Item 7. Management’s Discussion and Analysis
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 .
Description of the Company
We engineer, manufacture, market, and sell premium air conditioning and heating equipment consisting of standard, semi-custom, and custom rooftop units, data center cooling solutions, cleanroom systems, 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, data centers, medical and pharmaceutical, 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 rise in architectural billings and nonresidential building construction starts signal a 2022 recovery in nonresidential building construction after experiencing a downturn in 2021. Furthermore, general economic growth combined with pent-up demand from customers that delayed replacing old equipment is driving accelerated replacement demand. However, both the new construction and replacement markets are cyclical. If the domestic economy were to slow or enter a recession, this 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. Sales in the replacement markets are driven by various factors, including general economic growth, the Company’s new product introductions, fluctuations in the average age of existing equipment in the market, government regulations and stimulus, changes in market demand between more customized higher performing HVAC equipment and lower priced standard equipment, as well as many other factors. When new construction is down, we emphasize the replacement market. The replacement market in 2021 improved compared to 2020, while the new construction market was a bit slower.
We sell our products to property owners and contractors mainly through a network of independent manufacturers’ representatives. This go-to-market strategy is unique compared to most of our larger competitors in that most control their sales channel. We value the independent sales channel as we think it is a more effective way of attacking market share. Although we concede full control of the sales process with this strategy, the entrepreneurial aspect of the independent sales channel attracts the most talent and provides greater financial incentives for its salespeople. Furthermore, the independent sales channel sells different types of equipment from various manufacturers, allowing it to operate with more of a solutions-based mindset, as opposed to an internal sales department of a manufacturing company that is incentivized to only sell its equipment regardless if it is the best solution for the end customer. We also have a small internal sales force that supports the relationships between the Company and our sales channel partners. BasX sells highly customized products for unique applications for a more concentrated customer base and an internal sales force is more effective for such products. In total, our internal sales force makes up 65 individuals. 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.
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 coils, compressors, motors, and electrical controls.
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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, 2021, the prices for copper, galvanized steel, and stainless steel increased approximately 35.3%, 50.9%, and 45.4%, respectively, and aluminum decreased approximately 4.5%, from 2020. For the year ended December 31, 2020, the prices for copper, galvanized steel and stainless steel increased approximately 0.6%, 12.2%, 8.5%, and 12.8%, respectively, from 2019. We occasionally increase the price of our equipment to help offset any inflationary headwinds. In 2021, given the unusual amount of inflation in our materials, we implemented three price increases.
We also 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.
Consolidated Results of Operations
Years Ended December 31,
2021 2020 2019
(in thousands)
Net Sales $ 534,517 $ 514,551 $ 469,333
Cost of Sales 396,687 358,702 349,908
Gross Profit 137,830 155,849 119,425
Selling, general and administrative expenses 68,598 60,491 52,077
(Gain) loss on disposal of assets and insurance recoveries (21) (6,478) 337
Income from operations $ 69,253 $ 101,836 $ 67,011
The following are highlights of our results of operations, cash flows, and financial condition:
• Our backlog is at a record level due primarily to strong end-market demand.
• Organic bookings were up approximately 55% compared to 2020.
• On December 10, 2021, we completed the acquisition of BasX bringing the Company exposure to attractive end-markets into which the Company has historically had minimal exposure.
• Sales in 2021 grew year-over-year 3.9% to $534.5 million driven mainly by price increases.
Beginning in the fourth quarter of 2021, we report our financial results based on three reportable segments: AAON Oklahoma, AAON Coil Products, and BasX, which are further described in Item 1, due to the acquisition of BasX and internal leadership reporting changes. The Company's chief decision maker ("CODM"), our CEO, allocates resources and assesses the performance of each operating segment using information about the operating segment's net sales and income from operations. The CODM does not evaluate operating segments using asset or liability information.
