What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2021-05-06 compared with 2020-11-05 · 68 added, 146 removed, 183 unchanged (54% of the section changed)

8 unchanged sentences

We market our products to all 50 states in the United States and all provinces in Canada.

Foreign sales were approximately $8.4 million of our total net sales for the nine months just ended and $11.5 million of our sales during the same period of 2019.

Foreign sales were approximately $2.0 million of our total net sales for the three months just ended and $2.8 million of our sales during the same period of 2020.

Our business can be affected by a number of economic factors, including the level of economic activity in the markets in which we operate.

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Our sales strategy is currently balanced between new construction and replacement applications.

The new construction market through the third quarter of 2020 is showing signs of uncertainty.

The new construction market through the first quarter of 2021 is showing signs of improvement compared to 2020.

We continue to emphasize the benefits of AAON equipment to property owners in the replacement market.

Our manufacturing operations are considered a critical infrastructure industry, as defined by the U.S.

Department of Homeland Security, as such, the decrees issued by national, state, and local governments in response to the COVID-19 pandemic have had minimal impact on our operations except for higher employee absenteeism in our manufacturing facilities.

We maintained continuous operations during the nine months ended September 30, 2020.

Department of Homeland Security, as such, the decrees issued by national, state, and local governments in response to the COVID-19 pandemic have had minimal impact on our operations except for historical higher employee absenteeism, especially in June 2020, in our manufacturing facilities.

We maintained continuous operations during the three months ended March 31, 2021 except for the shut-down for planned maintenance in January and weather related event described in Note 1.

For the most part, our workers are able to socially distance themselves during the manufacturing process.

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The Company utilizes sanitation stations, requires the use of a facial covering when unable to socially distance, performs daily temperature scanning, and performs additional cleaning and sanitation throughout the day and deep cleaning overnight.

The Company did see significant employee absenteeism in the latter part of June 2020.

These unexpected employee absences resulted in reduced shipments and longer lead times in the second quarter of 2020.

During the third quarter 2020 employee attendance levels were stronger than previously anticipated.

Additionally, our work force has adapted well to school and childcare related issues.

While the Company's operations are primarily in Oklahoma and Texas, our domestic sales to customers cover almost all 50 states.

Only the state of Texas has more than 10% of our revenues.

For the nine months ended September 30, 2020, we've experienced record sales.

We have not seen a significant slow down or disruption in our customer jobs and have benefited from some of the new construction for temporary hospitals due to COVID-19.

The outlook for 2021 continues to present a lot of uncertainty.

The Architecture Billings Index has been down for several months, indicating a decline in construction, which may start to impact the new nonresidential construction market in late 2020.

Although construction may decline, our equipment is uniquely positioned to address COVID challenges by providing heightened filtration and sanitation through the use of MERV 13 filters, UV lights and bi-polar ionization installed in the factory.

The outlook for 2021 presents some uncertainty but looks positive as COVID-19 restrictions begin to lessen.

The Architecture Billings Index ("ABI") was down for most of 2020, indicating a decline in construction, which started to impact the new nonresidential construction market in late 2020.

This did slightly affect the Company with a slower order intake and caused us to slow down some of our production in the first quarter.

At the end of March, the ABI published its monthly index making February 2021 the first month since February 2020 that the ABI exceeded 50, indicating an expansion in the market.

Even if construction may decline, our equipment is uniquely positioned to address COVID-19 challenges by providing heightened filtration and sanitation through the use of MERV 13 filters, UV lights and bi-polar ionization installed in the factory.

With approximately 50% of our total sales already represented by the replacement market, we are confident of our ability to grow our market share in the replacement market while we continue to pursue opportunities in the new construction market.

With our improved lead times, we have been able to continue our planned reduction of our backlog to a more manageable level and we believe this will also allow our order intake to stay consistent but do not see significant growth opportunities in the near term

We had unrestricted cash and cash equivalents of $70.6 million as of September 30, 2020.

