Good afternoon ladies and gentlemen. Welcome to the AAON Inc. Fourth Quarter full and Full year Sales and Earnings for the year Ended December 2019 Call. There will be a question-and-answer period after the after management’s brief presentation. This call will last approximately 45 minutes to an hour.

I would now like to turn the meeting over to Gary Fields. Please go ahead sir..

Good afternoon. I’d like to read a forward-looking disclaimer to begin.

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.

Now, I would like to introduce Scott Asbjornson CFO to discuss fourth quarter numbers..

Welcome to our conference call. I’d like to begin by discussing the comparative results of the three months ended December 31, 2019 to December 31, 2018. Net sales were up 9.1% to $122.6 million from $112.3 million. The increase in net sales was the result of improved production capacity and efficiencies.

Gross profit increased 30.7% to $36.4 million from $27.8 million. As a percentage of sales gross profit was 29.7% in the quarter just ended compared to 24.8% in 2018. The increase in gross profit was due to more efficient operations. Selling general and administrative expenses increased 22.3% to $13.1 million from $10.7 million in 2018.

As a percentage of sales SG&A was 10.7% of total sales in the quarter just ended compared to 9.5% in 2018. The increase in SG&A was primarily due to professional fees related to our new market tax credit transaction that closed in the fourth quarter of 2019.

Income from operations increased 35.6% to $23.2 million or 18.9% of sales from $17.1 million or 15.2% of sales. Our effective tax rate increased to 25.6% from 24.2%. Net income increased 33.2% to $17.3 million or 14.1% of sales from $13.0 million or 11.5% of sales. Diluted earnings per share increased by 32% and to $0.33 per share from $0.25 per share.

Diluted earnings per share were based on 52,701,000 shares versus 52,421,000 shares in the same quarter a year ago. The results of the year ended December 31 2019 to December 31 2018 net sales were up 8.2% to $469.3 million from $433.9 million. This increase in sales was due to our improved production capacity.

Gross profit increased $15.9 million to $119.4 million from $103.5 million. As a percentage of sales gross profit was 25.4% in the year just ended compared to 23.9% in 2018. The company maintained a steady level of workforce throughout 2019.

Company continues to improve its labor and overhead efficiencies and expects improvements to continue as new sheet metal machines were placed into service in the last quarter of 2019 and early 2020. Selling general and administrative expenses increased 8.1% to $52.1 million from $48.2 million in 2018.

As a percentage of sales SG&A remained constant at 11.1% of total sales. Income from operations increased 21.1% to $67 million or 14.3% of sales from $55.4 million or 12.8% of sales. Our effective tax rate decreased to 19.9% from 23.7%.

Upon completion of the company’s 2018 tax return in 2019 the company recorded additional tax benefit due to higher-than-expected research and development credit of $0.6 million additionally in 2019 the company determined it could take advantage of an additional 1% tax credit in Oklahoma for years in which the company’s location was deemed to be within an enterprise zone.

The additional Oklahoma credit for being in an enterprise zone or otherwise allowable under Oklahoma law resulted in a benefit of $1.2 million. Net income increased 26.9% to $53.7 million or 11.4% of sales from $42.3 million or 9.8% of sales. Diluted earnings per share increased by 27.5% to $1.02 per share from $0.80 per share.

Diluted earnings per share were based on 52,635,000 shares versus 52,668,000 shares in the same period a year ago. At this time I will turn the call over to Rebecca Thompson our Chief Accounting Officer to discuss our balance sheet..

Thank you, Scott. Looking at the balance sheet you’ll see that we had a working capital balance of $131.5 million versus $93.2 million at December 31 2018. Cash and restricted cash totaled $44.4 million at December 31 2019. Our current ratio is approximately 3.3:1. Our capital expenditures for the year were $37.2 million.

We expect capital expenditures for 2020 to be approximately $73.2 million. Shareholders’ equity per diluted share is $5.51 at December 31, 2019 compared to $4.74 at December 31, 2018. I’d now like to turn the call over to Gary Fields our President..

