Document


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

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

For the quarterly period ended June 30, 2017
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) 
Nevada
87-0448736
(State or other jurisdiction
(IRS Employer
of incorporation or organization)
Identification No.)
2425 South Yukon, Tulsa, Oklahoma  74107
(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 [ü]                                 No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, 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 [ü]                                 No [ ]                               Not Applicable [ ]
 
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 [ü]
Accelerated filer  [ ]
Non-accelerated filer  [ ] (Do not check if a smaller reporting company)
Smaller 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 [ü]

As of July 28, 2017, registrant had outstanding a total of 52,603,622 shares of its $.004 par value Common Stock.




PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.
AAON, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
 
June 30, 2017
 
December 31, 2016
Assets
(in thousands, except share and per share data)
Current assets:
 
 
 
Cash and cash equivalents
$
33,552

 
$
24,153

Certificates of deposit
5,520

 
5,512

Investments held to maturity at amortized cost
12,732

 
14,083

Accounts receivable, net
43,114

 
43,001

Income tax receivable
809

 
6,239

Note receivable
26

 
25

Inventories, net
63,075

 
47,352

Prepaid expenses and other
888

 
616

Total current assets
159,716

 
140,981

Property, plant and equipment:
 

 
 

Land
2,233

 
2,233

Buildings
83,401

 
78,806

Machinery and equipment
168,375

 
158,216

Furniture and fixtures
13,458

 
12,783

Total property, plant and equipment
267,467

 
252,038

Less:  Accumulated depreciation
142,839

 
137,146

Property, plant and equipment, net
124,628

 
114,892

Note receivable
667

 
657

Total assets
$
285,011

 
$
256,530

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Current liabilities:
 

 
 

Revolving credit facility
$

 
$

Accounts payable
14,108

 
7,102

Dividends payable
6,849

 

Accrued liabilities
34,293

 
31,940

Total current liabilities
55,250

 
39,042

Deferred revenue
1,542

 
1,498

Deferred tax liabilities
9,895

 
9,531

Donations
577

 
561

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, 52,615,921 and 52,651,448 issued and outstanding at June 30, 2017 and December 31, 2016, respectively
210

 
211

Additional paid-in capital

 

Retained earnings
217,537

 
205,687

Total stockholders' equity
217,747

 
205,898

Total liabilities and stockholders' equity
$
285,011

 
$
256,530

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

- 1 -




AAON, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except share and per share data)
Net sales
$
101,326

 
$
102,319

 
$
187,404

 
$
187,741

Cost of sales
69,648

 
69,572

 
130,740

 
129,263

Gross profit
31,678

 
32,747

 
56,664

 
58,478

Selling, general and administrative expenses
11,971

 
10,561

 
22,501

 
19,474

Loss (gain) on disposal of assets
48

 
(12
)
 
47

 
(20
)
Income from operations
19,659

 
22,198

 
34,116

 
39,024

Interest income, net
71

 
67

 
131

 
141

Other income, net
34

 
10

 
45

 
127

Income before taxes
19,764

 
22,275

 
34,292

 
39,292

Income tax provision
5,970

 
7,550

 
10,281

 
13,016

Net income
$
13,794

 
$
14,725

 
$
24,011

 
$
26,276

Earnings per share:
 

 
 

 
 
 
 
Basic
$
0.26

 
$
0.28

 
$
0.46

 
$
0.47

Diluted
$
0.26

 
$
0.27

 
$
0.45

 
$
0.47

Cash dividends declared per common share:
$
0.13

 
$
0.11

 
$
0.13

 
$
0.11

Weighted average shares outstanding:
 

 
 

 
 
 
 
Basic
52,615,366

 
53,036,009

 
52,624,782

 
53,028,224

Diluted
53,151,134

 
53,574,702

 
53,176,425

 
53,563,676

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

- 2 -



AAON, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
 
 
 
 
 
 
 
 
 
Common Stock
 
Paid-in
 
Retained
 
 
 
Shares
 
Amount
 
Capital
 
Earnings
 
Total
 
(in thousands)
Balances at December 31, 2016
52,651

 
$
211

 
$

 
$
205,687

 
$
205,898

Net income

 

 

 
24,011

 
24,011

Stock options exercised and restricted
261

 

 
1,573

 

 
1,573

stock awards granted
 

 
 

 
 

 
 

 
 

Share-based compensation

 

 
3,529

 

 
3,529

Stock repurchased and retired
(296
)
 
(1
)
 
(5,102
)
 
(5,331
)
 
(10,434
)
Dividends

 

 

 
(6,830
)
 
(6,830
)
Balances at June 30, 2017
52,616

 
$
210

 
$

 
$
217,537

 
$
217,747


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

- 3 -



AAON, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
 
Six Months Ended 
 June 30,
 
2017
 
2016
Operating Activities
(in thousands)
Net income
$
24,011

 
$
26,276

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation
7,281

 
6,346

Amortization of bond premiums
29

 
151

Provision for losses on accounts receivable, net of adjustments
141

 
(42
)
Provision for excess and obsolete inventories
260

 
308

Share-based compensation
3,529

 
2,043

Loss (gain) on disposition of assets
47

 
(20
)
Foreign currency transaction gain
(24
)
 
(48
)
Interest income on note receivable
(13
)
 
(14
)
Deferred income taxes
364

 
(1,851
)
Changes in assets and liabilities:
 

 
 

Accounts receivable
(254
)
 
(8,417
)
Income taxes
5,430

 
4,033

Inventories
(15,983
)
 
(1,934
)
Prepaid expenses and other
(272
)
 
(550
)
Accounts payable
6,801

 
1,848

Deferred revenue
118

 
220

Accrued liabilities and donations
2,295

 
1,252

Net cash provided by operating activities
33,760

 
29,601

Investing Activities
 

 
 

