AAON
#Good afternoon.
I'd like to read a forward-looking disclaimer.
To the extent any statement presented herein deals with the 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'd like now to introduce <UNK> <UNK>, our Chief Financial Officer.
Welcome to our conference call.
I'd like to begin by discussing the comparative results of the 3 months ended March 31, 2018 versus March 31, 2017.
Net sales were up 15.1% to $99.1 million from $86.1 million.
New sales for the quarter are mainly due to the increases in our rooftop and water- sourcing heat pump products.
Our gross profit decreased 38.4% to $15.4 million from $25.0 million.
As a percentage of sales, gross profit was 15.5% in the quarter just ended compared to 29.0% in 2017.
In January of 2018, the company paid all employees a onetime bonus of $1,000 per employee as a result of the Tax Cut and Jobs Act, the Act, which lowered the federal corporate tax rate from 35% to 21%.
This bonus increase cost of sales by $1.9 million, excluding taxes and benefits.
Additionally, the company typically has seasonality in its sales and workforce with the fourth and first quarter being lower in production.
The company maintained a higher level of workforce through the end of 2017 and beginning of 2018 in anticipation of our growing business.
The company's water-source pump business also has a lower profit margin.
And given it is still in the early stages of production, this part of the business is not yet as profitable as our other products.
Selling, general and administrative expenses decreased 3% to $10.2 million from $10.5 million in 2017.
As a percentage of sales, SG&A decreased to 10.3% of total sales in the quarter just ended from 12.2% in 2017.
The overall decrease in SG&A was primarily due to a decrease in advertising expense and profit sharing.
Income from operations decreased 64.2% to $5.2 million or 5.2% of sales from $14.5 million or 16.8% of sales.
Our effective tax rate decreased to 18.7% from 29.7%.
The company's estimated annual 2018 effective tax rate, excluding discrete events, is expected to be approximately 28%.
The decrease in our effective rate was due to the Tax Cuts and Jobs Act that was enacted on December 22, 2017, lowering the federal corporate rate to 21%.
Net income decreased to $4.3 million or 4.3% of sales compared to $10.2 million or 11.9% of sales in 2017.
Diluted earnings per share decreased by 57.9% to $0.08 per share from $0.19 per share.
Dilutive earnings per share were based on 52,910,000 shares versus 53,190,000 shares in the same quarter a year ago.
I'll now turn things over to <UNK> <UNK>, our Chief Accounting Officer and Treasurer.
While net sales increased 15.1% for the quarter, our first quarter was fraught with various issues of which we've clearly identified and implemented corrective actions.
I'd like to talk about some of those details.
In the first quarter of 2017, we were unable to hire plant workers quick enough to meet the demand.
So coming into the first quarter of 2018, we retained a much greater plant workforce in anticipation of the stronger order input than actually occurred.
In January, versus forecast, we were down 40%.
In February, versus forecast, we were down 17.5%.
In March, we were down 15%.
So these orders weren't coming in the door near the rate that they were forecast.
Now these are not comparative to any other time period.
These are only comparative to forecast.
The one bit of good news is that in April, that we were 9% above forecast, so that loop of going down turned and went all the way up to in positive territory.
But through the end of April, we were still just a bit short of forecast.
It is trending in the right direction.
I want to make note that the architectural billing index has been in excess of the benchmark of 50, consistently over the past many months.
This supported the forecast that our sales channel was providing to us.
Our sales channel further confirmed that the orders were in the pipeline as forecast, but slower to release than originally expected.
April somewhat confirmed that assertion.
The next thing I want to go over is the timing of price increases.
So in November of 2017, we had a 3% price increase.
Approximately 50% of what we built in the first quarter had that price increase applied to it.
The other 50% was backlog that accumulated before the price increase.
Beginning right at the first of April, all product is being built on the new price that was established in November.
So component prices increased mostly beginning January 1, so that 50% of the backlog that was built in the first quarter had pressure on it, because those component prices had increased, yet we had not been able to effectively implement our price increase.
While our steel costs are committed well into the third quarter, some commodities such as aluminum were not, and they've had some impact at this time.
Not a great impact but it was some impact.
Probably the greatest impact was our elevated headcount.
We had this forecast from our sales channel partners that looked viable with all the other checks and balances that we utilized.
So we maintain that headcount.
We have approximately 30% surplus headcount versus that same amount of the year before.
Another pressure on us is our new laboratories coming online.
