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, Inc. DeForest R. Hinman - Walthausen & Co., LLC Jonathan P. Braatz - Kansas City Capital Associates.

Good afternoon, ladies and gentlemen. Welcome to AAON Inc. Third Quarter Sales and Earnings Review. There will be a question-and-answer period after management's brief presentation. This call will last approximately 45 minutes. I would now like to turn the meeting over to Mr. Asbjornson. Please go ahead, Mr. Asbjornson..

Good afternoon. Welcome to third quarter report of AAON's financial results. 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 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 now to introduce Scott Asbjornson, our CFO..

Welcome to our conference call. I'd like to begin by discussing the comparative results of the 3 months ended September 30, 2014 to September 30, 2013. Net sales were up 14.7% to $102.9 million from $89.7 million.

The increase in net sales was the result of the increase of number of units sold, as well as due to a change in the mix of tonnage and features, a 7% increase in the average price per unit sold as compared to 2013. Gross profit increased 25.3% to $33.4 million from $26.6 million.

As a percentage of sales, gross profit was 32.4% in the quarter just ended compared to 29.7% in 2013. The increase in the gross profit percentage is a combination of decreases in raw material costs and efficiencies gained from our investments in equipment.

Selling, general and administrative expenses increased 42.8% to $13.8 million from $9.7 million in 2013. As a percentage of sales, SG&A increased to 13.4% of total sales in the quarter just ended from 10.8% in 2013. The increase in SG&A is primarily due to a $3 million pledge to A Gathering Place for Tulsa, the company made in September 2014.

We feel it is important for AAON to be a part of this transformational project in our headquarter's community to help attract and retain employees. Income from operations increased 15.3% to $19.5 million or 19% of sales from $16.9 million or 18.9% of sales. Our effective tax rate decreased to 36.3% from 38.1%.

We expect our effective tax rate for the full year of 2014 to be approximately 34%. The 3 months ended September 2014 and 2013 had return to provision adjustments that caused the effective rate to be higher than expected. Net income increased 18.2% to $12.4 million or 12.1% of sales from $10.5 million or 11.7% of sales.

Diluted earnings per share increased by 15.8% to $0.22 per share from $0.19 per share. Diluted earnings per share were based on 55,484,000 shares versus 55,526,000 shares in the same quarter a year ago. The results of the 9 months ended September 30, 2014, to September 30, 2013. Net sales were up 9.6% to $271.6 million from $247.8 million.

The increase in net sales was primarily 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 19.3% to $83.1 million from $69.6 million. As a percentage of sales, gross profit was 30.6% in the 9 months just ended compared to 28.1% in 2013.

Selling, general and administrative expenses increased 24.5% to $32 million from $25.7 million in 2013. As a percentage of sales, SG&A increased to 11.8% of total sales in the 9 months just ended from 10.4% in 2013.

The increase in SG&A is primarily due to a $3.9 million increase in charitable donations, along with some increases in employee compensation and benefits. Income from operations increased 16.3% to $51.1 million or 18.8% of sales from $43.9 million or 17.7% of sales.

Our effective tax rate increased to 34.3% from 32.8% 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%. Net income increased 12.9% to $33.6 million or 12.4% of sales from $29.8 million or 12% of sales.

Diluted earnings per share increased by 13% to $0.61 per share from $0.54 per share. Diluted earnings per share were based on 55,423,000 shares versus 55,563,000 shares in the same period a year ago. At this time, I will turn the call over to Rebecca Thompson, our Chief Accounting Officer, to discuss the balance sheet..

Thank you, Scott. Looking at the balance sheet. You'll see that we had a working capital balance of $88.5 million versus $77.3 million at December 31, 2013. Cash and investments increased $4.8 million to $54.7 million since December 31, 2013. The investments have maturities ranging from 1 month to 22 months. Our current ratio is approximately 2.7:1.