Capital expenditures
(16,847
)
 
(15,825
)
Proceeds from sale of property, plant and equipment
7

 
1

Investment in certificates of deposits
(5,280
)
 
(4,112
)
Maturities of certificates of deposits
5,272

 
6,000

Purchases of investments held to maturity
(13,241
)
 
(9,782
)
Maturities of investments
14,063

 
3,801

Proceeds from called investments
500

 
1,010

Principal payments from note receivable
26

 
26

Net cash used in investing activities
(15,500
)
 
(18,881
)
Financing Activities
 

 
 

Borrowings under revolving credit facility

 
761

Payments under revolving credit facility

 
(761
)
Stock options exercised
1,573

 
1,255

Repurchase of stock
(9,368
)
 
(7,233
)
Employee taxes paid by withholding shares
(1,066
)
 
(441
)
Net cash used in financing activities
(8,861
)
 
(6,419
)
Net increase in cash and cash equivalents
9,399

 
4,301

Cash and cash equivalents, beginning of period
24,153

 
7,908

Cash and cash equivalents, end of period
$
33,552

 
$
12,209


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

- 4 -



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”). 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, 2016 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, 2016. 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 and coils.
 
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, the allowance for doubtful accounts, 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.
 
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, 2016.

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.

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 May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In August 2015, with the issuance of ASU 2015-14, the FASB amended the effective date for us to January 1, 2018.

The following ASUs were issued in 2016 along with ASU 2014-09 with the same effective dates and transition requirements:
ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which provides implementation guidance for Topic 606 on principal versus agent considerations.

- 5 -



ASU 2016-10, Identifying Performance Obligations and Licensing, which provides clarification for two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance.
ASU 2016-12, Revenue from Contracts with Customers, which further amends Topic 606.
ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, which further amends Topic 606.

The Company plans to adopt using the retrospective transition method. The Company has begun assessing the impact of ASU 2015-09 and believes the impact will not be material to the consolidated financial statements. Once we adopt ASU 2014-09, we do not anticipate that our internal control framework will materially change, but rather that existing internal controls will be modified and augmented, as necessary, to consider our new revenue recognition policy effective January 1, 2018.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which will address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The ASU becomes effective in the annual reporting period beginning after December 31, 2017, including interim reporting periods. We do not expect ASU 2016-01 will have a material effect on our consolidated financial statements and notes thereto.

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting, which addresses changes to the terms or conditions of a share-based payment award. The ASU becomes effective in the annual reporting period beginning after December 15, 2017, including interim reporting periods. We do not expect ASU 2017-09 will have a material effect on our consolidated financial statements and notes thereto.

2.  Revenue Recognition
 
We recognize revenues from sales of products when the title and risk of ownership pass to the customer. 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 July - November of each year.
 
In addition, the Company presents revenues net of sales tax and net of certain payments to 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. 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.

We are responsible for billings and collections resulting from all sales transactions, including those initiated by our Representatives. 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. 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. The Company is under no obligation related to Third Party Products.

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 $12.6 million and $13.7 million for the three months ended June 30, 2017 and 2016, respectively. The amounts of payments to our Representatives were $24.5 million and $27.7 million for the six months ended June 30, 2017 and 2016, respectively.

The Company also sells extended warranties on parts for various lengths of time ranging from 6 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.  Investments
 
Certificates of Deposit – We held $5.5 million in certificates of deposit at June 30, 2017 and December 31, 2016, respectively. At June 30, 2017, the certificates of deposit bear interest ranging from 0.85% to 1.10% per annum and have various maturities ranging from less than one month to approximately 12 months.
 

- 6 -



Investments Held to Maturity – Our investments held to maturity are comprised of $12.7 million of corporate notes and bonds with original maturities ranging from less than two months to approximately 10 months. The investments have moderate risk with S&P ratings ranging from AAA to BBB-.
 
We record the amortized cost basis and accrued interest of the corporate notes and bonds in the Consolidated Balance Sheets. We record the interest and amortization of bond premium to interest income in the Consolidated Statements of Income.
 
The following summarizes the amortized cost and estimated fair value of our investments held to maturity as of
June 30, 2017 and December 31, 2016:
 
 
Amortized
Cost
 
Gross
Unrealized
Gain
 
Gross
Unrealized
(Loss)
 
Fair
Value
June 30, 2017:
(in thousands)
Current assets:
 
 
 
 
 
 
 
 Investments held to maturity
$
12,732

 
$

 
$
(25
)
 
$
12,707

Non current assets:
 

 
 

 
 

 
 

Investments held to maturity

 

 

 

Total
$
12,732

 
$

 
$
(25
)
 
$
12,707

 
 
 
 
 
 
 
 
December 31, 2016:
 

 
 

 
 

 
 

Current assets:
 

 
 

 
 

 
 

Investments held to maturity
$
14,083

 
$

 
$
(12
)
 
$
14,071

Non current assets:
 

 
 

 
 

 
 

Investments held to maturity

 

 

 

Total
$
14,083

 
$

 
$
(12
)
 
$
14,071


4.  Accounts Receivable

Accounts receivable and the related allowance for doubtful accounts are as follows:
 
 
June 30,
2017
 
December 31, 2016
 
(in thousands)
Accounts receivable
$
43,195

 
$
43,091

Less:  Allowance for doubtful accounts
(81
)
 
(90
)
Total, net
$
43,114

 
$
43,001

 
 
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
Allowance for doubtful accounts:
(in thousands)
Balance, beginning of period
$
274

 
$
238

 
$
90

 
$
115

Provisions for losses on accounts receivables, net of recoveries
(43
)
 
(165
)
 
141

 
(42
)
Accounts receivable written off
(150
)
 

 
(150
)
 

Balance, end of period
$
81

 
$
73

 
$
81

 
$
73

 

- 7 -



5.  Inventories

Inventories are valued at the lower of cost or market. 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.
 
