(Exact name of registrant as specified in its charter)
iNevada
i87-0448736
(State
or other jurisdiction
(IRS Employer
of incorporation or organization)
Identification No.)
i2425
South Yukon Ave.,
iTulsa,
iOklahoma
i74107
(Address
of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (i918) i583-2266
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon Stock
iAAON
iNASDAQ
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
☐ Yes ☒ iNo
Indicate by check mark if the registrant is not required to file reports pursuant
to Section 13 or 15(d) of the Act.
☐ Yes ☒ iNo
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.
☒ iYes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).
☒ iYes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer or a smaller reporting company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
iLarge accelerated filer
☑
Accelerated filer
☐
Non-accelerated
filer
☐
Smaller reporting company
i☐
Emerging growth company
i☐
Indicate
by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act.)
i☐ Yes ☒ No
The aggregate market value of the common equity held by non-affiliates computed by reference to the closing price of registrant’s common stock on the last business day of registrant’s most recently completed second quarter June 30, 2019 was $i2,035.2
million.
As of February 24, 2020, registrant had outstanding a total of i52,092,212shares of its $.004 par value Common Stock.
iPortions
of registrant’s definitive Proxy Statement to be filed in connection with the Annual Meeting of Stockholders to be held May 12, 2020, are incorporated into Part III.
This Annual Report includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, “should”, “will”, and variations
of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligations to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Important factors that could cause results to differ materially from those in the forward-looking statements include (1) the timing and extent of changes in raw material and component prices, (2) the effects of fluctuations in the commercial/industrial new construction market, (3) the timing and extent of changes
in interest rates, as well as other competitive factors during the year, (4) general economic, market or business conditions, and (5) the correction of certain of our previously issued consolidated financial statements, which may affect investor confidence and raise reputational issues.
Explanatory Note
Error Correction Background
The Company noted errors in previously issued financial statements relating to share-based compensation expense for stock options and restricted stock awards held by retirement eligible employees and directors. See
Note 2, Error Correction located inPart II, Item 8 - Financial Statements and Supplementary Data for further detail.
We do not believe that the errors are quantitatively material to any period presented in our prior financial statements. However, due to the qualitative nature of the matters identified in our review, including the number of years over which the errors occurred, we determined that it would be appropriate to correct the errors in our previously issued consolidated financial statements.
Management
has evaluated the effects of the error correction regarding the effectiveness of the Company’s internal control over financial reporting and disclosure controls and procedures and has concluded that a material weakness existed as of December 31, 2019. See Part II, Item 9A - Controls and Procedures for further details.
The following parts of this Form 10-K include discussion of or disclosure related to the error corrections:
•Part I, Item 1A - Risk Factors
•Part II, Item 6 - Selected Financial Data
•Part
II, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
•Part II, Item 8 - Financial Statements and Supplementary Data
•Part II, Item 9A - Controls and Procedures
1
PART
I
Item 1. Business.
General Development and Description of Business
AAON, Inc., a Nevada corporation, (“AAON Nevada”) was incorporated on August 18, 1987. Our operating subsidiaries include AAON, Inc., an Oklahoma corporation, and AAON Coil Products, Inc., a Texas corporation. Unless the context otherwise requires, references in this Annual Report to “AAON”, the “Company”, “we”, “us”, “our”, or “ours” refer to AAON Nevada and our subsidiaries.
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 and coils.
Products and Markets
Our products serve the commercial and industrial new construction and replacement markets. To date, our sales have been primarily to the domestic market. Foreign sales accounted for approximately $14.8 million, $14.7 million, and $14.6 million of our sales in 2019, 2018, and 2017, respectively. As a percentage of sales, foreign sales accounted for approximately 3% , 3% and 4% of our net sales in each of those years, respectively.
Our
rooftop and condensing unit markets primarily consist of units installed on commercial or industrial structures of generally less than ten stories in height. Our air handling units, self-contained units, geothermal/water-source heat pumps, chillers, packaged outdoor mechanical rooms and coils are suitable for all sizes of commercial and industrial buildings.
The size of these markets is determined primarily by the number of commercial and industrial building completions. The replacement market consists of products installed to replace existing units/components that are worn or damaged and products to upgrade certain components, such as low leakage dampers, high efficiency heat exchangers and modern controls components. Currently, over half of the industry’s market consists of replacement units.
The commercial and industrial
new construction market is subject to cyclical fluctuations in that it is generally tied to housing starts, but has a lag factor of six to 18 months. Housing starts, in turn, are affected by such factors as interest rates, the state of the economy, population growth and the relative age of the population. When new construction is down, we emphasize the replacement market.
Based on our 2019 sales of $469.3 million, we estimate that we have approximately a 10% share of the greater than five ton rooftop market and a 2% share of the less than five ton market. During 2019, approximately 50% of our sales were generated from the renovation and replacement markets and 50% from new construction. The percentage of sales for new construction vs. replacement to particular customers is related to the customer’s stage of development.
We
purchase certain components, fabricate sheet metal and tubing and then assemble and test the finished products. Our primary finished products consist of a single unit system containing heating and cooling in a self-contained cabinet, referred to in the industry as “unitary products”. Our other finished products are chillers, packaged outdoor mechanical rooms, coils, air handling units, condensing units, makeup air units, energy recovery units, rooftop units, geothermal/water-source heat pumps and controls.
We offer four groups of rooftop units: the RQ Series, consisting of five cooling sizes ranging from two to six tons; the RN Series, offered in 28 cooling sizes ranging from six to 140 tons; the RL Series, which is offered in 21 cooling sizes ranging from 45 to 240 tons; and the RZ Series, which is offered in 15 cooling sizes ranging from 45 to 240 tons.
We
also offer the SA, SB and M2 Series as indoor packaged, water-cooled or geothermal/water-source heat pump self-contained units with cooling capacities of three to 70 tons.
2
Our small packaged geothermal/water-source heat pump units consist of the WH Series horizontal configuration and WV Series vertical configuration, from one-half to 30 tons.
We manufacture a LF Series air-cooled chiller, a LN Series air-cooled chiller, and a LZ Series chiller and packaged outdoor mechanical room, which are available in both air-cooled condensing and evaporative-condensed configurations, covering a range of four to 540 tons. BL Series boiler outdoor mechanical rooms are also available
with 400-6,000 MBH (1,000 BTU/hr) heating capacity. FZ Series fluid cooler outdoor mechanical rooms are also available with a range of 50 to 450 tons.
We offer four groups of condensing units: the CB Series, two to five tons; the CF Series, two to 70 tons; the CN Series, 55 to 140 tons; and the CL Series, 45 to 230 tons.
Our air handling units consist of the indoor F1, H3 and V3 Series and the modular M2 and M3 Series, as well as air handling unit configurations of the RQ, RN, RL, RZ and SA Series units.
Our energy recovery option applicable to our RQ, RN, RL, RZ and SB units, as well as our H3, V3, M2 and M3 Series air handling units, responds to the U.S. Clean Air Act mandate to increase fresh air in commercial structures. Our products are
designed to compete on the higher quality end of standardized products.
Our air-cooled chillers (LF, LN and LZ Series) are certified with the Air-Conditioning, Heating, and Refrigeration Institute (“AHRI”) in accordance with AHRI Standard 550/590. Our water-source heat pump products, including RN, RQ, M2, SB, WH and WV Series, are AHRI certified in accordance with ANSI/AHRI/ASHRAE/ISO 13256.
Our unitary products (RQ, RN, and CB Series) are certified with the AHRI in accordance with AHRI Standard AHRI 210/240 up to 5 tons capacity and AHRI Standard AHRI 340/360 up to 63 tons capacity.
Performance characteristics of our products range in cooling capacity from one-half to 540 tons and in heating capacity from 7,200 to 9,000,000 British
Thermal Units ("BTUs"). Many of our units far exceed these minimum standards and are among the highest efficiency units currently available.
A typical commercial building installation requires one ton of air conditioning for every 300-400 square feet or, for a 100,000 square foot building, 250 tons of air conditioning, which can involve multiple units.
AAON designs and produces controls solutions for all of our HVAC units including roof top units, air handlers, chillers, and water source heat pumps. In addition, we provide controls for variable air volume systems associated with those units, as well as controls products for other HVAC related equipment. Our controls are easily configurable to provide a wide variety of HVAC unit application options, and we are able to customize our controls, where necessary,
to meet unique customers’ requirements. Most of our controls are Underwriters Laboratories category ZPVI2 complaint and BACnet Testing Laboratories certified. In addition our economizer function is California Title 24 certified. All of these factors allow us to provide AAON controls with factory developed, approved and tested sequences of operation to optimize the performance of the AAON units.
Other AAON controls options include providing terminal blocks for field-installed controls and factory installed customer provided controls. With all these controls options available to us, we are able to use controls to help sell more AAON equipment. We also offer six control options: the Pioneer Silver, Pioneer Gold, Touchscreen Controller, Orion Controller, and terminal block for field installed controls, and factory installed customer provided controls.
Major
Customers
One customer, Texas AirSystems, accounted for 10% or more of our sales during 2019, 2018, and 2017.
3
Sources and Availability of Raw Materials
The most important materials we purchase are steel, copper and aluminum. We also purchase from other manufacturers certain components, including compressors, electric motors and electrical controls used in our products. We attempt to obtain the lowest possible cost in our purchases of raw materials and components, consistent with meeting specified quality standards. We are not dependent upon any one source for raw materials or the major
components of our manufactured products. By having multiple suppliers, we believe that we will have adequate sources of supplies to meet our manufacturing requirements for the foreseeable future.
We attempt to limit the impact of price fluctuations on these materials by entering into cancellable and non-cancellable fixed price contracts with our major suppliers for periods of six to 18 months. We expect to receive delivery of raw materials from our fixed price contracts for use in our manufacturing operations.
We have not been significantly impacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank
Act”) that contains provisions to improve transparency and accountability concerning the supply of certain minerals, known as “conflict minerals”, originating from the Democratic Republic of Congo and adjoining countries.
Representatives
We employ a sales staff of 44 individuals and utilize approximately 63 independent manufacturer representatives’ organizations (“Representatives”) having 105 offices to market our products in the United States and Canada. We also have one international sales organization, which utilizes 19 distributors in other countries. Sales are made directly to the contractor or end user, with shipments being made from our Tulsa, Oklahoma, Longview, Texas, or our Parkville, Missouri, facilities to the job site.
Our
products and sales strategy focuses on niche markets. The targeted markets for our equipment are customers seeking products of better quality than those offered, and/or options not offered, by standardized manufacturers.
To support and service our customers and the ultimate consumer, we provide parts availability through our Representatives' sales offices, as well as our two Tulsa, Oklahoma AAON operated retail parts stores, to serve the local markets. We also have factory service organizations at each of our plants. Additionally, a number of the Representatives we utilize have their own service organizations, which, in connection with us, provide the necessary warranty work and/or normal service to customers.
Warranties
Our
product warranty policy is: the earlier of one year from the date of first use or 18 months from date of shipment for parts only, including controls; an additional four years for compressors (if applicable); 15 years on aluminized steel gas-fired heat exchangers (if applicable); 25 years on stainless steel heat exchangers (if applicable); and ten years on gas-fired heat exchangers in RL products (if applicable). Our warranty policy for the RQ series covers parts for two years from date of unit shipment. Our warranty policy for the WH and WV Series geothermal/water-source heat pumps covers parts for five years from the date of manufacture.
The Company also sells extended warranties on parts for various lengths of time ranging from six months to ten years. Revenue for these separately priced warranties is deferred and recognized on a straight-line
basis over the separately priced warranty period.
Research and Development
Our products are engineered for performance, flexibility and serviceability. This has become a critical factor in competing in the heating, ventilation and air conditioning (“HVAC”) equipment industry. We must continually develop new and improved products in order to compete effectively and to meet evolving regulatory standards in all of our major product lines.
All of our Research and Development (“R&D”) activities are self-sponsored, rather than customer-sponsored. R&D activities have involved the RQ, RN, RL and RZ (rooftop units), F1, H3, SA, V3, M2 and M3 (air handling units), LF, LN and LZ (chillers), CB, CF, CN and CL (condensing
units), SA and SB (self-contained units), WH and WV
4
(water-source heat pumps), FZ (fluid coolers) and BL (boilers), as well as component evaluation and refinement, development of control systems and new product development. We incurred R&D expenses of approximately $14.8 million, $13.5 million, and $13.0 million in 2019, 2018, and 2017, respectively.
Our Norm Asbjornson Innovation Center ("NAIC") research and development laboratory facility that opened in 2019, includes many unique capabilities that to our knowledge exist nowhere else in the world. A few features of the NAIC include supply, return, and outside sound testing at actual load conditions, testing up to a 300 ton air conditioning
system, testing of up to a 540 ton chiller system and 80 million BTU/hr of gas heating test capacity. Environmental application testing capabilities include -20 to 140°F testing conditions, up to 8 inches per hour rain testing, up to 2 inches per hour snow testing and up to 50 mph wind testing. We believe we have the largest sound-testing chamber in the world for testing heating and air conditioning equipment and are not aware of any similar labs that can do this testing while putting the equipment under full environmental load. The unique capabilities of the NAIC will enable AAON to lead the industry in the development of quiet, energy efficient commercial and industrial heating and air conditioning equipment.