We've hired several people who are learning how to operate the lab at this point but the lab itself is not yet operational.
Portions of the new lab will be commissioned and operational early next month, with additional chambers coming online each month until final handoff in November.
We have to train these people.
It's essential to our immediate success upon completion of the lab, yet today, they're not showing any measurable contribution.
The next thing I want to discuss is the product mix.
If you will notice in the 10-Q, we've built approximately 6 fewer rooftop units the first quarter of this year, yet the revenue was up 12% on those rooftop units.
The result was we built units of greater complexity but at a much lower margin.
These very large complex units are very unique and they don't allow you to establish a whole lot of rhythm as you go down through the production line.
We had certain product sizes that we positioned for aggressive market share capture.
We've been achieving our goals with market share capture, but those came in at a lower gross margin than benchmark.
At the earlier stages of this effort, the dilutive effect of the overall margin was minimal, but the negative impact on the first quarter this year was sizable.
Our water-source heat pump business, while ramping up, we shipped over 1,600 units in the first quarter of 2018 compared with 2,485 units the entire year of 2017.
So all this is still a start-up business, with all the burdens expected of a start-up business, the product offering is accelerating and will gravitate towards profitability throughout the year.
We're on track to be significantly complete with the development of the products and manufacturing resources by the end of this year.
AHRI certification testing is ongoing.
Of the 7 units that were selected for testing, 4 of them have successfully completed the testing.
There is a fifth one in the test chamber at this time.
So we're getting closer and closer to achieving that final goal.
We don't have any determination of exactly when that will be, but we are well past the halfway mark at this point.
So I'd like to summarize with a few thoughts.
While the lab is currently putting pressure on the bottom line, it will enable development and refinement of technology, solidifying our very enviable position as a market leader.
Long term, the lab will prove to be a great investment.
All the units produced in the second quarter will be in accordance with the price increase in 2017.
We won't have that 50-50 dilution.
Then we have another price increase that's effective June 15.
That is forecast to offset many of the cost pressures previously discussed.
It will principally show up in production in the fourth quarter.
Many processes have been revised and improved.
Product mix has become more favorable.
Water-source heat effort is beginning to mature.
The plant workforce has been right-sized to meet customer shipment expectations and improve efficiency.
The Architectural Billings Index remains above 50, indicating the strength in the construction market for the balance of the year.
All these factors considered, we expect to see our margins improve over the fourth ---+ over the first quarter we're targeting historic levels over the next year.
I'd also like to point out that March 31, 2018, our backlog was at $74.1 million versus $68.9 million for the same period a year ago.
So now I will open it up to any questions.
I guess back on the gross margins and ---+ as you said a lot of moving pieces there, I'm trying to think about all of that.
But <UNK>, I think you said you expected to get kind of back at those historical levels, correct me if I'm wrong, over the next year.
As you think about it from here, is it kind of a progressive sort of stair step up as we move through '18 and then maybe to get there by the first quarter of '19.
Am I thinking about that right.
That's exactly the way we're thinking of it, <UNK>, the same way.
Okay, and from the materials cost side of things, I'm just trying to weigh all the different things going on in there.
Is that really the biggest impact here at the end of the day.
Not in the first quarter.
We had component prices, as I said, we had increasing component prices that they announced their price increases last fall, same as we did.
And the kind of the lesson I had to learn was how long it takes from the time I invoke a price increase until it actually hits in our plant floor due to the backlog and the timing of that.
I probably didn't lead that quite far enough and that's why only 50% was built at the new price, while I have some escalation in component prices.
Steel, we still had plenty of steel available at the price prior to any tariff announcement or any of that.
Aluminum was a little bit different, but aluminum is just a very small percentage of the cost of our overall product.
So as we go forward now, as we look at that, we got enough steel in poundage that at our current production rate, it will carry us deep into the third quarter, maybe all the way through the third quarter.
While our price increase that goes into effect in June, the very first unit that hits the plant floor first day of fourth quarter should be at the new price increase.
We believe that with the steel prices that they're talking about right now, which, by the way, are up 56%, not 25% like the tariff that was spoken to be, they're asking 56% premium.
We've analyzed that and if the prices stay that high, which we got reason to believe that they may subside a bit, but if the steel prices ---+ if the aluminum prices stay that high, that of the 5% price increase that goes into effect, we'll use up in excess of 3% of that 5% on those materials.