 
June 30,
2017
 
December 31, 2016
 
(in thousands)
Raw materials
$
55,930

 
$
43,438

Work in process
2,867

 
2,279

Finished goods
5,920

 
3,017

 
64,717

 
48,734

Less:  Allowance for excess and obsolete inventories
(1,642
)
 
(1,382
)
Total, net
$
63,075

 
$
47,352

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

  
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
Allowance for excess and obsolete inventories:
(in thousands)
Balance, beginning of period
$
1,442

 
$
894

 
$
1,382

 
$
757

Provisions for excess and obsolete inventories
200

 
171

 
260

 
308

Inventories written off

 

 

 

Balance, end of period
$
1,642

 
$
1,065

 
$
1,642

 
$
1,065


6.  Supplemental Cash Flow Information
 
 
Three months ended

Six months ended
 
June 30,
2017

June 30,
2016

June 30,
2017

June 30,
2016
Supplemental disclosures:
(in thousands)
Interest paid
$


$


$


$

Income taxes paid
$
4,127


$
10,329


$
4,488


$
10,847













Non-cash investing and financing activities:
 


 







Non-cash capital expenditures
$
(874
)

$
1,047


$
224


$
1,312

Dividends declared
6,849

 
5,834

 
6,849

 
5,834

 
7.  Warranties

The Company has warranties with various terms ranging from 18 months for parts to 25 years for certain heat exchangers. The Company has an obligation to replace parts or service its products 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.  

The Company has been working on modifications and refinements to its warranty policy. These modifications more clearly define what qualifies as a warranty claim and puts a deadline for when claims may be submitted. This has increased our warranty reserve and increased our warranty expense for the three and six months ended June 30, 2017, as detailed below.

- 8 -




Changes in the warranty accrual are as follows:
 
 
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
Warranty accrual:
(in thousands)
Balance, beginning of period
$
7,812

 
$
8,130

 
$
7,936

 
$
8,469

Payments made
(2,312
)
 
(1,004
)
 
(3,654
)
 
(1,657
)
Provisions
3,102

 
1,328

 
4,320

 
1,642

Balance, end of period
$
8,602

 
$
8,454

 
$
8,602

 
$
8,454

 
 
 
 
 
 
 
 
Warranty expense:
$
3,102

 
$
1,328

 
$
4,320

 
$
1,642

 
8.  Accrued Liabilities

Accrued liabilities are as follows:

 
June 30,
2017
 
December 31, 2016
 
(in thousands)
Warranty
$
8,602

 
$
7,936

Due to representatives
10,152

 
9,907

Payroll
3,238

 
4,129

Profit sharing
2,156

 
1,967

Worker's compensation
661

 
580

Medical self-insurance
623

 
872

Customer prepayments
4,010

 
2,256

Donations
600

 
600

Employee benefits and other
4,251

 
3,693

Total
$
34,293

 
$
31,940

 
9.  Revolving Credit Facility

Our revolving credit facility, which is provided by BOKF, NA dba Bank of Oklahoma, formerly known as Bank of Oklahoma, N.A. ("Bank of Oklahoma"), provides for maximum borrowings of $30.0 million. Under the line of credit, there is one standby letter of credit totaling $0.8 million. Borrowings available under the revolving credit facility at June 30, 2017 were $29.2 million. Interest on borrowings is payable monthly at LIBOR plus 2.5%. No fees are associated with the unused portion of the committed amount. We had no outstanding balance under the revolving credit facility at June 30, 2017 and December 31, 2016. The termination date of the revolving credit facility is July 27, 2018.

As of June 30, 2017, 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 June 30, 2017, our tangible net worth was $217.7 million and met the requirement of being at or above $125.0 million. Our total liabilities to tangible net worth ratio was 0.31 to 1, and met the requirement of not being above 2 to 1.


- 9 -



10.  Income Taxes

The provision (benefit) for income taxes consists of the following:

 
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
 
(in thousands)
Current
$
6,326

 
$
8,371

 
$
9,917

 
$
14,867

Deferred
(356
)
 
(821
)
 
364

 
(1,851
)
 
$
5,970

 
$
7,550

 
$
10,281

 
$
13,016


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

 
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
Federal statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
 
35.0
 %
State income taxes, net of Federal benefit
4.5

 
4.9

 
4.0

 
5.0

Domestic manufacturing deduction
(3.1
)
 
(3.5
)
 
(3.0
)
 
(3.5
)
Excess tax benefits
(4.8
)
 
(1.7
)
 
(5.8
)
 
(2.9
)
Other
(1.4
)
 
(0.8
)
 
(0.2
)
 
(0.5
)
Effective tax rate
30.2
 %
 
33.9
 %
 
30.0
 %
 
33.1
 %

The Company's estimated annual 2017 effective tax rate, excluding discrete events, is approximately 36%. Additionally, as noted in Note 11, the Company early adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, applying the changes for excess tax benefits and tax deficiencies prospectively effective January 1, 2016. As a result, excess tax benefits and deficiencies are reported as an income tax benefit or expense on the statement of income rather than as a component of additional paid-in capital on the statement of equity. Excess tax benefits and deficiencies are treated as discrete items to the income tax provision in the reporting period in which they occur.

We file income tax returns in the U.S., state and foreign income tax returns jurisdictions. We are subject to U.S. examinations for tax years 2013 to present, and to non-U.S. income tax examinations for the tax years of 2012 to present. In addition, we are subject to state and local income tax examinations for the tax years 2012 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.

