AAON, Inc.

Good afternoon, ladies and gentlemen. Welcome to Aon, Inc., first quarter sales and earnings call. There will be questions and answer period after the management's brief presentation. This call will last approximately 45 minutes to an hour. I would like to turn the meeting over to Mr. Gary Fields. Sir, the floor is yours.

Good afternoon. I'd like to start by reading a forward-looking disclaimer. To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. As such, it is subject to the occurrence of many events outside AON's control that could cause AON'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'd like to turn it over to Scott Asbjornson to discuss the first quarter numbers.

Welcome to our conference call. I'd like to begin by discussing the comparative results of the three months ended March 31st, 2020 versus March 31st, 2019. Net sales were up 20.8% to $137.5 million from $113.8 million. Net sales for the quarter are up due primarily to our increased sheet metal production from the additional Salvagnini machines that were placed into operation. Our gross profit increased 68.9% to $42.9 million from $25.4 million. As a percentage of sales, Gross profit was 31.2% in the quarter just ended compared to 22.3% in 2019. We continue to see overall raw material costs decrease. The company has improved its labor and overhead efficiencies through increased production and absorption of fixed costs. Selling, general, and administrative expenses increased 11.2%. to 15.2 million from 13.7 million in 2019. Additionally, as a percentage of sales, SG&A decreased to 11.1% of total sales in the quarter just ended from 12.0% in 2019. Income from operations increased 142.3% to 27.8 million or 20.2% of sales from 11.5 million or 10.1% of sales in 2019. Our effective tax rate decreased to 21.5% from 23.5%. The company's estimated annual 2020 effective tax rate, excluding discrete events, is expected to be approximately 25%. Net income increased to 21.9 million or 15.9% of sales compared to 8.8 million or 7.7% of sales in 2019. Diluted earnings per share increased by 141.2% to 41 cents per share from 17 cents per share. Diluted earnings per share were based on 52,871,000 shares versus 52,370,000 shares in the same period a year ago. At this time, I'll turn it 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 a working capital balance of $132.8 million versus $131.5 million on December 31, 2019. Unrestricted cash totaled $35.7 million at March 31, 2020. Our current ratio is approximately 3.1 to 1. Our capital expenditures were $21.9 million. We expect capital expenditures for the year to be approximately $73.2 million. The company had stock repurchases of $5.1 million during the first quarter. Shareholders' equity per diluted share is $5.79 at March 31st, 2020, compared to $5.51 at December 31st, 2019. I'd now like to turn the call over to Gary Fields, our president.