Our capital expenditures for the 9 months were $13.6 million. We expect our capital expenditures for the year to be $15 million to $16 million. Shareholders' equity per diluted share is $3.23 at September 30, 2014, compared to $2.95 at December 31, 2013.

The company also repurchased a total of 530,000 shares of AAON stock under its resumed buyback program for approximately $9.8 million during the third quarter of this year for an average price of $18.55 per share.

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..

As noted before, net sales were up 14.7% for the quarter and 9.6% for the 9 months, primarily due to a shift in product mix, as well as price increases at the first of last year. Redesigned products assisted greatly in the increase in this sales category.

Products growth has not been particular to any particular segment of the product line, just a general overall growth and a somewhat inclination to get larger tonnage units sold. We have had one notable change occur in our Longview facility.

Due to the fact that we are now outsourcing our condenser coils for a lower cost all aluminum coil compared to a copper aluminum coil, which we've previously manufactured, we now have gone to the point where approximately 50% of our sales from that facility are to outside sources, out to contractors and on jobs as opposed to intercompany sales to Tulsa.

So we have transitioned from being primarily a coil company to now being a joint coil company and other products, and we're slowly going to see that transformation continue on, and we'll become more and more an outside sales company out of the Longview facility.

The tone to our various markets and what's happening in our markets is kind of interesting. Now if I were to give you the order of -- we participate -- the order of what the increases are, you should be aware we participate in the markets that are identified by the federal government as 7 different markets.

The one which has gone up the most in both dollars as well as percentage has been manufacturing, which is a welcome find of increased activity in our manufacturing, construction market. The next one, which has gone up the most in terms of percentage growth has been the office market.

However, the office market, because it's a smaller market than the educational market, the educational market, even though it's #5 in order is, in dollars, virtually the same increase or very close to the same increase as office building increase. #3 in percentages is lodging.

But lodging is a smaller market, therefore, it doesn't increase the dollars as much as even #4, which is the commercial market, which increased the fourth largest. The fifth largest increase we have was back down there in that educational market which, in dollars, was equal virtually to #2. Our #6 increase is the very small market of religious.

So if you really look at that and see where the dollars came from, they came from the manufacturing, the office and the educational markets, they grow fast. The one which has not shown any increase is another kind of surprising one, the health care market actually has declined in dollars by 7.5%.

In actual dollars, it's dropped down from $74 million -- from $79 million -- or excuse me, I got the wrong column here. It dropped down from $41 million to $38 million. So it has backed off in both dollars and at a fairly good rate of 7.5%.

This is, however, in total, quite a remarkable improvement from previous quarters when we had quite a few negative ones as well as positive ones, and we basically were not moving forward very much.

This indicates that the market itself has actually started moving forward and we have taken additional market share to even make our growth more substantial. If we look, going down from that point and look at what's happening to our backlog, we see, as noted before, that we've gone up from $49.9 million to $54.8 million in our backlog.

Now what is that foreseeing? That incidentally is a 9.8% increase. That's a nice start to the fourth quarter, start out with more. In addition, I would tell you that the increases I've spoken of have been somewhat shifted to the last portion of this 9-month timeframe.

In other words, if I went back to the first quarter, you wouldn't have seen as much percentage growth nor as many dollars growth as what we've experienced in the third quarter.

The fourth quarter has every evidence of continuing that healthier situation, and we are expecting to do better in the fourth quarter of this year than we did in the fourth quarter of last year, starting off with a good backlog, added to it a better, healthier marketplace, and the fixed cost and the cost of steel and copper still are remaining very stable.

So we don't see any driving force other than we do have some in the labor arena, primarily due to increased salaries which we have put in place. We have not been experiencing a great deal of improvement in efficiency to offset those. So there is a little bit of increase in our cost structure.

Our capital expenditures, as was mentioned before, are probably going to be in the $15 million, $16 million area for the balance of the year. I'd like to open it now for questions as to what were taking place..

[Operator Instructions] Your first question comes from Joe Mondillo from Sidoti & Co..