Let’s talk about the net sales. So, we have had progressively price increases going back to 2017, but do it with the longer lead time the backlog flow through to actual production and actual sales takes a fair while to happen.

We’ve been working that backlog down working our lead by increasing the production rate and so we’re shortening our lead times. This will get the price increases through to the sales a little quicker. So right now the price increases have had a positive impact on our financial performance.

But more importantly the efficiencies we’ve gained with the higher revenue being able to dilute a lot of the fixed expenses has been very beneficial. We’re getting better labor efficiencies as well. In Q4 about 53% of what we built was on our latest pricing. So that leaves about 47% to be built at the older pricing in Q4.

So going forward, we’re thinking that Q1 will be built predominantly on the June 2019 price increase, which was 5%. And so you can do the ratio math there and see that there was still some accretion to the gross margin available due to that price increase somewhat offset by the 2020 wage increases.

So it won’t be absolutely accretive but it will be somewhat accretive. The water-source heat pumps 2019 we had revenue of $25 million. That is versus $14 million in 2018. So 2018 was double 2017’s revenue. 2019 is up considerably again.

2020 we think that that slope will be a little shallower than it was 2019 versus 2018, but we’re looking at a very solid business going forward with the heat pumps. We’ve been working on updating a lot of our products and improving them because there is technology improvements in components and strategies.

Our Norman Asbjornson Innovation Center is nearly fully utilized right now. We only have one chamber that is not totally usable. And this has allowed us to accelerate our development of new products. We received multiple awards throughout 2019 for introducing these industry-leading strategies and industry-leading efficiencies.

Replacement market versus the new market still remains relatively constant for us on an annual basis of about 50% each. In Q1, we book a fair amount of orders for replacement market more percentage than we do new construction in Q1. That’s preparing for primarily the school season where we’re doing a lot of change out of units in schools.

The markets that we’re participating in have remained very consistent over the last three maybe four quarters. So, I don’t see any particular market accelerating versus any others. The current scenario with markets is it looks like that going forward manufacturing is doing quite well.

I think we can thank the current administration for incentivizing manufacturers to be in North America in the United States. And we’re seeing a direct result of that with people either improving the HVAC equipment on existing manufacturing plants that might have been mothballed at one time that are now being repurposed or in new manufacturing.

So, let’s talk about the backlog. December 31, 2019 it was $142.7 million versus $151.8 million a year ago. So we decreased it 6%. And while at the same time we increased our production rate. So at this point in time we have generated production capacity that’s equal to or slightly greater than our booking capacity.

We have additional sheet metal manufacturing capacity coming online as we speak. And we’re also seeing bookings strengthen a bit over what they were due to our reduced lead times.

So, I think that it will be seesaw battle throughout 2020 to stay up with the bookings as they become more prevalent in light of the shorter lead times that we’ve been able to publish for people. We’re building a new 220,000 square foot manufacturing facility in Longview Texas that supplements our existing 234,000 square foot facility there.

So, you see it’s nearly doubling the footprint. One of the benefits of that is there’s about 77,000 square foot of that building will be utilized for relocating our inventory of coils that we manufacture in Longview to be used in Tulsa product.

So that 77,000 square foot will be freed up in Tulsa to allow us to install some additional sheet metal manufacturing equipment here in Tulsa and delay the need for us to build a building here in Tulsa.

So now, I would like to – Norman would you like to have any comments?.

Yes. Thank you. Glad to say hello to all of you again. We have traveled through a great deal of change in management of the company over the past three years since Gary came on board. I’ve been here to help at the level I am, but all the people who I asked to stay around a lot of the ones I asked to stay around until Gary came on board.

So he would given the freedom of choosing is replacements have left. So, we’ve had quite a large turnover of managerial personnel which has caused us some problems for the past couple of years those days are behind us.

