AAON, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the AAON Incorporated Second Quarter Sales and Earnings Call. At this time, all participants' lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star, then the number one on your telephone keypad. Thank you. I would now like to hand the conference over to your first presenter, Mr. Gary Fields. The floor is yours. You may begin.

Good afternoon. I'd like to begin 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. So now I'd like to begin with telling you a little bit about our experience with coronavirus and how it's affected our business. First of all, and of utmost importance, is to thank our employees. We've been able to maintain continuous operations. As a result, we have been able to assist with many COVID-19 projects. This is vital to our business as an essential business supplier. I'm very proud of the effort that our employees have gone to to maintain safety in the plant. They are all wearing masks, social distancing. They're doing temperature scans on arrival and at any point in time throughout the day that they feel like that it's necessary. When they clock in in the mornings or in the evenings, whichever at the beginning of their shift, they certify through a wellness reporting system in our clock in. So we did have some absenteeism because of coronavirus. In June, we had about the second week of June, we had a substantial decline in attendance. It bottomed out in mid-June, was mostly restored the second week of July. Very happy to say that we had very good results with our people returning to work healthy, and this was a temporary impact for that period of time I described, and we are mostly recovered on attendance, and these people came back very healthy again. I'd like to turn the call over to Scott Asbjornson, our Chief Financial Officer.

I'd like to begin by discussing the comparative results of the three months under June 30, 2020 versus June 30, 2019. Net sales were up 5.2% to $125.6 million from $119.4 million. Net sales for the quarter are up due primarily to our increased sheet metal production. from the additional Salvinini machines that were placed into operation, as well as our price increases implemented in 2019. Our gross profit increased 26.2% to $38.1 million from $30.2 million. As a percentage of sales, gross profit was 30.4% in the quarter just ended, compared to 25.3% 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 23.4% to $15.9 million from $12.9 million in 2019. Additionally, as a percentage of sales, SG&A increased to 12.7% of total sales in the quarter, just ended from 10.8% in 2019. SG&A is up due to increases in profit sharing, employee incentives driven by increased earnings, and largely to a $1.25 million contribution to Winifred Montana Public Schools on behalf of Norman Asbjornson in recognition for his transition from CEO to Executive Chairman. This equates to roughly 2.5 cents per share. from operations increased 28.4% to 22.2 million or 17.7% of sales from 17.3 million or 14.5% of sales in 2019. Our effective tax rate decreased to 20.0% from 22.7%. The company's estimated annual 2020 effective tax rate, excluding discrete events, is expected to be approximately 25.1%. Net income increased to $17.8 million or 14.2% of sales compared to $13.4 million or 11.2% of sales in 2019. Diluted earnings per share increased by 36.0% to $0.34 per share from $0.25 per share. Diluted earnings per share were based on 52,750,000 shares versus 52,747,000 shares in the same period a year ago. Now for the comparative results of six months into June 30th, 2020 versus June 30th, 2019. Net sales were up 12.8% to $263.1 million from $233.3 million. Net sales for the quarter are up due primarily to our increased cheap metal production from the additional Salvagnini machines that were placed into operation. Our gross profit increased 45.7% to $81.1 million from $55.6 million. As a percentage of sales, gross profit was 30.8% in the quarter just ended compared to 23.9% in 2019. As already noted, we have experienced decreased material costs and improved overhead absorption. Selling general and administrative expenses increased 17.2% to $31.2 million from $26.6 million in 2019. Additionally, as a percentage of sales, SG&A increased to 11.8% of total sales in the quarter just ended from 11.4% in 2019. Income from operations increased 73.8% to 50.0 million or 19.0% of sales from 28.8 million or 12.3% of sales in 2019. Our effective tax rate decreased to 20.8% from 23.1%. The company's estimated annual 2020 effective tax rate, excluding discrete events, is expected to be approximately 25.1%. Net income increased to 39.7 million or 15.1% of sales compared to 22.1 million or 9.5% of sales in 2019. Diluted earnings per share increased by 78.6%. to 75 cents per share from 42 cents per share. Diluted earnings per share were based on 52,885,000 shares versus 52,589,000 shares in the same period a year ago. At this time, I would like to turn the call over to Rebecca Thompson, Chief Accounting Officer in Treasury.

