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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________________ to ____________________
 
Commission file number:  0-18953
AAON, INC.
(Exact name of registrant as specified in its charter) 
Nevada 87-0448736
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
2425 South Yukon Ave., Tulsa, Oklahoma 74107
(Address of principal executive offices) (Zip Code)
(918) 583-2266
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes                                   No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes                                   No                                
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of "large accelerated filer", "accelerated filer", "small reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer Smaller reporting company
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
                                                   
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes                                   No 

Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock AAON NASDAQ

As of October 29, 2019, registrant had outstanding a total of 52,097,581 shares of its $.004 par value Common Stock.



PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.
AAON, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
  September 30, 2019 December 31, 2018
Assets (in thousands, except share and per share data)
Current assets:    
Cash and cash equivalents $ 28,373    $ 1,994   
Accounts receivable, net 56,083    54,078   
Income tax receivable 3,870    6,104   
Note receivable 28    27   
Inventories, net 80,623    77,612   
Prepaid expenses and other 1,559    1,046   
Total current assets 170,536    140,861   
Property, plant and equipment:    
Land 3,274    3,114   
Buildings 99,705    97,393   
Machinery and equipment 230,806    212,779   
Furniture and fixtures 17,310    16,597   
Total property, plant and equipment 351,095    329,883   
Less:  Accumulated depreciation 175,357    166,880   
Property, plant and equipment, net 175,738    163,003   
Intangible assets, net 331    506   
Goodwill 3,229    3,229   
Right of use assets 1,724    —   
Note receivable 594    598   
Total assets $ 352,152    $ 308,197   
Liabilities and Stockholders' Equity    
Current liabilities:    
Revolving credit facility $ —    $ —   
Accounts payable 11,118    10,616   
Accrued liabilities 42,764    37,455   
Total current liabilities 53,882    48,071   
Deferred tax liabilities 15,034    10,826   
Other long-term liabilities 3,669    1,801   
Commitments and contingencies
Stockholders' equity:    
Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued
—    —   
Common stock, $.004 par value, 100,000,000 shares authorized, 52,119,295 and 51,991,242 issued and outstanding at September 30, 2019 and December 31, 2018, respectively
209    208   
Additional paid-in capital 2,680    —   
Retained earnings 276,678    247,291   
Total stockholders' equity 279,567    247,499   
Total liabilities and stockholders' equity $ 352,152    $ 308,197   

The accompanying notes are an integral part of these consolidated financial statements.

- 1 -


AAON, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
  Three Months Ended 
 September 30,
Nine Months Ended 
 September 30,
  2019 2018 2019 2018
(in thousands, except share and per share data)  
Net sales $ 113,500    $ 112,937    $ 346,759    $ 321,607   
Cost of sales 86,115    80,174    263,406    245,869   
Gross profit 27,385    32,763    83,353    75,738   
Selling, general and administrative expenses 12,994    13,190    37,476    36,495   
Loss (gain) on disposal of assets     296    (9)  
Income from operations 14,385    19,571    45,581    39,252   
Interest income, net   36    49    171   
Other (expense) income, net (7)     (16)   11   
Income before taxes 14,387    19,612    45,614    39,434   
Income tax provision 560    5,527    7,924    9,398   
Net income $ 13,827    $ 14,085    $ 37,690    $ 30,036   
Earnings per share:    
Basic $ 0.27    $ 0.27    $ 0.72    $ 0.57   
Diluted $ 0.26    $ 0.27    $ 0.72    $ 0.57   
Cash dividends declared per common share: $ —    $ —    $ 0.16    $ 0.16   
Weighted average shares outstanding:    
Basic 52,111,444    52,238,796    52,086,209    52,315,719   
Diluted 52,722,127    52,627,541    52,624,583    52,715,390   
 
The accompanying notes are an integral part of these consolidated financial statements.