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Segment Operating Results for the Years Ended December 31, 2021 and 2020
For the years ended December 31,
2021 Percent of Sales 2
2020 Percent of Sales 2
$ Change % Change
(in thousands)
Net Sales 3
AAON Oklahoma $ 463,845 86.8 % $ 458,957 89.2 % $ 4,888 1.1 %
AAON Coil Products 66,589 12.5 % 55,594 10.8 % 10,995 19.8 %
BasX 1
4,083 0.8 % — — 4,083 —
Net sales $ 534,517 $ 514,551 $ 19,966 3.9 %
Cost of Sales 3
AAON Oklahoma $ 336,977 72.6 % 318,858 69.5 % $ 18,119 5.7 %
AAON Coil Products 56,514 84.9 % 39,844 71.7 % 16,670 41.8 %
BasX 1
3,196 78.3 % — — 3,196 —
Cost of sales $ 396,687 74.2 % $ 358,702 69.7 % $ 37,985 10.6 %
Gross Profit 3
AAON Oklahoma $ 126,868 27.4 % $ 140,099 30.5 % $ (13,231) (9.4) %
AAON Coil Products 10,075 15.1 % 15,750 28.3 % (5,675) (36.0) %
BasX 1
887 21.7 % — — 887 —
Gross profit $ 137,830 25.8 % $ 155,849 30.3 % $ (18,019) (11.6) %
1 BasX was acquired on December 10, 2021. We have included the results of BasX's operations in our consolidated financial statements as of December 11, 2021.
2 Cost of sales and gross profit for each segment are calculated as a percentage of the respective segment's net sales. Total cost of sales and total gross profit are calculated as a percentage of total net sales.
3 Presented after intercompany eliminations.
Total net sales increased $20.0 million or 3.9%, due primarily to price increases that totaled of approximately $26.3 million put into place over the last year that were realized during 2021. The acquisition of BasX in December 2021 added $4.1 million to net sales for the short period in December. AAON Coil Products saw a 16.5% increase in units sold, or approximately $9.7 million, due to the increase in capacity with the completion of the new manufacturing building at our Longview, Texas facility in early 2021. Those increases were offset by a total decrease in volumes of approximately $10.8 million due to challenges in COVID-19 related absenteeism, supply chain issues for certain parts, and challenges hiring additional production labor to achieve higher production rates. Additionally, our plants were shut down for several days in January 2021 for planned maintenance and in February 2021 for weather that resulted in lost volume of approximately $18.1 million. Part sales and other increased $9.6 million or 20.5%.
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As shown in the table below, we've experienced increases in the cost of our raw materials. We put multiple price increases in place during the year to counteract the increased cost of material; however, it took time for those price increases to work through our backlog and be realized. For this reason, we started to see erosion in our gross profit. In the second and third quarters, we encountered challenges in hiring additional production labor, resulting in unfavorable labor and overhead efficiencies, including the Company's ability to absorb certain fixed costs. In order to attract new employees, we increased starting wages for our production workforce by 7.0% in July 2021. In order to retain our existing employees, we also put a cost of living increase of 3.5% in place in October 2021 for all employees below the Director level. The second half of the year was also impacted by various part shortages. This caused us to rearrange production schedules, incur delays and inefficiencies in production, and incur more expensive freight costs. All these things combined with lower production volumes resulted in poor absorption of overhead which caused declines in our gross profit.
Raw Material Costs
Twelve month average raw material cost per pound as of December 31:
2021 2020 % Change
Copper $ 4.94 $ 3.65 35.3 %
Galvanized Steel $ 0.83 $ 0.55 50.9 %
Stainless Steel $ 2.05 $ 1.41 45.4 %
Aluminum $ 1.93 $ 2.02 (4.5) %
Selling, General and Administrative Expenses
Years Ended December 31, Percent of Sales
2021 2020 2021 2020
(in thousands)
Warranty $ 6,351 $ 6,621 1.2 % 1.3 %
Profit Sharing 8,526 11,593 1.6 % 2.3 %
Salaries & Benefits 23,458 20,159 4.4 % 3.9 %
Stock Compensation 5,543 5,341 1.0 % 1.0 %
Advertising 1,616 823 0.3 % 0.2 %
Depreciation 2,924 1,999 0.5 % 0.4 %
Insurance 3,010 1,066 0.6 % 0.2 %
Professional Fees 7,245 2,514 1.4 % 0.5 %
Donations 738 2,115 0.1 % 0.4 %
Other 9,187 8,260 1.7 % 1.6 %
Total SG&A $ 68,598 $ 60,491 12.8 % 11.8 %
Our profit sharing expenses decreased due to decreased earnings in 2021. Salaries & benefits increased due to increases in salaries and bonuses. Professional fees increased mostly due to the transaction costs associated with the acquisition of BasX (Note 4) of $4.4 million. Donations decreased 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 during 2020.