The new managers all of whom came out of existing personnel within our company we did not have to go outside to get these managers are coming up to a level of efficiency that we have historically had. We’ve had a very high degree of efficiency. And we’re on the road back to it now. And I think in my mind is not going to be so much a part but anymore.

That they have the abilities to exceed the degree of efficiencies which we had occurred prior to this beginning of changeover of management. Along the way, we’ve adopted the average age of this management by some 20 some to 30 years. So, we’re not going to be looking at another change necessitated by aging out of the management.

And the company has got a lot of talent in the age groups in the 30s and the early 40s. Now, running the company and you can see the kind of performance they’re giving. I fully expect this to increase the company to move forward at least the rate we have historically moved forward in both profitability and revenue.

And in a very good chance that both of them will accelerate even more. So we’re feeling very positive about the future of AAON. And I’d like to thank all of you who have supported me during the 33 years that I was building this company to what it is. It was at the time I turn it over to Gary and the new management.

Thank you and hope to listen in on a couple more calls..

Do we have any questions?.

[Operator Instructions] Your first question comes from the line of Brent Thielman of D.A. Davidson. Your line is open..

Hey, I guess maybe just starting maybe just around the question of supply disruptions been a little bit of that in the news here lately. And update us on what you’re seeing.

I if I remember right you’re waiting on a few more sheet metal machines to come in the new year to support some of that capacity in the factory I guess any disruptions you’re seeing there? Is everything on schedule?.

So far everything is on schedule. We’ve been receiving roughly one new machine a month for several months now. Four of those machines we have in operation four of those machines are yet to be put in operation. So they’ll provide us additional capacity. One of those machines should go full capacity tonight or tomorrow.

Two machines next Friday and one machine following in about 30 days. Those are machines that are on premises. We will be receiving another machine that’s already being unloaded at the port right now. That will be here next week or the following week.

So the machines that we have now have us running at a production rate that’s relatively in line with our bookings rate. So these other four machines as they can’t come on will afford us additional capacity and allow bookings to increase without increasing lead time.

So I think that we’ve bought this in pretty good alignment to stay pace production capacity increases with bookings increases and that will be the challenge that we’ll see. But I don’t see any interruptions at this point in time for any of the needed machines coming in..

Okay. That’s good to hear.

And I guess Gary just to kind of sum that up as these new machines come in by the third quarter you’ll expect all of that capacity to be ready to support that increase in bookings?.

Machines that we have now essentially we’re getting one machine per month through the end of the year. We have eight more machines to come. And so those eight more machines are coming approximately one per month. So, I don’t expect to get the last machine until I think late September and it takes about 45 days to put those into beneficial use.

So, I’ve actually got a milestone that’s dated 12 15 of 2020. And of those eight machines to come one of them is being unloaded at the port right now and two of them are on the water coming over. So there could be some delay in five one of those five machines that we’ve not been notified of.

But I think it would be a pretty minor delay from anything that we’ve seen. And the other thing is those other machines that are not yet on the water coming over here those are force capacity increases that we anticipate needing in mid- to late 2021.

I don’t think any of the machines that we’re depending on to meet capacity demands in 2020 are jeopardized at all..

Okay. Okay. And it looks like good water-source heat pump sales for the year I guess as I was backing into it.

Am I right that where sales and revenue dollars down in 4Q?.

On the water-source heat pump?.

Yes..

For Q4..

Fourth quarter....

I don’t have it broken out that way right here. It looks like it could have been just slightly off but I don’t think it was anything material that I recall. So, I’m not sure exactly how you’re discerning that to make that assumption..

Just backing out what I saw in the 10-K at the prior quarters. I guess what I was really getting to is I was just wondering given that has been a little bit of a drain on the gross margin whether that helped a bit here in the quarter since you didn’t know.

I don’t think it was material whatsoever. I think what helped in the quarter most substantially was increased production so that we got dilution of fixed overhead. I think that having 52.8% of the product built at the higher price the June price. I mean you just do the math on 52.8% of 5% that was some part of the gross margin expansion.

