AAON, Inc.
Q3 2016 Earnings Call Transcript

Published: 4 Nov 2016

[Operator:]

Good afternoon, ladies and gentlemen. Welcome to the AAON Third Quarter Sales and Earnings Call. There will be a question-and-answer period after management’s brief presentation. This call will last approximately 45 minutes to an hour. I would like to turn the meeting over to Mr. Asbjornson. Please go ahead, sir.

[Norman Asbjornson:]

Good afternoon. Norman Asbjornson here. Before proceeding, I'd like to read 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 occurrences 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. Before proceeding, I'd like to introduce Mr. Gary Fields, who has just recently joined us as President and I shall remain as Chief Executive Officer. Greetings an at this point primarily is to try and help us in the managerial functions which have occurred with our growth and our expected future growth. As many of you know, we are now bringing on water-source heat pumps and that's an additional burden and as you already know, last year we brought on three additional regional managers to try and help cover our sales activities and Gary is going to concentrate on all the sales activities whether the warranty or the sale of the product or anything else regarding customer service in that area and I shall pay more of my attention to the internal workings of the company so that we shall better serve our customer base. I'd like to have Gary say a moment a little bit to you and give you his brief background so that you are more up to date.

[Gary Fields:]

Good afternoon. This is Gary Fields. Going back to the beginning of my career fourth-generation HVAC, I've been involved in the business for a very, very long time. 35 years ago I entered into the independent manufacturers' representative segment of the business which is essentially the sales agents for firms such as AAON. Going back 32 years ago I joined a firm in Texas of which we when I joined it we had eight people. We grew the company to 200 people under my leadership. When I sold my interest in the company at the end of 2012 we had increased our revenue up to about $200 million. The company has continued to grow well. So our succession plan there was intact. At that point in time, I began consulting work for AAON, consulting with the representatives across North America of which I've reached approximately half of all of our representatives and given them counsel and guidance on business development, particularly with how to build a strong independent rep organization which benefits AAON as we have stronger representatives in the field. In May 2015, I was elected to the Board of Directors. I have continued to provide those consulting services, both to the outside representatives, but it's also given me an opportunity to work within the company on product development and refining existing product and sales technologies. I've been quite involved in the development of the water-source heat pump for instance. And then as of Tuesday of this week the Board of Directors elected me President. As Norm told you, I will concentrate primarily on sales activities which also include product development. And we believe that we can now accelerate our growth beyond what it's been.

[Norman Asbjornson:]

Thank you. Now I'd like to introduce Scott Asbjornson, our CFO, who will discuss our quarterly performance. Scott?

[Scott Asbjornson:]

Welcome to our third quarter conference call. I'd like to begin by discussing the comparative results of the three months ended September 30, 2016 to September 30, 2015. Net sales were up 10.8% to $104.6 million from $94.4 million. Sales increased primarily due to increased volume as compared to the prior year offset by changes in product mix. Our gross profit increased 9.6% to $33.1 million from $30.2 million. As a percentage of sales gross profit was 31.6% in the quarter just ended compared to 32.0% in 2015. Selling, general, and administrative expenses increased 3.4% to $10.4 million from $10.1 million in 2015. As a percentage of sales SG&A decreased to 9.9% of total sales in the quarter just ended from 10.7% in 2015. The overall increase in SG&A was primarily due to increased compensation and profit sharing expenses to better results versus the same period last year. The increase was partially offset by decreases in nonrecurring donations and warranty expenses. Income from operations increased 12.6% to $22.7 million or 21.7% of sales from $20.2 million or 21.4% of sales. Our effective tax rate decreased to 31.1% from 34.1%. The Indian Employment Credit and Research and Development Credit were not extended until December of 2015 for the 2015 and 2016 tax years. As such, the effective rate for the three months ended September 30, 2016 is reduced for the impact of these credits while the effective rate for the three months ended September 30, 2015 does not reflect these credits. The estimated annual 2016 effective tax rate, excluding discrete events is expected to be approximately 36.0%. Additionally, the company early adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, applying the changes for excess tax benefits and tax deficiencies prospectively. As a result, excess tax benefits and deficiencies are reported as an income tax benefit or expense on the statement of income rather than as a component of additional paid-in capital on the statement of equity. Excess tax benefits and deficiencies are treated as discrete items to the income tax provision in the reporting period in which they occur. For the three months ended September 30, 2016, the Company recorded $0.6 million in excess tax benefits as an income tax benefit. Net income increased to $15.7 million, or 15.0% of sales compared to $13.3 million or $14.0 percent of sales in 2015. Diluted earnings per share increased by 20.8% to $0.29 per share from $0.24 per share. Diluted earnings per share were based on 53 million [indiscernible] [technical difficulty] shares in the same quarter a year ago. The results of the nine months ended September 30, 2016 to September 30, 2015 net sales were up 11.8% to $292.3 million from $261.4 million. Sales increase due to increased volume as compared to the same period in 2015. Our gross profit increased 15.8% to $91.6 million from $79.1 million. As a percentage of sales gross profit was 31.3% in the nine months just ended compared to 30.3% in 2015. Selling, general and administrative expenses increased 0.3% to $29.9 million from $27.6 million in 2015. As a percentage of sales, SG&A decreased to 10.2% of total sales in the nine months just ended from 10.6% in 2015. The overall increase in SG&A was primarily due to increased compensation costs and profiteering expenses due to better results versus the same period last year. The increase was partially offset by a decrease in warranty expense related to continued improvement in quality control and other expenses which was higher in 2015 due to sales taxes to certain states. As a percentage of sales, SG&A decreased 0.4% due to effective cost management and efficiencies gained. Income from operations increased 19.7% to $61.7 million or 21.1% of sales from $51.6 million or 19.7% of sales. Our effective tax rate decreased to 32.4% from 36.4%. The company's estimated annual 2016 effective tax rate excluding discrete events is expected to be approximately 36.0%. The Indian Employment Credit and Research and Development Credit extended were not extended until December 2015 for the 2015 and 2016 tax years. As such, the effective rate for the nine months ended September 30, 2016 is reduced for the impact of these credits while the effective rate for the nine months ended September 30, 2015 does not reflect these credits. Additionally, the company early adopted ASU 2016 – 09 improvements to employees share-based payment accounting applying the changes for excess tax benefits and tax deficiencies prospectively. As a result, excess tax benefits and deficiencies are reported as an income tax benefit or expense on the statement of income rather than as a component of additional paid in capital on the statement of equity. Excess tax benefits and deficiencies are treated as discrete items to the income tax provision in the reporting period in which they occur. For the nine months ended September 30, 2016 the company recorded $1.8 million in excess tax benefits as an income tax benefit. Net income increased to $42.0 million or 14.4% of sales compared to $32.8 million or 12.5% of sales in 2015. Diluted earnings per share increased by 30.0% to $0.78 per share from $0.60 per share. Diluted earnings per share were based on 53,467,000 shares versus 54,623,000 shares in the same period a year ago. At this time, I'll turn it over to our Chief Accounting Officer, Rebecca Thompson to discuss the balance sheet.

