are the models WH and WV.

That is the new product that we began building.

In 2017, we built about -- well, not about, we built exactly 2,128 units that we shipped.

We built another roughly 1,800, 2,000 units that we put in our inventory.

But we shipped 2,128 units.

The first quarter of 2018 we expect to ship almost the exact same number of units.

In other words, the first quarter of 2018 we're going to ship as many heat pumps as we've shipped in total, since the inception of the WH and WV.

So it is accelerating in the direction that we expected it to.

It came a little later than we expected, as we've discussed in previous calls.

But it is arriving now.

It is going in the right direction.

And I think 2018 is going to meet our expectations on that.

The other products that have done quite well tend to be our larger-sized units, midsize and larger.

And some of those were up as much as 22% over any historical peak in the past.

That is one of the reasons that our very largest units continue to run anywhere between 2 and 4 weeks behind when customers are requesting them.

We're working diligently to resolve that, and we've made a lot of headway with it.

We believe that around the first part of April, we'll have that on track to delivering exactly when they've asked for it.

The other update on water-source heat pumps is the first manufacturing line we put -- and put together, we called line 6A, like alpha.

And it really comprised about 1/3 of what our ultimate manufacturing footprint was going to look like.

While 6B, bravo, is nearing completion.

That will allow us to build up to 30-ton horizontal and vertical water-source heat pumps.

Our current ability is to build up to 5 ton on line 6A.

So 6B enables us to build larger units and also to do some special prototyping and some rework on any units that didn't pass first try on the end-of-line test.

6C, like Charlie, is a high-volume, high-production line.

It very much looks like 6A, only quite a lot more manufacturing capability as far as production volumes.

And it's really arranged for the orders that -- and we've been getting some of these orders where you get a multitude of units that are identical.

We've had orders with as many as 380 identical units on it.

6C will run that at a much more efficient rate.

And that is due to come online August, possibly September.

So the water-source heat pumps, like I say, we've got everything going in our direction now.

The orders are coming in on a pretty steady basis, and we're able to produce the units to meet everyone's expectations.

The warranty incidents on these water-source heat pumps that we've started making on this line 6 has been nil.

We have had just very, very little trouble at all.

So that's been a great thing.

It was planned that way and the plans came together.

We -- in 2017, we had a couple of more rep agencies that were not performing to our expectations or weren't aligned for good long-term partnership and we replaced them.

These new reps, it usually takes between -- probably the most aggressive is 18 months and it probably averages more like 30, 36 months before they began to make any significant strides into positive territory.

However, this -- the most recent one that we replaced was only December 1, and he's already making an impact far beyond what the people are that we replaced.

So I've got hope for him that he'll break out of that mold and show me how to do this quicker than even 18 months.

We worked on redesigning some of our products, particularly 2 ends of our primary units, the RN series units.

The smallest units that we make in the RN series, we're in a significant redesign on them now in order to make them a benchmark-setting unit with regards to energy efficiency and capabilities.

The concept is complete.

The prototype is being configured right now.

And we're due to have all of that redesign completed in the third quarter of '18.

Also our largest of our RN series units, we've been concentrating on them for 2 regards.

We had more warranty incident with that series of units than we thought was tolerable.

And so we've resolved those issues.

But while we were resolving them, we found a way to be even more efficient in the process.

And so we've got 2 steps that we're taking, one immediately and one towards the end of third quarter, to make that unit even more robust and make it more efficient than it currently is.

The replacement market and the new construction market still maintain about a 50-50 equilibrium for us.

We have seen some indication that the Architectural Billings Index, the ABI.

The latest publication of it was, it was a very, very high number.

Do you remember the number, exactly, Scott?

57, I think.

I believe so.

I believe it was 57, which any mark above 50 is positive ground in that.

So in 2017, I believe there might have been 2 months that we're at or below 50.

But it's by and large been above 54 consecutively for quite a while.

That tells us that 9 to 12 months out it is when they published that, for instance, January, you wouldn't look for that activity to hit our order logs until 9 to 12 months from them.

So that gives us very strong feeling about 2018 remaining very strong.

So we've had growth in certain of our products that has been disproportionate to the others.

You see what the overall growth at the company was, and you can see how the backlogs up.

So you know we're going to continue to grow.

But our larger products have grown percentage-wise 2017 over 2016 more so than our smaller products grew.

The other thing that grew significantly, and I'll talk more about that in a minute, is air handling units.

These are traditionally indoor installations, not compressorized.

They have grown very nicely with a very limited offering that we have.

So with that, I'll go on to the market segments.