- 2 -


AAON, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
Nine Months Ended September 30, 2019
  Common Stock Paid-in Retained  
Shares Amount Capital Earnings Total
  (in thousands)
Balances at December 31, 2018 51,991    $ 208    $ —    $ 247,291    $ 247,499   
Net income —    —    —    37,690    37,690   
Stock options exercised and restricted 494      11,281    —    11,283   
stock awards granted          
Share-based compensation —    —    7,858    —    7,858   
Stock repurchased and retired (366)   (1)   (16,459)   —    (16,460)  
Dividends —    —    —    (8,303)   (8,303)  
Balances at September 30, 2019 52,119    $ 209    $ 2,680    $ 276,678    $ 279,567   
Three Months Ended September 30, 2019
Common Stock Paid-in Retained
Shares Amount Capital Earnings Total
(in thousands)
Balances at June 30, 2019 52,118    $ 209    $ 1,586    $ 262,774    $ 264,569   
Net income —    —    —    13,827    13,827   
Stock options exercised and restricted 110    —    3,598    —    3,598   
stock awards granted
Share-based compensation —    —    2,785    —    2,785   
Stock repurchased and retired (109)   —    (5,289)   —    (5,289)  
Dividends —    —    —    77    77   
Balances at September 30, 2019 52,119    $ 209    $ 2,680    $ 276,678    $ 279,567   
Nine Months Ended September 30, 2018
Common Stock Paid-in Retained
Shares Amount Capital Earnings Total
(in thousands)
Balance at December 31, 2017 52,422    $ 210    $ —    $ 237,016    $ 237,226   
Net income —    —    —    30,036    30,036   
Stock options exercised and restricted 301      3,503    —    3,504   
stock awards granted
Share-based compensation —    —    5,614    —    5,614   
Stock repurchased and retired (513)   (2)   (9,117)   (9,241)   (18,360)  
Dividends —    —    —    (8,391)   (8,391)  
Balances at September 30, 2018 52,210    $ 209    $ —    $ 249,420    $ 249,629   
Three Months Ended September 30, 2018
Common Stock Paid-in Retained
Shares Amount Capital Earnings Total
(in thousands)
Balances at June 30, 2018 52,290    $ 209    $ —    $ 238,228    $ 238,437   
Net income —    —    —    14,085    14,085   
Stock options exercised and restricted 75    —    1,205    —    1,205   
stock awards granted
Share-based compensation —    —    1,915    —    1,915   
Stock repurchased and retired (155)   —    (3,120)   (2,893)   (6,013)  
Balances at September 30, 2018 52,210    $ 209    $ —    $ 249,420    $ 249,629   

The accompanying notes are an integral part of these consolidated financial statements.

- 3 -


AAON, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
  Nine Months Ended 
 September 30,
  2019 2018
Operating Activities (in thousands)
Net income $ 37,690    $ 30,036   
Adjustments to reconcile net income to net cash provided by operating activities:    
Depreciation and amortization 17,627    12,865   
Amortization of bond premiums —    11   
Provision for losses on accounts receivable, net of adjustments 91    67   
Provision for excess and obsolete inventories 1,003    55   
Share-based compensation 7,858    5,614   
Loss (gain) on disposition of assets 296    (9)  
Foreign currency transaction gain (17)   (20)  
Interest income on note receivable (19)   27   
Deferred income taxes 4,208    864   
Changes in assets and liabilities:    
Accounts receivable (2,096)   146   
Income taxes 2,234    (649)  
Inventories (4,014)   (7,071)  
Prepaid expenses and other (513)   (792)  
Accounts payable 782    4,328   
Deferred revenue 263    (1,644)  
Accrued liabilities 5,190    364   
Net cash provided by operating activities 70,583    44,192   
Investing Activities    
Capital expenditures (30,831)   (34,328)  
Cash paid in business combination —    (6,377)  
Proceeds from sale of property, plant and equipment 68    11   
Investment in certificates of deposits (6,000)   (7,200)  
Maturities of certificates of deposits 6,000    7,920   
Purchases of investments held to maturity —    (9,001)  
Maturities of investments —    13,320   
Proceeds from called investments —    495   
Principal payments from note receivable 39    32   
Net cash used in investing activities (30,724)   (35,128)  
Financing Activities    
Stock options exercised 11,283    3,504   
Repurchase of stock (15,437)   (17,500)  
Employee taxes paid by withholding shares (1,023)   (860)  
Cash dividends paid to stockholders (8,303)   (8,400)  
Net cash used in financing activities (13,480)   (23,256)  
Net increase (decrease) in cash and cash equivalents 26,379    (14,192)  
Cash and cash equivalents, beginning of period 1,994    21,457   
Cash and cash equivalents, end of period $ 28,373    $ 7,265   

The accompanying notes are an integral part of these consolidated financial statements.
- 4 -


AAON, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
(Unaudited)

1. General

Basis of Presentation
 
The accompanying unaudited consolidated financial statements of AAON, Inc., a Nevada corporation, and our operating subsidiaries, all of which are wholly-owned, (collectively, the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (“SEC”). These financial statements have not been audited by the Company's independent registered public accounting firm, except that the consolidated balance sheet at December 31, 2018 is derived from audited consolidated financial statements. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. The financial statements reflect all adjustments (all of which are of a normal recurring nature) which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of the results that may be expected for a full year. Certain disclosures have been condensed in or omitted from these consolidated financial statements. The accompanying unaudited financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. All intercompany balances and transactions have been eliminated in consolidation.
 
We are engaged in the engineering, manufacturing, marketing and sale of air conditioning and heating equipment consisting of standard, semi-custom and custom rooftop units, chillers, packaged outdoor mechanical rooms, air handling units, makeup air units, energy recovery units, condensing units, geothermal/water-source heat pumps, coils and controls.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because these estimates and assumptions require significant judgment, actual results could differ from those estimates and could have a significant impact on our results of operations, financial position and cash flows. We reevaluate our estimates and assumptions as needed, but at a minimum on a quarterly basis. The most significant estimates include, but are not limited to, the fair-value of acquisitions, inventory reserves, warranty accrual, worker's compensation accrual, medical insurance accrual, income taxes and share-based compensation. Actual results could differ materially from those estimates.
 