So my first question has to do with sort of your top line growth that you've seen and the market share gains that you've seen. Through the first 9 months of this year, we've seen 10% top line growth versus industry, which is more so 4%, 5%. Last year you saw a 6% top line versus industry of 3%.

So you're almost doubling the industry the last 2 years or so. Just wondering if you could sort of comment on that and sort of update us on your thoughts on that, and whether that's sustainable, whether you think you're going to continue to take market share and why..

Yes, we do believe that -- we recently had an internal meeting of all of our upper management and we've discussed the fact that we've done a great deal in the past few years, actually, virtually from the beginning of the company's time of getting our factory in good condition, our manufacturing methods in good condition, our facilities all squared away.

And what we're seeing our situations being at the present time is a shift in emphasis more toward marketing and away from internal operations. And that's because internal operations are running very well and we've got adequate additional capacity.

And so we don't have to put as much emphasis on our internal operations as we do on trying to find a way to get more orders. So we're putting more emphasis there and we're going to also be putting more money into our marketing efforts. So we believe we'd be able to sustain and probably even improve on our ability to take market share.

It's all, I believe, based upon the Architectural Billings Index, which is showing the first significant and sustained upturn for the past few months that there will be more orders available because we think there will be more buildings coming out of that increased activity by the architects.

So at this point in time, we are mildly optimistic, I would say..

Is there any geographic sort of maybe more of targeting geographic region that maybe you have not been as strong in, in the past or certain product lines that are maybe recently introduced that are garnering more demand? Just trying to understand the above-industry growth that you've seen.

Any other sort of indication on what you're sort of pointing to that?.

There is obviously some regional differences in where that growth is coming from in the industry as a whole. It isn't, however, a significant difference. It isn't like one region of the country's doing very poorly and another, very well. They are all starting to get healthy, some more so than others.

And I wouldn't say that, that's going to have any noticeable effect on us because we are stronger in some regions than others. But -- and the balance, we think, is pretty much going to affect us equally. So we don't see any shift there. It's pretty much in uniform going forward.

Now we do see a shift and have been seeing a shift toward, as I mentioned a little bit ago, toward some of our larger tonnage equipment. And I think that kind of reflects what we did in our redesign.

As we've mentioned before, about 70%, maybe 80% of our business right now is coming out of products which were totally redesigned within the last 6 or 7 years, I guess, it would be.

And the ones that we started that redesign on were the bigger tonnages, so they've had more time to be out there and build a following than some of the new, smaller equipment that has come out more recently. However, we're seeing a good, strong growth in the smaller units also.

But my guess would be that they may start growing a little faster proportionately than the larger ones as time goes on, simply because they are more newer product in the marketplace than some of the bigger tonnage units. However, we are -- and I'll finish up of what the remaining 30% or 20% of market that we've got.

A goodly share of that is going to be in even larger tonnage units. So we are basically shifting from starting at, say, the midpoint in our size range going down. Now we're jumping back up and catching the very largest ones for a redesign.

So we believe that the bigger units are more indicative of larger buildings, more substantial buildings, and the smaller units are more tending toward the smaller buildings. So you could say that there's been an increase in activity in larger structures, probably..

That's probably a good sign, I'd say..

I think it is a good sign..

So that brings me to my second question, regarding the gross margins. There's a bunch of moving pieces here. The outsourcing, raw materials, the leverage on the higher sales that you saw, as well as the product mix that you made a highlight of.

Just trying to understand what your thoughts are on the sustainability in the margins that we saw in the quarter.

How much did product mix play a role? Was it the main factor? Or was leverage in the outsourcing a contributing factor as well? And in terms of the outsourcing, did we see the full effect in the third quarter from the outsourcing?.

The outsourcing definitely has significant impact. We probably got the benefit of 90% of the outsourcing in the third quarter. Probably -- there's probably 10%, maybe a little less than 10% yet to come in the fourth quarter. So most of that has been realized.

