AAON(AAON) - 2022 Q4 - Annual Report

Part I - Business and Risk Factors This section details AAON's HVAC business, operational risks, property holdings, and ongoing legal challenges Business Overview AAON designs, manufactures, and sells premium HVAC equipment across three segments, focusing on mass customization, energy efficiency, and indoor air quality for commercial and industrial markets Overview and Business Segments AAON engineers and manufactures premium HVAC equipment, operating through its AAON Oklahoma, AAON Coil Products, and BASX segments - The company is engaged in the engineering, manufacturing, marketing, and sale of premium air conditioning and heating equipment, including rooftop units, data center cooling solutions, and cleanroom systems[9] - AAON operates through three business segments: - AAON Oklahoma: Designs and manufactures a wide range of HVAC systems and controls - AAON Coil Products: Focuses on HVAC systems and manufacturing heating/cooling coils - BASX: Specializes in custom-engineered air handling systems for data centers, cleanrooms, and other industrial applications[10][11] Business Strategy, Products, and Marketing The company's strategy emphasizes mass customization, energy efficiency, and indoor air quality for its diverse HVAC product lines, primarily serving domestic markets - The company's business strategy is centered on "mass customization," using flexible manufacturing to produce standard, semi-custom, and custom equipment that emphasizes high performance, energy efficiency, and superior indoor air quality[13][14] - Sales are primarily domestic, with foreign sales accounting for only 3.1% of net sales in 2022[15] - Product offerings include rooftop units with cooling capacities from 2 to 261 tons, Zero Degree Cold Climate Air-Source Heat Pumps, and specialized data center and cleanroom solutions from the BASX segment[18][19][24][25] - The company is well-positioned to meet heightened demand for indoor air quality features, offering solutions for humidity control, MERV 13 filtration, increased outdoor air ventilation, and air disinfection to mitigate virus transmission[27][28][29] Sales, Customers, and Competition AAON markets products through independent representatives, faces customer concentration, and competes with larger industry players despite significant backlog growth - The company utilizes approximately 64 independent manufacturer representative organizations with 127 offices to market its products, primarily in the U.S. and Canada[30] - A single customer, Texas AirSystems LLC, accounted for 10% or more of sales in 2022, 2021, and 2020, representing a significant customer concentration[35] Order Backlog Growth | Date | Backlog (approx.) | | :--- | :--- | | February 1, 2023 | $547.3 million | | February 1, 2022 | $347.6 million | - Key competitors include larger, well-resourced companies such as Lennox, Trane, Carrier, and Johnson Controls, with Vertiv and STULZ competing in the BASX segment[37] Resources, R&D, and ESG The company manages raw material costs, significantly increased R&D investments, and actively pursues environmental, social, and governance initiatives - The most important raw materials are steel, copper, and aluminum, with the company using contracts to limit price fluctuation impacts[40] Research & Development Expenses (2020-2022) | Year | R&D Expense (approx.) | | :--- | :--- | | 2022 | $46.8 million | | 2021 | $16.6 million | | 2020 | $17.4 million | - The significant increase in 2022 R&D spending was driven by the inclusion of a full year of BASX operations and a continued commitment to innovation, supported by the advanced Norman Asbjornson Innovation Center (NAIC) laboratory[43][44] - The company is focused on ESG initiatives, including reducing greenhouse gas emissions, increasing hazardous waste recycling (over 14,928 tons of metal in 2022), and developing non-fossil fuel consuming products[55][57] Human Capital AAON has experienced significant employee headcount growth, maintains positive employee relations, and offers competitive benefits without union representation Employee Headcount Growth | Date | Total Employees | | :--- | :--- | | Feb 22, 2023 | 3,666 | | Feb 22, 2022 | 2,881 | | Feb 23, 2021 | 2,268 | - The company's employees are not represented by unions, and management considers employee relations to be good, offering competitive benefits including a 401(k) with a 175% employer match and a profit-sharing bonus plan[58][61] Risk Factors AAON faces risks from economic downturns, customer concentration, supply chain disruptions, cybersecurity threats, and evolving environmental regulations, particularly refrigerant transition costs - Pandemic & Economic Risks: Business can be adversely affected by public health emergencies like COVID-19 and is sensitive to economic conditions that influence the new construction and replacement markets[64][67] - Customer & Channel Risks: The company has a significant customer concentration, with one customer accounting for over 10% of sales, and is dependent on its network of third-party representatives to market and sell products[68][69] - Operational & Supply Chain Risks: The company may be adversely affected by the availability and price of raw materials (steel, copper, aluminum) and components, with a majority of operations concentrated in Tulsa, OK, posing a risk from natural disasters[74][80] - Technology & Cybersecurity Risks: The business is subject to risks from cybersecurity attacks and is reliant