AAON, INC. 10-Q

Item 1. Financial Statements. AAON, Inc. and Subsidiaries Consolidated Balance Sheets (Unaudited) September 30, 2023 December 31, 2022 Assets (in thousands, except share and per share data) Current assets: Cash and cash equivalents $ 212 $ 5,451 Restricted cash 22,323 498 Accounts receivable, net of allowance for credit losses of $ 385 and $ 477 , respectively 160,108 127,158 Inventories, net 214,507 198,939 Contract assets 25,306 15,151 Prepaid expenses and other 2,836 1,919 Total current assets 425,292 349,116 Property, plant and equipment: Land 15,296 8,537 Buildings 193,684 169,156 Machinery and equipment 381,271 342,045 Furniture and fixtures 41,488 30,033 Total property, plant and equipment 631,739 549,771 Less: Accumulated depreciation 274,909 245,026 Property, plant and equipment, net 356,830 304,745 Intangible assets, net 61,901 64,606 Goodwill 81,892 81,892 Right of use assets 12,252 7,123 Other long-term assets 6,376 6,421 Total assets $ 944,543 $ 813,903 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 29,917 $ 45,513 Accrued liabilities 90,986 78,630 Contract liabilities 19,576 21,424 Total current liabilities 140,479 145,567 Revolving credit facility, long-term 78,420 71,004 Deferred tax liabilities 14,744 18,661 Other long-term liabilities 16,247 11,508 New market tax credit obligation 1 12,169 6,449 Commitments and contingencies Stockholders' equity: Preferred stock, $ .001 par value, 5,000,000 shares authorized, no shares issued — — Common stock, $ .004 par value, 100,000,000 shares authorized, 81,231,513 and 80,137,776 issued and outstanding at September 30, 2023 and December 31, 2022, respectively 2 325 322 Additional paid-in capital 109,874 98,735 Retained earnings 2 572,285 461,657 Total stockholders' equity 682,484 560,714 Total liabilities and stockholders' equity $ 944,543 $ 813,903 1 Held by variable interest entities (Note 16) 2 Reflects three-for-two stock split effective August 16, 2023. The accompanying notes are an integral part of these consolidated financial statements. - 1 - AAON, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited) Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 (in thousands, except share and per share data) Net sales $ 311,970 $ 242,605 $ 861,880 $ 634,190 Cost of sales 195,861 177,014 574,599 475,159 Gross profit 116,109 65,591 287,281 159,031 Selling, general and administrative expenses 51,470 28,891 123,684 78,880 Loss (gain) on disposal of assets ( 25 ) — ( 13 ) ( 12 ) Income from operations 64,664 36,700 163,610 80,163 Interest expense, net ( 1,266 ) ( 954 ) ( 3,959 ) ( 1,694 ) Other income, net 93 54 370 295 Income before taxes 63,491 35,800 160,021 78,764 Income tax provision 15,413 8,327 29,447 17,286 Net income $ 48,078 $ 27,473 $ 130,574 $ 61,478 Earnings per share: Basic 1 $ 0.59 $ 0.34 $ 1.61 $ 0.77 Diluted 1 $ 0.58 $ 0.34 $ 1.57 $ 0.76 Cash dividends declared per common share 1 : $ 0.08 $ — $ 0.24 $ 0.13 Weighted average shares outstanding: Basic 1 81,418,800 79,777,987 81,140,473 79,543,925 Diluted 1 83,393,054 80,938,074 83,275,208 80,882,798 1 Reflects three-for-two stock split effective August 16, 2023. The accompanying notes are an integral part of these consolidated financial statements. - 2 - AAON, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Unaudited) Nine Months Ended September 30, 2023 Common Stock Paid-in Retained 1 Reflects three-for-two stock split effective August 16, 2023 Shares 1 Amount 1 Capital Earnings 1 Total (in thousands) Balances at December 31, 2022 80,138 $ 322 $ 98,735 $ 461,657 $ 560,714 Net income — — — 130,574 130,574 Stock options exercised, restricted stock awards 1,517 5 25,246 — 25,251 granted, and contingent shares issued (Note 15) Share-based compensation — — 12,102 — 12,102 Stock repurchased and retired ( 423 ) ( 2 ) ( 26,209 ) — ( 26,211 ) Dividends — — — ( 19,946 ) ( 19,946 ) Balances at September 30, 2023 81,232 $ 325 $ 109,874 $ 572,285 $ 682,484 Three Months Ended September 30, 2023 Common Stock Paid-in Retained Shares 1 Amount 1 Capital Earnings 1 Total (in thousands) Balances at June 30, 2023 81,569 $ 326 $ 128,636 $ 531,149 $ 660,111 Net income — — — 48,078 48,078 Stock options exercised and restricted 66 1 2,006 — 2,007 stock awards granted Share-based compensation — — 4,279 — 4,279 Stock repurchased and retired ( 403 ) ( 2 ) ( 25,047 ) — ( 25,049 ) Dividends — — — ( 6,942 ) ( 6,942 ) Balances at September 30, 2023 81,232 $ 325 $ 109,874 $ 572,285 $ 682,484 Nine Months Ended September 30, 2022 Common Stock Paid-in Retained Shares 1 Amount 1 Capital Earnings 1 Total (in thousands) Balances at December 31, 2021 78,792 $ 318 $ 81,654 $ 384,198 466,170 Net income — — — 61,478 61,478 Stock options exercised, restricted stock awards 1,265 3 10,987 — 10,990 granted, and contingent shares issued (Note 15) Share-based compensation — — 10,229 — 10,229 Stock repurchased and retired ( 234 ) — ( 8,921 ) — ( 8,921 ) Contingent consideration — — ( 6,000 ) — ( 6,000 ) Dividends — — — ( 10,088 ) ( 10,088 ) Balances at September 30, 2022 79,823 $ 321 $ 87,949 $ 435,588 $ 523,858 Three Months Ended September 30, 2022 Common Stock Paid-in Retained Shares 1 Amount 1 Capital Earnings 1 Total (in thousands) Balances at June 30, 2022 79,691 $ 321 $ 82,078 $ 408,107 $ 490,506 Net income — — — 27,473 27,473 Stock options exercised and restricted 186 — 4,605 — 4,605 stock awards granted Share-based compensation — — 3,321 — 3,321 Stock repurchased and retired ( 54 ) — ( 2,055 ) — ( 2,055 ) Dividends — — — 8 8 Balances at September 30, 2022 79,823 $ 321 $ 87,949 $ 435,588 $ 523,858 The accompanying notes are an integral part of these consolidated financial statements. - 3 - AAON, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 2023 2022 Operating Activities (in thousands) Net income $ 130,574 $ 61,478 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 33,439 25,624 Amortization of debt issuance cost 57 32 Amortization of right of use assets 166 191 (Recoveries of) provision for credit losses on accounts receivable, net of adjustments ( 92 ) 300 Provision for excess and obsolete inventories, net of write-offs 2,979 1,380 Share-based compensation 12,102 10,229 Gain on disposition of assets ( 13 ) ( 12 ) Foreign currency transaction loss — 42 Interest income on note receivable ( 15 ) ( 17 ) Deferred income taxes ( 3,917 ) ( 563 ) Changes in assets and liabilities: Accounts receivable ( 32,040 ) ( 63,593 ) Income taxes ( 12,472 ) 3,782 Inventories ( 18,547 ) ( 47,998 ) Contract assets ( 10,155 ) ( 3,843 ) Prepaid expenses and other long-term assets ( 896 ) ( 70 ) Accounts payable ( 15,631 ) 18,616 Contract liabilities ( 1,848 ) 24,249 Extended warranties 2,049 730 Accrued liabilities and other long-term liabilities 21,405 12,857 Net cash provided by operating activities 107,145 43,414 Investing Activities Capital expenditures ( 82,900 ) ( 41,586 ) Cash paid for building (Note 18) — ( 22,000 ) Cash paid in business combination, net of cash acquired — ( 249 ) Proceeds from sale of property, plant and equipment 129 12 Principal payments from note receivable 39 41 Net cash used in investing activities ( 82,732 ) ( 63,782 ) Financing Activities Proceeds from financing obligation, net of issuance costs 6,061 — Payment related to financing costs ( 398 ) — Borrowings under revolving credit facility 444,072 151,103 Payments under revolving credit facility ( 436,656 ) ( 114,812 ) Principal payments on financing lease — ( 115 ) Stock options exercised 25,251 10,990 Repurchase of stock ( 25,009 ) ( 7,943 ) Employee taxes paid by withholding shares ( 1,202 ) ( 978 ) Cash dividends paid to stockholders ( 19,946 ) ( 10,096 ) Net cash (used in) provided by financing activities ( 7,827 ) 28,149 Net increase in cash, cash equivalents and restricted cash 16,586 7,781 Cash, cash equivalents and restricted cash, beginning of period 5,949 3,487 Cash, cash equivalents and restricted cash, end of period $ 22,535 $ 11,268 The accompanying notes are an integral part of these consolidated financial statements. - 4 - AAON, Inc. and Subsidiaries Notes to the Consolidated Financial Statements (Unaudited) 1. General Basis of Presentation AAON, Inc. is a Nevada corporation which was incorporated on August 18, 1987. Our operating subsidiaries include AAON, Inc. ("AAON Oklahoma"), an Oklahoma corporation, AAON Coil Products, Inc. ("AAON Coil Products"), a Texas corporation, and BasX, Inc. ("BASX"), an Oregon corporation (collectively, the “Company”). The accompanying unaudited consolidated financial statements of AAON, Inc. and our operating subsidiaries, all of which are wholly-owned, have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (“SEC”). 