Hello. Welcome to the AAON, Inc. Fourth Quarter 2021 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this event is being recorded. I would now like to turn the event over to our host Mr. Joseph Mondillo, Director of Investor Relations. Mr. Mondillo, please go ahead.

Thank you, Andrea. Good afternoon, everyone. The press release announcing our fourth quarter financial results was issued after the market closed today and will be found on our corporate website aaon.com. On the call with me today are Gary Fields, President and CEO; and Rebecca Thompson, CFO and Treasurer. Just to begin with our customary forward-looking disclaimer. To the extent any statement presented herein deals with information that is not historical, including the outlook for the remainder of the year, such statements are 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 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. With that, I'll turn over the call to Rebecca.

Thank you, Joe. I want to start by reviewing the comparative results for the three months ending December 31, 2021, compared to December 31, 2020. Net sales increased by 16.8% to $136.3 million from $116.7 million. The rise in net sales for the quarter was mainly due to price increases, which accounted for roughly 10%. The acquisition of BasX Solutions, completed on December 10, added about 3%. Our gross profit fell by 21.7% to $26.5 million from $33.9 million. Gross profit as a percentage of sales was 19.5% for the recently ended quarter, down from 29.1% in 2020. The drop in gross profit was primarily tied to supply chain challenges that led to production limits and operational inefficiencies. Additionally, rising material costs and wages outpaced our price increases. Selling, general and administrative expenses grew by 44.4% to $21.1 million from $14.6 million in 2020; however, excluding $4.4 million related to acquisition costs, SG&A expenses increased by 14.4% year-over-year. As a percentage of sales, SG&A excluding these costs fell to 12.3% from 12.5% in the same quarter of 2020, largely due to reduced profit-sharing expenses resulting from lower pre-tax earnings compared to the same period last year. We recorded an income tax benefit of $0.8 million, attributed to our lower earnings this quarter and an excess tax benefit from stock awards of $1.6 million. Adjusted net income, which is a non-GAAP metric, decreased by 35.5% to $9.5 million, or 7% of sales, compared to $14.8 million, or 12.7% of sales in the prior year. Adjusted diluted earnings per share, another non-GAAP measure, declined by 35.7% to $0.18 per share from $0.28 per share. Now, turning to the year-end results for December 31, 2021, compared to December 31, 2020. Net sales for 2021 rose by 3.9% to $534.5 million from $514.6 million in 2020, driven mainly by price increases contributing around 5% for the year. Sales volumes decreased due to a planned plant shutdown in January, a weather-related shutdown in February, and various supply chain disruptions in the latter half of the year. The acquisition of BasX Solutions contributed about 1%. Our gross profit fell from $155.8 million to $237.8 million, resulting in a gross profit margin of 25.8% down from 30.3% in 2020. This decline was influenced by several factors, chiefly production constraints due to supply chain challenges and material inflation. Selling, general and administrative expenses increased by 13.4% to $68.6 million from $60.5 million in 2020. Excluding $4.4 million in acquisition-related costs, SG&A expenses rose by 6.1% year-over-year. As a percentage of sales, SG&A excluding these costs increased to 12% from 11.8% in 2020. Our effective tax rate fell to 15.1% from 22.5%, due to a lower tax rate in Oklahoma and more excess tax benefits from stock awards compared to the previous year. Adjusted net income for 2021 decreased by 17.1% to $62.1 million or 11.6% of sales, compared to $74.9 million or 14.6% of sales in 2020. Adjusted diluted earnings per share dropped by 17.7% to $1.16 from $1.41 per share. Now looking at the balance sheet, our working capital balance was $131.3 million compared to $161.2 million at December 31, 2020. Unrestricted cash was $2.9 million at the end of December 2021, with total debt at $40 million. During the quarter, we used $103.4 million in cash to finance the acquisition of BasX Solutions and drew down $14 million from our revolving line of credit for working capital needs. In the first quarter, we are set to close on the real estate related to the BasX acquisition, costing us $22 million. Early in the year, cash will also be used for working capital before a reversal in the latter part of the year. I expect net debt to increase slightly at the end of the first quarter before it begins to decrease. Our current ratio is approximately 2.5:1. Capital expenditures for 2021 amounted to $55.4 million, an 18.3% decrease from the previous year. Capital investments were lower than anticipated primarily due to project delays caused by supply chain issues and other economic factors. We have maintained our growth-related investments and are aggressive with our planning to support the strong organic growth we expect in the coming years. For 2022, we forecast capital expenditures of $100.4 million. The company executed stock repurchases totaling $22.5 million during the year ending December 31, 2021. Shareholders' equity per diluted share stands at $8.68 as of December 31, 2021, up from $6.61 at the same date in 2020. Now, I will pass the call to our CEO and President, Gary Fields.