Accounting Policies
 
A comprehensive discussion of our critical accounting policies and management estimates is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2018.

Business Combinations

We record the assets acquired and liabilities assumed in a business combination at their acquisition date fair values.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Fair value is based upon assumptions that market participants would use when pricing an asset or liability. We use the following fair value hierarchy, which prioritizes valuation technique inputs used to measure fair value into three broad levels:

Level 1: Quoted prices in active markets for identical assets and liabilities that we have the ability to access at the measurement date.
- 5 -


Level 2: Inputs (other than quoted prices included within Level 1) that are either directly or indirectly observable for the asset or liability, including (i) quoted prices for similar assets or liabilities in active markets, (ii) quoted prices for identical or similar assets or liabilities in inactive markets, (iii) inputs other than quoted prices that are observable for the asset or liability, and (iv) inputs that are derived from observable market data by correlation or other means.
Level 3: Unobservable inputs for the asset or liability including situations where there is little, if any, market activity for the asset or liability. Items categorized in Level 3 include the estimated business combination fair values of property, plant and equipment, intangible assets and goodwill.

The fair value hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall into different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to a fair value measurement requires judgment, considering factors specific to the asset or liability.

Intangible Assets

Our intangible assets include various trademarks, service marks and technical knowledge acquired in our February 2018 business combination (see Note 3). We amortize our intangible assets on a straight-line basis over the estimated useful lives of the assets. We evaluate the carrying value of our amortizable intangible assets for potential impairment when events and circumstances warrant such a review. 

Goodwill

Goodwill represents the excess of the consideration paid for the acquired businesses over the fair value of the individual assets acquired, net of liabilities assumed.  Goodwill at September 30, 2019 is deductible for income tax purposes. Goodwill is not amortized, but instead is evaluated for impairment at least annually. We perform our annual assessment of impairment during the fourth quarter of our fiscal year, and more frequently if circumstances warrant.

Recent Accounting Pronouncements

Changes to U.S. GAAP are established by the Financial Accounting Standards Board ("FASB") in the form of Accounting Standards Updates ("ASUs") to the FASB's Accounting Standards Codification ("ASC").

We consider the applicability and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial statements and notes thereto.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements: Changes to the Disclosure Requirement for Fair Value Measurements. The ASU includes additional disclosure requirements for unrealized gains and losses for Level 3 fair value measurement and significant observable inputs used to develop Level 3 fair value measurements. The ASU is effective for the Company beginning after December 15, 2019. We do not expect ASU 2018-13 will have a material effect on our consolidated financial statements and notes thereto.


2.  Revenue Recognition
 
On January 1, 2018, we adopted the new accounting standard FASB ASC 606, Revenue from Contracts with Customers, and all the related amendments to all contracts using the retrospective method. The impact at adoption was not material to the consolidated financial statements. The new accounting policy provides results substantially consistent with prior revenue recognition policies.

- 6 -


Disaggregated net sales by major source:
Three months ended 
 September 30,
Nine months ended 
 September 30,
2019 2018 2019 2018
(in thousands)
Rooftop Units $ 78,432    $ 86,498    $ 255,532    $ 244,978   
Condensing Units 4,416    5,356    13,622    14,492   
Air Handlers 6,523    5,686    18,150    17,479   
Outdoor Mechanical Rooms 181    311    1,488    2,178   
Water Source Heat Pumps 8,751    3,112    21,417    10,240   
Part Sales 10,313    5,030    25,602    17,692   
Other 4,884    6,944    10,948    14,548   
Net Sales
$ 113,500    $ 112,937    $ 346,759    $ 321,607   

Disaggregated units sold by major source:
Three months ended 
 September 30,
Nine months ended 
 September 30,
2019 2018 2019 2018
Rooftop Units 3,520    4,053    11,079    11,696   
Condensing Units 418    611    1,291    1,647   
Air Handlers 552    713    1,669    2,067   
Outdoor Mechanical Rooms     28    35   
Water Source Heat Pumps 1,311    1,162    5,977    3,780   
Total Units
5,808    6,547    20,044    19,225   

The Company recognizes revenue when it satisfies the performance obligation in its contracts. Most of the Company’s products are highly customized, cannot be resold to other customers and the cost of rework to be resold is not economical. The Company has a formal cancellation policy and generally does not accept returns on these units. As a result, many of the Company’s products do not have an alternative use and therefore, for these products we recognize revenue over the time it takes to produce the unit. For all other products that are part sales or standardized units, we satisfy the performance obligation when the title and risk of ownership pass to the customer, generally at time of shipment. Final sales prices are fixed based on purchase orders. Sales allowances and customer incentives are treated as reductions to sales and are provided for based on historical experiences and current estimates. Sales of our products are moderately seasonal with the peak period being July - November of each year.

