Good morning, ladies and gentlemen. Welcome to AAON, Incorporated Second Quarter Sales and Earnings Call. There will be a question-and-answer period after management’s brief presentation. This call will last approximately 45 minutes to 1 hour. I would now like to turn the meeting over to Gary Fields, CEO and President. Please go ahead.

Good morning. Thank you for joining us. I'd like to begin by reading a forward-looking disclaimer. A reminder, to the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statement is necessarily forward-looking and made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995, the Securities Act of 1933 and the Securities and Exchange Act of 1934, each as amended. As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ materially from those anticipated. Please see the risk factors contained in our most recent SEC filings, including the annual report on Form 10-K and the quarterly report on Form 10-Q. Today, joining me on the call, our Executive Chairman, Norm Asbjornson; and our Chief Financial Officer, Rebecca Thompson. Rebecca will open by reviewing our financial performance. Rebecca, please?

Thank you, Gary. I'd like to begin by discussing the comparative results for the three months ended June 30, 2021 versus June 30, 2020. Net sales increased 14.6% to $143.9 million from $125.6 million. The year-over-year increase was driven by a robust replacement demand broadly across our nonresidential building market. Higher production rates were also a contributing factor as we did not experience COVID-related employee absences like we did in 2020. Also the 4% price increase we implemented in early January was a driving factor. All these items are partially offset by changes in the product mix to lower-priced units. Our gross profit increased 10.4% to $42.1 million from $38.1 million. As a percentage of sales, gross profit was 29.3% in the quarter just ended compared to 30.4% in the second quarter of 2020. The slight decline in gross profit was mainly related to higher material costs. Selling, general and administrative expenses increased 6% to $16.9 million from $15.9 million in 2020. As a percentage of sales, SG&A decreased to 11.7% of total sales in the quarter just ended from 12.7% in the second quarter of 2020. SG&A as a percent of sales decreased as we did not have the $1.25 million donation we made in 2020 to Winifred Public School. Income from operations increased 13.6% to $25.2 million or 17.5% of sales from $22.2 million or 17.7% of sales in 2020. Our effective tax rate was decreased to 18.3% from 20%. The lower tax rate was mainly related to lower corporate income tax rates in the state of Oklahoma that were signed into law during the quarter. This resulted in a one-time benefit of $0.8 million. The company’s estimated annual 2021 effective tax rate, excluding discrete events, is expected to be approximately 25%. Net income increased to $20.6 million or 14.3% of sales compared to $17.8 million or 14.2% of sales in the first quarter of 2020. Diluted earnings per share increased by 11.8% to $0.38 per share from $0.34 per share in 2020. Turning to the balance sheet, you'll see that we had a working capital balance of $180.6 million versus $161.2 million at December 31, 2020. Unrestricted cash totaled $111.4 million at June 30, 2021, up from $79 million at the end of 2020. Our current ratio is approximately 3.3:1. Our capital expenditures were $33.2 million for the six months ended June 30, 2021. We expect capital expenditures for the year to be approximately $70 million. The company had stock repurchases of $10.3 million during the six months ended June 30, 2021. Shareholders' equity per diluted share is $7.14 at June 30, 2021, compared to $6.67 at December 31, 2020. I'd now like to turn the call back over to our CEO and President, Gary Fields.