Our capital expenditures during the nine months ended September 30, 2020 were $49.0 million, as compared to $30.8 million for the same period a year ago, and we anticipate our full-year 2020 capital expenditures will total approximately $73.2 million.

Our expansion to our Longview, Texas facility is on schedule and expected to be operational by January 2021.

We had unrestricted cash and cash equivalents of $97.0 million as of March 31, 2021.

Our capital expenditures during the three months ended March 31, 2021 were $16.4 million, as compared to $21.9 million for the same period a year ago, and we anticipate our full-year 2021 capital expenditures will total approximately $70.7 million.

Our expansion of our Longview, Texas facility was completed and operational during the first quarter 2021.

The Company also has $28.2 million available under its line of credit.

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There is also a possibility prices could rise in the future depending on the impact COVID-19 has on our supply chain.

At September 30, 2020, the price (twelve month trailing average) for copper, galvanized steel and aluminum decreased 4.1%, 2.0% and 2.2% (stainless steel increased 0.8%), respectively, as compared to the price (twelve month trailing average) at September 30, 2019.

At March 31, 2021, the price (twelve month trailing average) for copper, galvanized steel, stainless steel and aluminum increased 2.5%, 20.4%, 9.9%, and 8.4%, respectively, as compared to the price (twelve month trailing average) at March 31, 2020.

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.

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The following are recent highlights and items that impacted our results of operations, cash flows and financial condition:

• We experienced significant employee absenteeism, mostly in June, related to COVID-19 during the nine months ended that impacted our production.

• We continue to become more efficient.

Our gross profit percentage improved from 23.9% during the nine months ended in 2019 to 30.6% in 2020.

• We invested $49.0 million in capital expenditures, continuing our work on projects such as our Longview, TX expansion and the purchase of additional Salvagnini machines that will increase our sheet metal capacity.

• Total cash, cash equivalents and restricted cash was $78.6 million at September 30, 2020.

• Our first quarter results demonstrated a slowed demand as we started the quarter.

Due to the slowed demand, we shut-down for several days in January and performed planned maintenance.

Then, we encountered extreme weather conditions in February that resulted in additional days of plant shut-down.

• Bookings increased 21% in the first quarter of 2021 compared to 2020 indicating an improved demand for our products.

• We invested $16.4 million in capital expenditures, including completing our work on projects such as our Longview, TX expansion and the purchase of additional Salvagnini machines that will increase our sheet metal capacity.

• The first quarter of 2021, had a lower tax rate compared to the first quarter of 2020, due to an increase in our excess tax benefit related to stock awards of $1.8 million.

The following table shows our historical backlog levels:

September 30,

2021 December 31,

2019 September 30,

2020 March 31,

(in thousands)

$ 96,733 $ 74,417 $ 119,642

During 2018 and most of 2019, the Company struggled to maintain adequate sheet-metal production capacity that resulted in long lead times and a high backlog.

The Company started to increase its sheet-metal production at the end of 2019 with the

addition of new Salvagnini machines.

This led in part to a record fourth quarter of 2019 that helped reduce our backlog.

Since then, the Company has continued to increase its sheet-metal capacity, increase sales, improve lead times and reduce our backlog to a more manageable level.

The Company started 2020 with a high backlog from challenges in maintaining adequate sheet-metal production capacity in 2019.

The Company started to increase its sheet-metal production at the end of 2019 and into 2020 with the addition of new

Salvagnini machines.

This led in part to a all time record sales and earnings for the year-ended December 31, 2020 that helped reduce our backlog.

Since then, the Company improved lead times and reduced our backlog to the current, more manageable level.

Results of Operations

Three months ended September 30, 2020 vs.

Three months ended September 30, 2019

Three Months Ended March 31, 2021 vs.