In addition, the Company presents revenues net of sales tax and net of certain payments to our independent manufacturer representatives (“Representatives”). Representatives are national companies that are in the business of providing HVAC units and other related products and services to customers. The end user customer orders a bundled group of products and services from the Representative and expects the Representative to fulfill the order. Only after the specifications are agreed to by the Representative and the customer, and the decision is made to use an AAON HVAC unit, will we receive notice of the order. We establish the amount we must receive for our HVAC unit (“minimum sales price”), but do not control the total order price that is negotiated by the Representative with the end user customer.

We are responsible for billings and collections resulting from all sales transactions, including those initiated by our Representatives. The Representatives submit the total order price to us for invoicing and collection. The total order price includes our minimum sales price and an additional amount which may include both the Representatives’ fee and amounts due for additional products and services required by the customer. These additional products and services may include controls purchased from another manufacturer to operate the unit, start-up services, and curbs for supporting the unit (“Third Party Products”). All are associated with the purchase of a HVAC unit but may be provided by the Representative or another third party. The Company is under no obligation related to Third Party Products.

The Representatives’ fee and Third Party Products amounts (“Due to Representatives”) are paid only after all amounts associated with the order are collected from the customer. The amount of payments to our Representatives were $12.7 million and $11.7 million for the three months ended September 30, 2019 and 2018, respectively and $34.4 million and $36.6 million for the nine months ended September 30, 2019 and 2018, respectively.

- 7 -


The Company also sells extended warranties on parts for various lengths of time ranging from six months to 10 years. Revenue for these separately priced warranties is deferred and recognized on a straight-line basis over the separately priced warranty period.
 
3. Business Combination

On February 28, 2018, we closed on the purchase of substantially all of the assets of WattMaster Controls, Inc., (“WattMaster”). The assets acquired consisted primarily of intellectual property, receivables, inventory and fixed assets. The Company also hired substantially all of the WattMaster employees. These assets and workforce have allowed us to accelerate the development of our own electronic controllers for air distribution systems.  We funded the business combination with available cash of $6.0 million. We paid the final working capital settlement of $0.4 million with available cash in May 2018. We have included the results of WattMaster's operations in our consolidated financial statements beginning March 1, 2018.   
 
The following table presents the allocation of the consideration paid to the assets acquired and liabilities assumed, based on their fair values, in the acquisition of WattMaster described above:
(in thousands)
Accounts receivable $ 1,082   
Inventories 1,380   
Property, plant and equipment 340   
Intellectual property 700   
Goodwill 3,229   
Assumed current liabilities (354)  
     Consideration paid
$ 6,377   

Goodwill represents the excess of the consideration paid for the acquired businesses over the fair value of the individual assets acquired, net of liabilities assumed. Goodwill represents a premium paid to acquire the skilled workforce of the business acquired and is deductible for federal income tax purposes.

4.  Leases
 
We adopted ASU No. 2016-02, Leases (Topic 842), as amended, as of January 1, 2019, using the transition method, which becomes effective upon the date of adoption. The transition method allows entities to initially apply the new leases standard at the adoption date (January 1, 2019) and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. We have also elected the short-term lease measurement and recognition exemption which does not require balance sheet presentation for short-term leases. The Company historically does not enter into numerous or material lease agreements to support its manufacturing operations. Furthermore, any lease agreements entered into are usually less than a year and for leases on non material assets such as warehouse vehicles and office equipment. 

Adoption of the new standard resulted in the recording of additional lease right of use assets and lease liabilities of approximately $1.8 million as of January 1, 2019, which mostly relates to the multi-year facility lease assumed in the 2018 WattMaster acquisition. The cumulative-effect adjustment to the opening balance was immaterial to the consolidated financial statements as a whole. The standard did not materially impact our consolidated net earnings or cash flows. 


- 8 -


5.  Accounts Receivable

Accounts receivable and the related allowance for doubtful accounts are as follows:
 
  September 30,
2019
December 31, 2018
  (in thousands)
Accounts receivable $ 56,436    $ 54,342   
Less:  Allowance for doubtful accounts (353)   (264)  
Total, net
$ 56,083    $ 54,078   
 
  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
Allowance for doubtful accounts: (in thousands)
Balance, beginning of period $ 392    $ 208    $ 264    $ 119   
Provisions for losses on accounts receivables, net of adjustments (37)   (31)   91    67   
Accounts receivable written off, net of recoveries
(2)   —    (2)   (9)  
Balance, end of period $ 353    $ 177    $ 353    $ 177   
 
6.  Inventories

Inventories are valued at the lower of cost or net realizable value. Cost is determined by the first-in, first-out (“FIFO”) method. We establish an allowance for excess and obsolete inventories based on product line changes, the feasibility of substituting parts and the need for supply and replacement parts.

