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AAON, INC. - Quarter Report: 2020 September (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________________ to ____________________
 
Commission file number:  0-18953
AAON, INC.
(Exact name of registrant as specified in its charter) 
Nevada87-0448736
(State or other jurisdiction(IRS Employer
of incorporation or organization)Identification No.)
2425 South Yukon Ave.,Tulsa,Oklahoma74107
(Address of principal executive offices) (Zip Code)
(918) 583-2266
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes                   No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes                   No   
                             
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of "large accelerated filer", "accelerated filer", "small reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
                                                   
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes                       No 

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common StockAAONNASDAQ

As of November 3, 2020, registrant had outstanding a total of 52,242,095 shares of its $.004 par value Common Stock.



PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.
AAON, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
 September 30, 2020December 31, 2019
Assets(in thousands, except share and per share data)
Current assets:  
Cash and cash equivalents$70,603 $26,797 
Restricted cash7,998 17,576 
Accounts receivable, net of allowance for credit losses of $546 and $353, respectively
62,195 67,399 
Income tax receivable3,914 772 
Note receivable29 29 
Inventories, net78,819 73,601 
Prepaid expenses and other1,973 1,375 
Total current assets225,531 187,549 
Property, plant and equipment:  
Land3,804 3,274 
Buildings115,600 101,113 
Machinery and equipment267,763 236,087 
Furniture and fixtures18,342 16,862 
Total property, plant and equipment405,509 357,336 
Less:  Accumulated depreciation196,631 179,242 
Property, plant and equipment, net208,878 178,094 
Intangible assets, net97 272 
Goodwill3,229 3,229 
Right of use assets1,618 1,683 
Note receivable560 597 
Total assets$439,913 $371,424 
Liabilities and Stockholders' Equity  
Current liabilities:  
Revolving credit facility$— $— 
Accounts payable16,038 11,759 
Accrued liabilities45,468 44,269 
Total current liabilities61,506 56,028 
Deferred tax liabilities22,973 15,297 
Other long-term liabilities4,191 3,639 
New market tax credit obligation (a)6,351 6,320 
Commitments and contingencies
Stockholders' equity:  
Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued
— — 
Common stock, $.004 par value, 100,000,000 shares authorized, 52,264,801 and 52,078,515 issued and outstanding at September 30, 2020 and December 31, 2019, respectively
209 208 
Additional paid-in capital8,175 3,631 
Retained earnings336,508 286,301 
Total stockholders' equity344,892 290,140 
Total liabilities and stockholders' equity$439,913 $371,424 
 (a) Held by variable interest entities (Note 16)

The accompanying notes are an integral part of these consolidated financial statements.

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AAON, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 Three Months Ended 
 September 30,
Nine Months Ended 
 September 30,
 2020201920202019
(in thousands, except share and per share data)
Net sales$134,772 $113,500 $397,851 $346,759 
Cost of sales93,924 86,090 275,925 263,715 
Gross profit40,848 27,410 121,926 83,044 
Selling, general and administrative expenses14,716 12,374 45,869 38,963 
Loss (gain) on disposal of assets(61)296 
Income from operations26,131 15,030 76,118 43,785 
Interest income, net10 90 49 
Other income (expense), net15 (7)20 (16)
Income before taxes26,156 15,032 76,228 43,818 
Income tax provision5,696 742 16,111 7,380 
Net income$20,460 $14,290 $60,117 $36,438 
Earnings per share:  
Basic$0.39 $0.27 $1.15 $0.70 
Diluted$0.38 $0.26 $1.14 $0.69 
Cash dividends declared per common share:$— $— $0.19 $0.16 
Weighted average shares outstanding:  
Basic52,260,551 52,111,444 52,174,705 52,086,209 
Diluted53,151,295 52,722,127 52,955,049 52,624,583 
 
The accompanying notes are an integral part of these consolidated financial statements.

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AAON, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
Nine Months Ended September 30, 2020
 Common StockPaid-inRetained 
SharesAmountCapitalEarningsTotal
 (in thousands)
Balances at December 31, 201952,079 $208 $3,631 $286,301 $290,140 
Net income— — — 60,117 60,117 
Stock options exercised and restricted616 18,517 — 18,519 
stock awards granted     
Share-based compensation— — 8,546 — 8,546 
Stock repurchased and retired(430)(1)(22,519)— (22,520)
Dividends— — — (9,910)(9,910)
Balances at September 30, 202052,265 $209 $8,175 $336,508 $344,892 
Three Months Ended September 30, 2020
Common StockPaid-inRetained
SharesAmountCapitalEarningsTotal
(in thousands)
Balances at June 30, 202052,234 $209 $6,451 $316,035 $322,695 
Net income— — — 20,460 20,460 
Stock options exercised and restricted126 — 4,346 — 4,346 
stock awards granted
Share-based compensation— — 2,852 — 2,852 
Stock repurchased and retired(95)— (5,474)— (5,474)
Dividends— — — 13 13 
Balances at September 30, 202052,265 $209 $8,175 $336,508 $344,892 
Nine Months Ended September 30, 2019
Common StockPaid-inRetained
SharesAmountCapitalEarningsTotal
(in thousands)
Balances at December 31, 201851,991 $208 $— $249,235 249,443 
Net income— — — 36,438 36,438 
Stock options exercised and restricted494 11,281 — 11,283 
stock awards granted
Share-based compensation— — 9,854 — 9,854 
Stock repurchased and retired(366)(1)(16,459)— (16,460)
Dividends— — — (8,303)(8,303)
Balances at September 30, 201952,119 $209 $4,676 $277,370 $282,255 
Three Months Ended September 30, 2019
Common StockPaid-inRetained
SharesAmountCapitalEarningsTotal
(in thousands)
Balances at June 30, 201952,118 $209 $4,299 $263,003 $267,511 
Net income— — — 14,290 14,290 
Stock options exercised and restricted110 — 3,598 — 3,598 
stock awards granted
Share-based compensation— — 2,068 — 2,068 
Stock repurchased and retired(109)— (5,289)— (5,289)
Dividends— — — 77 77 
Balances at September 30, 201952,119 $209 $4,676 $277,370 $282,255 
The accompanying notes are an integral part of these consolidated financial statements.

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AAON, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
 Nine Months Ended 
 September 30,
 20202019
Operating Activities(in thousands)
Net income$60,117 $36,438 
Adjustments to reconcile net income to net cash provided by operating activities: 
Depreciation and amortization18,971 17,627 
Amortization of debt issuance cost31 — 
Provision for credit losses on accounts receivable, net of adjustments193 91 
Provision for excess and obsolete inventories1,776 1,003 
Share-based compensation8,546 9,854 
(Gain) loss on disposition of assets(61)296 
Foreign currency transaction loss (gain)18 (17)
Interest income on note receivable(19)(19)
Deferred income taxes7,676 3,614 
Changes in assets and liabilities:  
Accounts receivable5,011 (2,096)
Income taxes(3,142)2,283 
Inventories(6,994)(4,014)
Prepaid expenses and other(598)(513)
Accounts payable3,654 782 
Deferred revenue1,128 263 
Accrued liabilities688 4,991 
Net cash provided by operating activities96,995 70,583 
Investing Activities  
Capital expenditures(48,955)(30,831)
Proceeds from sale of property, plant and equipment61 68 
Investment in certificates of deposits— (6,000)
Maturities of certificates of deposits— 6,000 
Principal payments from note receivable38 39 
Net cash used in investing activities(48,856)(30,724)
Financing Activities  
Stock options exercised18,519 11,283 
Repurchase of stock(21,390)(15,437)
Employee taxes paid by withholding shares(1,130)(1,023)
Cash dividends paid to stockholders(9,910)(8,303)
Net cash used in financing activities(13,911)(13,480)
Net increase in cash, cash equivalents and restricted cash34,228 26,379 
Cash, cash equivalents and restricted cash, beginning of period44,373 1,994 
Cash, cash equivalents and restricted cash, end of period$78,601 $28,373 

The accompanying notes are an integral part of these consolidated financial statements.

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AAON, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
(Unaudited)

1. General

Basis of Presentation
 
The accompanying unaudited consolidated financial statements of AAON, Inc., a Nevada corporation, and our operating subsidiaries, all of which are wholly-owned, (collectively, the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (“SEC”).

Our financial statements consolidate all of our affiliated entities in which we have a controlling financial interest. Because we hold certain rights that give us the power to direct the activities of two variable interest entities ("VIEs") (Note 16) that most significantly impact the VIEs economic performance, combined with a variable interest that gives us the right to receive potentially significant benefits or the obligation to absorb potentially significant losses, we have a controlling financial interest in those VIEs.

These financial statements have not been audited by the Company's independent registered public accounting firm, except that the consolidated balance sheet at December 31, 2019 is derived from audited consolidated financial statements. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. The financial statements reflect all adjustments (all of which are of a normal recurring nature) which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of the results that may be expected for a full year. Certain disclosures have been condensed in or omitted from these consolidated financial statements. The accompanying unaudited financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. All intercompany balances and transactions have been eliminated in consolidation.
 
We are engaged in the engineering, manufacturing, marketing and sale of air conditioning and heating equipment consisting of standard, semi-custom and custom rooftop units, chillers, packaged outdoor mechanical rooms, air handling units, makeup air units, energy recovery units, condensing units, geothermal/water-source heat pumps, coils and controls.
 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because these estimates and assumptions require significant judgment, actual results could differ from those estimates and could have a significant impact on our results of operations, financial position and cash flows. We reevaluate our estimates and assumptions as needed, but at a minimum on a quarterly basis. The most significant estimates include, but are not limited to, inventory reserves, warranty accrual, worker's compensation accrual, medical insurance accrual, income taxes and share-based compensation. Actual results could differ materially from those estimates.

Impact of COVID-19 Pandemic

In March 2020, the World Health Organization characterized the coronavirus ("COVID-19") a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency. The rapid spread of the pandemic and the continuously evolving responses to combat it have had an increasingly negative impact on the global economy.