Thank you, Scott. Looking at the balance sheet, you'll see that we had a working capital balance of 143.2 million versus 131.5 million at December 31, 2019. Unrestricted cash totaled 61.3 million at June 30, 2020. Our current ratio is approximately 2.9 to 1. Our capital expenditures were 33.5 million. We expect capital expenditures for the year to be approximately 73.2 million. The company had stocks and purchases of $15.9 million during the six months ended June 30, 2020. Shareholders' equity per diluted share is $6.10 at June 30, 2020, compared to $5.51 at December 31, 2019. I'd now like to turn the call back over to our CEO and President, Gary Fields.

Net sales have increased. This is due, by and large, as Scott mentioned earlier, to the Salvagnini machines that allowed us to produce the sheet metal required to build our units. So once we produce the sheet metal, then it becomes more impacted by human activity. So absent of the... Thank you for joining us. Quick thing that can impact you. I suppose it could occur again, but we've done pretty well with that. So the projects that we have produced in relation to coronavirus, we've talked about last quarter some of those for New York. There's also been some other facilities that we've produced equipment for that For instance, in the state of Maine, there's a company up there that manufactures the swabs that are used for testing. They've expanded their facility substantially. We've already supplied quite a few units to them for their first expansion, and I think we're closing in on an order for another expansion that they have planned. They were very happy with what we did on the first one. So that's kind of the The jobs that are directly related. There's been a lot of indirect relationship in that there's been some community hospitals that have come out of mothballs that we've been able to provide some equipment to help renovate and update these. There's been a myriad of facilities that are, as a result of coronavirus, there was an awareness on the need to get these facilities up and going. The other thing we're seeing good activity on, and we're very well positioned with our equipment for, is increased vigilance on indoor air quality. The coronavirus is well known to be an aerosol transmitted virus, and so if you have the ability to do two things, one is capture that so that it's not recirculated, and two is if you have the ability to kill that virus inside the unit. And so we have strategies that have assisted with that with higher levels of filtration and different methods utilized. There's been two or three methods utilized to help reduce the live virus that's circulated. We're fairly unique in that regard in that our basic design of the air side of our equipment has additional static pressure capabilities to overcome the static pressure requirements of these higher filtration levels that ASHRAE has recommended. So this, again, positions us very well. mentioned before that absenteeism had an impact on production. We've restored that now, so we're producing again at daily numbers that are on par with the best daily numbers we've ever achieved. Sales coming in the door, bookings. We saw a decline throughout the spring and the early summer versus our expectations and versus 2019. However, July turned around substantially. We finished July's bookings substantially above 2019 and more in alignment with our expectations prior to coronavirus. We've also looked at activities that are in the pipeline with our sales channel partners and believe that we're poised for fairly solid results going through the next quarter. and so forth that there could be some debate on how well that's going to occur in Q4, Q1 and I think that a lot of states that opened up early on and got some activities going have seen a little pause in opening, and some have even contracted a bit. So these are things that are very unpredictable, so it's very hard to give a solid direction that things are going, but our backlog remains very stable, very strong, and it's nearing our ideal point so that our lead times are nearing their ideal point as well. Water source heat pumps, there's not been a whole lot of change in that business We saw a little weaker demand for it so far this year than what we did in 2019, but we've begun with some strategies to strengthen that primarily in the aftermarket replacement business, looking at what makes a more effective presentation of product for that, and we're in the midst of designing some additional product that's more ideal for that backwardly compatible replacement market such that if somebody has a failure that they don't want to repair the unit, you've got an instant change out for them. So that's some of our redesign that we've done in that regard. Our legacy products, as I would like to term them, the products that we build in Longview, Texas, the products that we build here in Tulsa prior to this water source heat pump under constant development for improvement. We've got a multitude of strategies and improvements that are rolling out on a weekly to monthly basis, and we believe that each one of these is going to have a positive impact on our growth potential and our market share growth. So at this point in time, we've seen everything relatively in line with past relationships as far as size of units and so forth. But I would like to point out that there's a couple of opportunities that we've been able to capture, and I think there's more on the horizon, and that is that there's some conditioned warehouses. These are warehouses that require... Air Conditioning. They