AAON's (AAON) CEO Norman Asbjornson on Q2 2016 Results - Earnings Call Transcript

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AAON, Inc. (NASDAQ:AAON) Q2 2016 Earnings Conference Call August 4, 2016 4:15 PM ET

Executives

Norman Asbjornson – Chief Executive Officer

Scott Asbjornson – Chief Financial Officer

Rebecca Thompson – Chief Accounting Officer

Analysts

Brent Thielman – D.A. Davidson

Joe Mondillo – Sidoti & Company

Jon Braatz – Kansas City Capital

Operator

Good afternoon, ladies and gentlemen. Welcome to the AAON Inc Second Quarter Ending June 30th Sales and Earnings Call. There will be a question-and-answer period after management’s brief presentation. This call will last approximately 45 minutes to an hour.

I’d like to turn the meeting over to Mr. Asbjornson. Please go ahead, sir.

Norman Asbjornson

Good afternoon. Thank you. Before going forward, I'd like to read a forward-looking disclaimer. To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year such statement is necessarily forward-looking and pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act of 1995.

As such, it is subject to the occurrence of many events outside AAON’s control that could cause AAON’s results to differ materially from those anticipated. Please see the risk factors contained in our most recent SEC filings, including the Annual Report on Form 10-K and the Quarterly Report on Form 10-Q.

Thank you. I’d like now to introduce Scott Asbjornson, our CFO.

Scott Asbjornson

Thank you, Norm. Welcome to our conference call. I would like to begin by discussing the comparative results of the three months ended June 30, 2016 to June 30, 2015. Net sales were up 13.3% to $102.3 million from $90.3 million. Sales increased due to increased volume as compared to the same period in 2015. The gross profit increased 20.8% to $32.7 million from $27.1 million. As a percentage of sales, gross profit was 32% in the quarter just ended compared to 30% in 2015.

Selling, general and administrative expenses increased 14.8% to $10.6 million from $9.2 million in 2015. As a percentage of sales SG&A increased to 10.3% of total sales in the quarter just ended from 10.2% in 2015. The overall increase in SG&A was primarily due to increased compensation and profit sharing expenses due to better results versus the same period last year. The increase was partially offset by a decrease in other expense, which was higher in 2015 due to sales taxes to certain states.

Income from operations increased 23.7% to $22.2 million or 21.7% of sales from $17.9 million or 19.9% of sales. Our effective tax rate decreased to 35.6% from 38.2%. The Indian Employment Credit and Research and Development Credit were not extended until December of 2015 for the 2015 and 2016 tax years. As such, the effective rate for the three months ended June 30, 2016 is reduced for the impact of these credits while the effective rate for the three months ended June 30, 2015 does not reflect these credits. The estimated annual 2016 effective tax rate, excluding discrete events is expected to be approximately 36.0%.

Net income increased to $14.3 million, or 14.0% of sales, compared to $11.1 million, or 12.3% of sales in 2015. Diluted earnings per share increased by 35% to $0.27 per share from $0.20 per share. Diluted earnings per share were based on 53,401,000 shares versus 54,670,000 shares in the same quarter a year ago. The results of the six months ended June 30, 2016 to June 30, 2015. Net sales were up 12.4% to $187.7 million from $167.0 million. Sales increased due to increased volume as compared to the same period in 2015.

Our gross profit increased 19.6% to $58.5 million from $48.9 million. As a percentage of sales gross profit was 31.1% in the six months just ended compared to 29.3% in 2015. Selling, general and administrative expenses increased 11.2% to $19.5 million from $17.5 million in 2015. As a percentage of sales, SG&A decreased to 10.4% of total sales in the six months just ended from 10.5% in 2015.

The overall increase in SG&A was primarily due to increased compensation cost and profit sharing expenses due to better results versus the same period last year. The increase was partially offset by a decrease in warranty expense related to continued improvement in quality control and other expense, which was higher in 2015 due to sales taxes to certain states.

Income from operations increased 24.2% to $39.0 million, or 20.8% of sales from $31.4 million, or 18.8% of sales. Our effective tax rate decreased to 36.0% from 37.9%. The Indian Employment Credit and Research and Development Credit are not extended until December 2015 for the 2015 and 2016 tax years.