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Our manufacturing operations are considered a critical infrastructure industry, as defined by the U.S. Department of Homeland Security, as such, the decrees issued by national, state, and local governments in response to the COVID-19 pandemic have had minimal impact on our operations except for higher employee absenteeism in our manufacturing facilities. We had continuous operations during the nine months ended September 30, 2020. For the most part, our workers are able to socially distance themselves during the manufacturing process. Additional precautions have been taken to social distance workers that work in close environments. The Company utilizes sanitation stations, requires the use of a facial covering when unable to socially distance, performs daily temperature scanning, and performs additional cleaning and sanitation throughout the day and deep cleaning overnight. The Company did see significant employee absenteeism in the latter part of June 2020. These unexpected employee absences resulted in reduced shipments and longer lead times in the second quarter 2020. During the third quarter 2020, employee attendance levels were stronger than previously anticipated. Additionally, our work force has adapted well to school and childcare related issues.

The magnitude of the impact of COVID-19 remains unpredictable and we, therefore, continue to anticipate potential supply chain disruptions, increased employee absenteeism and additional health and safety costs related to the COVID-19 pandemic that could unfavorably impact our business.

Although these disruptions and costs are expected to be temporary, there is significant uncertainty around the duration and overall impact to our business operations. We do not believe that the impact of the COVID-19 pandemic will have a material adverse effect on the results of our operations, financial position and cash flows as of and for the year ended December 31, 2020.

However, we are monitoring the progression of the pandemic and its potential effect on our financial position, results of operations and cash flows.
 
Accounting Policies
 
A comprehensive discussion of our critical accounting policies and management estimates is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2019.

Fair Value Measurements

We adopted ASU No. 2018-13, Fair Value Measurements (Topic 820), as amended, as of January 1, 2020. The ASU includes additional disclosure requirements for unrealized gains and losses for Level 3 fair value measurements and significant observable inputs used to develop Level 3 fair value measurements. There was not a material impact to financial statements upon adoption. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Fair value is based upon assumptions that market participants would use when pricing an asset or liability. We use the following fair value hierarchy, which prioritizes valuation technique inputs used to measure fair value into three broad levels:

Level 1: Quoted prices in active markets for identical assets and liabilities that we have the ability to access at the measurement date.
Level 2: Inputs (other than quoted prices included within Level 1) that are either directly or indirectly observable for the asset or liability, including (i) quoted prices for similar assets or liabilities in active markets, (ii) quoted prices for identical or similar assets or liabilities in inactive markets, (iii) inputs other than quoted prices that are observable for the asset or liability, and (iv) inputs that are derived from observable market data by correlation or other means.
Level 3: Unobservable inputs for the asset or liability including situations where there is little, if any, market activity for the asset or liability. Items categorized in Level 3 include the estimated fair values of property, plant and equipment, intangible assets and goodwill acquired in a business combination.

The fair value hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall into different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to a fair value measurement requires judgment, considering factors specific to the asset or liability.


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Intangible Assets

Our intangible assets include various trademarks, service marks and technical knowledge acquired in our February 2018 business combination. We amortize our intangible assets on a straight-line basis over the estimated useful lives of the assets. We evaluate the carrying value of our amortizable intangible assets for potential impairment when events and circumstances warrant such a review. 

Goodwill

Goodwill represents the excess of the consideration paid for the acquired businesses, in our February 2018 business combination, over the fair value of the individual assets acquired, net of liabilities assumed.  Goodwill at September 30, 2020 is deductible for income tax purposes. Goodwill is not amortized, but instead is evaluated for impairment at least annually. We perform our annual assessment of impairment during the fourth quarter of our fiscal year, and more frequently if circumstances warrant.

Recent Accounting Pronouncements

Changes to U.S. GAAP are established by the Financial Accounting Standards Board ("FASB") in the form of Accounting Standards Updates ("ASUs") to the FASB's Accounting Standards Codification ("ASC").

We consider the applicability and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial statements and notes thereto.

In December 2019, the FASB issued ASU 2019-12, Income Taxes: Simplifying the Accounting for Income Taxes. The ASU includes simplification of accounting for income taxes for franchise taxes, step up in tax basis for goodwill as part of a business combination and interim reporting of enacted changes in tax laws. The ASU is effective for the Company beginning after December 15, 2020. We do not expect ASU 2019-12 will have a material effect on our consolidated financial statements and notes thereto.

2.  Revenue Recognition
 
Disaggregated net sales by major source:
Three Months EndedNine Months Ended
September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
(in thousands)
Rooftop units$102,750 $78,432 $312,725 $255,532 
Condensing units6,304 4,416 15,307 13,622 
Air handlers5,805 6,523 18,068 18,150 
Outdoor mechanical rooms867 181 2,216 1,488 
Water source heat pumps6,770 8,751 14,269 21,417 
Part sales10,484 10,313 24,562 25,602 
Other1,792 4,884 10,704 10,948 
Net Sales
$134,772 $113,500 $397,851 $346,759 


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Disaggregated units sold by major source:
Three Months EndedNine Months Ended
September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Rooftop units4,372 3,520 12,179 11,079 
Condensing units593 418 1,447 1,291 
Air handlers534 552 1,545 1,669 
Outdoor mechanical rooms22 28 
Water source heat pumps1,847 1,311 5,109 5,977 
Total Units
7,352 5,808 20,302 20,044 

The Company recognizes revenue, presented net of sales tax, when it satisfies the performance obligation in its contracts. The primary performance obligation in our contract is delivery of the requested manufactured equipment. Most of the Company’s products are highly customized, cannot be resold to other customers and the cost of rework to be resold is not economical. The Company has a formal cancellation policy and generally does not accept returns on these units. As a result, many of the Company’s products do not have an alternative use and therefore, for these products we recognize revenue over the time it takes to produce the unit. For all other products that are part sales or standardized units, we satisfy the performance obligation when the control is passed to the customer, generally at time of shipment. Final sales prices are fixed based on purchase orders. Sales allowances and customer incentives are treated as reductions to sales and are provided for based on historical experiences and current estimates. Sales of our products are moderately seasonal with the peak period being May-October of each year.

We are responsible for billings and collections resulting from all sales transactions, including those initiated by our independent manufacturer representatives (“Representatives”). Representatives are national companies that are in the business of providing HVAC units and other related products and services to customers. The end user customer orders a bundled group of products and services from the Representative and expects the Representative to fulfill the order. These additional products and services may include controls purchased from another manufacturer to operate the unit, start-up services, and curbs for supporting the unit (“Third Party Products”). All are associated with the purchase of a HVAC unit but may be provided by the Representative or another third party. Only after the specifications are agreed to by the Representative and the customer, and the decision is made to use an AAON HVAC unit, will we receive notice of the order. We establish the amount we must receive for our HVAC unit (“minimum sales price”), but do not control the total order price that is negotiated by the Representative with the end user customer. The Representatives submit the total order price to us for invoicing and collection. The total order price includes our minimum sales price and an additional amount which may include both the Representatives’ fee and amounts due for additional products and services required by the customer. The Company is considered the principal for the equipment we design and manufacture and records that revenue gross. The Company has no control over the Third Party Products to the end customer and the Company is under no obligation related to the Third Party Products. Amounts related to Third Party Products are not recognized as revenue but are recorded as a liability and are included in accrued liabilities on the consolidated balance sheet.

The Representatives’ fee and Third Party Products amounts (“Due to Representatives”) are paid only after all amounts associated with the order are collected from the customer. The amount of payments to our Representatives were $11.5 million and $12.7 million for the three months ended September 30, 2020 and 2019, respectively. The amount of payments to our Representatives were $39.0 million and $34.4 million for the nine months ended September 30, 2020 and 2019, respectively.

The Company also sells extended warranties on parts for various lengths of time ranging from six months to 10 years. Revenue for these separately priced warranties is deferred and recognized on a straight-line basis over the separately priced warranty period.
 

3.  Leases
 
We adopted ASU No. 2016-02, Leases (Topic 842), as amended, as of January 1, 2019, using the transition method, which becomes effective upon the date of adoption. The transition method allows entities to initially apply the new leases standard at the adoption date (January 1, 2019) and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. We have also elected the short-term lease measurement and recognition exemption which does not require balance sheet presentation for

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short-term leases. The Company historically does not enter into numerous or material lease agreements to support its manufacturing operations. Furthermore, any lease agreements entered into are usually less than a year and for leases on non material assets such as warehouse vehicles and office equipment. 

Adoption of the new standard resulted in the recording of additional lease right of use assets and lease liabilities of approximately $1.8 million as of January 1, 2019, which mostly relates to the multi-year facility lease assumed in our February 2018 business combination. The cumulative-effect adjustment to the opening balance was immaterial to the consolidated financial statements as a whole. The standard did not materially impact our consolidated net earnings or cash flows.  As of September 30, 2020, our right of use assets and lease liabilities are approximately $1.6 million.


4.  Accounts Receivable

Accounts receivable and the related allowance for credit losses are as follows:
 
 September 30,
2020
December 31, 2019
 (in thousands)
Accounts receivable$62,741 $67,752 
Less:  Allowance for credit losses(546)(353)
Total, net
$62,195 $67,399 
 
 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Allowance for credit losses:(in thousands)
Balance, beginning of period$429 $392 $353 $264 
Provisions (recoveries) for expected credit117 (37)193 91 
losses, net of adjustments
Accounts receivable written off, net of recoveries
— (2)— (2)
Balance, end of period$546 $353 $546 $353 
 

5.  Inventories

Inventories are valued at the lower of cost or net realizable value. Cost is determined by the first-in, first-out (“FIFO”) method. We establish an allowance for excess and obsolete inventories based on product line changes, the feasibility of substituting parts and the need for supply and replacement parts.

The components of inventories and related changes in the allowance for excess and obsolete inventories account are as follows:

 September 30,
2020
December 31, 2019
 (in thousands)
Raw materials$76,673 $68,842 
Work in process1,541 1,825 
Finished goods4,717 5,578 
Total, gross
82,931 76,245 
Less:  Allowance for excess and obsolete inventories(4,112)(2,644)
Total, net
$78,819 $73,601 


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  Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Allowance for excess and obsolete inventories:(in thousands)
Balance, beginning of period$2,373 $2,350 $2,644 $1,210 
Provisions (recoveries) for excess and1,969 (150)1,776 1,003 
     obsolete inventories
Inventories written off(230)— (308)(13)
Balance, end of period$4,112 $2,200 $4,112 $2,200 


6.  Intangible Assets

Our intangible assets consist of the following:

September 30,
2020
December 31, 2019
(in thousands)
Intellectual property$700 $700 
Less: Accumulated amortization(603)(428)
       Total, net$97 $272 

Amortization expense recorded in cost of sales is as follows:

  Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
(in thousands)
Amortization expense$58 $58 $175 $175 


7.  Supplemental Cash Flow Information
 
 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Supplemental disclosures:(in thousands)
Income taxes paid$1,841 $1,116 $11,576 $1,510 
Non-cash investing and financing activities:  
Non-cash capital expenditures$(4,421)$(116)$625 $(280)
 

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8.  Warranties

The Company has product warranties with various terms ranging from one year from the date of first use or 18 months for parts to 25 years for certain heat exchangers. The Company has an obligation to replace parts if conditions under the warranty are met. A provision is made for estimated warranty costs at the time the related products are sold based upon the warranty period, historical trends, new products and any known identifiable warranty issues.  