tend to be very large buildings that they utilize larger units. So you don't have a large quantity of units. You have larger tonnage. This falls very well into our offerings. Some of our competitors are very limited on the size range they have. And so this has been able to provide us a really good opportunity. Some of those orders are already in-house. We have some more in the pipeline that are very, very significant. But manufacturing is the same thing. We've seen some acceleration in manufacturing project opportunities, some of which we've capitalized on. I mentioned once before that we were awarded the contract to supply the air conditioning equipment for the new Black & Decker Craftsman Tools manufacturing in North Texas. We have other manufacturing facilities, some of which we don't want to talk about individual projects so much when they're in the pipeline, but there are some opportunities out there that are boding very well for us. Office buildings are challenged. I think that we're going to see particularly spec office buildings, speculative office buildings declining coming up. Architectural Billing Index seems to support that new construction is going to be declining slightly. We've had four months in a row that architectural billing index has been below the benchmark of 50. So that puts more emphasis on us capitalizing on some of the markets that we're very strong in. And one of the things that I've noticed looking at the sales channel partners pipeline and talking to them is is that there are more and more opportunities that are owner-operated type facilities which bodes very well for us as opposed to speculative facilities or developer type facilities where they own them for a short period of time. So I guess the next part of our market segments that we've talked about in the past is lodging. Thank you very much. But that gives us an opportunity to go through and help these people with their efforts to modernize, update, and refresh some existing facilities. And we fit that very well. So with that, I'll conclude the market talk. Our backlog was 119.6 million at the June 30th, and that was versus 166.1 million a year ago. to some that may look unfavorable, to me it actually looks favorable because at $166 million our lead time was extraordinary and lengthy and this was restricting us from some really good opportunities. We had to turn down a lot of opportunities because we just weren't able to produce. We've worked very hard and for about a year now, maybe in a little excess of a year. We've been adding Salvagnini capacity, additional capacity, and streamlining our operations. And so now we're able to produce at a higher level. And that in itself brought the backlog down. And so at this point in time, our balance between backlog bookings and shipments is relatively in order. There were a handful of jobs that were delayed somewhat. It actually coincided well with the fact that we had some K-12 replacement business that we had units due in June and July primarily, and at the same time we were having the absenteeism rate, so we were a little bit challenged by that. As it turns out, those projects were all delayed because they had for their construction workers that had delayed their progress as well as school opening delays. So we were actually able to satisfy all of those shipment requirements with no delay to the actual outcome. We're seeing orders, as I said, in July rebounding very nicely, and I think this is in response somewhat to our lead times. A lot of opportunities are being presented to us, and one of the primary concerns has been, when can you deliver it? And we've been able to respond favorably to these. So that being the case, I think 2020, we will finish the year with modest growth, and I believe we'll begin 2021 with a relatively stable backlog. unless something catastrophic occurs in the overall economy that we've not yet seen. July results were good in spite of the fact that we had some absenteeism for the first few days of July. As of, I think it was July 12th was the first day that I saw us produce on a daily basis at our highest level, and we've been able to maintain that production level. So the first 10 or 11 days, of course, you had two days of holiday in there, but the first 10 or 11 days of the month were underperforming because of absenteeism. But once we hit around the 12th of July, we restored that. The balance of the year, barring any unexpected absenteeism again or anything catastrophic like that, We think that we're going to perform quite well for the rest of the year. One of the absenteeism issues that has been discussed, and there's been a lot of effort in the community, in our business itself, to assist with how to resolve is there's schools that have not gone into session on time, not planning to go into session on time, You've got people that are having some child care issues with what do they do with their kids while they're at work. I think they've become relatively well equipped on this now, it seems, because they've been dealing with this since late in the spring. I don't think we're going to have too much substantial impact from that. It's just a little bit of a nagging situation for a handful of people. With that, I'd like to open it up to questions.

At this time, I would like to remind everyone, in order to ask a question, simply press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Once again, to ask a question, it's star one on your telephone keypad. Your first question comes from the line of Brent Delman. Your line is now open. Please ask your question.