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 five variable interest entities ("VIEs") (Note 16) 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. These financial statements have not been audited by the Company's independent registered public accounting firm, except that the consolidated balance sheet at December 31, 2022 is derived from audited consolidated financial statements. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. The financial statements reflect all adjustments (all of which are of a normal recurring nature) which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of the results that may be expected for a full year. Certain disclosures have been condensed in or omitted from these consolidated financial statements. The accompanying unaudited financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. All intercompany balances and transactions have been eliminated in consolidation. We are engaged in the engineering, manufacturing, marketing, and sale of premium air conditioning and heating equipment consisting of standard, semi-custom, and custom rooftop units, data center cooling solutions, cleanroom systems, packaged outdoor mechanical rooms, air handling units, makeup air units, energy recovery units, condensing units, geothermal/water-source heat pumps, coils, and controls. Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because these estimates and assumptions require significant judgment, actual results could differ from those estimates and could have a significant impact on our results of operations, financial position and cash flows. We reevaluate our estimates and assumptions as needed, but at a minimum on a quarterly basis. The most significant estimates include, but are not limited to, inventory valuation, inventory reserves, warranty accrual, medical insurance accrual, income taxes, useful lives of property, plant, and equipment, estimated future use of leased property, share-based compensation, business combinations, revenue percentage of completion and estimated costs to complete. Actual results could differ materially from those estimates. Inflation and Labor Market In 2022 and continuing into 2023, we have witnessed increases in our raw material and component prices. Due to our favorable liquidity position, we continue to make strategic purchases of materials when we see opportunities. We continue to manage the increase in the cost of raw materials through price increases for our products. We have also experienced supply chain challenges related to specific manufacturing parts, which we have managed through our strong vendor relationships as well as expanding our list of vendors. - 5 - Additionally, we continue to experience challenges in a tight labor market, especially the hiring of both skilled and unskilled production labor. We have implemented the following wage increases to remain competitive and to attract and retain employees: • In March 2022, we awarded annual merit raises for an overall 3.0 % increase to wages. • In October 2022, we implemented a cost of living increase of 3.5 % in place for all employees below the Senior Leadership Team ("SLT") level. • In March 2023, we awarded annual merit raises for an overall 3.9 % increase to wages. We will continue to implement human resource initiatives to retain and attract labor to further increase production capacity. Beginning in 2023, initiatives included changing our employee paid time off policy, historically awarded in arrears at the beginning of each quarter, to accrue ratably over each pay period. Additionally, we enhanced our benefits for short-term disability, life insurance, paid parental leave, and paid military leave. Despite efforts to mitigate the impact of inflation, supply chain issues and the tight labor market, future disruptions, while temporary, could negatively impact our consolidated financial position, results of operations and cash flows. Change in Estimate During the first quarter of 2022, a review of the Company’s useful lives for certain sheet metal manufacturing equipment at our Longview, Texas location resulted in a change in estimate that increased the useful lives from between ten and twelve years to fifteen years. This determination was based on recent and estimated future production levels as well as management’s knowledge of the equipment and historical and future use of the equipment. The change in estimate was made prospectively and resulted in a decrease to depreciation expense within cost of sales on our consolidated statements of income of $ 1.8 million during the nine months ended September 30, 2022. WH Series and WV Series Water Source Heat Pump Units As part of the normal course of business, management continually monitors the profitability of the Company's various product series offerings. During the third quarter of 2022, management made the decision to no longer produce our small packaged geothermal/water-source heat pump units consisting of the WH Series horizontal configuration and WV Series vertical configuration, from one-half to 12 1/2 tons ("WH/WV"). These WH/WV units were produced solely out of the AAON Oklahoma facility. Production of the remaining WH/WV backlog was completed during the second quarter 2023. Accounting Policies A comprehensive discussion of our critical accounting policies and management estimates is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2022. Fair Value Measurements The 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. 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 fair values of property, plant and equipment, intangible assets, contingent consideration, and goodwill acquired in a business combination. - 6 - 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. Definite-Lived Intangible Assets Our definite-lived intangible assets include various trademarks, service marks, and technical knowledge acquired in business combinations. We amortize our definite-lived 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. Amortization is computed using the straight-line method over the following estimated useful lives: Intellectual property 30 years Customer relationships 14 years 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. 