So that's going to leave us something less than 2% for escalation of wages and miscellaneous and I think <UNK> gave me a number earlier today that wages are looking at about 2.7%.
That's what the general inflation trend is.
General inflation is 2.7%, so when we couple all of that together, the 5% price increase is kind of a hold your own, not really at this point in time anticipated as a you-get-ahead measure.
But at least the timing of it appears to be much more in line with when these additional costs are going to occur.
Like you said that the price increase that I did November 15, if I had to do over on it I would have done it September 15 and that way I would have had the full effect of it when they started seeing these escalated components.
Great.
Okay.
And I mean, it sounds like you should have some pretty good volume coming through here at least in the coming quarters.
Is that going to be enough to offset these pressures and still grow gross profit relative to last year.
I mean, I know you guys don't guide but (inaudible) gravity of this.
Well, yes, we have a very strong backlog, strengthening every moment, like I said, the forecast and the forecast was not relevant to another quarter.
The forecast was actually quite aggressive by the rep force.
I mean, if they would've achieved forecast, oh my gosh, this would've been a heck of a lot different phone call, but it is what it is.
In April, we were up 9% above their forecast, so it felt like a lot of those orders that we thought we were going to get in January, February and even in March, got pushed out a little bit and then they started flooding in here in April.
While it's a curse on one hand that we get that workforce as big as we did, thinking that, that work was going to get in here sooner than it did.
But now, it might be as they call the silver lining in the cloud, in that I actually do have enough workforce by and large to build what we need to build and meet people's expectations and get some revenue through this place.
So I'm very confident at this point with what we see that we're going to have a real good effect of recovering from what occurred in the first quarter.
Got it.
One more if I could.
I'll turn it over.
I apologize.
Did you talk about the certification status for the water-source heat pump.
If you did, I'm (inaudible)
I did.
I did but I don't mind going over it again.
AHRI chose 7 units to test for certification.
4 of those have been tested, successfully completed.
The fifth one is in their lab as we speak.
We have confidence, as much confidence in the one in the lab now and the other 2 yet to be tested as we did the first 4.
So our confidence in achieving that certification is sooner ---+ is strong.
We are at their mercy as we've always spoken about them testing when they do.
One of the key things to keep in mind, of the 7 units that they chose, only 2 of them are what we categorize as the new product, the WH and WV.
The other 5 were products that we have made for years before.
There was no reason to certify those in the past, though, because we were essentially the only ones building them.
And that's been a little bit of the challenge for AHRI is figuring out exactly how to test some of those.
So the majority of those have now been completed.
I think there's one left.
It's a challenging test for them, but of the 3 left to test, I think only one of them is anything that's extraordinary for them.
Otherwise, I believe they'll test at a normal testing pace.
The other thing to recognize about AHRI with their testing, all of us that belong to the AHRI program, all over equipment, which there's multiple sections that you're listing equipment in, AHRI pulls a certain percentage of units from your production line every year and tests them for continuous maintenance-type confirmation of your certification.
That is probably the most substantial use of their lab time.
So when you open up a new section, then it has to work around all of those other tests and you're very much of a secondary effort for them.
So that's what makes it so difficult to open up a new section.
And the other thing is, until all 7 units have been tested and passed, you can't certify any of them, okay.
It's a one or ---+ it's all or none, actually.
We are a little bit understaffed to equal right now as of today.
Hold on just a minute, I'm getting confirmation on this.
We're not having agreement.
Hold on.
What <UNK> means is that at our pace of production at the end of this quarter, we would likely need additional staff, but where we're at, at the moment, we are adequately staffed.
But you will see significant improvement from what we can predict at this point in terms of our headcount versus our production levels within the 2.
Well, all materials are typically at 40% or less of cost of goods sold.
It's 10% of the cost of goods sold.
Correct, and there are enough moving pieces that it's difficult enough to project that, but if I were going to make my best estimate just at the moment I would tend to say your initial thought of low 20 range is probably at the better end of where we're likely to be.
We could be at high teens, but it's somewhere right in that range.
I don't have it in the exact numbers, but there's 47 people affiliated with R&D in the lab, some of which have been here prior to the lab.
But those 47 people, some of them are productive now, but there's a substantial portion of them that are solely being trained and developing additional capacity in the lab.
Our engineering expense in total year-over-year is up about 1% of sales.
So the percentage it represented last year versus this year has increased by about 1%.
Probably dominant number of those are affiliated with the lab.
