Norman Asbjornson - CEO Scott Asbjornson - CFO Rebecca Thompson - Chief Accounting Officer.

Jon Braatz - Kansas City Capital Joe Mondillo - Sidoti & Company.

Good afternoon, ladies and gentlemen. Welcome to AAON, Inc. First Quarter Ending March 31st, 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 would like to turn the meeting over to Mr. Asbjornson. Please go ahead, Mr. Asbjornson..

Thank you. Before going into this, 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 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 CFO..

Thank you, Norm. Welcome to our conference call. I'd like to begin by discussing the comparative results of the three months ended March 31, 2016 to March 31, 2015. Net sales were up 11.3% to $85.4 million from $76.8 million. Sales increased primarily due to increased volume, as compared to the same period in 2015.

Our gross profit increased 18.0% to $25.7 million from $21.8 million. As a percentage of sales gross profit was 30.1% in the quarter just ended compared to 28.4% in 2015. Selling, general and administrative expenses increased 7.2% to $8.9 million from $8.3 million in 2015.

As a percentage of sales, SG&A decreased to 10.4% of total sales in the quarter just ended from 10.8% in 2015. The overall increase in SG&A was primarily due to increased compensation and profit sharing expenses due to be better results versus the same period last year.

The increase was partially offset by a decrease in warrant expense related to continued improvement in quality control. Income from operations increased 24.9% to $16.8 million or 19.7% of sales from $13.5 million or 17.6% of sales. Our effective tax rate decreased to 36.5% from 37.5%.

The Indian Employment Credit and Research and Development Credit are extended until December of 2015 for the 2015 and 2016 tax years. As such, the effective rate for the three months ended March 31, 2016 is reduced with the impact of these credits, while the effective rate for the three months ended March 31, 2015 does not reflect these credits.

Net estimated annual 2016 effective tax rate, excluding discrete events is expected to be approximately 36.0%. Net income increased to $10.8 million or 12.7% of sales, compared to $8.4 million or 10.9% of sales in 2015. Diluted earnings per share increased by 33.3% to $0.20 per share from $0.15 per share.

Diluted earnings per share were based on 53,430,000 shares versus 54,640,000 shares in the same quarter a year ago. At this time, I'd to turn it over to our Chief Accounting Officer, Rebecca Thompson..

Looking at the balance sheet, you'll see that we had a working capital balance of $92.2 million versus $80.8 million at December 31, 2015. Cash and investments totaled $43.2 million at March 31, 2016. Investments and maturities ranging from one month to 12 months. Our current ratio is approximately 3.4 to 1.

Our capital expenditures were $7.3 million for the quarter. We expect capital expenditures for the year to be approximately $32.7 million. Shareholders' equity per diluted share is $3.53 at March 31, 2016 compared to $3.28 at December 31, 2015. We continue to remain debt free.

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

Net sales were up 11.3% for the quarter. Sales increased primarily due to increase in volume as opposed to increased pricing.

The results of this was primarily attributable to a change in quantity of regional managers which we did in the first part of last year and the additional emphasis we placed upon helping our customers and our sales rep to get answers and function more efficiently. There was nothing more major in the additional sales other than this factor.

We did have some minor small changes in product, but they were not consequential. On various segments, the commercial, retail was reasonably good market, office was reasonably good market, medical was down, education has finally come back up and it is become a better growth market. Manufacturing is a real difficult one to judge.

According to the census bureau numbers it is up tremendously. However, most of that increase is due to refineries and things of that nature which do not have building projects associated with them and therefore are not viable places for us to get business. Lodging has come back very nicely, municipalities are so-so.

In general, there is been a modest increase in buildings and so we're getting a benefit from those increased volume in buildings. Backlog on March 31, 2016 was $60.3 million versus $55.4 million a year ago.

The outlook for remaining of 2016, our backlog is up in good shape because gross profit we believe we can maintain capital expenditures as was noted before will be approximately $33 million in total.

All in all, we are pretty much without any unusual occurrences coming for the rest of the year, as far as we can tell and it’s a fairly secure business plan at least far as we can see.

The only thing that is showing up as a potential real problem and it will be a problem, is that there are some governmental tariffs being installed and there of course some other changes, the biggest one of which is that price of steel which historically is being coming down for several years has gone back up again and will affect this in the latter two quarters of this year.

The increase is somewhere in the 20% to 25% method, which is a very severe increase.

