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

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

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

For the transition period from ____________________ to ____________________
 
Commission file number:  0-18953
AAON, INC.
(Exact name of registrant as specified in its charter) 
Nevada 87-0448736
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
2425 South Yukon Ave., 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                   No 

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

Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock AAON NASDAQ

As of August 4, 2020, registrant had outstanding a total of 52,261,676 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, 2020 December 31, 2019
Assets (in thousands, except share and per share data)
Current assets:    
Cash and cash equivalents $ 61,284    $ 26,797   
Restricted cash 9,561    17,576   
Accounts receivable, net 56,394    67,399   
Income tax receivable 5,154    772   
Note receivable 28    29   
Inventories, net 85,411    73,601   
Prepaid expenses and other 1,943    1,375   
Total current assets 219,775    187,549   
Property, plant and equipment:    
Land 3,804    3,274   
Buildings 112,735    101,113   
Machinery and equipment 260,548    236,087   
Furniture and fixtures 17,926    16,862   
Total property, plant and equipment 395,013    357,336   
Less:  Accumulated depreciation 190,585    179,242   
Property, plant and equipment, net 204,428    178,094   
Intangible assets, net 155    272   
Goodwill 3,229    3,229   
Right of use assets 1,665    1,683   
Note receivable 555    597   
Total assets $ 429,807    $ 371,424   
Liabilities and Stockholders' Equity    
Current liabilities:    
Revolving credit facility $ —    $ —   
Accounts payable 19,698    11,759   
Dividends payable 9,930    —   
Accrued liabilities 46,992    44,269   
Total current liabilities 76,620    56,028   
Deferred tax liabilities 20,358    15,297   
Other long-term liabilities 3,794    3,639   
New market tax credit obligation (a) 6,340    6,320   
Commitments and contingencies
Stockholders' equity:    
Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued
—    —   
Common stock, $.004 par value, 100,000,000 shares authorized, 52,234,119 and 52,078,515 issued and outstanding at June 30, 2020 and December 31, 2019, respectively
209    208   
Additional paid-in capital 6,451    3,631   
Retained earnings 316,035    286,301   
Total stockholders' equity 322,695    290,140   
Total liabilities and stockholders' equity $ 429,807    $ 371,424   
 (a) Held by variable interest entities (Note 16)

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,
  2020 2019 2020 2019
(in thousands, except share and per share data)
Net sales $ 125,596    $ 119,437    $ 263,079    $ 233,259   
Cost of sales 87,465    89,233    182,001    177,625   
Gross profit 38,131    30,204    81,078    55,634   
Selling, general and administrative expenses 15,939    12,912    31,153    26,589   
Loss (gain) on disposal of assets —      (62)   290   
Income from operations 22,192    17,286    49,987    28,755   
Interest income, net 19    31    80    40   
Other income (expense), net 32    17      (9)  
Income before taxes 22,243    17,334    50,072    28,786   
Income tax provision 4,439    3,943    10,415    6,638   
Net income $ 17,804    $ 13,391    $ 39,657    $ 22,148   
Earnings per share:    
Basic $ 0.34    $ 0.26    $ 0.76    $ 0.43   
Diluted $ 0.34    $ 0.25    $ 0.75    $ 0.42   
Cash dividends declared per common share: $ 0.19    $ 0.16    $ 0.19    $ 0.16   
Weighted average shares outstanding:    
Basic 52,099,694    52,120,272    52,160,348    52,087,626   
Diluted 52,750,401    52,747,199    52,885,491    52,589,845   
 
The accompanying notes are an integral part of these consolidated financial statements.
- 2 -



