Good afternoon, ladies and gentlemen. Welcome to the AAON, Incorporated Second 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 want to turn the conference over to Mr. Gary Fields. Please go ahead, sir..

Good afternoon, and welcome to the AAON 2019 second quarter earnings call. 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 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 turn it over to Scott Asbjornson, our CFO, to discuss the financial numbers..

Thank you, Gary. Welcome to our conference call. I’d like to begin by discussing the comparative results of the three months ended June 30, 2019, versus June 30, 2018. Net sales were up 9% to $119.4 million from $109.6 million.

Net sales for the quarter are up due to our price increases from 2018 and 2019 along with increases in our part and water-source heat pump sales. Our gross profit increased 9.4% to $30.2 million from $27.6 million. As a percentage of sales, gross profit was 25.3% in the quarter just ended compared to 25.2% in 2018.

Selling, general and administrative expenses increased 3% to $13.5 million from $13.1 million in 2018. However, as a percentage of sales, SG&A decreased to 11.3% of total sales in the quarter just ended from 11.9% in 2018. Income from operations increased 15.1% to $16.7 million or 14% of sales from $14.5 million or 13.2% of sales in 2018.

Our effective tax rate increased to 22.6% from 19.8%. The company’s estimated annual 2019 effective tax rate, excluding discrete events, is expected to be approximately 27%. Our effective tax rate in 2018 was lower than expected due to the various tax law changes.

Net income increased to $13 million or 10.9% of sales compared to $11.7 million or 10.7% of sales in 2018. Diluted earnings per share increased by 13.6% to $0.25 per share from $0.22 per share. Diluted earnings per share were based on 52,747,000 shares versus 52,718,000 shares in the same period a year ago.

The results of the six months ended June 30, 2019, versus June 30, 2018. Net sales were up 11.8% to $233.3 million from $208.7 million. Net sales for the six months ended are up mainly due to the price increases we implemented in 2018 and 2019. Our gross profit increased 30.2% to $56 million from $43 million.

As a percentage of sales, gross profit was 24% as compared to 20.6% in 2018. Material costs have maintained while the company continues to improve its labor and overhead efficiency. Selling, general and administrative expenses increased 5.1% to $24.5 million from $23.3 million in 2018.

As a percentage of sales, SG&A decreased to 10.5% of total sales as compared to 11.2% in 2018. The company’s warranty expense continues to improve. Income from operations increased 58.5% to $31.2 million or 13.4% of sales from $19.7 million or 9.4% of sales. Our effective tax rate increased to 23.6% from 19.5%.

The company’s estimated annual 2019 effective tax rate, excluding discrete events, is expected to be approximately 27%. As already mentioned, our 2018 effective tax rate was lower than expected due to changes in the tax law. Net income increased to $23.9 million or 10.2% of sales compared to $16 million or 7.6% of sales in 2018.

Diluted earnings per share increased by 50% to $0.45 per share from $0.30 per share. Diluted earnings per share were based on 52,590,000 shares versus 52,754,000 shares in the same period a year ago. At this time, I’ll turn the call over to Rebecca Thompson, our Chief Accounting Officer and Treasurer, to discuss our balance sheet..

Thank you, Scott. Looking at the balance sheet, you’ll see that we had working capital balance of $109.7 million versus $92.8 million at December 31, 2018. Cash and investments totaled $17.7 million at June 30, 2019. Our current ratio is approximately 2.9:1. Our capital expenditures were $16.8 million.

We expect capital expenditures for the year to be approximately $48.3 million. The company had stock repurchases of $11.2 million year-to-date. Shareholders’ equity per diluted share is $5.03 at June 30, 2019, compared to $4.70 at December 31, 2018. We continue to remaining debt-free. I’d now like to turn the call over to Gary Fields, our President..

Good afternoon. So first thing I’d like to discuss is the order bookings. Order bookings have slowed slightly here recently. This is a normal cyclical thing but I think it’s compounded by our extended lead times. We are seeing quite a lot of pressure because of that.

Even in light of both of those, we are still in excess of 90% of what we had forecast going back for our plan for 2019 as far as bookings coming in the door. That’s why you saw the backlog continue to increase this quarter over last quarter and this quarter versus a year ago.

So the backlog on June 30 was $179.6 million versus $156.6 million a year ago. The detriment to that is the longer lead times.

So it was all within our abilities to build more, but we run up on some difficulties with the sheet metal equipment in the form of in past years we had a Q1 and a Q4 that would be slightly lower production rate than Q2 and Q3 and it gave us more time to get ahead of the maintenance.

While we have this robust economy and the improved performance of our sales channel partners, we’ve not seen any turndown in Q1 or Q4 of orders coming in. So we’ve run with the throttles full – wide open and it’s begun to take its toll. So we revised some of our maintenance strategies. We’re getting additional Salvagnini machines.