And it definitely and primarily, the thing that, that was, was going to the all aluminum condenser coil, which reduced the material cost and therefore, reduced the cost of the product quite a bit. The rest of the margin is going to go up and down by how we're spending money and what we're preparing for.

I mentioned that we're going to be putting more emphasis on marketing effort, and more emphasis is going to require more personnel. And so we're going to be shifting some more money into that.

Now the question will be, do we pick up volume proportionately to the additional emphasis and additional cost that we put into our marketing personnel? That would be a question going forward. Because we are going to put a fair amount more effort into the marketing effort, more cost into it..

That's going to be SG&A though, right?.

It is..

So I guess, in terms of gross margins, what is your thoughts on the 32.4% that you put up in the quarter? Do you think that's sustainable? Or what are your thoughts sort of long term on that? I know seasonally, you're probably going to see a tick down in the fourth quarter.

But how much was product mix a contributing factor to that margin?.

Joe, this is Scott. Essentially, it's our opinion that you got the benefit, of course, of the coil and the much lower cost of that aluminum coil. But then to the other point you're bringing up, it's the mix of our products.

We did see a more expensive average selling price, which is driven by the features and options, as well as the tonnage that people were buying. So there was a good portion of it that came from that. How sustainable that is depends upon how the economy is doing and what people are choosing to buy.

If they're buying more optioned up products with higher margins, then it's sustainable. If they go back into more frugal mode, it may obviously impinge upon our gross margins in the future..

So if things continue to get improved in terms of end market demand, that could theoretically be sustainable, given that people are willing to spend more on customization?.

Potentially so. And as you pointed out, of course, going into the slow part of the year, your overhead will have a little bit less absorption as our revenue is tending to decline in the off season..

Right.

How is that customization and the higher-priced units, how has that been trending over several quarters? Has that been slowly rising over quarters? Or was this sort of the first quarter where you saw sort of a jump up in terms of that?.

I'd say it's really the first quarter that we have, so far. Whether it's sustainable or not, we can't really predict yet..

Okay. And then last question for me, the SG&A, as a percent of sales, it did decline a bit year-over-year. But sequentially, even though you saw a sequential growth in the top line, it was sort of similar to the second quarter. And I was under the understanding that, that may start to tick down maybe with the warranty expense possibly declining.

But you're also talking about marketing expenses now.

So what are your thoughts on the sort of 10.5% SG&A as a percent of sales?.

Well, our actual dollars spent, if you adjust for 2 large factors within the quarter, we're only slightly up over the same period of last year. We had our donation, of course, which is out there. And we've also got some additional potential bonus accrual that we have in the quarter.

And those 2 put together are about $3.8 million of impact on the income statement, which would leave us just slightly above last year, about $400,000 above where we were last year. So obviously, we're doing a relatively good job at overall control of SG&A. And I would expect that you should see it flat to declining as our revenue continues to grow..

Okay.

And is that warranty expense -- how large is that on a quarterly basis? And do you anticipate that to trend downward?.

Well for the 9 months, it was $4.2 million. And just one moment for the quarterly number. Our quarterly number was $1.6 million for this quarter, which was down actually, from $2.2 million last year. It was 1.6% of sales versus 2.6% of sales. But the donations by themselves were 2.9% for the quarter..

Okay. And do you anticipate that to fall or maintain or....

Well the donations, we anticipate to fall. We're not anticipating making another donation of that size..

No. I'm talking about the warranty..

The warranty, yes, we anticipate it to continue its downward trend. We've seen some improvements in our failure rates, which would indicate that we should be seeing that improving over the next few quarters..

Your next question comes from DeForest Hinman from AAC..

I have a couple of questions. So first on the capital spending, it looks like it's ticked up a little bit relative to our commentary a couple of quarters ago.

Can you kind of give us an update on what that money is being spent on and maybe some initial expectations for next year as well?.

Yes. This is Rebecca. We expect -- we ended up purchasing or putting down payments on some new Salvagnini machines. We had anticipated getting 2 for our Longview facility but we've also put down payment for 2 for our Tulsa facility, and that's what's caused a little bit of the uptick from our original projections of CapEx for the year.