The worst part of this where the tariffs have been put on steel and tariffs on refrigerant and tariffs on some other goods, as those tariffs are not applicable to our competition who work in other countries, in other words, and they were our competitors which we are now getting quite few of who function out of Mexico will not be impacted by these.

So the tariffs are – the governments raising the cost of our doing business relative to our competitors who are not in the United States, kind of sorry situation. Nothing else is occurring that is probably going to give us any difficulty and we believe we'll be able to handle difficulties, I just told you about. I'll open it up to questions now..

[Operator Instructions] And your first question comes from the line of Jon Braatz with Kansas City Capital. Your line is open..

Good afternoon, Norm..

Hi, John..

Norm, going back to the steel issue, 20%, 25% pricing - cost increase in the second half pretty significant, will you have and then also then the competitors pressures from Mexico, are you suggesting that you may have to eat those costs increases and as a result maybe have a few – a little bit of pressure on gross margins in the second half?.

That’s something we haven’t yet decided how we're going to handle it, but that is one of the possibilities John. And of course, this is not just for the air condition industry, this is of course….

Yes….

The entire spectrum of anybody who uses steel in the United States. So we are all faced with it, probably it might create some inflation, but of course, it will be inflation on our part, but it won't be inflation on our competition who isn’t subject to these costs..

Okay.

Are you seeing any additional pressure from let’s say copper or maybe you know, from some of the purchase product – for example, like motors and so on?.

No, we're not..

Okay. And then the other thing, Norm, in your press release and the commentary regarding your water-source heat pump, talk about significant sales will not be witnessed until mid-2017, was it related profits in 2018.

Is that a little bit different than what you had been saying, because I thought maybe we'd start seeing some more sales from this product line earlier in 2017 and maybe even in late 2016?.

Recognize we're kind of in the woods here, because this is totally new product line to us, so a lot it is pure speculation on our part. We believe that we will be able to get as many orders as we can handle. The question is how many – how much can we handle and recognize we're embarking upon building a product which we never built before.

But we have spent quite a bit of money, established on our manufacturing. We're still in the process of doing it. We have very high expectations for what we're putting in place, but when none other processes if they were been running, we haven’t talked to people how to run it, it’s a lot of conjecture was what we think is going to happen.

If I said on the positive side, I would say that we could strike into, without any doubt we can in '17, be in the $50 million to $60 million, $70 million range, if I got pessimistic I'd say its going to be $30 million to $40 million and its kind of an unknown factor.

We do have a lot talent here and we have spent a great deal of effort to come up with a manufacturing methodology which we believe will be cutting-edge technology and we've run it down for every way we can, as far as what happens with the work and so we had back up plans for everything that we're going to be tempting to do.

We just don’t know how smoothly we're going to be able to put this into production. When it is in production, and when it does do what we believe it’s going to do, we will definitely be the cost leader in manufacturing technology.

This is a very sophisticated, very – I'll just say this, our work in process is non-existent, but we start to build a unit, we build components just a few minutes or few hours before we build a unit. So our work in process in this environment is not going to be – is virtually going to be non-existent, that’s not herd of any manufacturing facility.

So it’s quite a different way that we're going to handle this..

Okay. One last follow up, I appreciate the uncertainty regarding the new product line.

But do you think you could get a sense in late 2016 whether you're going to be sort of at – whether you think you can be at the low end or the upper end of that sort of the range that you gave, would you get a sense early on or late in 2016 where that might – where you might fall in 2017 or would that be too early still?.

No, that’s very definitely probable..

Okay..

It’s the start up which we're going to be starting here in another month or so. There it’s going to start telling you how much problem we've got. So by sometime in the early fall, we'll pretty well know what our problems are, what our issues and what we have to do, we'll be able to project pretty well how fast we can handle.

So sometime in the October timeframe I would guess we will start having a very good idea what our abilities are to handle that and how - how much we can expect to do in 2017..

Okay. Thank you, Norm..

Your next question comes from the line of Matt McGuire [ph] with Eagle Asset Management. Your line is open..

Good afternoon. I am sorry if I missed it.

But the last couple of quarters you've been talking about renewed sales efforts on the West Coast, I am just wondering if you could update us on the progress of that effort?.

Okay. Well, we made major changes in our representation on more than the West Coast. We changed out Alabama, Kentucky, Arkansas, Las Vegas, and Northern California. And all of them are coming along at varying degrees of success, but overall collectively they have done pretty much what we anticipated.