I'd like to talk about some of the sales activity and some of the general environment that we're working in right now. So Aon was a company that was deemed an essential manufacturer, so we've continued to operate through and some of the shutdowns that have occurred for others. Our essential nature was proven when we were tasked with providing over 4,000 tons of air conditioning units, a total of 80 50-ton units, for two projects in New York. Stony Brook was one of them and Westbury was the other one. received the request for that equipment on the 29th of March and within nine days all of it was on site. So that was a rather heroic effort by all of our Aon employees and all of the sales channel participants that had to work their portion of the project. We've continued with A total of 124 units that have gone to these specific coronavirus emergency temporary facilities. But beyond that, we're seeing some new activity recently for support facilities going into the future. We received an order just this week for a project in the state of Maine. It's called Puritan. and these people make the swabs that we've heard so much about from President Trump's Coronavirus Task Force that are used in the quick turnaround testing. That project also required us to manufacture specific units for the specific application and provide those in about a week or 10 days. So the order came in. just a couple of days ago, and it'll go out in the next couple of days. Now I want to talk about our water source heat pumps a little bit. So our numbers of water source heat pumps in Q1 were less than what they had been on a quarterly basis. We had some growing pains in that heat pump business. Some of those growing pains were related to components that we selected, some material suppliers, Some of them were just the growing pains that occur when you're developing at a quick rate a new product. So we lost just a little bit of momentum, but we began to regain that. The lead time is very short, so all of this happened rather quickly. The April bookings on water source heat pumps strengthened considerably, so the momentum is going the right way. So we've reestablished our momentum. and we look for that to get back on track to improving. But at the same time, we evaluated the entire team that we have here on staff at Aon, realizing that this was a product that was a bit different than our legacy product and realizing that we didn't have as broad-based of experienced and knowledgeable people in that to flesh out our entire strategic plan for that. So we've been negotiating with some people that we're in the final throes of negotiating with that have extensive experience in water source heat pumps to join our team. And we expect in the next week or 10 days to have these people join our team. And this will allow us to execute the strategic plan that we put together and achieve things that we had talked about for quite a while with this. The next thing I want to talk about is our Norman Asbjornson Innovation Center. Those of you that have followed us for a few years know that we built a magnificent laboratory, and we've had a grand opening of it and so on and so forth. The physical facility itself is unequaled in the world. The capabilities of that are just not available anywhere else. And we had a core group of people that had been with the company for many years that had great experience with that, but they didn't have enough bandwidth in order to utilize that laboratory to its full capabilities as far as production capacity. For the last two years, they've been building that knowledge base and that team. And we finally got to a spot where we could spread those experienced people out time-wise and put on more shifts. So we are, in the next few days, enabling an around-the-clock, seven-day-a-week operation of the Norman Asbjornson Innovation Center. So this goes hand in hand with our efforts to accelerate our footprint with water source heat pumps. And all of it dovetails very nicely together. And I'll have to say from a timing standpoint concerning the Innovation Center that we're doing it just in time, but we didn't wait too long. There was really... No effective way to do it any quicker than we did due to construction schedule and training and so on and so forth. So we're very excited about the potential of compressing our roadmap, product development roadmap. The schedule that we have will be accelerated greatly by this new activity. I've spoken with our director of sales and he's polled all of his regional sales managers and they have updated me. They maintain a very close relationship with the sales channel and I've had a lot of personal phone calls with the sales channel myself just seeing where are we. This coronavirus has caused a lot of angst in the world and so where are we at? Well, at the end of Q1, we were at 90% of our plan on booked orders. So there was a slight impact from it, but it wasn't anything substantial. When they polled these people to see were those projects canceled or were they delayed, the overwhelming response is delayed, not canceled. There's been very, very few cancellations in the pipeline. We've had essentially no cancellations that I'm aware of in our backlog. It's just that the forward-looking... Pipeline, the four log, if you will. There was one or two projects that I was made aware of that they had anticipated being July, August, September projects that they've delayed till 2021, but they're very insignificant in the overall scope of things. As I read through the regional sales manager's comments, it's unanimous market strength of commercial healthcare industrial is very good. Market strength for hospitality has been hit the most. We have been fortunate over the years to participate in a lot of hotels and casinos both. And some of the casino projects that we knew were out there in the future are on hold. And some of the hotels have hit the pause button as well. I think that's very understandable. We've spoken over the last few quarters about the grow market. The grow market, according to each of the sales managers that participate with their sales channel in that, remains neutral. K-12 has been neutral to increasing. And in the Northeast, things are a little bit more constrained than they are in the rest of The schools are even at a pause right now. However, I did talk to one of the major players in our sales channel. He's in Philadelphia and Harrisburg, Pennsylvania. And he gave me notice last night that they have quite a few schools that they're about to be able to get released. So not exactly as dire as what the initial thoughts might have been. So overall, we're looking at bookings for the remainder of the year, maybe not being exactly on plan, but not being substantially lower than plan either. They'll be off just a little bit, it looks like. When I look at the various markets, you know, I just told you a bit about those. The one thing that I want to emphasize that I've seen some clarity on is health care. In this coronavirus situation, it was recognized that while in the urban areas they had large hospitals and they were able to construct some of these temporary facilities, either using large convention centers, the ship in the case of New York City, or the tents that we participated in. But when you got into the more distributed areas across North America, the rural areas, the suburban areas, then there was a substantial weakness. Over the last several years, there's been a lot of consolidation of healthcare facilities to these urban areas, leaving people to drive maybe as much as 150 miles to get any appropriate care. We're already seeing activity in these areas to reestablish some of those facilities that were mothballed, which gives an opportunity to update them.

It seems to be working now. I complained to the operator, and she said it was just very high call volume. So if you call back and try to get in... I'm sorry? I... So then you've got to hold on.

Go back. Continue.