I'd like to start off by saying that the second quarter was a bit better than we expected. Organic sales were up year-over-year, nearly 15%. And this is quite noteworthy for us because we're not facing the same easy comparison to 2020 that some of our nonresidential market competitors experienced. A great deal of the competitors peers in the HVAC market were down in the 20% to 25% range in 2020. So it's an easy upside for 2021 for them. On the other hand, we were up 5% in the second quarter of 2020 compared to the year before. So compared to our second quarter of 2019, which is where I'd really like to go back and talk about because that takes us pre-coronavirus. Our sales in second quarter 2021 were up over 20% versus 2019. Looking at it the same way the industry sales as an industry were down either flat to slightly down versus 2019. So this is quite an accomplishment that we've achieved. The other thing is we ended the year with our backlog at a lower level than was ideal. We had ramped up production significantly, which was a great thing and the orders had slowed down a bit while orders resumed right after the first of the year on a brisk pace. The backlog on June 30, 2021 is $138.1 million, up 35% year-over-year and 43% up over the end of the first quarter. The orders are up year-over-year 70% in the second quarter. So we see no demand slowdowns whatsoever. Talking to our sales channel, the pipeline is very robust. And so we're in real good shape going forward. The August 1 backlog was only slightly down from the end of June, but still in the $130 million range. I think it was $134 million. So we're maintaining a brisk pace of manufacturing as evidenced by the record quarter, bookings are very brisk, backlog is very robust. And so going forward, the rest of the year, we're looking at things to stay steady to maybe slightly strengthening. If the labor market was just a little more favorable for us to get more people then we would be prepared to accelerate even more. But we're in a very tight labor market right now. And I think that's industry-wide. I hear a lot of people talking about it. So I want to say that the replacement market demand has been much, much stronger. Historically, AAON had been about 50% replacement, 50% new construction. Thus far this year, we're running in the low to mid-60% range, I think 64% to 68% swinging back and forth on replacement. And this has been a dedicated effort of ours that we put in distinct sales channel guidance and support to make this happen and we're seeing the results, and we're very pleased with that. Now the new construction outlook is bright as it's been in a very, very long time. The Architectural Billing Index, Dodge Index, construction starts, all of these indexes are up substantially. The Architectural Billing Index has been up for several months in a row now. I think it's approaching five months that the Architectural Billing Index has been up. And I think that Dodge analytics support that it's actually getting into construction. So we're looking at all of our segments as we normally distribute them, commercial and retail is actually a little better than we anticipated. Office buildings are not horrible, they're not great. Medical and healthcare is much, much stronger than it's been in the past. Of course, education has always been a very strong area for AAON, and that continues to be. And with the focus on indoor air quality and some federal funding to help them with that, we look for that to continue and accelerate. Manufacturing has been just kind of decent, I won't call it good or bad. Lodging, again, has been a bit of a surprise. Not only if we renovated through the replacement market, a lot of lodging facilities, we're actually seeing a few new ones being built. So that's kind of where our markets are. I guess I left one out, the grow facility market. That's been more robust in 2021 than it had been in the recent few quarters. So our margins continue to march on, we were at 29.3% versus 30.4% a year ago. It was a little softer than we hoped. But overall, considering inflationary pressures, I think we did a very good job, where we had materials that were costing us more, we gained labor efficiency, manufacturing efficiency. The way we measure our manufacturing efficiency inside here is that we picked up several percentage points of improvement. The cost of goods sold, excluding materials components were down year-over-year by 1%. The June and September price increases have positioned us to maintain or possibly improve our gross margin in the second half. We expect most of that to happen in the fourth quarter and going into Q1 of 2022. So our timing typically, because our lead times average somewhere around eight to ten weeks. So when we have a price increase, it takes eight to ten weeks to flush the existing backlog through and get the new backlog out on the plant floor. So just tying that June 1, we had the price increase, about today would be about when we would start seeing that price increase hit the floor. So roughly half of Q3, you'll see that 4% price increase. We did have some pressures with some additional wage increases; we did this to maintain our competitive position in the labor market. We have had some success with that, and I look for continued success. I think we're doing an excellent job of managing SG&A, it's just up 6%, but with 15% sales growth. So that was not linear tracking; it was less than that, which is always a great thing. Both Tulsa and Longview have seen general productivity improvements. The average headcount across both operations combined is down about 5% year-over-year. The Longview headcount is up, the new building that we put in allowed us to get ahead of the curve and get some people in, and Tulsa's headcount is slightly down. So we've seen market share gains in multiple areas. Our water-source heat pump sales were up 69% versus this time last year. We got the newest AHRI data just yesterday, and it showed about a 1.5% market gain. So we were going from about 6% to 7.4%, I think is what it was. Parts sales, this is another wonderful occurrence for us. This was a very focused activity along with our replacement market. We've put in some very nice enhancements for the sales channels and support structures and some planning structures. So parts sales are up 42% year-over-year. Now last year, parts sales were down at this time, people weren't working on their buildings as much. So I don't have how that's relevant to 2019 other than I can tell you that parts sales are at a record level. So I know that we're well ahead of 2019 and 2020. Air handlers and condensing units sales were up 38%. This reflects a couple of things. One is our product has become more and more appreciated because we have an air source heat pump that has some very good operating characteristics to control humidity as well as serve as a heat pump in some larger sizes. The other thing is the new facility that we built in Longview has given us the capacity to meet the demand. We are ramping up that facility and doing quite well with that. So we're going to continue to invest. I think Rebecca said that we expect to spend $70 million in 2021, and we were in the mid-low to mid-30s—around $33 million at this point. This will be both refreshing some equipment that's a little slower or worn, aged out and also a little bit of accretive manufacturing capacity. So heading into the second half of the year, we're quite optimistic. Orders and backlog trends are strong. While there are some inflation headwinds that are a little bit of a challenge, we think we're ahead of that with our team. And so we believe that our margins will improve slightly throughout the year and end the year just slightly above our traditional target. In general, we expect sales and earnings to improve all through the second half of the year and going into the first part of next year because the 5% price increase across the board goes into effect September 1. We're not going to see that on the plant floor until the very end of Q4, and it will be more material in Q1 of 2022. Unlike most years where we've had a little bit of a bell curve, where Q1 and Q4 were down several percentage points in revenue versus Q2 and Q3, we're looking for Q3 to be at least comparable to Q2 with a slight increase. And we're looking at Q4 to—in all likelihood—be comparable to that. So we've kind of hit a rhythm here that we're looking for Q2, Q3 and Q4 to stack up relatively close to each other with maybe slight undulations but nothing substantial. It won't be because we don't have the orders and the bookings will be things that are totally outside of that, like Q4 has more holidays in it than Q3. So we'll be one or two days short in the amount of manufacturing because we do manufacture seven days a week. And so, that will affect it by a few dollars. But otherwise, I think we're in very good shape. So we will take any questions now.