Gain/Loss on Disposals of Assets and Insurance Proceeds
On April 22, 2020, our plant and office facilities in Tulsa, Oklahoma experienced hail related weather damage and we filed a property insurance claim which carried a $500,000 deductible. We did not experience any significant structural damage or any operational interruption as a result of this weather event. In November 2020, we reached a final settlement with our insurance carrier, resulting in a net cumulative gain of $6.4 million for year ended
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December 31, 2020. The received proceeds will be used in future periods to make improvements to the current roof at our plant and office facilities in Tulsa, Oklahoma to extend the overall useful life.
Income Taxes
Years Ended December 31, Effective Tax Rate
2021 2020 2021 2020
(in thousands)
Income tax provision $ 10,424 $ 22,966 15.1 % 22.5 %
On May 21, 2021, the State of Oklahoma enacted House Bill 2960, effectively reducing the corporate income tax rate in Oklahoma from 6% to 4%. As a result of these changes, the Company adjusted its state deferred tax assets and liabilities in the second quarter of 2021 using the newly enacted rate for the periods when they are expected to be realized resulting in a benefit of $0.8 million.
During the year ending December 31, 2021, the Company recorded an excess tax benefit of $5.4 million as compared to $3.2 million during 2020, an increase of 68.8%. The increase was primarily due to timing of stock option exercises as a result of our high stock price during the three months ended March 31, 2021 and three months ended December 31, 2021.
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Segment Operating Results for the Years Ended December 31, 2020 and 2019
For the years ended December 31,
2020 Percent of Sales 1
2019 Percent of Sales 1
$ Change % Change
(in thousands)
Net Sales 2
AAON Oklahoma $ 458,957 89.2 % $ 418,669 89.2 % $ 40,288 9.6 %
AAON Coil Products 55,594 10.8 % 50,664 10.8 % 4,930 9.7 %
Net sales $ 514,551 $ 469,333 $ 45,218 9.6 %
Cost of Sales 2
AAON Oklahoma $ 318,858 69.5 % 311,441 74.4 % $ 7,417 2.4 %
AAON Coil Products 39,844 71.7 % 38,467 75.9 % 1,377 3.6 %
Cost of sales $ 358,702 69.7 % $ 349,908 74.6 % $ 8,794 2.5 %
— % — %
Gross Profit 2
AAON Oklahoma $ 140,099 30.5 % $ 107,228 25.6 % $ 32,871 30.7 %
AAON Coil Products 15,750 28.3 % 12,197 24.1 % 3,553 29.1 %
Gross profit $ 155,849 30.3 % $ 119,425 25.4 % $ 36,424 30.5 %
1 Cost of sales and gross profit for each segment are calculated as a percentage of the respective segment's net sales. Total cost of sales and total gross profit are calculated as a percentage of total net sales.
2 Presented after intercompany eliminations.
Total net sales increased $45.2 million or 9.6%, mostly due to the increase of rooftop sales from AAON Oklahoma. AAON Oklahoma saw a increase in rooftop units volumes of 8.8%, or approximately $30.6 million, due in part to our increased sheet metal production from the additional Salvagnini machines that were placed into operation allowing increased production and from price increases put in place over the last year. Part sales and other decreased $3.4 million or 6.9%.
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 increased during the year. However, the Company had increased its inventory levels in 2019 and early 2020 at lower prices and was able to benefit from these lower priced raw materials as the inventory was consumed in 2020. The Company improved its labor and overhead efficiencies with our new sheet metal machines that were placed into service in the last quarter of 2019 and early 2020, eliminating any bottlenecks in our sheet metal production. The Company's headcount was also down compared to 2019, resulting in a higher production output per employee.
Raw Material Costs
Twelve month average raw material cost per pound as of December 31:
2020 2019 % Change
Copper $ 3.65 $ 3.63 0.6 %
Galvanized Steel $ 0.55 $ 0.49 12.2 %
Stainless Steel $ 1.41 $ 1.30 8.5 %
Aluminum $ 2.02 $ 1.79 12.8 %
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Selling, General and Administrative Expenses
Years Ended December 31, Percent of Sales
2020 2019 2020 2019
(in thousands)
Warranty $ 6,621 $ 8,047 1.3 % 1.7 %
Profit Sharing 11,593 7,448 2.3 % 1.6 %
Salaries & Benefits 20,159 13,394 3.9 % 2.9 %
Stock Compensation 5,341 6,690 1.0 % 1.4 %
Advertising 823 818 0.2 % 0.2 %
Depreciation 1,999 1,524 0.4 % 0.3 %
Insurance 1,066 805 0.2 % 0.2 %
Professional Fees 2,514 2,738 0.5 % 0.6 %
Donations 2,115 1,137 0.4 % 0.2 %
Other 8,260 9,476 1.6 % 2.0 %
Total SG&A $ 60,491 $ 52,077 11.8 % 11.1 %
The Company experienced a decrease in warranty claims paid of 15.6% in 2020. Our profit sharing expenses increased due to higher earnings in 2020. Salaries and benefits increased due to additional bonuses and employee incentives. Stock compensation was lower in 2020 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.