Okay. So I'm not sure how we were interrupted there. So the story on healthcare is that we're going to see a lot of facilities that were mothballed that are going to be renovated and put back in operation. Some of these have sat dormant for quite a while. and it'll be a good replacement opportunity. This is an area that Aon participates in substantially with our legacy products. So, I want to talk about the backlog next. March 31, it was 119.6 million versus 166.6 million in one year ago. The 166.6 million, while it seems attractive, was actually a bit detrimental. The real crux of that was that we didn't have our production rate high enough to meet the demand, and so we had accumulated and our lead times had lengthened. With the addition of all the Salvagnini machines and appropriate labor force efficiency gains, then we have been able to increase our production rates considerably, and thus we've been able to reduce the backlog, which is a favorable thing, so that we can get it in alignment with lead time expectations. Since the beginning of Q4, we've begun reducing lead times, our published lead times. We've had multiple announcements of lead time reductions, and I would say today that we're probably ranging about probably about 60% shorter lead times than we were a year ago. Does that look about right? Yeah. Eight weeks is our goal, and we're probably – we have some products that are six to eight weeks right now, but if you took the whole tranche, we're probably closer to ten weeks right now. Sound about right, Scott? Sound about right. Yeah. Okay. So our goal is eight weeks. While our goal is not to bring in less orders, it's to produce more. So we have put a lot of those Salvagnini machines in and in operation. We have four more yet coming throughout the year. So our production capacity has not yet peaked. And we will be monitoring the two things as they come together, the order volume and the production capacity. But it's very manageable. So I want to talk a little bit about... The supply chain, we've had some minor, I'll call them dust-ups with supply chain. They've all been manageable. One of the primary things that's occurred is we have various models of compressors available in our units, going from a base model, and then there's at least three, we'll call them upgrade models of various duties. We've had a few units that we've upgraded one or two models of compressors in order to produce the equipment because of the availability of them. The other thing that we've done is we've worked with our sales channel, and when we had any difficulty due to supply chain, then we've been able to help them work through the custom selections and select something that still met the project requirements. and we were able to meet the needs with the supply chain. Speaking to our purchasing department earlier today, the outlook is fairly stable, but it's not without its challenges, I'll say. But it's all manageable. The next thing I'd like to talk about is attendance and disruptions. So at our Longview facility, early on in the kind of the role of this coronavirus, we had one employee in the office in Longview at Aon Coal Products that began to show symptoms. And that person quarantined themselves right away. And they ended up being positive. And fortunately, they came through it just fine. But we contact traced everyone that she had been in contact with, and we quarantined those people, and there were no further positive cases. So we've only experienced, knock on wood, one case, and that was in the Longview facility. Longview being one of the companies, it's a separate entity and coal products, and it has fewer than 500 employees. So the rules that the government made for that were very favorable for the employees to take off and still be paid quite nicely by these programs. Our attendance went down to a low of 42%. But as of today, we're back up to 80%. And it's been trending upward for the last two, nearly, well, about two weeks solid. Yep. and we're expecting that to continue to trend up. But there's one other interesting aspect of it. While we had the opportunity to be on the television news stations to talk about our participation in these temporary hospitals, our newly appointed president of Aon Coal Products, Gene Stewart, was interviewed and they gave him the opportunity to say that we were hiring. and that we needed to hire 100 people in order to meet our production requirements. Within four or five days, we had 400 applicants. Now the only problem with that is, is in this situation with social distancing and all, it's very hard to get these people interviewed and onboarded in the same manner that you would in, you know, prior to coronavirus. So we have been working on that diligently. So while we're only at 80% of our desired attendance right now, in addition to those people that we expect to be coming back, we'll be hiring more people on top of that. And that effort's going fairly well as far as I know. Scott's verifying that for me. It's going quite well. In Tulsa, we have zero cases of coronavirus. Again, knock on wood. As of April 1st, we had 95% attendance. Well, 92% to 95% is kind of our historic range. There's always people that are out for vacation, standard illnesses, you know, just different reasons that they want to be gone. So you'll never be at 100%. So we were at 95%. Well, we had people that have extensive PTO.

Scott, is the number 480 hours what we allow them to accrue? It's the limit, yeah.

Yeah, so we allow them to accrue up to 480 hours of PTO time. which, as you know, that would be 12 weeks. Well, we normally manage this in a real diligent manner so that we don't have a substantial number of people out at one time. But again, with doing the right thing with the coronavirus, if people want to take off, they have the PTO time, then of course we're granting that request. So we went to a low of 64%. I think that date was April 25th was the low. But again, these people use their PTO. They left for a little while. They're coming back. And as of today, we're at 89%. And my understanding of the prospects of coming back to more like full strength is within the next week. End of next week. That we're fairly confident that they're coming back. But again... We want to hire approximately 100 people here in Tulsa as well, correct, Scott?

We're making good progress. We're down to about 55 left.

Okay. When I first opened that opportunity with Scott and the HR department, it was 100. Now we're down to 55 left, he just informed me. So we're making good progress on that. So with all of that said, with the lower attendance in both operations, Miraculously, April was nearly at our expectations for total production. So our efficiency has been just improving over and over and over. I'm very proud of the efficiency. Q1 financial numbers tell you that the efficiency has returned to numbers that you are accustomed to seeing from the aeon of the old. With that, I've finished everything I wanted to say. I would like to welcome Norm to have a few comments here.