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. The changes in the carrying amount of goodwill were as follows: Nine Months Ended September 30, 2023 2022 (in thousands) Balance, beginning of period $ 81,892 $ 85,727 Additions due to acquisitions — — Decreases due to business combination revisions 1 — ( 3,835 ) Balance, end of period $ 81,892 $ 81,892 1 Revisions related to the December 2021 acquisition of BASX. Recent Accounting Pronouncements Changes to U.S. GAAP are established by the Financial Accounting Standards Board ("FASB") in the form of Accounting Standards Updates ("ASUs") to the FASB's Accounting Standards Codification ("ASC"). We consider the applicability and impact of all ASUs. ASUs not listed or included within the Company's Annual Report on Form 10-K for the year ended December 31, 2022, were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial statements and notes thereto. - 7 - 2. Revenue Recognition The following tables show disaggregated net sales by reportable segment (Note 19) by major source, net of intercompany sales eliminations. Three Months Ended September 30, 2023 AAON Oklahoma AAON Coil Products BASX Total (in thousands) Rooftop units $ 221,417 $ — $ — $ 221,417 Condensing units — 7,636 — 7,636 Air handlers — 9,862 7,558 17,420 Outdoor mechanical rooms — 62 — 62 Cleanroom systems — — 5,355 5,355 Data center cooling solutions — 3,284 25,726 29,010 Water-source heat pumps — 3,898 — 3,898 Part sales 17,756 4 371 18,131 Other 1 7,281 1,023 737 9,041 $ 246,454 $ 25,769 $ 39,747 $ 311,970 Three Months Ended September 30, 2022 AAON Oklahoma AAON Coil Products BASX Total (in thousands) Rooftop units $ 154,171 $ — $ — $ 154,171 Condensing units — 12,720 — 12,720 Air handlers — 14,380 2,211 16,591 Outdoor mechanical rooms 58 118 — 176 Cleanroom systems — — 15,283 15,283 Data center cooling solutions — — 14,884 14,884 Water-source heat pumps 3,236 2,445 — 5,681 Part sales 15,724 — 176 15,900 Other 1 5,980 841 378 7,199 $ 179,169 $ 30,504 $ 32,932 $ 242,605 1 Other sales include freight, extended warranties and miscellaneous revenue. - 8 - Nine Months Ended September 30, 2023 AAON Oklahoma AAON Coil Products BASX Total (in thousands) Rooftop units $ 597,508 $ — $ — $ 597,508 Condensing units 61 34,243 — 34,304 Air handlers — 34,693 13,196 47,889 Outdoor mechanical rooms 208 274 — 482 Cleanroom systems — — 35,063 35,063 Data center cooling solutions — 6,524 56,079 62,603 Water-source heat pumps 3,128 10,064 — 13,192 Part sales 47,623 5 862 48,490 Other 1 18,142 3,459 748 22,349 $ 666,670 $ 89,262 $ 105,948 $ 861,880 Nine Months Ended September 30, 2022 AAON Oklahoma AAON Coil Products BASX Total (in thousands) Rooftop units $ 414,493 $ — $ — $ 414,493 Condensing units 242 33,645 — 33,887 Air handlers — 35,358 6,495 41,853 Outdoor mechanical rooms 612 488 — 1,100 Cleanroom systems — — 31,568 31,568 Data center cooling solutions — — 38,589 38,589 Water-source heat pumps 8,098 6,596 — 14,694 Part sales 39,797 — 507 40,304 Other 1 13,275 3,106 1,321 17,702 $ 476,517 $ 79,193 $ 78,480 $ 634,190 1 Other sales include freight, extended warranties and miscellaneous revenue. Due to the highly customized nature of many of the Company’s products and each product not having an alternative use to the Company without significant costs to the Company, the Company recognizes revenue over time as progress is made toward satisfying the performance obligations of each contract. The Company has formal cancellation policies and generally does not accept returns on these units. As a result, many of the Company’s products do not have an alternative use and therefore, for these products we recognize revenue over the time it takes to produce the unit. Contract costs include direct materials, direct labor, installation, freight and delivery, commissions and royalties. Other costs not related to contract performance, such as indirect labor and materials, small tools and supplies, operating expenses, field rework and back charges are charged to expense as incurred. Provisions for estimated losses on contracts in progress are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income, and are estimated and recognized by the Company throughout the life of the contract. The aggregate of costs incurred and income recognized on uncompleted contracts in excess of billings is shown as a contract asset within our consolidated balance sheets, and the aggregate of billings on uncompleted contracts in excess of related costs incurred and income recognized is shown as a contract liability within our consolidated balance sheets. For all other products that are part sales or standardized units, the Company recognizes revenue, presented net of sales tax, when it satisfies the performance obligation in its contracts. As the primary performance obligation in such a contract is delivery of the requested manufactured equipment, 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. - 9 - Sales allowances and customer incentives are treated as reductions to sales and are provided for based on historical experiences and current estimates. Historically, sales of our products were moderately seasonal with the peak period being May-October of each year due to timing of construction projects being directly related to warmer weather. However, in recent years, given the increases in demand of our product and increases in our backlog, sales have become more constant throughout the year. 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. The Company also sells extended warranties on parts for various lengths of time ranging from six months to 10 years. Revenue for these separately priced warranties is deferred and recognized on a straight-line basis over the separately priced warranty period. Representatives and Third Party Products We are responsible for billings and collections resulting from all sales transactions, including those initiated by 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. 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. 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. 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. The Company is considered the principal for the equipment we design and manufacture and records that revenue. The Company has no control over the Third Party Products to the end customer and the Company is under no obligation related to the Third Party Products. Amounts related to Third Party Products are not recognized as revenue but are recorded as a liability and are included in accrued liabilities on the consolidated balance sheets. The Representatives’ fee and Third Party Products amounts (“Due to Representatives”) are paid only after all amounts associated with the order are collected from the customer. The amount of payments to our Representatives were $ 20.1 million and $ 10.8 million for the three months ended September 30, 2023 and 2022, respectively, and $ 46.4 million and $ 28.7 million for the nine months ended September 30, 2023 and 2022, respectively. 3. Leases The Company has various lease arrangements for certain manufacturing and warehousing facilities, equipment rental, as well as administrative facilities. Currently, all leases are classified as operating leases. The following table presents the balances by lease type: Balance Sheet Classification September 30, 2023 December 31, 2022 Operating Leases Right of use assets Right of use assets $ 12,252 $ 7,123 Lease liability, short-term Accrued liabilities $ 1,858 $ 1,254 Lease liability, long-term Other long-term liabilities $ 10,684 $ 5,993 Since 2018, the Company has leased the manufacturing, engineering and office space used by our operations in Parkville, Missouri, which is classified as an operating lease. In October 2022, the Parkville, Missouri lease was amended to expand our manufacturing and office space from 51,000 square feet to 86,000 square feet. The amended lease provides for approximately 31,000 square feet of additional manufacturing and engineering space and approximately 4,000 square feet of additional office space. The amended lease extends the lease term through December 31, 2032. - 10 - In November 2022, the Company entered into a lease agreement for land and facilities in Tulsa, Oklahoma which provides an additional 198,000 square feet to support our operations. The lease term will expire October 31, 2025. On July 28, 2023, the Company entered into a lease agreement with a start date of September 1, 2023, for land and approximately 72,000 square feet of facilities in Redmond, Oregon to support our manufacturing operations. The lease term is approximately five years with additional renewal options. 