Gain/Loss on Disposals of Assets and Insurance Proceeds
On April 22, 2020, our plant and office facilities in Tulsa, Oklahoma experienced hail related weather damage and we filed a property insurance claim which carried a $500,000 deductible. We did not experience any significant structural damage or any operational interruption as a result of this weather event. In November 2020, we reached a final settlement with our insurance carrier, resulting in a net cumulative gain of $6.4 million for the year ended December 31, 2020. The received proceeds will be used in future periods to make improvements to the current roof at our plant and office facilities in Tulsa, Oklahoma to extend the overall useful life.
Income Taxes
Years Ended December 31, Effective Tax Rate
2020 2019 2020 2019
(in thousands)
Income tax provision $ 22,966 $ 13,320 22.5 % 19.9 %
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 Oklahoma Credit for being in an enterprise zone, or otherwise allowable under Oklahoma law, resulted in a benefit of $1.2 million.
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.
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Working Capital - Our unrestricted cash and cash equivalents decreased $76.2 million from December 31, 2020 to December 31, 2021 primarily due to the use of available cash on hand to fund the acquisition of BasX (Note 4). As of December 31, 2021, we had $3.5 million in cash and cash equivalents and restricted cash.
Revolving Line of Credit - Our revolving credit facility (“Revolver”), as amended and restated, provides for maximum borrowings of $100.0 million. As of December 31, 2021, we had a $40.0 million balance outstanding under the Revolver. We have one standby letter of credit totaling $1.8 million as of December 31, 2021 and 2020. Borrowings available under the Revolver at December 31, 2021, were $58.2 million. The Revolver expires on November 24, 2026.
Any outstanding loans under the Revolver bear interest at the daily compounded secured overnight financing rate ("SOFR") plus the applicable margin. Applicable margin, ranging from 1.25% - 1.75%, is determined quarterly based on the Company's leverage ratio. The Company is also subject to letter of credit fees, ranging from 1.25% - 1.75%, and a commitment fee, ranging from 0.10% - 0.20%. The applicable fee percentage is determined quarterly based on the Company's leverage ratio. At December 31, 2021, the weighted average interest rate of the Revolver was 1.3%. Fees associated with the unused portion of the committed amount are included in interest expense on our consolidated statements of income and were not material for the year ended December 31, 2021.
If SOFR cannot be determined pursuant to the definition, as defined by the Revolver agreement, any outstanding effected loans will be deemed to have been converted into alternative base rate ("ABR") loans. ABR loans would bear interest at a rate per annum equal to the highest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Rate in effect on such day plus 0.50%, or (c) daily simple SOFR for a one-month tenor in effect on such day plus 1.00%.
At December 31, 2021, we were in compliance with our financial covenants, as defined by the Revolver. These covenants require that we meet certain parameters related to our leverage ratio. At December 31, 2021, our leverage ratio was 0.42 to 1.0, which meets the requirement of not being above 3 to 1.
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.
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:
Agreement Execution Date Authorized Repurchase $ Expiration Date
May 16, 2018 1
$15 million March 1, 2019
March 5, 2019 1
$20 million March 4, 2020
March 13, 2020 $20 million ** 2
1 The 2018 and 2019 purchase authorizations were executed under 10b5-1 programs.
2 Expiration Date is at Board's discretion. The Company is authorized to effectuate repurchases of the Company's common stock on terms and conditions approved in advance by the Board.
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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:
2021 2020 2019
(in thousands, except share and per share data)
Program Shares Total $ $ per share Shares Total $ $ per share Shares Total $ $ per share
Open market — $ — $ — 103,689 $ 4,987 $ 48.10 5,799 $ 200 $ 34.46
401(k) 297,772 20,876 70.11 438,921 25,073 57.12 419,963 19,386 46.16
Directors and employees 22,526 1,590 70.59 23,272 1,169 50.23 28,668 1,207 42.11
Total 320,298 $ 22,466 $ 70.14 565,882 $ 31,229 $ 55.19 454,430 $ 20,793 $ 45.76
Inception to Date
(in thousands, except share and per share data)
Program Shares Total $ $ per share
Open market 4,205,255 $ 74,793 $ 17.79
401(k) 8,204,432 165,876 20.22
Directors and employees 2,027,727 22,341 11.02
Total 14,437,414 $ 263,010 $ 18.22
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.