Welcome. Many of you I've been speaking with for several years. I'd just kind of like to refresh you and give you a little bit of feel for where we are. When we bought the John Zink Company on October 1st of 1988, We bought 92 people along with it. We were doing about $10 million worth of manufacturing and about the similar amount of contract work. We were in the process of getting out of the contract business at that time. We now have slightly over 2,400 people, and you know what we're doing in the dollar. We've enjoyed some spectacular success. Other than for the first three months when we did have a losing time, we have never had another losing quarter since October 1st of 1989. And we've had some of the highest success ratios of anybody in the history of the heating and air conditioning industry. And if you look at what we just produced for the quarter, we have an all-time high profitability. That's due to the fact that There was a lot of things changing in the past year. We had gotten back into an inflationary environment. And while we were going through the change from one managerial group to another, we changed out a huge number of people in various levels of management. And while you can teach the new people what the fundamentals are, all the little nuances that are known by the people who have been here for a long time aren't easily transferable, and therefore those things collectively gave us considerable problems for the past two years. We have now gone past that. The people now that have been the replacement people now know those little areas to avoid to cause us problems with our productivity. And so consequently our productivity has been rising back to its historical range, and the people we have in those replacement positions I believe ultimately have at least as good a skill level as those people who they replaced and in some cases they have better skill levels. So the company has transitioned from one generational group to another. It has dropped the average age by a considerable amount. So we now have a fairly young managerial group. whereas three or four years ago we had a very old managerial group. So the company is much better positioned going forward. In addition, the new people with the dim and vigor that is so characteristic of younger people have moved us along a great deal in our methodologies, in our documentation of what's to be done, and our infrastructure is much stronger than it has ever been. The company has never been in as fine a condition it is with people, systems, infrastructure of all kinds, financials. In other words, we're about the top of the place we've ever been in the past. And so it gives me great pleasure as I bow out of a lot of the managerial and be just more of a consulting person to work with these people because I see great things potentially in the future. We do recognize that we've got a formidable challenge running against the virus, and we all of us are somewhat new in this, and it's not going to go away, probably never, for almost never, and certainly it's not going to be contained and put into what you might call a normal sequence for some period of time until the medical community gets some better handles on the medication to control it. So we believe we're on top of it well. We recognize that we could easily have flare-ups. We could easily have some problems. But I have very little concern with having it get out of control. We've got too many controls. We've got too much work going on. We've got too many things going on to try and keep ourselves healthy. So I don't expect anything's going to get real bad. Undoubtedly, we are going to have some flare-ups. That is for certain. But they're not going to be too detrimental to the future of the company. So if the industry and the economy holds in, and I believe it will, we came out of when the virus started, we had the strongest economy in the construction industry that we've ever had. And I'm just, in the month of May, I am finishing my 60th year in this industry, so I speak with probably the most long-term knowledge in this industry of anybody who's still active. And I can tell you that it looks very promising to me with the one big question mark, and that is how much damage is the virus doing to our economy? I certainly hope it's not going to destroy it too much, but I do have the belief that with the strength that it had prior to going into that, that strength is still out there, I think it's fairly easily reclaimable, but we do have a lot of challenges in working with it. We believe as far as Aon is concerned, we've got it under control. We know how to work with it. So speaking for one company, I think we're in great condition going forward and more than ready to get back with continued growth in the industry. I'd like to thank all of you who have helped me make this company what it is. Thank you. Bye.

Okay. With that, we'd like to open it up to questions.

Absolutely. Thank you, sir. And at this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Again, that's star, then the number one on your telephone keypad. If you wish to remove yourself from the queue, please press the pound key. We'll pause for just a moment to compile the Q&A roster. Presenters, your first question will come from the line of Mr. Brent Thielman from DA Davidson. Sir, please go ahead.

Hello, Brent. How are you today? Good. Good afternoon. Congrats on the quarter and challenging times, and congrats on the transition, I guess, officially here as well. Thank you. Yeah, that's a lot to talk about. Maybe I'll just start with the orders that were deferred. I think you only mentioned, Gary, maybe one or two. I can't imagine that's more than a few million dollars at that. I'm just curious, when you guys see that, does that stay in backlog? Do you keep it in backlog for something that shifts out, you know, kind of beyond a year? How do the mechanics of that work?

The ones that I talked about deferred were not in the backlog. Those were in the pipeline for the sales channel. They were talking about them, that they were pending orders. We had one small order for a grow facility that that they had had it in the backlog and had put a hold on it long before coronavirus. And I don't know what their actual difficulty was. I told them it was time to either fish or cut bait here about three weeks ago. And they decided to cancel that order. And then that representative immediately replaced it with two more. So that's the only cancellation that I'm aware of. It was an order for, I think it was about $500,000 if I remember right. Does that ring a bell? Okay, my recollection was it was about $500,000. But again, he replaced it within a couple of days with another one. So the only order in our backlog canceled is just that I'm aware of, is that one order.

There are some orders which have been delayed due to shutdowns in construction in various states. and those, because the equipment has not left our facility and has not been shipped, still are reflected within our backlog.

Right. And can you guys remind me, you know, I guess this is really more specifically to new construction projects, kind of the timing of when someone comes to you with an order. Is it proceeding when there's a hole in the ground or sometime after that? Just trying to kind of understand the timeline there.

Well, So it varies just a bit based on the pace of the project. If it is new construction like you just asked for, then the traditional process is the owner solicits bids from general contractors or construction managers. They solicit bids from subcontractors who then solicit bids simultaneously from our sales channel. So pretty much all the bids come together on the same day. usually takes in the 30 to 45 day timeframe to analyze those bids. Then when they're awarded, we go through a submittal process, which is about another 45 days. So about 90 days after bid is when there's an award. And then usually within about 30 to 45 days of that is when we get a release to manufacture. So somewhere in this award time, Some of the trade starts, and it's usually the excavation. And if it's a slab-on-grade kind of a building, single-story, like our plant that we're building in Longview, then we're going to get an order for equipment about the time the slab is in place. If it's a high-rise building where you're putting units on, say, every floor, the timing is the same. But if it's a high-rise building, say a 10-story building, that your unit goes up on the very top floor, then a lot of times you'll see three to four floors of steel or structure that are up before we see the order.

Okay. Okay, that's helpful, Gary. And then, you know, it sounds like, you know, January and February, I mean, just thinking about the last call, things were trending along fine. It sounds like April has kind of returned to normal. Just from an order intake perspective, is that the right way to characterize it, Gary?