Your first question comes from the line of Julio Romero with Sidoti & Company.

Good morning, Julio.

Good morning, Gary, Rebecca and Norm. How are you?

Good morning.

Good morning.

So I guess my first question is just on the increased volumes in the quarter, the increased production. Could you rank order the – you talked about the return to historical employee levels and increased manufacturing capacity. Can you just kind of rank order the two of those and talk about how they impacted volumes in the quarter?

Yes. Well, first off, the New Longview facility is so much more ideal than the old facility was that we're producing, I think casual math set around 27%, 28% more with the same number of people. Now we have more people there, so we're producing even more than that. But we've had a very nice gain in our Longview facility with the new plant. And that is primarily related to the infrastructure and the arrangement. Now we have added a few people in Longview versus a year ago. They are in the positive range by maybe 20 to 30 people, I think is what it is. In Tulsa, however, we're down probably 30 or 40 people versus last year on the plant floor. And yet we're producing at a very, very high level here as well. And that is an attribute to the manufacturing engineering group and the manufacturing group that have separately gone through and refined all of our processes, cleaned up a lot of loose ends, things that we knew were beneficial to the company that would make us more efficient. So we're several percentage points more efficient with that labor here. We measure it in terms of dollars of revenue per person on the plant floor and that dollars of revenue per person on the plant floor, let me calculate it here real quick, and I'll give you a percentage on that because I know what those numbers are. It's about 8% in revenue dollars on the plant floor, and this is absent of the price increase. I took that into account in that calculation. This is actual material going out the door. So to answer your question, if we had more people, we would go up linearly because the infrastructure is in place, everything is here. We could use about 200 people in Tulsa and about another 50 in Longview, and we would generate nice revenue with those, very nice profits because we’d absorb a lot of the fixed costs.

Got it. That's very helpful. And just thinking about the order growth, it's very robust, obviously, sequentially for the last two quarters. And you touched on the increased manufacturing capacity, how labor stands today? I guess, given all that, how do you see orders trending sequentially throughout the next few quarters?

Well, I think the rate that we're booking will maintain relatively steady for the next couple of quarters according to the intelligence we've gathered from our sales channel partners and what they tell us is in the pipeline. There are many drivers to that, but one of the key drivers is our lead time, whereas a couple of years ago, our lead time was very onerous to our efforts. Our sales channel partners told us we lost over $100 million in bookings opportunity because of that poor lead time. They had to turn down that many orders. Well, this year, we're not up $100 million in bookings, but we're approaching that. We're somewhere around $80 million above last year, I think…

Yes, I was thinking, yes.

