AAON, Inc. — Q2 2018 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2018. AAON engineers, manufactures and sells commercial heating and air-conditioning equipment. Financial statements are unaudited.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $109.6 million | $101.3 million | $208.7 million | $187.4 million |
| Gross profit | $27.6 million | $31.7 million | $43.0 million | $56.7 million |
| Gross margin | 25.2% | 31.3% | 20.6% | 30.2% |
| Operating income | $14.5 million | $19.7 million | $19.7 million | $34.1 million |
| Net income | $11.7 million | $13.8 million | $16.0 million | $24.0 million |
| Diluted EPS | $0.22 | $0.26 | $0.30 | $0.45 |
| Operating cash flow | Not separately provided | Not separately provided | $36.2 million | $33.8 million |
Q2 sales rose 8.2% year over year, while net income fell 15.2%. For the first half, sales increased 11.3%, but net income declined 33.6%. Q2 gross margin remained materially below the prior-year quarter, although management reported significant improvement compared with Q1.
Liquidity, debt and capital allocation
- At June 30, cash and equivalents were $15.9 million; certificates of deposit and held-to-maturity investments brought cash and investments to approximately $24.3 million, down about $6.1 million from year-end.
- There were no revolver borrowings; $29.2 million was available after a $0.8 million standby letter of credit. The company reported compliance with its financial covenants.
- After quarter-end, the credit facility was extended to July 26, 2021, with the borrowing rate reduced from LIBOR plus 2.5% to LIBOR plus 2.0%. The minimum tangible-net-worth covenant increased from $125 million to $175 million.
- First-half capital expenditures were $25.9 million. Investing cash use was $31.8 million, including $6.4 million for the WattMaster acquisition. Financing cash use was $10.0 million, including $11.5 million of stock repurchases.
- The company declared a $0.16-per-share dividend, up from $0.13 in 2017. A new open-market repurchase authorization of up to $15 million was established in May.
Material changes and management commentary
- Unit sales increased 8.7% in Q2 and 14.0% for the first half. Water-source heat pump sales and units rose substantially; management noted this product line has lower margins and remains in early production. Rooftop unit sales were broadly flat.
- Management attributed first-half margin pressure to a $1.9 million one-time employee bonus, higher staffing levels, lower-margin heat pumps, costs of bringing the research lab toward operation, and rising input costs. Twelve-month average prices increased 13.4% for copper, 14.6% for galvanized steel, 6.8% for stainless steel and 6.5% for aluminum.
- Backlog reached a reported record $156.6 million at June 30, compared with $81.2 million at December 31, 2017 and $83.5 million a year earlier. The company said order intake increased.
- WattMaster Controls was acquired on February 28 for total consideration of $6.4 million. The acquisition adds controls expertise and is intended to accelerate development of AAON’s electronic controllers.
- The company continued construction of a 134,000-square-foot research and development laboratory and investment in its water-source heat pump line.
Outlook, risks and unusual items
- Management estimated 2018 capital expenditures at approximately $53.2 million and an annual effective tax rate of approximately 27%, excluding discrete items. The company said existing cash, operating cash flow and financing capacity should meet foreseeable liquidity needs.
- Sales are moderately seasonal, with the peak period typically July through November. Management described new construction demand as unpredictable and uneven, and said it continues to emphasize the replacement market.
- Key stated risks include raw-material and component price changes, commercial and industrial construction cycles, interest rates, and general economic and competitive conditions. The filing also notes commodity-price exposure and possible use of supplier contracts to manage it.
- The 2018 effective tax rate was lower than 2017 following the federal corporate tax rate reduction to 21%; a tax benefit related to accelerated depreciation was also recognized. Revenue-standard adoption had no material impact.
- Management considered pending ordinary-course litigation unlikely to have a material adverse effect. No material contractual purchase agreements or material off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Whether the backlog converts to revenue and whether the sharp increase is sustained.
- Whether gross margins recover as heat pump production matures and lab start-up, staffing, bonus and input-cost pressures ease.
- Progress on the $53.2 million capital program, laboratory completion and resulting operating returns.
- Whether the amended credit facility and higher tangible-net-worth covenant leave sufficient financial flexibility.
- The sustainability of the estimated 27% tax rate and the effects of share repurchases, dividends and stock-based compensation on per-share results.