In 2020 we have a wage increase but it wasn’t in I don’t think do we have it in Q4 when did we do the wage increase?.

We had an additional wage increase in Q4 for our annual review..

Yes..

And that was the middle of the quarter middle of the quarter..

Middle of the quarter. So, we would add only a partial offset to that price increase for the increased ways. So the majority of it was efficiency gains. The majority of the gross margin improvement was efficiency gains. Not so much product mix..

Okay. Okay. As I pull this all together and think about further growth in heat pump products and the fact that you’ll have additional capacity to support more bookings.

I know you guys don’t guide but can you give us any kind of sense of the growth expectations you have for 2020 for the company?.

Well without giving an actual number I’ll just say that our compounded annual growth rate historically has been about 9%. Everything is pointing to the fact that I can beat that. The net margin compounded annual growth rate I think it approached 20%. And I think we could 16%. What it is..

16% from the beginning of time we’ve compounded the pump..

Yes. And so I think we can beat that as well. So we’re definitely going to be stronger in 2020 than we’ve been historically. Driven by two things. 2019 while it finished up at a good year it had parts of it that were pretty challenging.

And so if we kind of look to Q4 and projected it forward and said we did that four times plus maybe just a little bit of growth on top of it. I don’t think that would be entirely unreasonable..

Okay, that’s helpful. One last one if I could. it’s been a little bit of industry buzz around it. So, I’ll ask you guys a large international domiciled player that seems to be focusing a little more on the U.S. market and opened up a big facility I guess near Houston here recently.

Just curious if you run into them? Are you guys competing head-to-head? I guess If so are they causing any disruptions in the market?.

No it’s actually kind of ironic. There’s two or three things happening. About six or seven of our sales channel partners also sell Daikin. One of those sales channel partners is either our largest or second largest individual market for us in revenue that they produce for us. So if Daikin’s product is all that attractive.

Why are they selling so much AAON. And so we have this in about five or six locations and they’re just great organizations that understand the attributes of Daikin and the attribute of AAON and how to position each in the market. For those markets where we go head-to-head we actually enjoy competing against them.

They allow us they kind of validate what we’re doing..

Okay, that’s interesting input. Thanks, guys. Appreciated..

Your Next question comes from the line of Chuck Myers of Myer’s Family Office. Your line is open..

Good afternoon, guys. Good quarter. Thank you. I just had a few clarifications if possible to make sure we’re all on the same page. Last quarter on this call I had asked about the orders for Q4 and Gary I think you had mentioned at the very end of the call based on what you had seen already that you thought orders would definitely be up versus Q3.

And it looks like orders were basically flat about $100 million in each quarter.

I was curious was there anything in the last month or two that saw orders slowing?.

I think that our lead times persisted lengthened a little longer than what we had hoped. We had thought that we would get the production increases a little sooner than they actually occur. And so I think that’s probably the thing that had the biggest impact.

As we have increased production and shortened lead time than we restored order bookings back to our forecast levels..

Okay. And then just to pull that forward in your 10-K you did disclose that your backlog as of February one was down to $129 million so down about $13 million or $14 million from the end of the quarter.

Is it fair to say that January is just all of the slow bookings month? Or orders just happen to be slow in January? And is it fair to say that are we back to quarter end of $142 million or so by now?.

We’re not at $142 million for the reason that we’ve increased production rate. So somewhere in the recent past orders and production rates crossed where production was going out faster than orders were coming in because of the increased production equipment we put in. And then they began to parallel each other.

And it’s a good thing that we have production capacity that’s in excess of bookings and that we’ve actually been able to bring the backlog down a little bit. It’s a healthier position because we’ve been able to shorten our lead times which makes us more attractive.