4. Accounts Receivable Accounts receivable and the related allowance for credit losses are as follows: September 30, 2023 December 31, 2022 (in thousands) Accounts receivable $ 160,493 $ 127,635 Less: Allowance for credit losses ( 385 ) ( 477 ) Total, net $ 160,108 $ 127,158 Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Allowance for credit losses: (in thousands) Balance, beginning of period $ 306 $ 563 $ 477 $ 549 Provisions for (recoveries of) expected credit 79 119 ( 92 ) 300 losses, net of adjustments Accounts receivable written off, net of recoveries — — — ( 167 ) Balance, end of period $ 385 $ 682 $ 385 $ 682 5. Inventories Inventories are valued at the lower of cost or net realizable value. Cost is determined by the first-in, first-out (“FIFO”) method. We establish an allowance for excess and obsolete inventories based on product line changes, the feasibility of substituting parts and the need for supply and replacement parts. The components of inventories and related changes in the allowance for excess and obsolete inventories account are as follows: September 30, 2023 December 31, 2022 (in thousands) Raw materials $ 209,697 $ 194,159 Work in process 4,379 3,501 Finished goods 5,219 5,806 Total, gross 219,295 203,466 Less: Allowance for excess and obsolete inventories ( 4,788 ) ( 4,527 ) Total, net $ 214,507 $ 198,939 Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Allowance for excess and obsolete inventories: (in thousands) Balance, beginning of period $ 5,281 $ 1,871 $ 4,527 $ 1,787 Provision for (recoveries of) excess and 1,521 1,232 2,979 1,380 obsolete inventories Inventories written off ( 2,014 ) ( 38 ) ( 2,718 ) ( 102 ) Balance, end of period $ 4,788 $ 3,065 $ 4,788 $ 3,065 - 11 - 6. Intangible assets Our intangible assets consist of the following: September 30, 2023 December 31, 2022 Definite-lived intangible assets (in thousands) Intellectual property $ 6,295 $ 6,295 Customer relationships 47,547 47,547 Less: Accumulated amortization ( 6,512 ) ( 3,807 ) Total, net 47,330 50,035 Indefinite-lived intangible assets Trademarks 14,571 14,571 Total intangible assets, net $ 61,901 $ 64,606 Amortization expense recorded in selling, general and administrative expenses is as follows: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (in thousands) Amortization expense $ 902 $ 902 $ 2,705 $ 2,698 Excluding the impact of any future acquisitions, the Company anticipates amortization expense to be $ 3.6 million for each of the years ending 2023 through 2027. 7. Supplemental Cash Flow Information Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Supplemental disclosures: (in thousands) Interest paid $ 1,187 $ 974 $ 3,814 $ 1,507 Income taxes paid $ 12,081 $ 3,086 $ 45,724 $ 14,067 Non-cash investing and financing activities: Non-cash capital expenditures $ ( 1,536 ) $ 306 $ 35 $ 985 8. Warranties The Company has product warranties with various terms from one year from the date of first use or 18 months for parts, data center cooling solutions, and cleanroom systems to 25 years for certain heat exchangers. The Company has an obligation to replace parts if conditions under the warranty are met. A provision is made for estimated warranty costs at the time the related products are sold based upon the warranty period, historical trends, new products, and any known identifiable warranty issues. Changes in the warranty accrual are as follows: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Warranty accrual: (in thousands) Balance, beginning of period $ 16,900 $ 14,381 $ 15,682 $ 13,769 Payments made ( 3,337 ) ( 2,196 ) ( 7,653 ) ( 5,094 ) Warranty expense 4,248 3,046 9,782 6,556 Balance, end of period $ 17,811 $ 15,231 $ 17,811 $ 15,231 - 12 - 9. Accrued Liabilities and Other Long-Term Liabilities Accrued liabilities were comprised of the following: September 30, 2023 December 31, 2022 (in thousands) Warranty $ 17,811 $ 15,682 Due to representatives 15,888 15,545 Payroll 18,105 11,901 Profit sharing 7,349 5,451 Workers' compensation 428 367 Medical self-insurance 1,745 1,178 Customer prepayments 1,462 3,750 Donations, short-term 419 637 Litigation settlement (Note 17 ) 7,500 — Accrued income taxes 113 12,472 Employee vacation time 10,131 6,329 Lease liability, short-term 1,858 1,254 Property taxes 2,493 — Extended warranties, short-term 2,909 1,330 Other 2,775 2,734 Total $ 90,986 $ 78,630 Other long-term liabilities were comprised of the following: September 30, 2023 December 31, 2022 (in thousands) Lease liability $ 10,684 $ 5,993 Extended warranties 5,009 4,539 Donations and other 554 976 Total $ 16,247 $ 11,508 10. Revolving Credit Facility On May 27, 2022, we amended our $ 100.0 million Amended and Restated Loan Agreement dated November 24, 2021 (as amended, “Revolver”), to provide for maximum borrowings of $ 200.0 million. As of September 30, 2023 and December 31, 2022, we had $ 78.4 million and $ 71.0 million outstanding under the Revolver, respectively. We have two standby letters of credit totaling $ 2.3 million as of September 30, 2023. Borrowings available under the Revolver at September 30, 2023 were $ 119.3 million. The Revolver expires on May 27, 2027. On April 20, 2023, we amended the Revolver to allow for the occurrence of transactions associated with the New Markets Tax Credit executed on April 25, 2023 (Note 16). 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. The weighted average interest rate on borrowings outstanding on the Revolver was 6.5 % and 6.3 % for the three and nine months ended September 30, 2023, respectively, as compared to 3.5 % and 2.5 % for the three and nine months ended September 30, 2022, respectively. Fees associated with the unused portion of the committed amount are included in interest expense on our consolidated statements of income for the three and nine months ended September 30, 2023 and 2022. If SOFR cannot be determined pursuant to the definition, as defined by the Revolver agreement, any outstanding affected 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 %. - 13 - At September 30, 2023, we were in compliance with our covenants, as defined by the Revolver. Our financial covenants require that we meet certain parameters related to our leverage ratio. At September 30, 2023, our leverage ratio was 0.33 to 1.0, which meets the requirement of not being above 3 to 1. 11. Income Taxes The provision (benefit) for income taxes consists of the following: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (in thousands) Current $ 14,892 $ 8,763 $ 33,364 $ 17,849 Deferred 521 ( 436 ) ( 3,917 ) ( 563 ) Income tax provision $ 15,413 $ 8,327 $ 29,447 $ 17,286 The provision for income taxes differs from the amount computed by applying the Federal statutory income tax rate before the provision for income taxes. The reconciliation of the Federal statutory income tax rate to the effective income tax rate is as follows: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Federal statutory rate 21.0 % 21.0 % 21.0 % 21.0 % State income taxes, net of Federal benefit 3.4 5.0 4.0 4.7 Excess tax benefits related to share-based compensation (Note 12) ( 0.8 ) ( 1.5 ) ( 3.9 ) ( 1.6 ) Return to provision 0.9 ( 0.4 ) 0.3 ( 0.5 ) Research and development credits ( 0.2 ) ( 0.7 ) ( 0.9 ) ( 1.0 ) Change in valuation allowance (Oklahoma Investment Credit) — — ( 2.0 ) — Other — ( 0.1 ) ( 0.1 ) ( 0.7 ) Effective tax rate 24.3 % 23.3 % 18.4 % 21.9 % We have historically earned investment tax credits from the state of Oklahoma’s manufacturing property investment program. We use the flow-through method to account for investment tax credits earned on eligible tangible asset expenditures. Under this method, the investment tax credits are recognized as a reduction to our Oklahoma income tax expense in the year they are used. As part of our expansion projects in Oklahoma, we identified a separate, more advantageous Oklahoma credit program (non income tax related) which will cause us to discontinue our accumulation of credits for Oklahoma’s manufacturing property investment program after the 2022 tax year. The Company had investment tax credit carryforwards with a valuation allowance reserved against them as we did not have sufficient taxable income to utilize the carryforwards, in part because we generated more credit each year than we were able to utilize. Because the Company will not generate additional excess credits after our 2022 tax year, we will be able to use our credit