AAON, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
(Unaudited)
Six Months Ended June 30, 2020
  Common Stock Paid-in Retained  
Shares Amount Capital Earnings Total
  (in thousands)
Balances at December 31, 2019 52,079    $ 208    $ 3,631    $ 286,301    $ 290,140   
Net income —    —    —    39,657    39,657   
Stock options exercised and restricted 490      14,171    —    14,173   
stock awards granted          
Share-based compensation —    —    5,694    —    5,694   
Stock repurchased and retired (335)   (1)   (17,045)   —    (17,046)  
Dividends —    —    —    (9,923)   (9,923)  
Balances at June 30, 2020 52,234    $ 209    $ 6,451    $ 316,035    $ 322,695   
Three Months Ended June 30, 2020
Common Stock Paid-in Retained
Shares Amount Capital Earnings Total
(in thousands)
Balances at March 31, 2020 52,044    $ 208    $ —    $ 306,115    $ 306,323   
Net income —    —    —    17,804    17,804   
Stock options exercised and restricted 278      9,675    —    9,676   
stock awards granted
Share-based compensation —    —    3,343    —    3,343   
Stock repurchased and retired (88)   —    (6,567)   2,039    (4,528)  
Dividends —    —    —    (9,923)   (9,923)  
Balances at June 30, 2020 52,234    $ 209    $ 6,451    $ 316,035    $ 322,695   
Six Months Ended June 30, 2019
Common Stock Paid-in Retained
Shares Amount Capital Earnings Total
(in thousands)
Balances at December 31, 2018 51,991    $ 208    $ —    $ 249,235    249,443   
Net income —    —    —    22,148    22,148   
Stock options exercised and restricted 384      7,683    —    7,685   
stock awards granted
Share-based compensation —    —    7,786    —    7,786   
Stock repurchased and retired (257)   (1)   (11,170)   —    (11,171)  
Dividends —    —    —    (8,380)   (8,380)  
Balances at June 30, 2019 52,118    $ 209    $ 4,299    $ 263,003    $ 267,511   
Three Months Ended June 30, 2019
Common Stock Paid-in Retained
Shares Amount Capital Earnings Total
(in thousands)
Balances at March 31, 2019 52,099    $ 208    $ 4,346    $ 257,992    $ 262,546   
Net income —    —    —    13,391    13,391   
Stock options exercised and restricted 147      3,674    —    3,675   
stock awards granted
Share-based compensation —    —    2,379    —    2,379   
Stock repurchased and retired (128)   —    (6,100)   —    (6,100)  
Dividends —    —    —    (8,380)   (8,380)  
Balances at June 30, 2019 52,118    $ 209    $ 4,299    $ 263,003    $ 267,511   
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,
  2020 2019
Operating Activities (in thousands)
Net income $ 39,657    $ 22,148   
Adjustments to reconcile net income to net cash provided by operating activities:  
Depreciation and amortization 12,340    11,760   
Amortization of debt issuance cost 20    —   
Provision for losses on accounts receivable, net of adjustments 76    128   
Provision for excess and obsolete inventories (193)   1,153   
Share-based compensation 5,694    7,786   
(Gain) loss on disposition of assets (62)   290   
Foreign currency transaction loss (gain) 30    (13)  
Interest income on note receivable (12)   (26)  
Deferred income taxes 5,061    3,318   
Changes in assets and liabilities:    
Accounts receivable 10,929    (14,983)  
Income taxes (4,382)   2,925   
Inventories (11,617)   (585)  
Prepaid expenses and other (568)   (650)  
Accounts payable 2,893    (2,592)  
Deferred revenue 473    172   
Accrued liabilities 2,423    5,041   
Net cash provided by operating activities 62,762    35,872   
Investing Activities    
Capital expenditures (33,510)   (16,784)  
Proceeds from sale of property, plant and equipment 61    59   
Investment in certificates of deposits —    (6,000)  
Maturities of certificates of deposits —    2,000   
Principal payments from note receivable 25    28   
Net cash used in investing activities (33,424)   (20,697)  
Financing Activities    
Stock options exercised 14,173    7,685   
Repurchase of stock (15,937)   (10,191)  
Employee taxes paid by withholding shares (1,102)   (980)  
Net cash used in financing activities (2,866)   (3,486)  
Net increase in cash, cash equivalents and restricted cash 26,472    11,689   
Cash, cash equivalents and restricted cash, beginning of period 44,373    1,994   
Cash, cash equivalents and restricted cash, end of period $ 70,845    $ 13,683   

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”).