Yes, the primary products of ---+ that I'm talking about there comprised about 20% of all production first quarter and historically, they had been closer to 10%.
And so they provided twice the dilutive effect as to what they had in historic perspective.
The bookings backlog, it is down to less than 15%, closing in to 12% as of last night, in what's in the backlog.
So we look for that product mix to improve throughout the year.
And this is ---+ it's really influenced by 2 things.
One was that this larger product that we don't make as much margin on, we did a pretty stellar job of cleaning up various aspects of the product to make it more attractive.
So the sales of that product has gone up 3x over recent history, and the other products have not accelerated quite as fast.
So it became a bigger percentage.
Well now, some of the other products are beginning to move ahead with better percentage advancements and getting that back end to a more favorable ratio.
The other thing about it, because it did triple in quantity, it put us behind the gun as far as being able to manufacture.
So its lead time went way out ---+ well when the lead time goes way out, people don't buy, they won't wait that long.
So that was a reduction in the quantity.
But what also happened was it floated into the beginning of this year with all those extended lead times and all that reduction.
So it did not slow down in volume in the first quarter, it had to be increased in volume.
And then the rest of our product line is to the north [will slow down in] the first quarter.
Well, we could tell you what ---+ where we are.
Could we give them that.
Yes, give them that.
Well, April quarters were up 24% versus last April and our backlog is currently $92 million, as of today.
Yes, I believe it will be.
We've not seen anything.
It's too early to have seen any pull forward from the 2 price increases that I presided over.
It looks to me like we won't see pull forward until almost the week of the price increase, at the earliest, 1 week ahead of that.
So possibly what happens for June 1 through June 15 will be a huge anomaly.
But let's just say, a nice average booking day around here in the Tulsa operation is around $1.6 million or $1.7 million a day, let's say.
But the day ---+ on November 13, we booked 8 days, so you pulled 5 or 6 days were really easy, it looks right there.
I think it's going to continue to ramp up.
It's going to stair step some, based on certain things happening.
First off, our second segment of the manufacturing process will allow us to build some bigger units.
We have concept designs finished for those, but we don't yet have them fully vetted out, ready for manufacture.
We didn't have the facility to do it.
That facility comes online within the next couple of weeks.
So probably over the next few weeks, we will have some additional sizes available, which means that there are projects that we've been blocked out of because we didn't have the range of sizes that will start coming in.
So when we introduce this next ---+ 2 sizes, the 6 and 8 size units, that will stair step us up a good bit as far as availability.
Once we get the AHRI certification, which, cross my fingers, happens almost simultaneous with getting the additional product, that will stair step is up.
So we've got 2 significant stair step opportunities probably somewhere in this quarter to early next quarter, but things are ramping up.
We're having one aspect of it is that we have some early adopter type of operations went out there and sold some units and some another people that are standing around watching to see how those jobs went.
While they're getting favorable review, so now other people are getting to engage more readily.
So several things are starting to move loose at the same time.
Still are.
Yes, it's still on target to be finished sometime in August.
I don't think we want to ignore the fact that there's been a considerable effort put into the water-source heat pump.
A lot probably more so than ---+ probably the thing that's happened in the legacy product most significantly is that we've not continued to advance at the same rate that we were advancing at because we only had the ability to develop so much at one time.
Part of our additional overhead in addition to engineering was adding more people so that we could do more parallel projects at the same time.
And that's had some learning curve to it.
It's had some ramp-up time to that.
So I would say that in the earlier stage of it, it was probably more disruptive than it is currently, but I would say that there is some validity in your assertion.
If you give me a do over, I'm not only going to be a little earlier, but I'm going to be a little stronger too.
I doubt it.
Very likely I'll hit it again in October.
Well, the tariffs are ---+ a real question is to what the actual impact was going to be.
You don't want to curb sales to the point that ---+ you don't want to go up so much that you'd cut off the growth.
So it's a bit of a calculated risk either way.
You calculate what you think you can get.
And again, Norm has been a great adviser to me on this, but he's kind of left me alone on this.
So I had to suffer in my own soup.
And so like I said, if I have a do over on it, yes, I would do it a little earlier, I'd do it a little stronger.
And at this point in time, I believe what we've done going forward, is correct.
And we'll just continue to keep a further ---+ watch further down the road as to the way things are occurring.
The most significant thing, more so than the amount that I raised prices, the more significant thing was the timing.
