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.
•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.
Disaggregated net sales by major source:
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|
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|
|
|
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|
|
|
Three months ended
September 30,
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Nine months ended
September 30,
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|
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2019
|
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2018
|
|
2019
|
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2018
|
|
(in thousands)
|
|
|
|
|
|
|
Rooftop Units
|
$
|
78,432
|
|
|
$
|
86,498
|
|
|
$
|
255,532
|
|
|
$
|
244,978
|
|
Condensing Units
|
4,416
|
|
|
5,356
|
|
|
13,622
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|
|
14,492
|
|
Air Handlers
|
6,523
|
|
|
5,686
|
|
|
18,150
|
|
|
17,479
|
|
Outdoor Mechanical Rooms
|
181
|
|
|
311
|
|
|
1,488
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|
|
2,178
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|
Water Source Heat Pumps
|
8,751
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|
|
3,112
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|
|
21,417
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|
|
10,240
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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
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|
|
$
|
321,607
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|
Disaggregated units sold by major source:
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|
|
|
|
|
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
September 30,
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Nine months ended
September 30,
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|
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2019
|
|
2018
|
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2019
|
|
2018
|
Rooftop Units
|
3,520
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|
|
4,053
|
|
|
11,079
|
|
|
11,696
|
|
Condensing Units
|
418
|
|
|
611
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|
|
1,291
|
|
|
1,647
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|
Air Handlers
|
552
|
|
|
713
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|
|
1,669
|
|
|
2,067
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|
Outdoor Mechanical Rooms
|
7
|
|
|
8
|
|
|
28
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|
|
35
|
|
Water Source Heat Pumps
|
1,311
|
|
|
1,162
|
|
|
5,977
|
|
|
3,780
|
|
Total Units
|
5,808
|
|
|
6,547
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|
|
20,044
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|
|
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.
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 $0.4 million with available cash in May 2018. We have included the results of WattMaster's operations in our consolidated financial statements beginning March 1, 2018.
The following table presents the allocation of the consideration paid to the assets acquired and liabilities assumed, based on their fair values, in the acquisition of WattMaster described above:
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(in thousands)
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Accounts receivable
|
|
|
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$
|
1,082
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Inventories
|
|
|
|
|
1,380
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|
Property, plant and equipment
|
|
|
|
|
340
|
|
Intellectual property
|
|
|
|
|
700
|
|
Goodwill
|
|
|
|
|
3,229
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|
Assumed current liabilities
|
|
|
|
|
(354)
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Consideration paid
|
|
|
|
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$
|
6,377
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|
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.
5. Accounts Receivable
Accounts receivable and the related allowance for doubtful accounts are as follows:
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September 30,
2019
|
|
December 31, 2018
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(in thousands)
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|
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Accounts receivable
|
$
|
56,436
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|
|
$
|
54,342
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Less: Allowance for doubtful accounts
|
(353)
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|
|
(264)
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Total, net
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$
|
56,083
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|
|
$
|
54,078
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|
Three months ended
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|
Nine months ended
|
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|
September 30,
2019
|
|
September 30,
2018
|
|
September 30,
2019
|
|
September 30,
2018
|
Allowance for doubtful accounts:
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(in thousands)
|
|
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Balance, beginning of period
|
$
|
392
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|
|
$
|
208
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|
|
$
|
264
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|
|
$
|
119
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Provisions for losses on accounts receivables, net of adjustments
|
(37)
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|
(31)
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|
|
91
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|
|
67
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|
Accounts receivable written off, net of recoveries
|
(2)
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|
|
—
|
|
|
(2)
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|
|
(9)
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Balance, end of period