on its information technology infrastructure[82][84] - Regulatory Risks: The company is subject to extensive environmental regulations, with a key challenge being the mandated transition to a new, lower global warming potential refrigerant by 2025, which is expected to incur costs for product redesign, facility updates, and materials[85][91][92] Properties AAON owns and leases substantial manufacturing and R&D facilities in Oklahoma, Texas, and Oregon, with ongoing expansion efforts across its operational footprint - AAON Oklahoma: Owns multiple facilities in Tulsa, OK, including a 940,000 sq. ft. manufacturing building and the 134,000 sq. ft. NAIC R&D laboratory, and also leases a 51,000 sq. ft. plant in Parkville, MO, which is being expanded[95][97][99] - AAON Coil Products: Owns two main buildings in Longview, TX, totaling 485,000 sq. ft. of manufacturing/warehouse space, and purchased an additional 64,000 sq. ft. warehouse in January 2023[100] - BASX: Operates in a 194,000 sq. ft. plant/office in Redmond, OR, and leases smaller additional spaces[101] Legal Proceedings AAON is defending against a lawsuit from a former sales representative, Havtech, LLC, seeking at least $48.6 million in damages following a business relationship termination - A former sales representative, Havtech, LLC, filed a complaint challenging the termination of its business relationship and is seeking damages of at least $48.6 million, which the company believes are without merit[340] Part II - Market, Financials, and Controls This section details AAON's stock market activity, management's financial analysis, market risk exposures, consolidated financial statements, and internal controls Stock Market, Dividends, and Share Repurchases AAON's common stock trades on NASDAQ, with the company increasing cash dividends and conducting share repurchases while maintaining equity compensation plans Cash Dividends Declared per Share (2020-2022) | Declaration Date | Dividend per Share | | :--- | :--- | | May 15, 2020 | $0.19 | | Nov 10, 2020 | $0.19 | | May 17, 2021 | $0.19 | | Nov 9, 2021 | $0.19 | | May 18, 2022 | $0.19 | | Nov 8, 2022 | $0.24 | Share Repurchases (Q4 2022) | Period | Total Shares Purchased | Average Price Paid | | :--- | :--- | :--- | | Oct 2022 | 87,049 | $55.33 | | Nov 2022 | 23 | $65.00 | | Dec 2022 | 196 | $76.66 | | Total | 87,268 | $55.38 | - As of December 31, 2022, there were 3,599,896 securities remaining available for future issuance under the 2016 Long-Term Incentive Plan[105] Management's Discussion and Analysis (MD&A) AAON achieved record 2022 results with strong sales growth and improved margins, driven by acquisitions and pricing, while managing liquidity and planning significant capital expenditures Results of Operations AAON's 2022 operations saw significant net sales growth and improved gross margins, driven by acquisitions and pricing, despite rising raw material costs and SG&A expenses Consolidated Results of Operations (2021-2022) | Metric | 2022 (in millions) | 2021 (in millions) | % Change | | :--- | :--- | :--- | :--- | | Net Sales | $888.8 | $534.5 | 66.3% | | Gross Profit | $237.6 | $137.8 | 72.4% | | Gross Margin | 26.7% | 25.8% | +90 bps | | Income from Operations | $126.8 | $69.3 | 83.0% | - Net sales growth of $354.3 million was driven by the BASX acquisition (19.5% of growth), price increases ($100.0 million), and organic sales volume/mix ($149.8 million)[127] - AAON Coil Products segment gross margin increased significantly to 31.0% from 15.1% in 2021, primarily due to faster realization of price increases and increased operational efficiencies from its new manufacturing building[127] Raw Material Cost Increases (2022 vs 2021 Avg.) | Material | % Change | | :--- | :--- | | Copper | +13.4% | | Galvanized Steel | +14.5% | | Stainless Steel | +61.0% | | Aluminum | +14.0% | - SG&A expenses increased by $42.2 million to $110.8 million, largely due to a full year of BASX operations, increased salaries and benefits from headcount growth and wage hikes, and higher profit-sharing expenses[130][131] Liquidity and Capital Resources The company manages liquidity through a revolving credit facility, adjusted share repurchase activity, and plans substantial capital expenditures for 2023 - The company maintains a $200.0 million revolving credit facility, which had an outstanding balance of $71.0 million and available borrowings of $128.2 million as of December 31, 2022[135] Stock Repurchase Activity | Year | Total Repurchase (in millions) | | :--- | :--- | | 2022 | $13.8 | | 2021 | $22.5 | - The decrease in stock repurchases in 2022 was primarily due to the discontinuation of the 401(k) buyback program in June 2022[152] - The capital expenditure program for 2023 is estimated to be approximately $135.0 million[151] Cash Flow Analysis Cash flow analysis reveals stable operating cash, reduced investing outflows due to the prior year's BASX acquisition, and impacts from inventory and accounts receivable growth Summary of Cash Flows (2021-2022) | Activity | 2022 (in millions) | 2021 (in millions) | | :--- | :--- | :--- | | Net cash from operating activities | $61.3 | $61.2 | | Net cash used in investing activities | ($76.2) | ($158.7) | | Net cash from financing activities | $17.4 | $18.7 | - Cash used in investing activities decreased significantly in 2022 because 2021 included the $103.4 million cash payment for the BASX acquisition[150] - Operating cash flow was impacted by a $71.4 million increase in inventories to mitigate