11. 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. Since inception of the LTIP, non-qualified stock options and restricted stock awards were granted with the same vesting schedule as the previous plan. 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 3.8 million shares, comprised of 3.4 million new shares provided for under the 2016 Plan and approximately 0.4 million shares that were available for issuance under the previous LTIP, that are now authorized for issuance under the 2016 Plan, that 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 will be 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 shall be limited to independent directors. The Committee may delegate certain duties to one or more officers of the Company as provided in the 2016 Plan. 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.


- 10 -



The compensation cost related to unvested stock options not yet recognized as of June 30, 2017 is $10.0 million and is expected to be recognized over a weighted-average period of 2.5 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 six months ended June 30, 2017 and 2016 using a Black Scholes Model:
 
 
Six months ended
 
June 30, 2017
 
June 30, 2016
Director and Officers:
 
 
 
Expected dividend rate
$
0.26

 
$
0.22

Expected volatility
30.81
%
 
42.38
%
Risk-free interest rate
1.90
%
 
2.02
%
Expected life (in years)
5.0

 
8.0

 
 
 
 
Employees:
 

 
 

Expected dividend rate
$
0.26

 
$
0.22

Expected volatility
30.75
%
 
41.82
%
Risk-free interest rate
1.89
%
 
1.76
%
Expected life (in years)
5.0

 
8.0

 
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.
 
The following is a summary of stock options vested and exercisable as of June 30, 2017:
 
Range of
Exercise
Prices
 
Number
of
Shares
 
Weighted
Average
Remaining
Contractual Life
(in years)
 
Weighted
Average
Exercise
Price
 
Intrinsic
Value
(in thousands)
$4.54-$22.76
 
378,504

 
4.85

 
$
10.98

 
$
9,792

$23.57-$32.80
 
33,985

 
7.95

 
25.34

 
391

$32.85-$37.30
 

 

 

 

Total
 
412,489

 
5.10

 
$
12.16

 
$
10,183

 
The following is a summary of stock options vested and exercisable as of June 30, 2016:

Range of
Exercise
Prices
 
Number
of
Shares
 
Weighted
Average
Remaining
Contractual Life
(in years)
 
Weighted
Average
Exercise
Price
 
Intrinsic
Value
(in thousands)
$4.54-$8.65
 
344,958

 
5.06
 
$
7.67

 
$
6,843

$8.70-$22.76
 
37,505

 
7.39
 
15.77

 
440

$23.57-$28.27
 
7,664

 
8.66
 
23.57

 
30

Total
 
390,127

 
5.35
 
$
8.76

 
$
7,313


- 11 -




A summary of option activity under the plans is as follows:

Options
Shares
 
Weighted
Average
Exercise
Price
Outstanding at December 31, 2016
1,450,704

 
$
21.33

Granted
389,660

 
34.42

Exercised
(154,368
)
 
10.19

Forfeited or Expired
(64,886
)
 
30.51

Outstanding at June 30, 2017
1,621,110

 
$
25.17

Exercisable at June 30, 2017
412,489

 
$
12.16

 
The total intrinsic value of options exercised during the six months ended June 30, 2017 and 2016 was $4.0 million and $3.4 million, respectively. The cash received from options exercised during the six months ended June 30, 2017 and 2016 was $1.6 million and $1.3 million, respectively. The impact of these cash receipts is included in financing activities in the accompanying Consolidated Statements of Cash Flows.

Since 2007, as part of the LTIP and since May 2016 as part of the 2016 Plan, the Compensation Committee of the Board of Directors has authorized and issued restricted stock awards to directors and key employees. Restricted stock awards granted to directors vest one-third each year. All other restricted stock awards vest at a rate of 20% per year. 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.

These awards are recorded at their fair value on the date of grant and compensation cost is recorded using straight-line vesting over the service period. At June 30, 2017, unrecognized compensation cost related to unvested restricted stock awards was approximately $8.3 million, which is expected to be recognized over a weighted average period of 2.0 years.

A summary of the unvested restricted stock awards is as follows:
 
Restricted stock
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested at December 31, 2016
408,162

 
$
20.47

Granted
123,151

 
33.96

Vested
(121,956
)
 
21.09

Forfeited
(16,161
)
 
22.86

Unvested at June 30, 2017
393,196

 
$
24.41


- 12 -




A summary of share-based compensation is as follows:
 
 
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
Grant date fair value of awards during the period:
(in thousands)
Options
$
633

 
$
1,279

 
$
3,507

 
$
2,059

Restricted stock
1,582

 
1,043

 
4,182

 
2,942

Total
$
2,215

 
$
2,322

 
$
7,689

 
$
5,001

Share-based compensation expense:
 
 
 
 
 
 
 
Options
$
703

 
$
404

 
$
1,430

 
$
741

Restricted stock
1,181

 
691

 
2,099

 
1,302

Total
$
1,884

 
$
1,095

 
$
3,529

 
$
2,043

Income tax benefit/(deficiency) related to share-based compensation:
 
 
 
 
 
 
 
Options
$
494

 
$
417

 
$
1,285

 
$
1,130

Restricted stock
432

 
(33
)
 
705

 
(1
)
Total
$
926

 
$
384

 
$
1,990

 
$
1,129

 
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which makes several modifications to Topic 718 including: accounting for excess tax benefits and deficiencies; classifying excess tax benefits on the statement of cash flows; accounting for forfeitures; classifying awards that permit share repurchases to satisfy statutory tax-withholding requirement; and classifying tax payments on behalf of employees on the statement of cash flows. The ASU became effective for interim and annual reporting periods beginning after December 31, 2016. We early adopted the ASU effective January 1, 2016.
The Company previously applied a forfeiture rate to its share-based compensation expense and adjusted expense to actual as awards vested and/or were forfeited. Upon adoption of ASU 2016-09, the Company accounts for forfeitures as they occur, rather than estimating forfeitures as of an award's grant date.
Tax payments made on behalf of an employee by repurchasing shares of stock are now shown separately as cash outflows from financing activities on the statement of cash flows. This provision was retrospectively adopted and prior period cash flows have been reclassified to conform with this presentation.
Additionally, the Company retrospectively adopted the provision to classify excess tax benefits and deficiencies as cash flows from operating activities as part of cash payments for taxes on the statement of cash flows. Prior period cash flows have been reclassified to conform with this presentation.