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

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

Impact of COVID-19 Pandemic

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

Our manufacturing operations are considered a critical infrastructure industry, as defined by the U.S. Department of Homeland Security, as such, the decrees issued by national, state, and local governments in response to the COVID-19 pandemic have had minimal impact on our operations except for higher employee absenteeism in our manufacturing facilities. We had continuous operations during the six months ended June 30, 2020. For the most part, our workers are able to socially distance themselves during the manufacturing process. Additional precautions have been taken to social distance workers that work in close environments. The Company utilizes sanitation stations, requires the use of a facial covering, performs daily temperature scanning, and performs additional cleaning and sanitation throughout the day and deep cleaning overnight. The Company did see significant employee absenteeism in the latter part of June. These unexpected employee absences resulted in reduced shipments and longer lead times.
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The magnitude of the impact of COVID-19 remains unpredictable and we, therefore, continue to anticipate potential supply chain disruptions, employee absenteeism and additional health and safety costs related to the COVID-19 pandemic that could unfavorably impact our business.

Although these disruptions and costs are expected to be temporary, there is significant uncertainty around the duration and overall impact to our business operations. We believe it is possible that the impact of the COVID-19 pandemic could have a material adverse effect on the results of our operations, financial position and cash flows as of and for the year ended December 31, 2020.

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

Fair Value Measurements

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

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

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

Intangible Assets

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

Goodwill

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

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

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

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

2.  Revenue Recognition
 
Disaggregated net sales by major source:
Three Months Ended Six Months Ended
June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
(in thousands)
Rooftop units $ 99,145    $ 88,757    $ 209,975    $ 177,100   
Condensing units 4,505    5,156    9,003    9,206   
Air handlers 6,016    6,033    12,263    11,627   
Outdoor mechanical rooms 434    825    1,349    1,307   
Water source heat pumps 3,796    6,822    7,499    12,666   
Part sales 7,565    8,799    14,078    15,289   
Other 4,135    3,045    8,912    6,064   
Net Sales
$ 125,596    $ 119,437    $ 263,079    $ 233,259   

Disaggregated units sold by major source:
Three Months Ended Six Months Ended
June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Rooftop units 3,746    3,797    7,807    7,559   
Condensing units 446    479    854    873   
Air handlers 501    537    1,011    1,117   
Outdoor mechanical rooms   10    16    21   
Water source heat pumps 1,645    2,377    3,262    4,666   
Total Units
6,344    7,200    12,950    14,236   

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

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

The Representatives’ fee and Third Party Products amounts (“Due to Representatives”) are paid only after all amounts associated with the order are collected from the customer. The amount of payments to our Representatives were $14.9 million and $10.2 million for the three months ended June 30, 2020 and 2019, respectively. The amount of payments to our Representatives were $27.5 million and $21.7 million for the six months ended June 30, 2020 and 2019, respectively.

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

3.  Leases
 
We adopted ASU No. 2016-02, Leases (Topic 842), as amended, as of January 1, 2019, using the transition method, which becomes effective upon the date of adoption. The transition method allows entities to initially apply the new leases standard at the adoption date (January 1, 2019) and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. We have also elected the short-term lease measurement and recognition exemption which does not require balance sheet presentation for short-term leases. The Company historically does not enter into numerous or material lease agreements to support its manufacturing operations. Furthermore, any lease agreements entered into are usually less than a year and for leases on non material assets such as warehouse vehicles and office equipment. 