As such, the effective rate for the six months ended June 30, 2016 is reduced for the impact of these credits; while the effective rate for the six months ended June 30, 2015 does not reflect these credits. The estimated 2016 effective tax rate, excluding discrete events, is expected to be approximately 36.0%.

Net income increased to $25.1 million, or 13.4% of sales, compared to $19.5 million, or 11.7% of sales in 2015. Diluted earnings per share increased by 30.6% to $0.47 per share from $0.36 per share. Diluted earnings per share were based on 53,395,000 shares versus 54,715,000 shares in the same period a year ago.

At this time, I'll turn it over to our Chief Accounting Officer, Rebecca Thompson, to discuss our balance sheet.

Rebecca Thompson

Thank you, Scott. Looking at the balance sheet, you'll see that we had a working capital balance of $91.5 million versus $80.8 million at December 31, 2015. Cash and investments totaled $44.6 million at June 30, 2016, the investments and maturities ranging from one month to 13 months.

Our current ratio is approximately 2.7 to 1. Our capital expenditures were $15.8 million for the six months ended June 30, 2016. We expect capital expenditures for the year to be approximately $32.7 million. Shareholders' equity per diluted share is $3.65 at June 30, 2016, compared to $3.28 at December 31, 2015. We also continue to remain debt free. In June 2016, the company executed a 10b5-1 repurchase agreement in accordance with the rules and regulations of the SEC, allowing the company to repurchase an aggregate amount of $25 million or a total of approximately 2 million shares from the open market.

I'd now like to turn the call back over to Norm, who will discuss our results in further detail, along with new products and the outlook for the remainder of the year.

Norman Asbjornson

Net sales were up $13.3 million for the quarter. Sales increase was only due to volume increase, we have not had any price increases. Water-source heat pump is in line. I would like to take a moment to talk about that. We decided approximately one year ago in August to go into the water-source heat pump business.

We have started out with an extremely aggressive plan to both design product and put in place manufacturing facility. We have accomplished approximately 60% of the design of all the products we’re going to be needing to do that achievement and we have got – we’re down to the commissioning level of commissioning our manufacturing facility, which will then allow us to go into production around the end of this month.

In one year’s timeframe that is an extraordinary accomplishment. I am extremely proud of the people in AAON for accomplishing it. It would normally be a multi-year process we have accomplished in one year. I’ll now talk a little bit about the total business [Audio Dip] business segment. The replacement market seems to be the unknown and difficult one to judge. The new construction market is by ABI, Architecture Billings Index running at a positive pretty much consistently throughout the year. So that means 6 to 9 months forward looking there are increased numbers of buildings being put on the market.

There is still many of the people who are paying for having them design go ahead and contract for production of the buildings. The AHRI the industry reporting service on equipment is showing that in the commercial sector we are getting growth recurring and there seems to be some disconnect between the percentage of growth from AHRI and the industries reporting to this sets this Census Bureau on the number of dollars being spent on the buildings.

So the AHRI is lagging a little bit as far as percentage is compared to what the industry reporting does through this Census Bureau as far as the type of buildings. That must be attributable to a little bit of softness in the replacement market.

And there is no real good other way to find out what’s going on in the replacement market but we would kind of concur that there seems to be a little softer than rates in the new construction market. The good thing on that is that we are more reliant on the new construction market than we are in the replacement market and that may be to some extent why we are finding that we are doing better than some of the other people who are reporting in the AHRI are doing.

We look down through commercial buildings, are having a little bit more of a struggle as in commercial and retail buildings and that seems to be in excess of buildings in that arena. Office buildings are showing a little more strength, medical and healthcare surprisingly is not showing as much strength as one would think. Education has come back a little bit more, manufacturing is doing quite well, lodging is doing quite well. So it’s a mixed bag as far what the census bureau is reporting that is occurring in the building traits.

The backlog on June 30, 2016 of $69.3 million compares to $66 million a year ago. So we are still growing backlog which is generally an amount that is consumed in the following two months of production. So you could expect that most of that $69.3 million that's in the backlog as of June 30, to have been built and shipped during July and August.

