AAON, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. AAON engineers, manufactures and sells commercial heating and air-conditioning equipment. Financial amounts below are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $113.5 | $112.9 | $346.8 | $321.6 |
| Gross profit / margin | $27.4 / 24.1% | $32.8 / 29.0% | $83.4 / 24.0% | $75.7 / 23.5% |
| Operating income | $14.4 | $19.6 | $45.6 | $39.3 |
| Net income | $13.8 | $14.1 | $37.7 | $30.0 |
| Diluted EPS | $0.26 | $0.27 | $0.72 | $0.57 |
- Quarterly comparison: Sales edged up 0.5%, despite total units sold falling 11.3%. Higher parts and water-source heat-pump sales supported revenue. Gross margin declined to 24.1%, and operating income fell about 26%, as labor and engineering costs rose and sheet-metal production was reduced by machine downtime. Net income declined 1.8%; the lower tax provision partly offset weaker operating results.
- Nine-month comparison: Sales increased 7.8% and units sold rose 4.3%. Management attributed sales growth mainly to 2018–2019 price increases, parts sales and higher water-source heat-pump volume. Gross margin improved to 24.0% from 23.5%; operating income rose about 16% and net income about 25%.
- Cash flow: Operating cash flow was $70.6, versus $44.2 in the prior-year period. Capital expenditures were $30.8, implying operating cash flow less capital expenditures of about $39.8. Investing cash use was $30.7 and financing cash use was $13.5. Cash rose $26.4 from year-end to $28.4.
- Liquidity and debt: No revolving-credit borrowings were outstanding. The $30.0 revolving facility had $28.7 available after a $1.3 standby letter of credit; it expires July 2021. Current assets were $170.5 and current liabilities $53.9. The company reported compliance with credit covenants; tangible net worth was $279.6 and liabilities-to-tangible-net-worth was 0.3:1.
Material developments, outlook and risks
- Backlog was $165.3 at September 30, up from $126.8 a year earlier and $151.8 at December 31, 2018. Management said order intake continued to support the high backlog.
- Management expected overall raw-material costs to continue declining into 2020 and labor and overhead efficiencies to improve as new sheet-metal machines entered service in late 2019 and early 2020. The company was continuing construction of a 134,000-square-foot research and development laboratory, with full operation expected in 2020. Estimated 2019 capital expenditures were approximately $48.3.
- Management described the commercial and industrial new-construction market as robust in 2018 and through Q3 2019, but showing signs of uncertainty. Risks identified include economic and construction-market weakness, changes in raw-material and component prices, interest rates and competition. Sales are moderately seasonal, with a July–November peak.
- The estimated 2019 effective tax rate, excluding discrete items, was approximately 24%. The Q3 effective rate was 3.9%, including effects from tax adjustments and credits; the nine-month rate was 17.4%. The filing notes Oklahoma tax-credit benefits and an additional research-and-development credit benefit recorded after the 2018 tax return was completed.
- Subsequent event: On October 24, 2019, AAON entered a New Markets Tax Credit financing transaction to support Longview, Texas expansion. It received a $23.0 allocation and arranged a $22.5 loan to a subsidiary; AAON also provided approximately $15.9 as a 25-year, 1.0% loan receivable to the investor. The arrangement includes a company guarantee and potential partial debt forgiveness after a seven-year compliance period. Noncompliance could require indemnification for tax-credit recapture; management said it did not anticipate recapture.
- Warranty expense improved year over year, which management linked to quality-control improvements. The warranty accrual was $12.4 at quarter-end. The excess-and-obsolete inventory allowance was $2.2, versus $1.2 at year-end 2018; the nine-month provision was $1.0.
- The company reported ordinary-course legal claims, but assessed the likelihood of a material adverse outcome as remote. It disclosed one material purchase obligation of approximately $3.4 expiring in December 2020, and no material off-balance-sheet arrangements.
Important facts for investors to verify
- Whether margins recover from Q3’s production disruption and higher labor and engineering costs.
- Whether backlog converts to sales amid lower quarterly unit volume and uncertainty in new construction.
- Progress, spending and expected returns from the laboratory, production-line investments and Longview expansion.
- NMTC financing terms, guarantee exposure, compliance obligations and potential debt forgiveness.
- Sustainability of tax benefits and the approximately 24% full-year tax-rate estimate, alongside warranty and inventory-reserve assumptions.