Good afternoon. Well, in the fourth quarter, there were three major positive achievements in the quarter. The backlog continued to grow at a significant rate, reaching a new record level. We closed on the acquisition of BasX Solutions, which was the company's first acquisition of substantial size in 20 years. And in October, we hosted our first sales event in several years with our independent sales channel, where we introduced a package of new products that we believe will be game changers. Obviously, the fourth quarter financial results were disappointing. Sales, gross margin, operating margin, and earnings were all weaker than we anticipated when we last spoke to you in November. However, I believe we are going to emerge from this as a much stronger company, which will help facilitate a robust growth trajectory. Speaking of the growth trajectory, we believe our long-term outlook remains intact. For those who have listened to us recently, we have aspirational goals, which include growing revenue organically in the double digits per year over the next several years. Nothing has happened over the last nine months to lead us to believe these goals are unachievable. In fact, we are optimistic about the outlook. The backlog reflects that, and we're beginning to pull out of a lot of the issues that constrained our ability to produce. So, let's take a deeper dive into the quarter and then discuss the outlook. The environment our industry has faced over the last 12 months has been one of the most challenging ever, if not the most challenging in the last 30 years. Inflation is rapid, and supply chain issues made managing operations extremely tough, all while trying to manage the challenges of the pandemic. Inflation pressures continued through the fourth quarter. We've been very disciplined with our pricing and still confident we'll fully recoup gross margins at the 30% plus level. We need to work faster through the lower margin backlog and start producing products priced at our most recent price increases. Unfortunately, supply chain has prevented this from happening in the fourth quarter. The fourth quarter was the most challenging quarter of the year when it came to supply chain. October and November were particularly tough months. The supply chain issues led to less than optimal production rates, causing operational inefficiencies, unabsorbed fixed costs, and an unfavorable mix of products that were priced lower than our recent price increases. These supply chain issues posed a significant constraint on production but also exacerbated inflationary effects. Now, there were some positives in the quarter that we’re looking forward to: first, at this point in time, we believe October and November were the worst we’ll see regarding supply chain issues. December saw an improvement. January, and now February have continued that positive trend. The margin profile of our backlog is quickly improving. Lastly, as I mentioned earlier, we're going to emerge from this as a stronger company. The supply chain issues forced us to significantly increase the number of multi-source components. I mentioned earlier that this has been one of the most challenging environments our industry has faced in over 30 years. Facing such challenges almost always leads to a stronger operation and a more capable management team, provided you have the right people. I'm very confident we have the right people managing this company. Therefore, I feel what we've gone through will make us a much stronger company, enabling us to execute our growth strategy more effectively. Now let's look back on some of those achievements in a little more detail, focusing on the backlog. At the end of 2021, total backlog was up 250% from a year ago and up 43% from the end of the third quarter. Excluding BasX, organic backlog was up 201% year-over-year and 23% quarter-over-quarter. Organic bookings in the quarter were up year-over-year by 67%. The growth rate is consistent with what we observed in the previous two quarters, as strong demand continued through the end of the year. Order trends remained robust through the first two months of 2022, including both legacy AAON and BasX. This performance is remarkable, especially when compared to the industry, which is not growing nearly as quickly. It tells us we have the right strategy and we’re executing well. Our strategy includes focusing on customized high-performance energy-efficient HVAC equipment to capitalize on secular trends like decarbonization and indoor air quality. This has been the foundation of AAON for 30 years. While much of our market is just starting to discuss manufacturing more capable equipment to meet these new demands, we've mastered it over decades. Offering lower costs of ownership and selling a high-quality product at a minimal price premium, we have the longest useful age on the market, the most energy-efficient products, and those that are the easiest to service and maintain. Continuous improvement in productivity is essential. Our manufacturing operations are highly automated. We've always seen a culture of maximizing productivity, but we still see new areas of improvement and will continue to focus on this. We've also been strengthening our sales channel considerably. We have the strongest sales channel in the industry and are assisting our channel partners now more than ever in various ways to help improve their success. We believe these efforts to support our channel partners are leading to market share gains. Innovation and new products are at the core of AAON. We've focused on parts and service, with parts sales reaching a record for us in 2021, growing 26.3%. As a total of revenue, parts made up 8%, the highest percentage of total sales in company history. So, overall, the growth in backlog reaffirms that we have the right strategy in place. Furthermore, we measured the size of our total addressable market to be $30 billion, which is about 50 times the size of our company. Thus, we believe there is significant potential for growth moving forward. Our strength in end markets is broad-based, but data centers, warehouses related to e-commerce, education, manufacturing, healthcare, and retail were all strong points for us, while hotels showed weakness. Replacement drove much of the demand in 2021, but new construction markets are beginning to pick up. Leading indicators continue to point to a recovery in construction following the slow-down in 2021, including the ABI, Dodge index, and non-residential construction starts, all indicating positive trends. Thus, one of the positives we