carryforwards against future taxable income and the related valuation allowance was reversed resulting in a one-time benefit of $ 3.1 million to the income tax provision for the nine months ended September 30, 2023. As of September 30, 2023, we have investment tax credit carryforwards of approximately $ 3.8 million. These credits have estimated expirations from the year 2039 through 2043. The Company's estimated annual 2023 effective tax rate, excluding discrete events, is approximately 24.1 %. We file income tax returns in the U.S., state and foreign income tax returns jurisdictions. We are subject to U.S. income tax examinations for tax years 2019 to present, and to non-U.S. income tax examinations for the tax years 2018 to present. In addition, we are subject to state and local income tax examinations for the tax years 2018 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. - 14 - 12. Share-Based Compensation As discussed in Note 15, the Company declared a three-for-two stock split effective August 16, 2023. All share and per share information has been updated to reflect the effect of this stock split. On May 22, 2007, our stockholders adopted a Long-Term Incentive Plan (“LTIP”) which provided an additional 5.0 million shares that could be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance units and performance awards. Under the LTIP, the exercise price of shares granted could not be less than 100 % of the fair market value at the date of the grant. On May 24, 2016, our stockholders adopted the 2016 Long-Term Incentive Plan ("2016 Plan") which provides for approximately 13.4 million shares, comprised of 5.1 million new shares provided for under the 2016 Plan, approximately 0.6 million shares that were available for issuance under the previous LTIP that are now authorized for issuance under the 2016 Plan, approximately 3.9 million shares that were approved by the stockholders on May 15, 2018, and an additional 3.8 million shares that were approved by the stockholders on May 12, 2020. Under the 2016 Plan, shares can be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance awards, dividend equivalent rights, and other awards. Under the 2016 Plan, the exercise price of shares granted may not be less than 100 % of the fair market value at the date of the grant. The 2016 Plan 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. Options The following weighted average assumptions were used to determine the fair value of the stock options granted on the original grant date for expense recognition purposes for options granted during the nine months ended September 30, 2023 and 2022 using a Black Scholes-Merton Model: Nine months ended September 30, 2023 September 30, 2022 Directors and SLT 1 : Expected (annual) dividend rate $ 0.32 $ 0.25 Expected volatility 37.89 % 36.00 % Risk-free interest rate 4.39 % 2.21 % Expected life (in years) 4.0 4.0 Employees: Expected (annual) dividend rate $ 0.32 $ 0.25 Expected volatility 38.30 % 37.38 % Risk-free interest rate 4.41 % 2.20 % Expected life (in years) 3.0 3.0 1 SLT consists of officers and key members of management. 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. - 15 - The following is a summary of stock options vested and exercisable as of September 30, 2023: Range of Exercise Prices Number of Shares Weighted Average Remaining Contractual Life (in years) Weighted Average Exercise Price Intrinsic Value ( in thousands ) $ 13.95 - $ 27.58 1,528,983 4.52 $ 24.70 $ 49,191 $ 28.28 - $ 37.16 534,293 6.72 30.91 13,870 $ 37.63 - $ 69.62 210,415 7.44 48.06 1,857 Total 2,273,691 5.31 $ 28.32 $ 64,918 A summary of stock option activity under the plans is as follows: Stock Options Shares Weighted Average Exercise Price Outstanding at December 31, 2022 4,560,520 $ 30.14 Granted 326,506 61.16 Exercised ( 864,524 ) 29.19 Forfeited or Expired ( 106,291 ) 33.90 Outstanding at September 30, 2023 3,916,211 $ 32.83 Exercisable at September 30, 2023 2,273,691 $ 28.32 The total pre-tax compensation cost related to unvested stock options not yet recognized as of September 30, 2023 is $ 10.7 million and is expected to be recognized over a weighted average period of approximately 1.3 years. The total intrinsic value of options exercised during the nine months ended September 30, 2023 and 2022 was $ 27.6 million and $ 6.7 million, respectively. The cash received from options exercised during the nine months ended September 30, 2023 and 2022 was $ 25.3 million and $ 11.0 million, respectively. The impact of these cash receipts is included in financing activities in the accompanying consolidated statements of cash flows. Restricted Stock The fair value of restricted stock awards is based on the fair market value of AAON, Inc. common stock on the respective grant dates, reduced for the present value of dividends. At September 30, 2023, unrecognized compensation cost related to unvested restricted stock awards was approximately $ 5.7 million, which is expected to be recognized over a weighted average period of approximately 1.5 years. A summary of the unvested restricted stock awards is as follows: Shares Weighted Average Grant Date Fair Value Unvested at December 31, 2022 217,168 $ 33.34 Granted 73,633 59.70 Vested ( 92,977 ) 32.57 Forfeited ( 4,846 ) 38.52 Unvested at September 30, 2023 192,978 $ 43.64 - 16 - PSUs We have awarded performance restricted stock units ("PSUs") to certain officers and employees under our 2016 Plan. Unlike our restricted stock awards, these PSUs are not considered legally outstanding and do not accrue dividends during the vesting period. These PSUs vest based on the level of achievement with respect to the Company's total shareholder return ("TSR") benchmarked against similar companies included in the capital goods sector of the S&P SmallCap 600 Index. The TSR measurement period is three years . At the end of the measurement period, each award will be converted into common stock at 0 % to 200 % of the PSUs held, depending on overall TSR as compared to the S&P SmallCap 600 Index benchmark companies. The total pre-tax compensation cost related to unvested PSUs not yet recognized as of September 30, 2023 is $ 5.0 million and is expected to be recognized over a weighted average period of approximately 1.7 years. The following weighted average assumptions were used to determine the fair value of the PSUs granted on the original grant date for expense recognition purposes for PSUs granted during the nine months ended September 30, 2023 and 2022 using a Monte Carlo Model: Nine months ended September 30, 2023 September 30, 2022 Expected (annual) dividend rate $ 0.32 $ 0.25 Expected volatility 32.71 % 37.60 % Risk-free interest rate 4.66 % 2.00 % Expected life (in years) 2.8 2.8 The expected term of the PSUs is based on their remaining performance period. 