Changes in the warranty accrual are as follows:
 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Warranty accrual:(in thousands)
Balance, beginning of period$13,160 $11,666 $12,652 $11,421 
Payments made(1,687)(2,023)(4,481)(5,200)
Provisions2,054 2,707 5,356 6,129 
Balance, end of period$13,527 $12,350 $13,527 $12,350 
Warranty expense:$2,054 $2,707 $5,356 $6,129 
 

9.  Accrued Liabilities

Accrued liabilities were comprised of the following:

 September 30,
2020
December 31, 2019
 (in thousands)
Warranty$13,527 $12,652 
Due to representatives10,257 11,538 
Payroll7,448 5,058 
Profit sharing3,000 1,721 
Worker's compensation646 522 
Medical self-insurance247 707 
Customer prepayments2,151 4,627 
Donations604 354 
Employee vacation time3,493 3,804 
Other4,095 3,286 
Total
$45,468 $44,269 
 

10.  Revolving Credit Facility

Our revolving credit facility, as amended, ("BOK Revolver") provides for maximum borrowings of $30.0 million, which is provided by BOKF, NA dba Bank of Oklahoma (“Bank of Oklahoma”). Under the line of credit, there is one standby letter of credit totaling $1.7 million. Borrowings available under the revolving credit facility at September 30, 2020 were $28.3 million. Interest on borrowings is payable monthly at LIBOR plus 2.0%. No fees are associated with the unused portion of the committed amount. We had no outstanding balance under the revolving credit facility at September 30, 2020 and December 31, 2019. The revolving credit facility expires on July 26, 2021.

As of September 30, 2020, we were in compliance with our financial covenants. These covenants require that we meet certain parameters related to our tangible net worth and total liabilities to tangible net worth ratio. At September 30, 2020, our tangible net worth was $344.9 million and met the requirement of being at or above $175.0 million. Our total liabilities to tangible net worth ratio was 0.3 to 1, and met the requirement of not being above 2 to 1.


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11.  Income Taxes

The provision (benefit) for income taxes consists of the following:
 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
 (in thousands)
Current$3,081 $446 $8,435 $3,766 
Deferred2,615 296 7,676 3,614 
     Income tax provision$5,696 $742 $16,111 $7,380 

The provision for income taxes differs from the amount computed by applying the Federal statutory income tax rate before the provision for income taxes.

The reconciliation of the Federal statutory income tax rate to the effective income tax rate is as follows:

 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Federal statutory rate21.0 %21.0 %21.0 %21.0 %
State income taxes, net of Federal benefit2.3 1.3 4.0 4.2 
Amended Oklahoma tax returns— (4.5)— (2.0)
Excess tax benefits(2.3)(1.7)(3.3)(3.1)
Return to provision adjustments0.5 (7.1)0.2 (2.1)
Other0.3 (4.1)(0.8)(1.2)
     Effective tax rate21.8 %4.9 %21.1 %16.8 %
During the three months ended September 2019, upon completion of the Company's 2018 tax return, the Company recorded an additional benefit due to higher than expected research and development credit of $0.6 million. Historically, the Company has taken advantage of the Oklahoma Investment/New Jobs Credit ("OK Credit"). This OK Credit allows the Company to take a credit equal to 1% of eligible investments each year for five years, beginning with the year of investment. The Company determined it could take advantage of an additional 1% tax credit for years in which the Company's location was deemed to be within an enterprise zone. The additional OK Credit for being in an enterprise zone, or otherwise allowable under Oklahoma law resulted in a benefit of $0.3 million for 2018 and $0.9 million for our 2015, 2016 and 2017 amended returns, combined.

The Company's estimated annual 2020 effective tax rate, excluding discrete events, is approximately 24%. We file income tax returns in the U.S., state and foreign income tax returns jurisdictions. We are subject to U.S. income tax examinations for tax years 2016 to present, and to non-U.S. income tax examinations for the tax years 2015 to present. In addition, we are subject to state and local income tax examinations for the tax years 2015 to present. The Company continues to evaluate its need to file returns in various state jurisdictions. Any interest or penalties would be recognized as a component of income tax expense.

Coronavirus Aid, Relief, and Economic Security Act

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted on March 27, 2020, and includes a retroactive correction to the 2017 Tax Cuts and Jobs Act that allows for much faster depreciation of qualified improvement property that is placed in service after December 31, 2017. Under current rules, the calculation of depreciation or repair deductions for prior years can be recomputed and a one-time catch-up adjustment is allowed in the current tax year for missed deductions. The adjustment is the difference between depreciation or repair deductions claimed versus depreciation or repair deductions that could have been claimed by the end of the prior tax year and does not require amending any prior year tax returns.


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12. Share-Based Compensation

On May 22, 2007, our stockholders adopted a Long-Term Incentive Plan (“LTIP”) which provided an additional 3.3 million shares that could be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance units and performance awards, in addition to the shares from the previous plan, the 1992 Plan. Since inception of the LTIP, non-qualified stock options and restricted stock awards have been granted with a five year vesting schedule. Under the LTIP, the exercise price of shares granted could not be less than 100% of the fair market value at the date of the grant.

On May 24, 2016, our stockholders adopted the 2016 Long-Term Incentive Plan ("2016 Plan") which provides for approximately 8.9 million shares, comprised of 3.4 million new shares provided for under the 2016 Plan, approximately 0.4 million shares that were available for issuance under the previous LTIP that are now authorized for issuance under the 2016 Plan, approximately 2.6 million shares that were approved by the stockholders on May 15, 2018, and an additional 2.5 million shares that were approved by the stockholders on May 12, 2020. Under the 2016 Plan, shares can be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance awards, dividend equivalent rights, and other awards. Under the 2016 Plan, the exercise price of shares granted may not be less than 100% of the fair market value at the date of the grant. The 2016 Plan is administered by the Compensation Committee of the Board of Directors or such other committee of the Board of Directors as is designated by the Board of Directors (the “Committee”). Membership on the Committee is limited to independent directors. The Committee will determine the persons to whom awards are to be made, determine the type, size and terms of awards, interpret the 2016 Plan, establish and revise rules and regulations relating to the 2016 Plan and make any other determinations that it believes necessary for the administration of the 2016 Plan. The Committee may delegate certain duties to one or more officers of the Company as provided in the 2016 Plan.

Options

The total pre-tax compensation cost related to unvested stock options not yet recognized as of September 30, 2020 is $23.4 million and is expected to be recognized over a weighted average period of 3.1 years.

The following weighted average assumptions were used to determine the fair value of the stock options granted on the original grant date for expense recognition purposes for options granted during the nine months ended September 30, 2020 and 2019 using a Black Scholes-Merton Model:
 Nine months ended
 September 30, 2020September 30, 2019
Directors and Officers:  
Expected dividend rate$0.33$0.32
Expected volatility31.63%29.54%
Risk-free interest rate0.64%2.40%
Expected life (in years)5.05.0
Employees:  
Expected dividend rate$0.32$0.32
Expected volatility31.31%29.54%
Risk-free interest rate0.68%2.39%
Expected life (in years)5.05.0
 
The expected term of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Volatility is based on historical volatility of our stock over time periods equal to the expected life at grant date.
 

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The following is a summary of stock options vested and exercisable as of September 30, 2020:
 
Range of
Exercise
Prices
Number
of
Shares
Weighted
Average
Remaining
Contractual Life
(in years)
Weighted
Average
Exercise
Price
Intrinsic
Value
(in thousands)
$7.18 -$36.95 526,235 5.51$28.03 $16,957 
$37.00 -$40.87 1,978 7.3438.50 43 
$41.37 -$60.32 210,496 8.1941.53 3,940 
Total738,709 6.28$31.90 $20,940 
 
The following is a summary of stock options vested and exercisable as of September 30, 2019:

Range of
Exercise
Prices
Number
of
Shares
Weighted
Average
Remaining
Contractual Life
(in years)
Weighted
Average
Exercise
Price
Intrinsic
Value
(in thousands)
$7.18 -$33.20 350,549 5.29$21.07 $8,717 
$33.40 -$40.87 124,622 7.7935.63 1,284 
$41.37 -$50.68 4,070 0.6741.37 19 
Total479,241 5.90$25.03 $10,020 

A summary of stock option activity under the plans is as follows:
Stock OptionsSharesWeighted
Average
Exercise
Price
Outstanding at December 31, 2019
3,627,047 $36.32 
Granted
1,038,542 44.84 
Exercised
(547,808)33.80 
Forfeited or Expired
(214,838)40.48 
Outstanding at September 30, 2020
3,902,943 $38.71 
Exercisable at September 30, 2020
738,709 $31.90 
 
The total intrinsic value of options exercised during the nine months ended September 30, 2020 and 2019 was $12.1 million and $7.0 million, respectively. The cash received from options exercised during the nine months ended September 30, 2020 and 2019 was $18.5 million and $11.3 million, respectively. The impact of these cash receipts is included in financing activities in the accompanying Consolidated Statements of Cash Flows.

Restricted Stock

The fair value of restricted stock awards is based on the fair market value of AAON, Inc. common stock on the respective grant dates, reduced for the present value of dividends. At September 30, 2020, unrecognized compensation cost related to unvested restricted stock awards was approximately $5.3 million, which is expected to be recognized over a weighted average period of 2.9 years.