Adoption of the new standard resulted in the recording of additional lease right of use assets and lease liabilities of approximately $1.8 million as of January 1, 2019, which mostly relates to the multi-year facility lease assumed in our February 2018 business combination. The cumulative-effect adjustment to the opening balance was immaterial to the consolidated financial statements as a whole. The standard did not materially impact our consolidated net earnings or cash flows.  As of June 30, 2020, our right of use assets and lease liabilities are approximately $1.7 million.


4.  Accounts Receivable

Accounts receivable and the related allowance for doubtful accounts are as follows:
 
  June 30,
2020
December 31, 2019
  (in thousands)
Accounts receivable $ 56,823    $ 67,752   
Less:  Allowance for doubtful accounts (429)   (353)  
Total, net
$ 56,394    $ 67,399   
 
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  Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Allowance for doubtful accounts: (in thousands)
Balance, beginning of period $ 647    $ 379    $ 353    $ 264   
Provisions (recoveries) for losses on accounts (218)   13    76    128   
receivables, net of adjustments
Balance, end of period $ 429    $ 392    $ 429    $ 392   
 

5.  Inventories

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

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

  June 30,
2020
December 31, 2019
  (in thousands)
Raw materials $ 79,902    $ 68,842   
Work in process 2,275    1,825   
Finished goods 5,607    5,578   
Total, gross
87,784    76,245   
Less:  Allowance for excess and obsolete inventories (2,373)   (2,644)  
Total, net
$ 85,411    $ 73,601   

   Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Allowance for excess and obsolete inventories: (in thousands)
Balance, beginning of period $ 2,365    $ 1,567    $ 2,644    $ 1,210   
Provisions (recoveries) for excess and 81    796    (193)   1,153   
     obsolete inventories
Inventories written off (73)   (13)   (78)   (13)  
Balance, end of period $ 2,373    $ 2,350    $ 2,373    $ 2,350   


6.  Intangible Assets

Our intangible assets consist of the following:

June 30,
2020
December 31, 2019
(in thousands)
Intellectual property $ 700    $ 700   
Less: Accumulated amortization (545)   (428)  
       Total, net $ 155    $ 272   

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Amortization expense recorded in cost of sales is as follows:

   Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
(in thousands)
Amortization expense $ 58    $ 58    $ 117    $ 117   


7.  Supplemental Cash Flow Information
 
  Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Supplemental disclosures: (in thousands)
Income taxes paid $ 6,711    $ 41    $ 9,735    $ 394   
Non-cash investing and financing activities:    
Non-cash capital expenditures $ 6,046    $ (1,232)   $ 5,046    $ (164)  
Dividends declared 9,930    $ 8,355    $ 9,930    $ 8,355   
 

8.  Warranties

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

Changes in the warranty accrual are as follows:
  Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Warranty accrual: (in thousands)
Balance, beginning of period $ 12,940    $ 11,424    $ 12,652    $ 11,421   
Payments made (1,617)   (2,071)   (2,794)   (3,177)  
Provisions 1,837    2,313    3,302    3,422   
Balance, end of period $ 13,160    $ 11,666    $ 13,160    $ 11,666   
Warranty expense: $ 1,837    $ 2,313    $ 3,302    $ 3,422   
 
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9.  Accrued Liabilities

Accrued liabilities were comprised of the following:

  June 30,
2020
December 31, 2019
  (in thousands)
Warranty $ 13,160    $ 12,652   
Due to representatives 9,068    11,538   
Payroll 7,716    5,058   
Profit sharing 2,524    1,721   
Worker's compensation 648    522   
Medical self-insurance 915    707   
Customer prepayments 2,533    4,627   
Employee 401(k) profit sharing 2,870    —   
Donations 604    354   
Employee vacation time 3,645    3,804   
Other 3,309    3,286   
Total
$ 46,992    $ 44,269   
 

10.  Revolving Credit Facility

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

As of June 30, 2020, we were in compliance with our financial covenants. These covenants require that we meet certain parameters related to our tangible net worth and total liabilities to tangible net worth ratio. At June 30, 2020, our tangible net worth was $322.7 million and met the requirement of being at or above $175.0 million. Our total liabilities to tangible net worth ratio was 0.3 to 1, and met the requirement of not being above 2 to 1.