Going forward, we're looking to spend $18 million to $20 million a year over the next 5 years..

The Salvagnini machines incidentally are sheet metal fabricating machines. And what we found there was that as we moved up in tonnage size that we've discussed before, we -- our estimate of what the capacity of our sheet metal shop was proved to be incorrect.

Because before we factored it off from -- several years ago, we tried to estimate what our capacity was based upon the mix that we have been, which was smaller tonnage units. And as we went up, we found out that the dollars didn't go up directly with the sheet metal requirement.

The sheet metal requirement went up more rapidly as we went into bigger tonnage units. And it also, therefore, reduced the amount of capability we thought we had in surplus in sheet metal fabrication. And so we weren't thinking we were going to have to go out and buy any more machines this past year.

And we became aware that we were able to get through. But we didn't have any cushion left. And so we went out and bought a couple more machines, as we're going to do again next year because we believe we've got a gold cycle going and we don't want to be limited by our fabrication, sheet metal fabrication capabilities.

So we bought 2 just to get back to the kind of cushion we thought we had that we proved to be incorrect. And then we're going to be buying a couple more next year to give us some additional because we're fairly optimistic about the economy and our ability to take market..

And the CapEx for those additional machines next year should appear in the first quarter..

Okay. And I think I've asked this question a couple of times in the past. We kind of have that good problem of good cash flows and we can fund our CapEx outlook internally. We bought back a little bit more stock in the third quarter.

But what are we thinking in terms of capital management going forward? Are we more inclined to focus on dividends? Or do we continue with the share repurchase? Or do we do both?.

Well we have announced our dividend for the end of this year at $0.09 a share, which will be payable December 23. However, going forward, we have some estimates on cash flow, and for this year, the balance of this year, we projected $20 million worth of stock repurchase. We've already bought back about $9.5 million of that.

So we have about $10.5 million to repurchase, and we will be going back into the market actively as soon as our blackout period is lifted on Monday. So we do anticipate using all of that before the end of the year, provided that market conditions justify and allow us to do that.

Next year, I'm sure there will be further discussion about the use of the capital, but it would be expected by myself that we would continue this practice of taking surplus cash flow and using it to repurchase when we are able to do so in the market..

However, if the market does go up significantly, we would probably change that to additional dividend..

Your next question comes from Jon Braatz of Kansas City Capital..

I know raw material costs, I mean, your entire cost structure, rather benign.

When you look out towards 2015, would you -- do you see any possibility of any price increases going forward, if the market continues to strengthen?.

Well, it's always a debate we have internally, and you can get an answer from anyone here that's going to be different than the one I'm going to give you, probably. But what we focus on is not necessarily percent profit. What we focus on is total dollars of profitability.

And so then you get into the argument, how much volume will we forego if we raise the price by a certain amount and how much increased dollars will we get by doing that as opposed to not raising it and getting less dollar per sale, but the number of sales will go up to give us more dollars on the bottom line.

So that's always a debate which you can find varying opinions here in the company.

At the present time, because we are doing quite well at the top line and we seem to be getting more and more in a competitive posture every year that goes by, and because we do have the capacity in the facility and we've got the capacity in the machinery, we just need people, we will probably tend not to raise prices as much as what we could readily do because we'll probably be able to put more dollars on the bottom line if we hold back on the price increases a little bit..

I will add that the statement about just adding people, we are adding some sheet metal capacity but compared to the expected revenue increase that, that sheet metal capacity can support, we believe that it well outstrips the additional capital expenditures, so just needed to add that..

Okay. Are you -- well, bad connection.

But are you seeing any movement in your raw material costs, Norm, at this time?.

No, we're not..

[Operator Instructions] There are no further questions at this time..

All right. Well, if there are no additional questions, we will say thank you for listening and for being a part of our ownership. We will talk to you again at the end of the fourth quarter when we fully expect to have a very positive conversation. Thank you..

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