Norman H. Asbjornson - Chairman, Chief Executive Officer, President, President of AAON Canada Inc, President of AAON Properties Inc and President of AAON Coil Products Inc Scott M.

Asbjornson - Chief Financial Officer and Vice President of Finance Rebecca A. Thompson - Chief Accounting Officer

Joseph Mondillo - Sidoti & Company, LLC Jonathan P. Braatz - Kansas City Capital Associates

Good afternoon. Norman Asbjornson here.

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

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

I'd like to introduce Scott Asbjornson, our Chief Financial Officer, now. Scott?

Welcome to our second quarter conference call. I'd like to begin by discussing the comparative results of the 3 months ended June 30, 2014 to June 30, 2013.

Net sales were up 1.2% to $92.3 million from $91.2 million. The increase in net sales was the result of price increases put in place at the end of the first quarter of 2013.

Gross profit increased 0.7% to $27.9 million from $27.7 million. As a percentage of sales, gross profit was 30.2% in the quarter just ended compared to 30.3% in 2013.

Selling, general and administrative expenses increased 16.4% to $10.6 million from $9.1 million in 2013. As a percentage of sales, SG&A increased to 11.5% of total sales in the quarter just ended from 10.0% in 2013.

The increase in SG&A is primarily due to a $1 million charitable donation the company has made in April 2014. Income from operations decreased 7.3% to $17.3 million, or 18.7% of sales, from $18.6 million or 20.4% of sales.

Our effective tax rate decreased from 36.1% to 34.7%, due to updated estimates related to certain state credits that caused the rate for the second quarter 2013 to be higher than expected. We expect our effective tax rate for the full year of 2014 to be approximately 34.0%.

Net income decreased 6.2% to $11.4 million, or 12.3% of sales, from $12.1 million or 13.3% of sales. Diluted earnings per share decreased by 9.1% to $0.20 per share from $0.22 per share.

Diluted earnings per share were based on 55,568,000 shares versus 55,725,000 shares in the same quarter a year ago. The results of the 6 months ended June 30, 2014 to June 30, 2013.

Net sales were up 6.7% to $168.7 million from $158.1 million. The increase in net sales was the result of a shift in product mix and the price increases put in place at the end of the first quarter of 2013.

Gross profit increased 15.7% to $49.7 million from $43.0 million. As a percentage of sales, gross profit was 29.5% in the 6 months just ended compared to 27.2% in 2013.

Selling, general and administrative expenses increased 13.4% to $18.2 million from $16.1 million in 2013. As a percentage of sales, SG&A increased to 10.8% of total sales in the quarter just ended from 10.2% in 2013.

The increase in SG&A is primarily due to a $1 million charitable contribution the company made in April 2014. Income from operations increased 16.9% to $31.5 million, or 18.7% of sales, from $27.0 million or 17.1% of sales.

Our effective tax rate increased from 29.5% to 33.1% due to certain federal credits taken in 2013 that have not been extended for 2014. We expect our effective tax rate for the full year of 2014 to be approximately 34.0%.

Net income increased 10% to $21.2 million, or 12.6% of sales, from $19.3 million or 12.2% of sales. Diluted earnings per share increased by 8.6% to $0.38 per share from $0.35 per share.

Diluted earnings per share were based on 55,604,000 shares versus 55,584,000 shares in the same period a year ago. To discuss our balance sheet, we have our Chief Accounting Officer, Rebecca Thompson.

We had a working capital balance of $92.4 million versus $77.3 million at December 31, 2013. Cash and investments increased $7.5 million to $57.3 million since December 31, 2013, the investments and maturities ranging from 1 month to 24 months.

Our current ratio is approximately 2.9:1. Our capital expenditures were $5.9 million for the 6 months.

Our budgeted capital expenditures for 2014 is approximately $13 million. Shareholders' equity per diluted share is $3.20 at June 30, 2014, compared to $2.95 at December 31, 2013.

We paid cash dividends of $4.8 million on July 2, 2014, an increase of 30% over dividends of $3.7 million on July 2, 2013. I'd now like to turn the call back over to Norm, who will discuss our results in further detail, along with the new products and the outlook for the remainder of the year.

Net sales were up 1.2% for the quarter and 6.7% for the 6 months. Sales increased due to price increase, some redesigned products and growth in the unit size of the products that we were selling.

Longview, which we have reduced the coil business from on the intercompany sales due to our transition into the all-aluminum coil, has increased their contractor sales, approximately offsetting the change in the sales to the Tulsa facility. The tone of the business in our various market segments is kind of as follows: the first part of the year, we had an extremely cold year, which delayed markets in all of our markets and kind of pushed the whole market back a few months -- or a month or so due to the cold weather, and construction was not able to begin as soon as possible.