And so, I think lead time has been a very motivating factor for that. Now there are people that have always wanted AAON equipment, and were even willing to pay for it, but they weren't willing to wait for it. That's the demographic that is different this year than we were a couple of years back. So we have a handle on the production needs. We have surplus capacity in the infrastructure. And now that we have behind us the federal government subsidy to people not working seems that we're maybe gaining a little ground on that. That only ended about five weeks ago here in Oklahoma and also in Texas; it was right at the end of June. But we've seen a very noticeable increase in applicants and qualified applicants. So I have great confidence that we will continue to service our market with acceptable or even appreciated lead times. People appreciate the lead times that we have.

Got it. And just to clarify, the rate of bookings could continue to rise sequentially?

The rate of bookings, I believe is going to stay relatively steady. So if we would look at our rate year-to-date on bookings, then it looks like that stays relatively steady. Unlike normally, about this time of year, we see a decline in bookings rate. But at this point in time, we've not seen a decline in bookings rate and the pipeline is telling us it's going to remain at this steady rate.

And you're looking at that from a year-over-year basis or…

I'm looking at that for the past six months basis for a rate.

Okay. I guess I'm missing what could go wrong? I mean, everyone is suffering from industrywide supply constraints, with respect to some labor – I don't know.

What could go wrong list is very – that's extensive. I mean, we got this delta variant that's going around. One of our plugs of 2020 that could come into a blessing of 2021 is we had a significant number of our people on the plant floor that had coronavirus in 2020. If you'll recall from about mid-June to mid-July, we lost hundreds of people that either had it or thought they had it and decided to stay out. The other thing is that we had vaccinations available here at the plant. We had a healthcare facility that brought mobile vaccinations into the plant, and we had several hundred people that took advantage of that. So I don't know what our percent vaccination is out there. But if I was to make just a little bit of napkin-math guess and say between those that have had the virus and those that have been vaccinated, I’d say we’ve achieved herd immunity, we're looking really good. We do have a spot here and there where we've got a couple of people out even at this point in time. But something like that could definitely rear its ugly head again. Supply chain, we are in a very, very good position. I sat down with that group earlier this week to review everything. We have an unusually large inventory right now. If you look through the queue, you’ll see what's our inventory, $83 million, $87 million something like that. $87 million, yes, it’s $87 million, that's not ideal in terms of best use of cash, you'd like for that to be more like 10% of revenue, it should be down in the $50 million, $60 million range. But I'm going to tell you, in 2021, I'm the proudest guy on the block to have $87 million because I can build equipment. And we've had some irritants from supply chain, but we haven't had anything that's plagued this and shut us down and some of these things. But there's a myriad of things that are going out there that you've never seen before. Maybe you've seen them and they came back. But we have a high level of confidence. We went through 2020 with around 10% growth in the face of all of our competitors essentially were down 15%, 20%, 25%. So we navigated through that very nasty rough condition better than most. I think this team is very strong, very capable and that we are continuing to navigate through all those obstacles with great skill.

Thank you for the color there. And just last one, I just—you mentioned $87 million of inventory. I imagine all things considered in this environment, you've got to have a little more inventory than you need than not. I mean how are you thinking about those inventory levels?

Absolutely. I went through there. We have not had any supply chain issues that have slowed us down. We have had a buffer. So when we had one of our suppliers of compressors that was having problems getting some insignificant little component that kept them from completing a compressor, for instance. And they said, we're going to be delayed two, three weeks on this next shipment. Well, I had four months' worth of inventory here of that particular compressor. And so that two or three weeks didn't do anything to us; it was innocuous. These people that are running closer to just in time on their inventory, they're sitting there looking at a bunch of units they can't build. So I'm very proud of what our purchasing department and logistics control department has done in keeping us ahead of these issues. Steel is another one. I hear people talking about, oh, I can't get steel. We not only have this place full of steel, we got warehouses full of steel, already paid for, waiting on us. So we're in very good shape.

Great. I'll hop back into the queue, and thanks for taking the questions.

Certainly.

Your next question comes from Jon Braatz with Kansas City Capital.