[Rebecca Thompson:]

Thank you, Scott. We had a working capital balance of $98 million versus $80.8 million at December 31, 2015. Cash in investments totaled $41.3 million at September 30, 2016, the investments on maturities ranging from one month to 10 months. Our current ratio is approximately 3.3

[Norman Asbjornson:]

Net sales were up 10.8% for the quarter. Sales increased due to increased volumes and no price increase was included in that. Potential for the Water-Source Heat Pump has not been realized as early as early as we had earlier thought. It is now entered production stage which was a very interesting thing and as much as we did not copy an existing or known manufacturing format. We have gone to what we think is very, very advanced our manufacturing methodology. So the actually manufacturing of sheet metal, copper and insulation is all automated. There are no individuals involved in the manufacturing of those components. Our operation is strictly facilitative between moving the things between those functions in the automated machinery and moving them to the production line, the only other people on the production line our the assemblers and the final test individuals. So it is an extremely software driven operation which we had to create a lot of software that was not purchased off the shelf or not even close to off the shelf, it was strictly created in-house by our personnel. In addition to the computerization provided by the manufacturers, finding this system that we're using, research [indiscernible] [technical difficulty] we bought equipment from six different countries around the world, if we found something that was unique and advanced and very serious. So, as we're bringing on line at a higher rate. It is going to prove to be a very, very, productive environment in which we should cover the costs of producing the product considerably from a more conventional manner. We are not running it at a high rate of speed yet, however, because it was a challenge to get the software cleaned up, debugged if you will, and have it now to the point like I say it is running, but we're running at a very low volume right, we're running down well, whereas the vine is designed to go up well over a 100 unit today, we're running it down about 10% of that rate because as we are running through a bug we don’t want a lot of personnel standing around waiting while we debug the software. It is not a major debugging process. The major debugging has already been done. It is all minor nuisance debugging that is occurring which doesn't take very long, but we still don't want people standing around drawing money and not being able to produce because of some little minor software bug. As the bugs less than which they do on a daily basis we gradually step up the amount of personnel that we're putting on the line and step up the production as far as the quality of dealers. Because the way we are going and the way we are going to do this we are producing standardized units which is a substantial part of the marketplace as opposed to a unit with options on it. So we are concentrating on standard units first and when we get those all done and all of our systems debugged for all unit sizes that we are building, then we will start adding the option packages to situation. We will along the way put up some units into the manufacturing process with options so that we don't stop the line when we're running through the software problem with the options we'll just pull the unit off the line, get the debugging fixed out so we can put it back on the line and then stick it on the line and let it run through. So we have a very organized methodology accelerating our productivity and not having to back up because of problems. We are debugging constantly and have done an extensive amount already and we are down so heading into the more minor amount of debugging. This will allow us obviously to in sometime in the first part of next year we will be able to turn up the volume quite a bit and we will start having a noticeable effect on the P&L statement. The balance of this quarter because of the fact that we're starting out with a given size and manufacturing a few hundred of each of those sizes, we are going to end up with a large number of units in stock which is all planned in our marketing plan, but along the way because most jobs require a mixture of different unit sizes, we don't necessarily have all the mixture raised yet because we're just stocking up, stocking our shelves so to speak. And therefore we will not put a lot of dollars on the bottom line in this quarter. We will put inventory in stock. Our fourth quarter expectations is not up in the millions, it's in the hundreds of thousands as far as how much we will actually ship. And it will depend upon finding the right mixture of potential orders against what we've already built and put in stock so that we can supply the equipment. However that will rapidly change starting next year because by the end of this year we anticipate to have a substantial number of our standard units in stock ready to go and be ready to build units with options, so the world will change rather dramatically in the first quarter of next year for us. We are very pleased with the way the product is being received. We are very pleased with the way the manufacturing is turning out. We have far fewer problems than we have anticipated. They've all been more nuisance problems than they have a significant problem that we haven’t taken care of. So no significant problems has occurred to us, but we've had plenty of debugging to do on software and that has been the function that has really caused us to have a slow start up once the debugging of software. Let's talk a little bit now about the marketplace. As you know the major share of our market is somewhere around 50% of it normally at this point is replacement market then about the same, about 50% new construction. And for those of you who have been with us for a while you know that earlier in our lifecycle we were more heavily into new construction and not so much in replacement and then during the slowdown from 2008 up until recently the replacement market was assuming a larger percentage of our business and we got up to where we were running well up in the 57% on replacement and 47% in new construction and it has recently started balancing out at about 50

