AAON

AAON, INC. 10-Q Summary: Period Ended June 30, 2004

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2004, and the six months ended on that date. AAON, Inc. engineers, manufactures, and markets air-conditioning and heating equipment, including rooftop units, chillers, and air-handling units. The company operates manufacturing facilities in Tulsa, Oklahoma; Longview, Texas; and, following a recent acquisition, Mississauga, Ontario, Canada. Demand is tied to commercial and industrial new construction cycles and replacement markets.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 15.6% for the quarter and 14.9% for the six-month period compared to 2003. Growth was driven by new product introductions, economic improvement, and the acquisition of Air Wise Inc. (contributing $441,000 in sales since May 4, 2004).
• Margin Compression: Gross profit margins declined significantly (from 23.7% to 14.8% for the quarter). Management attributed this to rising raw material costs (steel and copper), startup costs for a coil project, and operational disruptions including a four-day facility closure in Tulsa due to power outages and equipment failures in Longview.
• Expense Increases: SG&A expenses rose due to higher warranty costs associated with increased sales volume and increased bad debt expense.
• Balance Sheet: Accounts receivable increased by $2.1 million and inventories by $2.3 million to support sales growth. Property, plant, and equipment increased by $8.5 million due to facility expansions and the Canada acquisition.

Outlook, Risks, and Unusual Items

• Acquisition: On May 4, 2004, the company acquired assets of Air Wise Inc. for $1.778 million, financed by operating cash flow. A subsequent event noted a property purchase in Burlington, Canada, for approximately $1.385 million to expand production.
• Capital Expenditures: The company has committed approximately $1.0 million to complete a sheet metal facility in Tulsa and $1.4 million for the Canada operation, both to be funded by operating cash flow.
• Stock Repurchases: The company continues its buyback program, repurchasing 36,300 shares in Q2 2004 at an average price of $19.66. Approximately 370,236 shares remain available for purchase under the program.
• Risks: Significant risks include volatility in raw material prices (steel, copper, aluminum), fluctuations in the commercial construction market, and interest rate changes. The company does not use derivatives to hedge these risks.
• Liquidity: Cash and cash equivalents dropped to $17,000 by period end, though the company holds a $3.5 million certificate of deposit and has a $15.15 million revolving credit facility with no outstanding balance.

Investor Verification Checklist

• Raw Material Hedging: Verify the company's strategy for managing steel and copper price volatility, given the significant margin compression reported.
• Operational Stability: Assess the long-term impact of the reported facility outages and equipment failures on future production capacity and delivery schedules.
• Liquidity Position: Monitor the low cash balance ($17,000) relative to upcoming capital commitments ($2.4 million) and the reliance on the revolving credit facility if cash flow tightens.
• Warranty Reserves: Review the adequacy of warranty reserves given the increase in warranty expense and the integration of the new Canadian subsidiary.
• Acquisition Integration: Evaluate the financial performance of the Air Wise acquisition beyond the initial partial quarter contribution.