However, by June, if we just make a comparison of June figures, which really will represent what transpired during the year, the markets in which we participate, lodging went up very high. It went up almost 19%, but it's only about 5% of our market.

Offices went up even greater. It is a little over 20% or thereabouts and is a fairly decent sized portion of our market at 13%.

Commercial, which represents approximately 10% change -- a little over 9% actually, is a bigger market, about 17% of our market. Health care actually went down between 5% and 6%.

It represents about 14% of our market. Education, which is, by far, the largest market we're serving, almost twice as large as any other market, went down a little over 6%.

It is, we believe, about 32% of our market. Religious is a very small market, but it went up a little over 4%.

Manufacturing went up around 8% and represents about 11% of the market. So all told, our market went up somewhat modestly.

And by the end of the year -- or the end of the quarter, our bookings of business is up a little more than what the market was up. However, the way in which that market came in due to the cold weather in the first quarter and also a price increase, which we had in March 2013, which brought in -- pulled in a lot of orders from following months, we had more business in-house at the end of the first quarter last year than we did this year.

Now as I said, we gradually got all that money back into the order flow, that $15 million roughly that got pulled in by the price increase last year. It all came in during this year and then some beyond it, so that we are ahead of last year by a reasonable amount.

But because it came in late in a -- later in the year, it didn't give us an opportunity to build it and get it out the door. Now there were some issues involved in what has taken place in the second quarter other than just the pushback from lack of orders coming out as soon as possible, as they would have the previous year.

The other thing that is very hard to put a quantity on, but I'll try and give you some idea what happened, we've made a lot of the transitions [ph] from the tube and fin coil over to the all-aluminum coil during the second quarter. And of course, that necessitated a total redesign in the condensing unit on every unit which we transition to.

Anytime you make a change, a significant change on the unit, of course, there are costs involved in making that change, not the least of which is the learning curve of the people assembling the product who have to learn how to build an entirely different condensing unit on the unit. And the people doing the refrigerant charging had to change that too because that portion of the unit as well was changed.

So those are hard things to quantify. But I had to quantify the difference of why we didn't get quite as high on the volume.

The revenue side is what we have been anticipated. It's a mixture between the lateness of when we got our orders and the slowdown, which occurred due to our transitioning into the all-aluminum coils.

The all-aluminum coils and the bad weather, both have been onetime incidents, but they nevertheless affected us. So they affected us both on the top line and on the bottom line.

To try and quantify it would be a very guessing -- big guessing game, so I won't try it. But we definitely did a few -- a couple -- $2 million, $3 million probably between those 2 on the top line and we probably did $0.01 or $0.02, maybe even $0.03 on the bottom line.

So those with a big issue which changed us. We are now about 90% changed over to the aluminum coils, somewhere around that on the dollar sales.

So going forward, there will be a lot less involvement in changing over to the aluminum coils. And we are starting to get the benefit from cost reduction from the aluminum coils.

We also, of course, during this transition on our Longview facility, had, had to transition our sales from Coils to Tulsa to products we're building down there for the outside contractors. And that had also a disruptive effect to the Longview facility.

That, again, is mostly transitioned, so going forward, neither one of the facilities will be bothered, particularly by the change over to the aluminum coils. That pretty much concludes what I have here, other than to talk a little bit about what is foreseen by various industry indexes.

As you know, a little better than half of our business comes from replacement business, and that is pretty much steady. That's following along just pretty much as one would expect.

The big differential one is new construction. New construction based upon government statistics in the fields, in the markets that we're covering, is still down over 20% from prerecession times.

The construction industry, nonresidential construction industry is one of the biggest laggards in recovering from the recession. A lot of indexes, however, are indicating a pretty good recovery is underway.

And as I mentioned, we have some recovery in this second quarter, and we have some recovery in the year. But we're still, as I say, still 20% down from prerecession times in dollars.

So we've got quite a ways to go to get back to it. There are some indexes, mainly Architectural Billings Index, which has generally been positive all this year, and in summary, is definitely positive.

That generally indicates orders that we will build on about 9 to 12 months from now. So we're hopeful that things are going to continue to grow, and this reversal which we're still in the process of trying to recover from, will start being an assistance rather than an impediment.

Operator, I'd like to now turn this over to the people for questions and answers. Do you have that, Nick?

So Norm, my first question has to do with the orders that you saw within the quarter. The orders were up almost 26%, $108 million in the quarter.

Just wondering if you could give us any more color regarding what's driving that, how did it trend from April, May, June, and what we're looking at now in July?

There's a big disruptive in there, as you know, because of that price increase we put in effect last year, pulled orders out of April, May and June last year -- into the first quarter of last year, and we did not have that occur this year, so we reclaimed a lot of dollars right there. But in addition to that, as you mentioned, we definitely have sustained growth in orders over the previous year when you look at it, where it is at the end of the second quarter.