The components of inventories are as follows:
  September 30,
2019
December 31, 2018
  (in thousands)
Raw materials $ 74,950    $ 67,995   
Work in process 2,271    4,060   
Finished goods 5,602    6,767   
Total, gross
82,823    78,822   
Less:  Allowance for excess and obsolete inventories (2,200)   (1,210)  
Total, net
$ 80,623    $ 77,612   
 
The related changes in the allowance for excess and obsolete inventories account are as follows:
   Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
Allowance for excess and obsolete inventories: (in thousands)
Balance, beginning of period $ 2,350    $ 1,407    $ 1,210    $ 1,118   
Provisions for excess and obsolete inventories (150)   (263)   1,003    55   
Inventories written off —    (30)   (13)   (59)  
Balance, end of period $ 2,200    $ 1,114    $ 2,200    $ 1,114   


- 9 -


7.  Intangible Assets

Our intangible assets consist of the following:

September 30,
2019
December 31, 2018
(in thousands)
Intellectual property $ 700    $ 700   
Less: Accumulated amortization (369)   (194)  
       Total, net $ 331    $ 506   

Amortization expense recorded in cost of sales is as follows:

   Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
(in thousands)
Amortization expense $ 58    $ 58    $ 175    $ 136   


8.  Supplemental Cash Flow Information
 
  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
Supplemental disclosures: (in thousands)
Interest paid $ —    $ —    $ —    $  
Income taxes paid $ 1,116    $ 2,500    $ 1,510    $ 9,183   
Non-cash investing and financing activities:    
Non-cash capital expenditures $ (116)   $ 1,159    $ (280)   $ 288   
 
9.  Warranties

The Company has warranties with various terms ranging from 18 months for parts to 25 years for certain heat exchangers. The Company has an obligation to replace parts if conditions under the warranty are met. A provision is made for estimated warranty costs at the time the related products are sold based upon the warranty period, historical trends, new products and any known identifiable warranty issues.  

Changes in the warranty accrual are as follows:
  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
Warranty accrual: (in thousands)
Balance, beginning of period $ 11,666    $ 11,458    $ 11,421    $ 10,483   
Payments made (2,023)   (2,355)   (5,200)   (6,078)  
Provisions 2,707    3,050    6,129    7,748   
Balance, end of period $ 12,350    $ 12,153    $ 12,350    $ 12,153   
Warranty expense: $ 2,707    $ 3,050    $ 6,129    $ 7,748   
 
- 10 -


10.  Accrued Liabilities

Accrued liabilities were comprised of the following:

  September 30,
2019
December 31, 2018
  (in thousands)
Warranty $ 12,350    $ 11,421   
Due to representatives 11,890    11,024   
Payroll 4,465    4,182   
Profit sharing 1,613    1,835   
Worker's compensation 619    567   
Medical self-insurance 1,074    1,207   
Customer prepayments 2,819    2,367   
Employee vacation time 4,050    3,173   
Other 3,884    1,679   
Total
$ 42,764    $ 37,455   
 
11.  Revolving Credit Facility

Our revolving credit facility ("BOK Revolver"), as amended, provides for maximum borrowings of $30.0 million, which is provided by BOKF, NA dba Bank of Oklahoma (“Bank of Oklahoma”). Under the line of credit, there is one standby letter of credit totaling $1.3 million. Borrowings available under the revolving credit facility at September 30, 2019 were $28.7 million. Interest on borrowings is payable monthly at LIBOR plus 2.0%. No fees are associated with the unused portion of the committed amount. We had no outstanding balance under the revolving credit facility at September 30, 2019 and December 31, 2018. The revolving credit facility expires on July 26, 2021.

As of September 30, 2019, we were in compliance with our financial covenants. These covenants require that we meet certain parameters related to our tangible net worth and total liabilities to tangible net worth ratio. At September 30, 2019, our tangible net worth was $279.6 million and met the requirement of being at or above $175.0 million. Our total liabilities to tangible net worth ratio was 0.3 to 1, and met the requirement of not being above 2 to 1.

On October 24, 2019 we amended the BOK Revolver to allow for the occurrence of transactions associated with the New Markets Tax Credit transaction (Note 16). This amendment also removed section 8.1.4 which required our Chief Executive Officer, Norman Asbjornson, to maintain ownership of 25% of the Company. As Mr. Norman Asbjornson does not currently, and has not for several years maintained this level of ownership, a limited waiver of default was also added to the amendment.


12.  Income Taxes

The provision (benefit) for income taxes consists of the following:
  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
  (in thousands)
Current $ 464    $ 5,101    $ 3,716    $ 8,534   
Deferred 96    426    4,208    864   
$ 560    $ 5,527    $ 7,924    $ 9,398   

The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate before the provision for income taxes.

- 11 -


The reconciliation of the Federal statutory income tax rate to the effective income tax rate is as follows:
  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
Federal statutory rate 21.0  % 21.0  % 21.0  % 21.0  %
State income taxes, net of Federal benefit 1.3    5.0    4.2    5.9   
Amended Oklahoma tax returns (4.5)   —    (2.0)   —   
Excess tax benefits (1.7)   (2.1)   (3.1)   (3.1)  
Return to provision adjustments (7.1)   4.2    (2.1)   0.5   
Other (5.1)   0.1    (0.6)   (0.5)  
Effective tax rate 3.9  % 28.2  % 17.4  % 23.8  %

Upon completion of the Company's 2018 tax return, the Company recorded an additional benefit due to higher than expected research and development credit of $0.6 million. Historically, the Company has taken advantage of the Oklahoma Investment/New Jobs Credit ("OK Credit"). This OK Credit allows the Company to take a credit equal to 1% of eligible investments each year for five years, beginning with the year of investment. The Company determined it could take advantage of an additional 1% tax credit for years in which the Company's location was deemed to be within an enterprise zone. The additional OK Credit for being in an enterprise zone, or otherwise allowable under Oklahoma law resulted in a benefit of $0.3 million for 2018 and $0.9 million for our 2015, 2016 and 2017 amended returns, combined.