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. A summary of the unvested PSUs is as follows: Shares Weighted Average Grant Date Fair Value Unvested at December 31, 2022 93,982 $ 36.62 Granted 58,130 84.42 Vested — — Forfeited — — Unvested at September 30, 2023 1 152,112 $ 54.88 1 Consists of 22,222 PSUs cliff vesting December 31, 2023, 71,760 PSUs cliff vesting December 31, 2024, and 58,130 PSUs cliff vesting December 31, 2025. Key Employee Awards As part of the December 2021 acquisition of BASX, the Company granted awards to key employees of BASX ("Key Employee Awards"). Unlike our restricted stock awards under the 2016 Plan, the Key Employee Awards are not considered legally outstanding and do not accrue dividends during the vesting period. The potential future issuance of the Key Employee Awards is contingent upon BASX meeting certain post-closing earn-out milestones during each of the years ending 2021, 2022 and 2023 as defined by the BASX acquisition membership interest purchase agreement ("MIPA Agreement") and continued employment with the Company. At the end of the earn-out period, ending December 31, 2023, each eligible Key Employee Award will vest and be converted into common stock. The fair value of Key Employee Awards is based on the fair market value of AAON common stock on the grant date. The total pre-tax compensation cost related to unvested Key Employee Awards not yet recognized as of September 30, 2023 is $ 0.3 million and is expected to be recognized over a weighted average period of approximately 0.3 years. - 17 - A summary of the unvested Key Employee Awards is as follows: Shares Weighted Average Grant Date Fair Value Unvested at December 31, 2022 39,899 $ 53.45 Granted — — Vested — — Forfeited — — Unvested at September 30, 2023 39,899 $ 53.45 Share-Based Compensation A summary of share-based compensation is as follows: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Grant date fair value of awards during the period: (in thousands) Options $ 106 $ 480 $ 5,224 $ 5,979 PSUs — 109 4,907 2,190 Restricted stock 246 164 4,396 3,319 Total $ 352 $ 753 $ 14,527 $ 11,488 Share-based compensation expense: Options $ 2,228 $ 2,104 $ 6,604 $ 6,483 PSUs 737 188 1,820 665 Restricted stock 1,053 768 2,903 2,290 Key employee awards 261 261 775 791 Total $ 4,279 $ 3,321 $ 12,102 $ 10,229 Income tax benefit related to share-based compensation: Options $ 478 $ 531 $ 5,639 $ 1,022 Restricted stock 16 3 680 231 Total $ 494 $ 534 $ 6,319 $ 1,253 Share-based compensation expense is recognized on a straight-line basis over the service period of the related share-based compensation award. Historically, stock options and restricted stock awards, granted to employees, vested at a rate of 20 % per year. Restricted stock awards granted to directors historically vested 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. As of March 2021, all new grants of stock options and restricted stock awards, granted to employees, vest at a rate of 33.3 % per year. Forfeitures are accounted for as they occur. Historically, if the employee or director is retirement eligible (as defined by the applicable LTIP or 2016 Plan) or becomes retirement eligible during the service period of the related share-based compensation award, the service period (and compensation expense recognition) 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. All stock options and restricted stock awards granted on or after March 1, 2020 to retirement eligible employees or directors contain a one-year employment requirement (minimum service period) or the entire award is forfeited. Forfeitures are accounted for as they occur. The PSUs cliff vest on December 31, at the end of the third year from the date of grant. Share-based compensation expense is recognized on a straight-line basis over the service period of PSUs. The PSUs are subject to several service and market conditions, as defined by the PSU agreement, which allows the holder to retain a pro-rata amount of awards as a result of certain termination conditions, retirement, change in common control, or death. Forfeitures are accounted for as they occur. - 18 - The Key Employee Awards cliff vest on December 31, 2023. Share-based compensation expense is recognized on a straight-line basis over the service period of the Key Employee Awards when it is probable that the performance conditions will be satisfied. The Key Employee Awards are subject to several service and performance conditions, as defined by the Key Employee Award agreement, which allows the holder to retain an amount of the awards as a result of certain termination conditions or change in common control. Forfeitures are accounted for as they occur. 13. Employee 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 6 % deferral rate and currently contributing employees deferral rates will be increased to 6 % unless their current rate is at or above 6 % or the employee elects to decline the automatic enrollment or increase. Administrative expenses are paid for by Plan participants. The Company paid no administrative expenses during the nine months ended September 30, 2023 and 2022. The Company matches 175 % up to 6 % of employee contributions of eligible compensation. Additionally, Plan participant forfeitures are used to reduce the cost of the Company contributions. Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (in thousands) Contributions, net of forfeitures, made to the defined contribution plan $ 4,497 $ 4,189 $ 13,164 $ 10,768 Profit Sharing Bonus Plans We maintain a discretionary profit sharing bonus plan under which approximately 10 % of pre-tax profit from AAON Oklahoma and AAON Coil Products is paid to eligible employees on a quarterly basis in order to reward employee productivity. Eligible employees are regular full-time employees of AAON Oklahoma or AAON Coil Products 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. BASX has a separate employee incentive program (EIP) under which 5 % of BASX's pre-tax profit, plus certain add backs, is paid ratably to eligible employees based on days-of-pay during the fiscal year. Eligible employees are regular full-time and part-time employees who have worked during the year and are still employed when the EIP payment is made following the end of the fiscal year, excluding members of BASX's senior leadership team and any employee paid commissions or royalties. Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (in thousands) Profit sharing bonus plan and employee incentive plan expense $ 6,954 $ 4,137 $ 17,772 $ 8,952 - 19 - Employee Medical Plan At AAON Oklahoma and AAON Coil Products, we self-insure for our employees' health insurance, and make medical claim payments up to certain stop-loss amounts. We estimate our self-insurance liabilities using an analysis provided by our claims administrator and our historical claims experience. 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 Plans. In addition, the Company matches 175 % of a participating AAON Oklahoma and AAON Coil Products employee's allowed contributions to a qualified health saving account to assist employees with health insurance plan deductibles. BASX is insured for healthcare coverage through a third party. 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 Plans. In addition, the Company contributes certain amounts for BASX's employees enrolled in a high deductible plan to a qualified health savings account to assist employees with health insurance plan deductibles. Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (in thousands) Medical premium payments $ 4,455 $ 3,429 $ 11,255 $ 7,418 Health saving account contributions 1,460 968 3,718 2,871 14. Earnings Per Share Basic net income per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share assumes the conversion of all potentially dilutive securities and is calculated by dividing net income by the sum of the weighted average number of shares of common stock outstanding plus all potentially dilutive securities. Dilutive common shares consist primarily of stock options and restricted stock awards. The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2023 and 2022: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Numerator: (in thousands, except share and per share data) Net income $ 48,078 $ 27,473 $ 130,574 $ 61,478 Denominator: Basic weighted average shares 3 81,418,800 79,777,987 81,140,473 79,543,925 Effect of dilutive shares related to stock based compensation 1,3 1,974,254 1,160,087 1,993,664 1,135,815 Effect of dilutive shares related to contingent consideration 2 ,3 — — 141,071 203,058 Diluted weighted average shares 3 83,393,054 80,938,074 83,275,208 80,882,798 Earnings per share: Basic 3 $ 0.59 $ 0.34 $ 1.61 $ 0.77 Dilutive 3 $ 0.58 $ 0.34 $ 1.57 $ 0.76 Anti-dilutive shares: Shares 3 360,408 1,146,759 296,072 1,040,848 1 Dilutive shares related to stock options, restricted stock, PSUs and Key Employee Awards (Note 12) 2 Dilutive shares related to contingent shares issued to the former owners of BASX (Note 15) 3 Reflects three-for-two stock split effective August 16, 2023. - 20 - 15. Stockholders’ Equity Stock Repurchases The Board has authorized one active stock repurchase program for the Company. The Company may purchase shares on the open market from time to time. 