It's not quite normal. It's just a little bit short of that. But, yes, it's not a drastic change. But it's beginning to regain. We could feel when people started reopening their states because things became more efficient. Now, all of our sales channel partners, when we talked to them, said, we didn't quit working. We have been working remotely from home. But it's very inefficient with time because it's hard to get everyone together in those scenarios to make those decisions. So it just strings out the process. For instance, I was talking to one of the sales channel partners yesterday. that they had intended on sending us orders for a bunch of K-12 schools for the replacement of units for the summertime activity. They had intended on having those into us in early April, yet we got the first of them this week and they said by next week we'd have all of them. So they're paperwork's running, say, 20 to 30 days behind schedule.

Okay. Maybe one more and I'll get back in line. The hospital-related orders, what's the revenue contribution to that, Gary?

I think our traditional slice of the pie is around 9% of our revenue goes to hospitals.

And the whole job is about $4 million.

You're talking about one specific job. No, he's talking hospitals in general, the whole market. You are talking about the whole market, not just those specific two jobs we did.

Well, I guess that's helpful, too. You said 9% for, I think, hospitals, but the two jobs I'd be interested, too, if you're able to share.

Well, those two jobs in New York, those coronavirus that we delivered in the one-week time frame, that was $4 million.

Okay. Okay, great. I'll get back in line. Thanks. All right. Thank you.

Thank you, sir. And, of course, at this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Listen, sirs, your next question will come from the line of Mr. Joe Mondillo from the Dorian Company. Sir, please go ahead.

Hello, Joe. Hi, everyone. Good afternoon, actually. Hope you're all doing well.

Doing well.

So, Gary, I just wanted to ask regarding your comments on attendance, employee attendance, and that you finished with sort of production in April, meeting your expectations. Were those expectations, you know, sort of pre-COVID? So have you changed the expectations based on The economic, you know, the market's coming down and the volatility in the stock market and economic downturn. Or was that sort of pre-COVID April expectations and they're meeting your expectations despite the employee attendance? Could you just clarify expectations that you're referring to?

I am talking pre-COVID. We have not had any reslating of our expectations at this point. With our backlog the way it is, We have not reslated anything yet.

We're not to the eight-week goal yet.

Okay. So that brings me to sort of the lead times and backlog. You mentioned that your ideal or your lead time goal is eight weeks. What would that translate into sort of an ideal backlog size? I'm just trying to... I want you to frame that because, you know, backlog's coming down, and so I just want to get a sense of where should backlog sort of stabilize in an ideal size, given your capacity that you have right now.

It would be like two-thirds of a quarter would be the ideal backlog. And understand that our production rate is increasing, so that's a moving target. So if I took a snapshot in time today... and did two thirds, what's two thirds of 137 million? It's about 100 million, right? And if you'll go back and look at transcripts from the past, I was asked this question maybe a year ago and said, if you had the ideal backlog when you ended 2019, what would that be? And I said at that point in time, 100 million. So we remain Thinking that somewhere between 100 and 110 million is the ideal backlog because that serves our clients best with lead time, but it's also a reflection of the increased production capacity we have.

Okay.

Now, I want to pray. While we're talking about backlog, I want to talk about one or two other things that some of you might capture, some of you might not. The backlog is for units that are ordered to be built to suit. They're built to order. We also have a substantial inventory of water source heat pumps that we sell from the inventory. Those are not in backlog because we ship them within one or two days of the order, so they are inconsequential to it. The other thing is our parts business has begun to materialize as something that's fairly substantial for the company, and that doesn't go into backlog. So that's two revenue streams that you put on top of what our production capacity is.

If I could, they would appear in the backlog to the extent that the order was in-house and had not shipped at the end of the period. So they do show up in the backlog, but only for a blink of an eye, practically. Correct.

That's what I was trying to say, because of the two-day roughly. Got it. And so going back to sort of your April expectations and your conversation about hiring 100 people at Tulsa, and I believe you said 100 at each facility?

Yeah, 100 in Longview, yes.

I would assume your expectations, you know, relative to pre-COVID, which I guess are maintained, would be that orders would be rising in April seasonally, and, you know, they generally rise into the summer, which I suppose it's correct to imply that's why you're hiring into May and June to handle that increase in order rates? Is that fair?

Well, the order rate has been stable, but we're working an awful lot of overtime, particularly in Longview. For in excess of a year, we've been running the plant floor probably 20% plus overtime. Yes, Scott's nodding his head yes. in excess of 20% overtime. So we'd like to gain the efficiency of these people working a standard 40-hour week and have more people rather than wearing them out. Because after people work overtime for so long, then their productivity goes down. Tulsa has some overtime as well, and we're trying to eliminate that. But we're still trying to increase capacity, yes.

Okay, so I guess that would bring me to the gross margins, which finally on track, I guess. Congratulations, finally getting there. Yep. You know, one of your best quarters in a long time. So how would that sort of translate into gross margin? You know, you're bringing on more people, but then, you know, your overtime is coming down, and then I guess essentially, hopefully, your productivity actually increases. So how are you thinking about the gross margin at this point in time, especially relative to, you know, you were talking about a goal of 32 percent and, you know, in a seasonally light gross margin quarter being the March quarter, you were almost there. So how do you think about that?