- 13 -



The following table displays the prior period quantitative effects on the consolidated financial statements:
 
Three months ended
 
Six months ended
 
June 30,
2016
 
June 30,
2016
 
As Reported
 
As Restated
 
As Reported
 
As Restated
 
(in thousands, except share and per share data)
Consolidated Statement of Income
 
 
 
 
 
 
 
Income tax provision
$
7,934

 
$
7,550

 
$
14,145

 
$
13,016

Net income
14,341

 
14,725

 
25,147

 
26,276

Earnings per share:


 


 


 


     Basic
$
0.27

 
$
0.28

 
$
0.47

 
$
0.47

     Diluted
0.27

 
0.27

 
0.47

 
0.47

Weighted average shares outstanding:
 
 
 
 
 
 
 
     Diluted
53,401,238

 
53,574,702

 
53,395,361

 
53,563,676

 
 
 
 
 
 
 
 
Consolidated Statement of Cash Flows
 
 
 
 
 
 
 
Change in income taxes


 


 
$
5,162

 
$
4,033

12.  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.

ASU 2016-09 impacts the calculation of diluted weighted average shares under the treasury stock method as the Company no longer increases or decreases the assumed proceeds from an employee vesting in, or exercising, a share-based payment award by the amount of excess tax benefits or deficiencies taken to additional paid-in capital.
 
Three months ended
 
Six months ended
 
June 30,
2017
 
June 30,
2016
 
June 30,
2017
 
June 30,
2016
 
(in thousands, except share and per share data)
Numerator:
 
 
 
 
 
 
 
Net income
$
13,794

 
$
14,725

 
$
24,011

 
$
26,276

Denominator:
 

 
 

 
 
 
 
Basic weighted average shares
52,615,366

 
53,036,009

 
52,624,782

 
53,028,224

Effect of dilutive stock options and restricted stock
535,768

 
538,693

 
551,643

 
535,452

Diluted weighted average shares
53,151,134

 
53,574,702

 
53,176,425

 
53,563,676

Earnings per share:
 

 
 

 
 
 
 
Basic
$
0.26

 
$
0.28

 
$
0.46

 
$
0.47

Diluted
$
0.26

 
$
0.27

 
$
0.45

 
$
0.47

Anti-dilutive shares:
 

 
 

 
 
 
 
Shares
760,438

 
504,954

 
772,202

 
498,043



- 14 -



13. Stockholders’ Equity

Stock Repurchase - 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. Effective May 24, 2016, the Board authorized up to $25.0 million in open market repurchases and on June 2, 2016, the Company executed a repurchase agreement in accordance with the rules and regulations of the SEC allowing the Company to repurchase an aggregate amount of $25.0 million or a total of approximately 2.0 million shares from the open market. The agreement expired on April 15, 2017. 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. Al1 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:
 
Six Months Ended 
 June 30,
Inception to date
 
2017
2016
Program
Shares
Total $
$ per share
Shares
Total $
$ per share
Shares
Total $
$ per share
Open market
8,676

$
283,654

$
32.69

10,230

$
265,402

$
25.94

3,843,495

$
61,232,115

$
15.93

401(k)
258,051

9,083,606

35.20

274,147

6,967,393

25.41

6,340,494

74,816,326

11.80

Directors and employees
30,158

1,066,450

35.36

17,128

440,828

25.74

1,903,790

16,730,059

8.79

Total
296,885

$
10,433,710

$
35.14

301,505

$
7,673,623

$
25.45

12,087,779

$
152,778,500

$
12.64


Dividends - At the discretion of the Board of Directors, 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 24, 2016
June 10, 2016
July 1, 2016
$
0.11

November 9, 2016
December 2, 2016
December 23, 2016
$
0.13

May 16, 2017
June 9, 2017
July 7, 2017
$
0.13


14. 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 or cash flows.

- 15 -




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, 2016. 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, 2016. 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 and coils. 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 certain provinces in Canada. Foreign sales were approximately $5.5 million of our total net sales for the six months just ended and $7.9 million of our sales during the same period of 2016.

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. When new construction is down, we emphasize the replacement market. The new construction market in 2016 through the second quarter of 2017 continued to be unpredictable and uneven. Thus, we continue to emphasize promotion of the benefits of AAON equipment to property owners in the replacement market.

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.

The price levels of our raw materials have remained relatively consistent the past few years, but the market continues to be volatile and unpredictable as a result of the uncertainty related to the U.S. economy and a weakening global economy. For the six months ended June 30, 2017, the price for aluminum, galvanized steel and stainless steel increased by approximately 1.2%, 7.9%, and 0.9%, respectively, while the price for copper decreased by approximately 3.7% from the six months ended June 30, 2016.

In 2015, AAON initiated the design of a new Water Source Heat Pump product line and its affiliated manufacturing facility. We have brought the product into the marketplace and are in the final stages of completing this introduction into a $500-$600 million new market.

In 2016, we began construction of a 162,000 square foot laboratory building with ten testing cells contained within it. This unique laboratory will have capabilities beyond anything known to exist in the world and will elevate AAON's research and design capabilities accordingly. Completion of this lab in 2018 will therefore be quite significant.