11.  Income Taxes

The provision (benefit) for income taxes consists of the following:
  Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
  (in thousands)
Current $ (789)   $ 1,534    $ 5,354    $ 3,320   
Deferred 5,228    2,409    5,061    3,318   
     Income tax provision $ 4,439    $ 3,943    $ 10,415    $ 6,638   

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

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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,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Federal statutory rate 21.0  % 21.0  % 21.0  % 21.0  %
State income taxes, net of Federal benefit 4.4    5.2    4.8    5.6   
Excess tax benefits (3.8)   (4.7)   (3.8)   (3.8)  
Other (1.6)   1.2    (1.2)   0.3   
     Effective tax rate 20.0  % 22.7  % 20.8  % 23.1  %
The Company's estimated annual 2020 effective tax rate, excluding discrete events, is approximately 25%. We file income tax returns in the U.S., state and foreign income tax returns jurisdictions. We are subject to U.S. income tax examinations for tax years 2016 to present, and to non-U.S. income tax examinations for the tax years 2015 to present. In addition, we are subject to state and local income tax examinations for the tax years 2015 to present. The Company continues to evaluate its need to file returns in various state jurisdictions. Any interest or penalties would be recognized as a component of income tax expense.

Coronavirus Aid, Relief, and Economic Security Act

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted on March 27, 2020, and includes a retroactive correction to the 2017 Tax Cuts and Jobs Act that allows for much faster depreciation of qualified improvement property that is placed in service after December 31, 2017. The retroactive correction allows for 100% first-year bonus depreciation for qualified improvement property placed in service in the tax years ended 2018 to 2022. Alternatively, companies can depreciate qualified improvement property placed in service during the tax year ended 2018 and beyond over 15 years using the straight-line method. Amending a prior period return to claim 100% first-year bonus depreciation for qualified improvement property placed in service in those years could result in a net operating loss that can be carried back to a prior tax year to recover taxes paid in that prior year.

As the Company collects and prepares necessary data and interprets the CARES Act and any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, additional adjustments to the financial statements may be made. We don't expect these additional adjustments to materially impact the provision for income taxes and effective tax rate in the period in which the adjustments are made. We expect the final accounting for the tax effects of the CARES Act to be completed by the third quarter in 2020.


12. Share-Based Compensation

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

On May 24, 2016, our stockholders adopted the 2016 Long-Term Incentive Plan ("2016 Plan") which provides for approximately 8.9 million shares, comprised of 3.4 million new shares provided for under the 2016 Plan, approximately 0.4 million shares that were available for issuance under the previous LTIP that are now authorized for issuance under the 2016 Plan, approximately 2.6 million shares that were approved by the stockholders on May 15, 2018, and an additional 2.5 million shares that were approved by the stockholders on May 12, 2020. Under the 2016 Plan, shares can be granted in the form of stock options, stock appreciation rights, restricted stock awards, performance awards, dividend equivalent rights, and other awards. Under the 2016 Plan, the exercise price of shares granted may not be less than 100% of the fair market value at the date of the grant. The 2016 Plan is administered by the Compensation Committee of the Board of Directors or such other committee of the Board of Directors as is designated by the Board of Directors (the “Committee”). Membership on the Committee is limited to independent directors. The Committee 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.

