Share-Based Compensation

9 Months Ended

Sep. 30, 2021

Share-based Payment Arrangement [Abstract]

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. 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 (as amended, the "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 determines the persons to whom awards are to be made, the type, size and terms of awards, interprets the 2016 Plan, establishes and revises rules and regulations relating to the 2016 Plan and makes any other determinations that it believes necessary for the administration of the 2016 Plan. The Committee may delegate certain duties to one or more officers of the Company as provided in the 2016 Plan.

Options

The total pre-tax compensation cost related to unvested stock options not yet recognized as of September 30, 2021 is $19.5 million and is expected to be recognized over a weighted average period of approximately 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 nine months ended September 30, 2021 and 2020 using a Black Scholes-Merton Model:


	Nine months ended
	September 30, 2021	September 30, 2020
Directors and SLT1:
Expected dividend rate	$0.38	$0.33
Expected volatility	35.78%	31.63%
Risk-free interest rate	0.51%	0.64%
Expected life (in years)	4.0	5.0
Employees:
Expected dividend rate	$0.38	$0.32
Expected volatility	38.69%	31.31%
Risk-free interest rate	0.30%	0.68%
Expected life (in years)	3.0	5.0
1 Senior Leadership Team ("SLT") consists of officers and key members of management.

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 September 30, 2021:


Range of Exercise Prices					Number of Shares	Weighted Average Remaining Contractual Life (in years)	Weighted Average Exercise Price		Intrinsic Value (in thousands)
$	8.17	-	$	40.87	593,901	4.88	$	30.33	$	20,790
$	41.37	-	$	41.37	415,541	6.72	41.37		9,961
$	42.42	-	$	73.36	139,605	8.36	45.08		2,828
			Total		1,149,047	5.97	$	36.12	$	33,579

The following is a summary of stock options vested and exercisable as of September 30, 2020:


Range of Exercise Prices					Number of Shares	Weighted Average Remaining Contractual Life (in years)	Weighted Average Exercise Price		Intrinsic Value (in thousands)
$	7.18	-	$	36.95	526,235	5.51	$	28.03	$	16,957
$	37.00	-	$	40.87	1,978	7.34	38.50		43
$	41.37	-	$	60.32	210,496	8.19	41.53		3,940
			Total		738,709	6.28	$	31.90	$	20,940

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


Stock Options	Shares	Weighted Average Exercise Price
Outstanding at December 31, 2020	3,752,945	$	39.00
Granted	360,980	72.93
Exercised	(412,284)	35.35
Forfeited or Expired	(140,077)	48.51
Outstanding at September 30, 2021	3,561,564	$	42.49
Exercisable at September 30, 2021	1,149,047	$	36.12

The total intrinsic value of options exercised during the nine months ended September 30, 2021 and 2020 was $15.1 million and $12.1 million, respectively. The cash received from options exercised during the nine months ended September 30, 2021 and 2020 was $14.6 million and $18.5 million, respectively. The impact of these cash receipts is included in financing activities in the accompanying Consolidated Statements of Cash Flows.

Performance Awards

We have awarded performance restricted stock units ("PSUs") to certain officers and key employees under our 2016 Plan. Unlike our restricted stock awards, these PSUs are not considered legally outstanding and do not accrue dividends during the vesting period. These PSUs vest based on the level of achievement with respect to the Company's three year total shareholder return ("TSR") benchmarked against similar companies included in the capital goods sector of the S&P SmallCap 600 Index. The TSR measurement period is the three years ending December 31, 2023. At the end of the measurement period, each award will be converted into common stock at 0% to 200% of the PSUs held, depending on overall TSR as compared to the S&P SmallCap 600 Index benchmark companies.

The total pre-tax compensation cost related to unvested PSUs not yet recognized as of September 30, 2021 is $1.1 million and is expected to be recognized over a weighted average period of approximately 2.2 years.

The following weighted average assumptions were used to determine the fair value of the PSUs granted on the original grant date for expense recognition purposes for PSUs granted during the nine months ended September 30, 2021 using a Monte Carlo Model:


			Nine months ended
			September 30, 2021

Expected dividend rate			$0.38
Expected volatility			39.10%
Risk-free interest rate			0.28%
Expected life (in years)			2.60

The expected term of the PSUs is based on the remaining performance period ending December 31, 2023. 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.

A summary of the unvested PSUs is as follows:


	Shares	Weighted Average Grant Date Fair Value
Unvested at December 31, 2020	—	$	—
Granted	18,483	87.78
Vested	—	—
Forfeited	(1,632)	87.78
Unvested at September 30, 2021	16,851	$	87.78

Restricted Stock

The fair value of restricted stock awards is based on the fair market value of AAON, Inc. common stock on the respective grant dates, reduced for the present value of dividends. At September 30, 2021, unrecognized compensation cost related to unvested restricted stock awards was approximately $4.8 million, which is expected to be recognized over a weighted average period of approximately 2.3 years.

A summary of the unvested restricted stock awards is as follows:


	Shares	Weighted Average Grant Date Fair Value
Unvested at December 31, 2020	224,691	$	38.22
Granted	32,600	69.12
Vested	(89,523)	35.85
Forfeited	(7,051)	49.81
Unvested at September 30, 2021	160,717	$	45.29

Share-Based Compensation

A summary of share-based compensation is as follows:


	Three Months Ended				Nine Months Ended
	September 30, 2021		September 30, 2020		September 30, 2021		September 30, 2020
Grant date fair value of awards during the period:	(in thousands)
Options	$	152	$	258	$	6,870	$	12,332
Performance awards	32		—		1,622		—
Restricted stock	80		—		2,253		3,316
Total	$	264	$	258	$	10,745	$	15,648

Share-based compensation expense:
Options	$	2,167	$	2,208	$	6,594	$	6,136
Performance awards	166		—		355		—
Restricted stock	658		644		1,835		2,410
Total	$	2,991	$	2,852	$	8,784	$	8,546

Income tax benefit/(deficiency) related to share-based compensation:
Options	$	440	$	579	$	3,010	$	1,990
Restricted stock	1		9		820		503
Total	$	441	$	588	$	3,830	$	2,493

Share-based compensation expense is recognized on a straight-line basis over the service period of the related stock options and restricted stock awards. Historically, 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. As of March 2021, all new grants of stock options and restricted stock awards, granted to employees, vest at a rate of 33.3% per year. Forfeitures are accounted for as they occur.

Historically, if the employee or director is retirement eligible (as defined by the applicable LTIP or 2016 Plan) or becomes retirement eligible during service period of the related stock options and restricted stock 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 stock options and restricted stock 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.

Share-based compensation expense is recognized on a straight-line basis over the service period of the performance awards. The performance awards cliff vest at the end of the performance period. The performance awards are subject to several service conditions and market conditions, as defined by the performance restricted stock unit agreement, which allows the holder to retain a pro-rata amount of awards as a result of certain termination conditions, retirement, change in common control or death. Forfeitures are accounted for as they occur.