Business context and reporting period
AAON, Inc. manufactures and sells commercial heating and air-conditioning equipment. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013; comparisons are with the corresponding 2012 periods unless stated otherwise. Sales are seasonal, with the peak period typically July through November.
Financial performance and liquidity
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $89.7 million | $76.8 million | $247.8 million | $225.1 million |
| Gross profit | $26.6 million | $17.1 million | $69.6 million | $51.8 million |
| Gross margin | 29.7% | 22.3% | 28.1% | 23.0% |
| Operating income | $16.9 million | $10.4 million | $43.9 million | $32.2 million |
| Net income | $10.5 million | $6.0 million | $29.8 million | $19.9 million |
| Diluted EPS, adjusted for 3-for-2 split | $0.28 | $0.16 | $0.80 | $0.54 |
Q3 operating margin was 18.9%, versus 13.5%; nine-month operating margin was 17.7%, versus 14.3%. SG&A rose faster than sales: to $9.7 million in Q3 (up 43.6%) and $25.7 million for nine months (up 31.2%).
For the nine months, operating cash flow was $38.8 million, compared with $38.4 million. Investing activities used $32.7 million, including substantial purchases of certificates of deposit and held-to-maturity investments; financing activities used $7.0 million. Cash and cash equivalents decreased to $2.3 million from $3.2 million at year-end 2012.
At September 30, 2013, current assets were $109.1 million and current liabilities $43.1 million, yielding working capital of $66.0 million. The company reported no revolver borrowings and $29.1 million of available capacity after a $0.9 million standby letter of credit. In addition to cash, it held $12.7 million in certificates of deposit and $29.3 million in held-to-maturity investments. Total assets were $220.1 million and stockholders’ equity $161.9 million. The credit facility was amended to extend its termination date to July 27, 2014; the company reported compliance with its covenants.
Material changes versus prior periods
- Q3 sales increased 16.8%; management attributed growth to market-share gains in new construction and replacement markets and April 2013 price increases. Nine-month sales rose 10.1%, also reflecting construction and manufacturing activity pulled forward by warm winter weather.
- Gross margin expanded in both comparison periods, which management attributed primarily to lower raw-material costs and price increases. Nine-month copper, steel and aluminum prices were down approximately 2.27%, 5.83% and 5.15%, respectively, from the prior-year period.
- Higher SG&A included increased warranty and profit-sharing costs, employee benefits and share-based compensation. Nine-month warranty expense was $5.3 million, versus $3.7 million.
- Nine-month net income benefited from a lower effective tax rate (32.8%, versus 38.3%), including reinstated R&D and Indian Employment Credits and a change in estimate for certain 2012 tax credits.
Outlook, commentary, risks and unusual items
No specific sales or earnings forecast is provided. Management said operating cash flow and the revolver, or comparable financing, were expected to support liquidity for fiscal 2013 and the foreseeable future, and anticipated continued covenant compliance. The company estimated a 33.4% annual effective tax rate for 2013.
Key risks cited include economic conditions and cyclical commercial and industrial construction demand, raw-material and component price volatility, interest-rate changes and competition. The company uses supplier contracts, typically covering six to 18 months, to manage some commodity exposure; it entered no key-raw-material derivative contracts in the periods presented. Foreign sales were 6.7% of nine-month sales, versus 6.0% a year earlier.
Other notable items: a $0.3 million gain from insurance proceeds exceeding repair costs for prior-year ice-storm damage; a three-for-two stock split effective July 2, 2013; and a $0.10-per-share semiannual dividend paid in July. After quarter-end, the board declared another $0.10-per-share dividend, payable December 23, 2013. Ordinary-course claims and legal actions were disclosed; management did not expect them to have a material effect.
Management reported disclosure controls and procedures were effective. A material weakness in internal control over financial reporting identified at year-end 2012, involving review procedures for intercompany activities, income taxes and inventory, was still undergoing remediation and testing; management expected testing to continue during the balance of 2013.
Important facts for investors to verify
- Whether sales growth and improved gross margins persist, given seasonal demand, construction-market cyclicality and the effect of April price increases and lower input costs.
- How warranty accruals and costs develop as sales grow; the warranty accrual was $7.5 million at September 30, 2013.
- The composition, maturities and credit quality of the company’s deposit and held-to-maturity investments, including the disclosed A+ to BBB- ratings for corporate notes and bonds.
- Whether the company completes remediation testing and resolves the previously reported internal-control material weakness.
- The sustainability of the reduced effective tax rate, including the effects of tax credits and estimates.