There's been really no change in our distribution: commercial and retail; office building; medical, health care; education; manufacturing; lodging and municipalities.

All remain in the same shares that they have been historically for the last 12 months.

But what we have seen is that there's an opportunity for air handling units, indoor air handling units primarily.

We built some outdoor air handling units, and we'll continue to do that.

But we look to how we exploit this growth and how we are planning for that growth.

So that being the case, water-source heat pumps coming up to production nicely.

The R&D lab, the first environmental sales will come online on May 1. And then we'll be bringing on more environmental sales each month all the way through and October 1 is our date that we slated for a grand opening with all sales operational.

This is going to allow us to develop some additional products in a parallel format.

Right now, we're constrained by the environmental chambers that we have operational.

From a standpoint of the gross profit, we're going to do our very best to maintain that gross profit.

We believe that we have arrested the warranty incidents.

We don't think we have any unusual occurrences.

So 2018 looks to be pretty solid.

The one thing I will point out though is that the water-source heat pump will continue to be a little bit of a pressure on the gross profits because we're still in a startup mode, where we're going to have some volume in the water-source heat pump this year.

But I don't look forward to contributing much to the gross profit lines yet.

So the CapEx, Scott and Rebecca mentioned earlier, we've slated out at $53.2 million for this year.

And that includes finishing out the lab.

There was quite a lot of the lab expenditures that ended up getting over into 2018.

That's renovation of some equipment or replacement of some equipment.

And line 6B and line 6C for the water-source heat pump, those are the primary drivers.

We do have a very small sum of money in our CapEx set aside for exploring and developing a new air handling unit manufacturing facility.

We're currently involved in a site selection.

We've narrowed this down to 4 sites, 2 in Texas, 2 in Oklahoma.

We'll be making a decision in the next 30 to 45 days on what the site is, and we'll explain more about that at the time.

But what I wanted to say about that is we're currently, we have about $22 million to $24 million that we're doing in indoor air handling units right now.

And it's been accelerating for the last few years.

We've got a lot of strategic initiatives that will enhance our ability to expand that business at a rate much faster than the majority of all of our other products.

So in addition to the water-source heat pump that's going to ramp up at a rate that won't be in line with the other equipment percentage-wise.

The air handlers won't be too far behind that on what we have planned for that.

So with that, I believe, we are open to questions.

(Operator Instructions) And your first question comes from Jon Braatz.

Gary, you characterized early on the backlog number being somewhat bloated, and it reflects the price increase in November.

Does it all -- do you sense any increase in the backlog because of general market conditions?

You see any evidence that there is some momentum building in the market, in general?

I do.

The backlog right now is at 21% over its historic numbers.

That's about $10 million.

And so it looks like that's going to be our new normal.

Because like I said we pretty much got everything back in line delivering on customer's expectations.

So the backlog is somewhat normalized at this moment.

Okay.

And I guess -- I guess, it probably doesn't take a genius to figure out that this -- the backlog at year-end implies a pretty healthy first quarter sales number?

I like the way you terminate -- term that.

Yes.

Okay.

Okay.

Turning to the water-source heat pump.

You have not received accreditation yet, I believe.

And...

That is true.

And when might you expect that?

And do you think that's having any negative consequences on your sales and marketing efforts?

All right.

So first off, the AHRI certification, it's called enlisting.

They began to -- we sent the units to them on August 27, '17, their testing schedule was quite full and they began testing.

But they had not been able to complete.

They pulled 7 pieces of equipment to test.

They have completed 4 of those.

The fifth one is in right now.

So looking at their schedule, that's not real expeditious the way I see it.

But it's looking imminent that we should have all that testing completed very soon.

As far as its impact on sales, I think it would be naive to say otherwise.

It has had an impact because I spend entirely too much energy talking about the certification, which means that people have some reservation about moving forward until that occurs.

There's always customers that will move forward because they know and trust AAON.

And the fact that all of our other products are certified and the fact that this is kind of like the equivalent of patent pending.

The certification, we've submitted the units, they're there, they're being tested.

And so the vast majority of really understand it when there's an entity such as an energy provider that's providing rebates, well, you're not getting any rebates without certification.

So those projects that are driven by rebates are definitely out of our reach, in general, at this point.

Okay.

It’s been sort of a sort of a moving target, but what is sort of your expectations now for the water-source heat pump in 2018.

I'd have to go back and look up my notes, you thought you would grab this much market first year and second year.

But can you sort of update us a little bit on your expectations?

Well, our goals are to reach 5% market share this year.

And then each year that goes after this to add an additional 5% market share.