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Options

The total pre-tax compensation cost related to unvested stock options not yet recognized as of June 30, 2020 is $26.5 million and is expected to be recognized over a weighted average period of 3.4 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, 2020 and 2019 using a Black Scholes-Merton Model:
  Six months ended
  June 30, 2020 June 30, 2019
Directors and Officers:    
Expected dividend rate $0.33 $0.32
Expected volatility 31.63% 29.54%
Risk-free interest rate 0.64% 2.40%
Expected life (in years) 5.0 5.0
Employees:    
Expected dividend rate $0.32 $0.32
Expected volatility 31.23% 29.54%
Risk-free interest rate 0.69% 2.40%
Expected life (in years) 5.0 5.0
 
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, 2020:
 
Range of
Exercise
Prices
Number
of
Shares
Weighted
Average
Remaining
Contractual Life
(in years)
Weighted
Average
Exercise
Price
Intrinsic
Value
(in thousands)
$ 7.18    - $ 36.95    592,236    5.76 $ 27.90    $ 15,632   
$ 37.00    - $ 40.87    6,518    3.29 38.16    105   
$ 41.37    - $ 57.82    260,412    8.30 41.46    3,340   
Total 859,166    6.51 $ 32.09    $ 19,077   
 
The following is a summary of stock options vested and exercisable as of June 30, 2019:

Range of
Exercise
Prices
Number
of
Shares
Weighted
Average
Remaining
Contractual Life
(in years)
Weighted
Average
Exercise
Price
Intrinsic
Value
(in thousands)
$ 7.18    - $ 33.20    386,282    5.57 $ 21.63    $ 11,028   
$ 33.40    - $ 40.87    190,504    7.43 35.57    2,784   
$ 41.37    - $ 50.18    6,070    0.87 41.37    53   
Total 582,856    6.13 $ 26.39    $ 13,865   
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A summary of stock option activity under the plans is as follows:
Stock Options Shares Weighted
Average
Exercise
Price
Outstanding at December 31, 2019
3,627,047    $ 36.32   
Granted
1,023,067    44.66   
Exercised
(417,486)   33.95   
Forfeited or Expired
(110,352)   40.49   
Outstanding at June 30, 2020
4,122,276    $ 38.52   
Exercisable at June 30, 2020
859,166    $ 32.09   
 
The total intrinsic value of options exercised during the six months ended June 30, 2020 and 2019 was $8.8 million and $5.0 million, respectively. The cash received from options exercised during the six months ended June 30, 2020 and 2019 was $14.2 million and $7.7 million, respectively. The impact of these cash receipts is included in financing activities in the accompanying Consolidated Statements of Cash Flows.

Restricted Stock

The fair value of restricted stock awards is based on the fair market value of AAON, Inc. common stock on the respective grant dates, reduced for the present value of dividends. At June 30, 2020, unrecognized compensation cost related to unvested restricted stock awards was approximately $6.2 million, which is expected to be recognized over a weighted average period of 3.2 years.

- 14 -


A summary of the unvested restricted stock awards is as follows:
 
Restricted Stock Shares Weighted
Average
Grant Date
Fair Value
Unvested at December 31, 2019
267,484    $ 34.42   
Granted
76,148    43.54   
Vested
(106,695)   32.58   
Forfeited
(3,590)   40.11   
Unvested at June 30, 2020
233,347    $ 38.15   

Share-Based Compensation

A summary of share-based compensation is as follows: 
Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Grant date fair value of awards during the period: (in thousands)
Options $ 1,169    $ 127    $ 12,074    $ 20,071   
Restricted stock 806    876    3,316    4,584   
Total $ 1,975    $ 1,003    $ 15,390    $ 24,655   
Share-based compensation expense:
Options $ 2,296    $ 1,522    $ 3,928    $ 6,144   
Restricted stock 1,047    857    1,766    1,642   
Total $ 3,343    $ 2,379    $ 5,694    $ 7,786   
Income tax benefit/(deficiency) related to share-based compensation:
Options $ 680    $ 488    $ 1,411    $ 731   
Restricted stock 160    304    494    455   
Total $ 840    $ 792    $ 1,905    $ 1,186   
 
Share-based compensation expense is recognized on a straight-line basis over the service period of the related share-based compensation award. Stock options and restricted stock awards, granted to employees, vest at a rate of 20% per year. Restricted stock awards granted to directors historically vest one-third each year or, if granted on or after May 2019, vest over the shorter of directors' remaining elected term or one-third each year. Forfeitures are accounted for as they occur.