Well, I have said that I was working for a range of 28 to 32 percent, that that was the historic range of the company that I actually targeted 30 as being ideal. So we've already gotten beyond what's ideal. But we're going to see that stabilize. It'll go up and down just a little bit. But like I talked about adding some overhead staff in order to develop more water source heat pump product, for instance. So if I can gain some efficiency by doing away with some overtime and trade that for some people that can develop product for the future, I could probably keep my goal of 30% pretty solidified. So I've got a teeter-totter here I'm trying to keep balanced. I'm trying to add some assets to the company that will provide for future growth, but I'm also trying to fund them by making this thing more efficient.

Got it. So, also, I wanted to ask about the revenue that you saw in the first quarter relative to, I guess, maybe near-term expectations because, you know, usually we see the head and shoulder shape where, you know, the out quarters are sort of slightly down and the June and September quarter are a little higher. Is this an abnormal year? You mentioned, you stated that orders are sort of stable and Is this a little bit of an abnormal year where maybe the June quarter is comparable to the first quarter? Or do you think you could still see that typical seasonality that you generally see historically?

You categorized it first by calling it abnormal. So we've been in an abnormal situation for a couple of years now. We've had more orders than we could produce. So we went into... The first day of 2020 with a backlog that was much higher than what was ideal and conducive to good lead times and best practices. So we were able to keep the throttles full. And we went into Q4 the same way. Because Q4, we typically start turning down. Q4 and Q1 are the two that are usually lower. And Q2 and Q3 are usually the top ones that you're talking about. So because we were still gaining capacity We were able to keep the throttles full forward in Q4 and full forward in Q1. So I would say that if we were so lucky as to duplicate Q1 and Q2, then I would call that a great achievement. Normally, you would say Q2 would be larger, but having some labor challenges just a little bit and this, that, and the other, you know, I don't want to get our hopes up that Q2 is going to outrun Q1 because I just don't see that happening. But I also don't see any substantial decline. I mean, it's going to be nip and tuck, Q2 possibly looking similar to Q1.

Okay. Yeah, I just wanted to clarify that because I wasn't sure. I have one more question. Well, I have a few more questions, but I'll one more quick one. No, you go ahead. The CARES Act benefit that I read in the 10-Q, I guess this is a tax benefit where you can, you know, retroactive, you know, full depreciation or something related to going back to 2018. And so I thought your tax rate would benefit, but you stated sort of a guidance of 25%, which is, I think, what you've sort of been talking about, you know, over the past year or so. Is there a chance that is lower than 25%?

No. What we would be doing is getting accelerated depreciation on the qualified improvement property. So it would just be a timing difference between our current payable and our deferred tax liability. So it doesn't really impact our overall effective tax rate. This is the timing of when we would be paying those taxes.

Okay, so you're cashbackers. Okay. All right. Got it. All right. Thanks a lot. I'll hop back in queue. Thanks, guys. Thank you, Jeff.

Thank you, sir. And presenters, your next question will come from the line of Mr. Brian Gaines from Springhouse Capital. So your line is now live. Please proceed.

Thank you. Good. Good. Yourself?

Good.

Okay. I just, you know, you had a nice quarter in terms of pricing of the rooftop units. Are we kind of through the cycle of price increases? You kind of catching up to where you had to be to get to the margin? Or is there still further pricing to come?

We have not announced any further price increases. We don't see any need to on the near-term horizon. Some raw materials, I just got an analysis from my purchasing department today. We track nine substantial materials that we purchase, copper, steel, aluminum, stainless steel, heat exchanger tubes, coils, and compressors. And anyhow, these nine things, they were down eight-tenths of a percent as a tranche versus a year ago. But they also make up about 70% of all the materials that we purchase. So the other 30% of materials we purchase are harder to scrutinize to that same level. But our feeling is that they are up just a little bit. So I would say our material cost is flat. Now, the one thing I do want to say about price increases is on, we had two categories of equipment that we had a price increase on in December of 19. One of those categories was the equipment that we build in our Longview facility. And since we have a shorter lead time, that didn't fully get into Q1, but part of it did. But Longview is only about, what, 10% to 12% of our revenue. So even if they got a little bump, it's not going to be anything that's going to show up very much. Then another product group that comprises another 10% to 12%. That's our very, very large tonnage units. It got a price increase at the same date, but its lead time's a little longer. So we're probably looking at a very, very small tweak of that product entering the production floor sometime in Q2. And so... There is just a very small adjustment yet to be had at the bottom line because of that, but there's nothing further on the horizon.

And you feel pretty good competitively? I know you've had big price increases, but I imagine the industry has as well, so you've kind of just kept up?

Yeah, we've done quite well. We had what we call a rep council meeting. We have six regions. and we select two or three representative organizations from each region and then we have at least an annual if not a semi-annual conference with these people and that way we can explore, you know, get good feedback from the field as a big group, you know, are we seeing any pricing pressures. We just had that meeting last week, virtually by the way. Normally we have it at a nice resort but the resort's closed and we're all social distancing. So we had it virtually. There was one rep that talked about a little bit of competitive pressure on one particular style of unit, and the rest of the group kind of chimed in and told him how he could position himself better to overcome that, that he really didn't need a discount. So I would say the pressure for discounts, the pressure on pricing is very quiet. Our primary driver has been lead time. until we got this lead time down to a desirable number, and we're nearly there, not quite, I don't think pricing's an issue at all.