|
$
|
353
|
|
|
$
|
177
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|
|
$
|
353
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|
|
$
|
177
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|
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:
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|
|
September 30,
2019
|
|
December 31, 2018
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(in thousands)
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|
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Raw materials
|
$
|
74,950
|
|
|
$
|
67,995
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Work in process
|
2,271
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|
|
4,060
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|
Finished goods
|
5,602
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|
|
6,767
|
|
Total, gross
|
82,823
|
|
|
78,822
|
|
Less: Allowance for excess and obsolete inventories
|
(2,200)
|
|
|
(1,210)
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|
Total, net
|
$
|
80,623
|
|
|
$
|
77,612
|
|
The related changes in the allowance for excess and obsolete inventories account are as follows:
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|
|
|
|
|
|
Three months ended
|
|
|
|
Nine months ended
|
|
|
|
September 30,
2019
|
|
September 30,
2018
|
|
September 30,
2019
|
|
September 30,
2018
|
Allowance for excess and obsolete inventories:
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(in thousands)
|
|
|
|
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Balance, beginning of period
|
$
|
2,350
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|
|
$
|
1,407
|
|
|
$
|
1,210
|
|
|
$
|
1,118
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|
Provisions for excess and obsolete inventories
|
(150)
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|
|
(263)
|
|
|
1,003
|
|
|
55
|
|
Inventories written off
|
—
|
|
|
(30)
|
|
|
(13)
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|
|
(59)
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|
Balance, end of period
|
$
|
2,200
|
|
|
$
|
1,114
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|
|
$
|
2,200
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|
|
$
|
1,114
|
|
7. Intangible Assets
Our intangible assets consist of the following:
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|
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|
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|
|
|
|
|
September 30,
2019
|
|
December 31, 2018
|
|
|
(in thousands)
|
|
|
Intellectual property
|
|
$
|
700
|
|
|
$
|
700
|
|
Less: Accumulated amortization
|
|
(369)
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|
|
(194)
|
|
Total, net
|
|
$
|
331
|
|
|
$
|
506
|
|
Amortization expense recorded in cost of sales is as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
Nine months ended
|
|
|
|
September 30,
2019
|
|
September 30,
2018
|
|
September 30,
2019
|
|
September 30,
2018
|
|
(in thousands)
|
|
|
|
|
|
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Amortization expense
|
$
|
58
|
|
|
$
|
58
|
|
|
$
|
175
|
|
|
$
|
136
|
|
8. Supplemental Cash Flow Information
|
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|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
Nine months ended
|
|
|
|
September 30,
2019
|
|
September 30,
2018
|
|
September 30,
2019
|
|
September 30,
2018
|
Supplemental disclosures:
|
(in thousands)
|
|
|
|
|
|
|
Interest paid
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5
|
|
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:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. 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.
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.
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
|
|
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
|
|
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
|
7
|
|
|
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. 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. 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.
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
|
|
|
$
|
298
|
|
|
$
|
706
|
|
|
$
|
890
|
|
Payments to affiliates
|
32
|
|
|
48
|
|
|
225
|
|
|
159
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2019
|
|
December 31, 2018
|
|
(in thousands)
|
|
|
Due from affiliates
|
$
|
119
|
|
|
$
|
79
|
|
Due to affiliates
|
—
|
|
|
—
|
|
19. Segments
The following table summarizes certain financial data related to our segments. Transactions between segments are recorded based on prices negotiated between the segments. Sales of units represent the selling price of our units plus freight and other miscellaneous charges less any returns and allowances. Parts include sales of purchased and fabricated parts including our coils along with the related freight and less any returns and allowances. The “Other” category in the table below includes certain sales cost and expenses that are not allocated to the reportable segments.
Asset information by segment is not easily identifiable or reviewed by the chief operating decision maker. As such, this information is not included below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
|
(in thousands)
|
|
|
|
|
|
|
Sales
|
|
|
|
|
|
|
|
Units
|
$
|
102,499
|
|
|
$
|
104,957
|
|
|
$
|
319,820
|
|
|
$
|
300,623
|
|
Parts - External
|
11,028
|
|
|
8,321
|
|
|
27,287
|
|
|
21,700
|
|
Parts - Inter-segment
|
6,448
|
|
|
7,669
|
|
|
21,665
|
|
|
21,306
|
|
Other
|
(27)
|
|
|
(341)
|
|
|
(348)
|
|
|
(716)
|
|
Eliminations
|
(6,448)
|
|
|
(7,669)
|
|
|
(21,665)
|
|
|
(21,306)
|
|
Net sales
|
$
|
113,500
|
|
|
$
|
112,937
|
|
|
$
|
346,759
|
|
|
$
|
321,607
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
|
|
|
|
|
|
Units
|
$
|
27,713
|
|
|
$
|
33,488
|
|
|
$
|
84,998
|
|
|
$
|
79,407
|
|
Parts - External
|
5,074
|
|
|
3,893
|
|
|
13,245
|
|
|
9,880
|
|
Parts - Inter-segment
|
44
|
|
|
(39)
|
|
|
889
|
|
|
325
|
|
Other
|
(5,402)
|
|
|
(4,618)
|
|
|
(14,890)
|
|
|
(13,549)
|
|
Eliminations
|
(44)
|
|
|
39
|
|
|
(889)
|
|
|
(325)
|
|
Net gross profit
|
$
|
27,385
|
|
|
$
|
32,763
|
|
|
$
|
83,353
|
|
|
$
|
75,738
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|