We’re into a pretty much that we finish off, we know where we are pretty much for the third quarter. So because it's in the new back log and we're still even though this soft market seems to be out there we are still continually doing fairly well compared to last year and we continue to do so. But we did think at our announcement there was a proper thing to do to alert you, the market in general seems to be kind of squishy some days it's up and some days it’s down more than we would normally expect.

In spite of that we continue to deal pretty well but it is soft market and it is a challenging market. We don't see any downturn in our immediate income right at this point in time. It was not intended to say that we were getting a downturn in our backlog. Although it has diminished a little bit as of percentage of growth. It is still very healthy and outgrowing our previous works.

So as far as we can see which is the third quarter, the third quarter looks quite good for AR. The fourth quarter is because we don't have orders in the backlog for the fourth quarter are very still unknown. All we could do is say that we see no reason based upon what's happening right now for us to have anything but a fairly good fourth quarter as well.

We do however have a very difficult comparison to meet because we had an outstanding fourth quarter last year. So that will present us with some problems. We do have a couple other problems that we must talk about however besides that. And that’s the gross profit. While we don't shoot to maintain a percentage profit so much what we focus on is more how many dollars we put to the bottom line.

So we're willing to sacrifice gross margin if we can put more dollars to the bottom line, probably you could see if you look at us historically we tend to make very good profit. And we expect to continue to making very good profit. So that as far as we can see it at the present time as a healthy situation for us. Our worst case scenario has to do with the fact that we’ve enjoyed a diminishing of commercial products, of production products commodities primarily and steel being one of them. Copper, aluminum being the others.

The copper, aluminum, and steel still hanging in there at a very attractive price. The steel however has had a notable upturn due to a governmental duty that was applied a few months ago by our government against Chinese steel. And that did cause a substantial increase in the steel cost however as is always the case in most things the immediate reaction and it usually modifies itself for a variety of reasons as time goes on and such has been the case in the case of steel.

So that we are seeing a little bit different perspective on the steel increase than we did in the preceding conference call when it had just happened at that time. Let Scott give you kind of a outside look at what steel is doing to, since he is probably at more closely than that of I.

Scott Asbjornson

Yes what we anticipated at the present time is that a worst case scenario is the increase in steel price could diminish our gross margin by an amount equivalent to approximately 2% of sales. We are working on a project to bring it below 1% of sales but that is still in the works of the present time. So our worst case scenario that we are predicting at the current rate is at 2% of sales impact to gross margin. We anticipate we can bring it in below that but we are not certain. And it's not finalized as of yet turn that back over to Norm.

Norman Asbjornson

Okay, now there’s but against that we have three small areas which can positively affect. The first one that most likely comes to everybody's mind is well raise your price, I would point out that we are by far the most profitable company in the industry. And if we are the sole price increaser some people would think you’ll love us for being that. So it is a little bit nebulous on that basis and at this point in time we've not seen although we have heard that some our competitors are intending to raise the price because of steel but we have not seen this happen yet.

So that's not a decided factor as to whether we should employ that or not. The next to both of which have been occurring to us throughout the past year has been increased productivity. We continue to believe that our productivity is going to increase and so that will diminish that effect on our P&L. The mix think of it as if we continue growing the business three quarters we’ll somewhat over absorb our fixed overhead. So those two things will be modifiers to the cost increases well. At this point in time it’s certainly nothing out there that is causing us panic it's just causing us a little discomfort. And then we’ll until we find the – determine that we’re going to have some way to over come it. The biggest unknown in the whole scenario that we’re not discussing too much, although I’ve mentioned so far is water source heat pumps. This is an unusual situation for me. I’ve been in this industry a very long time. And generally speaking, what I just start out in some venture, there is a number of bad things happened a long way just like there’s number of good things happened a long way.

I’ve got to tell you this has been a very delightful experience, the personnel here at AAON, who undertook to design the product have been hitting all their schedules. The personnel who are involved in putting together the manufacturing have been hitting their schedules. In addition to which it results that they are obtaining is truly outstanding, we expect to have a very wonderful product and an extraordinarily productive manufacturing environment. And as I say in both cases we are starting to round the curve hitting for the finish line. And we sold any – or have we got any significant orders yet, the answer is no.