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: Effective Date Authorized Repurchase $ Expiration Date March 13, 2020 $ 20 million November 9, 2022 November 3, 2022 $ 50 million ** 1, 2 1 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. 2 As of September 30, 2023, there is approximately $ 25.0 million remaining under the current stock repurchase program. The Company repurchases shares of AAON, Inc. stock from 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. Lastly, the Company also had a stock repurchase arrangement by which employee-participants in our 401(k) savings and investment plan were entitled to have shares in AAON, Inc. stock in their accounts sold to the Company. The 401(k) Plan was amended in June 2022 to discontinue this program. No additional shares have been purchased by the Company under this arrangement since June 2022. Our repurchase activity is as follows: Nine Months Ended September 30, 2023 September 30, 2022 (in thousands, except share and per share data) Program Shares 1 Total $ $ per share 1 Shares 1 Total $ $ per share 1 Open market 402,873 $ 25,009 $ 62.08 53,218 $ 2,030 $ 38.14 401(k) — — — 155,904 5,913 37.93 Employees 20,218 1,202 59.45 24,889 978 39.29 Total 423,091 $ 26,211 $ 61.95 234,011 $ 8,921 $ 38.12 1 Reflects three-for-two stock split effective August 16, 2023. Our repurchase activity since Company inception, including our current authorized stock repurchase programs, are as follows: Inception to September 30, 2023 (in thousands, except share and per share data) Program Shares 1 Total $ $ per share 1 Open market 6,893,924 $ 106,625 $ 15.47 401(k) 12,462,552 171,789 13.78 Directors and employees 3,087,651 24,562 7.95 Total 22,444,127 $ 302,976 $ 13.50 1 Reflects three-for-two stock split effective August 16, 2023. - 21 - Cash Dividends At the discretion of the Board, we pay cash dividends. Board approval is required to determine the date of declaration and amount for each cash dividend payment. Our recent cash dividends are as follows: Declaration Date 1 Record Date Payment Date Dividend per Share 2 Annualized Dividend per Share 2 May 18, 2022 June 3, 2022 July 1, 2022 $ 0.13 $ 0.26 November 8, 2022 November 28, 2022 December 16, 2022 $ 0.16 $ 0.32 March 1, 2023 March 13, 2023 March 31, 2023 $ 0.08 $ 0.32 May 18, 2023 June 9, 2023 June 30, 2023 $ 0.08 $ 0.32 August 18, 2023 September 8, 2023 September 29, 2023 $ 0.08 $ 0.32 1 Effective with the cash dividend declared on March 1, 2023 (paid on March 31, 2023), the Company moved from semi-annual cash dividends to quarterly cash dividends. 2 Reflects three-for-two stock split effective August 16, 2023. Stock Split On July 7, 2023, the Board of Directors declared a three-for-two stock split of the Company's common stock to be paid in the form of a stock dividend. Stockholders of record at the close of business on July 28, 2023 received one additional share for every two shares they held as of that date on August 16, 2023 (ex-dividend date August 17, 2023). Cash was paid in lieu of fractional shares (approximately $ 0.5 million). All share and per share information has been updated to reflect the effects of this stock split. The retroactive effect of the stock split resulted in an approximately $ 0.1 million reclass between common stock and retained earnings within stockholders' equity on the consolidated balance sheet. Contingent Shares Issued in BASX Acquisition As discussed above, the Company declared a three-for-two stock split effective August 16, 2023. All share and per share information has been updated to reflect the effect of this stock split. In December 2021, we closed on the acquisition of BASX. Under the MIPA Agreement, we committed to $ 78.0 million in the aggregate of contingent consideration to the former owners of BASX, which is payable in approximately 1.56 million shares of the Company's common stock, par value $ 0.004 per share. The shares do not accrue dividends. Under the MIPA Agreement, the potential future issuance of the shares is contingent upon BASX meeting certain post-closing earn-out milestones during each of the years ended 2021, 2022, and 2023. Based on the final allocation of the consideration paid, we estimated the fair value of contingent consideration related to these shares to be approximately $ 60.0 million, which is included in additional paid-in capital on the consolidated balance sheets. As of September 30, 2023, 0.58 million shares and 0.73 million shares related to the earn-out milestones for the years ended 2022 and 2021, respectively, have been issued to the former owners of BASX as private placements exempt from registration with the SEC under Rule 506(b), which are included in common stock on the consolidated statements of stockholders' equity. 16. New Markets Tax Credit 2019 New Markets Tax Credit On October 24, 2019, the Company entered into a transaction with a subsidiary of an unrelated third-party financial institution (the “2019 Investor”) and a certified Community Development Entity under a qualified New Markets Tax Credit (“2019 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 “2019 Project”). In connection with the 2019 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 2019 Project. Upon closing of the 2019 NMTC transaction, the Company provided an aggregate of approximately $ 15.9 million to the 2019 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 2019 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 the NMTCs. - 22 - This transaction also includes a put/call feature either of which can be exercised at the end of the seven-year compliance period. The 2019 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 2019 Investor's interest of $ 6.5 million is recorded in New market tax credit obligation on the consolidated balance sheets. The Company incurred approximately $ 0.3 million of debt issuance costs related to the above transactions, which are being amortized over the life of the transaction. 2023 New Markets Tax Credit On April 25, 2023, the Company entered into a transaction with a subsidiary of an unrelated third-party financial institution (the “2023 Investor”) and a certified Community Development Entity under a qualified New Markets Tax Credit (“2023 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 “2023 Project”). In connection with the 2023 NMTC transaction, the Company received a $ 23.0 million NMTC allocation for the 2023 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 2023 NMTC transaction, the Company provided an aggregate of approximately $ 16.7 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 $ 16.7 million in proceeds plus capital contributed from the 2023 Investor was used to make an aggregate $ 23.8 million loan to a subsidiary of the Company. This financing arrangement is secured by a guarantee from the Company, including an unconditional guarantee of the NMTCs. The net proceeds from the closing of the 2023 NMTC is included in restricted cash on our consolidated balance sheets required to be used for the 2023 Project. This transaction also includes a put/call feature either of which can be exercised at the end of the seven-year compliance period. The 2023 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 2023 Investor's interest of $ 5.7 million is recorded in New market tax credit obligation on the consolidated balance sheets. The Company incurred approximately $ 0.4 million of debt issuance costs related to the above transactions, which are being amortized over the life of the transaction. The 2019 Investor and 2023 Investor are each subject to 100 percent recapture of the 2019 and 2023 NMTC, respectively, 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 2019 NMTC arrangements and 2023 NMTC arrangements, respectively. Noncompliance with applicable requirements could result in the 2019 and/or 2023 Investors' projected tax benefits not being realized and, therefore, require the Company to indemnify the 2019 Investor and 2023 Investor for any loss or recapture of the 2019 NMTC and 2023 NMTC, respectively, 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 either of these financing arrangements. The 2019 Investor and 2023 Investor and its majority owned community development entity are considered VIEs and the Company is the primary beneficiary 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 transactions in these VIEs outside of the financing transactions executed as part of the 2019 NMTC or 2023 NMTC arrangements, respectively. 