Our recent dividends are as follows:
Declaration Date Record Date Payment Date Dividend per Share
May 20, 2019 June 3, 2019 July 1, 2019 $0.16
November 6, 2019 November 27, 2019 December 18, 2019 $0.16
May 15, 2020 June 3, 2020 July 1, 2020 $0.19
November 10, 2020 November 27, 2020 December 18, 2020 $0.19
May 17, 2021 June 3, 2021 July 1, 2021 $0.19
November 9, 2021 November 26, 2021 December 17, 2021 $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 2022 and the foreseeable future.
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.
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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.
2021 2020 2019
(in thousands)
Operating Activities
Net Income $ 58,758 $ 79,009 $ 53,711
Income statement adjustments, net 46,566 44,793 42,440
Changes in assets and liabilities:
Accounts receivable (9,737) 19,859 (13,412)
Income tax receivable (1,136) (3,815) 5,129
Inventories (45,955) (9,726) 2,557
Contract assets 1,886 — —
Prepaid expenses and other 1,374 (2,364) (329)
Accounts payable 10,899 (2,155) 280
Contract liabilities (229) — —
Deferred revenue 447 1,010 425
Accrued liabilities and donations (1,690) 2,203 7,124
Net cash provided by operating activities 61,183 128,814 97,925
Investing Activities
Capital expenditures (55,362) (67,802) (37,166)
Insurance proceeds — 6,417 —
Cash paid in business combination, net of cash acquired (103,430) — —
Purchases of investments — — (6,000)
Maturities of investments and proceeds from called investments — — 6,000
Other 73 112 120
Net cash used in investing activities (158,719) (61,273) (37,046)
Financing Activities
Borrowings under revolving credit facility 40,000 — —
Proceeds from financing obligation, net of issuance costs — — 6,614
Payment related to financing costs — — (301)
Stock options exercised 21,148 21,418 12,625
Repurchase of stock (20,876) (30,060) (19,586)
Employee taxes paid by withholding shares (1,590) (1,169) (1,207)
Cash dividends paid to stockholders (19,947) (19,815) (16,645)
Net cash provided by (used in) financing activities $ 18,735 $ (29,626) $ (18,500)
Cash Flows from Operating Activities
The decrease in cash flows from receivables was due to the increase in sales in the fourth quarter of 2021 as compared to 2020, as a result of the planned Company shutdown during the last week of December 2020. The decrease in cash flows from inventory is a result of increased costs of materials and some larger purchases made in the year to help deter supply chain issues and long lead times. The increase in cash flows from accounts payable is primarily driven by the timing of payments.
Cash Flows from Investing Activities
Cash flows from investing activities increased in 2021 as compared to 2020 and 2019 primarily due to the cash paid for the acquisition of BasX (Note 4) in December 2021. This increase is offset by decreased capital expenditures in 2021 compared to 2020 and insurance proceeds received in November 2020. The capital expenditures for 2020
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relate to the completion of our Longview facility expansion as well as the addition to and replacement of sheet metal manufacturing equipment.
Our capital expenditure program for 2022 is estimated to be approximately $100.4 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 historically affected by the timing of stock options exercised by our employees and repurchases of the Company's stock. However, in 2021, the increase in cash from financing activities is primarily related to borrowings under our revolving credit facility to manage our working capital needs after our available cash on hand was used to fund the BasX acquisition.
Our stock buyback program and dividends paid were $22.5 million and $19.9 million for the year ended December 31, 2021, respectively. We expect to continue the buyback program as well as paying semi-annual dividends at historical rates. The future costs of the buyback program could fluctuate based on market conditions including our published stock price and buyback transaction volume.
Commitments and Contractual Agreements
We had no material contractual purchase agreements as of December 31, 2021.
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.
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. We discuss these estimates with the Audit Committee of the Board of Directors periodically.
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 and replacement parts, and for estimated shrinkage. Assumptions used to estimate inventory reserves include future manufacturing requirements and industry trends. Evolving technology and changes in product mix or customer demand can significantly affect the outcome of this analysis.
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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; 18 months for data center cooling solutions and cleanroom systems; 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 our historical 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 installation. 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.