Some of them obviously are running ahead of others, some of dragging a little bit, but so far we've not lost faith in our decisions on any of those places. So it’s our expectation that as times goes on here they will continue to get better and better and we'll realize more out of those markets.

But in addition to that, probably the more significant thing is by taking and putting seven regional managers out, doing work - four of them were doing before, all of the rest of the sales force is getting a great deal, more attention.

And that’s really probably more of the story that should be told and in the end they did show, change out so the people because we're getting the ability to help our customers and our sales force and all the markets much better now that we have the additional personnel to help them.

And that’s probably doing us more good than just once where we changed our personnel..

Thanks so much. Great job..

[Operator Instructions] Your next question comes from the line of Joe Mondillo with Sidoti & Company. Your line is open..

Good afternoon, Norm, Scott. I apologize, I missed the beginning on the call, so I apologize if I am covering something that’s already been talked about.

But one thing I noticed, in the first quarter of 2015 there was a sales tax payment that hit the SG&A line, excluding that, gets you to about $7.7 million in the first quarter of '15, which makes the SG&A look like it increases by about 15% year-over-year, as a percent of sales it also rises year-over-year? I am just wondering what was the result of that and if that’s going to be a common theme going forward for the rest of this year?.

Yes, we did have that sales tax impact in the first quarter of last year and that is an issue which has resolved it or its been resolved at this point, there is not an impact in this year. But we did have our other cost issues with profit sharing and other expenses which increased.

And so in anticipate that yes, you will see our cost structure about the level that sat in the first quarter going forward. We also had some other similar items in the second quarter, but it won't be there this year either..

Right.

So, is it better to look at it as an absolute number run rate going forward or as a percent of sales?.

I would try and look at it more as a run rate, as the dollars going forward..

So about $9 million?.

Yes, as profits go up in the organization, profit sharing goes up, right, and that’s in SG&A. So as our profit sharing goes up and our profits go up, then our SG&A is automatically driven up by that occurrence. So to the extent that we make more money, our SG&A - dollar is also go up as well..

Right. So if you – I mean, if you use $9 million as a run rate though that makes the SG&A year-over-year sort of flattish, excluding those sales tax payments in the beginning of last year.

So it probably won't be a run rate because that would imply a flattish SG&A right, assuming you're going to see revenue growth which the first quarter definitely implies, shouldn’t it be higher than the $9 million run rate?.

Well, what you'll see going forward is as we make more profit then it will probably grow, the question is exactly what that number will be. But it’s somewhere in this ballpark is our anticipation. But it is driven in large part by warranty and profit sharing..

Okay.

In terms of how the quarter shaped up from the beginning to the end, how did the –can you describe how the order flows trended and how we're looking now that we're in the first month of May, how is the second quarter is looking?.

The first two months of the year were surprisingly soft and we were becoming quite concerned and March along and changed fairly dramatically and pulled us out of the woods, so to speak. April didn’t hold up to the March performance, but it did pretty well and now we're in May and we seem to beginning another improvement in May.

So its not a consistent trend line, in other words, it was down for two months, up for one month, modestly up or sort of stable for another month and now it appears to be going back up again for the months we're in right now.

So you can't project often what the month-to-month has been like because they've been kind of theoretic, but the general trend line has been positive..

All right.

And then in regard to the gross margin improvement year-over-year, what were the – is there anyway you can break out the drivers of that margin expansion?.

We don’t have that broken out at the present time. We do have just our cost increases on raw materials within our Q that we could refer to. But we don’t have how much percentage of our improvement came from each of those factors..

Okay.

But the raw materials was a positive benefit in the first quarter?.

Yes, raw materials have been positive for several months, may actually for two years now..

Right..

But as we mentioned steel was going up significantly in third and fourth quarters. And so we're not too certain if that’s the driving force because of its tariff that’s been put in there, what trigged it because copper and aluminum those seem to be following soon.

And so it just looks like the opportunity to get the steel price back up based upon the tariff has been taking advantage by the steel industry. And so steel costs are going up at least so they are right now making commitments about 20% more money than what we're paying today for steel in the third and fourth quarter..

Okay. And I know, last year I think product mix, some of your more customized larger tonnage type units, I think performed a little weaker than some of your smaller tonnage last year which weighed on your gross margin a little bit.

How is that sort of trended, how is the demand for more of your customized high margin type stuff have been tracking this year?.