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A summary of the unvested restricted stock awards is as follows:
Restricted StockSharesWeighted
Average
Grant Date
Fair Value
Unvested at December 31, 2019
267,484 $34.42 
Granted
76,148 43.54 
Vested
(108,215)32.55 
Forfeited
(8,216)39.88 
Unvested at September 30, 2020
227,201 $38.17 

Share-Based Compensation

A summary of share-based compensation is as follows: 
Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Grant date fair value of awards during the period:(in thousands)
Options$258 $244 $12,332 $20,315 
Restricted stock— — 3,316 4,584 
Total$258 $244 $15,648 $24,899 
Share-based compensation expense:
Options$2,208 $1,539 $6,136 $7,683 
Restricted stock644 529 2,410 2,171 
Total$2,852 $2,068 $8,546 $9,854 
Income tax benefit/(deficiency) related to share-based compensation:
Options$579 $233 $1,990 $964 
Restricted stock503 462 
Total$588 $240 $2,493 $1,426 
 
Share-based compensation expense is recognized on a straight-line basis over the service period of the related share-based compensation award. Stock options and restricted stock awards, granted to employees, vest at a rate of 20% per year. Restricted stock awards granted to directors historically vest one-third each year or, if granted on or after May 2019, vest over the shorter of directors' remaining elected term or one-third each year. Forfeitures are accounted for as they occur.

Historically, if the employee or director is retirement eligible (as defined by the applicable LTIP or 2016 Plan) or becomes retirement eligible during service period of the related share-based compensation award, the service period (and compensation expense recognition) is the lesser of 1) the grant date, if retirement eligible on grant date, or 2) the period between grant date and retirement eligible date. All share-based compensation awards granted on or after March 1, 2020 to retirement eligible employees or directors contain a one-year employment requirement (minimum service period) or the entire award is forfeited.


13. Employee Benefits

Defined Contribution Plan - 401(k)

We sponsor a defined contribution plan (the “Plan”). Eligible employees may make contributions in accordance with the Plan and IRS guidelines. In addition to the traditional 401(k), eligible employees are given the option of making an after-tax contribution to a Roth 401(k) or a combination of both. The Plan provides for automatic enrollment and for an automatic increase to the deferral percentage at January 1st of each year and each year thereafter. Eligible employees are automatically enrolled in the Plan at a 6% deferral rate and currently contributing employees deferral rates will be increased to 6% unless their current rate is above 6% or the employee elects to decline the automatic enrollment or increase. Administrative expenses are paid for by Plan participants. The Company paid no administrative expenses during the three and nine months ended September 30, 2020 and 2019.


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The Company matches 175% up to 6% of employee contributions of eligible compensation. Additionally, Plan participant forfeitures are used to reduce the cost of the Company contributions.

Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
(in thousands)
Contributions made to the defined contribution plan$2,242 $1,820 $6,791 $5,270 

Profit Sharing Bonus Plan

We maintain a discretionary profit sharing bonus plan under which approximately 10% of pre-tax profit is paid to eligible employees on a quarterly basis in order to reward employee productivity. Eligible employees are regular full-time employees who are actively employed and working on the first and last days of the calendar quarter and who were employed full-time for at least three full months prior to the beginning of the calendar quarter, excluding the Company's senior leadership team.

Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
(in thousands)
Profit sharing bonus plan expense$3,000 $1,684 $8,691 $4,948 

Employee Medical Plan

We self-insure for our employees' health insurance. Eligible employees are regular full-time employees who are actively employed and working. Participants are expected to pay a portion of the premium costs for coverage of the benefits provided under the Plan. We estimate our self-insurance liabilities using an analysis provided by our claims administrator and our historical claims experience. In addition, the Company matches 175% of a participating employee's allowed contributions to a qualified health saving account to assist employees with our health insurance plan deductibles.

Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
(in thousands)
Medical claim payments$2,985 $1,650 $6,843 $4,500 
Health saving account contributions890 790 2,663 2,410 


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14.  Earnings Per Share

Basic net income per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share assumes the conversion of all potentially dilutive securities and is calculated by dividing net income by the sum of the weighted average number of shares of common stock outstanding plus all potentially dilutive securities. Dilutive common shares consist primarily of stock options and restricted stock awards.

The following table sets forth the computation of basic and diluted earnings per share:
 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
Numerator:(in thousands, except share and per share data)
Net income
$20,460 $14,290 $60,117 $36,438 
Denominator:  
Basic weighted average shares
52,260,551 52,111,444 52,174,705 52,086,209 
Effect of dilutive stock options and restricted stock
890,744 610,683 780,344 538,374 
Diluted weighted average shares
53,151,295 52,722,127 52,955,049 52,624,583 
Earnings per share:  
Basic
$0.39 $0.27 $1.15 $0.70 
Diluted
$0.38 $0.26 $1.14 $0.69 
Anti-dilutive shares:  
Shares
118,832 1,834,379 473,295 1,886,728 


15. Stockholders’ Equity

Stock Repurchases

The Board has authorized three stock repurchase programs for the Company. The Company may purchase shares on the open market from time to time, up to a total of 5.7 million shares. The Board must authorize the timing and amount of these purchases and all repurchases are in accordance with the rules and regulations of the SEC allowing the Company to repurchase shares from the open market.

Our open market repurchase programs are as follows:

Agreement Execution DateAuthorized Repurchase $Expiration Date
May 16, 2018 1
$15 millionMarch 1, 2019
March 5, 2019 1
$20 millionMarch 4, 2020
March 13, 2020$20 million
** 2
1 The 2018 and 2019 purchase authorizations were executed under 10b5-1 programs.
2 Expiration Date is at Board's discretion. The Company is authorized to effectuate repurchases of the Company's common stock on terms and conditions approved in advance by the Board.

The Company also has a stock repurchase arrangement by which employee-participants in our 401(k) savings and investment plan are entitled to have shares in AAON, Inc. stock in their accounts sold to the Company. The maximum number of shares to be repurchased is contingent upon the number of shares sold by employee-participants.

Lastly, the Company repurchases shares of AAON, Inc. stock from certain of its directors and employees for payment of statutory tax withholdings on stock transactions. All other repurchases from directors or employees are contingent upon Board approval. All repurchases are done at current market prices.

Our repurchase activity is as follows:

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Nine Months Ended
September 30, 2020September 30, 2019
(in thousands, except share and per share data)
ProgramSharesTotal $$ per shareSharesTotal $$ per share
Open market103,689 $4,987 $48.10 5,799 $200 $34.46 
401(k)303,112 16,403 54.12 335,139 15,237 45.46 
Directors and employees22,655 1,130 49.88 24,948 1,023 41.00 
Total
429,456 $22,520 $52.44 365,886 $16,460 $44.99 

Our repurchase activity since Company inception, including our current authorized stock repurchase programs, are as follows:
Inception toSeptember 30, 2020
(in thousands, except share and per share data)
ProgramSharesTotal $$ per share
Open market4,205,255 $74,793 $17.79 
401(k)7,770,851 136,330 17.54 
Directors and employees2,004,584 20,712 10.33 
Total
13,980,690 $231,835 $16.58 

Subsequent to September 30, 2020 and through November 3, 2020, the Company repurchased 52,646 shares for $3.3 million from our 401(k) savings and investment plan.

Dividends

At the discretion of the Board, we pay semi-annual cash dividends. Board approval is required to determine the date of declaration and amount for each semi-annual dividend payment.

Our recent dividends are as follows:
Declaration DateRecord DatePayment DateDividend per Share
May 20, 2019June 3, 2019July 1, 2019$0.16
November 6, 2019November 27, 2019December 18, 2019$0.16
May 15, 2020June 3, 2020July 1, 2020$0.19


16. New Markets Tax Credit

On October 24, 2019, the Company entered into a transaction with a subsidiary of an unrelated third-party financial institution (the “Investor”) and a certified Community Development Entity under a qualified New Markets Tax Credit (“NMTC”) program pursuant to Section 45D of the Internal Revenue Code of 1986, as amended, related to an investment in plant and equipment to facilitate the expansion of our Longview, Texas manufacturing operations (the “Project”). In connection with the NMTC transaction, the Company received a $23.0 million NMTC allocation for the Project and secured low interest financing and the potential for future debt forgiveness related to the Project.

Upon closing of the NMTC transaction, the Company provided an aggregate of approximately $15.9 million to the Investor, in the form of a loan receivable, with a term of twenty-five years, bearing an interest rate of 1.0%. This $15.9 million in proceeds plus capital contributed from the Investor was used to make an aggregate $22.5 million loan to a subsidiary of the Company. This financing arrangement is secured by equipment at the Company's Longview, Texas facilities and a guarantee from the Company, including an unconditional guarantee of NMTCs.

This transaction also includes a put/call feature that either of which can be exercised at the end of the seven-year compliance period. The Investor may exercise its put option or the Company can exercise the call, both of which could serve to trigger forgiveness of a portion of the debt. The Investor's interest of $6.3 million is recorded in New market tax credit obligation on the consolidated balance sheet. The Company incurred approximately $0.3 million of debt issuance costs related to the above transactions, which are being amortized over the life of the transaction.


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The Investor is subject to 100 percent recapture of the NMTC it receives for a period of seven years, as provided in the Internal Revenue Code and applicable U.S. Treasury regulations in the event that the financing facility of the Borrower under the transaction (AAON Coil Products, Inc.) becomes ineligible for NMTC treatment per the Internal Revenue Code requirements. The Company is required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangement. Noncompliance with applicable requirements could result in the Investor’s projected tax benefits not being realized and, therefore, require the Company to indemnify the Investor for any loss or recapture of the NMTC related to the financing until such time as the recapture provisions have expired under the applicable statute of limitations. The Company does not anticipate any credit recapture will be required in connection with this financing arrangement.

The Investor and its majority owned community development entity are considered VIEs and the Company is the primary beneficiary of the VIEs. Because the Company is the primary beneficiary of the VIEs, they have been included in the consolidated financial statements. There are no other assets, liabilities or transaction in these VIEs outside of the financing transactions executed as part of the NMTC arrangement.


17. Commitments and Contingencies
 
We are subject to various claims and legal actions that arise in the ordinary course of business. We closely monitor these claims and legal actions and frequently consult with our legal counsel to determine whether they may, when resolved, have a material adverse effect on our financial position, results of operations or cash flows and we accrue and/or disclose loss contingencies as appropriate. We have concluded that the likelihood is remote that the ultimate resolution of any pending litigation or claims will be material or have a material adverse effect on the Company's business, financial position, results of operations and/or cash flows.