Share-Based Compensation – We measure and recognize compensation expense for all share-based payment awards made to our employees and directors, including stock options, restricted stock awards, performance stock units ("PSUs"), and key employee awards ("Key Employee 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 stock options, restricted stock awards, and PSUs. Compensation expense is recognized for the Key Employee Awards on a straight line basis over the service period when the performance condition is determined to be probable. 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 fair value of the PSUs is estimated on the date of grant using the Monte Carlo Model. The use of the Black-Scholes-Merton option valuation model and the Monte Carlo Model requires the input of subjective assumptions such as: the expected volatility, the expected term of the grant, forward-looking market conditions, risk-free rate, and expected dividend yield for stock options. The fair value of restricted stock awards and Key Employee Awards is based on the fair market value of AAON common stock on the respective grant dates. The fair value of restricted stock awards is reduced for the present value of dividends.
Definite-Lived Intangible Assets
Definite-lived intangible assets include various customer relationships and intellectual property acquired in business combinations. The fair value of customer relationships and intellectual property is estimated based on management’s judgments and assumptions or third party valuation models. These models requires the use of subjective inputs and assumptions such as expected useful lives, growth of existing customers, attrition of customers, future margins and expenses, discount rates, and future revenue growth. These inputs and assumptions can be inherently uncertain and can significantly affect the outcome of the estimates and analysis. We amortize our definite-lived intangible assets on a straight-line basis over the estimated useful lives of the assets. Our definite-lived intangible assets have estimated used lives of between 14 and 30 years. We evaluate the carrying value of our amortizable intangible assets for potential impairment when events and circumstances warrant such a review.
Goodwill and Indefinite-Lived Intangible Assets
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. Indefinite-lived intangible assets consist of trademarks and trade names. The fair value of trademarks and trade names is estimated based on management’s judgments and assumptions or third party valuations. These models requires the us of subjective inputs such as royalty rate, discount rate, and terminal value.
Goodwill and indefinite-lived intangible assets are not amortized, but instead are 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 and indefinite-lived intangible assets exceeds their carrying amount. If we conclude that it is more likely than not that the fair value of a reporting unit and indefinite-lived assets does not exceed their carrying amount, we calculate the fair value for the report unit and indefinite-lived assets and compare the amount to their carrying amount. If the fair value of a reporting unit and indefinite-lived asset exceeds their
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carrying amount, the reporting unit and indefinite-lived assets are not considered impaired. If the carrying amount of the reporting unit and indefinite-lived assets exceeds their fair value, the reporting unit and indefinite-lived assets are considered to be impaired and the balance is reduced by the difference between the fair value and carrying amount of the reporting unit and indefinite-lived assets.
We performed a qualitative assessment as of December 31, 2021 to determine whether it was more likely than not that the fair value of the reporting unit and indefinite-lived assets was greater than the carrying value of the reporting unit and indefinite-lived assets. Based on these qualitative assessments, we determined that the fair value of the reporting unit and indefinite-lived assets was more likely than not greater than the carrying value of the reporting unit and indefinite-lived assets.
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 impairment assessment included macro-industry trends, market participant considerations, historical profitability, including free cash flows, and forecasted multi-year operating results. Changes in operating results and other assumptions could materially affect these estimates. A considerable amount of management judgment and assumptions are required in performing the impairment tests.
Contingent Consideration - As part of a business combination, we agreed to issue shares of the Company's common
stock based on certain milestones in accordance with the acquisition agreement. This contingent consideration is valued at fair value on the acquisition date and is included in goodwill and additional paid-in capital on the consolidated balance sheets.
The fair value of the contingent consideration was determined using the Option Pricing Method through a Monte Carlo simulation, as this model is appropriate for contingent considerations for which the payoff structure is nonlinear. The use of this model requires the input of subjective inputs and assumptions such as: future earnings, the expected volatility of future earnings, risk-free rate, discount rate, and future stock performance. These inputs and assumptions can be inherently uncertain and can significantly affect the outcome of the estimates and analysis.
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 October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with Customers which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers . Generally, this new guidance will result in the acquirer recognizing contract assets and contract liabilities at the same amounts recorded by the acquiree. Historically, such amounts were recognized by the acquirer at fair value in acquisition accounting. The guidance should be applied prospectively to acquisitions occurring on or after the effective date. The guidance is effective for years beginning after December 15, 2022, including interim periods within those years. Early adoption is permitted, including in interim periods, for any financial statements that have not yet been issued. We adopted this standard at the beginning of the fourth quarter of 2021. Upon adoption, this update did not have a material effect on our consolidated financial position or result of operations.
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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.
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