You saw the announcement of four additional machines that were ordered as a result of our 2018 planning activities. And then midyear this year, we placed an order for an additional four machines. And this will get us ahead of where we’re at with our sheet metal equipment.

Scott and his group with the HR have done a great job of getting people in the door. And so we’re no longer looking at a shortage of people. Now we’re looking at a shortage of sheet metal.

And like I say, we recognized this over a year ago that we were going to be coming upon this, and we placed an order for the four machines and just seeing things trending the same direction, we increased it. So the next thing I’d like to discuss is that backlog of $179.6 million.

I’ve given a little bit of an analysis on the backlog in the past and I’ll have an update on that analysis. We are currently 20% of our backlog, as of today, is at a pricing level that was prior to our March 6, 2019 price increase. So that backlog that we built on in Q2 was predominantly prior to December.

So Q3 is going to be predominantly on the December price and easing into the March price. The remaining backlog, 54% of it, is the March price up until June 5, when we had an additional 5% price increase. And 26% of our backlog is at the June 5 price level or newer.

So what that kind of runs down to is Q3 will be built at approximately a 4% higher price than was Q2. And Q4, part of the quarter will be built at an additional 2% above that. So we will see some accretion in the gross margin and the bottom line. The pricing that we have on materials at this point has stabilized.

However, I understand that there was additional announcements of more tariffs yet to come just today. We have no idea yet what impact that will have on us but we anticipate that it very well could have some impact.

And so I don’t want to take all of these price increases being accretive at this point in time because we could see some additional pricing pressures. Now let’s look at our markets.

We continue to have very good distribution across all the segments of the markets that we have traditionally served, commercial retail, office building, medical health care, education, manufacturing, lodging, municipalities, data centers and grow facilities. The grow facilities are continue to be another outlook that’s improving.

Data centers have kind of stabilized for us, I’m not seeing any additional growth over what we have seen, but it’s a stable portion of our business. But grow facilities, it seems to be spreading further and further. Initially, we saw two or three states that we were having some success with grow facilities.

And now it’s multiple states, plus all of Canada. Our representative in the Eastern half of Canada, multiple representatives, they’ve all participated. A significant portion of their order entry this year has been for grow facilities. For the remainder of the year, we are going to be working on increasing our sheet metal capacity.

As I said, we have been adding Salvagnini machines, which our first one arrived about 2.5 weeks ago now. And it takes between 30 days and 45 days to get one of those machines put into operation. And we’re getting essentially 1 machine per month for the rest of the year. So we will be increasing that capacity.

Water-source heat pump production has done very good. Do you have the numbers in front of you, Rebecca? I’ll circle back to that because I’ve got the numbers in the 10-Q on that. The R&D lab has come along quite well. It’s not 100% complete. But the marquee portion of the new Norman Asbjornson Innovation Center has come into use.

We have now tested two units successfully, by the way, for the Jacob Javits Center that we’ve talked about before. These were tested for acoustical, thermal and air flow performance all simultaneously, something that cannot be accomplished by any other laboratory in the world. One of these units was 130 tons capacity and one was 180 tons capacity.

That laboratory has the ability to test a unit all the way to 300 tons capacity. So I was very proud of our engineering department, the fact that what they have been modeling for years and not have the ability to measure empirically with a facility like this, they now have that ability and their modeling proved very solid.

So this is something that’s going to be beneficial to us in many ways. The laboratory, we have tasked it with essentially three primary activities. One third of its operation is for developing new products, innovative new products. We know that acoustics and energy efficiency are both demands out there in the marketplace.

And we will be able to – we’re already ahead of the market in a lot of aspects with that. We will be able to move that even further ahead and prove the concept. So that’s one third of the activities.

One third of the activities planned are for testing projects such as Nike that we talked about before and Jacob Javits and One Willoughby Center, which is a high-rise office building in Manhattan. So we can test these facilities and prove to these people that our equipment does what it say it will do.

And the third activity is that the vast majority of our equipment we produce is certified and rated by AHRI. And so we test this equipment to make sure we’re in accordance with our AHRI certification and ratings. So those are the three primary activities for the lab. I’m very happy to report that the lab is mostly in utilization.

There is 1 chamber yet to be completed. It will be completed late this fall. So we look at somewhere between January and February having 100% utilization of all 10 chambers in our new laboratory. I’m going to circle back to the water-source heat pumps.

Year-to-date, we have produced $6.822 million worth of water-source heat pumps compared to $2.741 million same period 2018. So we’ve more than doubled the dollar volume of the water-source heat pump business in 2019. The number of units, 12,666 units as compared to 7,128 units.

So some of the units we’re building now are at higher dollars per unit obviously because we didn’t quite double the number of units. But we’re staying on that pace. We’re finally on pace to meet our expectations with the water-source heat pump. Gross profit. We’re still working on improvements.

I told you about the price increases that are in the backlog, the expectation is that a significant portion of the price increase will reach the gross margin line. There are some unknowns, as we say, with these new tariffs that are coming. And there’s other pricing pressures that could occur that we’ve not yet seen. Capital expenditures for the year.

We had originally thought we were going to spend around $38 million to $40 million this year. As I said, I went back to the Board in June and asked to purchase four more of the Salvagnini machines. So now with what we think we’ll spend on those with Salvagnini’s commitment on when to ship them, it’s looking like $48 million.

So now, Norm, do you have any comments you’d like to contribute today?.

Yes. I’ll just say that I’m very pleased that many of you have been with me for a long time. And I’m staying and what we’re seeing and helping along and my job requirement’s diminishing every day as everybody comes up to speed. And this was a bigger changeover than just replacing my efforts.

A lot of the people who have been with the company from the beginning and even before, when it was owned by other people, have retired. And so we’ve had an enormous transition from a lot of 60- and 70-year-old people to a bunch of 25- and 30- and 35- and 40-, 50-year-old people. Largely haven’t transitioned to people in their 50s or likewise.

We’ve made a almost two-generation jump. So this is an organization which not only is getting all of these manufacturing facilities in continually better condition, more capable. We’ve made an enormous jump with this laboratory which gives us capabilities that don’t exist anywhere in the world.

Significant – we’re not talking about marginal additional capabilities. We’re talking about very huge additional capabilities. And we’re starting to get the benefits from that. That’s going out into the marketplace. People are understanding that we do have this capability.

And we do have this credibility and it’s going to be materializing in additional business and growth for the company and our ability to maintain our pricing and get what we want.

So we did have a transition problem, which we’ve gone through for the past couple of years, but we’re coming out of the transition problem and we’re now fine tuning back up to historical price levels that we’ve been running. And we’re moving forward with new product and increased capabilities and volume.

I very much appreciated working with many of you for very many years. And I feel very comfortable, very happy because being the largest shareholder, I too am concerned with how it’s operating, and I’m most satisfied with the direction it’s taking. Thank you..

With that, we’ll take any questions from the callers..

[Operator Instructions].

Do we have any questions?.

Your first question comes from the line of Joe Mondillo. [Sidoti & Company, LLC].

Hello Joe..

Hi guys. Good afternoon. [Indiscernible].

So I wanted to see if you have any idea or could quantify the effect of the downtime in machinery in the quarter?.

Well, obviously, we met our revenue projection. I will say that May, we were on track to exceed the revenue projection. June, it looked like we were going to be right on it and then it just started falling in June. And I think that on one particular little time frame there, we just had – we had run the machines so hard.

And our maintenance personnel were working as hard as they could to keep up with it, but it began to be more than the PM [ph] began to be firefighting. And so I would say that, again, April was – April was actually on target. May was a little ahead of target and then June fell off.

So I would say that if the machinery had held up for us as it did in April and May, then we would have met or possibly even exceeded revenue expectations. So that looks like what the impact was..

And could you quantify sort of what, I guess, your expectations maybe – were if you think you would have been all right around there?.

I think we would have been plus $5 million for sure if we could have kept the machines running at the same rate they were in April and the better part of May. I think it cost us somewhere around $5 million in revenue in June. Now we’ve gotten ahead of that to some degree and we got the new machine.

We got new machines here that will supplement some of these machines that are needing a break, if you will. And you would think that a machine wouldn’t need to take a break. But it does. These things are extremely complex. And it’s nothing major that shuts them down.

They have a lot of hydraulic pumps and hydraulic lines and things like that going to the shears and the punches and so forth. And that’s probably been what’s most problematic, if you just haven’t had time to shut it down and service those things, not like we used to do when we had this off-peak time.

So getting these additional machines will keep us from running into what I call the service factor on these. So right now, we’re running a bit into the service factor because the demand is so high. And when you do that, eventually, you’re going to – it’s going to stack up on you. And I think June, it stacked up on us pretty good.

July, we began to get ahead of it. We didn’t get entirely ahead of it but we made good progress. I got a report about an hour ago that we’re in as good a shape as we’ve been in several months on the number of machines that are actually running at their full capability. And then we’re within probably three more weeks of having 1 new machine come online.

And then every 30 days after that, we’re going to have a new machine coming online for the next seven months..

Okay. So it sounds like July was….

Go ahead Joe..

I was just going to sort of sum up. It sounds like July sounds like there was still a little bit of an issue, maybe not as bad as June, maybe a slight issue carrying into August but really not that significant and should be all fine by September.

Is that a good way to sum it up?.

That’s very right. I’ve got milestones for completion dates for either significant overhauls, repairs, machine additions and so forth that reflect exactly what you just said. And they’ve been meeting all the milestones for me. We have a very bold plan now..

Okay. And then just looking at the operations as a whole, I mean, you sort of addressed a little bit that there’s been issues over the last several quarters.

How about labor issues in terms of the turnover that you guys were challenged with last year? Any other operational issues? Could you update us on all the rest of the operations and challenges that you’ve had in 2018?.

In 2019? So....

Well, the issues that you had in 2018 but....

Yes, yes. Okay. I – all right. So as of today, we have an ideal headcount, actually somewhat surplus by just a handful of people, because the sheet metal machines haven’t picked up.

So I’m seeing – when I go down the plant line, rather than seeing units that are nose-to-tail solid with no gaps in between them, some of the product lines, especially in June, I would see gaps between them and that was because the people were assembling them faster than we were able to produce the parts to assemble.

And so they were waiting on parts. So we had a little inefficiency due to that because we had assembly people out there that didn’t have an adequate supply of parts. So as we resolved these sheet metal machines, we resolved that. I think Scott and his group have done a stellar job of getting the people in here we need.

We’re getting the turnover rate reduced. We’re getting these people trained better. And so we’re in a good position, as these sheet metal machines begin producing more sheet metal, we’re in a good position to assemble that. So I think that is not something that’s staring at us with any kind of difficulty like it had been..

Okay.

And then just in general, aside from the machinery and it sounds like headcount is in a pretty good spot, how are the operations just in terms of efficiencies? How do you see them today compared to a year ago? Or just in general, how do you see them? Any comment on that?.

They are improving. I think there’s various struggles throughout these efficiencies that we continue to look at and address and hone. Norm, he went on a little vacation, and he came back. This morning was his first morning back, and he hadn’t talked to anybody in the plant. He just looked at what was going on.

And he and I sat and had about 1.5 hour to 2-hour chat this morning. And he says, Gary, he says I think you’ve got problems in these areas. And I said, okay. I’m working on those, but let me go investigate a bit further. So I got production control, I got manufacturing. I said tell me your viewpoint of what’s going on out there. And they did.

And I said, so how many of you have talked to Norm today? And they said, none of us. Why? I said, well, he came in here cold turkey, all fresh from his vacation and told me exactly what was wrong. Now that’s pretty stellar right there.

So that’s the kind of things that Norm is still doing for us, is he’s helping to find where we’re not seeing clearly what the issues are. And there’s a lot of things that I was able to see that other people weren’t and we’ve been able to resolve those in the sales channel partners, the sales process, the warranty resolution, some of those things.

But when it got down to the manufacturing, of course that wasn’t my strength. That was a steep learning curve for me. And I’ve been three years nearly now climbing this hill, on this curb. And we’ve done pretty good but not great. And he did great for so many years. I mean, it’s quite a bar to jump up to hit the efficiency that he had it running at.

But we’re getting there. And it was really just quite a revelation to me when he tells me what he believes was the issue. And then when we got to peeling the onion layers back to see where is this occurring, he nailed it exactly. That makes it just awful, by the way..

Certainly seems like a – more of a mountain than a hill, but seems like things are headed in the right direction..

Well, we have a backlog like we’ve never had in the history of the company. We have orders coming in like it’s never come in, in the history of the company. We’re only slightly behind what our forecast bookings rate were. And it’s because of the long lead times.

If we could solve the problems with the lead times, shorten them by getting this production up, meeting our goals for revenue, our lead times would come down and the order bookings would flow again at the rates that we had forecast. We know precisely why those have turned into – it has nothing to do with the market.

I’ve got sales channel partners all across North America saying, Gary, if you can deliver these units on this date, I’ve got this order. But when I start adding all that up, heck, I’m ahead of forecast if I could satisfy all of those..

Great. Could you – just last question for me, and I’ll let someone else have a chance.

Just the order levels looking at April, May, June, July, how did those trends – how did the order trends occur over the four months, the last four months?.

Up until the second half of June, we were running at 98% to 101% of forecast. And starting about the third week in June, we’ve begun to retreat slightly versus our forecast to drag us back to about 90% of forecast or a little better right now, 90%, 91% of forecast.

So that’s when lead time became more and more sensitive, was a lot of these projects that they wanted to order in June, they wanted delivery in August, which in historical times we were able to do. We’re just not able to do that right now. Our average lead time right now is much more than the eight to 10 weeks that it had been in the past..

Okay.

And just a follow-up on that, when do you – so do you have projections in terms of getting lead times down, in terms of getting these Salvagninis in place and, I guess, also getting your workforce and operations in place? What’s your sort of – what are the lead times right now? And when do you think you’ll get them down to, I don’t know, it’s normal or lower? What are your thoughts on that?.

We have put planning together all the way through the end of 2020, monthly planning in both facilities. So one of the things that we did is on Friday, we had a Board meeting. And we – the Board approved the construction of 195,000 square-foot addition to our Longview facility. And let me give you some proportions there.

Longview currently has 234,000 square feet. And this is Phase 1 of a building that has a total plan of 422,000 square feet. But I got authorization on Friday to build 195,000 square feet. That building will not be of any use to us until January 1, 2021. But that’s the planning process we’re doing. So let’s go back to that.

We have in Longview, we have recently relocated a product that we were building in Tulsa. We’ve relocated it to Longview because they have more capacity to build it there. And it fit their product portfolio better than it did here. It’s an indoor vertical self-contained water cooler product.

So we moved that product down to Longview, which gave us more capabilities here because we weren’t disturbed by a product that didn’t fit the portfolio so well. So that was a little optimization. So with that being said, we have forecast our production capabilities month by month, actually day by day, all the way through 2020.

And we will see continuous growth. And at the same time, we’re going to be drawing back the lead times. To ultimately answer your question, I think that we will be first quarter before we’ve got lead times reduced to anything materially. But then, when we’ve reduced them materially, I think the order intake could outrun that again.

And the backlog could go back up. It’s going to be seesaw battle all the way through the end of 2020. As we gain manufacturing capacity, as we shorten the lead times, it will open up more opportunities. They will fill that lead time and they will fill that capacity. We don’t have any issues forecast for getting orders in the door.

It’s all a matter of managing what’s going out the door. And as we get more out the door, there’ll be more opportunity for coming in.

Does that answer your question, Joe?.

Yes. It does. I appreciate the color Gary. I will hop back in the queue. Let’s someone has a chance. Thanks.

And your next question comes from the line of Jon Braatz. [Kansas City Capital Associates].

Hello Jon..

Good morning. Good afternoon everybody..

Hi Jon..

Hi Norm, how are you?.

Great..

Gary, as you talk about extended lead times and some production issues and so on, are you hearing from your sales force, your distributors that you’ve lost some orders? Have they simply walked away? Or are these – they keep the orders with you and sort of bite the bullet?.

Well, the reason our backlog is big as it is, is large as it is, is because they bit the bullet on a lot of these and not used them as aggressively as possible and so have we. But we had still lost a tremendous opportunity. I’ve got a e-mail box full of e-mails from sales channel partners saying I can’t take this order because I can’t meet delivery.

And so we have failed to book opportunities as a result of lead time, there is no doubt whatsoever. Now what the magnitude of that is, it will be pure speculation but it’s material. It’s material..

Does it – do you think it – the failure to – your ability to meet some of these lead times or deliver the product, do you think that has legs and that customer – potential customer won’t come back to you? Or will they come back to you as things improve?.

Well, I’m going to tell you that you could pick any one customer and you could grow a case any way you wanted to. You could say there’s going to be a customer out there that says, I won’t do this again. You can have a customer out there that says, well, I’ll have to think about it again.

And then when you show them all – when they’ve been a long-time AAON customer, they know all of the advantages of AAON, and they’re feeling this pressure, then those people will always be loyal to you. They’ll always be there.

The other thing is, as we upgraded the sales channel, those people that we have on board, and I’m very pleased with the vast majority of our sales channel at this point in time. We’ve worked on refining it for several years now. I started participating clear back in 2013 on helping improve the sales channel.

And we’ve revised it and tweaked on it to the point now where I’m very, very happy with the vast majority of them. Well, these people are the best in the business that if anybody can help us recover from this issue, I believe they can.

Now there was a time when we had some weaker sales channel partners that would absolutely use this as an excuse as to why they were not performing..

Okay. Okay. Good. Gary, with the additional eight new machines you’re installing, what kind of a capacity increase is that? What – how much of additional production capacity will you have now? And I assume they’re not replacing the old ones. These are net new additions..

Well, there’s some of both..

[Indiscernible].

Yes. They will easily keep us in front of bookings rate that we’ve seen so far. I mean it is a significant. Yes, there’ll be something else that will show up, that will keep us from realizing all of the capacity available by the sheet metal equipment.

We’re already looking down the road at two or three items that could be the next hurdles, trying to make sure we’re prepared. But after we cut and break and bend the sheet metal, then a vast majority of it goes to a foam process to make a double-wall foam panel. Last year and the year before, we put in new foam presses, additional foam presses.

We believe we’re ahead of that. But just to make sure, we got more foam presses on the way in both locations, here and there. Then the next thing is going to be the copper that we bend on these CNC computerized copper benders. Well, just today, I signed purchase orders for two more of those.

So we’re looking down the road whereas we’re not capacity constrained anywhere other than sheet metal now. We’re doing a better job of overall manufacturing planning that we’ve done since I’ve been here. I got better people in place with better thought processes, starting with Jeff McGee that we were able to get from Salvagnini last October.

He’s really helped a lot with this. And he leads our manufacturing planning process. So we’re looking at all of the infrastructure. As I told you, we’re looking all the way out to the demand. We have a plan all the way up to 2023 as to how this – we believe it’s going to unfold and we’re making those preparations.

That’s what our strategic – written strategic plan is. And that’s why we’re ahead of the game, getting the new building going for Longview, moving the product down there.

So to answer your question empirically, it’s significant percentage increase because whereas we’re replacing some machines – and this is another reason we went backwards just a little bit. The machines that, in order to replace them, you’ve got to take them totally out of service, get them out of the way in order to put in a new one in their place.

When I look immediately west of my office here, there’s a big blank area. It’s about 100-foot wide and probably 400 foot east to west that we’re just now putting the new machines in. Well, those old machines have some capacity. So we lost a little capacity while we’re putting the new machines in there.

But then we have accretive machines going in that we had to prepare space for. So one of the things in this facility planning we had to do, we go through here and find additional meaningful and effective space to put additional machines. It wasn’t like we just have a couple of hundred thousand square foot of blank space sitting.

Yes, some of it was relocating this product to move it to the new building in Longview. Doing that made space for two Salvagnini machines right there. So I’m going to say it’s considerably accretive. Exact percentage, I don’t have a figure in my head right now..

But I guess, importantly, it sounds like, as you look forward, you don’t see any production bottlenecks, serious production bottlenecks, assuming the demand for the product continues to be strong..

That is correct, Jon. I said to people, we got about a 60-day knothole that we got to squeeze through here. And in about 60 more days, we’re going to come through that knothole, we’re going to be able to improve lead times, we’re going to be able to improve on-time delivery performance and we’re going to have additional manufacturing capacity..

Okay. And one last question. Gary, in your commentary, you talked about a couple of unknowns and maybe cost, if you want to call it cost unknowns. You mentioned tariffs, but you also referenced maybe some cost increases in other areas. And you really didn’t say anything specific.

Is there something on your mind about some cost pressures elsewhere?.

Well, common sense tells me that if there was a tariff – let me give you an example. Vast majority of our compressors come from Emerson Technologies’ couplings. The vast majority of those come from either Lebanon, Missouri or somewhere up in Ohio. So you’d say, well, the tariff doesn’t affect that. Well, it does.

There’s two or three parts inside that compressor that are made in China that now have a tariff on them potentially. So I’ve not gotten an announcement from Emerson of any additional price increase.

But it wouldn’t surprise me if any moment they don’t say, you know what, we’re building these two or three components in China and they just got an additional tariff put on them. So here’s your price increase on your compressor.

So I just think there’s going to be a ripple effect that I cannot put my thumb on right now and give you a definitive this went up or that went up. I think that’s where I’m speculating that there’s going to be some inflationary pressures on some of these components..

Okay. I think one of your component suppliers is Baldor, if I remember correctly..

That is correct..

Would they have the same – potentially the same issues in terms of parts coming from China?.

They do..

Okay..

And then, we use a lot of variable frequency drives or electronically commutated motors. But the solid-state electronic components for those, by and large, come from China. So there’s some little contributory parts and some larger finished components that I believe are going to affect the price of those larger finished components..

Okay. Okay. Very good. Gary thank you very much..

Thank you, Jon..

And your next question comes from the line of Chuck Myers [ph]..

Hi guys. Thank you so much for your time..

Yes. Chuck how are you doing..

Good. Just a few, I think, relatively quick questions and maybe one or two longer ones. You mentioned that you are seeing some orders written slowdown recently.

I’m curious, can you give us a real-time backlog number versus the $179 million from a little over a month ago?.

Sure. Let me pull up my daily dashboard and tell you what it was this morning. Take me just a second here to find it. It comes in at 3:30 in the morning, came in at 3:25 this morning. Our backlog, as of this morning is $173,793,355..

Perfect. Thank you.

My second question is it seems like given what we’re seeing with sales each quarter and the back – changes in the backlog, that your order intake is something like $130 million, $135 million a quarter, which it would have – if that’s right, it appears that you’re adding enough capacity to meet that demand and then start working down the backlog over the next quarter or two.

Is that sort of a right guestimate?.

And then some. That’s exactly right. When we sat down – I had been doing a rolling 12-month forward forecast and I extended that to 18 just so – because the lead time from when I go to the Board and say, I need equipment.

By the time I get that approval, by the time I order it, by the time I get it in here and by the time I install it, I’m looking at close to a year. So when I was only looking with good solid numbers 12 months out, I didn’t have enough time to respond. So I extended that planning process on distinct activities out to 18 months.

Now we have a five-year strategic plan and we’ve kept that in mind. When we’re doing things like building the building in Longview, that 195,000 square foot is forecast to take us deep into 2023.

But then we said wait a minute, what’s going to happen after that? So we’ve got plans already drawn to take that building, we can add 65,000 or 70,000 square foot at a time if we choose or if the market demand’s strong enough, we can just jump out there and finish it at 422,000.

So whereas we got slightly behind the curve on manufacturing capacity and this demand was much stronger than we thought it was going to be with the original thought process when I came here and we thought we were kind of in line with it, but the demand has exceeded that so now we have retooled our thinking not only to catch up with what the current demand is but to get ahead of it and stay ahead of it..

Got it. And if I look back at the last peak margin year, it was 2016, you guys did just under 21% EBIT margins and just around 24% EBITDA margins. It’s looking like 2020 might sort of be the peak year in this cycle. And who knows where the economy is going, but let’s just assume that’s the case.

Given the product mix changes that you’ve had over the last few years and assuming that everything sort of goes as you think, do you think that the blended margin of this business in looking at 2020 will be above, at or below the 2016 peak margins?.

Well, I’m targeting 2016. That was a stellar year. And so I’m targeting those kinds of margins. What we have stated is that we are now managing this business aggressively for a gross margin between 28% and 32%. And then we’re doing everything we can to contain cost below that gross margin number, the SG&A.

But understand, 1 variable to the SG&A, as our profit goes up, our profit sharing goes up. So it’s kind of a management issue there.

But it’s my expectation that we have the abilities, barring any unforeseen circumstances, to restore this business to 28% to 32% gross margin range and contain our cost for the SG&A other than the profit sharing that I mentioned. So we should be able to manage back to EBITDA very close to what you’ve stated..

Okay. So that would be at sort of the high end, it sounds like, that would be a goal but it still sounds like it....

It is, yes, but at the high end. The high end....

It doesn’t sound like there’s much ability to get beyond that in this business, though..

No, but if we’re increasing the revenue at those percentages, we’re increasing the dollars to the bottom line. So our earnings per share is going to continue to increase and that’s the ultimate goal. Put more cash in the bank..

Got it. And two last quick questions. This quarter, I think your tax rate effective was on 22.5% and you keep saying around 27%. I assume there’s just some discrete items in the quarter.

But going forward, is 27% sounds like the right tax rate for the next few years if nothing changes?.

That would be correct. Our discrete items are typically the excess tax benefit on our stock awards, which as our stock price goes up, the benefit is typically bigger. So – but yes, it should be 27%, excluding those discrete items..

And we also have been using equity more aggressively in the last few years. So the possibility of that continuing to be an issue is certainly present..

Okay. And then on the share repurchase, obviously I think you have a lot of fans on the call. You’ve built a great company here, but at some price, buying back shares probably isn’t a great use of capital, just given where the multiple on the stock is.

Do you guys – can you just give us 30 seconds on how you think about at what price the price is too high?.

Well, let’s put it this way. From my perspective, this is Scott Asbjornson, we’re using equity as a significant part of our compensation. Typically, it’s going out in the form of a stock option which requires our employees to buy it at the price at which that option is issued.

Therefore I would tend to say that it would not be unreasonable for the company to be in the market reabsorbing those shares that are being issued at some price relative to what those people are receiving as an option. We certainly don’t want to dilute our existing shareholders.

So we are watching our outstanding share count carefully and going to be trying to maintain a flat to slight decline over time..

Great. Thanks guys..

Your next question comes from the line of Brent Thielman [D.A. Davidson]..

Hello Brent..

Brent, your line is open..

Brent, we are having technical difficulties with your line it seems like..

Okay..

Your next question comes from the line of Matt McGeary [Eagle Asset Management, Inc.]. .

Hello Matt.

How are doing today?.

Good. Good. Thank you. Thanks for your time. I appreciate it. Just a couple of quick ones. I was glad to hear that you’ve made good progress on the labor front. I’m just curious, maybe some commentary on how you’ve been – managed to do that given the challenges in the economy broadly on that front, one.

Two, I’m hoping you could give us a little more color on the end market. Is there particular areas of strength that you’re seeing? And I’m also curious what percentage of your business now roughly is that – the grow facilities. Thank you..

So this is Scott. Relative to personnel, probably one of the biggest things we did earlier this year was we determined that the economy was going very well for the entry-level workers. And so we raised our entry-level wage somewhat aggressively to try to make sure that we were as competitive and attractive as we could be to those incoming employees.

We believe we’ve got a good mix at this point to be competitive. And we’re doing obviously some additional on-boarding efforts to try and make those people feel welcome and a part of our team when they join us..

Yes.

So what was his – after the onboard – after the labor issue, what is your next question, Matt?.