The first production will start occurring about the end of this month, the first part of the next month. And we are going to start it out very slowly and we are planning a very slow ramp up until the first part of November. And the reason for the slow ramp up is if you start ramping up and you put lot of personnel on the line and there you start running into a lot of problems, you all of a sudden have a lot of money inefficiencies which is very negative to your bottom line. So we have chosen to do slow ramp up which of course if we don’t have those problems will impact our P&L negatively and the respective we won’t make the profit we could possibly make. But on the other hand if we do run into some problems we are not going to have a negative impact upon our P&L which would occur if we did a fast ramp up.

So we’ve chosen to do a slow ramp up until the first part of November at which point time we will determine if we’ve gotten a problems. And we will then at that point adjust our production and our order take and everything accordingly. We do have approximately space for approximately $1 million to $2 million worth of inventory and its our intent to go into production without worrying so much about building for given order but we got to build for inventory and orders which will give us more stability in our manufacturing process less likely would it have problems and better opportunity to really ramping up once we start going because we will have some inventory in place as well.

So we are taking somewhat of a – which you might say a cautious approach to the way we are going to go into the manufacturing. And why would you say we would do this. Our manufacturing methodologies up-to-date have been best described as mass customization and something which we feel we have an outstanding ability and if we go to surpass the industry in that type of manufacturing environment and that’s been largely the responsible thing for giving us such a successful company here.

In this environment, goal that we are going into, I had in my past work for and in fact one of the previous companies into the Water Source Heat Pump business. So I had 16 years of water source heat pump business back in my inference in this industry. It, of course, is a very old knowledge so we have used our representatives many of whom have great deal with Water Source Heat Pump business to give us guidance we have also been in the process of very slowly and very cautiously searching out and gaining knowledge by hiring people who have correct knowledge in the Water Source Heat Pump business.

The net result of it is we think we are entering a market with an extraordinarily attractive product to the customers. And we think that with all the way we approach the manufacturing in which we have spent approximately $12 million of that $15 million in capital which we spent it on putting that production line in place with a highly automated effort in every place we could. Virtually every piece of equipment it will be used to manufacture the Water Source Heat Pump is new equipment. Specifically selected for its ability to manufacture that type of product, so we think our productivity is going to outstanding with an outstanding product we have a great deal of belief that we are going to make that equal to the profitability of the existing profit product we have but it will probably take us a year to get all the wrinkles out of it.

All the people who trained within the company before we hit that. So in the interim we will be gradually building the profit percentage if you will as we slowly gain the knowledge and how to run the operation and get through little kings worked out of the manufacturing. But as everyone within the company very optimistic about what its going to do for the company we don’t think its going to get to where its really doing what we want until probably like 2018 but it will start affecting us next year.

At this point in time, I would like to open it for question-and-answers. We just embark upon that.

Question-and-Answer Session

Operator

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

Brent Thielman

Hi, good afternoon.

Norman Asbjornson

Good afternoon.

Brent Thielman

Some of the comments on the markets staffing, I appreciate all that different viewpoints there. I’m wondering are you seeing evidence of that maybe more specific in the regions or markets where you haven’t made significant sales managers, sales channel changes?

Norman Asbjornson

We always have weakness for your personnel [indiscernible] strong as they are in some of the other areas. And so yes that is true for instance big change we did last year putting those regional managers and they’ve had varying degrees of success but by and large they’ve been successful but there is no question that’s been varying degrees. And also in the change out of the sales of people if we had out there the manufacturers’ reps. They have been coming on but when we got rid of the other people they worked of course doing nothing and so its taken a while for those others to even get back to equally what the other ones were doing.

So both of those were negatives on us last year, really heard us in the second and third quarter of last year and kind of disappeared in the fourth quarter of last year and the first quarter and the second quarter this year. All of those people are coming up to speed better.

What I think we are seeing to some degree is improvement that we have made in both the regional managership as well as the sales offices and the corresponding additional efforts we’ve been able to get to our existing offices is kind of offsetting some of this weak situation we are seeing in the marketplace. And that’s why we are still performing fairly well.