Hello, Brent. Hey. Hey, good afternoon, guys. Gary, maybe first off, I mean, despite some of the disruptions seemingly late in the quarter, the gross margins are holding up pretty well. Thanks for at least some view on what you think sales can do through the remainder of the year. I know that's subject to a lot of things. How do you feel about maintaining these margins at these levels given all the varying factors out there and barring any change in the inflationary environment?

We look at each month standalone as they occur. and June was surprisingly good. This absenteeism, that PTO time for those people is accrued and so it doesn't affect us in a negative way. The thing that you don't get is you don't get the dilution of the fixed cost when you don't have the revenue. So I think that I'm very proud of what our team did in managing cost and managing the people for the best outcome. June is a standalone month, was relatively representative on a gross margin basis for the whole quarter, as I recall. Yep, I'm getting a nod of approval from my accounting folks here. So June was relatively on par with that. Since we just closed out July, we've not seen those numbers. But revenue in July looked fairly similar to June?

I believe so, yes.

Yeah, so... So having the same sort of controls in place on the efficiency and just the scrutiny to every little detail in the business, I would expect that July performed somewhat on par with June, maybe slightly less, but somewhat on par. August is starting off with really, really good production and good attendance. and so I think that August and we've got good backlog to run through September at this rate and good prospects on the horizon. So I think that the stability in gross margin performance is very probable.

Okay. And Gary, just to clarify, I mean, I think typically third quarter is one of your stronger quarters. Do you expect A Step Up in Revenue from the Second Quarter?

My production team can give me a pretty good forecast of what revenue is going to look like because they've got their production schedule fairly solidified and they've got their rhythm for it. So we're about a week early for being able to determine that. But I would expect Q3 probably to be in the same range as Q2. It won't be the normal bump up that you've seen historically. And again, that was largely affected by that absenteeism those first 10 or 11 days of July. Do you both agree with that?

I would tend to say so. I think effectively the impact we had from coronavirus was split half between the end of June and the beginning of July. And so you're going to probably see somewhat of a mirror image.

Yep, that's the way I saw it as well. Thank you, Scott.

Okay, and just to clarify, given the lead times have shortened, I assume all the All the work in your backlog reflects most current pricing that's out there. You don't have much. I have no pricing.

No, no. We had, as I recall, it was relatively across the board price increase in June of 19. That's fully enabled in the production. I would say even Q2 it was fully enabled. There was a small price increase, selective price increase in December. Again, I think some part of Q2 captured that, and I would say that Q3 is entirely on that. But that was very inconsequential to the overall gain because it was on select equipment. Even though it was 4% or 5%, it was on probably, let's see, it was on Longview Equipment and Line 5. Yeah, so it was affected on somewhere around 20% of our revenue performance. We got about half of Q2 with that price level on the plant floor.

Got it. Last one, I'll get back and clear. The indoor air quality upgrades, is that considered a part sale or is that a full-on replacement of a unit?

Full-on replacement of a unit for most of these facilities. Let's say you go to an elementary school that was built even 15 years ago. And let's say they did not purchase Aon equipment. So the equipment that they purchased, the fan that supplies the air to the space and recirculates it, doesn't have the capability of overcoming these additional filtration levels that we're talking about. The other thing is is those units that a lot of our competitors sold on those projects, don't have the space in them for these virus-killing devices. And so our units accommodate both, and that strategy in our units has been available for many years. So we didn't have to do any new design, redesign, or anything like that. We have a project that we are supplying to the Carrollton Farmers Branch Texas School District. I think there's nearly 600 units. And They are adding the virus-killing device, and then we added the higher filtration. And so that's just one example of a school district that recognized this. And that was all planned before coronavirus. And they came in and added this virus-killing device once they saw the effect of it with coronavirus.

Okay. Thank you guys for taking the questions. I'll get back in line. Thank you.

Our next question comes from the line of Joe Mondillo. Your line is now open. Please ask your question.

Hey, Gary, Scott.

Hello, how are you doing?

Doing well, thanks. I wanted to start with following up on Brent's last question and just to expand on that. What kind of units are you referring to? Is it water source heat pumps or rooftops? And then in addition to that, is there other types of units that maybe you don't manufacture or other types of systems that could be a substitute at all? And then lastly, as far as the uniqueness that you mentioned regarding the static pressure, could you expand on that and how many – producers out there can provide what you're referring to there.