- 16 -







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

Overall units sold increased approximately 5.3% as compared to the same period last year.
Cash and cash equivalents increased $9.4 million primarily from cash inflows from operations.
We invested $16.8 million in capital expenditures in connection with the construction of our new research and development lab, water source heat pump line and other internal projects.
Increased warranty costs due modifications and refinements in our policy, which are expected to be short-term.

Backlog

The following table shows our historical backlog levels:
6/30/2017
12/31/2016
6/30/2016
(in thousands)
$
83,528

$
49,127

$
69,296

 
 
 



Results of Operations

Three Months Ended June 30, 2017 vs. Three Months Ended June 30, 2016

Units Sold
 
Three Months Ended 
 June 30,
 
2017
 
2016
 
 
 
 
Rooftop Units
4,173

 
4,759

Split Systems
1,397

 
937

Outdoor Mechanical Rooms
15

 
22

Water Source Heat Pumps
518

 
76

Total Units
6,103

 
5,794


Net Sales
 
 
Three Months Ended 
 June 30,
 
 
 
 
 
2017
 
2016
 
Change
% Change
 
 
(in thousands, except unit data)
Net sales
 
$
101,326

 
$
102,319

 
$
(993
)
(1.0
)%
Total units
 
6,103

 
5,794

 
309

5.3
 %

Total units sold for the three months ended June 30, 2017 are up, but net sales remain relatively flat due to changes in our product mix.


- 17 -



Cost of Sales
 
 
Three Months Ended 
 June 30,
 
Percent of Sales
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
Cost of sales
 
$
69,648

 
$
69,572

 
68.7
%
 
68.0
%
Gross Profit
 
31,678

 
32,747

 
31.3
%
 
32.0
%

As noted in our raw material prices below, the Company has seen increases in our cost of sales due to the increased steel prices. This increase is offset slightly by better absorption of overhead.

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.

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

 
 
2017
 
2016
 
% Change
 
 
 
 
 
 
 
Copper
 
$
3.37

 
$
3.50

 
(3.7
)%
Galvanized Steel
 
$
0.41

 
$
0.38

 
7.9
 %
Stainless Steel
 
$
1.18

 
$
1.17

 
0.9
 %
Aluminum
 
$
1.68

 
$
1.66

 
1.2
 %

Selling, General and Administrative Expenses
 
 
Three Months Ended 
 June 30,
 
Percent of Sales
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
Warranty
 
$
3,102

 
$
1,328

 
3.1
 %
 
1.3
 %
Profit Sharing
 
2,154

 
2,517

 
2.1
 %
 
2.5
 %
Salaries & Benefits
 
2,427

 
3,160

 
2.4
 %
 
3.1
 %
Stock Compensation
 
1,367

 
749

 
1.3
 %
 
0.7
 %
Advertising
 
171

 
448

 
0.2
 %
 
0.4
 %
Depreciation
 
154

 
214

 
0.2
 %
 
0.2
 %
Insurance
 
205

 
315

 
0.2
 %
 
0.3
 %
Professional Fees
 
262

 
281

 
0.3
 %
 
0.3
 %
Donations
 
189

 
103

 
0.2
 %
 
0.1
 %
Bad Debt Expense
 
(43
)
 
(165
)
 
 %
 
(0.2
)%
Other
 
1,983

 
1,611

 
2.0
 %
 
1.6
 %
Total SG&A
 
$
11,971

 
$
10,561

 
11.8
 %
 
10.3
 %

The overall increase in SG&A was primarily due to increased warranty expenses. The Company has been working on modifications and refinements to its warranty policy. These modifications more clearly define what qualifies as a warranty claim and puts a deadline for when claims may be submitted. This has increased our warranty reserve and increased our warranty expense for the three months ended June 30, 2017.


- 18 -



Income Taxes
 
 
Three Months Ended 
 June 30,
 
Effective Tax Rate
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
Income tax provision
 
$
5,970

 
$
7,550

 
30.2
%
 
33.9
%

The Company’s estimated annual 2017 effective tax rate, excluding discrete events, is expected to be approximately 36.0%. Additionally, the Company early adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, applying the changes for excess tax benefits and tax deficiencies prospectively effective January 1, 2016. As a result, excess tax benefits and deficiencies are reported as an income tax benefit or expense on the statement of income rather than as a component of additional paid-in capital on the statement of equity. Excess tax benefits and deficiencies are treated as discrete items to the income tax provision in the reporting period in which they occur. For the three months ended June 30, 2017 and 2016, the Company recorded $1.0 million and $0.4 million, respectively, in excess tax benefits as an income tax benefit.





Six months ended June 30, 2017 vs. Six months ended June 30, 2016

Units Sold
 
Six Months Ended June 30,
 
2017
 
2016
 
 
 
 
Rooftop Units
7,647

 
8,253

Split Systems
2,542

 
1,739

Outdoor Mechanical Rooms
39

 
31

Water Source Heat Pumps
896

 
139

Total Units
11,124

 
10,162


Net Sales
 
 
Six Months Ended 
 June 30,
 
 
 
 
 
2017
 
2016
 
Change
% Change
 
 
(in thousands, except unit data)
Net sales
 
$
187,404

 
$
187,741

 
$
(337
)
(0.2
)%
Total units
 
11,124

 
10,162

 
962

9.5
 %

Similar to our quarter results. the six months ended June 30, 2017 saw increases in total units sold but changes in our product mix to smaller and less expensive units.


- 19 -



Cost of Sales
 
 
Six Months Ended 
 June 30,
 
Percent of Sales
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
Cost of sales
 
$
130,740

 
$
129,263

 
69.8
%
 
68.9
%
Gross Profit
 
56,664

 
58,478

 
30.2
%
 
31.1
%

As noted in our raw material prices below, the Company has seen increases in our cost of sales due to the increased steel prices. This increase is offset slightly by better absorption of overhead.