Okay.

Market is about $500 million, correct?

It was in 2017, and that's why I'm more willing to term it in percent of market share because if the market goes up, then I hope to get more and if the market goes down, then I get a little less.

But our goals have been stated to be 5% market share, 10%, 15%, 20%, 25%.

And your next question comes from Brent Thielman.

Scott, just wanted to be clear on the warranty expense thing.

It caught us off guard, again, this quarter a bit.

So that should start to normalize here in the first quarter.

Is that the way to think about this?

Well, it should.

We currently believe we're on trend at the moment with first quarter of '17.

Hopefully, as the quarter progresses, it will come down even beyond that.

We don't know of any major problems that are outstanding that are needing to be resolved.

So our expectation is that over the course of the year, we should see it improve significantly over last year.

Got it.

Okay.

And then, I guess, just another question on the pump line.

Did you guys offer the sales-dollar impact for the fourth quarter?

No.

No.

We did not.

Okay.

It's not real hard to figure out.

It was 2,128 units and they average little over $1,200 a unit.

So it was around $2.6 million, $2.7 million was the total 2017 impact of the WH, WV.

Recognizing other facts, we make heat pumps -- water-source heat pumps in all of our other, we'll call them, legacy products, the rooftop products.

And those have been running around $16 million, $17 million a year.

So we're not talking about those in conjunction with this conversation.

All the conversations about the water-source heat pumps that we've had have all been about the new product, which is model WH and WV.

Those are the small indoor units.

Got it.

Okay.

That's helpful.

And then, Gary, just want to dig in a little bit more on the indoor handling units.

I think you said sort of $22 million to $24 million business per year.

Yes.

Can you just expand on what you guys are exactly evaluating?

And kind of where you think that business could go over the next few years?

Is it too early to put numbers around it?

Well, I'm not ready to put numbers around it per se.

Because it's -- we're in the planning stages right now.

We're planning what the product line would look like.

We're planning what the manufacturing process would be.

We're utilizing a lot of what we learned on this small water-source heat pump to cross that over into this air handling unit business.

There is a lot of things in that regard that -- we're just now in the infancy of building that plan out.

Fact is tomorrow is my first substantial committee meeting with the various stakeholders in the business that have influence on how that will occur.

So the bottom line is that last time I looked, air handlers were about a $2.2 billion annual market.

And we believe that there's room for us to grow and expand into more of that market.

Because currently, like I said we're about $22 million to $24 million in there.

There are manufacturers that have been bought by consolidators, and there are various things that their sales channel partners are nervous about.

So a lot of our sales channel already participates in this market.

One of the driving factors for getting into the water-source heat pump was our sales channel was already selling around $75 million, $80 million of that type product and the manufacturers that we're supplying them were leaving room for improvement.

And so they encouraged us to get into this business and said that when we got in and got in the way that they envisioned, that they would be onboard with us.

Well, we know that our same sales channel partners are extraordinarily involved in the air handling unit business, way beyond the $75 million, $78 million.

Fact is, my former company, Texas Air Systems does around close to $40 million in air handlers just themselves in the state of Texas.

So it's a significant opportunity for us.

It's one that I had in excess of 30 years of experience within the sales channel side.

And I very much understand that market, and it very much plays to the strengths of what we do here at AAON.

What we learned on the water-source heat pump as far as how to automate several of the manufacturing processes and how to automate going from the user interface all the way through to production control for scheduling.

That software that we developed, all of that will be utilized in this new expanded air handling unit business.

So yes, I'm very excited about the possibilities of it.

But it's very early to be talking about any kind of numbers.

What we can say is that it's a business we have extensive experience with.

We're already established in it.

And this is an expansion of how we do, what we do.

And we have a follow-up from Jon Braatz.

Gary, in your commentary you have mentioned that you expect the -- you hope the water-source heat pump, you were talking about gross margins and gross profit to make a contribution to the gross profit.

Are you referring to maybe contribute to a gross margin increase here, I mean, it's contributing the gross profit, am I correct?

Yes.

We're not selling them lacking some profit.

But it's not as profitable as we expect it to be.

It's not as profitable as the benchmark for the whole company.

Right.

Okay.

Okay.

Fine.

Okay.

And the other thing, on the warranty, last year 2017 we had a big warranty expenses.

Is there something new or different at the company, or you had a couple people that retired?

Is it something -- is there something at the company that and the way you're doing, handling things that may have contributed to the warranty expenses because we really haven't had issues like this in the past.

But is there something new and different that might be adding to the -- might have added to the warranty expenses in 2017?