saw from the quarter was the backlog of orders. Now let's discuss the BasX Solutions acquisition. This was our second significant achievement. This was the first acquisition of substantial size in 20 years, and historically AAON has not been very acquisitive. This was a special deal for us, and we believe it will generate accelerated growth for AAON and very attractive returns for our shareholders. The 2.5 months that we've owned BasX Solutions have been extremely rewarding. Throughout the negotiations, there were many metrics that BasX had projected, some of which seemed quite aspirational. I’m pleased to say they hit every one of those targets. The collaboration with the BasX Group is bringing some new opportunities for AAON, expanding possibilities that they always believed were achievable with the right partner, and these are materializing quickly. Dave Benson and I recently visited some sales channel partners and end-user clients in the Upper Midwest and came away with outstanding opportunities that hopefully when we speak next time, we can share more about capitalizing on. In October, we hosted a sales meeting in Dallas with about 600 channel partners. One of the things we introduced was a new state-of-the-art showroom trailer. Other manufacturers have similar trailers, but none of them have anything quite like this. It's a Class 8 Kenworth truck pulling a 53-foot trailer that expands on both sides to create a 1,000 square foot showroom when parked. It has a hydraulic system for easy operation. There is also virtual reality inside where we can demonstrate how to build a unit, and explore the manufacturing plant and our processes. The feedback on this marketing tool has been exceptionally positive. The game-changing products we introduced included the EcoFit Water-Source Heat Pump, noted for its efficiency. We developed a new model called ProFit, designed to replace the majority of existing units in the market while ensuring backward compatibility. As noted, around 64% of all rooftop units manufactured worldwide currently use gas heat. We believe that trend will start to reverse, moving toward more electric heat solutions like air source heat pumps, which we have manufactured for years. Our recent advancements allowed us to develop low ambient or cold climate capable units, now effective down to zero degrees Fahrenheit. Regarding our marketing efforts, historically, AAON's marketing focus has not been robust. We have relied on sales channel partners to leverage their technical expertise for sales. While this strategy remains, we’re providing more support tools. The showroom trailer I mentioned is a significant addition. Additionally, we are building a new customer experience center that's due for completion later this year. This center will showcase our superior fan systems and many energy-efficient features. Our investment in marketing will align with our current positioning; we are transitioning from a niche player to a more mainstream competitor. The order book supports this change, and it's time to broaden our marketing efforts. As for capital investments, we continue to invest in the company. Rebecca mentioned a projected capital expenditure of $100.4 million in 2022, almost double what we spent in 2021. Supply chain constraints had affected our intended spending last year, specifically for machinery from Europe that arrived late. We do have some carryover from last year but remain committed to investing heavily, with maintenance CapEx around $35 million and the majority aimed at growth. We target organic sales growth in double digits over the next several years and will keep investing in our capacity to service those bookings. Overall, we remain very optimistic about our long-term outlook. However, there are still some uncertainties in the near-term. Supply chain issues will ease, but we are not yet back to normal. Inflation remains a challenge, with slight reductions in steel prices but increases in most other areas, including components, raw materials, wages, and freight. We've initiated four price increases since the start of 2021, including the latest on January 1st. Additionally, we announced another price increase today, effective March 31. We will continue to exercise discipline in our pricing strategy and expect our margins to fully recover. Although we do not provide earnings guidance, I want to share how we anticipate 2022 will unfold. This will pertain to the legacy AAON business. From January 21 to January 22, we initiated four price increases across the board, totaling 21%. In 2021, we recognized only around 5% of that increase, with the remainder applied to backlog, so it wasn't materialized until 2022, which we expect to see in double digits. Today's price increase will provide marginal benefits in 2022 while primarily impacting 2023. Our unit volumes decreased by 2% in 2021, including a 6% reduction in core rooftop units. Depending on the challenges in construction, we should have a reasonably easy comp regarding volumes, and with the backlog growing significantly, we expect a recovery in volume particularly in the second half of the year. There's no structural change in our gross margin, and we're confident our gross margins will recover to our target of 30% plus. The question remains about timing, which we estimate will occur in the second half of the year. SG&A expenses will increase this year, with earnings expected to rise, leading to an increase in our profit-sharing expense. Higher headcount and wages will be significant drivers, alongside expenses for depreciation and investments in technology. We would typically expect some leverage on SG&A; however, in this environment, we expect it will increase similarly to revenue growth. As for BasX Solutions, in 2021 it generated $80.7 million in revenue and $10 million in EBITDA. BasX faces similar conditions as legacy AAON regarding backlog and orders, which are up significantly despite supply chain constraints. Overall, we are effectively managing these short-term macro challenges, but our long-term outlook remains very promising. Before I take any questions, I want to thank all of our employees for their hard work in 2021, which was challenging due to pandemic-related issues. I also want to recognize our channel partners. We greatly value your business and will continue to support you. Lastly, I want to mention our participation at the JPMorgan Industrial Conference in New York City on March 17 and the Sidoti Virtual Conference on March 23 and 24. I hope to see you at those events. But now, I’ll open it up for questions.