Okay, so let's divide this up a little bit. So in indoor units, virtually every competitor we have has this capability because indoor units don't tend to be so commoditized. They're not an in-stock, on-the-shelf kind of a unit. They're built to order. So virtually everyone that's building indoor air handling units has the capability of providing a fan system that is capable of overcoming this. Indoor air handling units typically go with chill water systems. For the products that we produce in Longview, Texas, we have a high percentage of ours that are what's called a split system. They also include a condensing unit and they have refrigerant run through their coils rather than chill water. So when you're talking about those indoor split systems, you start narrowing this down a little bit because a lot of our competitors don't have a real effective offering of this style of split system with these kind of capabilities. So for many years, our successes of the split systems we produce in Longview were due to the attributes they had with some application strategies. In other words, A lot of projects with chill water, which are typically your larger central projects, central plant projects, we were able to duplicate that kind of performance with a split system and scale that down. So some projects need an indoor air unit because they don't have roof structure or roof square footage available for a rooftop unit. So that buys well for Longview. Now, when we're talking about packaged rooftop units, When we're talking about units that are 25 tons and smaller, then virtually all of our competitors, with a small exception, that would be Daikin, their fan systems will not accommodate this additional static pressure for these higher filtration requirements. So we have essentially one competitor that can match us on fan performance on these 25-ton and smaller units, and that would be Daikin. And when we look at it from a competitive standpoint, that's quite nice to compete against them. When we go above 25 tons, then it starts sprinkling in a few manufacturers here and there, between 25 and 50 tons, we'll say, that can do these sorts of things. Now, once we get above 50 tons, then it becomes even more of those manufacturers are capable of doing that. So our most substantial opportunity is in the 2 through 25 ton sized equipment that our strategy and our value proposition are extraordinary. Water source heat pumps, we do have fan capability to step up the filtration capabilities in those. That was one of our innate designs because we recognized this ability even before coronavirus that there were many applications that would desire a higher level of filtration. So as far as water source heat pump manufacturers going head to head, we do have unique capabilities once again in that facet.

Okay. And have you, I don't know which one would be maybe the most ideal Fitted for sort of COVID air quality, if there is one, have you seen any, I guess just broadly, have you seen any indication that you've started to see increased demand or is it still too early?

Related to the increased filtration or the virus killing devices going in the units?

I guess just anything related to putting in COVID-related systems because of air quality and filtration.

I think we're on the early parts of that, Joe. And let me tell you, ASHRAE is our industry resource for research and development. And it's done on a – all of our peers participate on these committees and on these research opportunities. and so this is a collaboration between the entire industry and ASHRAE published a paper recently describing what they thought were best practices for how to handle this airborne virus, this aerosol virus and that was increased filtration levels. It's called a MERV level, M-E-R-V, increased MERV level filtration as well as coupling that with one of the three strategies for virus killing. So UV lights are an obvious choice for killing a virus, but the problem is that to have the intensity required to kill the virus at any speed as it goes through the unit in its normal speed, the intensity has to be much higher than what we were accustomed to having in the past. Most of the UV devices that the industry has been installing in their units was to kill any surface-borne viruses and bacterias that might accumulate on the cooling coil. So this strategy of increasing the intensity of UV is rather new, and it's something that ASHRAE put in one of their recommendations. There's also some ionization-type virus-killing devices that are getting some attention, as well as a plasma device Thank you. Thanks for providing that color. Very interesting.

How about as far as your COVID-related end market trouble spots being retail, office, hotels? They make up 40% to 50% of your revenue. Construction is overall 50% or so of your revenue. How do you view maybe the positive aspects of construction? COVID-related demand to some of the adverse effects to the pandemic in terms of those end markets?