The biggest change we've seen occurring has been the growth of larger tonnaged equipment. And that has been going on for some time now with our company, and it was very noticeable in the second quarter that we were getting a lot of larger tonnage orders than what we had been getting in the past.

So there has been a marked shift in the size of the units we're getting. Also, I mentioned back at the commercial market, which grew approximately 9% to 10% in the year, has seem to be a very good market for us.

We -- the lodging, as I mentioned, is very small thing, so we didn't get a whole lot of boost out of that. The office building had a phenomenal growth.

We didn't participate as well as I would like to out of the office building, so most of our growth came out of the commercial. We do because we've been very strong in the educational market.

We did suffer from the decline in the educational market.

All right. So when you look at the larger tonnage orders coming in and coming from commercial, is that sort of a case in point where there's just a larger projects out there, larger buildings that are requiring bigger tonnage type stuff, which I would think would mean that things are opening up?

Larger-type projects mean more money is being spent and that's a good sign of the business. Is that a fair way of looking at it?

That's probably somewhat true. I would say, however, there's a bigger thing that we simply managed to claim a larger percentage of it.

A lot of them in the commercial market worked such large jobs, and we've gotten a lot more jobs in that market. And I'd say that's been at least equal to any growth in the size of the jobs.

Okay. Is there any specific region in the country that's definitely doing much better than elsewhere for you guys?

I would say we've done particularly relatively well in the Midwestern region. We've started picking up a little bit better in the Southwestern region as well.

And the Northeast has continued to be fairly strong. The Southeast, we're putting a lot more attention to it, but we haven't seen as much results yet.

But I expect that the Southeast is going to start growing much faster. The West Coast seems to be a little more behind than the rest of the country.

Okay. Then moving on sort of to the transition on the coil production from the in-house to the outsourcing.

I'm wondering if you could give us an update on when you expect, on a run rate, you start to realize a majority of the savings from this transition? Is it in the fourth quarter, including reduction of headcount at Longview?

So if you look at the total savings throughout the whole transition, at what point in time do we see nearly like 80% to 90% of the total savings throughout this effort.

We're at about that point at the present time.

Okay. So largely...

Right in that point now, we're making that transition.

Okay, okay. And estimation of savings from this transition using the outsourcer, any update on what the expectation there is?

We're anticipating somewhere potentially of 1% on the bottom line. However, that may be eaten up in other costs since we see labor costs have been increasing slightly over this year.

Okay, okay. And then just lastly and I'll jump back in queue.

The SG&A as a percent of sales, that increased year-over-year, as well as sequentially, even if you take out the $1 million contribution to the library. What's going -- what's driving that higher as a percent of sales?

And what's sort of your expectation in the back half of the year going into '15?

Well, this year, we've had some transitions in our SG&A staffing as far as some changes in personnel, which have caused some cost alterations there. We don't anticipate the percentage growing.

It may actually decline slightly, in particular as a percentage of sales going forward. But we had some transitionary costs during this past year -- or the past 6 months.

The transition he's talking about is, we started out as a very small operation, extremely small, and as you grow, you get to a certain point where you think you need -- have certain needs that you put off, and then you get to a certain point it makes sense to start spending them. But in order to spend it and get to realize the gain on it, you have to make an investment.

And we're now making an investment in people to do a lot of cost reduction in our processes, just a lot of industrial engineering that we didn't do very well before. So it's a growing thing that we're doing.

Right now, we're spending the money and it'll start coming back from the improvement in the operation over time.

I jumped on late, but can you talk a little bit about -- the market seem to have been strengthening a little bit, and with your revenues being off in the quarter, did -- do you think you'll still gain market share? Or can you talk a little bit about your market share gains or losses?

And I apologize if you talked a little bit about it, but I guess I did jump on late.

Okay, yes. I went down through all the various markets we're meeting and...

Don't do that again.

No, I'll just make a generalized statement for you. And it has grown, as you indicated, modest.

We've outgrown that. We've grown more than the market change.

But what really distorts all of our analysis work is the fact that a year ago, in March, we had a price increase of about 3%, and that pulled in about $15 million out of subsequent months into March of last year. So March of last year and first quarter last year looks much better on order input than first quarter this year because we didn't have that price increase.

However, second quarter of this year, now we got that $15 million that was pulled into the first quarter last year. We got it into the second quarter this year.

So the second quarter this year on order input looks far better than the second quarter of last year. So you have to look at the 2 together to make any rational understanding.

And in that relationship, we have outgrown the increase in the market by a respectable amount, and hopefully, will continue to do so going forth in the last quarter -- or second -- third and fourth quarter, I should say. So yes, it's true that it got stronger, depending upon how you want to look at it, 2%, 3%, something in that vicinity.

Because the one thing that I don't think did strengthen, part -- about half -- a little over half of our market is in replacement market, and that, as far as I can see, didn't change appreciably from year-to-year. So all the growth that you got in the building part of it was modified by the fact that the replacement market might not have grown quite that much.

Okay. The -- I think the -- you mentioned that the improvements that you're looking for in terms of the conversion to the aluminum coil, you're talking about a 1% improvement.

Was that your net margin improving on the bottom line by 1%? What is that -- what are you referring to that 1%?

That was net income.

Okay. So 1% -- a 1% improvement in net income from these changes?

Correct. But we're also seeing some increases that have been taking place with respect to our labor costs.

Just a couple of questions, guys. So just to clarify that last question.

The 1%, you're talking about net profit margin, correct? Or...

Net income after tax.

Okay. So you roughly did $35 million, $36 million of net income last year, and you would be thinking 1% of that, which would be -- what is that, $350,000, roughly?

No, I'm talking on sales. It's 1%.

Okay. So as a margin percentage?

Okay. That's what I thought you were thinking of.

To follow up my question regarding the orders in the quarter, was just wondering also how the month of July and the first week of August has been trending compared to what you saw in the second quarter.

First, July was pretty much on schedule. August, so far, has been weak.

I'm not sure exactly why we're running a little weak on order input, but we are, so far, running weak. These are normally -- I'd like to tell you, they're normally kind of weak months, but it's weaker than I would anticipate in August right now.

Okay. But we're only a week in, so maybe it's just that...

They all work out pretty well, but it is definitely running weaker in August than I thought.

Okay. And then could you give us an update on the parts distribution business?

That's been a small piece of the entire company, but it's been growing considerably and it is higher margin. So any updates there?

It is running along quite well. However, it's running a little bit behind what our expectations were at this point in time.

The people who were involved in that are assuring me that it's likely to come back into what we're budgeting by the time the year is over. A lot of that is hard to judge because what's happening is, as we grow this thing, we get orders from representatives who are getting much more serious about selling parts.

And their orders will be quite large orders for parts, will be up in maybe a few hundred thousand dollars sometimes. And that takes -- moves all the parts sales into a very concentrated group.

Those parts normally will be used for over a period of quite some long time to come. So as they're stocking up on parts, which has been kind of sporadic because, at various times, various ones have decided to give us a large stocking order.

It makes it somewhat unpredictable, but what we're going to get in orders month-to-month because of those stock orders, which are coming in rather erratic. But in the sum, you look at the totality of it, we're running a little lower than we had anticipated at this point, but not much.

Okay. So if anything, if it picks up, that should, if anything, help your gross margin expand even more.

Yes. And it's a good thing when somebody makes a big commitment and does it because they may get serious about being more of a parts supplier in their general area.

And they build a marketplace, which then will feed into us even heavier than it was before. So each one of the commitments that they make is good for them and good for us.

But it is kind of hard to guess what's going to take place sometimes.

All right. And then just lastly, was wondering if you get an update us on your CapEx budgets for the year and what you're looking at there.

Yes. As we noted, we're at $5.9 million, I think it was, out of $13 million so far.

And we fully expect to be somewhere around the $13 million that we anticipated. And we have one last big one coming in, which is we bought some more sheet-metal fabricating equipment, and that will take -- make a big dent in the remainder of that dollars.

The rest of the stuff is pretty much small items, just a whole host of different things we're doing around here, improving of production lines, improving methodologies and spending just little bits of money here and there all over the place. And like I say, $13 million looks to be a reasonable number for the year.

All right. And then I know I said -- I just said one last question, but in terms of the cash, any new thinking behind uses of cash?

Well, we have a lot of thinking, but I wouldn't call any of it new except a discussion where, as you can see, we're flooded with plenty compared to what we normally have, and we haven't figured out what to do better. Undoubtedly, at some point, I don't have any idea.

We'll probably, at some point, increase the dividend again, but I'm not exactly sure when. We do have that one big issue which we have been talking about for some time, about the facility for the laboratory.

And we're getting closer and closer to building that laboratory. And when we do decide to do that, that's going to take, as we've talked before, somewhere in the $20 million area that we got to do.

So it'll make quite a dent in the cash.

On the dividend issue, just to point out, in our releases, we have referred to it now as a $0.09 a share, which, if you do that on the pre-split numbers, that's actually a 35% increase as opposed to what was previously announced of a 30% increase, because they don't make half-cents. So you would notice that in our press releases if we have rounded that up.

All right, if we have no other questions, I want to thank everybody who's on the line. We appreciate your being involved and listening with us.

We'll look forward to seeing you at the end of the third quarter, hopefully, give you a very fine third quarter. Again, thank you, and have a good afternoon.