I think that’s what we are hoping that – from what we see it on the forecast that we get from the PL, we get forecast from them on a regular basis showing what they anticipated by the due for the next few months. And so far it’s still looking fairly promising in that respect.

Brent Thielman

Okay, that’s encouraging. And then – yes, your comments on the steel cost impact, I appreciate the color there, were some of the things that you are doing that kind of counteract that? Is that how we are going to see that in the third quarter or is that going to be more than fourth quarter event?

Norman Asbjornson

Well, here’s the way we see at the present time. We were using a 100% U.S. manufactured steel. What happened when the duty was applied, very, very big duty that the government applied to the Chinese steel, they did not apply it to all manufacture’s steel from all countries throughout the world. And so to varying degrees, of course, as would normally be when the scarcity appears, which happened, the U.S. manufactures immediately raised their price significantly. Some of the foreign get to some degree, but not this much.

And basically the chain of supply and everything got altered by the nature of the restrictions specific to the Chinese steel, and some of our suppliers were accustomed, working with some other foreign countries as well as the domestic ones. And so some of our supply chain immediately said we can give you foreign steel at a diminished cost, and then in some cases we’ve taken them up on it.

Recognize, we always forward price as much as we could do, and we're just now getting to the point where we're starting to get close to running out of that pre-bought steel. So our increases are starting to happen, but it looks like what is going to happen to us is we model a little bit of high – you might call high priced steel, that’s going to happen to us over the next two or three months.

And then because we're getting ourselves in better shape to know how to buy foreign steel and also because that there's the old pendulum always swings too far one way or the other, the U.S. steel manufactures are starting to break down. And so we're thinking there's going to be a little bit of cost increase more in the later part of the – maybe in the fourth quarter and then it's going to diminish again as it was going into the first quarter, that's kind of – what we kind of think is going to happen. All of this of course is somewhat supported by what is occurring to us and some of it is speculation.

Brent Thielman

Got it. Understood. Sounds like it’s still kind of a fluid situation.

Norman Asbjornson

It is.

Brent Thielman

On the Water Source Pump line, as you start to introduce this quarter, and obviously in the future quarters, does that going to meaningfully move SG&A from here?

Norman Asbjornson

I don't expect its going to have a great deal of effect on the SG&A, although it will have some because we're going to be hiring some dedicated sales personnel to sell Water Source Heat Pump because the knowledge of selling that kind of product is not present very well in our present organizational structure. So we're bringing dedicated people in, and then of course, it will take a few months for them to really pay for themselves. And so it will trip us up for a little bit.

Brent Thielman

Okay. And then just one last one for me on the pump line. Are we going to start to see that that show up in backlog or do you plan to include that in there going forward?

Norman Asbjornson

It will include in backlog, it is another company product, and so it will be pulled right in. We work just like we do internally now. We carrying individual profit and loss on various product lines and we’ll do the same on the Water Source Heat Pump. So we have no way how it's doing and how’s it’s contributing, but what you will see out there will be a combined Water Source Heat Pump and all of our past and existing product lines, you will not see it as a separate item.

Brent Thielman

Understood. Thanks for all the color and best of luck this quarter.

Norman Asbjornson

Thank you.

Operator

Your next question comes from line of Joe Mondillo from Sidoti & Company. Your line is open.

Joe Mondillo

Hey, guys, good afternoon.

Norman Asbjornson

Hi, Joe.

Joe Mondillo

So just – I just wanted to follow-up with some of the commentary that we've been talking about regarding the steel prices. So the first half of the year you were able to roughly expand your gross margins by roughly about 200 basis points year-over-year, and you're talking about how the back half could be a maximum of 200 basis point headwind, and with all the productivity improvements you're seeing that are going to offset that. Could we still see gross margin expansion in the back half of the year on a year-over-year basis?

Scott Asbjornson

Look, if you are comparing the full year, then you'll still get the benefit of what's already taken place in the first half of this year, so you would see that, certainly. And as far as continuing to see the – say, the third quarter better than just what the third quarter by itself of last year, I would anticipate that as well, because a lot of the third quarter is still going to have an expensive steel in it. The more challenging one is going to come up when we get to the fourth quarter.