Well, I think what you've described is relatively accurate that some of these markets are declining. As far as new construction, they're definitely in jeopardy of declining because the Architectural Billing Index has been a great indicator and it's four months in a row that it's been below the benchmark of 50 that says things are going in a positive direction. So there will be more emphasis on replacement business. It's something that when I came here nearly four years ago now that I recognized was a significant market opportunity for us and we've been putting strategies in place to increase that and I think we're making good traction with that. Our sales channel is as a whole as we improved it. Some of the characteristics of the improved partners that we selected were due to that aspect of their business, that they had a focus on this aftermarket replacement solutions type business. So I think that a lot of the improvements we made in the sales channel are going to have a beneficial impact to us shifting from 50-50 50% new construction, 50% replacement. I would look for over the next 18 months for our ratio to change somewhat and our new construction to be a smaller percentage and our replacement business to be a larger percentage. When it comes to water source heat pumps particularly that is an absolute strategy that must be utilized because the new construction Some of the biggest markets for water source heat pumps were hotels and high-rise condominiums, both of which I think are going to be substantially curtailed. But on the other hand, if they're not building new hotels and not building new condominiums, they've got units that have got age on them that are failing that have got to be replaced. So we have had a full-time effort on increasing that business for about 18 months. in the water source heat pumps, and we've seen some configurations and equipment strategies that would make our product offering even more attractive, and we're deep into the design of these additional characteristics and features that are going to enhance that. We're looking for somewhere in Q1 to have a complete generation of equipment, water source heat pump equipment, introduced that will be specifically to address this replacement market, be backwardly compatible. Then the other thing to offset some of these industries and segments that are going downwardly trending, there's some upwardly trending opportunities as well. Some of which I've talked about before in more vague terms that I can talk more specific now. Large scale Conditioned Warehouses. There are companies that have online ordering, online processing of ordering and home delivery that are building additional facilities across North America. We've been successful in securing one particular business of that was building six new facilities across North America. And at this point in time, we've secured the order for four of those facilities. Each one of them is not, as an individual, not material to our business, but they're all incremental and they're all beneficial. Then the other thing is we've seen some on-shoring or reestablishing of manufacturing here in North America. We have secured some of that work already, and we have some in our pipeline being developed. One of those projects is extraordinary. it's in the early stages of it but it's one that we expect to be awarded within this month and so hopefully when we're having this call next quarter we'll be able to tell more about that but at this point in time it's a little early but there's a lot of opportunities out there to offset the downside now overall the growth is going to be challenging but I think that when you looked at Some of our peers and the reporting that they've had up to this point, they're reporting 20% to 25% down for the quarter. They're reporting 20% to 25% down for their outlook for the year. So our quarter was up by how many percent, Scott? Five percent. Five percent for the quarter, and that was somewhat constrained by the absenteeism We would have been up a decent amount more than that if we would have not had the absenteeism. So we're going in the opposite direction of a lot of our competitors and peers. We are gaining market share. Our value proposition is more appreciated now than ever. And I've always said, and this is something that Norm has validated for me, is in these times of downturn, that's when we actually flourish because people have time to consider the value proposition, and we win that very often.

Okay. Well, thanks for that. I just wanted to also just follow up on sort of the backlog and the effect to what that has, and you gave sort of an indication of what you're thinking for the third quarter. I'm just trying to think sort of further out than the third quarter. Did this sort of mishap or, you know, maybe not mishap, but The issues with your absentees, did that affect where your backlog is today, which is relatively pretty high if you look back two years ago. It's still 20%, 25% higher than where it was two years ago, even though it's down year over year from here. To that extent, how much did this sort of affect going into the fourth quarter, do you think? Say you get sort of maybe flat to modest growth in orders in the third quarter. Do you see a recovery starting in the fourth quarter in that sort of scenario?