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. Cost of sales increased overall due to increased commodity prices.

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

 
 
2017
 
2016
 
% Change
 
 
 
 
 
 
 
Copper
 
$
3.37

 
$
3.50

 
(3.7
)%
Galvanized Steel
 
$
0.41

 
$
0.38

 
7.9
 %
Stainless Steel
 
$
1.18

 
$
1.17

 
0.9
 %
Aluminum
 
$
1.68

 
$
1.66

 
1.2
 %





Selling, General and Administrative Expenses
 
 
Six Months Ended 
 June 30,
 
Percent of Sales
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
Warranty
 
$
4,320

 
$
1,642

 
2.3
%
 
0.9
 %
Profit Sharing
 
3,810

 
4,450

 
2.0
%
 
2.4
 %
Salaries & Benefits
 
5,428

 
6,202

 
2.9
%
 
3.3
 %
Stock Compensation
 
2,445

 
1,405

 
1.3
%
 
0.7
 %
Advertising
 
1,137

 
757

 
0.6
%
 
0.4
 %
Depreciation
 
312

 
437

 
0.2
%
 
0.2
 %
Insurance
 
449

 
643

 
0.2
%
 
0.3
 %
Professional Fees
 
839

 
839

 
0.4
%
 
0.4
 %
Donations
 
403

 
212

 
0.2
%
 
0.1
 %
Bad Debt Expense
 
141

 
(62
)
 
0.1
%
 
 %
Other
 
3,217

 
2,949

 
1.7
%
 
1.6
 %
Total SG&A
 
$
22,501

 
$
19,474

 
12.0
%
 
10.4
 %

The overall increase in SG&A was primarily due to increased warranty expenses. The Company has been working on modifications and refinements to its warranty policy. These modifications more clearly define what qualifies as a warranty claim and puts a deadline for when claims may be submitted. This has increased our warranty reserve and increased our warranty expense for six months ended June 30, 2017.


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Income Taxes
 
 
Six Months Ended 
 June 30,
 
Effective Tax Rate
 
 
2017
 
2016
 
2017
 
2016
 
 
(in thousands)
 
 
 
 
Income tax provision
 
$
10,281

 
$
13,016

 
30.0
%
 
33.1
%

The Company’s estimated annual 2017 effective tax rate, excluding discrete events, is expected to be approximately 36.0%. Additionally, the Company early adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, applying the changes for excess tax benefits and tax deficiencies prospectively effective January 1, 2016. As a result, excess tax benefits and deficiencies are reported as an income tax benefit or expense on the statement of income rather than as a component of additional paid-in capital on the statement of equity. Excess tax benefits and deficiencies are treated as discrete items to the income tax provision in the reporting period in which they occur. For the six months ended June 30, 2017 and 2016, the Company recorded $1.9 million and $1.1 million, respectively, in excess tax benefits as an income tax benefit.

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 our revolving credit facility.

Our cash and investments increased $8.1 million from December 31, 2016 to June 30, 2017 and totaled $51.8 million at June 30, 2017.

Under the line of credit, there was one standby letter of credit of $0.8 million as of June 30, 2017. At June 30, 2017, we have $29.2 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 June 30, 2017 and December 31, 2016. Interest on borrowings is payable monthly at LIBOR plus 2.5%. The termination date of the revolving credit facility is July 27, 2018.

At June 30, 2017, 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 June 30, 2017, our tangible net worth was $217.7 million, which meets the requirement of being at or above $125.0 million. Our total liabilities to tangible net worth ratio was 0.31 to 1.0 which meets the requirement of not being above 2 to 1.

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. Effective May 24, 2016, the Board authorized up to $25.0 million in open market repurchases and on June 2, 2016, the Company executed a repurchase agreement in accordance with the rules and regulations of the SEC allowing the Company to repurchase an aggregate amount of $25.0 million or a total of approximately 2.0 million shares from the open market. The agreement expired on April 15, 2017. 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. Any 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:
 
Six Months Ended 
 June 30,
Inception to date
 
2017
2016
Program
Shares
Total $
$ per share
Shares
Total $
$ per share
Shares
Total $
$ per share
Open market
8,676

$
283,654

$
32.69

10,230

$
265,402

$
25.94

3,843,495

$
61,232,115

$
15.93

401(k)
258,051

9,083,606

35.20

274,147

6,967,393

25.41

6,340,494

74,816,326

11.80

Directors and employees
30,158

1,066,450

35.36

17,128

440,828

25.74

1,903,790

16,730,059

8.79

Total
296,885

$
10,433,710

$
35.14

301,505

$
7,673,623

$
25.45

12,087,779

$
152,778,500

$
12.64


Dividends - At the discretion of the Board of Directors, 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 24, 2016
June 10, 2016
July 1, 2016
$
0.11

November 9, 2016
December 2, 2016
December 23, 2016
$
0.13

May 16, 2017
June 9, 2017
July 7, 2017
$
0.13


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 2017 and the foreseeable future.


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Statement of Cash Flows

The following table reflects the major categories of cash flows for the six months ended June 30, 2017 and 2016. For additional details, see the Condensed Consolidated Statements of Cash Flows in the condensed consolidated financial statements.