We are occasionally party to short-term, cancellable and occasionally non-cancellable, fixed price contracts with major suppliers for the purchase of raw material and component parts. We expect to receive delivery of raw materials for use in our manufacturing operations. These contracts are not accounted for as derivative instruments because they meet the normal purchase and normal sales exemption. We had no material contractual purchase obligations as of September 30, 2020.



18.  Related Parties

The Company purchases some supplies from an entity controlled by the Company’s Executive Chairman. The Company sometimes makes sales to the Executive Chairman for parts. Additionally, the Company sells units to an entity owned by a member of the CEO's immediate family. This entity is also one of the Company’s Representatives and as such, the Company makes payments to the entity for third party products.  All related party transactions are made on standard Company terms.

The following is a summary of transactions and balance with affiliates:

 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
(in thousands)
Sales to affiliates$662 $338 $2,550 $706 
Payments to affiliates110 32 207 225 
September 30,
2020
December 31,
2019
(in thousands)
Due from affiliates$425 $22 
Due to affiliates— 



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19. Segments

The following table summarizes certain financial data related to our segments. Transactions between segments are recorded based on prices negotiated between the segments. Sales of units represent the selling price of our units plus freight and other miscellaneous charges less any returns and allowances. Parts include sales of purchased and fabricated parts including our coils along with the related freight and less any returns and allowances. The “Other” category in the table below includes certain sales cost and expenses that are not allocated to the reportable segments.

Asset information by segment is not easily identifiable or reviewed by the chief operating decision maker. As such, this information is not included below.

 Three Months EndedNine Months Ended
 September 30,
2020
September 30,
2019
September 30,
2020
September 30,
2019
 (in thousands)
Sales   
     Units$123,827 $102,499 $372,267 $319,820 
     Parts - External11,222 11,028 26,162 27,287 
     Parts - Inter-segment5,659 6,448 18,074 21,665 
     Other(277)(27)(578)(348)
     Eliminations(5,659)(6,448)(18,074)(21,665)
             Net sales$134,772 $113,500 $397,851 $346,759 
  
Gross Profit
     Units$41,675 $27,729 $128,523 $84,888 
     Parts - External4,917 5,077 11,641 13,236 
     Parts - Inter-segment(758)44 (1,587)889 
     Other(5,744)(5,396)(18,238)(15,080)
     Eliminations758 (44)1,587 (889)
             Net gross profit$40,848 $27,410 $121,926 $83,044 


20.  Error Correction

We have corrected herein our consolidated financial statements as of September 30, 2019 and for the three and nine months ended September 30, 2019, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 250, Accounting Changes and Error Corrections.

Error Correction Background

During the preparation of the 2019 Annual Report on Form 10-K (filed on February 27, 2020) the Company noted errors in previously issued financial statements relating to share-based compensation expense for stock options and restricted stock awards held by retirement eligible employees and directors. As defined by our Long-Term Incentive Plans (Note 12), stock options and restricted stock awards are fully vested when an active employee or director meets certain retirement eligibility requirements. We have corrected the previously issued 2019 financial statements to recognize all share-based compensation, related to retirement eligible employees or directors, by the earlier of the grant date (if retirement eligible on grant date) or ratably from grant date to retirement eligible date. The corrected financial statements also include corrections for the tax effect of the share-based compensation corrections as well as the corrections' impact on our prior periods' employees profit sharing bonus plan (Note 13).


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Description of Tables

The following tables represent our corrected consolidated statements of income and statements of stockholders' equity for the three and nine months ended September 30, 2019 and statements of cash flows for the nine months ended September 30, 2019, as well as our corrected consolidated balance sheet data at September 30, 2019. The values as previously reported for September 30, 2019 were derived from our Quarterly Report on Form 10-Q for the three and nine month ended September 30, 2019 filed on October 31, 2019.

Consolidated Statements of Income
Three Months Ended September 30, 2019Nine Months Ended September 30, 2019
Previously ReportedCorrectionsAs CorrectedPreviously ReportedCorrectionsAs Corrected
(in thousands, except share and per share data)
Net sales$113,500 $— $113,500 $346,759 $— $346,759 
Cost of sales86,115 (25)(a)86,090 263,406 309 (a)263,715 
Gross profit27,385 25 27,410 83,353 (309)83,044 
Selling, general and administrative expenses12,994 (620)(b)12,374 37,476 1,487 (b)38,963 
Loss (gain) on disposal of assets— 296 — 296 
Income from operations14,385 645 15,030 45,581 (1,796)43,785 
Interest income, net— 49 — 49 
Other (expense) income, net(7)— (7)(16)— (16)
Income before taxes14,387 645 15,032 45,614 (1,796)43,818 
Income tax provision560 182 (c)742 7,924 (544)(c)7,380 
Net income$13,827 $463 $14,290 $37,690 $(1,252)$36,438 
Earnings per share:
Basic$0.27 $— $0.27 $0.72 $(0.02)$0.70 
Diluted$0.26 $— $0.26 $0.72 $(0.03)$0.69 
Cash dividends declared per common share:$— $— $— $0.16 $— $0.16 
Weighted average shares outstanding:
Basic52,111,444 — 52,111,444 52,086,209 — 52,086,209 
Diluted52,722,127 — 52,722,127 52,624,583 — 52,624,583 
Balance Sheet Data (at end of period):
Current assets$170,536 $(252)(c)$170,284 
Total assets352,152 (252)(c)351,900 
Current liabilities53,882 (779)(d)53,103 
Deferred income taxes15,034 (2,161)(c)12,873 
Total stockholders' equity$279,567 $2,688 (e)$282,255 

(a) The share-based compensation correction to cost of sales for the three and nine months ended September 30, 2019 was approximately $0.1 million and $0.3 million, respectively.

(b) The share-based compensation correction to selling, general and administrative expenses for the three and nine months ended September 30, 2019 was approximately $0.7 million and $1.7 million, respectively. Included in the correction to selling, general and administrative expenses is a correction to our employee profit sharing bonus plan (Note 13) of approximately $0.1 million and $0.2 million for the three and nine months ended September 30, 2019, respectively.

(c) The corrections to income tax receivable and deferred tax liability are the tax effect of the share-based compensation correction.

(d) This is the cumulative reduction of our employee profit sharing bonus plan (Note 13) liability as a result of the share-based compensation correction. The prior period costs were recovered through our estimated 2019 fourth quarter payment which was paid in early 2020.

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(e) This is the cumulative effect on stockholders' equity as a result of the share-based compensation correction. See table below for a description of the changes in stockholders' equity in the consolidated statements of stockholders' equity for the three and nine months ended September 30, 2019, respectively.
Consolidated Statements of Stockholders’ Equity
Nine Months Ended September 30, 2019
Common StockPaid-inRetained
SharesAmountCapitalEarningsTotal
As Previously Reported(in thousands)
Balances at December 31, 201851,991 $208 $— $247,291 $247,499 
Net income— — — 37,690 37,690 
Stock options exercised and restricted494 11,281 — 11,283 
stock awards granted
Share-based compensation— — 7,858 — 7,858 
Stock repurchased and retired(366)(1)(16,459)— (16,460)
Dividends— — — (8,303)(8,303)
Balances at September 30, 2019 52,119 209 2,680 276,678 279,567 
Correction Impacts
Balances at December 31, 2018— — — 1,944 1,944 
Net income— — — (1,252)(1,252)
Stock options exercised and restricted— — — — — 
stock awards granted
Share-based compensation— — 1,996 — 1,996 
Stock repurchased and retired— — — — — 
Dividends— — — — — 
Balances at September 30, 2019— — 1,996 692 2,688 
As Corrected
Balances at December 31, 201851,991 $208 $— $249,235 $249,443 
Net income— — — 36,438 36,438 
Stock options exercised and restricted494 11,281 — 11,283 
stock awards granted
Share-based compensation— — 9,854 — 9,854 
Stock repurchased and retired(366)(1)(16,459)— (16,460)
Dividends— — — (8,303)(8,303)
Balances at September 30, 201952,119 $209 $4,676 $277,370 $282,255 

See descriptions of changes to net income in the consolidated statement of income for the nine months ended September 30, 2019 in the table above.





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Consolidated Statements of Stockholders’ Equity
Three Months Ended September 30, 2019
Common StockPaid-inRetained
SharesAmountCapitalEarningsTotal
As Previously Reported(in thousands)
Balances at June 30, 201952,118 $209 $1,586 $262,774 $264,569 
Net income— — — 13,827 13,827 
Stock options exercised and restricted110 — 3,598 — 3,598 
stock awards granted
Share-based compensation— — 2,785 — 2,785 
Stock repurchased and retired(109)— (5,289)— (5,289)
Dividends— — — 77 77 
Balances at September 30, 201952,119 209 2,680 276,678 279,567 
Correction Impacts
Balances at June 30, 2019— — 2,713 229 2,942 
Net income— — — 463 463 
Stock options exercised and restricted— — — — — 
stock awards granted
Share-based compensation— — (717)— (717)
Stock repurchased and retired— — — — — 
Dividends— — — — — 
Balances at September 30, 2019— — 1,996 692 2,688 
As Corrected
Balances at June 30, 201952,118 $209 $4,299 $263,003 $267,511 
Net income— — — 14,290 14,290 
Stock options exercised and restricted110 — 3,598 — 3,598 
stock awards granted
Share-based compensation— — 2,068 — 2,068 
Stock repurchased and retired(109)— (5,289)— (5,289)
Dividends— — — 77 77 
Balances at September 30, 201952,119 $209 $4,676 $277,370 $282,255 

See descriptions of changes to net income in the consolidated statement of income for the three months ended September 30, 2019 in the table above.















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Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2019
Previously ReportedCorrectionsAs Corrected
Operating Activities(in thousands)
Net income$37,690 $(1,252)$36,438 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization17,627 — 17,627 
Provision for credit losses on accounts receivable, net of adjustments91 — 91 
Provision for excess and obsolete inventories1,003 — 1,003 
Share-based compensation7,858 1,996 9,854 
Loss (gain) on disposition of assets296 — 296 
Foreign currency transaction (gain) loss(17)— (17)
Interest income on note receivable(19)— (19)
Deferred income taxes4,208 (594)3,614 
Changes in assets and liabilities:
Accounts receivable(2,096)— (2,096)
Income taxes2,234 49 2,283 
Inventories(4,014)— (4,014)
Prepaid expenses and other(513)— (513)
Accounts payable782 — 782 
Deferred revenue263 — 263 
Accrued liabilities and donations5,190 (199)4,991 
Net cash provided by operating activities70,583 — 70,583 
Investing Activities
Capital expenditures(30,831)— (30,831)
Proceeds from sale of property, plant and equipment68 — 68 
Investment in certificates of deposits(6,000)— (6,000)
Maturities of certificates of deposits6,000 — 6,000 
Principal payments from note receivable39 — 39 
Net cash used in investing activities(30,724)— (30,724)
Financing Activities
Stock options exercised11,283 — 11,283 
Repurchase of stock(15,437)— (15,437)
Employee taxes paid by withholding shares(1,023)— (1,023)
Cash dividends paid to stockholders(8,303)— (8,303)
Net cash used in financing activities(13,480)— (13,480)
Net increase in cash and cash equivalents 26,379 — 26,379 
Cash and cash equivalents, beginning of year1,994 — 1,994 
Cash and cash equivalents, end of year$28,373 $— $28,373 

See descriptions of changes to net income and the balance sheet in the tables above.


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Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto, which are included in this report, and our audited consolidated financial statements and the notes thereto, which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

This discussion contains or incorporates by reference “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts, but rather are based on expectations, estimates, assumptions and projections about our industry, business and future financial results, based on information available at the time this report is filed with the SEC or, with respect to any document incorporated by reference, available at the time that such document was prepared. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those identified in the section entitled “Forward-Looking Statements” in this Item 2 of this Quarterly Report on Form 10-Q and in the section entitled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. We do not assume any obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or circumstances or otherwise, except as required by law.

Overview

We engineer, manufacture and market air conditioning and heating equipment consisting of standard, semi-custom and custom rooftop units, chillers, packaged outdoor mechanical rooms, air handling units, makeup air units, energy recovery units, condensing units, geothermal/water-source heat pumps, coils and controls. These products are marketed and sold to retail, manufacturing, educational, lodging, supermarket, medical and other commercial industries. We market our products to all 50 states in the United States and all provinces in Canada. Foreign sales were approximately $8.4 million of our total net sales for the nine months just ended and $11.5 million of our sales during the same period of 2019.

Our business can be affected by a number of economic factors, including the level of economic activity in the markets in which we operate. The uncertainty of the economy has negatively impacted the commercial and industrial new construction markets. A further decline in economic activity could result in a decrease in our sales volume and profitability. Sales in the commercial and industrial new construction markets correlate closely to the number of new homes and buildings that are built, which in turn is influenced by cyclical factors such as interest rates, inflation, consumer spending habits, employment rates and other macroeconomic factors over which we have no control.

We sell our products to property owners and contractors through a network of manufacturers’ representatives and our internal sales force. The demand for our products is influenced by national and regional economic and demographic factors. The commercial and industrial new construction market is subject to cyclical fluctuations in that it is generally tied to housing starts, but has a lag factor of six to 18 months. Housing starts, in turn, are affected by such factors as interest rates, the state of the economy, population growth and the relative age of the population. Our sales strategy is currently balanced between new construction and replacement applications. The new construction market through the third quarter of 2020 is showing signs of uncertainty. We continue to emphasize the benefits of AAON equipment to property owners in the replacement market.

Our manufacturing operations are considered a critical infrastructure industry, as defined by the U.S. Department of Homeland Security, as such, the decrees issued by national, state, and local governments in response to the COVID-19 pandemic have had minimal impact on our operations except for higher employee absenteeism in our manufacturing facilities. We maintained continuous operations during the nine months ended September 30, 2020. For the most part, our workers are able to socially distance themselves during the manufacturing process. Additional precautions have been taken to social distance workers that work in close environments. The Company utilizes sanitation stations, requires the use of a facial covering when unable to socially distance, performs daily temperature scanning, and performs additional cleaning and sanitation throughout the day and deep cleaning overnight. The Company did see significant employee absenteeism in the latter part of June 2020. These unexpected employee absences resulted in reduced shipments and longer lead times in the second quarter of 2020. During the third quarter 2020 employee attendance levels were stronger than previously anticipated. Additionally, our work force has adapted well to school and childcare related issues.


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While the Company's operations are primarily in Oklahoma and Texas, our domestic sales to customers cover almost all 50 states. Only the state of Texas has more than 10% of our revenues. For the nine months ended September 30, 2020, we've experienced record sales. We have not seen a significant slow down or disruption in our customer jobs and have benefited from some of the new construction for temporary hospitals due to COVID-19. The outlook for 2021 continues to present a lot of uncertainty. The Architecture Billings Index has been down for several months, indicating a decline in construction, which may start to impact the new nonresidential construction market in late 2020. Although construction may decline, our equipment is uniquely positioned to address COVID challenges by providing heightened filtration and sanitation through the use of MERV 13 filters, UV lights and bi-polar ionization installed in the factory. With approximately 50% of our total sales already represented by the replacement market, we are confident of our ability to grow our market share in the replacement market while we continue to pursue opportunities in the new construction market. With our improved lead times, we have been able to continue our planned reduction of our backlog to a more manageable level and we believe this will also allow our order intake to stay consistent but do not see significant growth opportunities in the near term

We had unrestricted cash and cash equivalents of $70.6 million as of September 30, 2020. Our capital expenditures during the nine months ended September 30, 2020 were $49.0 million, as compared to $30.8 million for the same period a year ago, and we anticipate our full-year 2020 capital expenditures will total approximately $73.2 million. Our expansion to our Longview, Texas facility is on schedule and expected to be operational by January 2021. The Company also has $28.3 million available under its line of credit. Should the Company experience an unexpected downturn due to COVID-19; spending on dividends and capital expenditures can be reduced and the line of credit can be utilized.

The principal components of cost of goods sold are labor, raw materials, component costs, factory overhead, freight and engineering expense. The principal high volume raw materials used in our manufacturing processes are steel, copper and aluminum, and are obtained from domestic suppliers. We also purchase from domestic manufacturers certain components, including compressors, motors and electrical controls. We have experienced minimal disruption to our supply chain due to COVID-19.

The price levels of most raw materials were stable in the past twelve months, but we are beginning to see increases in raw material costs. There is also a possibility prices could rise in the future depending on the impact COVID-19 has on our supply chain. At September 30, 2020, the price (twelve month trailing average) for copper, galvanized steel and aluminum decreased 4.1%, 2.0% and 2.2% (stainless steel increased 0.8%), respectively, as compared to the price (twelve month trailing average) at September 30, 2019.

We attempt to limit the impact of price fluctuations on these materials by entering into cancellable and non-cancellable fixed price contracts with our major suppliers for periods of six to 18 months. We expect to receive delivery of raw materials from our fixed price contracts for use in our manufacturing operations.

The following are recent highlights and items that impacted our results of operations, cash flows and financial condition:

We experienced significant employee absenteeism, mostly in June, related to COVID-19 during the nine months ended that impacted our production.
We continue to become more efficient. Our gross profit percentage improved from 23.9% during the nine months ended in 2019 to 30.6% in 2020.
We invested $49.0 million in capital expenditures, continuing our work on projects such as our Longview, TX expansion and the purchase of additional Salvagnini machines that will increase our sheet metal capacity.
Total cash, cash equivalents and restricted cash was $78.6 million at September 30, 2020.


Backlog

The following table shows our historical backlog levels:

September 30,
2020
December 31,
2019
September 30,
2019
(in thousands)
$84,885 $142,747 $165,325 

During 2018 and most of 2019, the Company struggled to maintain adequate sheet-metal production capacity that resulted in long lead times and a high backlog. The Company started to increase its sheet-metal production at the end of 2019 with the

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addition of new Salvagnini machines. This led in part to a record fourth quarter of 2019 that helped reduce our backlog. Since then, the Company has continued to increase its sheet-metal capacity, increase sales, improve lead times and reduce our backlog to a more manageable level.

Results of Operations

Three months ended September 30, 2020 vs. Three months ended September 30, 2019

Units Sold
Three Months Ended
September 30,
2020
September 30,
2019
Rooftop units4,372 3,520 
Condensing units593 418 
Air handlers534 552 
Outdoor mechanical rooms
Water source heat pumps1,847 1,311 
Total Units
7,352 5,808 

Net Sales
 Three Months Ended
 September 30,
2020
September 30,
2019
Change% Change
(in thousands, except unit data)
Net sales$134,772 $113,500 $21,272 18.7 %
Total units7,352 5,808 1,544 26.6 %

Our net sales increased by 18.7% due in part to our price increases in the past year and more so from increases in sheet metal production.

Cost of Sales
 Three Months EndedPercent of Sales
September 30,
2020
September 30,
2019
 20202019
(in thousands)
Cost of sales$93,924 $86,090 69.7 %75.9 %
Gross profit40,848 27,410 30.3 %24.1 %

We continue to see overall raw material costs decrease. The Company has improved its labor and overhead efficiencies through increased production and absorption of fixed costs.

Twelve-month average raw material cost per pound as of September 30:

20202019% Change
Copper$3.52 $3.67 (4.1)%
Galvanized Steel$0.50 $0.51 (2.0)%
Stainless Steel$1.32 $1.31 0.8 %
Aluminum$1.76 $1.80 (2.2)%



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Selling, General and Administrative Expenses
Three Months EndedPercent of Sales
September 30,
2020
September 30,
2019
20202019
(in thousands)
Warranty$2,054 $2,707 1.5 %2.4 %
Profit sharing3,000 1,684 2.2 %1.5 %
Salaries & benefits4,725 3,437 3.5 %3.0 %
Stock compensation1,330 767 1.0 %0.7 %
Advertising229 146 0.2 %0.1 %
Depreciation515 400 0.4 %0.4 %
Insurance254 218 0.2 %0.2 %
Professional fees542 693 0.4 %0.6 %
Donations106 155 0.1 %0.1 %
Bad debt expense117 (37)0.1 %— %
Other1,844 2,204 1.4 %1.9 %
Total SG&A$14,716 $12,374 10.9 %10.9 %

Profit sharing expenses increased due to our increased earnings for the three months ended 2020 as compared to 2019. Salaries & benefits is up as well due in part to additional incentives for our employees as a result of the Company's strong performance.

Income Taxes
 Three Months EndedEffective Tax Rate
September 30,
2020
September 30,
2019
 20202019
(in thousands)
Income tax provision$5,696 $742 21.8 %4.9 %

The Company’s estimated annual 2020 effective tax rate, excluding discrete events, is expected to be approximately 24%.

During the three months ended September 2019, upon completion of the Company's 2018 tax return, the Company recorded additional benefit due to higher than expected research and development credit of $0.6 million. Historically, the Company has taken advantage of the Oklahoma Investment New Jobs Credit ("OK Credit"). This OK Credit allows the Company to take a credit equal to 1% of eligible investments each year for five years, beginning with the year of investment. The Company determined it could take advantage of an additional 1% tax credit for years in which the Company's location was deemed to be within an enterprise zone. The additional OK Credit for being in an enterprise zone, or otherwise allowable under Oklahoma law, resulted in a benefit of $0.3 million for 2018 and $0.9 million for our 2015, 2016 and 2017 amended returns, combined.

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Results of Operations

Nine Months Ended September 30, 2020 vs. Nine Months Ended September 30, 2019

Units Sold
Nine Months Ended
September 30,
2020
September 30,
2019
Rooftop units12,179 11,079 
Condensing units1,447 1,291 
Air handlers1,545 1,669 
Outdoor mechanical rooms22 28 
Water source heat pumps5,109 5,977 
Total Units
20,302 20,044 

Net Sales
 Nine Months Ended
September 30,
2020
September 30,
2019
 Change% Change
(in thousands, except unit data)
Net sales$397,851 $346,759 $51,092 14.7 %
Total units20,302 20,044 258 1.3 %

Our net sales increased by 14.7% due in part to our increased sheet metal production from the additional Salvagnini machines that were placed into operation allowing increased production in our rooftop units and in part from price increases put in place over the last year and a half.

Cost of Sales
 Nine Months EndedPercent of Sales
September 30,
2020
September 30,
2019
 20202019
(in thousands)
Cost of sales$275,925 $263,715 69.4 %76.1 %
Gross profit121,926 83,044 30.6 %23.9 %

We continue to see overall raw material costs decrease. The Company has improved its labor and overhead efficiencies through increased production and absorption of fixed costs.

Twelve-month average raw material cost per pound as of September 30:

20202019% Change
Copper$3.52 $3.67 (4.1)%
Galvanized steel$0.50 $0.51 (2.0)%
Stainless steel$1.32 $1.31 0.8 %
Aluminum$1.76 $1.80 (2.2)%



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Selling, General and Administrative Expenses
Nine Months EndedPercent of Sales
September 30,
2020
September 30,
2019
20202019
(in thousands)
Warranty$5,356 $6,129 1.3 %1.8 %
Profit sharing8,691 4,948 2.2 %1.4 %
Salaries & benefits14,921 10,602 3.8 %3.1 %
Stock compensation4,020 5,989 1.0 %1.7 %
Advertising446 496 0.1 %0.1 %
Depreciation1,470 1,092 0.4 %0.3 %
Insurance733 594 0.2 %0.2 %
Professional fees1,796 1,723 0.5 %0.5 %
Donations1,892 1,019 0.5 %0.3 %
Bad debt expense193 91 — %— %
Other6,351 6,280 1.6 %1.8 %
Total SG&A$45,869 $38,963 11.5 %11.2 %

Profit sharing expenses increased due to our increased earnings for the period. Salaries & benefits is up as well due in part to additional incentives for our employees as a result of the Company's strong performance. Stock compensation is lower because the valuation of the Company-wide equity grant awarded in March 2020 was less than the grant awarded in March 2019. Donations increased due to the contribution of approximately $1.3 million to Winifred, Montana Public Schools in recognition of Norman H. Asbjornson's transition from CEO to Executive Chairman.

Income Taxes
 Nine Months EndedEffective Tax Rate
September 30,
2020
September 30,
2019
 20202019
(in thousands)
Income tax provision$16,111 $7,380 21.1 %16.8 %

The Company’s estimated annual 2020 effective tax rate, excluding discrete events, is expected to be approximately 24%. During the three months ended September 2019, upon completion of the Company's 2018 tax return, the Company recorded additional benefit due to higher than expected research and development credit of $0.6 million. Historically, the Company has taken advantage of the Oklahoma Investment New Jobs Credit ("OK Credit"). This OK Credit allows the Company to take a credit equal to 1% of eligible investments each year for five years, beginning with the year of investment. The Company determined it could take advantage of an additional 1% tax credit for years in which the Company's location was deemed to be within an enterprise zone. The additional OK Credit for being in an enterprise zone, or otherwise allowable under Oklahoma law, resulted in a benefit of $0.3 million for 2018 and $0.9 million for our 2015, 2016 and 2017 amended returns, combined.

Liquidity and Capital Resources

Our working capital and capital expenditure requirements are generally met through net cash provided by operations and the occasional use of the revolving bank line of credit based on our current liquidity at the time.

Working Capital - Our unrestricted cash increased $43.8 million from December 31, 2019 to September 30, 2020 and totaled $70.6 million at September 30, 2020.

Revolving Line of Credit - Under the line of credit with Bank of Oklahoma, there was one standby letter of credit of $1.7 million as of September 30, 2020. At September 30, 2020, we have $28.3 million of borrowings available under the revolving credit facility. No fees are associated with the unused portion of the committed amount.

We had no outstanding balance under the revolving credit facility at September 30, 2020 and December 31, 2019. Interest on borrowings is payable monthly at LIBOR plus 2.0%. The termination date of the revolving credit facility is July 26, 2021.

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At September 30, 2020, we were in compliance with all of the covenants under the revolving credit facility. We are obligated to comply with certain financial covenants under the revolving credit facility. These covenants require that we meet certain parameters related to our tangible net worth and total liabilities to tangible net worth ratio. At September 30, 2020, our tangible net worth was $344.9 million, which meets the requirement of being at or above $175.0 million. Our total liabilities to tangible net worth ratio was 0.3 to 1.0 which meets the requirement of not being above 2 to 1.

New Market Tax Credit Obligation - On October 24, 2019, the Company entered into a transaction with a subsidiary of an unrelated third-party financial institution (the “Investor”) and a certified Community Development Entity under a qualified New Markets Tax Credit (“NMTC”) program pursuant to Section 45D of the Internal Revenue Code of 1986, as amended, related to an investment in plant and equipment to facilitate the expansion of our Longview, Texas manufacturing operations (the “Project”). In connection with the NMTC transaction, the Company received a $23.0 million NMTC allocation for the Project and secured low interest financing and the potential for future debt forgiveness related to the expansion of its Longview, Texas facilities.

Upon closing of the NMTC transaction, the Company provided an aggregate of approximately $15.9 million to the Investor, in the form of a loan receivable, with a term of twenty-five years, bearing an interest rate of 1.0%. This $15.9 million in proceeds plus capital contributed from the Investor was used to make an aggregate $22.5 million loan to a subsidiary of the Company. This financing arrangement is secured by equipment at the Company's Longview, Texas facilities, and a guarantee from the Company, including an unconditional guarantee of NMTCs.

Stock Repurchases - The Board has authorized three stock repurchase programs for the Company. The Company may purchase shares on the open market from time to time, up to a total of 5.7 million shares. The Board must authorize the timing and amount of these purchases and all repurchases are in accordance with the rules and regulations of the SEC allowing the Company to repurchase shares from the open market.

Our open market repurchase programs are as follows:

Agreement Execution DateAuthorized Repurchase $Expiration Date
May 16, 2018 1
$15 millionMarch 1, 2019
March 5, 2019 1
$20 millionMarch 4, 2020
March 13, 2020$20 million
** 2
1 The 2018 and 2019 purchase authorizations were executed under 10b5-1 programs.
2 Expiration Date is at Board's discretion. The Company is authorized to effectuate repurchases of the Company's common stock on terms and conditions approved in advance by the Board.

The Company also has a stock repurchase arrangement by which employee-participants in our 401(k) savings and investment plan are entitled to have shares in AAON, Inc. stock in their accounts sold to the Company. The maximum number of shares to be repurchased is contingent upon the number of shares sold by employee-participants.

Lastly, the Company repurchases shares of AAON, Inc. stock from certain of its directors and employees for payment of statutory tax withholdings on stock transactions. All other repurchases from directors or employees are contingent upon Board approval. All repurchases are done at current market prices.


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Our repurchase activity is as follows:
Nine Months Ended
September 30, 2020September 30, 2019
(in thousands, except share and per share data)
ProgramSharesTotal $$ per shareSharesTotal $$ per share
Open market103,689 $4,987 $48.10 5,799 $200 $34.46 
401(k)303,112 16,403 54.12 335,139 15,237 45.46 
Directors and employees22,655 1,130 49.88 24,948 1,023 41.00 
Total
429,456 $22,520 $52.44 365,886 $16,460 $44.99 

Our repurchase activity since Company inception, including our current authorized stock repurchase programs, are as follows:
Inception toSeptember 30, 2020
(in thousands, except share and per share data)
ProgramSharesTotal $$ per share
Open market4,205,255 $74,793 $17.79 
401(k)7,770,851 136,330 17.54 
Directors and employees2,004,584 20,712 10.33 
Total
13,980,690 $231,835 $16.58 

Dividends - At the discretion of the Board, we pay semi-annual cash dividends. Board approval is required to determine the date of declaration and amount for each semi-annual dividend payment.

Our recent dividends are as follows:
Declaration DateRecord DatePayment DateDividend per Share
May 20, 2019June 3, 2019July 1, 2019$0.16
November 6, 2019November 27, 2019December 18, 2019$0.16
May 15, 2020June 3, 2020July 1, 2020$0.19

Based on historical performance and current expectations, we believe our cash and cash equivalents balance, the projected cash flows generated from our operations, our existing committed revolving credit facility (or comparable financing) and our expected ability to access capital markets will satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our operations in 2020 and the foreseeable future.


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Statement of Cash Flows

The following table reflects the major categories of cash flows for the nine months ended September 30, 2020 and 2019. For additional details, see the consolidated financial statements.