Okay. And is there any way you can kind of give dollar value of orders in March and April of what it is kind of year over year?

No, that's kind of forward-looking information that we don't talk about.

Okay. Can you give any kind of expectations for QQ, kind of overall, what you're thinking?

Well, I already did when Joe was asking questions. Maybe you overlooked that. Historically, before I got here, the company had a swing that Q4 and Q1 were usually somewhere in the range of 10 to 20% lower than Q2 and Q3. And so you always saw a 10% to 20% swing between those. And so since I've been here, we've gotten more orders in. We've lagged on production. So we've kept the production throttles full forward. So we've not seen that same bell curve. So Joe, a minute ago, was asking, do we think the bell curve's back? In other words, you did really good Q1, but is Q2 going to go up 10% or 20%? And I said, no. If we were able to duplicate Q2, what we did in Q1, I think that would be more than a reasonable expectation. And I think it's a possibility, but it's not a promise.

No, no, I heard that. I was talking more orders and less kind of revenue.

Orders, yes, they have also been most affected by lead time. As we brought lead times down, Then orders were beginning to gather some momentum. Then the coronavirus came along and kind of nipped that in the bud. And so basically at the end of March, we were at 92% of our plan or expectations on orders booked. And we remain kind of in that same range right now.

Okay. And is it fair to say were you kind of heading into COVID at the end of February? Were you at 100% of plan or are you well ahead of plan?

We were really close to plan.

Okay. Thanks, Gary.

Yep.

Thank you, sir. And presenters, you do have a follow-up question from Mr. Brent Stillman from DA Davidson. Sir, please proceed.

Hello, Brent. Hey. Back again. Yep. Gary, the water source heat pump category sounds like you've obviously made some changes. Appreciate the comments and what you're trying to do there. I don't think you mentioned this, but are you expecting that product line to get back to kind of growth mode here in the coming quarter? Is it going to take a few more quarters to get there?

I'm going to tell you it's going to take a little while for this reason. Coronavirus has probably affected that product category as much or more so than anything. because the largest target market for us with our current product offering has been high-rise condominiums and hotels, which both are going to be under substantial pressure going forward. But I do have the story of why we got into water source heat pumps and how we thought we would leverage our legacy product to sales of these. Our sales representative in Albuquerque, New Mexico, also covers El Paso, Texas. Earlier this week, he sent in a very, very nice order for water source heat pumps, and it was half of the total order volume, roughly, was our legacy product configured as water source heat pumps. But these were unique operating characteristics. They were 100% outside air, called dedicated outside air water source heat pumps that were roof mounted. But it was coupled with a good group of the indoor units that are what we call the WH and WV models, which are the new ones that we've had all this commentary about. Well, all along, the strategy was that those rooftop-style units, we are unique in that there's very few people that make those, if anyone. There's certain operating strategies and certain sizes that we're the only ones that make. that when we had that, that very often they were accompanied by this other water source heat pump. Well, prior to us going to this effort and putting this new product together, other manufacturers on their line sheet were getting that business. So now they're beginning to give that business to us. And so I was very, very pleased to see this. They did a case study on it on their LinkedIn page. That's how I discovered it. And then I went and looked up the order and saw what a nice deal it was.

Got it. Maybe one quick follow-up. I mean, this goal, target, lead times that you guys want to get it to, do you think you'll be there in the second quarter?

Going to be really close, really close. I walk the plant floor nearly every day. The people that are out there are working very hard, even though we're a little understaffed. And like I said, they met our – very close to met our expectations in April. So that helps a lot. The orders slowed down to about the 92% level. That's going in the wrong direction for that. But now those orders are going to start coming in. As I said, we've got school orders and things that are beginning to accelerate as the world opens back up. But at the same time, I noticed that we had another new Salvagnini machine that I was quite pleasantly surprised to see that it was here. It was in place. The Salvinini people were here commissioning it, and they told me that by the end of this week I would have that. Well, each Salvinini machine, you know, adds appreciably to our production capability. So we're going to have increasing production capability. If we can get these people back in here and get to work, which I think we're going to do, everything's pointing very nicely to that, that by the end of Q2, I think our demand and our Production Capability will come in alignment to get that lead time right where we want it.

Okay. And by virtue of that, I mean, then the sales line is probably going to mimic the order line a little closer, I mean, versus what we've seen.

That would be ideal. That would be ideal.

Okay. All right. Thank you, guys. Best of luck. Thank you, Brent.

Thank you so much, sir. And of course, at this time, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone keypad. Presenters, you also have a follow-up question from Mr. Joe Mondillo from Sidoti and Company. So please go ahead.