Three Months Ended March 31, 2020

Three Months Ended

September 30,

2020 September 30,

2021 March 31,

Rooftop units 2,959 4,061

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Three Months Ended

September 30,

2020 September 30,

2021 March 31,

Change % Change

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Total units 5,601 6,606 (1,005) (15.2) %

Our net sales increased by 18.7% due in part to our price increases in the past year and more so from increases in sheet metal production.

The first quarter of 2020, benefited from a high backlog that allowed the Company to run at full capacity and set all time record highs for revenues in the first quarter.

The order intake began to slow in late 2020 and the Company intentionally slowed production to keep its backlog at a healthy level.

Additionally, the Company lost production days in January for planned maintenance and in February due to impacts of bad weather.

Cost of Sales

Three Months Ended Percent of Sales

September 30,

2020 September 30,

2021 March 31,

(in thousands)

1 unchanged sentence

Gross profit 33,157 42,947 28.6 % 31.2 %

We continue to see overall raw material costs decrease.

The Company has improved its labor and overhead efficiencies through increased production and absorption of fixed costs.

Twelve-month average raw material cost per pound as of September 30:

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, which are obtained from domestic suppliers.

We continue to see overall raw material costs increase.

The decrease in overall production, driven by slowing demand and order intake at the beginning of the period, resulted in unfavorable labor

and overhead inefficiencies, including the Company's ability to absorb certain fixed costs.

This resulted in a overall decrease in gross margin during three months ended March 31, 2021 as compared to 2020.

Twelve-month average raw material cost per pound as of March 31:

2021 2020 % Change

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Three Months Ended Percent of Sales

September 30,

2020 September 30,

2021 March 31,

(in thousands)

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Total SG&A $ 14,696 $ 15,214 12.7 % 11.1 %

Profit sharing expenses increased due to our increased earnings for the three months ended 2020 as compared to 2019.

Salaries & benefits is up as well due in part to additional incentives for our employees as a result of the Company's strong performance.

Profit sharing expenses decreased due to our decreased earnings for the period.

Insurance increased due to an increase in overall premiums during the period.

Three Months Ended Effective Tax Rate

September 30,

2020 September 30,

(in thousands)

Income tax provision $ 5,696 $ 742 21.8 % 4.9 %

The Company’s estimated annual 2020 effective tax rate, excluding discrete events, is expected to be approximately 24%.

During the three months ended September 2019, upon completion of the Company's 2018 tax return, the Company recorded additional benefit due to higher than expected research and development credit of $0.6 million.

Historically, the Company has taken advantage of the Oklahoma Investment New Jobs Credit ("OK Credit").

This OK Credit allows the Company to take a credit equal to 1% of eligible investments each year for five years, beginning with the year of investment.

The Company determined it could take advantage of an additional 1% tax credit for years in which the Company's location was deemed to be within an enterprise zone.

The additional OK Credit for being in an enterprise zone, or otherwise allowable under Oklahoma law, resulted in a benefit of $0.3 million for 2018 and $0.9 million for our 2015, 2016 and 2017 amended returns, combined.

Results of Operations

Nine Months Ended September 30, 2020 vs.

Nine Months Ended September 30, 2019

Nine Months Ended

September 30,

2020 September 30,

Rooftop units 12,179 11,079

Condensing units 1,447 1,291

Air handlers 1,545 1,669

Outdoor mechanical rooms 22 28

Water source heat pumps 5,109 5,977

20,302 20,044

Nine Months Ended

September 30,

2020 September 30,

Change % Change

(in thousands, except unit data)

Net sales $ 397,851 $ 346,759 $ 51,092 14.7 %

Total units 20,302 20,044 258 1.3 %

Our net sales increased by 14.7% due in part to our increased sheet metal production from the additional Salvagnini machines that were placed into operation allowing increased production in our rooftop units and in part from price increases put in place over the last year and a half.

Cost of Sales

Nine Months Ended Percent of Sales

September 30,

2020 September 30,

(in thousands)

Cost of sales $ 275,925 $ 263,715 69.4 % 76.1 %

Gross profit 121,926 83,044 30.6 % 23.9 %

We continue to see overall raw material costs decrease.