Good morning, everyone.

Good morning, Jon.

Gary, I have a question maybe Norm can chime in, too. We saw a dramatic shift in the mix in this quarter to a lot of lower-priced units. I guess, historically, have you seen such a shift before? And is it being driven by the replacement market, business being so strong?

It's being driven by two things, Jon. And it's being driven this quarter that we just ordered was driven by the K-12 school business. And a significant portion of that was replacement versus new. So what happened there, in my opinion, was the demand for better indoor air quality. The things that I’ve touted that AAON has very strong capability of our inherent design is very desirable. A lot of schools said we're going to replace our units. And we want AAON units, and we had lead time available. We have the kind of equipment that they wanted available, and we were able to service that. We got one order from one school district in North Texas that was 811 units, and there were only five SKUs in the whole thing. This is what generated more of those small units was that K-12 business that we serviced.

Hi, Jon.

Yes, Norm.

I don't have anything to add, but I cannot understand what was said.

All right. Would you – Gary, would you expect that to continue that mix?

Well, I think the mix will bounce out to more traditional going for the rest of the year. It's still going to be biased somewhat towards the smaller units for a little while, but it will start swinging back towards midsize to larger units as a higher percentage of the mix for the balance of the year because we've completed delivery on the vast majority of those schools. Now, a lot of that delivery took place in July and August, so the first one and a half months, two months of this quarter. And that's why I say it's beginning to swing now. When I look at the line rates for the various manufacturing lines that make the different size units, I'm seeing the smaller unit line, the daily rates slowed down just a little, the midsize and larger line picked up a little. So this is kind of a balancing quarter right here. In Q4, I think, will be spot on normal from everything I can see.

Okay. Okay. Secondly, last night, I went back and looked at some of the early things I wrote on the water-source heat pump. And at the time when it was first introduced, the opportunity was around $100 million and that was over a three to five-year time frame. And Gary, we're sitting at $25 million now maybe for the full year. I think that's sort of what my numbers show. The manufacturing doesn't seem to be a problem anymore. What is it going to take to get to the $100 million? Is that still a goal, has things changed maybe competitively or anything like that, that maybe is going to make it tougher to get to that $100 million? Is that really still an opportunity?

It is absolutely still an opportunity, and I've described it for the past two or three quarters. What we did was we sat down and went for a clean sheet design, took all the input from the market on all the desirable features and characteristics that they wanted. And that's what we designed and introduced. We were a bit naive to the fact that about 75% of the overall market—60% to 75% is replacement market. And when they replace these, the configuration needs to be as near identical as possible because they have minutes or hours to replace these things, not days and weeks. And so we didn't take that into account with our initial design. Now our initial design has maintained a very nice rate of sale where we have people that like all those characteristics we designed into it. So we're going to continue to offer our initial design because it is very—like you said—about $25 million a year. But in order to get to that bigger part of the market and those numbers work out exactly right. If it's 25% new construction and 75% replacement market and we need to be at $100 million, we're at 25% of that. Like 80-something of our units are going in new construction; near—all of our units are going into new construction. So we have—we're closing in on finishing the design testing implementation of a backwardly compatible ideal replacement unit. We're having a sales meeting in early October in Grapevine, Texas. It's our intention and our goal to introduce that new line to our sales channel partners there. We only have a national sales meeting every two to three years. We make sure that when we do that, we've got a significant number of advancements and new things to share with them. And so that's where we're at this year. And this water source heat pump line will be shared with about 1,000 sales channel partners, individuals in October, if that's a three-day sales meeting. And I look for 2022 to resume the growth of the water source heat pump business.

Okay. So the design and the manufacturing is all completed or nearly completed so that you'll be ready to go at the beginning of the year?

Yes. I checked in on that again earlier this week to make sure that at our October sales meeting, we would have all the testing, all the data, all the marketing materials, everything for a full rollout. We will have a full rollout in early October in that sales meeting, complete, ready to go.

Okay, okay. All right, Gary, thank you very much.

Thank you, Jon.

Your next question comes from the line of David Derman with GreenSummit.

Hi, Gary.

Hello, David. How are you today?