So the goal going forward and it looks attainable is to keep those two parallel as far as both of them growing at the same rate but with having production buffer more capacity than bookings so that the bookings can’t catch us again. Now I don’t want the backlog to go back up. I want to achieve this through increased production.

And so far we’ve been doing that..

And so just looking at Q3 and Q4 you both had you had orders of about $100 million each quarter. If you’re going to be doing $125 or $130 million or $135 million of revenue per quarter this year obviously we do want to see orders pick back up.

Is it reasonable to expect that Q1 and Q2 orders will be in that $125 million to $135 million range? Or is that too high?.

That’s not too high..

Okay. Okay great. And my final question we had talked about or someone had asked on the last call about gross margins be getting back toward 30%. And you had mentioned or someone did that maybe not immediately by the end of but by the end of next year which is this year now 2020 you thought that was achievable.

You did pretty much that in Q4 and this EBIT margins of about 19%. 19% or 20% EBIT margin is sort of the historical peak high of the company.

Do you think it’s reasonable to think that we’re going to be sustainably above the 19% or 20% historical peak? Or is that going to be sort of the ceiling going forward and then we’ll go into a cyclical low at some point in the future again?.

I don’t know about the cyclical low, but I’ll tell you about the high. I think the 19% to 20% EBIT is a very admirable number and one of the things to bear in mind is just the company makes more profit above that line. We have profit sharing for our employees that will kind of help it stay in that range.

So if we can keep our gross margin in the 30% to 31% range and produce 19% to 20% of EBIT along with increased revenue then we’re going to be putting a lot more dollars to the bottom line and we’re not going to get those percentage ratios out of whack..

Okay. So it sounds like 19% to 20% is going to be the peak.

You’ll have a lot more profit dollars but because of the profit sharing and maybe other issues 19% to 20% we should assume as sort of the peak-ish number for the next foreseeable future?.

That’s the way I see it. Yes..

Okay. That’s all I have. Thank you so much.

Your next question comes from the line of Davis Derman of GreenSummit. Your line is open..

Hi, everyone. Hello there. I’m trying to get closer to where the capacity expansion plans are really focused. Because I understand as well that the company anticipates spending a fair amount of capital to expand the business this year.

And what I don’t think directly I’m trying to reconcile this in your 10-K and you guys helpfully pointed out in your presentations. The total units that the company is manufacturing outside of the heat pump business have been a sort of slow and steady decline particularly in I call it our primary revenue category on the rooftop side.

So can you help out a little? And if we’re making fewer units why are there such need for more capacity? And why are the all these sort of construction issues that we saw or execution issues that have been experienced?.

We need to build a lot more units. The demand is there for more units. That’s why the backlog went up as much as it did. So we’ve struggled....

Shifting sides..

Yes. Plus there’s two things with that we’ve had shifting sides. In 2019 units 80 tons of air conditioning capacity and greater had a 39% growth 2019 versus 2018 in the industry as a whole.

So my backlog on those units grew throughout that period of time until our lead time got out in the 28- to 32-week range and then that limited our ability to book more orders. There were a lot more orders out there that were available to our sales channel partners if we would have had a more attractive lead time.

Well with the increased capacity we’ve been able to allocate some of it to that line and we’ve actually increased the rate of manufacturing considerably on that line....

And there’s a lot more sheet metal for those.

And we’re now down to 18 weeks on one portion of it and 20 weeks lead time on the other. So, we’ve pulled several weeks out of that make that more attractive. That those units also require a lot more sheet metal pieces as well as size of sheet metal. I mean we’re talking about units that are generally one unit per truckload.

And so when you’re building more of those units at that size you don’t you’ve got a fairly low production rate on those.

And even though you increased it a lot percentage-wise and the revenue increases nicely with those because there are an expensive dollars per ton type of unit the physical number of units going out the plant doesn’t increase considerably.

But our demand for all unit sizes is increasing and our lead times were not attractive on any size units until we got this increased manufacturing capacity. So in 2020 our number of rooftop units that we produce is forecast to be a nice turnaround of that decline and be an increase and that’s exclusive of the water-source heat pump..