The Company's estimated annual 2019 effective tax rate, excluding discrete events, is approximately 24%. Our estimated effective tax rate for 2019 decreased due to the additional credit we expect to realize in Oklahoma. We file income tax returns in the U.S., state and foreign income tax returns jurisdictions. We are subject to U.S. income tax examinations for tax years 2014 to present, and to non-U.S. income tax examinations for the tax years 2014 to present. In addition, we are subject to state and local income tax examinations for the tax years 2014 to present. The Company continues to evaluate its need to file returns in various state jurisdictions. Any interest or penalties would be recognized as a component of income tax expense.


13. Share-Based Compensation

On May 22, 2007, our stockholders adopted a Long-Term Incentive Plan (“LTIP”) which provided an additional 3.3 million shares that could be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance units and performance awards, in addition to the shares from the previous plan, the 1992 Plan. Since inception of the LTIP, non-qualified stock options and restricted stock awards have been granted with a five years vesting schedule. Under the LTIP, the exercise price of shares granted could not be less than 100% of the fair market value at the date of the grant.

On May 24, 2016, our stockholders adopted the 2016 Long-Term Incentive Plan ("2016 Plan") which provides for approximately 6.4 million shares, comprised of 3.4 million new shares provided for under the 2016 Plan, approximately 0.4 million shares that were available for issuance under the previous LTIP that are now authorized for issuance under the 2016 Plan, and an additional 2.6 million shares that were approved by the stockholders on May 15, 2018. Under the 2016 Plan, shares can be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance awards, dividend equivalent rights, and other awards. Under the 2016 Plan, the exercise price of shares granted may not be less than 100% of the fair market value at the date of the grant. The 2016 Plan will be administered by the Compensation Committee of the Board of Directors or such other committee of the Board of Directors as is designated by the Board of Directors (the “Committee”). Membership on the Committee shall be limited to independent directors. The Committee may delegate certain duties to one or more officers of the Company as provided in the 2016 Plan. The Committee will determine the persons to whom awards are to be made, determine the type, size and terms of awards, interpret the 2016 Plan, establish and revise rules and regulations relating to the 2016 Plan and make any other determinations that it believes necessary for the administration of the 2016 Plan.

Options - The total pre-tax compensation cost related to unvested stock options not yet recognized as of September 30, 2019 is $26.8 million and is expected to be recognized over a weighted average period of 3.8 years.

- 12 -


The following weighted average assumptions were used to determine the fair value of the stock options granted on the original grant date for expense recognition purposes for options granted during the nine months ended September 30, 2019 and 2018 using a Black Scholes-Merton Model:
 
  Nine months ended
  September 30, 2019 September 30, 2018
Directors and Officers:    
Expected dividend rate $0.32    $0.26   
Expected volatility 29.54%    29.73%   
Risk-free interest rate 2.40%    2.20%   
Expected life (in years) 5.0 5.0
Employees:    
Expected dividend rate $0.32    $0.26   
Expected volatility 29.54%    29.82%   
Risk-free interest rate 2.39%    2.48%   
Expected life (in years) 5.0 5.0
 
The expected term of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Volatility is based on historical volatility of our stock over time periods equal to the expected life at grant date.
 
The following is a summary of stock options vested and exercisable as of September 30, 2019:
 
Range of
Exercise
Prices
Number
of
Shares
Weighted
Average
Remaining
Contractual Life
(in years)
Weighted
Average
Exercise
Price
Intrinsic
Value
(in thousands)
$ 7.18    - $ 33.20    350,549    5.29 $ 21.07    $ 8,717   
$ 33.40    - $ 40.87    124,622    7.79 35.63    1,284   
$ 41.37    - $ 50.68    4,070    0.67 41.37    19   
Total 479,241    5.90 $ 25.03    $ 10,020   
 
The following is a summary of stock options vested and exercisable as of September 30, 2018:

Range of
Exercise
Prices
Number
of
Shares
Weighted
Average
Remaining
Contractual Life
(in years)
Weighted
Average
Exercise
Price
Intrinsic
Value
(in thousands)
$ 5.67    - $ 32.80    362,715    5.54 $ 18.14    $ 7,132   
$ 32.85    - $ 33.80    5,484    4.08 33.18    25   
$ 34.00    - $ 40.60    81,417    5.87 34.32    283   
Total 449,616    5.58 $ 21.25    $ 7,440   