And in my past 32 years of career, when I put a price increase, I saw it hit the bottom line much, much faster.
And so at this juncture, it was a little hard to understand how it was so much longer before it got through the entire process and got to the bottom line.
Well, I have clear understanding on that now, I assure you.
John, one of the things of turning the company over to somebody, you can't tell them what to do all the time.
They don't learn by being told everything they should do.
So sometimes you have to suffer a little bit in silence and hope that it doesn't have too much of a negative effect.
So therein is part of what's going on and it's not just the fact that I'm backing out of the picture, we had the Vice President of Manufacturing and Head of Plant Construction and Senior Vice President and enumerable other people are at the same age level, a little younger than myself even, have left.
In last 18 months, we've had a considerable change and up to level management.
And all of these people naturally do not have years of experience, but still going to move quickly.
And so they're all a little bit hesitant, they all move a little more gingerly than what maybe a more experienced person would do.
So we collectively put all those people together against the new people.
Now you ask yourself, how did these new people measure up to the old people.
Well, I'm going to admit something.
I think <UNK> is due to be a better person in this position than me in the long term because he starts at a different level and he didn't have to do all the heavy lifting that had to be done to get us to this point.
So I'll start right there and I'll then either make a further assumption, across the board all of the people who retired I think have been replaced by at least comparable and in most cases superior potential person.
But this potential person ---+ people aren't where they are potentially.
They're just rising to that point.
So there's been a lot of that has been very hidden in our problem areas in that we didn't have realized problems as quickly, we didn't respond as quickly nor anything else.
The other side of this was we got misled a little bit by the duties.
The duties of 25% on steel and 10% on aluminum.
The actual fact is as we sit here right today, both of them are up somewhere in the mid-50s, they're up 56%, 57%.
But we didn't think it was going to go that far, but the commodity people, when they get an opening, they do like everybody else, they ask for more than they really expect to get.
But initially for a while, they won't get that price.
So you're really sitting here kind of floundering, wondering what the real numbers is going to be once it settles down and we don't know that at this point in time and neither do our competitors.
So we're all guessing.
We're playing a guessing game and a timing game.
And it's quite different than it's been for many, many years.
It's been very, very ---+ we haven't had very much excitement in the industry.
We haven't had very much change and everything's been very predictable.
So this duty that was thrown out, everybody says, okay, got to go for 25 and 10.
Wrong, way wrong.
And so we all have been trapped a little by what's actually occurring out there.
And I know from history, I've been at this an awful long time, they all come out that way and then purchasers finally figure a way to get around them a little bit and they'll get that lowered down.
But we never know how much that will come down.
So we're still a little bit in the dark about what's going on for the future here.
And as that kind that settles out, we're going to see how much more we need to implement that adjustment to it.
Right now, I think we're good because even though we're at open market price on aluminum, we're at ---+ we got a fixed price all the way through until sometime August, September on the steel.
So we're not being ---+ the steel thing isn't hitting us on the commodity.
It is hitting us on the components, however, because the people who we buy components for, may not have that protection on their steel and so they have to raise their price on us on components.
All right.
So let's talk about intangible versus tangible.
The tangible component of it is that we've got a product development road map that is currently moving at a slow pace because of the number of lab chambers that we have available to develop product.
So we will have several times the number of chambers available to us when the new lab is completed.
So rather than having this slow pace of product development, we'll be able to accelerate that probably around 4 or 5 times and the reason I'm not able to give you an exact on that is because these people that we're training now, again, we got to get people trained.
Just because you have a chamber available, it doesn't mean that we've got qualified people to operate it.
So we're trying to lead that situation by training some people now in our existing lab chambers so that they'll be ready to go.
So from a tangible standpoint, we'll be able to accelerate the development of products.
We have plenty of ideas on our product development road map that the constraint, the primary constraint is available lab chamber time.
So that's the tangible.
The next thing is we already have 3 projects that our sales channel has secured because we will be able to test their product for that project in our lab and vet out all the operational characteristics, improve the airflow thermal and acoustical performance of these.
Our sales channel partner in New York City, so apparently it's a new high-rise building because they have 26 units that go 1 per floor is the typical arrangement.
And they sold that with the fact that we will be testing those units in our lab to demonstrate exactly what they need to do for acoustical mitigation in that space.
So it will be a sales enhancement tool related to certain projects as well as developing products.
All right.
Thank you.
We look forward to talking to you at the next conference call.
Good day.