17. Commitments and Contingencies Havtech Litigation On January 24, 2022, one of the Company’s former independent sales representative firms, Havtech, LLC (and its affiliate, Havtech Parts Division, LLC, collectively “Plaintiffs”), filed a complaint (the “Complaint”) in the Circuit Court for Howard County, Maryland ( Havtech, LLC, et al., v. AAON, Inc., et al. ). The Complaint challenged the Company’s termination of its business relationship with Plaintiffs. The Company removed the action to the United States District Court for the District of Maryland (Northern Division) and moved to dismiss the Complaint. Plaintiffs’ First Amended Complaint (“First Amended Complaint”) was entered by the court on July 28, 2022. The First Amended Complaint asserts that the Company improperly terminated Plaintiffs and seeks damages alleged to be no less than $ 48.6 million, plus fees and costs. The Company filed its Answer to First Amended Complaint on January 31, 2023. On September 28, 2023, the parties attended a court ordered settlement conference and agreed to resolve the case for $ 7.5 million. A settlement agreement was entered into on October 25, 2023 and the case has been dismissed with prejudice. The settlement of $ 7.5 million has been included in accrued liabilities on our consolidated balance sheets and selling, general and administrative expenses on our consolidated statement of income. The final payment was made on October 26, 2023. - 23 - Other Matters The Company is involved from time to time in claims and lawsuits incidental to our business arising from various matters, including alleged violations of contract, product liability, warranty, environmental, regulatory, personal injury, intellectual property, employment, tax and other laws. 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 do not believe these matters will have a material adverse effect on our business, financial position, results of operations or cash flows. We are occasionally party to short-term and long-term, cancellable and occasionally non-cancellable, contracts with major suppliers for the purchase of raw material and component parts. We expect to receive delivery of raw material and component parts 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. We had no material contractual purchase obligations as of September 30, 2023, except as noted below. On April 27, 2022, the Company entered into a purchase and sale agreement with a third-party manufacturer to purchase certain assets to design and manufacture fan wheels for the purchase price of $ 6.5 million. As of September 30, 2023, we have paid approximately $ 3.5 million related to this agreement, which is included in other long-term assets and property, plant and equipment, with the remaining $ 3.0 million included in accounts payable and other long-term assets on our consolidated balance sheets. The final payment was made on October 30, 2023. 18. Related Parties The following is a summary of transactions and balances with related parties: Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (in thousands) Sales to affiliates $ 1,047 $ 450 $ 4,811 $ 3,529 Payments to affiliates 90 30 872 1,033 September 30, 2023 December 31, 2022 (in thousands) Due from affiliates $ 190 $ 432 Due to affiliates 232 — The nature of our related party transactions is as follows: • The Company sells units to an entity owned by a member of the CEO/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. • The Company purchases some supplies from entities controlled by two of the Company’s board members and a member of the Company's executive management team. • The Company periodically makes part sales and makes payments to a board member related to a consulting agreement. • The Company periodically rents space partially owned by the CEO/President for various Company meetings. • From December 10, 2021 through May 31, 2022, the Company leased a manufacturing and office facility in Redmond, Oregon from an entity in which certain members of BASX management have an ownership interest. This facility was purchased 100 % by the Company on May 31, 2022. - 24 - 19. Segments The Company has determined that it has three reportable segments for financial reporting purposes. Management evaluates the performance of its business segments primarily on gross profit. The Company's chief operating 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. AAON Oklahoma: AAON Oklahoma designs, manufactures, sells and services standard, semi-custom and custom heating, ventilation and air conditioning ("HVAC") systems, designs and produces controls solutions for all of our HVAC units and sells retail parts to customers through our two retail part stores in Tulsa, Oklahoma as well as online. Through our Norman Asbjornson Innovation Center ("NAIC") research and development laboratory facility in Tulsa, Oklahoma, the Company is able to test units under various environmental conditions. AAON Oklahoma includes the operations of our Tulsa, Oklahoma and Parkville, Missouri facilities, our NAIC research and development laboratory facility and two retail parts locations. AAON Coil Products: AAON Coil Products designs and manufactures a selection of our standard, semi-custom and custom HVAC systems. AAON Coil Products also designs and manufactures various heating and cooling coils to be used in HVAC systems, mostly for the benefit of AAON Oklahoma and AAON Coil Products. AAON Coil Products consists of operations at our Longview, Texas facilities. BASX: BASX provides product development design and manufacturing of custom engineered air handling systems including high efficiency data center cooling solutions, cleanroom HVAC systems, commercial/industrial HVAC systems and modular solutions. Additionally, BASX designs and manufactures cleanroom environmental control systems to support hospital surgical suites, pharmaceutical process facilities, semiconductor and electronics manufacturing, laboratory and isolation modular cleanrooms for facility flexibility. BASX consists of operations at our Redmond, Oregon facility. The following table summarizes certain financial data related to our segments. Transactions between segments are recorded based on prices negotiated between the segments. The Gross Profit amounts shown below are presented after elimination entries. Three Months Ended Nine Months Ended September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Net Sales (in thousands) AAON Oklahoma External sales $ 246,454 $ 179,169 $ 666,670 $ 476,517 Inter-segment sales 768 998 3,467 2,157 AAON Coil Products External sales 25,769 30,504 89,262 79,193 Inter-segment sales 11,871 8,037 28,687 24,047 BASX External sales 39,747 32,932 105,948 78,480 Inter-segment sales ( 74 ) 61 1,426 61 Eliminations ( 12,565 ) ( 9,096 ) ( 33,580 ) ( 26,265 ) Net sales $ 311,970 $ 242,605 $ 861,880 $ 634,190 Gross Profit AAON Oklahoma $ 94,174 $ 45,643 $ 231,403 $ 111,216 AAON Coil Products 8,307 10,564 22,948 26,344 BASX 13,628 9,384 32,930 21,471 Gross profit $ 116,109 $ 65,591 $ 287,281 $ 159,031 - 25 - September 30, 2023 December 31, 2022 Long-lived assets (in thousands) AAON Oklahoma $ 251,298 $ 213,731 AAON Coil Products 77,434 68,013 BASX 45,805 35,578 Total long-lived assets $ 374,537 $ 317,322 Intangible assets and goodwill AAON Oklahoma $ 3,229 $ 3,229 AAON Coil Products — — BASX 140,564 143,269 Total intangible assets and goodwill $ 143,793 $ 146,498