The Company has improved its labor and overhead efficiencies through increased production and absorption of fixed costs.

Twelve-month average raw material cost per pound as of September 30:

2020 2019 % Change

Copper $ 3.52 $ 3.67 (4.1) %

Galvanized steel $ 0.50 $ 0.51 (2.0) %

Stainless steel $ 1.32 $ 1.31 0.8 %

Aluminum $ 1.76 $ 1.80 (2.2) %

Selling, General and Administrative Expenses

Nine Months Ended Percent of Sales

September 30,

2020 September 30,

(in thousands)

Warranty $ 5,356 $ 6,129 1.3 % 1.8 %

Profit sharing 8,691 4,948 2.2 % 1.4 %

Salaries & benefits 14,921 10,602 3.8 % 3.1 %

Stock compensation 4,020 5,989 1.0 % 1.7 %

Advertising 446 496 0.1 % 0.1 %

Depreciation 1,470 1,092 0.4 % 0.3 %

Insurance 733 594 0.2 % 0.2 %

Professional fees 1,796 1,723 0.5 % 0.5 %

Donations 1,892 1,019 0.5 % 0.3 %

Bad debt expense 193 91 — % — %

Other 6,351 6,280 1.6 % 1.8 %

Total SG&A $ 45,869 $ 38,963 11.5 % 11.2 %

Profit sharing expenses increased due to our increased earnings for the period.

Salaries & benefits is up as well due in part to additional incentives for our employees as a result of the Company's strong performance.

Stock compensation is lower because the valuation of the Company-wide equity grant awarded in March 2020 was less than the grant awarded in March 2019.

Donations increased due to the contribution of approximately $1.3 million to Winifred, Montana Public Schools in recognition of Norman H.

Asbjornson's transition from CEO to Executive Chairman.

Nine Months Ended Effective Tax Rate

September 30,

2020 September 30,

2021 March 31,

(in thousands)

1 unchanged sentence

The Company’s estimated annual 2021 effective tax rate, excluding discrete events, is expected to be approximately 27%.

Historically, the Company has taken advantage of the Oklahoma Investment New Jobs Credit ("OK Credit").

This OK Credit allows the Company to take a credit equal to 1% of eligible investments each year for five years, beginning with the year of investment.

The Company determined it could take advantage of an additional 1% tax credit for years in which the Company's location was deemed to be within an enterprise zone.

During the three months ended March 31, 2021, the Company recorded an excess tax benefit of $2.9 million as compared to $1.1 million during the same period in 2020, an increase of 173%.

The increase was primarily due to timing of stock awards as a result of our high stock price during the three months ended March 31, 2021.

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 unrestricted cash increased $43.8 million from December 31, 2019 to September 30, 2020 and totaled $70.6 million at September 30, 2020.

Revolving Line of Credit - Under the line of credit with Bank of Oklahoma, there was one standby letter of credit of $1.7 million as of September 30, 2020.

At September 30, 2020, we have $28.3 million of borrowings available under the revolving credit facility.

Working Capital - Our unrestricted cash increased $18.0 million from December 31, 2020 to March 31, 2021 and totaled $97.0 million at March 31, 2021.

Revolving Line of Credit - Under the line of credit, there was one standby letter of credit of $1.8 million as of March 31, 2021.

At March 31, 2021, we have $28.2 million of borrowings available under the revolving credit facility.

No fees are associated with the unused portion of the committed amount.

We had no outstanding balance under the revolving credit facility at September 30, 2020 and December 31, 2019.

We had no outstanding balance under the revolving credit facility at March 31, 2021 and December 31, 2020.

Interest on borrowings is payable monthly at LIBOR plus 2.0%.

The termination date of the revolving credit facility is July 26, 2021.

At September 30, 2020, we were in compliance with all of the covenants under the revolving credit facility.