There he is.

We had -- in our sales department, we had leadership in there that was making little situations where somebody would make a warranty claim, he wouldn't vet it out real well.

And maybe would give them a discount on a project in order to make them happy.

More like a sales concession.

So it really wasn't officially a warranty item, but it kind of had a little up to that.

So some of that was discovered when we replaced that person.

And so we cleaned up a little of that.

That was a little of it.

But more often than not what it was is we had mainly, our sales channel partners that would go out there and fix problems and it in some instances, they didn't even turn the bills into us for an extended period of time.

And basically, I set my foot down and said, "Look, you got to get these bills in here and get this cleaned up.

You can't just leave it sitting out there dangling forever.

We got to address this directly and clean it up." So it was just some people that have a little bit of lackadaisical attitude towards resolving the issues.

And they were making decent money on the sale of the product and they just kind of went along happy-go-lucky, if you will.

And then would eventually get around to cleaning it up.

So I kind of put a time line on him.

And I said anything that's 90-days old or older, I'm not going to consider.

So you better get it cleaned up.

So that was a good part of what was happening.

Then at the same time when these young guys came in, they wanted to make an impact, not only in product as far as production rate, but they believed that the other guys weren't staying up with -- being as diligent as they wanted to be with getting some of these issues identified and cleaned up.

And so the first half of the year was a lot of really hard work.

Then like I said before, we had a couple of vendors that supplied equipment to us, components that either we didn't understand how to apply them as well as we needed to, or they didn't -- they weren't as robust as we had hoped for.

It was different scenarios with each one of them.

But we got all of that vetted out and resolved to.

So the first half of the year was probably as much effort on as many people's part as you can to make sure that we cleaned everything up, and we had a clean slate to go forward with.

And that was both in the equipment that we produced being the best quality.

We knew how to produce with the best vendor partners on these purchase components.

And it was also an adjustment in policy.

So it took a little longer to get that energy.

That energy went into the flywheel, and then it took a little longer to get it totally exhausted and through the flywheel.

But another thing to keep in mind is that, while there was a period of time when those claims in actual payments was going up, well then that causes accrual to go up.

And so a lot of what we're seeing was the accrual increased as well.

And then once the trend starts back the other way then some of that accrual will come back to us.

Okay.

Okay.

One last question.

When line 6B begins or starts up in September -- August, September, it seemed like 6A took a long time to fine-tune and get it running smoothly.

Do you think it would take line 6B to that type of time -- length of time to move into full production?

No.

So let me clarify this.

6B is actually going to come online in the next 30 to 45 days.

Yes.

6C -- 6C, Charlie, won't come online until about September.

So 6B, 6 bravo, will be coming online in the next 30, 45 days and that is to build some larger product up to 30 tons horizontal and vertical.

We are developing that product, but some of it we have to get the line finished in order to be able to build the product.

We don't have anywhere to build that large of a water-source heat pump.

So yes, it's going to take some time in 2018 to develop the product.

We have the engineering completed on some of these additional larger sizes, but until we build and prototype and run them through there then we can't really test them, vet them out and perfect them.

So it won't take as long as 6A because we have established procedures on a lot of the construction methods already.

For instance, we don't have to learn how to use the induction brazing equipment.

We already know how to use that, and we just extend it down to this line.

A lot of the other functions that occurred in the learning process of 6A, we don't have to relearn them.

We only have to extend them.

And one of the most key things, Norm talked about this extensively throughout the year, was the development of the software.

So we had to take multiple manufacturers with their own unique software language and integrate them into one common software language that we could operate as a system and have that all integrated.

And it has to be very well sequenced because when you punch the button to start a product through there, then everything has to happen in a very choreographed exact sequence.

Otherwise, you'll end up at a point on the line where you don't have a part that you need because they -- this is the true definition of just-in-time manufacturing.

When we start the product on the manufacturing line, there is nothing from a fabrication standpoint prebuilt.

Like we do in the rest of the plant.

The rest of the plant, we have sheet metal and self-assemblies in about a 3-day inventory, on average.

This we have 0 when you start it.

So we've streamlined that software a whole lot.

Every now and then we get a little hiccup in it, but it's an every now and then.

I mean, mostly this line runs very smooth now, and so we'll be able to take that same concept and just extend it on down to 6B.

So that learning curve has been accomplished and won't be a problem going forward.

And we have no more questions in queue.

Well, thank you very much.

We appreciate it.

And we will speak to you, again, in May for our first quarter results.

Have a nice day.

This does conclude today's conference call.

You may now disconnect.