AAON, Inc. — Q1 2017 Form 10-Q
Business and period: AAON engineers, manufactures, and sells commercial heating and air-conditioning equipment. This unaudited report covers the three months ended March 31, 2017, compared with Q1 2016; interim results may not indicate full-year performance.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $86.1 million | $85.4 million | +0.8% |
| Gross profit / margin | $25.0 million / 29.0% | $25.7 million / 30.1% | Profit down 2.9%; margin down 1.1 percentage points |
| Income from operations | $14.5 million | $16.8 million | Down 14.1% |
| Net income | $10.2 million | $11.6 million | Down 11.6% |
| Diluted EPS | $0.19 | $0.22 | Down $0.03 |
| Operating cash flow | $10.2 million | $16.0 million | Down $5.8 million |
| Capital expenditures | $6.1 million | $7.3 million | — |
Units sold increased 14.9% to 5,021, while sales rose only 0.8%; management attributed the difference primarily to product mix. Sales growth was driven by volume. Gross margin contracted as cost of sales rose to 71.0% of sales from 69.9%. SG&A increased 18.1% to $10.5 million, or 12.2% of sales versus 10.4%, primarily from higher warranty, advertising, and share-based compensation expense.
Financial position and liquidity
- At March 31, cash and cash equivalents were $31.6 million; certificates of deposit and held-to-maturity investments totaled another $10.3 million. Management reported cash and investments of $41.9 million, down $1.9 million from year-end.
- Current assets were $146.2 million and current liabilities $41.1 million. Working capital was approximately $105.1 million.
- No borrowings were outstanding on the $30.0 million revolving facility; $29.2 million remained available after a $0.8 million standby letter of credit. The facility expires July 27, 2018. The company reported compliance with covenants.
- Operating cash flow fell mainly because inventory increased $8.7 million, reflecting higher sales volume and activity in the water-source heat-pump line. Investing activities provided $3.3 million, mainly from maturities of investments; financing used $6.0 million, primarily for stock repurchases. Cash increased $7.5 million during the quarter.
- Stock repurchases totaled $6.9 million, or 198,928 shares. No cash dividend was declared in the quarter; the filing lists prior 2016 semiannual dividends of $0.11 and $0.13 per share.
Outlook, commentary, and risks
- Management estimated 2017 capital expenditures at approximately $41.8 million, including investment in a new research and development lab, a water-source heat-pump line, and other internal projects. It expects available cash, operating cash flow, its credit facility, and potential capital-market access to meet 2017 and foreseeable liquidity needs.
- The estimated 2017 effective tax rate was approximately 36%, excluding discrete items. Q1’s reported effective rate was 29.7%, including $1.1 million of excess tax benefits from share-based compensation.
- Management described commercial and industrial new construction as unpredictable and uneven and said it was emphasizing the replacement market. Risks identified include economic and construction-market fluctuations, raw-material and component prices, interest rates, and competition. Copper and stainless-steel prices declined year over year, galvanized steel was unchanged, and aluminum increased slightly; commodity prices remain volatile.
- Warranty expense rose to $1.2 million from $0.3 million, while warranty payments were $1.3 million. The ending warranty accrual was $7.8 million. Management’s estimates depend on historical trends, product changes, and identifiable warranty issues.
- The company said pending ordinary-course claims and litigation were unlikely to have a material adverse effect. It reported no material changes to risk factors, no material off-balance-sheet arrangements, and no material contractual purchase agreements.
- Revenue-recognition standard ASU 2014-09 was scheduled for adoption January 1, 2018 using the retrospective method. The company was still assessing its impact and did not expect a material effect; its evaluation was not yet complete.
Important facts for investors to verify
- Whether sales growth and margins improve as product mix, unit volumes, and the replacement market evolve.
- Whether the higher warranty provision indicates a sustained change in product costs or reflects timing and estimates.
- Progress and spending against the approximately $41.8 million 2017 capital-expenditure plan, and the resulting effect on cash generation.
- Inventory growth, conversion to sales, and operating cash flow during the seasonal peak period.
- The final impact and transition effects of the 2018 revenue-recognition adoption, and the tax rate excluding discrete share-based compensation benefits.
- Use of the credit facility and compliance with covenants; the filing states $29.2 million was available and no amount was drawn at quarter-end.