At March 31, 2021, we were in compliance with all of the covenants under the revolving credit facility.

We are obligated to comply with certain financial covenants under the revolving credit facility.

These covenants require that we meet certain parameters related to our tangible net worth and total liabilities to tangible net worth ratio.

At September 30, 2020, our tangible net worth was $344.9 million, which meets the requirement of being at or above $175.0 million.

At March 31, 2021, our tangible net worth was $373.0 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.

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Our open market repurchase programs are as follows:

Agreement Execution Date Authorized Repurchase $ Expiration Date

Effective Date Authorized Repurchase $ Expiration Date

May 16, 2018 1

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Our repurchase activity is as follows:

Nine Months Ended

September 30, 2020 September 30, 2019

Three Months Ended

March 31, 2021 March 31, 2020

(in thousands, except share and per share data)

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Our repurchase activity since Company inception, including our current authorized stock repurchase programs, are as follows:

Inception to September 30, 2020

Inception to March 31, 2021

(in thousands, except share and per share data)

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November 10, 2020 November 27, 2020 December 18, 2020 $0.19

May 15, 2020 June 3, 2020 July 1, 2020 $0.19

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 2021 and the foreseeable future.

Statement of Cash Flows

The following table reflects the major categories of cash flows for the nine months ended September 30, 2020 and 2019.

The following table reflects the major categories of cash flows for the three months ended March 31, 2021 and 2020.

For additional details, see the consolidated financial statements.

Nine Months Ended

September 30,

2020 September 30,

Three Months Ended

2021 March 31,

(in thousands)

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Capital expenditures (16,404) (21,877)

Purchases of investments — (6,000)

Maturities of investments and proceeds from called investments — 6,000

Net cash used in investing activities (16,390) (21,804)

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Employee taxes paid by withholding shares (1,217) (953)

Cash dividends paid to stockholders (9,910) (8,303)

Net cash used in financing activities $ (13,911) $ (13,480)

Net cash provide by (used in) financing activities $ 3,036 $ (8,021)

Cash Flows Provided by Operating Activities

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The Company has been able to improve its collections of outstanding receivables due in part through prepayment of orders.

The Company also has also increased the purchase of inventory to take advantage of current favorable pricing and also to prevent future supply chain disruptions.

The decrease cash flows from receivables was due to the planned Company shut down during the last week of December 2020 which lowered overall accounts receivable at December 31, 2020.

The Company has also increased the purchase of inventory to take advantage of favorable pricing and also to prevent future supply chain disruptions.

Cash Flows Used in Investing Activities

The capital expenditures for 2020 related to the expansion of our Longview, Texas facility, which was completed and became operational during early 2021.

Additionally in 2020, we purchased Salvagnini sheet metal fabrication machines and completed our R&D lab as well as other operational improvements.

The capital expenditure program for 2021 is estimated to be approximately $70.7 million.

The capital expenditures for 2020 relate to the expansion of our Longview, Texas facility, purchase of additional Salvagnini sheet metal fabrication machines, completion of our R&D lab and other operational improvements.

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 Used in Financing Activities

Stock options exercised increased due to the increase in the number of employee options exercised and increases in our stock price.

The Company also purchased approximately $5.0 million of our outstanding stock through the open market buyback program (Note 15 ) during the nine months ended September 30, 2020.

Stock options exercised increased due to the increase in the number of employee options exercised and increase in our stock price.

The Company also purchased approximately $5.0 million of our outstanding stock through the open market buyback program (Note 13 ) during the three months ended March 31, 2020.

Off-Balance Sheet Arrangements

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Contractual Obligations

We had no material contractual purchase obligations as of September 30, 2020.

We had no material contractual purchase obligations as of March 31, 2021.

Critical Accounting Policies

There have been no material changes in the Company’s critical accounting policies during the nine months ended September 30, 2020.

There have been no material changes in the Company’s critical accounting policies during the three months ended March 31, 2021.

Recent Accounting Pronouncements

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis