AAON, INC. 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 endedDecember 31, 2020 . 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 theSEC 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 endedDecember 31, 2020 . 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 inthe United States and all provinces inCanada . Foreign sales were approximately$11.0 million of our total net sales for the nine months just ended and$8.4 million of our sales during the same period of 2020. 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 2021 has improved compared to 2020. 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 theU.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 isolated higher employee absenteeism, especially inJune 2020 , in our manufacturing facilities. OurLongview, TX facility suffered from COVID-19 related absenteeism in the quarter endingSeptember 30, 2021 , which reduced the production of coils that were needed to complete units at ourTulsa, OK facility. We maintained continuous operations during the nine months endedSeptember 30, 2021 except for the shutdown for planned maintenance inJanuary 2021 and theFebruary 2021 weather related event described in Note 1. 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 and we have facilitated voluntary on-site COVID-19 vaccine clinics. The Company utilizes sanitation stations and performs additional cleaning and sanitation throughout the day. While the Company's operations are primarily inOklahoma andTexas , our domestic sales to customers cover almost all 50 states. Only the state ofTexas is responsible for more than 10% of our revenues. Because we have managed to maintain almost continuous operations with reasonable lead times through 2020 and 2021, our order intake is strong and has increased throughout 2021 as the economy has opened back up and COVID-19 restrictions have lessened. We expect to increase our production for the remainder of 2021 and into 2022. - 22 - -------------------------------------------------------------------------------- The Architecture Billings Index ("ABI") was down for most of 2020, indicating a decline in construction, which started to impact the new nonresidential construction market in late 2020. This slightly impacted the Company with a slower order intake level and caused us to slow down some of our production in the beginning of the first quarter 2021. Beginning inFebruary 2021 , the ABI index began a historic rebound with the May andJune 2021 ABI Index being two of the highest scores in the index's 25-year history. While the ABI did start to decline in June and July, August and September were two straight months of increases. Even if new construction declines, our equipment is uniquely positioned to address COVID-19 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. We had unrestricted cash and cash equivalents of$101.8 million as ofSeptember 30, 2021 . Our capital expenditures during the nine months endedSeptember 30, 2021 were$42.6 million , as compared to$49.0 million for the same period a year ago, and we anticipate our full-year 2021 capital expenditures will total approximately$60.0 million . The expansion of ourLongview, Texas facility was completed and operational during the first quarter 2021. The Company also has$28.2 million available under its line of credit. Additionally, we continue to experience challenges in a tight labor market, especially the hiring of both skilled and unskilled production labor. InJuly 2021 , we increased starting wages for our production workforce by 7.0%. We also have put a cost of living increase of 3.5% in place in October for all employees below the Director level. We will continue to implement human resource initiatives to retain and attract labor to further improve productivity and production efficiencies. 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. Although, we have experienced some supply chain challenges, due to our strong vendor relationships as well as our favorable liquidity position, we have experienced minimal disruption to our supply chain due to COVID-19. While our supply chain disruptions to date have been minimal and intermittent, they have impacted the production process which creates inefficiencies and can deteriorate our profit margins. The price levels of most raw materials were stable prior to 2020, but we continue to see increases in raw material costs which we are managing through price increases to counteract their impact. There is also a possibility prices could rise in the future depending on the impact COVID-19 and subsequent inflation has on our supply chain. AtSeptember 30, 2021 , the price (twelve month trailing average) for copper, galvanized steel, stainless steel and aluminum increased 38.3%, 79.5%, 39.8%, and 56.7%, respectively, as compared to the price (twelve month trailing average) atSeptember 30, 2020 . We anticipate that the average cost of raw materials and certain components purchased, including the impact of rising inflation and tariffs, for the remainder of 2021 will be higher than the costs experienced during the year endedDecember 31, 2020 . 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:
•Our backlog is at a record level, 144% higher than it was at
•Our third quarter 2021 results demonstrated a positive performance, despite the external challenges, with sales increasing approximately 2.8% for the three months ended as compared to the same period last year.
•Bookings increased approximately 60% in the third quarter of 2021 compared to
2020 indicating an improved demand for our products as well as increase in
orders in advance of our announced
•Our warranty expense decreased 38% in the third quarter of 2021 compared to
2020 as a result of the quality control efforts the Company has put in place in
the past few years.
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Backlog
The following table shows our historical backlog levels:
September 30, December 31, September 30,
2021 2020 2020
(in thousands)
$ 181,813 $ 74,417 $ 84,885
The Company started 2020 with a high backlog due to challenges maintaining
adequate sheet-metal production capacity in 2019. The Company started to
increase its sheet-metal production capacity at the end of 2019 and into 2020
with the addition of new Salvagnini machines. This led in part to all time
record sales and earnings for the year-ended December 31, 2020 that helped
reduce our backlog at the end of 2020. In 2021, as a result of our decreased
lead time, increase in demand, and increase in orders in advance of our
announced June 1, 2021 and September 1, 2021 price increase, bookings increased
approximately 60% in the third quarter of 2021 compared to 2020.
Results of Operations
Three months endedSeptember 30, 2021 vs. Three months endedSeptember 30, 2020 Units Sold Three Months Ended September 30, September 30, 2021 2020 Rooftop units 3,746 4,372 Condensing units 560 593 Air handlers 646 534 Outdoor mechanical rooms 2 6 Water source heat pumps 1,576 1,847 Total Units 6,530 7,352 Net Sales Three Months Ended September 30, September 30, 2021 2020 Change % Change (in thousands, except unit data) Net sales$ 138,571 $ 134,772 $ 3,799 2.8 % Total units 6,530 7,352 (822) (11.2) % While the third quarter of 2021 benefited from an increased demand, challenges hiring additional production labor hindered our ability to produce at the same capacity during the three months endedSeptember 30, 2021 as compared toSeptember 30, 2020 . This resulted in an 11.2% decrease in total units sold, mostly related to our rooftop units. The quarter benefited from our January andJune 2021 price increases, which realized approximately a 5.0% increase in sales in the period. Our parts sales were also up 15% for the quarter that helped increase our net sales for the period. - 24 - --------------------------------------------------------------------------------
Cost of Sales
Three Months Ended
September 30, September 30, Percent of Sales
2021 2020 2021 2020
(in thousands)
Cost of sales $ 102,552 $ 93,924 74.0 % 69.7 %
Gross profit 36,019 40,848 26.0 % 30.3 %
The principal components of cost of sales are labor, raw materials, component
costs, factory overhead, freight out and engineering expense. The principal high
volume raw materials used in our manufacturing processes are steel, copper and
aluminum, which are obtained from domestic suppliers. The increase in raw
material costs were approximately 6.9% of sales for the quarter which were not
completely offset by the realization of price increases we put in place during
the year. The tightening labor market has caused us to also implement raises in
entry level wages ahead of realizing our price increases. The reduction in
overall unit production, due to challenges hiring additional production labor,
resulted in unfavorable labor and overhead inefficiencies, including the
Company's ability to absorb certain fixed costs. Lastly, the small disruptions
to our production schedule from supply chain delays negatively impacted our
production efficiency. All of these factors resulted in a decrease in gross
profit during the three months ended September 30, 2021 as compared to 2020.
Twelve-month average raw material cost per pound as of
2021 2020 % Change
Copper $ 4.95 $ 3.58 38.3 %
Galvanized steel $ 0.79 $ 0.44 79.5 %
Stainless steel $ 1.79 $ 1.28 39.8 %
Aluminum $ 1.88 $ 1.20 56.7 %
Selling, General and Administrative Expenses
Three Months Ended
September 30, September 30, Percent of Sales
2021 2020 2021 2020
(in thousands)
Warranty $ 1,272 $ 2,054 0.9 % 1.5 %
Profit sharing 2,358 3,000 1.7 % 2.2 %
Salaries & benefits 6,029 4,725 4.4 % 3.5 %
Stock compensation 1,418 1,330 1.0 % 1.0 %
Advertising 225 229 0.2 % 0.2 %
Depreciation 645 515 0.5 % 0.4 %
Insurance 733 254 0.5 % 0.2 %
Professional fees 851 542 0.6 % 0.4 %
Donations 97 106 0.1 % 0.1 %
Bad debt expense (12) 117 - % 0.1 %
Other 2,281 1,844 1.6 % 1.4 %
Total SG&A $ 15,897 $ 14,716 11.5 % 10.9 %
The Company's warranty expense continues to improve after making significant
quality control improvements in the past two years. Profit sharing expenses
decreased due to our decreased earnings for the period. Salaries and benefits
are up due to increases in bonuses and employee incentives.
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Income Taxes
Three Months Ended
September 30, September 30, Effective Tax Rate
2021 2020 2021 2020
(in thousands)
Income tax provision $ 4,527 $ 5,696 22.5 % 21.8 %
The Company's estimated annual 2021 effective tax rate, excluding discrete events, is expected to be approximately 25%. The effective rate is lower than our estimated rate due to the impact related to excess tax benefits.
Nine Months EndedSeptember 30, 2021 vs. Nine Months EndedSeptember 30, 2020 Units Sold Nine Months Ended September 30, September 30, 2021 2020 Rooftop units 11,362 12,179 Condensing units 1,696 1,447 Air handlers 1,846 1,545 Outdoor mechanical rooms 22 22 Water source heat pumps 5,108 5,109 Total Units 20,034 20,302 Net Sales Nine Months Ended September 30, September 30, 2021 2020 Change % Change (in thousands, except unit data) Net sales$ 398,235 $ 397,851 $ 384 0.1 % Total units 20,034 20,302 (268) (1.3) % In 2021, the Company lost production days in January for planned maintenance and in February due to impacts of bad weather. While the second and third quarter of 2021 benefited from an increasing demand, challenges hiring additional production labor hindered our ability to produce units at the same capacity in 2020. Although overall units sold decreased approximately 1.3% for the nine months ended September 30 2021 vs 2020, sales increased 0.1% due primarily to ourJanuary 2021 price increase. The Company's June price increase has been slower to realize given our large backlog and slightly longer lead times. Cost of Sales Nine Months Ended September 30, September 30, Percent of Sales 2021 2020 2021 2020 (in thousands) Cost of sales$ 286,952 $ 275,925 72.1 % 69.4 % Gross profit 111,283 121,926 27.9 % 30.6 % The principal components of cost of sales are labor, raw materials, component costs, factory overhead, freight out and engineering expense. The principal high volume raw materials used in our manufacturing processes are steel, copper and aluminum, which are obtained from domestic suppliers. We continue to see overall raw material costs increase. In addition, - 26 - -------------------------------------------------------------------------------- reduction in overall unit production due to challenges hiring additional production labor, resulting in unfavorable labor and overhead inefficiencies, including the Company's ability to absorb certain fixed costs. Combined with the increase in overall raw material costs, this resulted in an overall decrease in gross profit during the nine months endedSeptember 30, 2021 as compared to 2020.
Twelve-month average raw material cost per pound as of
2021 2020 % Change
Copper $ 4.95 $ 3.58 38.3 %
Galvanized steel $ 0.79 $ 0.44 79.5 %
Stainless steel $ 1.79 $ 1.28 39.8 %
Aluminum $ 1.88 $ 1.20 56.7 %
Selling, General and Administrative Expenses
Nine Months Ended
September 30, September 30, Percent of Sales
2021 2020 2021 2020
(in thousands)
Warranty $ 4,767 $ 5,356 1.2 % 1.3 %
Profit sharing 7,409 8,691 1.9 % 2.2 %
Salaries & benefits 17,088 14,921 4.3 % 3.8 %
Stock compensation 4,077 4,020 1.0 % 1.0 %
Advertising 692 446 0.2 % 0.1 %
Depreciation 1,979 1,470 0.5 % 0.4 %
Insurance 2,194 733 0.6 % 0.2 %
Professional fees 2,258 1,796 0.6 % 0.5 %
Donations 323 1,892 0.1 % 0.5 %
Bad debt expense (29) 193 - % - %
Other 6,730 6,351 1.7 % 1.6 %
Total SG&A $ 47,488 $ 45,869 11.9 % 11.5 %
Profit sharing expenses decreased due to our decreased earnings for the period.