Go ahead, Joe. Hi, guys. Thanks for taking a couple follow-ups. So I first wanted to ask about SDNA. You know, it's down year over year, but the big thing that I noticed when I looked at the queue, when you add up, I guess it's profit sharing, salaries, and stock comp, you add up those three line items and they have, you know, increased pretty substantially as a percent of sales over the last four or five quarters. Is that just standard sort of Wage compensation, inflation, and should that sort of stabilize? And I guess just in a more broad question just as a whole SG&A, should we expect SG&A as apprentice? Usually you tend to see SG&A as a percent of sales decline as your revenue. You can leverage that. Should we expect that?

Well, I'm going to pick one out of the three that you asked about. I'm going to let Scott or Rebecca handle the other two. Profit sharing is the one I'm going to pick. Profit sharing is a fixed formula. It's 10% of our pre-tax profit goes to our employees. I'm very proud to say that on Monday, we will be issuing checks for $1,643 per employee that qualifies for Our profit sharing, that's for this quarter. Virtually everyone except the C-suite. I mean, there's some qualifications as to how long you have to be here, but it's roughly, what, six months? Six to nine months, depending on when you onboarded. So virtually anyone that's been here six months plus is eligible for that profit sharing. So that's $1,643 per employee that are getting that. So that's 10% of our pre-tax profit that goes to that. So that number will always vary with the profit. So as our sales become more profitable and the profit is a bigger percentage, then that will be as well. And then one other thing to keep in mind is we have a 175% match on their 401k. And so if they'll put in 6%, we'll put in 10.5%. So that also goes for another $172 for all of those employees that are in that 6% category, which, again, I walked the plant floor this morning because we announced profit sharing, and I was asking people about it. I did not find one employee that did not contribute at the full 6%. So they're all getting that $172, all of them I talked to. Scott, would you like to talk about the other two items?

Well, if you'll notice, our stock comp, what we issued out this first quarter – was substantially less than what it was same time last year as we reduced the volume of options that we issued out. A large part of that was driven by our changes in base wages for our entry level personnel as we converted more of their total compensation package at the entry level of the organization into a cash basis and a little bit less of it into the equity platform. So you did see actually our grants decline, but That's the overall comp program that we have. And our base pay is seeing some upward pressure in terms of wages up in all positions. And that was mostly driven by last year. This year, we're already seeing some indications within our database that says that wages are going to back off from the growth rate that they had last year. We're not quite sure how that'll play out as the year progresses, but we're already starting to see that inflation rate on the data set decline.

Okay, got it. I also wanted to ask about going out, essentially your independent sales reps and selling the product over the last month or month and a half, given sort of the shutdowns and You know, people, you know, social distancing. Has, you know, you sort of indicated that your orders have stabilized or whatnot, but, I mean, I would have thought they would have been down even more, and I guess the read-through should be that, you know, the read-through should be a really good positive. I think it's just the fact that your orders are stable and not down. So, how have they been able to sell the product without You know, seeing their customers.

Well, there's several ways. Some of them are pretty crafty. Our representative in Chicago, Windy City Reps, led by Jim Wilson, he called me and says, Gary, I want to share this story with you, and I want you to share this story with some others. He said, we had sales presentation seminars to our community. and we did it by WebEx, but we gave them a Grubhub voucher where we bought their lunch, but they had a Grubhub voucher. So these people, if they logged in, then they validated their Grubhub voucher, they got their lunch brought to them. Now I thought that was pretty clever. I don't remember the exact participation numbers he had, but it was substantial. But that keeps the early part of the sales process Rowling. That's the design part of the process you do with consulting engineers. Then, as I've heard others speak, other than the very largest projects that require an on-site interview of the contractors, so your mid-sized to smaller projects, which tend to be more in our wheelhouse anyhow, Those projects are still being awarded absent of a long interview process that you might see on a very, very large project. So it's not as efficient time-wise as it is person-to-person. But over the years, we've evolved into a business method where with mobile phones and internet and WebEx and Zoom and all these other things, We've been conducting business this way to some degree all along, but not as intensely as we're doing now. So, like I say, there's some places that have slowed up a bit more, and there's some that have slowed up a bit less. You know, when I look at it, Pennsylvania, for instance, prior to coronavirus, in their region in the Northeast, they were one of the top performers as far as percentage of expectations. and they've fallen back just a little bit. But again, I talked to them yesterday and they've got school orders coming in to me right away. So they've still managed to do the work. It's difficult, but I'm going to fall back to one thing that I've told many of you. We have the finest sales channel partners in the industry, unequivocally. There is no other sales channel that's as good as our guys. They are aggressive, They are innovative, and they're just great performers. And so I'm very proud of them, very proud to be associated with them. And our performance on bookings is an attestment to that.

All right. Well, thanks for taking my questions, and good luck with everything, guys, and stay safe and well. Thanks a lot. Thanks, Joe.

Thank you so much. and presenters. There are no further questions at this time. Please continue.

Well, we want to thank you for joining us. We will talk to some of you again next week when we have our annual meeting of our stockholders on May 12th. Until then, have a nice week. Stay safe. Bye-bye.

And again, thank you everyone for participating. This concludes today's conference. You may now disconnect. Have a lovely day and stay safe.