I think that's reasonable to assess it that way. When we look at the commentary we're having with our sales channel partners, the general tenor is that things are improving. As things began to open back up, things are beginning to move. A good many of them believe that there's adequate opportunities out there to kind of maintain our position. But then we keep getting presented with these unique opportunities. This large manufacturing opportunity that's being presented to us right now is very lead time sensitive. And because of our increased capacity, we are absolutely able to meet their scheduled requirements. and when the discussion with some of the other contenders for the project, they're all challenged by that. They're not willing to commit to this very aggressive schedule. So when I go back to the planning we did a couple of years ago, realizing that we didn't have as much production capacity as we needed and we started getting things rearranged, cleaned up in the plant, re-utilizing some space, better utilizing it, getting more Salvagnini machines in here. When we built our new laboratory, for instance, we had an existing laboratory here in Tulsa. We have two manufacturing buildings here. The west building is our biggest footprint building. The east building was our original manufacturing building and we build our smaller tonnage units there and But we also had our original laboratory in there. Well, once we got the new laboratory up and going, we demoed that space. And working with our manufacturing engineering group here in the office, we devised a whole new manufacturing line for one of our most popular products, one of our products that caused us to go out to an exorbitant lead time last year You know, 35, 40 weeks lead time. Well, we've been able to arrest that to around 16 weeks right now. But when we get this new manufacturing line up and going, we will be able to produce these large tonnage units, the ones that are more standard configuration at 150% greater rate than we do right now. And when we look at that, that means we'll be able to offer those units in a six to eight week timeframe on a regular basis. So that opportunity with that new manufacturing line, which will come on board, they're telling me sometime in December, so I'm kind of counting on it, you know, to start Q1, have that capacity available. Well, there's opportunities out there for those style units. These are the larger units. They run, I think they run 55 tons to 140 tons. Is that right, Norm? 55 on the small? Yeah, 55 to 140. So these fit, these larger units, Conditioned warehouses and some data center type battery cooling areas and things like that. They fit it very well. And so we're increasing our manufacturing capacity right there. And with that reduced lead time on that, so many of these projects are very, very sensitive to lead time. When these people start planning these data centers, when they pull the trigger, they want to be done yesterday. and so we're going to be able to respond to that even better than we are today.

One thing just to make sure that we're all understanding is our backlog is expected to potentially still decline in the sense that it's supposed to represent roughly about two months' worth of our production and that historically has been what we have found to be kind of an ideal range overall for us and that may be where we end up by the end of the year.

Yeah, so if we can end up the year with the across-the-board lead time being that eight weeks with some opportunity for some five- and six-week lead time on certain product groups, then that's going to put us in a very, very strong position going into 2021.

Okay. Well, thanks for taking my questions. I'll hop back in the queue. Thanks.

Mm-hmm.

Once again, I would like to remind everyone, in order to ask a question, simply press star, then the number one on your telephone keypad. We don't have any questions at this time. Oh, we have a follow-up question from the line of Joe Mondillo. Your line is open. Please ask your question.

Hey, guys. If you don't mind, I just have a couple of thoughts.

Sure, sure. Go ahead, Joe.

So as far as capacity right now, what size backlog, just so we sort of have an idea, what size backlog could you increase to where your lead times don't get extended or it doesn't cap your revenue? I'm just wondering how much revenue can this business sort of handle at this point?

Well, it's a moving target because we continue to add manufacturing capacity. The new building in Longview, for instance, we went from 234,000 square foot original facility down there. We're building 220,000 square feet. They're going to turn that building over to me in late November. We'll have that capacity coming online Q1, and so we'll have more capacity for Longview. Right now, if I segment Longview's backlog out there, They're at about 12 weeks right now, aren't they?

I believe they are.

Yeah, and that's a more lead time sensitive product group than what we produce here in Tulsa. You know, ideal down there is five to six weeks. Well, rather than curtail the orders, I want to increase the manufacturing capacity. So that'll come on January 1st. And so, you know, the ideal backlog today is for Longview would be substantially less than what it is. The ideal backlog for Longview starting January 1st is going to be about where it is right now. So that's that moving target. Now, Longview has traditionally been, what, 10%, 12% of our revenue? Is that about right? Yeah, roughly 10% to 12%. So if the Tulsa products were to become stagnant, which they won't, but if they were, then Longview's We're expecting good growth opportunity out of Longview in 2021. We've got multiple programs that we're working on with software development to expedite the processing and bill of materials generation so we can shorten lead times to utilize that manufacturing capacity. Then here in Tulsa, we still don't have all of our Salvagnini machines installed that we ordered for accretive capacity. We've got one machine right now that looks to be probably two weeks away from coming online, so that'll be some incremental capacity growth. So to answer your question, today, with the capacity I have today, the ideal backlog looks somewhere between 90 and 100 million. But I have increasing capacity coming on incrementally over the next few months, so that's going to be a moving target.

One of the things we're also working on is trying to make sure that we have capacity to deal with short lead time requests in a growing effort as we move forward.