 
Six months ended June 30,
 
2017
 
2016
 
(in thousands)
Operating Activities
 
 
 
Net Income
$
24,011

 
$
26,276

Income statement adjustments, net
11,614

 
6,873

Changes in assets and liabilities:
 
 
 
Accounts receivable
(254
)
 
(8,417
)
Income taxes
5,430

 
4,033

Inventories
(15,983
)
 
(1,934
)
Prepaid expenses and other
(272
)
 
(550
)
Accounts payable
6,801

 
1,848

Deferred revenue
118

 
220

Accrued liabilities & donations
2,295

 
1,252

Net cash provided by operating activities
33,760

 
29,601

Investing Activities
 
 
 
Capital expenditures
(16,847
)
 
(15,825
)
Purchases of investments
(18,521
)
 
(13,894
)
Maturities of investments and proceeds from called investments
19,835

 
10,811

Other
33

 
27

Net cash used in investing activities
(15,500
)
 
(18,881
)
Financing Activities
 
 
 
Stock options exercised
1,573

 
1,255

Repurchase of stock
(9,368
)
 
(7,233
)
Employee taxes paid by withholding shares
(1,066
)
 
(441
)
Net cash used in financing activities
$
(8,861
)
 
$
(6,419
)

Cash Flows Provided by Operating Activities

Cash outflows for inventory purchases has increased related to increased volume of unit sales as we enter the peak season for the Company as well increased offerings in product mix. This is offset by better collections of our accounts receivable in part from our prepayment program with customers.

Cash Flows Provided by Investing Activities

The decrease in the net outflow is due to maturity of our investment portfolio versus the timing of reinvestment. The capital expenditure program for 2017 is estimated to be approximately $48.5 million.

Cash Flows Used in Financing Activities

While the number of shares repurchased remained relatively consistent as compared to the prior year, the increase in the Company's share price drove the increased cash outflows for buyback activity.

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.

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Contractual Obligations

We had no material contractual purchase agreements as of June 30, 2017.

Critical Accounting Policies

There have been no material changes in the Company’s critical accounting policies during the six months ended June 30, 2017.

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, and (4) general economic, market or business conditions.

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.
 
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.

- 24 -



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, 2016. 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 2016 Annual Report.

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

On May 17, 2010, the Board authorized a stock buyback program, targeting open market repurchases of up to approximately 5% (2.9 million shares) of the Company's outstanding stock. In May 2015, the Board authorized repurchases up to an additional 2.75 million shares, or a total of approximately 5.7 million shares. In October 2015, the Board authorized $25.0 million for use under the Company's stock buyback program. Effective May 24, 2016, the Board authorized up to $25.0 million in open market repurchases and on June 2, 2016, the Company executed a repurchase agreement in accordance with the rules and regulations of the SEC allowing the Company to repurchase an aggregate amount of $25.0 million or a total of approximately 2.0 million shares from the open market. The agreement expired on April 15, 2017. We have repurchased a total of approximately 3.8 million shares under these programs for an aggregate price of $61.2 million, or an average price of $15.93 per share. We purchased the shares at current market prices.

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. Through June 30, 2017, we repurchased approximately 6.3 million shares for an aggregate price of $74.8 million, or an average price of $11.80 per share. We purchased the shares at current market prices.

Periodically, 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. Through June 30, 2017, we repurchased approximately 1.9 million shares for an aggregate price of $16.7 million, or an average price of $8.79 per share. We purchased the shares at current market prices.

Repurchases during the second quarter of 2017 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
April 2017
 
40,916

 
$
35.63

 
40,916

 

May 2017
 
38,966

 
36.81

 
38,966

 

June 2017
 
18,075

 
36.88

 
18,075

 

Total     
 
97,957

 
$
36.33

 
97,957

 

 


- 25 -



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.

On May 16, 2017, the Company held its Annual Meeting. At the Annual Meeting, the Company's stockholders (i) elected each of the nominees listed below to the Company's Board of Directors to serve until the 2020 Annual Meeting of Stockholders, or until their respective successors are elected and qualified; (ii) ratified the selection of Grant Thornton, LLP as the Company's independent registered public accounting firm for the fiscal year ending December 31, 2017; (iii) approved, on an advisory basis, the compensation of the Company's named executive officers and (iv) approved, on an advisory basis, the frequency of future advisory votes on executive compensation once every three years. The final results for the votes regarding each proposal are set forth below.

(i) The voting results with respect to the election of each director were as follows:
Nominees:
For
Against
Abstain
Broker Non-Votes
Stephen O. LeClair
46,452,649
385,737
18,883
3,588,836
Jack E. Short
46,631,954
206,478
18,837
3,588,836

(ii) The voting results with respect to the ratification of the selection of Grant Thornton, LLP as the Company's
independent registered public accounting firm for the fiscal year ending December 31, 2017 were as follows:
For
Against
Abstain
Broker Non-Votes
49,997,734
431,917
16,454

(iii) The voting results with respect to the approval, on an advisory basis, of the compensation of the Company's named executive officers were as follows:
For
Against
Abstain
Broker Non-Votes
45,127,570
1,499,511
230,188
3,588,836

(iv) The voting results with respect to the approval, on an advisory basis, the frequency of future advisory votes on executive compensation every three years were as follows:
Votes for One Year
Votes for Two Years
Votes for Three Years
Abstain
Broker Non-Votes
20,713,923
3,751,205
22,357,579
34,562

Item 5.  Other Information.

At the May 16, 2017 Board of Directors meeting following the Annual Meeting, the Board of Directors declared a regular semi-annual cash dividend of $0.13 per share. The dividends were paid to stockholders of record as of the close of business on June 9, 2017, with a payment date of July 7, 2017.


- 26 -



Item 6.  Exhibits.
 
 
(a)          Exhibits
 
 
 
 
 
(i)
Section 302 Certification of CEO
 
(ii)
Section 302 Certification of CFO
 
(iii)
Section 1350 Certification of CEO
 
(iv)
Section 1350 Certification of CFO
 
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: August 3, 2017
By:
/s/ Norman H. Asbjornson
 
 
Norman H. Asbjornson
  President/CEO
 
 
 
 
 
 
Dated: August 3, 2017
By:
/s/ Scott M. Asbjornson
 
 
Scott M. Asbjornson
Chief Financial Officer

- 27 -