AAON, Inc. — Q2 2019 Form 10-Q
Business and period: AAON engineers and manufactures commercial heating and air-conditioning equipment. This unaudited report covers the quarter and six months ended June 30, 2019; comparisons are with the same 2018 periods. Amounts below are in millions unless noted.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $119.4 | $109.6 | $233.3 | $208.7 |
| Gross profit / margin | $30.2 / 25.3% | $27.6 / 25.2% | $56.0 / 24.0% | $43.0 / 20.6% |
| Income from operations | $16.7 | $14.5 | $31.2 | $19.7 |
| Net income | $13.0 | $11.7 | $23.9 | $16.0 |
| Diluted EPS | $0.25 | $0.22 | $0.45 | $0.30 |
- Q2 sales increased 9.0%; total units sold rose 8.5%. Six-month sales increased 11.8%; total units sold rose 12.3%.
- Six-month operating cash flow was $35.9 million, versus $36.2 million. Investing cash outflow was $20.7 million, compared with $31.8 million; financing cash outflow was $3.5 million, compared with $10.0 million.
- Capital expenditures were $16.8 million for the six months, versus $25.9 million. Cash and cash equivalents were $13.7 million at June 30; the company also held $4.0 million in certificates of deposit. The MD&A describes combined cash and cash equivalents as $17.7 million.
- No revolving-credit borrowings were outstanding. The company reported $28.7 million of availability under its $30.0 million facility, after a $1.3 million standby letter of credit. It was in compliance with covenants.
- Total assets were $342.3 million and stockholders’ equity was $264.6 million at June 30. Current liabilities were $59.0 million and current assets $168.6 million.
Changes and management commentary
- Six-month gross margin improved to 24.0% from 20.6%. Management cited improved labor and overhead efficiencies and relatively stable material costs; Q2 gross margin was nearly flat year over year.
- Water-source heat pump sales were a notable growth contributor: six-month product sales increased to $12.7 million from $7.1 million. Rooftop units remained the largest product category.
- Backlog was $179.6 million at June 30, up from $151.8 million at December 31, 2018 and $156.6 million a year earlier. Management said order intake continued to support a high backlog.
- Management characterized 2018 and the first half of 2019 new-construction demand as robust but showing signs of uncertainty, and said it continued to emphasize replacement-market sales.
Outlook, risks, and notable items
- Management estimated a 2019 effective tax rate of approximately 27%, excluding discrete events. The reported six-month effective rate was 23.6%.
- 2019 capital expenditures were estimated at approximately $48.3 million, including completion of the research and development laboratory, water-source heat pump lines, and Tulsa facility expansion. Management expected the lab to be completed in 2019.
- Risks identified include economic weakness and cyclicality in commercial and industrial construction, interest-rate changes, competition, and volatility in raw-material and component prices. Twelve-month average galvanized steel and stainless steel prices were up 10.6% and 4.8%, respectively; aluminum was up 1.7%, while copper was down 2.9%. Supplier fixed-price contracts of six to 18 months are used to manage exposure.
- The company recorded approximately $1.8 million of lease right-of-use assets and lease liabilities upon adopting the new lease standard in January 2019; management said the adoption did not materially affect earnings or cash flows.
- Inventory obsolescence provisions were $1.2 million for the first half, versus $0.3 million a year earlier. Warranty expense declined to $3.4 million from $4.7 million, which management attributed to quality-control improvements.
- Legal claims arise in the ordinary course; management considered a material adverse outcome remote. One material raw-material purchase obligation was approximately $1.1 million, expiring in December 2019. The filing reported no material changes to previously disclosed risk factors.
- The company repurchased $11.2 million of shares during the first half and declared $0.16 per common share in dividends. Management believed available cash, operating cash flow, and credit availability would meet foreseeable needs.
Important facts for investors to verify
- Whether the elevated backlog converts to sales and remains supported by new orders, particularly if construction markets weaken.
- Whether margin improvement persists as raw-material costs, labor and overhead, and product mix change.
- Execution, timing, and return on the planned $48.3 million of 2019 capital expenditures, including the laboratory and production expansions.
- Cash conversion and working-capital trends, especially the increase in accounts receivable and the adequacy of inventory and warranty reserves.
- The assumptions behind the approximately 27% full-year tax-rate estimate and any discrete tax effects.