Yeah, we've got to have headroom between demand and production capacity. If we don't have that headroom, then you begin to discourage these people because they call and say, hey, I need this unit in this lead time. And if you have to say no, they look for either an alternative solution or they just give up altogether. and so you know having additional manufacturing capacity to have that headroom for that that peaking. So over the last two or three years you've not seen the bell curve that had existed through most of the life of the company. I believe in 2021 that we're more likely to see that bell curve begin to re-establish itself and by 2022 I think it'll be firmly in place. That being that Q2, Q3 have higher revenue numbers than Q1, Q4.

Got it. How about raw materials? About 12 to 18 months ago, the spread between input prices and output prices sort of squeezed your margins, and I believe that sort of started to reverse in the other direction, but now we're seeing copper is pretty high historically and some other raw materials have been rising. So where are we on the price-cost situation?

I have a sheet that they give me from our purchasing group that has about 70% of all of our purchased materials, whether those are finished goods like compressors and motors or whether they're raw materials like copper, aluminum, steel and stainless steel. Overall, that's quite stable right now. We've had some things go down, some things go up. As a trend, it was down just a little bit year to date and we were able to lock in some pricing protection on certain aspects of that for... Do you remember how long we were able to lock in that steel? Yeah, so in the 12 to 18 month range on some of these materials, we've been able to lock in a buy price. So if those things begin to go up and I've got this locked in price, then I kind of like my chances with that. I think we've done quite well. So just to summarize that, Joe, I think right now what I'm seeing and what I've been given for the next six months outlook on material pricing is it's no impact, positive or negative. It's neutral.

Okay, good. And then as far as the SG&A, I think I may have missed it, but was that inflated? I thought I heard maybe Scott said there was a donation in the SG&A.

Yeah, you did miss that, Joe. You did miss that. So on May 12th, when the board of directors so graciously appointed me the CEO, that is the same day that Norm was appointed executive chairman. And so that's a next step for both of us. And in honor of that, the board voted for and granted a one-time contribution to The Winifred, Montana Independent School District, which is where Norm was born and raised. And I'm proud to say that Norm, Scott, myself, and Doug Wichman went there and presented that check in person to them for $1.25 million. So that was an SG&A expense in Q2. And if you look at that,

There's roughly two and a half cents a share on a pre-tax basis and a little bit under two cents a share on an after-tax basis.

Yeah. Okay. So even with our absenteeism, if you'll make an allowance for that contribution, we were pretty darn close to earnings expectations. And our SG&A would have been pretty much in line with what you had previously thought.

Mm-hmm.

Yes, correct. Even with taking that out, though, the SG&E is still up 14%, but I guess... Profit sharing, though. Yes.

Profit sharing. Don't forget, my employees, we allocate 10% of our pre-tax earnings to profit sharing. We issue the check. The check goes out Monday. Give me that exact amount, $1,256,000.

I don't know the exact number off the top of my head, but I'll get it for you.

Get it real quick. So it was $1,686 the first quarter, and I believe the number was $1,256. This is per employee, all employees with the exception of... $1,276.19 per eligible employee.

I was short by $20. That's $2.45 per regular hour of work.

Yeah, so that profit sharing is an SG&A expense, and it's our biggest variable. The two biggest variables in our SG&A expenses typically are warranty and profit sharing. And so warranty is down and profit sharing is up, and that's the way we want it to be.

Same period last year, that amount was $1,091. Okay, so that's a 25% increase. Almost. Almost.

27% increase. over last year. So at this point in time this year, on a dollars per hour basis, give me that calculation.

It was $2.45 per regular hour.

That was for the quarter.

For the quarter.

Year to date were $2.80.

$2.80. I don't remember the exact amount.

Yeah, yeah. So for year to date, our employees have gotten $2.80 an hour year to date in profit sharing bonus.

One part of this, G&A, we like to see going up.

Yeah, no, for sure. That definitely makes sense. Well, that's all the questions I had. I appreciate you taking the extra ones, and good luck with the back half of the year. Thanks a lot. Thank you, Joe.

Thank you, Joe.

All right, with no further questions, I want to thank all of you for participating and listening today. We'll talk to you in November for our third quarter results. Have a nice day.

That concludes today's call. Thank you for your participation and you may now disconnect. Have a great evening and stay safe, everyone.