AAON, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The interim financial statements are unaudited. AAON engineers, manufactures and sells commercial heating and air-conditioning equipment.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $112.9 million | $113.7 million | $321.6 million | $301.1 million |
| Gross profit | $32.8 million | $35.7 million | $75.7 million | $92.3 million |
| Operating income | $19.6 million | $22.6 million | $39.3 million | $56.7 million |
| Net income | $14.1 million | $14.7 million | $30.0 million | $38.7 million |
| Diluted EPS | $0.27 | $0.28 | $0.57 | $0.73 |
| Gross margin | 29.0% | 31.4% | 23.5% | 30.7% |
- Q3 sales decreased 0.6% year over year, while units sold rose 4.6%; lower rooftop-unit sales were the main reason revenue declined.
- For the first nine months, sales grew 6.8% and units sold increased 10.6%. Water-source heat-pump unit sales rose to 3,780 from 1,510, but management said this product line carries lower margins.
- Nine-month operating cash flow was $44.2 million, versus $41.9 million. Capital expenditures were $34.3 million, compared with $26.4 million.
- Cash and cash equivalents were $7.3 million at September 30; cash, certificates of deposit and held-to-maturity investments totaled approximately $10.7 million. The company reported no revolving-credit borrowings and $29.2 million available under its facility.
- Total assets were $314.0 million and stockholders’ equity was $249.6 million. The current ratio was approximately 2.7. No long-term debt balance is reported.
Material changes and notable items
- Profitability weakened year over year: nine-month gross profit fell 17.9% and net income fell 22.5%, despite higher sales. Q3 gross margin improved from earlier 2018 quarters, but remained below the prior-year quarter.
- Management cited higher raw-material costs, including year-over-year increases in trailing-average prices for copper (8.6%), galvanized steel (16.7%), stainless steel (11.0%) and aluminum (8.3%). Tariffs and trade restrictions contributed to cost pressure.
- Nine-month cost of sales included a $1.9 million one-time employee bonus paid in January 2018 following enactment of the Tax Cuts and Jobs Act. Management also cited elevated staffing around year-end 2017 and early 2018 as factors in the first-quarter margin decline.
- Backlog reached a reported record $126.8 million at September 30, up from $73.8 million a year earlier and $81.2 million at December 31, 2017.
- AAON acquired substantially all assets of WattMaster Controls on February 28 for $6.4 million, funded with available cash. The acquisition added controls expertise and resulted in $3.2 million of goodwill and $0.6 million of net intangible assets at quarter-end.
- Capital spending supported a new research and development laboratory, the water-source heat-pump line and other projects. The company estimated 2018 capital expenditures of approximately $40 million.
- The nine-month effective tax rate was 23.8%, versus 32.1% in 2017, primarily reflecting the lower federal corporate tax rate. Management estimated a 2018 annual effective tax rate of approximately 26%, excluding discrete items.
Outlook, liquidity and risks
- Management said cash, projected operating cash flow, the committed credit facility and expected access to capital markets should meet working-capital, capital-expenditure and other liquidity needs in 2018 and the foreseeable future. No formal revenue or earnings guidance is provided in the filing.
- The revolving facility provides up to $30 million, with a $0.8 million standby letter of credit; it matures July 26, 2021. AAON reported compliance with its financial covenants at quarter-end.
- Management described commercial and industrial construction demand as unpredictable and uneven, and noted the business’s exposure to economic cycles, interest rates, commodity and component prices, and competition. Sales are moderately seasonal, with the peak period July through November.
- AAON may use fixed-price supplier contracts of six to 18 months to manage commodity-price exposure. Management reported no material off-balance-sheet arrangements and no material contractual purchase agreements at quarter-end.
- Ordinary-course legal claims were disclosed; management considered the likelihood of a material adverse outcome remote. The filing reported no material changes to the risk factors in the 2017 Form 10-K.
Important facts for investors to verify
- Whether the record backlog converts to shipments and revenue, and whether demand remains strong beyond the seasonal peak.
- Whether gross margins recover despite commodity-cost and tariff pressures and the lower-margin product mix.
- Progress on the laboratory, water-source heat-pump investment and WattMaster integration, including associated spending and returns.
- Cash use from capital expenditures, dividends and repurchases: nine-month cash declined by $14.2 million, while cash dividends paid were $8.4 million and stock repurchases were $17.5 million.
- The assumptions behind the approximately $40 million capital-expenditure estimate and approximately 26% annual tax-rate estimate.