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

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13. Employee Benefits

Defined Contribution Plan - 401(k)

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

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

Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
(in thousands)
Contributions made to the defined contribution plan $ 2,099    $ 2,090    $ 4,549    $ 3,450   

Profit Sharing Bonus Plan

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

Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
(in thousands)
Profit sharing bonus plan expense $ 2,524    $ 1,958    $ 5,691    $ 3,264   

Employee Medical Plan

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

Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
(in thousands)
Medical claim payments $ 1,983    $ 1,330    $ 3,858    $ 2,850   
Health saving account payments 899    900    1,773    1,620   

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14.  Earnings Per Share

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

The following table sets forth the computation of basic and diluted earnings per share:
  Three Months Ended Six Months Ended
  June 30,
2020
June 30,
2019
June 30,
2020
June 30,
2019
Numerator: (in thousands, except share and per share data)
Net income
$ 17,804    $ 13,391    $ 39,657    $ 22,148   
Denominator:    
Basic weighted average shares
52,099,694    52,120,272    52,160,348    52,087,626   
Effect of dilutive stock options and restricted stock
650,707    626,927    725,143    502,219   
Diluted weighted average shares
52,750,401    52,747,199    52,885,491    52,589,845   
Earnings per share:    
Basic
$ 0.34    $ 0.26    $ 0.76    $ 0.43   
Diluted
$ 0.34    $ 0.25    $ 0.75    $ 0.42   
Anti-dilutive shares:    
Shares
1,047,616    1,898,078    650,526    1,912,902   


15. Stockholders’ Equity

Stock Repurchases

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

Our open market repurchase programs are as follows:

Agreement Execution 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 in AAON, Inc. stock in their accounts sold to the Company. The maximum number of shares to be repurchased is contingent upon the number of shares sold by employee-participants.

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



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Our repurchase activity is as follows:
Six Months Ended
June 30, 2020 June 30, 2019
(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    5,799    $ 200    $ 34.46   
401(k) 208,604    10,957    52.53    226,708    9,991    44.07   
Directors and employees 22,147    1,102    49.76    24,065    980    40.73   
Total
334,440    $ 17,046    $ 50.97    256,572    $ 11,171    $ 43.54   

Our repurchase activity since Company inception, including our current authorized stock repurchase programs, are as follows:
Inception to June 30, 2020
(in thousands, except share and per share data)
Program Shares Total $ $ per share
Open market 4,205,255    $ 74,793    $ 17.79   
401(k) 7,676,343    130,883    17.05   
Directors and employees 2,004,076    20,684    10.32   
Total
13,885,674    $ 226,360    $ 16.30   

Subsequent to June 30, 2020 and through August 4, 2020, the Company repurchased 45,615 shares for $2.6 million from our 401(k) savings and investment plan.

Dividends

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

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


16. New Markets Tax Credit

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

Upon closing of the NMTC transaction, the Company provided an aggregate of approximately $15.9 million to the Investor, in the form of a loan receivable, with a term of twenty-five years, bearing an interest rate of 1.0%. This $15.9 million in proceeds plus capital contributed from the Investor was used to make an aggregate $22.5 million loan to a subsidiary of the Company. This financing arrangement is secured by equipment at the Company's Longview, Texas facilities and a guarantee from the Company, including an unconditional guarantee of NMTCs.
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This transaction also includes a put/call feature that either of which can be exercised at the end of the seven-year compliance period. The Investor may exercise its put option or the Company can exercise the call, both of which could serve to trigger forgiveness of a portion of the debt. The Investor's interest of $6.3 million is recorded in New market tax credit obligation on the consolidated balance sheet. The Company incurred approximately $0.3 million of debt issuance costs related to the above transactions, which are being amortized over the life of the transaction.

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

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


17. Commitments and Contingencies