supply chain disruptions and a $56.3 million increase in accounts receivable due to higher sales volume[147][149] Critical Accounting Estimates Management's critical accounting estimates involve significant judgment for inventory valuation, warranty accruals, share-based compensation, and goodwill impairment assessments - Management identifies several critical accounting estimates requiring significant judgment, including: - Inventory: Valued at lower of cost or net realizable value, with reserves for obsolescence and shrinkage - Warranty Accrual: Estimated based on historical trends and known issues - Share-Based Compensation: Fair value is estimated using Black-Scholes-Merton and Monte Carlo models, which require subjective assumptions - Goodwill and Intangible Assets: Assessed for impairment annually (in Q4) or when triggering events occur, with the 2022 qualitative assessment indicating no impairment[157][160][163][165] Market Risk Disclosures AAON faces market risks from commodity price volatility and interest rate fluctuations on its variable-rate debt, with a 1% rate increase impacting pre-tax income by $0.7 million - The company is exposed to price volatility in commodities such as steel, copper, and aluminum[172] - The company is exposed to interest rate risk on its $71.0 million of outstanding variable-rate debt, where a 1% increase in the interest rate would reduce annual income before taxes by about $0.7 million[173] Financial Statements and Supplementary Data This section presents the audited consolidated financial statements, including balance sheets, income statements, and cash flows, with notes detailing key accounting policies and transactions Independent Auditor's Report Grant Thornton LLP issued an unqualified audit opinion, highlighting manual inventory adjustments as a critical audit matter due to valuation complexities - The independent auditor, Grant Thornton LLP, issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2022[179][180] - The auditor identified "manual inventory adjustments" as a critical audit matter due to the substantial management judgment and estimation uncertainty involved in inventory valuation, particularly given recent raw material price changes and supply chain challenges[184][185] Consolidated Financial Statements This section provides key consolidated financial statements, including balance sheet accounts and income statement performance metrics for recent fiscal years Key Balance Sheet Data (as of Dec 31) | Account | 2022 (in millions) | 2021 (in millions) | | :--- | :--- | :--- | | Total Current Assets | $349.1 | $218.1 | | Total Assets | $813.9 | $650.2 | | Total Current Liabilities | $145.6 | $86.8 | | Total Stockholders' Equity | $560.7 | $466.2 | Key Income Statement Data (Year Ended Dec 31) | Account | 2022 (in millions) | 2021 (in millions) | 2020 (in millions) | | :--- | :--- | :--- | :--- | | Net Sales | $888.8 | $534.5 | $514.6 | | Gross Profit | $237.6 | $137.8 | $155.8 | | Net Income | $100.4 | $58.8 | $79.0 | | Diluted EPS | $1.86 | $1.09 | $1.49 | Notes to Financial Statements The notes detail significant accounting policies, including the BASX acquisition's financial impact, share-based compensation, and segment-level performance data - Note 4 (Business Combination): The acquisition of BASX closed on Dec 10, 2021, with the final allocation of the $103.7 million consideration resulting in $78.7 million of goodwill and $68.4 million of intangible assets (customer relationships, intellectual property, trademarks)[254][259][260] - Note 14 (Share-Based Compensation): Total share-based compensation expense was $13.7 million in 2022, compared to $11.8 million in 2021, including costs for stock options, restricted stock, PSUs, and special awards for key BASX employees[315] - Note 22 (Segments): Provides a detailed breakdown of external sales, inter-segment sales, and gross profit for the three reportable segments, with AAON Oklahoma having external sales of $663.8 million, AAON Coil Products $107.3 million, and BASX $117.7 million in 2022[356] Controls and Procedures Management and the independent auditor concluded that AAON's disclosure controls and internal control over financial reporting were effective as of December 31, 2022 - Management concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report (December 31, 2022)[358] - Management's annual report on internal control over financial reporting concluded that the company maintained effective internal control as of December 31, 2022[359][360] - The independent registered public accounting firm, Grant Thornton LLP, audited and issued an unqualified opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2022[361][363] Part III - Corporate Governance and Executive Compensation This section's content on corporate governance, executive compensation, and related matters is incorporated by reference from the company's 2023 Proxy Statement - Information required by Items 10, 11, 12, 13, and 14 of Form 10-K is incorporated by reference from the company's definitive Proxy Statement to be filed for the 2023 Annual Meeting of Stockholders[370][372][373][374] Part IV - Exhibits and Schedules This section provides a comprehensive list of all financial statements, schedules, and exhibits filed as part of the Form 10-K report - This part lists all exhibits filed with the Form 10-K, including the Amended and Restated Loan Agreement, various long-term incentive plans, a list of subsidiaries, and CEO/CFO certifications[375]