I’m good, I appreciate it. I wanted to make sure I understood your thinking in terms of how much backlog in terms of weeks of revenue you're looking to keep. I don't remember exactly. I think in the past, you had wanted to keep maybe somewhere in the round of eight weeks of capacity in backlog, but it seems like that's a moving target as you ramp up your capacity and your production and your efficiency. So could you update us on that, please?

Well, your numbers are almost exactly right. Ideal backlog would be about eight weeks because our production continues to increase. Now we've got substantial infrastructure in place that we don't have enough personnel to fully utilize. So our ramp-up is much quicker now than it has been in the past. Three, four years ago, we were behind on infrastructure. And that's why we built the new building in Longview, which was a three-year endeavor start to finish. And that's why we went through and cleaned up the Tulsa facility and added a lot of production here. So we can ramp up faster than we could in the past. But our ideal backlog right now would be eight weeks. Now I will tell you there's a little peril with eight weeks across the board. Your high volume moving products, they're smaller-sized units. That's not a problem whatsoever, six weeks, eight weeks is all the same; it's fine. But when you start getting into the larger-sized units that you have lower volumes, then it's really hard to have an inventory, some of the unique parts that it takes to build those units. And the supply chain being a little cloudy right now for some of those low-volume components makes it a little more difficult. I will say as a total tranche eight weeks is ideal. But if I divided that up from product lines, the smaller lines would be six weeks and the larger lines would be maybe 10 or 12 weeks.

Okay. So at a blend right now, you look like you're about call it, 12 weeks on the backlog, and the sales are roughly similar right now?

Yes. So right now, our published lead times across the border with rare exception or 10 weeks. And the reason for that is project planning. Some of this backlog we have is due to project planning; they have the order in here, but we allow them to put a date that's longer than lead time so that they get their spot in the waiting line. We've got some projects that have been delayed because they can't staff them, so they've moved a little bit. But if you looked at it in simple, like you said, back of the envelope math, it does look like somewhere around 12 weeks. But when you look at it on our production schedule, you'll see that we've published in 10 weeks and everything is in the green, very little in the red as far as being tardy versus commitment.

Got it. And if I understood your comments earlier in the call appropriately, looking for your orders signed to continue at roughly at a similar pace in the second half of the year that they signed in the first half of the year. And very simple math, you signed about $320 million in orders in the first half of the year. So if I assume something similar in the second half, it's another $320 million, you thought your sales may maintain at roughly their current rate, which is, call it, $280 million or $290 million. It seems like another $30 million or $40 million of backlog might accrue. So your backlog might end up. It seems like closer to 11 to 12 weeks, if I'm understanding...

We've got the bookings a little off. Looking today, August 5, year-to-date total is $335 million.

That is through August 5th. That's really helpful.

Yes. Yes, that's through August. So I think when you go back and cycle that through, let's see here, that's—I don't have a month-to-date average, but I don't have a year-to-date average. I see that, that's plus $91 million versus a year ago. I don't know how many days in the year there are to August 5.

It's 217 days. So if I'm just doing simple...

35 divided by 2017. Give me that one, while you're doing the math.

Sorry, yes, I took the $365 million on 2017 gets you to – if I'm following orders signed of, call it, $615 million or so.

Well, it's $335 million, not $365 million.

I was doing strict days, right, 217 total days.

Strict days, got you, got you. Okay. Well, and we only have 355 days; we have 10 days of holidays that we don't book.

Okay. Okay. So if I call it $600 million plus or minus of bookings, revenues to date are, call it, $260 million plus you're thinking you might do roughly another $290 million in the back half of the year roughly. Would get you to about – yes, it would be roughly equivalent, I guess, for the back half where you wouldn't really expand dramatically.

That's what I— that was my math.

I really appreciate you helping me.

Yes.

There are no further questions. I will now turn the call over to Gary Fields for any closing remarks.

Just wanted to clarify one thing. In my prepared commentary, I said when talking about productivity, I said materials were down 1%. What I meant to say was our cost of goods sold, excluding our materials were down 1%. So just to clear up that one little thing there. All right. With that, we will close. We appreciate everyone's interest in AAON and calling in. We are looking forward to talking to you again in November for our third quarter results. Have a nice day.

This concludes today’s conference call. Thank you for participating. You may now disconnect.