Ten testing chambers within the NAIC allow AAON to meet and maintain AHRI and DOE certification and solidify the
Company’s industry position as a technological leader in the manufacturing of HVAC equipment. Current voluntary industry certification programs and government regulations only go up to 63 tons of air conditioning as that is the largest environmental chamber currently available for testing. The NAIC contains both a 100 ton and a 540 ton chamber, allowing us to uniquely prove to customers our capacity and efficiency on these larger units.
The NAIC was designed to test units well beyond the standard AHRI rating points and allows us to offer testing services on AAON equipment throughout range our of application. This capability is vital for critical facilities where the units must perform properly and allows our customers to verify the performance of our units in advance, rather than after installation. These same capabilities will enable AAON to develop new extended range of operation
equipment and prove its capabilities.
Backlog
Our backlog as of February 1, 2020 was approximately $129.2 million, compared to approximately $147.0 million as of February 1, 2019. The current backlog consists of orders considered by management to be firm and our goal is to fill orders within approximately 60 to 90 days after an order is deemed to become firm; however, the orders are subject to cancellation by the customers in which case, cancellation charges apply up to the full price of the equipment.
Working Capital Practices
Working capital practices in the industry center
on inventories and accounts receivable. Our management regularly reviews our working capital with a view of maintaining the lowest level consistent with requirements of anticipated levels of operation. Our greatest needs arise during the months of July - November, the peak season for inventory (primarily purchased material) and accounts receivable. Our working capital requirements are generally met by cash flow from operations and a bank revolving credit facility, which currently permits borrowings up to $30 million and had no balance outstanding at December 31, 2019. We believe that we will have sufficient funds available to meet our working capital needs for the foreseeable future.
Seasonality
Sales of our products are moderately seasonal with the peak period being July - November
of each year due to timing of construction projects being directly related to warmer weather.
Competition
In the standardized market, we compete primarily with Lennox International, Inc., Trane (Ingersoll Rand Limited), York (Johnson Controls Inc.) and Carrier (United Technologies Corporation). All of these competitors are substantially larger and have greater resources than we do. Our products compete on the basis of total value, quality, function, serviceability, efficiency, availability of product, reliability, product line recognition and acceptability of sales outlets. However, in new construction where the contractor is the purchasing decision maker, we are often at a competitive disadvantage because of the emphasis placed on initial cost. In the replacement market and other owner-
5
controlled
purchases, we have a better chance of getting business since quality and long-term cost are generally taken into account.
Employees
As of February 11, 2020, we employed 2,290 direct employees and contract personnel. Our employees are not represented by unions. Management considers its relations with our employees to be good.
Patents, Trademarks, Licenses and Concessions
We do not consider any patents, trademarks, licenses or concessions to be material to our business operations, other than patents issued regarding our energy recovery wheel option, blower,
gas-fired heat exchanger, evaporative-cooled condenser de-superheater and low leakage damper which have terms of 20 years with expiration dates ranging from 2020 to 2033.
Environmental Matters
Laws concerning the environment that affect or could affect our operations include, among others, the Clean Water Act, the Clean Air Act, the Resource Conservation and Recovery Act, the Occupational Safety and Health Act, the National Environmental Policy Act, the Toxic Substances Control Act, regulations promulgated under these Acts and any other federal, state or local laws or regulations governing environmental matters. We believe that we are in compliance with these laws and that future compliance will not materially affect our earnings or competitive position.
We
also strive to protect the environment, work with suppliers who do the same and encompass sustainable business practices in our manufacturing operations. AAON is dedicated to leading the company into a bright sustainable future. We have joined Sustainable Tulsa, a local non-profit organization, in creating an AAON Scor3card to implement more sustainable processes throughout all company locations (Tulsa, Longview and Parkville). We recognize that sustainability is both profitable and economical.
Since 2014, we have changed out our lighting to a much more energy efficient system. 80% of our lighting was Metal Halide and 20% was fluorescent. Currently, we are about 80-90% LED, and 10-20% fluorescent. We will be 100% LED by the end of 2020. The combination of the LED upgrade with our advanced lighting control
system, AAON saves about $400,000/year on electricity. We have also received a similar amount from power company rebates. These power savings equate to about 5,000,000 kWh saved per year. The LED lighting has also created a better work environment for our employees and requires less maintenance.
In addition to this, we have installed more energy efficient HVAC systems, air compressors and building insulation.
At the Tulsa facility, paper and metal recycling programs are in place. Numerous waste streams have been identified by our internal GoGreen employee committee that could be recycled, reused or reduced. We are also implementing a program to sort all our metals that has been identified to produce more profits. At the Longview facility, metal, cardboard and wood recycling. The metal recycling also includes sorting all metals for maximum rebates.
At the Parkville facility, recycling efforts are currently being researched and pursued. We recover oil in our sheet metal manufacturing area, which is then recycled. Rags are washed and returned to us be used again, preventing them from entering a landfill.
AAON is also committed to designing and manufacturing innovative HVAC products of the highest quality, efficiency, and performance. Our water-source heat pump products recover otherwise wasted energy and employ it to cool, heat and provide dehumidification to a building, making it one of the most efficient and environmentally friendly systems. AAON packaged rooftop units with two stage compressors are optimized with high efficiency evaporator and condenser coils, and variable speed fans leading to an AHRI Certified performance up to 19.15 SEER and 20.2 IEER. AAON H3/V3 Series energy recovery wheel air handling units provide energy
efficient 100% outside air ventilation by recovering energy that would otherwise be exhausted from a building. LZ Series packaged outdoor mechanical rooms are engineered to maximize the efficiency of the complete hydronic system - compressors, condenser, and evaporator. Factory installed 98% efficiency boilers with pumping packages are available for applications that require hot water. Energy saving waterside economizers are available for chilled water systems that require cooling at low ambient conditions.
6
Available Information
Our Internet website
address is http://www.aaon.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, will be available free of charge through our Internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information on our website is not a part of, or incorporated by reference into, this annual report on Form 10-K.
Copies
of any materials we file with the SEC can also be obtained free of charge through the SEC’s website at http://www.sec.gov, at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549, or by calling the SEC at 1-800-732-0330.
Item 1A. Risk Factors.
The following risks and uncertainties may affect our performance and results of operations. The discussion below contains “forward-looking statements” as outlined in the Forward-Looking Statements section above. Our ability
to mitigate risks may cause our future results to materially differ from what we currently anticipate. Additionally, the ability of our competitors to react to material risks will affect our future results.
Our business can be hurt by economic conditions.
Our business is affected by a number of economic factors, including the level of economic activity in the markets in which we operate. Sales in the commercial and industrial new construction markets correlate to the number of new homes and buildings that are built, which in turn is influenced by cyclical factors such as interest rates, inflation, consumer spending habits, employment rates and other macroeconomic factors over which we have no control. In the HVAC business, a decline in economic activity as a result of these cyclical or other factors typically
results in a decline in new construction and replacement purchases which could impact our sales volume and profitability.
Our results of operations and financial condition could be negatively impacted by the loss of a major customer.
From time to time in the past we derived a significant portion of our sales from a limited number of customers, and such concentration may continue in the future. In 2019, 2018, and 2017, one customer, Texas AirSystems, accounted for more than 10% of our sales. The loss of, or significant reduction in sales to, a major customer could have a material adverse effect on our results of operations, financial condition and cash flow. Further, the addition of new major customers in the future could increase our customer concentration risks as described above.
We
may be adversely affected by problems in the availability, or increases in the prices, of raw materials and components.
Problems in the availability, or increases in the prices, of raw materials or components could depress our sales or increase the costs of our products. We are dependent upon components purchased from third parties, as well as raw materials such as steel, copper and aluminum. Occasionally, we enter into cancellable and non-cancellable contracts on terms from six to 18 months for raw materials and components at fixed prices. However, if a key supplier is unable or unwilling to meet our supply requirements, we could experience supply interruptions or cost increases, either of which could have an adverse effect on our gross profit.
We
risk having losses resulting from the use of non-cancellable fixed price contracts.
Historically, we have attempted to limit the impact of price fluctuations on commodities by entering into non-cancellable fixed price contracts with our major suppliers for periods of six to 18 months. We expect to receive delivery of raw materials from our fixed price contracts for use in our manufacturing operations. These fixed price contracts are not accounted for using hedge accounting since they meet the normal purchases and sales exemption.
7
We
may not be able to successfully develop and market new products.
Our future success will depend upon our continued investment in research and new product development and our ability to continue to achieve new technological advances in the HVAC industry. Our inability to continue to successfully develop and market new products or our inability to implement technological advances on a pace consistent with that of our competitors could lead to a material adverse effect on our business and results of operations.
We may incur material costs as a result of warranty and product liability claims that would negatively affect our profitability.
The development, manufacture, sale and use of our products involve a risk of
warranty and product liability claims. Our product liability insurance policies have limits that, if exceeded, may result in material costs that would have an adverse effect on our future profitability. In addition, warranty claims are not covered by our product liability insurance and there may be types of product liability claims that are also not covered by our product liability insurance.
We may not be able to compete favorably in the highly competitive HVAC business.
Competition in our various markets could cause us to reduce our prices or lose market share, which could have an adverse effect on our future financial results. Substantially all of the markets in which we participate are highly competitive. The most significant competitive factors we face are product reliability, product performance,
service and price, with the relative importance of these factors varying among our product line. Other factors that affect competition in the HVAC market include the development and application of new technologies and an increasing emphasis on the development of more efficient HVAC products. Moreover, new product introductions are an important factor in the market categories in which our products compete. Several of our competitors have greater financial and other resources than we have, allowing them to invest in more extensive research and development. We may not be able to compete successfully against current and future competition and current and future competitive pressures faced by us may materially adversely affect our business and results of operations.
Norman H. Asbjornson, our founder, has served as our Chief Executive Officer from inception to date and President from inception to November 2016. He has provided the leadership and vision for our strategy and growth. Although important responsibilities and functions have been delegated to other highly experienced and capable management personnel, and our products are technologically advanced and well positioned for sales well into the future, the death, disability or retirement of Mr. Asbjornson could impair the growth of our business. We do not have an employment agreement with Mr. Asbjornson.
The Board of Directors attempts to manage this risk by continually engaging in succession planning
concerning Mr. Asbjornson (as well as other key management personnel), as demonstrated by the Board’s appointment of Gary D. Fields as President of AAON in November 2016.
Our business is subject to the risks of interruptions by cybersecurity attacks.
We depend upon information technology infrastructure, including network, hardware and software systems to conduct our business. Despite our implementation of network and other cybersecurity measures, our information technology system and networks could be disrupted or experience a security breach from computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Our security measures may not be adequate to protect against highly targeted sophisticated cyber-attacks,
or other improper disclosures of confidential and/or sensitive information. Additionally, we may have access to confidential or other sensitive information of our customers, which, despite our efforts to protect, may be vulnerable to security breaches, theft, or other improper disclosure. Any cyber-related attack or other improper disclosure of confidential information could have a material adverse effect on our business, as well as other negative consequences, including significant damage to our reputation, litigation, regulatory actions and increased cost.
8
Exposure to environmental liabilities could adversely affect our results of operations.
Our
future profitability could be adversely affected by current or future environmental laws. We are subject to extensive and changing federal, state and local laws and regulations designed to protect the environment in the United States and in other parts of the world. These laws and regulations could impose liability for remediation costs and result in civil or criminal penalties in case of non-compliance. Compliance with environmental laws increases our costs of doing business. Because these laws are subject to frequent change, we are unable to predict the future costs resulting from environmental compliance.
We are subject to potentially extreme governmental regulations and policies.
We always face the possibility of new governmental regulations, policies and trade agreements which could have a substantial or even extreme negative
effect on our operations and profitability. Negotiations during the summer of 2013 mitigated some of the negative effects of the Department of Energy Final Rule, Regulatory Identification No. 1904-AC23, published on March 7, 2011. However, certain additional testing and listing requirements are still in place and scheduled to be phased in.
Several other intrusive component part governmental regulations are in process. If these proposals become final rules, the effect would be the regulation of compressors and fans in products for which the Department of Energy does not have current authority. This could affect equipment we currently manufacture and could have an impact on our product design, operations and profitability.
The Dodd-Frank Wall Street Reform and Consumer Protection
Act contains provisions to improve transparency and accountability concerning the supply of certain minerals, known as “conflict minerals”, originating from the Democratic Republic of Congo and adjoining countries. As a result, in August 2012, the SEC adopted annual disclosure and reporting requirements for those companies who use conflict minerals in their products. Accordingly, we began our reasonable country of origin inquiries in fiscal year 2013, with initial disclosure requirements beginning in May 2014. There are costs associated with complying with these disclosure requirements, including for due diligence to determine the sources of conflict minerals used in our products and other potential changes to products, processes or sources of supply as a consequence of such verification activities. The implementation of these rules could adversely affect the sourcing, supply and pricing of materials used in our products. As there may be only a limited number
of suppliers offering “conflict free” conflict minerals, we cannot be sure that we will be able to obtain necessary conflict minerals from such suppliers in sufficient quantities or at competitive prices. Also, we may face reputational challenges if we determine that certain of our products contain minerals not determined to be conflict free or if we are unable to sufficiently verify the origins for all conflict minerals used in our products through the procedures we may implement.
Our operations could be negatively impacted by new legislation as well as changes in regulations and trade agreements, including tariffs and taxes. Unfavorable conditions resulting from such changes could have a material adverse effect on our business, financial condition and results of operations.