Nine Months Ended
 September 30,
2020
September 30,
2019
 (in thousands)
Operating Activities
  Net Income$60,117 $36,438 
  Income statement adjustments, net37,131 32,449 
  Changes in assets and liabilities:
 Accounts receivable5,011 (2,096)
 Income taxes(3,142)2,283 
 Inventories(6,994)(4,014)
 Prepaid expenses and other(598)(513)
 Accounts payable3,654 782 
 Deferred revenue1,128 263 
 Accrued liabilities & donations688 4,991 
  Net cash provided by operating activities96,995 70,583 
Investing Activities
  Capital expenditures(48,955)(30,831)
Purchases of investments— (6,000)
Maturities of investments and proceeds from called investments— 6,000 
  Other99 107 
  Net cash used in investing activities(48,856)(30,724)
Financing Activities
  Stock options exercised 18,519 11,283 
  Repurchase of stock(21,390)(15,437)
  Employee taxes paid by withholding shares(1,130)(1,023)
  Cash dividends paid to stockholders(9,910)(8,303)
  Net cash used in financing activities$(13,911)$(13,480)

Cash Flows Provided by Operating Activities

The Company manages cash needs through working capital rather than drawing on its line of credit. Collections and payments cycles are on a normal pattern and fluctuate due to timing of receipts and payments. The Company has been able to improve its collections of outstanding receivables due in part through prepayment of orders. The Company also has also increased the purchase of inventory to take advantage of current favorable pricing and also to prevent future supply chain disruptions.

Cash Flows Used in Investing Activities

The capital expenditure program for 2020 is estimated to be approximately $73.2 million. The capital expenditures for 2020 relate to the expansion of our Longview, Texas facility, purchase of additional Salvagnini sheet metal fabrication machines, completion of our R&D lab and other operational improvements. Many of these projects are subject to review and cancellation at the discretion of our CEO and Board of Directors without incurring substantial charges.

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Cash Flows Used in Financing Activities

Stock options exercised increased due to the increase in the number of employee options exercised and increases in our stock price. The Company also purchased approximately $5.0 million of our outstanding stock through the open market buyback program (Note 15) during the nine months ended September 30, 2020.

Off-Balance Sheet Arrangements

We are not party to any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

Contractual Obligations

We had no material contractual purchase obligations as of September 30, 2020.

Critical Accounting Policies

There have been no material changes in the Company’s critical accounting policies during the nine months ended September 30, 2020.

Recent Accounting Pronouncements

See Note 1 of the Notes to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, “will”, “should”, and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Important factors that could cause results to differ materially from those in the forward-looking statements include (1) the timing and extent of changes in raw material and component prices, (2) the effects of fluctuations in the commercial/industrial new construction market, (3) the timing and extent of changes in interest rates, as well as other competitive factors during the year, (4) general economic, market or business conditions, and (5) the impact of COVID-19 on the economy, demand for our products and our operations, including the measures taken by governmental authorities to address it, which may precipitate or exacerbate other risks and/or uncertainties.


Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

Commodity Price Risk

We are exposed to volatility in the prices of commodities used in some of our products and we may use fixed price cancellable and non-cancellable contracts with our major suppliers for periods of six to 18 months to manage this exposure.
 

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Item 4.  Controls and Procedures.
 
(a) Evaluation of Disclosure Controls and Procedures
 
As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer with the oversight of the Audit Committee, regarding the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded, as of the end of the period covered by this Quarterly Report, that our disclosure controls and procedures were effective.

(c) Changes in Internal Control over Financial Reporting

There have been no changes in internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.




PART II – OTHER INFORMATION
Item 1. Legal Proceedings.

We are subject to various claims and legal actions that arise in the ordinary course of business. We closely monitor these claims and legal actions and frequently consult with our legal counsel to determine whether they may, when resolved, have a material adverse effect on our financial position, results of operations, or cash flows and we accrue and/or disclose loss contingencies as appropriate. We have concluded that the likelihood is remote that the ultimate resolution of any pending litigation or claims will be material or have a material adverse effect on the Company's business, financial position, results of operations or cash flows.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019. The risk factors described in our Annual Report could materially adversely affect our business, financial condition or future results. There have been no material changes to the risk factors included in our 2019 Annual Report, except as follows:

Our business, results of operations, financial condition, cash flows and stock price can be adversely affected by pandemics, epidemics or other public health emergencies, such as the recent outbreak of COVID-19.

Our business, results of operations, financial condition, cash flows and stock price can be adversely affected by pandemics, epidemics or other public health emergencies, such as the recent outbreak of COVID-19 which has spread from China to many other countries including the United States. In March 2020, the World Health Organization characterized COVID-19 as a pandemic, and the President of the United States declared the COVID-19 outbreak a national emergency. The outbreak has resulted in governments around the world implementing increasingly stringent measures to help control the spread of the virus, including quarantines, “shelter in place” and “stay at home” orders, travel restrictions, business curtailments, school closures, and other measures. In addition, governments and central banks in several parts of the world have enacted fiscal and monetary stimulus measures to counteract the impacts of COVID-19.

We are considered a critical infrastructure industry, as defined by the U.S. Department of Homeland Security. Although we have continued to operate our facilities to date consistent with federal guidelines and state and local orders, the outbreak of COVID-19 and any preventive or protective actions taken by governmental authorities may have a material adverse effect on our operations, supply chain, customers and transportation networks, including business shutdowns or disruptions. The extent to which COVID-19 may adversely impact our business depends on future developments, which are highly uncertain and unpredictable, depending upon the severity and duration of the outbreak and the effectiveness of actions taken globally to contain or mitigate its effects. Any resulting financial impact cannot be estimated reasonably at this time, but may materially adversely affect our business, results of operations, financial condition and cash flows. Even after the COVID-19 pandemic has subsided, we may experience materially adverse impacts to our business due to any resulting economic recession or depression. Additionally, concerns over the economic impact of COVID-19 have caused extreme volatility in financial and other capital markets which has and may continue to adversely impact our stock price and our ability to access capital markets. To the extent

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the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in our 2019 Annual Report, such as those relating to our products and financial performance.

Operations may be affected by natural disasters, especially since most of our operations are performed at a single location.

Natural disasters such as tornadoes and ice storms, as well as accidents, acts of terror, infection and other factors beyond our control could adversely affect our operations. Especially, as our facilities are in areas where tornadoes are likely to occur, and the majority of our operations are at our Tulsa facilities, the effects of natural disasters and other events could damage our facilities and equipment and force a temporary halt to manufacturing and other operations, and such events could consequently cause severe damage to our business. We maintain insurance against these sorts of events; however, this is not guaranteed to cover all the losses and damages incurred. Furthermore, we may experience increases in our insurance premium costs in relation to these matters that may have a material adverse effect upon our business, liquidity, financial condition or results of operations.

We may not be able to successfully develop and market new products.

Our future success will depend upon our continued investment in research and new product development and our ability to continue to achieve new technological advances in the HVAC industry. Our inability to continue to successfully develop and market new products or our inability to implement technological advances on a pace consistent with that of our competitors could lead to a material adverse effect on our business and results of operations. Furthermore, our continued investment in new product development may render certain legacy products and components obsolete resulting in increased inventory obsolescence expense that may have a material adverse effect upon our financial condition or results of operations.

Item 2.  Unregistered Sales of Equity and Securities and Use of Proceeds.

The Company may repurchase AAON, Inc. stock on the open market from time to time, up to a total of 5.7 million shares. We have repurchased a total of approximately 4.2 million shares (at current market prices) under the various open market stock buyback programs for an aggregate price of $74.8 million, or an average price of $17.79 per share. The Board must authorize the timing and amount of these purchases and all repurchases are in accordance with the rules and regulations of the SEC allowing the Company to repurchase shares from the open market.

On July 1, 2005, we entered into a stock repurchase arrangement by which employee-participants in our 401(k) savings and investment plan are entitled to have shares of AAON, Inc. stock in their accounts sold to the Company. The maximum number of shares to be repurchased is contingent upon the number of shares sold by employees. From inception through September 30, 2020, we repurchased approximately 7.8 million shares (at current market prices) for an aggregate price of $136.3 million, or an average price of $17.54 per share.

Lastly, the Company repurchases shares of AAON, Inc. stock from certain of its directors and employees. The number of shares to be repurchased is contingent upon Board approval. From inception through September 30, 2020, we repurchased approximately 2.0 million shares (at current market prices) for an aggregate price of $20.7 million, or an average price of $10.33 per share.

Repurchases during the third quarter of 2020 were as follows:
 
 ISSUER PURCHASES OF EQUITY SECURITIES
Period(a)
Total
Number
of Shares
(or Units)
Purchased
(b)
Average
Price
Paid
Per Share
(or Unit)
(c)
Total Number
of Shares (or
Units) Purchased
as part of
Publicly Announced
Plans or Programs
(d)
Maximum Number (or
Approximate Dollar
Value) of Shares (or
Units) that may yet be
Purchased under the
Plans or Programs
July 202043,971 $56.92 43,971 — 
August 202021,585 59.06 21,585 — 
September 202029,460 57.64 29,460 — 
Total     95,016 $57.62 95,016 — 
 


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Item 3. Defaults Upon Senior Securities.

None.

Item 4.  Mine Safety Disclosures.

Not applicable.

Item 4A.  Submission of Matters to a Vote of Security Holders.

None.

Item 5.  Other Information.

None.

Item 6.  Exhibits.
 
Exhibit #Description
Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification by Chief Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Certification by Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
Interactive data files pursuant to Rule 405 of Regulation S-T formatted in iXBRL (Inline Extensible Business Reporting Language): (i) our Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019; (ii) our Consolidated Statements of Income for the three and nine months ended September 30, 2020 and 2019; (iii) our Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2020 and 2019; (iv) our Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019; and (vi) the notes to our Consolidated Financial Statements.
104Cover Page Interactive Data File pursuant to Rule 406 of Regulation S-T formatted in iXBRL (Inline Extensible Business Reporting Language) and contained in Exhibit 101.
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 AAON, INC.
   
   
Dated: November 5, 2020By:
/s/ Gary D. Fields
  
Gary D. Fields
 Chief Executive Officer
   
   
Dated: November 5, 2020By:/s/ Scott M. Asbjornson
  Scott M. Asbjornson
Chief Financial Officer


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