[Operator:]

[Operator Instructions] Our first question comes from the line of Jon Braatz from Kansas City Capital. Your line is open.

[Jon Braatz:]

Good afternoon, Norm.

[Norman Asbjornson:]

Hi Jon.

[Jon Braatz:]

What can you tell me about as you look forward, about incoming orders for the new heat pump, are you seeing them at a level where you'd like to see them and are you taking orders for the for sort of the custom heat pump with options?

[Norman Asbjornson:]

Well we are. We've asked the representatives to give us one order for one unit they would buy for display from each one of our roughly 100 offices and with whatever they think is a popular option for their marketplace that will give us somewhere around 100 units with options which represent what they individually think they have to have for their markets. So that's going to give us an indication because a lot of them will be repeating the same option from a lot of offices and other options won't repeat. And so we'll get a sense of what the ratio is of the options that they are going to wanting from us. And we will be building those while we're building the stock of units that we're going to have standardized units with no options on there, we'll be stocking those. Because of the fact that we are not building all the different sizes, and currently we decided we would look at what the market says, what the HRI [ph] says the market is about the size of the particular unit. For instance, the 3 ton horizontal is statistically the biggest sailor in the industry. So that's what we're going to build and we're going to build the most of those. We have enough storage space to store approximately 2300 units, which if you wanted to put a dollar figure to that is probably going to be an average of let's say $1500 a unit, and you can see what we can put into stock if we get it fully stocked. And since we're doing it just one year to the size in time, we could sell a lot of whatever we're building right away early, but we don’t even have some of the ones that we're going to build later in the fall. And consequently doing a new job which may have a variety of sizes just doesn’t work at this point. So basically what we're doing is selling into the replacement market and a lot of the reps we have that have another product line do stocking job on their own and so they can order some stocked units of any given size that they choose in putting stock to service the customer on the ones and twos he orders which there's a lot of in this industry and the Water-Source Heat Pump industry. And they've set up to do that right on their own stock. So that's really what we're supplying as replacement market units right now and we're just starting to build because we're just now really getting into production. So we don't have many orders and we don’t have – haven’t done much shipments yet. We've done two very small shipments to two different ends of the country, one down out West and one out East and we're just in the infancy and starting t ship product and take orders. But as we've said, before half of our reps already have another line and then they indicated that they will be doing a lot of business with us and they are already in the business. So they are the ones who are buying some stocked units or going to buy some stocked units and net result is at this point we're just getting started in all [indiscernible].

[Jon Braatz:]

Okay, all right Norm. Thank you very much.

[Operator:]

[Operator Instructions] There are no further questions at this time. I will turn the call back over to the presenters.

[Norman Asbjornson:]

Okay, well thank you very much for joining us for this conference call. We, like I said are largely optimistic with a little bump in the road here which we attribute to election and once that has passed we think we'll be back on a very smooth roll again, optimistic about where we're going to go. Thank you very much for tuning in and we'll talk to you next quarter.

[Operator:]

This concludes today's conference call. You may now disconnect.