- 13 -


A summary of option activity under the plans is as follows:
Shares Weighted
Average
Exercise
Price
Outstanding at December 31, 2018
2,445,849    $ 30.77   
Granted
1,965,520    41.46   
Exercised
(394,024)   28.63   
Forfeited or Expired
(293,299)   36.71   
Outstanding at September 30, 2019
3,724,046    $ 36.17   
Exercisable at September 30, 2019
479,241    $ 25.03   
 
The total intrinsic value of options exercised during the nine months ended September 30, 2019 and 2018 was $7.0 million and $5.0 million, respectively. The cash received from options exercised during the nine months ended September 30, 2019 and 2018 was $11.3 million and $3.5 million, respectively. The impact of these cash receipts is included in financing activities in the accompanying Consolidated Statements of Cash Flows.

Restricted Stock - Since 2007, as part of the LTIP and since May 2016, as part of the 2016 Plan, the Compensation Committee of the Board of Directors has authorized and issued restricted stock awards to directors and key employees. Historically, restricted stock awards granted to directors vest at one-third each year. As of May 2019, all new restricted stock awards granted to directors vest ratably over each director's remaining elected term. All other restricted stock awards vest at a rate of 20% per year. The fair value of restricted stock awards is based on the fair market value of AAON, Inc. common stock on the respective grant dates, reduced for the present value of dividends.

These awards are recorded at their fair value on the date of grant and compensation cost is recorded using straight-line vesting over the service period. At September 30, 2019, unrecognized compensation cost related to unvested restricted stock awards was approximately $7.6 million, which is expected to be recognized over a weighted average period of 2.8 years.

A summary of the unvested restricted stock awards is as follows:
 
Shares Weighted
Average
Grant Date
Fair Value
Unvested at December 31, 2018
292,450    $ 28.54   
Granted
112,018    40.92   
Vested
(109,514)   26.99   
Forfeited
(12,103)   33.87   
Unvested at September 30, 2019
282,851    $ 33.81   
- 14 -


A summary of share-based compensation is as follows: 
Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
Grant date fair value of awards during the period: (in thousands)
Options $ 244    $ 53    $ 20,315    $ 12,633   
Restricted stock —    18    4,584    3,379   
Total $ 244    $ 71    $ 24,899    $ 16,012   
Share-based compensation expense:
Options $ 1,874    $ 1,076    $ 5,156    $ 3,202   
Restricted stock 911    839    2,702    2,412   
Total $ 2,785    $ 1,915    $ 7,858    $ 5,614   
Income tax benefit/(deficiency) related to share-based compensation:
Options $ 233    $ 379    $ 964    $ 980   
Restricted stock   26    462    245   
Total $ 240    $ 405    $ 1,426    $ 1,225   
 

14.  Earnings Per Share

Basic net income per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share assumes the conversion of all potentially dilutive securities and is calculated by dividing net income by the sum of the weighted average number of shares of common stock outstanding plus all potentially dilutive securities. Dilutive common shares consist primarily of stock options and restricted stock awards.

The following table sets forth the computation of basic and diluted earnings per share:
  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
  (in thousands, except share and per share data)
Numerator:    
Net income
$ 13,827    $ 14,085    $ 37,690    $ 30,036   
Denominator:    
Basic weighted average shares
52,111,444    52,238,796    52,086,209    52,315,719   
Effect of dilutive stock options and restricted stock
610,683    388,745    538,374    399,671   
Diluted weighted average shares
52,722,127    52,627,541    52,624,583    52,715,390   
Earnings per share:    
Basic
$ 0.27    $ 0.27    $ 0.72    $ 0.57   
Diluted
$ 0.26    $ 0.27    $ 0.72    $ 0.57   
Anti-dilutive shares:    
Shares
1,834,379    1,950,343    1,886,728    1,929,453   

- 15 -


15. Stockholders’ Equity

Stock Repurchase - The Board has authorized three stock repurchase programs for the Company. Al1 other repurchases from directors or employees are contingent upon Board approval. All repurchases are done at current market prices.

The Company may purchase shares on the open market from time to time, up to a total of 5.7 million shares. The Board must authorize the timing and amount of these purchases. In May 2018, the Board authorized up to $15.0 million in open market repurchases and on May 18, 2018, the Company executed a repurchase agreement in accordance with the rules and regulations of the SEC allowing the Company to repurchase shares from the open market. The agreement expired on March 1, 2019. In February 2019, the Board authorized up to $20.0 million in open market repurchases and on March 5, 2019, the Company executed a repurchase agreement in accordance with the rules and regulations of the SEC allowing the Company to repurchase shares from the open market. The agreement will expire on March 4, 2020.

The Company also has a stock repurchase arrangement by which employee-participants in our 401(k) savings and investment plan are entitled to have shares in AAON, Inc. stock in their accounts sold to the Company. The maximum number of shares to be repurchased is contingent upon the number of shares sold by employee-participants.

Lastly, the Company repurchases shares of AAON, Inc. stock from certain of its directors and employees for payment of statutory tax withholdings on stock transactions.