Joe Mondillo

Okay. And…

Norman Asbjornson

And we just talked about being somewhat fluid.

Joe Mondillo

Right. And then if you look at that fourth quarter, you're also seeing a tough comp on the top line or the volume side of things. So the fourth quarter could be difficulty whereas the third quarter maybe not as much.

Scott Asbjornson

That would be our take on it.

Joe Mondillo

Okay. And then – sorry.

Norman Asbjornson

We just have – we have weak – somewhat weak third quarter last year and a strong fourth quarter.

Joe Mondillo

Okay. Right. So looking at your backlog the last two quarters; if you compare the revenue growth in a quarter relative to the backlog growth of the previous quarter, you were able to outperform the backlog growth, which tells me that the first month of that next quarter you’ve received a pretty good order intake. So I was wondering how – I guess the month of July has looked for you guys so far in terms of overall.

Norman Asbjornson

The month of July – the order input on the month of July was weak. The order input so far in the month of August has been strong.

Joe Mondillo

Okay. All right. And then in terms of the SG&A, last year you had some of that – some tax situation that was a one-time type of item in the SG&A line. So if you exclude that in the second quarter of last year you were out of roughly about 9.7% and sort of similar in the first quarter, which makes the SG&A, the percent of sales for the first half of this year higher than it was last year even though you're seeing much better revenue line. Just wondering why the percent of sales SG&A is rising. I understand on an absolute basis, but as a percent of sales, I would think it would fall.

Scott Asbjornson

Look, part of what we have that goes into that SG&A is we have sales incentive payments, bonuses as we payout, and we also have profit sharing. Those are two big components of what have increased, is obviously we've been doing fairly well on our sales side this year, though our salespeople compared to last year at the same time are getting more significant compensation, so that we're seeing the compensation largely to our salespeople and the infinite plans going up.

Joe Mondillo

So is the compensation or the commission rates – are the rates actually going up as well?

Scott Asbjornson

Well, they have a formula that’s driven by their achievement towards our budget for their regions. And so some of them are doing better than others and that had a progressive increase. So it’s a little bit better than ado, it will get to be a higher value for them as a percent of their base compensation.

Joe Mondillo

Okay. And then just lastly and I don’t if you mentioned this regarding the water-source heat pump, actually I got a couple of questions regarding water-source heat pump. In the second quarter, did you realize any cost that significantly affected the bottom-line at all?

Scott Asbjornson

Relative to the water-source heat pump?

Joe Mondillo

Yes.

Scott Asbjornson

No for the most part what we have been doing is being captured for capitalization when the lines start up.

Joe Mondillo

Okay. And just in terms of your outlook of that market, I know it’s, I think relatively slow, just given energy prices. You mentioned in the past that you think you may be able to, low-hanging fruit upwards of may be 20% of the market share, which I think is roughly around $100 million you’ve talked about. Do you still think that’s a possibility in the next two years call, or is that going to be tough? I’m sure you’re going to shoot for it, but is that going to be challenging to get to 20% market share in just a matter of a couple of years?

Norman Asbjornson

No question to be tough, next year would be impossible, the second year in 2018 it would still be quite a stretch, but we think that we’ve got enough things going for us that is going to be kind of like when you start learning to run and walk, you kind of stumble every now and then, you didn’t intend to. I suspect that’s going to cause us so many problems as we try and ramp this whole thing up, we’ll occasionally stumble a little bit too much. And then that will prevent it. As far as the ability to take the market, I don’t think that is going to be the big problem for us, I think, we’ve got the salesforce that’s necessary to do it, I think we have the product that’s necessary to do it, I’m sure that we’re putting in place the production facility necessary to do it, but the stumbling, I think is going to happen.

Joe Mondillo

Okay. And then I just actually have one last question. In terms of your CapEx budget this year what are you exactly looking that to be – looking for that to be?

Scott Asbjornson

We have budgeted $32.7 million. We still anticipate that we’re likely to spend somewhere close to that, but we don’t have an updated figure that shows any changes in any direction up or down, but we’re anticipating the $32.7 million is pretty solid.

Joe Mondillo

Okay great, thanks a lot. I appreciate you taking my questions.

Scott Asbjornson

Thank you.