Salaries and benefits are up slightly due to increases in bonuses, severance
payouts and employee incentives. Insurance expense increased due to an increase
in overall premiums during the period.
Income Taxes
Nine Months Ended
September 30, September 30, Effective Tax Rate
2021 2020 2021 2020
(in thousands)
Income tax provision $ 11,264 $ 16,111 17.6 % 21.1 %
The Company's estimated annual 2021 effective tax rate, excluding discrete
events, is expected to be approximately 25%. The nine months ended September 30,
2021 had a lower tax rate, compared to 2020, due to an increase in our excess
tax benefit related to stock awards of $1.3 million or 54%. The increase was
primarily due to timing of stock awards as a result of our high stock price
during the three months ended March 31, 2021 . In addition, in May 2021 , the
State of Oklahoma reduced corporate tax rate from 6% to 4%. As a result of these
changes, the Company adjusted its state deferred tax assets and liabilities in
the second quarter of 2021 using the newly enacted rate for the periods when
they are expected to be realized.
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--------------------------------------------------------------------------------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
Revolving Line of Credit - Under the revolving credit facility, there was one standby letter of credit of$1.8 million as ofSeptember 30, 2021 . AtSeptember 30, 2021 , we have$28.2 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
As ofSeptember 30, 2021 , we were in compliance with our financial covenants related to the revolving credit facility. These financial covenants require that we meet certain parameters related to our consolidated leverage ratio and our consolidated total liabilities to tangible net worth ratio. AtSeptember 30, 2021 , our consolidated leverage ratio was 0.02 to 1 and met the requirement of being less than 2 to 1. Our consolidated total liabilities to tangible net worth ratio was 0.3 to 1, and met the requirement of being less than 2 to 1. New Market Tax Credit Obligation - OnOctober 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 ourLongview, 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 itsLongview, 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'sLongview, 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 theSEC allowing the Company to repurchase shares from the open market.
Our open market repurchase programs are as follows:
Effective Date Authorized Repurchase $ Expiration Date
May 16, 2018 1 $15 million March 1, 2019
March 5, 2019 1 $20 million March 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 of
Lastly, the Company repurchases shares ofAAON, 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. - 28 - --------------------------------------------------------------------------------
Our repurchase activity is as follows:
Nine Months Ended
September 30, 2021 September 30, 2020 (in thousands, except share and per share data)
Program Shares Total $ $ per share Shares Total $ $ per share
Open market - $ - $ - 103,689 $ 4,987 $ 48.10
401(k) 220,336 15,014 68.14 303,112 16,403 54.12
Directors and employees 21,779 1,537 70.57 22,655 1,130 49.88
Total 242,115 $ 16,551 $ 68.36 429,456 $ 22,520 $ 52.44 Our repurchase activity since Company inception, including our current
authorized stock repurchase programs, are as follows:
Inception to September 30, 2021
(in thousands, except share and per share data)
Program Shares Total $ $ per share
Open market 4,205,255 $ 74,793 $ 17.79
401(k) 8,126,996 160,014 19.69
Directors and employees 2,026,980 22,288 11.00
Total 14,359,231 $ 257,095 $ 17.90
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 Date Record Date Payment Date Dividend per Share
May 15, 2020 June 3, 2020 July 1, 2020 $0.19
November 10, 2020 November 27, 2020 December 18, 2020 $0.19
May 17, 2021 June 3, 2021 July 1, 2021 $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 2021 and the foreseeable future.
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