In the fourth quarter
of 2019, we identified a material weakness in our internal control over financial reporting. Our failure to establish and maintain effective internal control over financial reporting could result in material misstatements in our financial statements and cause investors to lose confidence in our reported financial information, which in turn could cause the trading price of our outstanding stock to decline.
During the year ended December 31, 2019, we identified a material weakness in our internal control over financial reporting related to the appropriate policies and procedures in place to properly recognize share-based compensation for retirement eligible participants in our Long-Term Incentive Plans. For further information regarding this matter, please refer to Item 9A. Controls and Procedures.As
a result of such weakness, management, with the oversight of the Audit Committee, determined to correct our consolidated financial statements at December 31, 2018 and for the years ended December 31, 2018 and December 31, 2017, selected financial data at and for the years ended December 31, 2016 and 2015, each of the unaudited quarterly periods for September 30, 2019, June 30, 2019, March 31, 2019, December 31, 2018, September 31, 2018, June 30, 2018 and March
31, 2018 and the impacted amounts within the accompanying footnotes thereto.
9
Management’s ongoing assessment of internal control over financial reporting may in the future identify additional weaknesses and conditions that need to be addressed. Any failure to improve our internal control over financial reporting to address identified weaknesses in the future, if they were to occur, could prevent us from maintaining accurate accounting records and discovering material accounting errors, which in turn, could adversely affect our business and the value of our outstanding stock.
We reached a determination to correct certain of our previously issued consolidated
financial statements, which may affect investor confidence and raise reputational issues.
As discussed in the Explanatory Note preceding Item 1, Business, in Note 2, Error Correction, and in Note 25, Quarterly Results (Unaudited), in this Annual Report on Form 10-K, we reached a determination to correct our consolidated financial statements at December 31, 2018 and for the years ended December 31, 2018 and December 31, 2017, selected financial data at and for the year ended December 31,
2016 and 2015, and each of the unaudited quarterly periods September 30, 2019, June 30, 2019, March 31, 2019, December 31, 2018, September 31, 2018, June 30, 2018 and March 31, 2018. As a result, we have become subject to a number of additional risks and uncertainties, which may affect investor confidence in the accuracy of our financial disclosures and may raise reputational issues for our business.
We are subject to adverse changes in tax laws.
Our tax expense or benefits
could be adversely affected by changes in tax provisions, unfavorable findings in tax examinations or differing interpretations by tax authorities. We are unable to estimate the impact that current and future tax proposals and tax laws could have on our results of operations. We are currently subject to state and local tax examinations for which we do not expect any major assessments.
We are subject to international regulations that could adversely affect our business and results of operations.
Due to our use of representatives in foreign markets, we are subject to many laws governing international relations, including those that prohibit improper payments to government officials and commercial customers, and restrict where we can do business, what information or products we can supply
to certain countries and what information we can provide to a non-U.S. government, including but not limited to the Foreign Corrupt Practices Act, U.K. Bribery Act and the U.S. Export Administration Act. Violations of these laws, which are complex, may result in criminal penalties or sanctions that could have a material adverse effect on our business, financial condition and results of operations.
Operations may be affected by natural disasters, especially since most of our operations are performed at a single location.
Natural disasters such as tornadoes and ice storms, as well as accidents, acts of terror, infection and other factors beyond our control could adversely affect our operations. Especially, as our facilities are in areas where tornadoes are likely to occur, and the majority of our operations
are at our Tulsa facilities, the effects of natural disasters and other events could damage our facilities and equipment and force a temporary halt to manufacturing and other operations, and such events could consequently cause severe damage to our business. We maintain insurance against these sorts of events; however, this is not guaranteed to cover all the losses and damages incurred.
If we are unable to hire, develop or retain employees, it could have an adverse effect on our business.
We compete to hire new employees and then seek to train them to develop their skills. We may not be able to successfully recruit, develop and retain the personnel we need. Unplanned turnover or failure to hire and retain a diverse, skilled workforce, could increase our operating costs and adversely affect our results of operations.
Variability in self-insurance liability estimates could impact our results of operations.
We self-insure for employee health insurance and workers’ compensation insurance coverage up to a predetermined level, beyond which we maintain stop-loss insurance from a third-party insurer for claims over $225,000 and $750,000 for employee health insurance claims and workers’ compensation insurance claims, respectively. Our aggregate exposure varies from year to year based upon the number of participants in our insurance plans. We estimate our self-insurance liabilities using an analysis provided by our claims administrator and our historical
10
claims
experience. Our accruals for insurance reserves reflect these estimates and other management judgments, which are subject to a high degree of variability. If the number or severity of claims for which we self-insure increases, it could cause a material and adverse change to our reserves for self-insurance liabilities, as well as to our earnings.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
As of December 31,
2019, we own all of our Tulsa, Oklahoma, and Longview, Texas, facilities, consisting of approximately 1.76 million square feet of space for office, manufacturing, warehouse, assembly operations and parts sales. We believe that our facilities are well maintained and are in good condition and suitable for the conduct of our business.
Our plant and office facilities in Tulsa, Oklahoma, consist of a 342,000 sq. ft. building (327,000 sq. ft. of manufacturing/warehouse space and 15,000 sq. ft. of office space) located on a 12-acre tract of land at 2425 South Yukon Avenue, and a 940,000 sq. ft. manufacturing/warehouse building and a 70,000 sq. ft. office building located on an approximately 85-acre tract of land across the street from the original facility (2440 South Yukon Avenue) (the “Tulsa facilities”).
Our
manufacturing area is in heavy industrial type buildings, with some coverage by overhead cranes, containing manufacturing equipment designed for sheet metal fabrication and metal stamping. The manufacturing equipment contained in the facilities consists primarily of automated sheet metal fabrication equipment, supplemented by presses. Assembly lines consist of six cart-type conveyor lines and one roller-type conveyor line with variable line speed adjustment, which are motor driven. Subassembly areas and production line manning are based upon line speed.
In 2019, we opened our new engineering research and development laboratory at the Tulsa facilities, since named the Norman Asbjornson Innovation Center. The three-story 134,000 square foot stand alone facility is both an acoustical and a performance measuring laboratory. The new facility consists of ten test chambers allowing AAON to
meet and maintain industry certifications. This facility is located West of the 940,000 sq. ft. manufacturing/warehouse building at 2425 South Yukon Avenue. The Norman Asbjornson Innovation Center is substantially complete and expected to reach full operational status in mid-2020.
In addition to a retail part store location at our Tulsa facilities, we also own a 13,500 sq. ft. stand alone building (7,500 sq. ft. warehouse and 6,000 sq. ft. office) which is utilized as an additional retail parts store to provide our customers more accessibly to our products. The building is on approximately one acre and is located at 9528 E 51st St in Tulsa, Oklahoma.
Our operations in Longview, Texas, are conducted in a plant/office building at 203-207 Gum Springs Road, containing 263,000 sq. ft. on 39 acres. The manufacturing
area (approximately 256,000 sq. ft.) is located in three 120-foot wide sheet metal buildings connected by an adjoining structure. The remaining 7,000 square feet are utilized as office space. The facility is built for light industrial manufacturing.
In August 2019, construction began on a 220,000 sq. ft. building expansion adjacent to our current Longview, Texas facilities. The new building is expected to be completed in late 2020 and will be used for both coil warehouse storage and equipment manufacturing operations.
Our operations in Parkville, Missouri, are conducted in a leased plant/office at 8500 NW River Park Drive, containing 48,000 sq. ft. We believe that the leased facility is well maintained and in good condition and suitable for the conduct of our business.
Item
3.Legal Proceedings.
We are not a party to any pending legal proceeding which management believes is likely to result in a material liability and no such action has been threatened against us, or, to the best of our knowledge, is contemplated.
11
Item 4. Mine Safety Disclosure.
Not applicable.
PART
II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is quoted on the NASDAQ Global Select Market under the symbol “AAON”. The table below summarizes the intraday high and low reported sale prices for our common stock for the past two fiscal years. As of the close of business on February 24, 2020, there were 973 holders of record of our common stock.
Dividends - At the discretion of the Board of Directors, we pay semi-annual cash dividends. Board approval is required to determine the date of declaration and amount for each semi-annual dividend payment.
The following is a summary of our share-based compensation plans as of December 31, 2019:
EQUITY
COMPENSATION PLAN INFORMATION
Plan category
(a)
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(b)
Weighted-average exercise price of outstanding options, warrants and rights
(c)
Number of securities remaining available for future issuance under equity compensation plans
(excluding securities reflected in column (a))
The 2007 Long-Term Incentive Plan
270,427
$
17.11
—
The 2016 Long-Term Incentive Plan
268,522
$
34.11
2,565,799
12
Repurchases
during the fourth quarter of 2019, which include repurchases from our open market, 401(k) and employee repurchase programs, were as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
(a)
Total
Number
of
Shares
(or Units
(b)
Average
Price
Paid
(Per Share
(c)
Total Number
of Shares (or
Units) Purchased
as part of
Publicly Announced
(d)
Maximum Number (or
Approximate
Dollar
Value) of Shares (or
Units) that may yet be
Purchased under the
Period
Purchased)
or Unit)
Plans or Programs
Plans or Programs
October
2019
30,725
$
47.32
30,725
—
November 2019
20,201
49.93
20,201
—
December
2019
37,617
49.76
37,617
—
Total
88,543
$
48.95
88,543
—
Comparative
Stock Performance Graph
The following performance graph compares our cumulative total shareholder return, the NASDAQ Composite and a peer group of U.S. industrial manufacturing companies in the air conditioning, ventilation, and heating exchange equipment markets from December 31, 2014 through December 31, 2019. The graph assumes that $100 was invested at the close of trading December 31, 2014, with reinvestment of dividends. Our peer group includes Lennox International, Inc., Ingersoll Rand Limited, Johnson Controls Inc., and United Technologies Corporation. This table is not intended to forecast future performance of our Common Stock.
This
stock performance graph is not deemed to be “soliciting material” or otherwise be considered to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 (Exchange Act) or to the liabilities of Section 18 of the Exchange Act, and should not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act, except to the extent the Company specifically incorporates it by reference into such a filing.
13
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with our Financial Statements and Supplementary Data thereto included under Item 8 of this report and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Item 7.
Years
Ended December 31,
Results of Operations:
2019
2018
2017
2016
2015
(in thousands, except per share data)
Net
sales
$
469,333
$
433,947
$
405,232
$
383,977
$
358,632
Net income (a)
$
53,711
$
42,329
$
53,830
$
53,020
$
44,932
Earnings
per share:
Basic (a)
$
1.03
$
0.81
$
1.02
$
1.00
$
0.83
Diluted
(a)
$
1.02
$
0.80
$
1.01
$
0.99
$
0.82
Cash dividends declared per common share:
$
0.32
$
0.32
$
0.26
$
0.24
$
0.22
December
31,
Financial Position at End of Fiscal Year:
2019
2018
2017
2016
2015
(in
thousands)
Working capital (a)
$
131,521
$
93,167
$
104,002
$
102,287
$
81,106
Total
assets (a)
371,424
307,994
296,590
256,335
232,683
Revolving credit facility
—
—
—
—
—
New
market tax credit obligation
6,320
—
—
—
—
Total stockholders’ equity (a)
290,140
249,443
238,925
208,410
181,124
(a)
We have corrected previously reported consolidated financial data for fiscal years ended 2018, 2017, 2016 and 2015, as well as the related balance sheets. See Note 2, Error Correction, in Item 8, Financial Statements and Supplementary Data, for additional information.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The
following discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including the consolidated financial statements and related notes contained in Item 8, Financial Statements and Supplementary Data.
Correction of an Error
We have corrected our previously issued consolidated financial statements contained in this Annual Report on Form 10-K. Refer to the Explanatory Note preceding Item 1, Business, for background on the correction, the fiscal periods impacted, control considerations, and other information.
In addition, we have changed certain previously reported financial
information at December 31, 2018 and for the years ended December 31, 2018 and December 31, 2017 in this Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, including but not limited to information within the Results of Operations section.
See Note 2, Error Correction, in Item 8, Financial Statements and Supplementary Data, for additional information related to the correction of an error.
We engineer, manufacture, market and sell 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 pump, coils and controls. These products are marketed and sold to retail, manufacturing, educational, lodging, supermarket, medical and other commercial industries. We market our products to all 50 states in the United States and certain provinces in Canada.
Our business can be affected by a number of economic factors, including the level of economic activity in the markets in which we operate. The recent uncertainty of the economy
has negatively impacted the commercial and industrial new construction markets. A further decline in economic activity could result in a decrease in our sales volume and profitability. Sales in the commercial and industrial new construction markets correlate closely to the number of new homes and buildings that are built, which in turn is influenced by cyclical factors such as interest rates, inflation, consumer spending habits, employment rates and other macroeconomic factors over which we have no control.
We sell our products to property owners and contractors through a network of manufacturers’ representatives and our internal sales force. The demand for our products is influenced by national and regional economic and demographic factors. The commercial and industrial new construction market is subject to cyclical fluctuations in that it is generally tied to housing starts, but has a lag factor
of six to 18 months. Housing starts, in turn, are affected by such factors as interest rates, the state of the economy, population growth and the relative age of the population. When new construction is down, we emphasize the replacement market. The new construction market in 2019 continued to be unpredictable and uneven. Thus, throughout the year, we emphasized promotion of the benefits of AAON equipment to property owners in the replacement market.
The principal components of cost of sales are labor, raw materials, component costs, factory overhead, freight out and engineering expense. The principal high volume raw materials used in our manufacturing processes are steel, copper and aluminum. We also purchase from other manufacturers certain components, including compressors, motors and electrical controls.
The price levels
of our raw materials fluctuate given that the market continues to be volatile and unpredictable as a result of the uncertainty related to the U.S. economy and global economy. For the year ended December 31, 2019, the prices for copper, galvanized steel, stainless steel and aluminum decreased approximately 3.2%, 5.8%, 2.3% and 1.6%, respectively, from 2018. For the year ended December 31, 2018, the prices for copper, galvanized steel and stainless steel increased approximately 4.7%, 18.2%, 11.8% and 6.4%, respectively, from 2017.
We attempt to limit the impact of price fluctuations on these materials by entering into cancellable and non-cancellable fixed price contracts with our major suppliers for periods
of six to 18 months. We expect to receive delivery of raw materials from our fixed price contracts for use in our manufacturing operations.
The following are highlights of our results of operations, cash flows, and financial condition:
•We started to realize the price increases put in place in 2018 and early 2019.
•We saw improvement in our gross margin despite sheet metal fabrication downtime and changes in personnel.
•Overall units sold increased approximately 4.6% for the year ended 2019, as compared to the same period last year.
•We
continue to see growth and improvement in our water-source heat pump line that increased revenues by $10.8 million.
•Our warranty expense has stabilized and we expect to see continued improvement.
•We spent $37.2 million in capital expenditures in 2019, continuing our work on such projects as our new research and development lab, water-source heat pump production line and additional Salvagnini machines that will increase our sheet metal capacity.
•Our order intake level continued to support our high backlog.
Most of the increase in revenues is due to our price increases in 2018 which were realized during 2019. Additionally, our parts sales and water-source heat pumps sales continue to grow with increases of $7.0 million and $10.8 million, respectively.
Cost of Sales
Years
Ended December 31,
Percent of Sales
2019
2018
2019
2018
(in thousands)
Cost
of sales
$
349,908
$
330,414
74.6
%
76.1
%
Gross Profit
$
119,425
$
103,533
25.4
%
23.9
%
The
principal components of cost of sales are labor, raw materials, component costs, factory overhead, freight out and engineering expense. The principal high volume raw materials used in our manufacturing processes are steel, copper and aluminum. As shown below, our average raw material prices decreased during the year, a trend we expect to continue into 2020. The Company also maintained a steady level of workforce throughout 2019. The Company continues to improve its labor and overhead efficiencies and expects improvements to continue as new sheet metal machines were placed into service in the last quarter of 2019 and early 2020.
Twelve month average raw material cost per pound as of December 31:
2019
2018
%
Change
Copper
$
3.63
$
3.75
(3.2)
%
Galvanized Steel
$
0.49
$
0.52
(5.8)
%
Stainless
Steel
$
1.30
$
1.33
(2.3)
%
Aluminum
$
1.79
$
1.82
(1.6)
%
16
Selling,
General and Administrative Expenses
Years Ended December 31,
Percent of Sales
2019
2018
2019
2018
(in
thousands)
Warranty
$
8,047
$
8,807
1.7
%
2.0
%
Profit Sharing
7,448
6,165
1.6
%
1.4
%
Salaries
& Benefits
13,394
12,638
2.9
%
2.9
%
Stock Compensation
6,690
4,733
1.4
%
1.1
%
Advertising
818
762
0.2
%
0.2
%
Depreciation
1,524
950
0.3
%
0.2
%
Insurance
805
1,235
0.2
%
0.3
%
Professional
Fees
2,738
2,441
0.6
%
0.6
%
Donations
1,137
933
0.2
%
0.2
%
Bad
Debt Expense
91
174
—
%
—
%
Other
9,385
9,356
2.0
%
2.2
%
Total
SG&A
$
52,077
$
48,194
11.1
%
11.1
%
The Company experienced a decrease in warranty claims paid of 13.4% in 2019. Our profit sharing expenses are up due to higher earnings. Depreciation has increased due to our continued expansion
of our facilities. The Company makes company wide equity grants each year that cause our increases in stock compensation. We raised our minimum wage twice during 2019 and work to keep our salaries consistent with market rates to help retain employees.
Income Taxes
Years
Ended December 31,
Effective Tax Rate
2019
2018
2019
2018
(in thousands)
Income
tax provision
$
13,320
$
13,171
19.9
%
23.7
%
Upon completion of the Company's 2018 tax return in 2019, the Company recorded additional benefit due to higher
than expected research and development credit of $0.6 million. Additionally in 2019, the Company determined it could take advantage of an additional 1% tax credit in Oklahoma 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 $1.2 million.
Most
of the increase in revenues is due to our price increase from November 2017. Additionally, our parts sales and water-source heat pumps sales continued to grow with increases of $6.4 million and $4.7 million, respectively.
17
Cost of Sales
Years
Ended December 31,
Percent of Sales
2018
2017
2018
2017
(in thousands)
Cost
of sales
$
330,414
$
281,581
76.1
%
69.5
%
Gross Profit
$
103,533
$
123,651
23.9
%
30.5
%
The
principal components of cost of sales are labor, raw materials, component costs, factory overhead, freight out and engineering expense. The principal high volume raw materials used in our manufacturing processes are steel, copper and aluminum. As shown below, our raw material prices increased during the year. Additionally, in January 2018, the Company paid all employees a one-time bonus of $1,000 per employee as a result of the Tax Cuts and Jobs Act (the “Act”) which lowered the federal corporate tax rate from 35% to 21%. This bonus increased cost of sales by $1.9 million, excluding taxes and benefits. The Company maintained a higher level of workforce through the end of 2017 and beginning of 2018 in anticipation of our growing business. The growth in order intake during the beginning of 2018
did not occur as quickly as anticipated.
Twelve month average raw material cost per pound as of December 31:
2018
2017
%
Change
Copper
$
3.75
$
3.58
4.7
%
Galvanized Steel
$
0.52
$
0.44
18.2
%
Stainless
Steel
$
1.33
$
1.19
11.8
%
Aluminum
$
1.82
$
1.71
6.4
%
Selling,
General and Administrative Expenses
Years Ended December 31,
Percent of Sales
2018
2017
2018
2017
(in
thousands)
Warranty
$
8,807
$
11,233
2.0
%
2.8
%
Profit Sharing
6,165
8,414
1.4
%
2.1
%
Salaries
& Benefits
12,638
11,586
2.9
%
2.9
%
Stock Compensation
4,733
4,396
1.1
%
1.1
%
Advertising
762
1,735
0.2
%
0.4
%
Depreciation
950
720
0.2
%
0.2
%
Insurance
1,235
1,005
0.3
%
0.2
%
Professional
Fees
2,441
1,888
0.6
%
0.5
%
Donations
933
724
0.2
%
0.2
%
Bad
Debt Expense
174
179
—
%
—
%
Other
9,356
7,491
2.2
%
1.8
%
Total
SG&A
$
48,194
$
49,371
11.1
%
12.2
%
The Company experienced a decrease in warranty claims paid of 9% in 2018. Additionally, the Company had a change in
estimate in how it calculates its estimated failure rate that is applied to sales to estimate our potential future liability for warranty claims. This change in estimate reduced our accrual, and thus our expense, by $0.9 million. Our profit sharing expenses are also down due to lower earnings. Our advertising expense decreased due to cost savings on our annual sales show. Professional fees have increased related to additional services and work
18
performed for the Wattmaster acquisition. These fees are not expected to be recurring. Our other expenses have increased due to sales concessions granted to our customers.
Income Taxes
Years
Ended December 31,
Effective Tax Rate
2018
2017
2018
2017
(in thousands)
Income
tax provision
$
13,171
$
20,794
23.7
%
27.9
%
The Tax Cuts and Jobs Act was enacted on December 22, 2017. The overall effective tax rate decreased from 27.9% to 23.7% due to the reduced corporate rate of 35% to 21% in 2018. At the end of 2017, we recorded a $3.7
million reduction in expense due to the remeasuring of our deferred taxes due to the Act.
Liquidity and Capital Resources
Our working capital and capital expenditure requirements are generally met through net cash provided by operations and the occasional use of the revolving bank line of credit based on our current liquidity at the time.
Working Capital - Our cash, cash equivalents and restricted cash increased $42.4 million from December 31,
2018 to December 31, 2019. As of December 31, 2019, we had $44.4 million in cash, cash equivalents and restricted cash.
Revolving Line of Credit - On July 26, 2018 we renewed our $30.0 million line of credit (“BOK Revolver”) with BOKF, NA dba Bank of Oklahoma (“Bank of Oklahoma”). Under the line of credit, there was one standby letter of credit of $1.7 million as of December 31, 2019. At December 31, 2019 we have $28.3 million of borrowings available under the revolving credit facility. No fees are associated with the unused portion of the committed amount.
As
of December 31, 2019 and 2018, there were no outstanding balances under the revolving credit facility. Interest on borrowings is payable monthly at LIBOR plus 2.0%. The weighted average interest rate was .0426 and .042 for the years ended December 31, 2019 and 2018, respectively.
At December 31, 2019, we were in compliance with all of the covenants under the BOK Revolver. We are obligated to comply with certain financial covenants under the BOK Revolver. These covenants require that we meet certain parameters related to our tangible net worth and total liabilities to tangible net worth ratio. At December 31,
2019, our tangible net worth was $290.1 million, which meets the requirement of being at or above $175.0 million. Our total liabilities to tangible net worth ratio was 0.3 to 1.0 which meets 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 19). 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.
New
Market Tax Credit Obligation - 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.
19
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.
Stock Repurchase - The Board has authorized three stock repurchase programs for the Company.
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 and all repurchases are in accordance with the rules and regulations of the SEC allowing the
Company to repurchase shares from the open market.
Our open market repurchase programs are as follows:
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. All other repurchases from directors
or employees are contingent upon Board approval. All repurchases are done at current market prices.
Our repurchase activity is as follows:
2019
2018
2017
(in
thousands, except share and per share data)
Program
Shares
Total $
$ per share
Shares
Total $
$ per share
Shares
Total $
$
per share
Open market
5,799
$
200
$
34.46
252,272
$
8,374
$
33.19
8,676
$
284
$
32.69
401(k)
419,963
19,386
46.16
497,753
18,472
37.11
467,580
16,336
34.94
Directors
and employees
28,668
1,207
42.11
33,751
1,097
32.49
45,878
1,614
35.19
Total
454,430
$
20,793
$
45.76
783,776
$
27,943
$
35.65
522,134
$
18,234
$
34.92
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)
7,467,739
119,927
16.06
Directors
and employees
1,981,929
19,582
9.88
Total
13,551,234
$
209,315
$
15.45
Dividends - At
the discretion of the Board of Directors, we pay semi-annual cash dividends. Board approval is required to determine the date of declaration and amount for each semi-annual dividend payment.
Based on historical performance and current expectations, we believe our cash and cash equivalents balance, the projected cash flows generated from our operations, our existing committed revolving credit facility (or comparable financing) and our expected ability to access capital markets will satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our operations in 2020 and the foreseeable future.
Statement of Cash Flows
The table below reflects a summary of our net cash flows provided by operating activities, net cash flows used in investing activities, and net
cash flows used in financing activities for the years indicated.
2019
2018
2017
(in thousands)
Operating
Activities
Net Income
$
53,711
$
42,329
$
53,830
Income statement adjustments, net
42,440
28,513
21,022
Changes
in assets and liabilities:
Accounts receivable
(13,412)
(2,832)
(7,516)
Income tax receivable
5,129
(4,448)
4,591
Inventories
2,557
(5,598)
(23,698)
Prepaid
expenses and other
(329)
(528)
98
Accounts payable
280
(1,176)
3,043
Deferred revenue
425
412
258
Accrued
liabilities
7,124
(1,816)
6,366
Net cash provided by operating activities
97,925
54,856
57,994
Investing Activities
Capital
expenditures
(37,166)
(37,268)
(41,713)
Cash paid for business combination
—
(6,377)
—
Purchases of investments
(6,000)
(16,201)
(18,521)
Maturities
of investments and proceeds from called investments
6,000
25,145
29,112
Other
120
66
70
Net cash used in investing activities
(37,046)
(34,635)
(31,052)
Financing
Activities
(Payments) borrowings under revolving credit facility, net
—
—
—
Proceeds from financing obligation, net of issuance costs
6,614
—
—
Payment
related to financing costs
(301)
—
—
Stock options exercised
12,625
4,987
2,259
Repurchase of stock
(19,586)
(26,846)
(16,620)
Employee
taxes paid by withholding shares
(1,207)
(1,097)
(1,614)
Cash dividends paid to stockholders
(16,645)
(16,728)
(13,663)
Net cash
used in financing activities
$
(18,500)
$
(39,684)
$
(29,638)
21
Cash Flows from Operating Activities
Cash flows from operating activities increased in 2019 mainly as a result of our continuing operations results which included the
full year of price increases enacted during 2018, combined with an overall decrease in the average cost of inventory raw materials in 2019. In 2018, the Company's cash flows were tighter due to our capital expenditures and business combination that was completed during the year. For 2019, the Company saw an increase in customer prepayments and lower warranty claims that decreased our liability payments. Our increased federal and state tax credits created additional cash inflows.
Cash Flows from Investing Activities
Cash flows from investing activities increased marginally in 2019 as compared to 2018. Cash flows from investing activities are primarily affected by the
timing of our capital expenditures and purchase/maturity of investments with available cash. Additionally, we paid approximately $6.4 million in 2018 related to our February 2018 business combination.
The capital expenditures for 2019 relate to the completion of our R&D lab and water-source heat pump lines, along with expansion of our Longview facility. Our capital expenditure program for 2020 is estimated to be approximately $73.2 million. Many of these projects are subject to review and cancellation at the discretion of our CEO and Board of Directors without incurring substantial charges.
Cash Flows from Financing Activities
Cash flows from financing activities is primarily affected by the timing of stock options exercised
by our employees. Cash flows from stock options exercised increased to the increase in our publically traded stock price. Additionally, we received approximately $6.6 million in net proceeds in 2019 related to the New Markets Tax Credit transaction (Note 19).
Off-Balance Sheet Arrangements
We are not party to any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.
Commitments and Contractual Agreements
We had no material contractual purchase agreements as of December
31, 2019, except for one contractual purchase obligation for approximately $2.5 million that expires in December 2020.
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 or cash flows.
22
Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) requires management to make estimates and assumptions about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue and expenses in our consolidated financial statements and related notes. We base our estimates, assumptions and judgments on historical experience, current trends and other factors believed to
be relevant at the time our consolidated financial statements are prepared. However, because future events and their effects cannot be determined with certainty, actual results could differ from our estimates and assumptions, and such differences could be material. We believe the following critical accounting policies affect our more significant estimates, assumptions and judgments used in the preparation of our consolidated financial statements.
Inventory Reserves – We establish a reserve for inventories based on the change in inventory requirements due to product line changes, the feasibility of using obsolete parts for upgraded part substitutions, the required parts needed for part supply sales, replacement parts and for estimated shrinkage.
Warranty – A provision is made for
estimated warranty costs at the time the product is shipped and revenue is recognized. Our product warranty policy is: the earlier of one year from the date of first use or 18 months from date of shipment for parts only; an additional four years for compressors (if applicable); 15 years on aluminized steel gas-fired heat exchangers (if applicable); 25 years on stainless steel heat exchangers (if applicable); and ten years on gas-fired heat exchangers in RL products (if applicable). Our warranty policy for the RQ series covers parts for two years from date of unit shipment. Our warranty policy for the WH and WV Series geothermal/water-source heat pumps covers parts for five years from the date of manufacture. Warranty expense is estimated based on the warranty period, historical warranty trends and associated costs, and any known identifiable warranty issue.
Due to the absence of warranty
history on new products, an additional provision may be made for such products. Our estimated future warranty cost is subject to adjustment from time to time depending on changes in actual warranty trends and cost experience. Should actual claim rates differ from our estimates, revisions to the estimated product warranty liability would be required.
Stock Compensation – We measure and recognize compensation expense for all share-based payment awards made to our employees and directors, including stock options and restricted stock awards, based on their fair values at the time of grant. Compensation expense is recognized on a straight-line basis over the service period of the related share-based compensation award. Forfeitures are accounted for as they occur. The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing
model. The use of the Black-Scholes-Merton option valuation model requires the input of subjective assumptions such as: the expected volatility, the expected term of the options granted, expected dividend yield and the risk-free rate. The fair value of restricted stock awards is based on the fair market value of AAON common stock on the respective grant dates, reduced for the present value of dividends.
New 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.
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 December 2019, the FASB issued ASU 2019-12, Income Taxes: Simplifying the Accounting for Income Taxes. The ASU includes simplification of accounting for income taxes for franchise taxes, step up in tax basis for goodwill as part of a business combination and interim reporting of enacted changes in tax laws. The ASU is effective for the Company beginning after December 15, 2020. We do not expect ASU 2019-12 will have a material effect 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
23
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.
Item
7A. Quantitative and Qualitative Disclosures About Market Risk.
Commodity Price Risk
We are exposed to volatility in the prices of commodities used in some of our products and, occasionally, we use fixed price cancellable and non-cancellable contracts with our major suppliers for periods of six to 18 months to manage this exposure.
24
Item 8. Financial Statements and Supplementary Data.
INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
AAON, Inc.
Opinion on the financial statements
We have audited the accompanying
consolidated balance sheets of AAON, Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its
operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 26, 2020
expressed an adverse opinion.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our
audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matter
The
critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Inventory – manual inventory adjustments
As described in Note 3 to the
Company’s financial statements, the Company reports inventory using the first in, first out (“FIFO”) method, which involves manual adjustments recorded to the general ledger such as inventory variance, inventory allowance and labor and overhead adjustments. These manual adjustments have been identified as a critical audit matter.
The principal consideration for our determination such manual inventory adjustments as a critical audit matter is these manual adjustments require substantial use of management estimates and requires the Company to have effective inventory valuation processes. Significant management judgments and estimates utilized to determine manual inventory adjustments are subject to estimation
uncertainty and require significant auditor subjectivity in evaluating the reasonableness of those judgments and estimates.
26
Our audit procedures related to the manual inventory adjustments included the following, among others.
•We tested the design and operating effectiveness of controls over inventory valuation, including the standard cost updates in the accounting system and the completeness and accuracy of the inputs to the inventory variance calculation and any related adjustments.
•We verified the
Company’s standard costing of inventory approximated FIFO by obtaining FIFO buildups and inspected underlying documents for a sample of raw materials.
•We assessed the reasonableness of management’s inventory reserve by recalculating the reserve using management’s inputs, and evaluated those inputs for reasonableness.
•We tested labor and overhead rate changes by recalculating the rates used and tested any adjustments recorded to the general ledger.
Common
stock, $ii.004/ par value, ii100,000,000/
shares authorized, ii52,078,515/ and ii51,991,242/
issued and outstanding at December 31, 2019 and 2018, respectively
i208
i208
Additional
paid-in capital
i3,631
i—
Retained
earnings
i286,301
i249,235
Total
stockholders’ equity
i290,140
i249,443
Total
liabilities and stockholders’ equity
$
i371,424
$
i307,994
(a)
Held by variable interest entities (Note 18)
The accompanying notes are an integral part of these consolidated financial statements.
AAON, Inc. is a Nevada corporation which was incorporated on August 18, 1987. Our operating subsidiaries include AAON, Inc., an Oklahoma corporation and AAON Coil Products, Inc., a Texas corporation (collectively, the “Company”). The Consolidated Financial Statements include our accounts and the accounts of our subsidiaries.
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.
2. iError Correction
We have corrected herein our consolidated financial statements at December 31, 2018 and for the years ended December 31, 2018
and December 31, 2017, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 250, Accounting Changes and Error Corrections.
The unaudited interim financial information for the quarterly periods ended September 30, 2019, June 30, 2019, March 31, 2019, December 31, 2018, September 30, 2018, June 30, 2018 and March 31, 2018, has also been corrected and is included in Note 25, Quarterly
Results (Unaudited). The 2019 quarterly corrections will be reflected in the filing of our future 2020 unaudited interim consolidated financial statement filings in Quarterly Reports on Form 10-Q.
Error Correction Background
The Company noted errors in previously issued financial statements relating to share-based compensation expense for stock options and restricted stock awards held by retirement eligible employees and directors. As defined by our Long-Term Incentive Plans (Note 16), stock options and restricted stock awards are fully vested when an active employee or director meets certain retirement eligibility requirements. We corrected the financial statements to recognize all share-based compensation,
related to retirement eligible employees or directors, by the earlier of the grant date (if retirement eligible on grant date) or ratably from grant date to retirement eligible date. The corrected financial statements also include corrections for the tax effect of the share-based compensation corrections as well as the corrections' impact on our prior periods' employees profit sharing bonus plan (Note 17).
We do not believe that the errors are quantitatively material to any period presented in our prior financial statements. However, due to the qualitative nature of the matters identified in our review, including the number of years over which the errors occurred, we determined that it would be appropriate to correct the errors in our previously issued consolidated financial statements. Accordingly, we have corrected our consolidated financial statements and the impacted amounts within
the accompanying footnotes thereto.
32
Description of Tables
i
The following tables represent our corrected consolidated statements of income, statements of stockholders'
equity, and statements of cash flows for the years ended December 31, 2018 and December 31, 2017, as well as our corrected consolidated balance sheet at December 31, 2018. The values as previously reported for years ended 2018 and 2017 were derived from our Annual Report on Form 10-K for the year ended December 31, 2018 filed on February 28, 2019.
(a)
The share-based compensation correction to cost of sales for the year ended December 31, 2017 was approximately$i0.3 million. There was ino
correction required for the year ended December 31, 2018 for cost of sales.
(b) The share-based compensation correction to selling, general and administrative expenses for the years ended December 31, 2018 and 2017 was approximately $i0.5 million and $i0.1 million,
respectively. Included in the correction to selling, general and administrative expenses is a correction to our employee profit sharing bonus plan (Note 17) of approximately $i0.1 million and $i0.1 million
for the years ended December 31, 2018 and 2017, respectively.
(c) The correction to income taxes is the tax affect of the share-based compensation correction discussed above.
Common
stock, $ii.004/ par value, ii100,000,000/
shares authorized, ii51,991,242/ and ii52,422,801/
issued and outstanding at December 31, 2018 and 2017, respectively
i208
i—
i208
Additional
paid-in capital
i—
i—
i—
Retained
earnings
i247,291
i1,944
(c)
i249,235
Total
stockholders’ equity
i247,499
i1,944
i249,443
Total
liabilities and stockholders’ equity
$
i308,197
$
(i203)
$
i307,994
(a)
The correction to income tax receivable and deferred tax liability are the tax effect of the share-based compensation corrections.
(b) This is the cumulative reduction of our employee profit sharing bonus plan (Note 17) liability as a result of the share-based compensation correction. The prior period costs will be recovered through our estimated 2019 fourth quarter payment which will be paid in early 2020.
(c) See descriptions of the stockholders' equity in the consolidated statements of stockholders' equity for the year ended December 31, 2018 in sections below.
Adjustments
to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
i17,655
i—
i17,655
i15,007
i—
i15,007
Amortization
of bond premiums
i13
i—
i13
i47
i—
i47
Provision
for losses on accounts receivable, net of adjustments
i174
i—
i174
i179
i—
i179
Provision
for excess and obsolete inventories
i152
i—
i152
i264
i—
i264
Share-based
compensation
i7,374
i488
i7,862
i6,458
(i145)
i6,313
(Gain)
loss on disposition of assets
(i12)
i—
(i12)
i45
i—
i45
Foreign
currency transaction loss (gain)
i55
i—
i55
(i59)
i—
(i59)
Interest
income on note receivable
(i27)
i—
(i27)
(i25)
i—
(i25)
Deferred
income taxes
i2,849
(i208)
i2,641
(i1,554)
i805
(i749)
Changes
in assets and liabilities:
Accounts receivable
(i2,832)
i—
(i2,832)
(i7,516)
i—
(i7,516)
Income
tax receivable
(i4,461)
i13
(i4,448)
i4,596
(i5)
i4,591
Inventories
(i5,598)
i—
(i5,598)
(i23,698)
i—
(i23,698)
Prepaid
expenses and other
(i528)
i—
(i528)
i98
i—
i98
Accounts
payable
(i1,176)
i—
(i1,176)
i3,043
i—
i3,043
Deferred
revenue
i412
i—
i412
i258
i—
i258
Accrued
liabilities and donations
(i1,766)
(i50)
(i1,816)
i6,353
i13
i6,366
Net
cash provided by operating activities
i54,856
i—
i54,856
i57,994
i—
i57,994
Investing
Activities
Capital expenditures
(i37,268)
i—
(i37,268)
(i41,713)
i—
(i41,713)
Cash
paid in business combination
(i6,377)
i—
(i6,377)
i—
i—
i—
Proceeds
from sale of property, plant and equipment
i13
i—
i13
i10
i—
i10
Investment
in certificates of deposits
(i7,200)
i—
(i7,200)
(i5,280)
i—
(i5,280)
Maturities
of certificates of deposits
i10,080
i—
i10,080
i7,912
i—
i7,912
Purchases
of investments held to maturity
(i9,001)
i—
(i9,001)
(i13,241)
i—
(i13,241)
Maturities
of investments held to maturity
i14,570
i—
i14,570
i19,700
i—
i19,700
Proceeds
from called investments
i495
i—
i495
i1,500
i—
i1,500
Principal
payments from note receivable
i53
i—
i53
i60
i—
i60
Net
cash used in investing activities
(i34,635)
i—
(i34,635)
(i31,052)
i—
(i31,052)
Financing
Activities
Stock
options exercised
i4,987
i—
i4,987
i2,259
i—
i2,259
Repurchase
of stock
(i26,846)
i—
(i26,846)
(i16,620)
i—
(i16,620)
Employee
taxes paid by withholding shares
(i1,097)
i—
(i1,097)
(i1,614)
i—
(i1,614)
Cash
dividends paid to stockholders
(i16,728)
i—
(i16,728)
(i13,663)
i—
(i13,663)
Net
cash used in financing activities
(i39,684)
i—
(i39,684)
(i29,638)
i—
(i29,638)
Net
decrease in cash and cash equivalents
(i19,463)
i—
(i19,463)
(i2,696)
i—
(i2,696)
Cash
and cash equivalents, beginning of year
i21,457
i—
i21,457
i24,153
i—
i24,153
Cash
and cash equivalents, end of year
$
i1,994
$
i—
$
i1,994
$
i21,457
$
i—
$
i21,457
37
No
corrections impacted the classifications between net operating, net investing, or net financing cash flow activities.
3. iSummary of Significant Accounting Policies
i
Principles
of Consolidation
These financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.
Our financial statements consolidate all of our affiliated entities in which we have a controlling financial interest. Because we hold certain rights that give us the power to direct the activities of itwo
variable interest entities ("VIEs") (Note 18) that most significantly impact the VIEs economic performance, combined with a variable interest that gives us the right to receive potentially significant benefits or the obligation to absorb potentially significant losses, we have a controlling financial interest in those VIEs.
/
i
Cash and Cash Equivalents
We
consider all highly liquid temporary investments with original maturity dates of three months or less to be cash equivalents. Cash and cash equivalents consist of bank deposits and highly liquid, interest-bearing money market funds.
The Company’s cash and cash equivalents are held in a few financial institutions in amounts that exceed the insurance limits of the Federal Deposit Insurance Corporation. However, management believes that the Company’s counterparty risks are minimal based on the reputation and history of the institutions selected.
i
Restricted
Cash
Restricted cash held at December 31, 2019 consist of bank deposits and highly liquid, interest-bearing money market funds held for the purpose of the Company's qualified New Markets Tax Credit program (Note 19) to benefit an investment in plant and equipment to facilitate the expansion of our Longview, Texas manufacturing operations.
The Company’s restricted cash is held in a financial institutions in amounts that exceed the insurance limits of the Federal Deposit Insurance Corporation. However, management believes that the
Company’s counterparty risks are minimal based on the reputation and history of the institutions selected.
At December 31, 2019 and 2018, we held iino/
investments. We record the amortized cost basis and accrued interest of the corporate notes and bonds in the Consolidated Balance Sheets. We record the interest and amortization of bond premium to interest income in the Consolidated Statements of Income.
i
Accounts and Note Receivable
Accounts and note receivable are stated at amounts due from customers, net of an allowance for doubtful accounts. We generally do not require that our customers provide collateral. The
Company determines its allowance for doubtful accounts by considering a number of factors, including the credit risk of specific customers, the customer’s ability to pay current obligations, historical trends, economic and market conditions and the age of the receivable. Accounts are considered past due when the balance has been outstanding for ninety days past negotiated credit terms. Past due accounts are generally written-off against the allowance for doubtful accounts only after all collection attempts have been exhausted.
38
i
Concentration
of Credit Risk
Our customers are concentrated primarily in the domestic commercial and industrial new construction and replacement markets. To date, our sales have been primarily to the domestic market, with foreign sales accounting for approximately i3%, i3%
and i4% of revenues for the years ended December 31, 2019, 2018, and 2017, respectively. iiiOne//
customer, Texas AirSystems, accounted for approximately 10% of our sales during 2019, 2018 and 2017. No other customer accounted for more than 5% of our sales during 2019, 2018 and 2017. iOne customer, Texas AirSystems, accounted for approximately 10% of our accounts receivable balance at December 31, 2019. No other customer accounted for 5% or more of our accounts receivable balance at December 31, 2019 and 2018.
/
i
Inventories
Inventories
are valued at the lower of cost or net realizable value using the first-in, first-out (“FIFO”) method. Cost in inventory includes purchased parts and materials, direct labor and applied manufacturing overhead. 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.
i
Property, Plant and Equipment
Property, plant and equipment, including significant
improvements, are recorded at cost, net of accumulated depreciation. Repairs and maintenance and any gains or losses on disposition are included in operations.
i
Depreciation is computed using the straight-line method over the following estimated useful lives:
Buildings
i3
- i40 years
Machinery and equipment
i3 - i15
years
Furniture and fixtures
i3 - i7 years
//
i
Business
Combinations
We record the assets acquired and liabilities assumed in a business combination at their acquisition date fair values.
Fair Value Financial Instruments and Measurements
iThe carrying amounts of cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate fair value because of the short-term maturity of the items. The carrying amount
of the Company’s revolving line of credit, and other payables, approximate their fair values either due to their short term nature, the variable rates associated with the debt or based on current rates offered to the Company for debt with similar characteristics.
i
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.
39
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.
iIntangible Assets
Our
intangible assets include various trademarks, service marks and technical knowledge acquired in our February 2018 business combination (Note5). 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.
i
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 December 31, 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.
To perform this assessment, we first consider qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit exceeds its carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit does not exceed its carrying amount, we calculate the fair value
for the reporting unit and compare the amount to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired. If the carrying amount of a reporting unit exceeds its fair value, goodwill is considered to be impaired and the goodwill balance is reduced by the difference between the fair value and carrying amount of the reporting unit.
We performed a qualitative assessment as of December 31, 2019 to determine whether it was more likely than not that the fair value of the reporting unit was greater than the carrying value of the reporting unit. Based on these qualitative assessments, we determined that the fair value of the reporting unit was more likely than not greater than the carrying value of the reporting unit.
Estimates
and assumptions used to perform the impairment evaluation are inherently uncertain and can significantly affect the outcome of the analysis. The estimates and assumptions we use in the annual goodwill impairment assessment included market participant considerations and future forecasted operating results. Changes in operating results and other assumptions could materially affect these estimates.
i
Impairment of Long-Lived Assets
We review long-lived
assets for possible impairment when events or changes in circumstances indicate, in management’s judgment, that the carrying amount of an asset may not be recoverable. Recoverability is measured by a comparison of the carrying amount of an asset or asset group to its estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the undiscounted cash flows are less than the carrying amount of the asset or asset group, an impairment loss is recognized for the amount by which the carrying amount of the asset or asset group exceeds its fair value.
i
Research
and Development
The costs associated with research and development for the purpose of developing and improving new products are expensed as incurred. For the years ended December 31, 2019, 2018, and 2017 research and development costs amounted to approximately $i14.8 million, $i13.5
million, and $i13.0 million, respectively.
/
40
i
Advertising
Advertising
costs are expensed as incurred. Advertising expense for the years ended December 31, 2019, 2018, and 2017 was approximately $i0.8 million, $i0.8
million, and $i1.7 million, respectively.
/
i
Shipping
and Handling
We incur shipping and handling costs in the distribution of products sold that are recorded in cost of sales. Shipping charges that are billed to the customer are recorded in revenues and as an expense in cost of sales. For the years ended December 31, 2019, 2018, and 2017 shipping and handling fees amounted to approximately $i14.4
million, $i12.6 million, and $i11.4 million, respectively.
/
i
Income
Taxes
Income taxes are accounted for under the asset and liability method. The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. Excess tax benefits and deficiencies are reported as an income tax benefit or expense on the statement of income and are treated as discrete items to the income tax provision in the reporting period in which they occur. We establish accruals for unrecognized tax positions when it is more likely than not that our tax return positions may not be fully sustained. The Company records a valuation allowance for deferred tax assets when, in the opinion of management,
it is more likely than not that deferred tax assets will not be realized.
i
Share-Based Compensation
The Company recognizes expense for its share-based compensation based on the fair value of the awards that are granted. The Company’s
share-based compensation plans provide for the granting of stock options and restricted stock. The fair values of stock options are estimated at the date of grant using the Black-Scholes-Merton option valuation model. The use of the Black-Scholes-Merton option valuation model requires the input of subjective assumptions. The fair value of restricted stock awards is based on the fair market value of AAON common stock on the respective grant dates, reduced for the present value of dividends.
Compensation expense is recognized on a straight-line basis over the service period of the related share-based compensation award. Stock options and restricted stock awards, granted to employees, vest at a rate of i20%
per year. Restricted stock awards granted to directors historically vest one-third each year or, if granted on or after May 2019, vest over the shorter of directors' remaining elected term or one-third each year. If the employee or director is retirement eligible (as defined by the Long Term Incentive Plans) or becomes retirement eligible during service period of the related share-based compensation award, the service period is the lesser of 1) the grant date, if retirement eligible on grant date, or 2) the period between grant date and retirement eligible date. Forfeitures are accounted for as they occur.
i
Derivative
Instruments
In the course of normal operations, the Company occasionally enters into contracts such as forward priced physical contracts for the purchase of raw materials that qualify for and are designated as normal purchase or normal sale contracts. Such contracts are exempted from the fair value accounting requirements and are accounted for at the time product is purchased or sold under the related contract.
The Company does not engage in speculative transactions, nor does the Company hold or issue financial instruments for trading purposes.
Revenue Recognition
On January 1, 2018, we adopted the new accounting standard FASB ASC Topic 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.
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
41
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 control is passed 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 was $i46.1 million, $i47.8 million, and
$i51.8 million for each of the years ended December 31, 2019, 2018, and 2017, respectively.
The Company also sells extended warranties on parts for various lengths of time ranging from six months to i10
years. Revenue for these separately priced warranties is deferred and recognized on a straight-line basis over the separately priced warranty period.
i
Insurance Reserves
Under the Company’s insurance programs, coverage is obtained for significant liability limits as well as those risks required to be insured by law or contract.
It is the policy of the Company to self-insure a portion of certain expected losses related primarily to workers’ compensation and medical liability. Provisions for losses expected under these programs are recorded based on the Company’s estimates of the aggregate liabilities for the claims incurred.
i
Product Warranties
A provision is made
for the estimated cost of maintaining product warranties to customers at the time the product is sold based upon historical claims experience by product line. The Company records a liability and an expense for estimated future warranty claims based upon historical experience and management’s estimate of the level of future claims. Changes in the estimated amounts recognized in prior years are recorded as an adjustment to the liability and expense in the current year.
i
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 allowance for doubtful accounts, inventory reserves,
42
warranty
accrual, workers compensation accrual, medical insurance accrual, share-based compensation and income taxes. Actual results could differ materially from those estimates.
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
will allow us to accelerate the development of our own electronic controllers for air distribution systems. We funded the business combination with available cash of $i6.0 million. In May 2018, we paid the final working capital settlement of $i0.4
million with available cash. We have included the results of WattMaster’s operations in our consolidated financial statements beginning March 1, 2018.
43
i
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
$
i1,082
Inventories
i1,380
Property,
plant and equipment
i340
Intellectual property
i700
Goodwill
i3,229
Assumed
current liabilities
(i354)
Consideration paid
$
i6,377
/
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.
6. iLeases
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 $ii1.8/ million
as of January 1, 2019, which mostly relates to the multi-year facility lease assumed in the 2018 WattMaster acquisition (Note 5). The cumulative-effect adjustment to the opening balance was immaterial to the consolidated financial statements as a whole. The standard did not materially impact our consolidated net earnings or cash flows.
7. iAccounts
Receivable
Accounts receivable and the related allowance for doubtful accounts are as follows:
In connection with the closure of our Canadian facility on May 18, 2009, we sold land and a building in September 2010 and assumed a note receivable from the borrower secured by the property. The C$i1.1 million, i15
year note has an interest rate of i4.0% and is payable to us monthly, and has a C$i0.6 million balloon payment due in iOctober
2025. Interest payments are recognized in interest income.
We evaluate the note for impairment on a quarterly basis. We determine the note receivable to be impaired if we are uncertain of its collectability based on the contractual terms. At December 31, 2019 and 2018, there was iino/
impairment.
The Company has warranties with various terms from i18
months for parts to i25 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.
The
change in estimate relates to the Company’s failure rate calculation. During 2018, in reviewing claims data, the Company noted specific claims that were the result of an isolated incident and not representative of the Company’s historical performance or representative of expected future claims. As such, these claims were accounted for as a specific accrual for warranty liability and excluded from our failure rate that the Company utilizes in estimating future claims.
46
13.
iAccrued Liabilities
i
At December 31, accrued liabilities were comprised of the following:
Our revolving credit facility (“BOK Revolver”), as amended, provides for maximum borrowings of $i30.0
million which is provided by BOKF, NA dba Bank of Oklahoma (“Bank of Oklahoma”). Under the line of credit, there was one standby letter of credit totaling $i1.7 million as of December 31, 2019. Borrowings available under the revolving credit facility at December 31, 2019, were $i28.3
million. Interest on borrowings is payable imonthly at LIBOR plus i2.0%. iNo
fees are associated with the unused portion of the committed amount. As of December 31, 2019 and 2018, we had iino/
balance outstanding under our revolving credit facility. The revolving credit facility expires on July 26, 2021. At December 31, 2019 and 2018, the weighted average interest rate of our revolving credit facility was i4.3% and i4.2%,
respectively.
At December 31, 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 December 31, 2019 our tangible net worth was $i290.1 million, which meets the requirement of being at or above $i175.0
million. Our total liabilities to tangible net worth ratio was i0.3 to 1.0, which meets the requirement of not being above i2 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 19). This amendment also removed section 8.1.4 which required our Chief Executive Officer, Norman Asbjornson, to maintain ownership of i25% 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.
15. iIncome Taxes
i
The
provision (benefit) for income taxes consists of the following:
The
provision for income taxes differs from the amount computed by applying the statutory federal income tax rate before the provision for income taxes.
i
The reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:
The
Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. Major changes under the Act include the following:
•Reducing the corporate rate to 21 percent
•Doubling bonus depreciation to i100 percent for five years
•Further limitations on executive compensation deductions
•Eliminating
the domestic manufacturing deduction
As a result of these changes, the Company adjusted its deferred tax assets and liabilities in 2017 using the newly enacted rates for the periods when they are expected to be realized. The remeasurement in 2017 resulted in a benefit to income taxes of $i3.7
million. The new bonus depreciation provisions resulted in the Company taking $i3.2 million of bonus depreciation in 2017. The Company also has historically taken the domestic manufacturing deduction. The Company will no longer receive the benefit
of this deduction which typically has lowered our effective tax rate by i3.0%.
The Company sometimes has executive compensation that exceeds the $i1.0
million limitation. Typically the limit is exceeded due to the volume of stock activity performed by the executives during the year. The limit could also be exceeded by the Chief Executive Officer receiving the maximum amount under our executive annual cash incentive bonus plan. Any compensation that exceeded this limitation in 2018 and in the future will be a permanent difference and cause an increase to our income tax provision.
Upon completion of the Company's 2018 tax return in 2019, the Company recorded additional benefit due to higher than expected research and development credit of $i0.6 million.
Additionally in 2019, the Company determined it could take advantage of an additional i1% tax credit in Oklahoma 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 $i1.2 million.
Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes.
48
i
The significant components of the Company’s deferred tax assets and liabilities are as
follows:
We
file income tax returns in the U.S., state and foreign income tax returns jurisdictions. We are subject to U.S. examinations for tax years 2016 to present, and to non-U.S. income tax examinations for the tax years 2015 to present. In addition, we are subject to state and local income tax examinations for tax years 2015 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.
16. iShare-Based
Compensation
On May 22, 2007, our stockholders adopted a Long-Term Incentive Plan (“LTIP”) which provided an additional i3.3 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 year vesting schedule. Under the LTIP, the exercise price of shares granted may not be less than i100% 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 i6.4 million shares, comprised of i3.4
million new shares provided for under the 2016 Plan, approximately i0.4 million shares that were available for issuance under the previous LTIP that are now authorized for issuance under the 2016 Plan, and an additional i2.6
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 i100% of the fair market value at the date
of the grant. The 2016 Plan is 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 is 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 determines the persons to whom awards are to be made, determines the type, size and terms of awards, interprets the 2016 Plan, establishes and revises rules and regulations relating to the 2016 Plan and makes any other determinations that it believes necessary for the administration of the 2016 Plan.
49
i
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 December 31, 2019, 2018, and 2017 using a Black Scholes-Merton Model:
2019
2018
2017
Director
and Officers:
Expected dividend yield
$
i0.32
$
i0.26
$
i0.26
Expected
volatility
i29.54
%
i29.73
%
i30.81
%
Risk-free
interest rate
i2.40
%
i2.20
%
i1.90
%
Expected
life (in years)
i5.00
i5.00
i5.00
Employees:
Expected
dividend yield
$
i0.32
$
i0.26
$
i0.26
Expected
volatility
i29.54
%
i29.82
%
i30.67
%
Risk-free
interest rate
i2.38
%
i2.51
%
i1.89
%
Expected
life (in years)
i5.00
i5.00
i5.00
/
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.
i
The
following is a summary of stock options vested and exercisable as of December 31, 2019:
Weighted
Average
Weighted
Range
of
Number
Remaining
Average
Exercise
of
Contractual
Exercise
Intrinsic
Prices
Shares
Life
Price
Value
(in
thousands)
$i7.18 - i34.10
i451,077
i5.44
$
i23.47
$
i11,702
$i34.15
- i40.87
i86,122
i7.82
i36.33
i1,126
$i41.37
- i50.68
i1,750
i1.81
i41.59
i14
Total
i538,949
i5.81
$
i25.58
$
i12,842
The
following is a summary of stock options vested and exercisable as of December 31, 2018:
Weighted
Average
Weighted
Range
of
Number
Remaining
Average
Exercise
of
Contractual
Exercise
Intrinsic
Prices
Shares
Life
Price
Value
(in
thousands)
$i5.67 - i32.80
i456,223
i5.72
$
i20.25
$
i6,757
$i32.85
- i34.10
i42,552
i7.47
i33.95
i47
$i34.15
- i42.94
i17,202
i8.30
i35.19
i7
Total
i515,977
i5.95
$
i21.88
$
i6,811
/
50
The
following is a summary of stock options vested and exercisable as of December 31, 2017:
Weighted
Average
Weighted
Range
of
Number
Remaining
Average
Exercise
of
Contractual
Exercise
Intrinsic
Prices
Shares
Life
Price
Value
(in
thousands)
$i4.54 - i22.76
i424,130
i4.36
$
i12.41
$
i10,303
$i23.57
- i32.85
i107,456
i8.31
i30.10
i709
$i32.90
- i37.30
i25,725
i9.19
i34.07
i68
Total
i557,311
i5.35
$
i16.82
$
i11,080
i
A
summary of option activity under the plans is as follows:
The
total pre-tax compensation cost related to unvested stock options not yet recognized as of December 31, 2019 is $i19.4 million and is expected to be recognized over a weighted-average period of i3.58
years.
The total intrinsic value of options exercised during the years ended December 31, 2019, 2018, and 2017 was $i8.1 million, $i5.4
million, and $i4.5 million, respectively. The cash received from options exercised during the year ended December 31, 2019, 2018, and 2017 was $i12.6
million, $i5.0 million, and $i2.3 million, respectively. The impact of these cash receipts is included in financing activities
in the accompanying Consolidated Statements of Cash Flows.
i
A summary of the unvested restricted stock awards is as follows:
At
December 31, 2019, unrecognized compensation cost related to unvested restricted stock awards was approximately $i4.6 million which is expected to be recognized over a weighted average period of i2.64
years.
51
A summary of share-based compensation is as follows for the years ended December 31, 2019, 2018, and 2017:
i
2019
2018
2017
Grant
date fair value of awards during the period:
(in thousands)
Options
$
i20,442
$
i12,932
$
i3,699
Restricted
stock
i4,631
i3,609
i4,217
Total
$
i25,073
$
i16,541
$
i7,916
/
i
2019
2018
2017
Share-based
compensation expense:
(in thousands)
Options
$
i9,145
$
i5,344
$
i3,095
Restricted
stock
i2,654
i2,518
i3,218
Total
$
i11,799
$
i7,862
$
i6,313
/
i
2019
2018
2017
Income
tax benefit related to share-based compensation:
(in thousands)
Options
$
i1,197
$
i980
$
i1,413
Restricted
stock
i575
i353
i1,051
Total
$
i1,772
$
i1,333
$
i2,464
/
17.
iEmployee Benefits
Defined Contribution Plan - 401(k)
We sponsor a defined contribution plan (the “Plan”). Eligible employees may make contributions in accordance with the Plan and IRS guidelines. In addition to the traditional 401(k), eligible employees are given the option of making an after-tax contribution to a Roth 401(k) or a combination
of both. The Plan provides for automatic enrollment and for an automatic increase to the deferral percentage at January 1st of each year and each year thereafter. Eligible employees are automatically enrolled in the Plan at a i6% deferral rate and currently contributing employees deferral rates will be increased to i6%
unless their current rate is above i6% or the employee elects to decline the automatic enrollment or increase. Administrative expenses are paid for by Plan participants. The Company paid iiino//
administrative expenses for the years ended 2019, 2018 and 2017.
i
The Company matches i175%
up to i6% of employee contributions of eligible compensation. Additionally, Plan participant forfeitures are used to reduce the cost of the Company contributions.
Contributions made to the defined contribution plan
$
i7.0
$
i8.1
$
i6.1
/
52
Profit
Sharing Bonus Plan
i
We maintain a discretionary profit sharing bonus plan under which approximately i10%
of pre-tax profit is paid to eligible employees on a quarterly basis in order to reward employee productivity. Eligible employees are regular full-time employees who are actively employed and working on the first and last days of the calendar quarter and who were employed full-time for at least three full months prior to the beginning of the calendar quarter, excluding the Company's senior leadership team.
We self-insure for our employee's health insurance. Eligible employees are regular full-time employees who are actively employed and working. Participants are expected to pay a portion of the premium costs for coverage of the benefits provided under the Plan. We estimate our self-insurance liabilities using an analysis provided by our claims administrator and our historical claims experience. In addition, the Company
matches i175% of a participating employee's allowed contributions to a qualified health saving account to assist employees with our heath insurance plan deductibles.
The Board has authorized three stock repurchase programs for the Company. The Company may purchase shares on the open market from time to time, up to a total of i5.7 million
shares. The Board must authorize the timing and amount of these purchases and all repurchases are in accordance with the rules and regulations of the SEC allowing the Company to repurchase shares from the open market.
i
Our open market repurchase programs are as follows:
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. All other repurchases from directors or employees are contingent upon Board approval. All repurchases are done at current market prices.
53
i
Our repurchase
activity is as follows:
2019
2018
2017
(in
thousands, except share and per share data)
Program
Shares
Total $
$ per share
Shares
Total $
$ per share
Shares
Total $
$
per share
Open market
i5,799
$
i200
$
i34.46
i252,272
$
i8,374
$
i33.19
i8,676
$
i284
$
i32.69
401(k)
i419,963
i19,386
i46.16
i497,753
i18,472
i37.11
i467,580
i16,336
i34.94
Directors
& employees
i28,668
i1,207
i42.11
i33,751
i1,097
i32.49
i45,878
i1,614
i35.19
Total
i454,430
$
i20,793
$
i45.76
i783,776
$
i27,943
$
i35.65
i522,134
$
i18,234
$
i34.92
Inception
to Date
(in thousands, except share and per share data)
Program
Shares
Total $
$ per share
Open market
i4,101,566
$
i69,806
$
i17.02
401(k)
i7,467,739
i119,927
i16.06
Directors
& employees
i1,981,929
i19,582
i9.88
Total
i13,551,234
$
i209,315
$
i15.45
/
Dividends
At
the discretion of the Board of Directors, we pay semi-annual cash dividends. Board approval is required to determine the date of declaration and amount for each semi-annual dividend payment.
We
paid cash dividends of $i16.6 million, $i16.7 million, and $i13.7
million in 2019, 2018, and 2017, respectively.
19. iNew 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 $i23.0 million
NMTC allocation for the Project and secured low interest financing and the potential for future debt forgiveness related to the Project.
Upon closing of the NMTC transaction, the Company provided an aggregate of approximately $i15.9 million to the Investor, in the form of a loan receivable, with a term of itwenty-five
years, bearing an interest rate of i1.0%. This $i15.9 million in proceeds plus capital contributed from the Investor was used to make an aggregate
$i22.5 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 value attributable to the put/call is nominal. The
54
Investor's interest of $i6.3 million
is recorded in New market tax credit obligation on the consolidated balance sheet. The Company incurred approximately $i0.3 million of debt issuance costs related to the above transactions, which are being amortized over the life of the transaction.
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.
The Investor and its majority owned community development entity are considered VIEs and the Company is the primary beneficiary of the VIEs. This conclusion was reached based on the following:
•the ongoing activities of the VIEs--collecting and remitting interest and fees and NMTC compliance--were all considered in the initial design and are not expected to significantly affect performance throughout the life of the VIE;
•contractual arrangements obligate the Company to comply
with NMTC rules and regulations and provide various other guarantees to the Investor and community development entity;
•the Investor lacks a material interest in the underling economics of the project; and
•the Company is obligated to absorb losses of the VIEs.
Because the Company is the primary beneficiary of the VIEs, they have been included in the consolidated financial statements. There are no other assets, liabilities or transaction in these VIEs outside of the financing transactions executed as part of the NMTC arrangement.
20. iCommitments
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 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 December 31, 2019, we had ione material
contractual purchase obligation for approximately $i2.5 million that expires in December 2020.
21. iNew
Accounting Pronouncements
i
Changes to U.S. GAAP are established by the FASB in the form of accounting standards updates (“ASUs”) to the FASB’s Accounting Standards Codification.
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 December 2019, the FASB issued ASU 2019-12, Income Taxes: Simplifying the Accounting for Income Taxes. The ASU includes simplification of accounting for income taxes for franchise taxes, step up in tax basis for goodwill as part of a business combination and interim reporting of enacted changes in tax laws. The ASU is effective for the
55
Company beginning after December 15, 2020. We do not expect ASU 2019-12 will have a material effect 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.
22. iEarnings
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.
i
The
following table sets forth the computation of basic and diluted earnings per share:
2019
2018
2017
Numerator:
(in thousands, except share and per share data)
Net
income
$
i53,711
$
i42,329
$
i53,830
Denominator:
Basic
weighted average shares
i52,079,865
i52,284,616
i52,572,496
Effect
of dilutive stock options and restricted stock
i555,550
i383,323
i506,238
Diluted
weighted average shares
i52,635,415
i52,667,939
i53,078,734
Earnings
per share:
Basic
$
i1.03
$
i0.81
$
i1.02
Dilutive
$
i1.02
$
i0.80
$
i1.01
Anti-dilutive
shares:
Shares
i1,868,087
i1,920,313
i785,825
/
23.iRelated
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.
i
Following
is a summary of transactions and balances with affiliates:
Subsequent to December 31, 2019 and through February 24, 2020, the Company repurchased i11,144 shares for $i0.6 million from
employees for payment of statutory tax withholdings on stock transactions and i73,780 shares for $i3.9 million from our
401(k) savings and investment plan.
25.iQuarterly Results (Unaudited) (As Corrected)
i
The
following is a summary of the quarterly results of operations for the years ended December 31, 2019 and 2018:
Quarter
First
Second
Third
Fourth
(in
thousands, except per share data)
2019
Net sales
$
ii113,822/
$
ii119,437/
$
ii113,500/
$
i122,574
Gross
profit
ii25,430/
ii30,204/
ii27,410/
i36,381
Net
income
ii8,757/
ii13,391/
ii14,290/
i17,273
Earnings
per share:
Basic
$
ii0.17/
$
ii0.26/
$
ii0.27/
$
i0.33
Diluted
$
ii0.17/
$
ii0.26/
$
ii0.26/
$
i0.33
2018
Net
sales
$
ii99,082/
$
ii109,588/
$
ii112,937/
$
ii112,340/
Gross
profit
ii15,196/
ii27,661/
ii32,830/
ii27,846/
Net
income
ii3,154/
ii11,697/
ii14,514/
ii12,964/
Earnings
per share:
Basic
$
ii0.06/
$
ii0.22/
$
ii0.28/
$
ii0.25/
Diluted
$
ii0.06/
$
ii0.22/
$
ii0.27/
$
ii0.25/
/
57
The
following tables reconcile our previously reported quarterly financial information with the corrected quarterly financial information as of and for the three months ended March 31, 2019 and 2018.
(a)
The share-based compensation correction to cost of sales for the quarters ended March 31, 2019 and 2018 was approximately $i0.4 million and $i0.2 million,
respectively.
(b) The share-based compensation correction to selling, general and administrative expenses for the quarters ended March 31, 2019 and 2018 was approximately $i3.0 million and $i1.6 million,
respectively. Included in the correction to selling, general and administrative expenses is a correction to our employee profit sharing bonus plan (Note 17) of approximately $i0.4 million and $i0.2 million
for the quarters ended March 31, 2019 and 2018, respectively.
(c) The corrections to income tax receivable and deferred tax liability are the tax effect of the share-based compensation correction.
(d) This is the cumulative reduction of our employee profit sharing bonus plan (Note 17) liability as a result of the share-based compensation correction. The prior period costs will be recovered through our estimated 2019 fourth quarter payment which will be paid in early 2020.
(e) This is the cumulative effect on stockholders' equity as result of the share-based compensation correction. See Note 2, Error
Correction, for a descriptions of the changes in stockholders' equity in the consolidated statements of stockholders' equity for the years ended December 31, 2019 and 2018.
58
The following tables reconcile our previously reported quarterly financial information with the corrected quarterly financial information as of and for the three months ended June 30, 2019 and 2018.
(a)
The share-based compensation correction to cost of sales for the quarters ended June 30, 2019 and 2018 was approximately $i0.1 million and $i0.1 million,
respectively.
(b) The share-based compensation correction to selling, general and administrative expenses for the quarters ended June 30, 2019 and 2018 was approximately $i0.6 million and $i0.1 million,
respectively. Included in the correction to selling, general and administrative expenses is a correction to our employee profit sharing bonus plan (Note 17) of approximately $i0.1 million and $i0.1 million
for the quarters ended June 30, 2019 and 2018, respectively.
(c) The corrections to income tax receivable and deferred tax liability are the tax effect of the share-based compensation correction.
(d) This is the cumulative reduction of our employee profit sharing bonus plan (Note 17) liability as a result of the share-based compensation correction. The prior period costs will be recovered through our estimated 2019 fourth quarter payment which will be paid in early 2020.
(e) This is the cumulative effect on stockholders' equity as result of the share-based compensation correction. See Note 2, Error
Correction, for a descriptions of the changes in stockholders' equity in the consolidated statements of stockholders' equity for the years ended December 31, 2019 and 2018.
59
The following tables reconcile our previously reported quarterly financial information with the corrected quarterly financial information as of and for the three months ended September 30, 2019 and 2018.
(a)
The share-based compensation correction to cost of sales for the quarters ended September 30, 2019 and 2018 was approximately $i0.1 million and $i0.1 million,
respectively.
(b) The share-based compensation correction to selling, general and administrative expenses for the quarters ended September 30, 2019 and 2018 was approximately $i0.7 million and $i0.6 million,
respectively. Included in the correction to selling, general and administrative expenses is a correction to our employee profit sharing bonus plan (Note 17) of approximately $i0.1 million and $i0.1 million
for the quarters ended September 30, 2019 and 2018, respectively.
(c) The corrections to income tax receivable and deferred tax liability are the tax effect of the share-based compensation corrections.
(d) This is the cumulative reduction of our employee profit sharing bonus plan (Note 17) liability as a result of the share-based compensation correction. The prior period costs will be recovered through our estimated 2019 fourth quarter payment which will be paid in early 2020.
(e) This is the cumulative effect on stockholders' equity as result of the share-based compensation correction. See Note 2, Error
Correction, for a descriptions of the changes in stockholders' equity in the consolidated statements of stockholders' equity for the years ended December 31, 2019 and 2018.
60
The following table reconciles our previously reported quarterly financial information with the corrected quarterly financial information as of and for the three months ended December 31, 2018.
(a)
The share-based compensation correction for cost of sales for the quarter ended December 31, 2018 was approximately $i0.1 million.
(b) The share-based compensation correction to selling, general and administrative expenses for the quarter ended December 31, 2018 was approximately $i0.6 million. Included
in the correction to selling, general and administrative expenses is a correction to our employee profit sharing bonus plan (Note 17) of approximately $i0.1 million for the quarter ended December 31, 2018.
(c) The corrections to income tax receivable and deferred tax liability are the tax effect of the share-based compensation corrections.
(d) This is the cumulative
reduction of our employee profit sharing bonus plan (Note 17) liability as a result of the share-based compensation correction. The prior period costs will be recovered through our estimated 2019 fourth quarter payment which will be paid in early 2020.
(e) This is the cumulative effect on stockholders' equity as result of the share-based compensation correction. See Note 2, Error Correction, for a descriptions of the changes in stockholders' equity in the consolidated statements of stockholders' equity for the years ended December 31, 2018.
61
26.
iSegments
i
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 represents the selling price of our units plus freight and other miscellaneous charges less any returns and allowances. Parts includes 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.
Item
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not Applicable.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2019. Based on that evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2019, due to the existence of the material weakness in our internal control over financial reporting described below, our disclosure controls and procedures were not effective to ensure that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.
62
(b) Management’s
Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Our internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In making our assessment of internal control over financial reporting, management has used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in the 2013 Internal Control—Integrated Framework. Based on our assessment, our management concluded that we did not maintain effective internal control over financial reporting as of December 31, 2019 due to the material weakness in establishing the accounting policy for share-based compensation for retirement eligible employees.
A
material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2019 has been audited by Grant Thornton LLP, our independent registered public accounting firm, as stated in their report which is included in this Item 9A of this report on Form 10-K.
(c) Remediation of Material Weakness
Our
management is in the process of executing a plan to remediate the material weakness described above. This plan includes the implementing of a process and control to ensure a more complete and comprehensive review is performed for researching and establishing the Company's accounting policies.
We have begun and expect to continue implementing the changes in our internal control over financial reporting to remediate the material weakness described above. The material weakness will not be considered remediated until the applicable remediated controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.
(d) Changes in Internal
Control over Financial Reporting
Except as discussed in item (c) above, there have been no changes in internal control over financial reporting that occurred during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
63
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
AAON, Inc.
Opinion on internal control over financial reporting
We
have audited the internal control over financial reporting of AAON, Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, because of the effect of the material weakness described in the following paragraphs on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal
Control—Integrated Framework issued by COSO.
A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment.
The Company identified a material weakness related to the accounting for share-based compensation for retirement eligible employees. The
Company’s controls related to technical accounting research and specific provisions of the plan agreements and the identification of and monitoring of retirement eligible employees were not designed effectively to ensure that the Company correctly interpreted and applied technical accounting requirements for share-based compensation for retirement eligible employees.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2019. The material weakness identified above was considered in determining
the nature, timing, and extent of audit tests applied in our audit of the 2019 consolidated financial statements, and this report does not affect our report dated February 26, 2020 which expressed an unqualified opinion on those financial statements.
Basis for opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal
control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control
based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and limitations of internal control over financial reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
64
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect
on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by Items 401, 405, 406 and 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated by reference to the information contained in our definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with our annual meeting
of shareholders scheduled to be held on May 14, 2020.
Code of Ethics
We adopted a code of ethics that applies to our principal executive officer, principal financial officer and principal accounting officer or persons performing similar functions, as well as other employees and directors. Our code of ethics can be found on our website at www.aaon.com. We will also provide any person without charge, upon request, a copy of such code of ethics. Requests may be directed to AAON, Inc., 2425 South Yukon Avenue, Tulsa,
Oklahoma74107, attention Scott M. Asbjornson, or by calling (918) 382-6242.
Item 11. Executive Compensation.
The information required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K is incorporated by reference to the information contained in our definitive Proxy Statement
to be filed with the Securities and Exchange Commission in connection with our annual meeting of shareholders scheduled to be held on May 12, 2020.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by Item 403 and Item 201(d) of Regulation S-K is incorporated by reference to the information contained in our definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with our annual meeting of stockholders scheduled to be held May
12, 2020.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required to be reported pursuant to Item 404 of Regulation S-K and paragraph (a) of Item 407 of Regulation S-K is incorporated by reference in our definitive proxy statement relating to our annual meeting of shareholders scheduled to be held May 12, 2020.
Our Code of Conduct guides the Board of Directors in its actions and deliberations with respect to related party transactions. Under
the Code, conflicts of interest, including any involving the directors or any Named Officers, are prohibited except under any guidelines approved by the Board of Directors. Only the Board of Directors may waive a provision of the Code of Conduct for a director or a Named Officer, and only then in compliance with all applicable laws, rules and regulations. We have not entered into any new material related party transactions and have no preexisting material related party transactions in 2019, 2018, or 2017.
Item 14. Principal Accountant Fees and Services.
This information is incorporated by reference in our definitive Proxy
Statement to be filed with the Securities and Exchange Commission in connection with our annual meeting of stockholders scheduled to be held May 12, 2020.
66
PART IV
Item 15.
Exhibits
and Financial Statement Schedules.
(a)
Financial statements.
(1)
The
consolidated financial statements and the report of independent registered public accounting firm are included in Item 8 of this Form 10-K.
(2)
The consolidated financial statements other than those listed at item (a)(1) above have been omitted because they are not required under the related instructions or are not applicable.
(3)
The exhibits listed at item (b) below are filed as part of, or incorporated by reference
into, this Form 10-K.
Incorporated by reference to exhibits to our Annual Report on Form 10-K for the fiscal year ended December 31, 1991, and to our Form S-8 Registration Statement No. 333-52824.
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
As of February 24, 2020, AAON, Inc., a Nevada corporation, (“AAON”) has one class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our Common Stock.
Description of Common Stock
The following description
of our Common Stock is a summary based on and qualified by our Amended and Restated Articles of Incorporation of AAON, Inc. (as further amended to date, the “Articles of Incorporation”) and our Bylaws (as amended to date, the “Bylaws”).
Authorized Capital Shares
Our authorized capital shares consist of 100,000,000 shares of common stock, $0.004 par value per share (“Common Stock”), and 5,000,000 shares of series preferred stock, $0.001
par value per share (“Preferred Stock”). The outstanding shares of our Common Stock are fully paid and nonassessable.
Voting Rights
Holders of Common Stock are entitled to one vote per share on all matters voted on by the stockholders, including the election of directors. Our Common Stock does not have cumulative voting rights.
Dividend Rights
Subject to the rights of holders of outstanding shares of Preferred Stock, if any, the holders of Common Stock are entitled to receive dividends, if any, as may be declared from time to time by the Board of Directors in its discretion out of funds legally available for the payment of dividends.
Liquidation
Rights
Subject to any preferential rights of outstanding shares of Preferred Stock, if any, holders of Common Stock will share ratably in all assets legally available for distribution to our stockholders in the event of dissolution.
Other Rights and Preferences
Our Common Stock has no sinking fund or redemption provisions or preemptive, conversion or exchange rights.
Listing
The Common Stock is traded on The Nasdaq Stock Market LLC under the trading symbol “AAON.”
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have issued our reports dated February 26, 2020, with respect to the consolidated financial statements and internal control over financial reporting included in the Annual Report of AAON, Inc. on Form 10-K for the year ended December 31, 2019. We consent to the incorporation by reference of said reports in the Registration Statements of AAON, Inc. on Forms S-8 (File No. 333-151915, File No. 333-207737, File No. 333-212863
and File No. 333-226512).
1.I have reviewed this Annual Report on Form 10-K of AAON, Inc.
2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant,
including our consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
d)disclosed in this report any change in the registrant’s internal controls over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The
registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
1.I have reviewed this Annual Report on Form 10-K of AAON, Inc.
2.Based
on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including our consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)designed
such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
d)disclosed in this report any change in the registrant’s
internal controls over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s
auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
In connection with the Annual Report of AAON, Inc. (the “Company”), on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Norman H. Asbjornson, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted
pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and our results of operations.
In connection with the Annual Report of AAON, Inc. (the “Company”), on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Scott M. Asbjornson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350,
as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and our results of operations.