Operator

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

Jon Braatz

Good morning guys – good afternoon. Most of my questions have been answered, but Norman correct me may be I'm wrong, but in your press release you talk about, on the water-source heat pump, a profit impact – not a significant profit impact until 2018. Has that changed at all, because I thought maybe we were looking for something possibly more in 2017, late 2017?

Norman Asbjornson

We're looking to start impacting it in 2017, obviously it will be occurring. It may start occurring a little bit in 2016, but what we’re saying in 2018 it would be a very major part of our profit. If we get there as we spoke earlier, if we get in very close to the $100 million in revenue, we’d better be doing a pretty good job on the bottom line or we made a bad mistake in someplace. And we don't think we have made any mistake. But we think until then it's just going to be a growing thing because this is – as my reference to the stumbling occurs the stumbling is going to be cost negative it's going to be hurting us whenever we do stumble for whatever reason.

And so during 2017 that's probably going to happen. Now how much is going to happen? Oh I wish I knew. If I knew how to do it, I wouldn’t stumble. But I’m just cautioning historically my experience is that things don't always go quite the way you think there are going to go. And I fully expect that will be the case here.

I will say that I’ve been very, very pleased with all the performance of the people within the company at what's been going on so far, they have nailed things down remarkably well, and right no schedule, right on every aspect of what they're doing. We made a presentation to our Board of Directors this week. I think they came away positively blown away by what they saw and the way we’re putting this thing together.

The manufacturing, just to refresh some people's minds, may not. We set out 28 ago with two distinctly strong beliefs, we had to be to be successful, we’ve had to be the technological leader in product and we had to be the technological leader as much as we could afford to be in manufacturing methods. Well as much as we could afford to be has pretty much gone away now. So what we did in putting this water-source heat pump together, we looked world-wide for everything that would possibly work in improving productivity, in building water-source heat pumps in mass method and it will be very much.

Just to give you just a little hint, we will not have paper running around out there, we will have TV screens all over the manufacturing thing which will be telling the people how to put stuff together. We will virtually eliminate certain functions that would be normal in a normal manufacturing methodology. We have built instead of this being a spread out one storey type manufacturing facility it is a two-storey facility with [Audio Dip] first floor and second floor back and forth, with first floor being the assembly area and the second floor being there support area. Very different approach that we've used in this and we expect we will make it extraordinary efficient methodology for building.

We also know that because we are doing so many things that nobody has real experience we had to be very, very careful there. We’ve had to test them very thoroughly as we're doing constantly on a daily basis and I’ve become very thrilled with the fact that we're really coming down to the homestretch and we just seem to be doing better and better and the possibility for stumbling seems to be lessened every day.

So I’m very, very optimistic about what's going to happen, but I'm still cautious, I’m still concerned with the probability we're going to stumble in some place.

Jon Braatz

I understand. Scott you talked a little bit about some actions that you might initiate to reduce that 2% number that you mentioned and mitigate the higher cost of steel. What might some of those actions be? And do you just – is it simply buying and sourcing your steel from different areas and different firms, or is it more than that?

Scott Asbjornson

No it is doing better sourcing and sourcing from outside of the United States.

Jon Braatz

Okay, okay. Will that include...

Norman Asbjornson

So that’s…

Jon Braatz

I've always – I’ve heard about problems with Chinese steel, would that include Chinese steel?

Norman Asbjornson

No.

Scott Asbjornson

No.

Jon Braatz

Okay.

Norman Asbjornson

We will be getting steel from other parts of the world.

Jon Braatz

Okay, thank you.

Norman Asbjornson

The big problem we have is we have not had organizational set up in the purchasing of steel from mill site. And so we're having to develop those sources of steel, in areas prove them and make sure that we’re getting the quality we want. So we’re doing a lot of work in areas that we’re not accustomed to.

Jon Braatz

Thanks for that.

Scott Asbjornson

Thank you.

Norman Asbjornson

Thank you.

Operator

There are no further questions at this time.

Norman Asbjornson

All right I’d like to thank the audience. See you again in November for our third quarter and end results. And we are very optimistic we’re going to have a very nice time in November. Talk to you then. Thank you.

Operator

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

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