Just curious if you could provide a little bit more color on – you made some comments about various end markets. I’m just sort of curious if you can give us a little more flavor on which areas are particularly strong. And I’m curious specifically about the grow facilities and how big of a part of your business that is today..

Grow facilities at the end of 2019 could very well account for close to 10% of our revenue. So that’s come from two years ago, it was 0%. So that’s pretty significant. The other markets have all appreciated at about an even level to get us to where we’re at today. So there’s been no other outlier that’s been a significant increase.

They’d just all come up at about – it’s like the tide brought all of them up together. The grow facility, like I say, is one that it’s very likely to approach 10% of our revenue. And the good thing is, is that our representatives have done a great job of distributing that across all of our products.

We have products that are built in Longview that they’ve applied to grow facilities, we’ve got water-source heat pumps they’d applied to grow facilities as well as packaged rooftop units. So they’ve been very creative with what they’ve done and how they’ve done it.

But the real overlying thing there is, is that we have an operating strategy available in all three of those product styles. The split system, indoor air handler, outdoor condensing unit, the water-source heat pump and the packaged rooftop. We have operating strategies that are favorable for that grow facility unlike a lot of our competitors..

Thank you..

And your next question comes from the line of David Durmann [ph]. .

Hello David.

How are doing today?.

Well. Thanks for the call guys. A couple of questions here. One of the previous questioners said they were looking at sales and the change in backlog and were concluding that the company was generating orders of, I think, they said $130 million to $135 million, which I think you guys concurred with.

I understand there are a lot of puts and takes, but is it fair to assume that the company’s goal, since that sort of net order number has sort of flatlined around that $130 million to $135 million....

That’s per quarter..

Did you – per quarter? Thank you. You’re trying to get your production to be in line with that level? Is that….

No, I need it greater than that, because if I was able – look, the first month that we have put out as much as we brought in was July. And it was because July orders turned down, as I said. So if we can keep narrowing that gap to where – if we can build more than that’s coming in, then the lead times will shorten, then the opportunities will reemerge.

So it’s going to be a seesaw between the two. So right now, I think that $130 million to $135 million per quarter is a very accurate number of what’s been found in the door. I just looked at what we’ve gotten, that’s very accurate. And of course, we’ve only been putting out $119 million, $120 million out the door.

So that’s why the backlog has grown, very easy math, it’s very public too. We have got – we have got to get the backlog reduced in order to reduce our lead time. And so we’ve got to get the production rate up.

If we were capable of running $150 million a quarter at this point in time, if I could just wave a magic wand, the demand is there, we can run $150 million a quarter, no problem, from orders coming in to support that. We just haven’t yet been able to reach that level.

But that’s what all this planning is for, is to try and get to that kind of capability..

That makes sense. But I was interested to learn, as you explained, that grow facilities are maybe going to approach an exit rate of 10% of the business.

Could you remind us, you said they were near 0% was it, did you say a couple of years ago?.

Yes, I’m going to say – it’s – the first time that they hit my radar screen at all was a few months – I became the President November of 2016, and I’m going to say that there was a person came in here in early 2017 that wanted to make a deal with us, that he was going to focus on grow facilities.

He wanted to have the ability to go approach it on a national basis. We knew nothing about the grow facility industry, how to approach it. He was our first entree to that. And he started off on that quite successfully. He continues to run at a very nice rate.

But then as time has gone by since early to mid-2017, as time’s gone by, we’ve seen that become more widespread. But we’ve also seen the adoption of legal cannabis in more states and then the legalization across the entire country of Canada in this time frame as well. So....

The build-out of the industry..

Pardon?.

The build-out of the industry..

Yes, the build-out of the industry. Last count I had, they was something around 19 or 20 states that had, in one form or another, legal cannabis, whether it was recreational or medical. If you drive across the turnpike in Oklahoma right now, all the billboards you see is about cannabis facilities. It’s astounding.

And so this is a fast-emerging business. And I don’t know where it’s going to flesh out. But I would forecast that within the next three years to five years, it will be legal in all 50 states in one form or another. And then the federal government is going to have to address it.

And this could – we could be on the very leading edge of what’s happening here. It could take a substantial upturn until it reaches its saturation level which could be several years down the road..

Yes. Well, it’s interesting. I’m curious, you mentioned both the sales here in the States and I think you mentioned earlier in the call, Eastern Canada.

Do you have a rough sense for how large the Canadian piece of that business is relative to the business here in the U.S.?.

Year-to-date, it’s been close to half of our opportunity..

Understood. Well, I appreciate your enthusiasm for that. I would say obviously [indiscernible] I appreciate it. It’s very interesting. Thank you for the time..

Yes..

[Operator Instructions] And there are no further questions at this time..

Well, thank you for participating in the call today. We’ll speak to you again in November for our third quarter results. Have a nice day..

That does conclude today’s conference. Thank you for participating. You may now disconnect..