Got it. That’s useful. And I guess the water-source heat pumps has as you were I think alluding to have been on a clearly different trend. Although my recollection is historically that’s been a hard business on the manufacturing side. And although it’s been growing well it hasn’t necessarily been a profitable business that added scale.

Is something changing there? Are you finding that that business is actually starting to produce profitable growth?.

Well it was always profitable but it was at a lower profit than other products in the building. And a lot of that was the efficiency of learning how to operate this manufacturing system that we put in place that’s unique.

No one else in the industry has a manufacturing system for water-source heat pumps that even as they all pale in comparison to this. So this has been very complex and some of the things that even though we did animation type modeling of the flow process.

And that was very good technology to develop from until we actually operated it we couldn’t see some of these things they wouldn’t occur in the animation. So we’ve encountered them. Fortunately we were smart enough to build this in four phases. 6a, 6b, 6c and then 7.

And so those four phases allowed us to each time say what did we learn about the previous phase. How do we eliminate some of those snags and gotchas and move forward with a better technology in the next phase. And then at some point in time we’ll be able to circle back to the first phase and resolve some of those issues with that.

But the whole thing is about the water-source heat pump. We have a sizable investment in manufacturing equipment and facility there. That is not yet amortizing out because the revenue is not there for it yet. So, where we have suffered to have manufacturing capacity for our legacy equipment. We’ve had far more demand than we’ve had capacity.

The water-source heat pumps has been the inverse of that. We’ve been building the demand. You can see we doubled 2018 over 2017 and 2019 over 2018 was a substantial increase not quite double $25 million versus $14 million. And so we’ve been ramping that up very rapidly.

But until we get that business up in the $50 million to $60 million range that it doesn’t have a chance of amortizing the depreciation on the equipment out and getting the other efficiencies dialed in that we have on the legacy equipment.

So we’re probably another year or two away from expecting margins on that equipment to approach the legacy equipment margins..

Understood. And just one last question. It seems like in many ways the company continues to get the benefits of pricing action that was taken. And as we go from 50% roughly to 100% sort of enjoyment of that. We’re getting also the benefit at the same time as you guys have pointed out in your 10-K of lower raw material input costs.

So it seems like in many ways it’s perhaps the best of times for the company there. I’m curious though is there some risk of alienating customers notwithstanding that they accepted these price increases. It was done in a different sort of commodity environment.

And I’m just curious how you balance that? And what kind of pushback or intention you anticipate from any of that?.

While there’s been some raw material price decreasing components have gone up. Our total material cost is relatively flat. And so there’s really not anything there that is going to alarm any of our customers. The other that there’s been wage rate increases due to lower unemployment rates demand for employees.

So we’re all in a trend of raising the rates. I think relative to our competitors our price increases have been mostly in line with payers. What we did was got behind them. Some of our competitors started raising prices before I did. And so I didn’t do much more than catch up to them.

I really didn’t have any price increases versus the industry that were higher. So our sales channel partners have not yet seen any substantial pressure from a pricing standpoint. The same margin of premium that AAON has had in the past still remains fairly close to the same premium margin but it’s a great value proposition.

They know how to present that value. And that’s why the bookings are still in alignment with that. Our biggest impediment to bookings growth has been lead time.

And our biggest detriment to lead time had been insufficient capacity manufacturing capacity we now have those things all in better alignment we only a week ago Tuesday published a new lead time bulletin shortening lead times back to they’re not quite at our historic best lead times but they’re very close to that.

And as we get more capacity coming online there’s some opportunity to possibly reduce those again but it’s with the lead times that we already reduced we’re seeing an increase in bookings. So, I don’t know that we’ll be able to actually catch up with any more lead time reductions..

Understood. Thank you..

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

We thank you for listening and we look forward to speaking with you again in May for our first quarter results. Have a nice day..