Our repurchase activity is as follows:
Nine months ended 
 September 30,
2019 2018
(in thousands, except share and per share data)
Program Shares Total $ $ per share Shares Total $ $ per share
Open market 5,799    $ 200    $ 34.46    116,289    $ 3,840    $ 33.02   
401(k) 335,139    15,237    45.46    373,129    13,661    36.61   
Directors and employees 24,948    1,023    41.00    24,457    860    35.15   
Total
365,886    $ 16,460    $ 44.99    513,875    $ 18,361    $ 35.73   

Our repurchase activity since Company inception, including our current authorized stock repurchase programs, are as follows:
Inception to date
(in thousands, except share and per share data)
Program Shares Total $ $ per share
Open market 4,101,566    $ 69,806    $ 17.02   
401(k) 7,382,915    115,778    15.68   
Directors and employees 1,978,209    19,398    9.81   
Total
13,462,690    $ 204,982    $ 15.23   

Subsequent to September 30, 2019 and through October 29, 2019, the Company repurchased 27,532 shares for $1.3 million from our 401(k) savings and investment plan.

Dividends - At the discretion of the Board, we pay semi-annual cash dividends. Board approval is required to determine the date of declaration and amount for each semi-annual dividend payment.

Our recent dividends are as follows:
Declaration Date Record Date Payment Date Dividend per Share
May 18, 2018 June 8, 2018 July 6, 2018 $0.16   
November 8, 2018 November 29, 2018 December 20, 2018 $0.16   
May 20, 2019 June 3, 2019 July 1, 2019 $0.16   


- 16 -


16. New Markets Tax Credit

On October 24, 2019, the Company entered into a transaction with a subsidiary of an unrelated third-party financial institution (the “Investor”) and a certified Community Development Entity under a qualified New Markets Tax Credit (“NMTC”) program pursuant to Section 45D of the Internal Revenue Code of 1986, as amended, related to an investment in plant and equipment to facilitate the expansion of our Longview, Texas manufacturing operations (the “Project”). In connection with the NMTC transaction, the Company received a $23.0 million NMTC allocation for the Project and secured low interest financing and the potential for future debt forgiveness related to the expansion of its Longview, Texas facilities.

Upon closing of the NMTC transaction, the Company provided an aggregate of approximately $15.9 million to the Investor, in the form of a loan receivable, with a term of twenty-five years, bearing an interest rate of 1.0%. This $15.9 million in proceeds plus capital contributed from the Investor was used to make an aggregate $22.5 million loan to a subsidiary of the Company. This financing arrangement is secured by equipment at the Company's Longview, Texas facilities and a guarantee from the Company, including an unconditional guarantee of NMTCs.

This transaction also includes a put/call feature that either of which can be exercised at the end of the seven-year compliance period. The Investor may exercise its put option or the Company can exercise the call, both of which could serve to trigger forgiveness of a portion of the debt.

The Investor is subject to 100 percent recapture of the NMTC it receives for a period of seven years, as provided in the Internal Revenue Code and applicable U.S. Treasury regulations in the event that the financing facility of the Borrower under the transaction (AAON Coil Products, Inc.) becomes ineligible for NMTC treatment per the Internal Revenue Code requirements. The Company is required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangement. Noncompliance with applicable requirements could result in the Investor’s projected tax benefits not being realized and, therefore, require the Company to indemnify the Investor for any loss or recapture of the NMTC related to the financing until such time as the recapture provisions have expired under the applicable statute of limitations. The Company does not anticipate any credit recapture will be required in connection with this financing arrangement.


17. Commitments and Contingencies
 
We are subject to various claims and legal actions that arise in the ordinary course of business. We closely monitor these claims and legal actions and frequently consult with our legal counsel to determine whether they may, when resolved, have a material adverse effect on our financial position, results of operations or cash flows and we accrue and/or disclose loss contingencies as appropriate. We have concluded that the likelihood is remote that the ultimate resolution of any pending litigation or claims will be material or have a material adverse effect on the Company's business, financial position, results of operations and/or cash flows.

We are occasionally party to short-term, cancellable and occasionally non-cancellable, fixed price contracts with major suppliers for the purchase of raw material and component parts. We expect to receive delivery of raw materials for use in our manufacturing operations. These contracts are not accounted for as derivative instruments because they meet the normal purchase and normal sales exemption. At September 30, 2019, we had one material contractual purchase obligation for approximately $3.4 million that expires in December 2020.


18.  Related Parties

The Company purchases some supplies from an entity controlled by the Company’s CEO. The Company sometimes makes sales to the CEO for parts. Additionally, the Company sells units to an entity owned by a member of the President's immediate family. This entity is also one of the Company’s Representatives and as such, the Company makes payments to the entity for third party products.  All related party transactions are made on standard Company terms.

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The following is a summary of transactions and balance with affiliates:

  Three months ended Nine months ended
  September 30,
2019
September 30,
2018
September 30,
2019
September 30,
2018
(in thousands)
Sales to affiliates $ 338