No, its still kind of weak, the place that’s helping us out is sort to of the mid level, in other words, not real big equipment, but not a small equipment, right in the middle ground and that seems to be the strong point we're running in right now, which is a good market for us, it’s a good profitable place for us to be in.

So it’s not hurting us at all. But the higher end, the product doesn’t seem to be having a market out there like it use to. We seem to have lost that market back in - to some degree back in phase 2008 or '09 and it doesn’t seem to ever fully be recovered..

Okay. And then just last one from me.

Regarding the new water-source heat pump venture, should we expect any cost overruns or inefficiencies, as you start in the early phases of ramping this up or is that not really a risk?.

The big risk is teaching our people how to do it and having production efficiencies. As far as to having control, the methodologies we set up give us extremely good control over what we're doing. So we're not going to have cost overruns of components and you know, and out of control manufacturing, that simply will not happen.

The biggest problem is going to be how fast can we can bring our people up to speed and for them to manufacture the way we expect it to happen..

Is there anyway to tell us that this could be a risk in the second and third quarter of – are we going to hear about that maybe later this year….

As I mentioned little bit ago, we would expect it, by October, November we will be able to pretty well see what our situation is. Because our start up, we're going to start – try and get things moving a little bit. In July we're going to do a little more, it’s actually running the manufacturing a little.

We'll be doing prototype running in July and checking out things, checking out functionality of various manufacturing things in July. In August we'll actually be trying to run the full scale running, and by September we will start knowing whether or not we are going to be able to run it pretty well.

By October we'll be able to make some pretty good estimates of how long it’s going to take us to get at to where we were, between now and then it’s a lot of guess work..

Okay. All right. Well, appreciate it. Thanks a lot..

Thank you..

There are no further questions at this time. Actually we do have one more question and it’s from the line of Jon Braatz with Kansas City Capital. Your line is open..

Norm, just a follow up, as you began commercializing the new heat pump, will there, will be a higher warranty reserve for that product initially?.

Well, the things we have done should not cause us to have a higher warranty. They just about eliminate to a large degree warranty problems for a whole lot of sources. We've changed the way we're going to manufacturer and we're doing things, I'll give you just one example.

One of the danger things it causes refrigerant problems, refrigeration problems, everybody brazes all your joints and your refrigeration system with a sadolin [ph] system with a torch, we are not, we are going to induction wielding, induction wielding means that you don’t create any flame around it at all, you do it strictly with induction, electrical induction and to this joint and it gives you an extremely clean and extremely fine joint.

So we're doing things like that, that have not been done in this industry and they should make our product a whole lot better and lot less subject to having problems. But tick on that when because that one probably creates about as many problems using a sadolin toward brazed joint.

That probably creates as many related problems and building air condition, you know, is about any thing and we're doing away with that, we're not going to do that at all. So we already have been running cash things, so this not hypothetical at all, it’s just that we don’t know about lot of other things we're doing.

My guess on this is we will come out on deferred write off to that with virtually no more, probably less warrant cost than the product we're building today..

Okay. All right. Thank you very much..

And there are no further questions at this time. I will turn the call back over to our presenters for any closing remarks..

Okay. Thank you very much for joining us for this review of our first quarter. The discussion about what the rest of the year is. As we've talked - a lot of the discussions been as we'd expect to be on the probability of what the water-source heat pumps going to be, I would say that you should think of this.

We have done a lot to try and find out what the industry would really like to have in a product and we made several advances which we feel very secure and thinking we're going to make the product extremely attractive to the customers.

On the production side of it, as I've just briefly described here, we were already into the manufacturing arena and we got outside of the air conditioning market, went out and just manufacturing and mass production strictly on its own and we look for anything that might be out there which would aid us to be a much better manufacturer of water-source heat pumps.

We think we've got those things in. We think we've gone through them whole part of that, so that we don’t have any hidden surprises and we fully expect to have a very state of the art manufacturing facility. Our biggest unknown at this time is how long it’s going to take us to come up to speed.

And that’s always the case anytime we are doing something new, I don’t think its going to take very long, but that’s all my opinion and its not mourned by any fact at this time, but like I said by October, November we're going to be able to say we have facts and it adheres what it tell us.

So we're very optimistic about where this is going to take us in the water-source heat pump business. Thank you..

Ladies and gentlemen, this concludes today's conference call. You may now disconnect..