Thank you. The floor is now open for questions and answers. Our first question is from Brent Thielman of D.A. Davidson. Brent, please go ahead when you’re ready.

Thank you. Good afternoon.

Yes.

Maybe first, it sounds like we've transitioned here into a period sort of December through February that hasn't seen the level of disruption you've seen before. Maybe you could just help us out with what's improved in particular in the supply chain, that's allowed you to pick up production rates? And what confidence are you getting from suppliers that they can meet the requirements medium and short term?

Yes. Good question, Brent. So while we didn't have significant issues on our plant floors in Q4 due to coronavirus, some of our suppliers did, and some issues emerged in late Q3 when they were manufacturing components for us. We observed a noticeable improvement beginning in October, which continued to get better in November, enabling us to bring additional suppliers in for these items. By December, these solutions were quite helpful, and we achieved uninterrupted operations in January and February. However, there are still challenges with some electronic components, but we've been adept at managing those. We have acquired equipment that allows us to select alternative electronic components to solve potential issues. Things have improved significantly, but I cannot predict what the Ukraine situation might do; earlier today I read that Ukraine is a major supplier of neon and palladium, both crucial for chip manufacturing. To summarize, while the situation remains complex, we have improved significantly and are in a much better position.

Okay. And would you expect to be able to run off all the remaining lower-priced backlog here in the first quarter, or will there be some carryover into the second quarter as well?

Let's analyze the numbers from October, November, and December. All production in October was based entirely on the backlog booked prior to the September first price increase of 2021. The same was true for November. In December, we started seeing a trickle of improved production. By January, 76% of what we built was based on the September 1 price increase, so we had approximately 4% better margin profile from that price increase. For February, we anticipate production will be almost entirely based on that 5% higher price backlog. Starting the year, we nearly have all of our backlog at improved margins. The 8% increase that went into effect on January 1 will likely not be fully realized until the end of the next quarter. Thus, we will have a better margin profile due to the backlogs we are processing now.

Yeah, understood. Maybe last one for me and the organic bookings obviously super strong. I know one of the things you've talked about is, you've had more advantageous lead times perhaps versus some of your competition. I don't know if that still stands; whether this is a function of just better confidence, Gary, among customers and the marketing efforts. Maybe if you could just dissect some of those things that are driving such a substantial gain there?

Sure. Our lead times did extend slightly, but we still maintain an advantageous position. The improvements we've made in our sales channel and the support we've provided them, along with the tools we've implemented, have made them more effective. When I began here nearly six years ago, we had regions that were strong in performance and others that struggled. Now those regions are performing more uniformly and meeting our expectations. Particularly, the Southeast region has historically been a strong one for AAON but was underperforming prior to my leadership; however, we've recently made adjustments to our sales channels there and now they are doing exceptionally well. Additionally, our lead times are advantageous, and our focus on enhancing indoor air quality measures—historically a specialty for AAON—has now reached broader market recognition. These collective improvements have significantly driven our business.

Very good. I'll get back in line. Thank you for taking the question.

Yes, thank you.

I'll now open up our next question from Julio Romero from Sidoti & Company, LLC. Julio, when you're ready, go ahead.

Great. Thanks. Good afternoon, Gary and Rebecca. Just staying on the order trend, organic orders still strong, but it's down a bit sequentially at $177 million by my math, slightly down from the last two quarters. Can you discuss how orders are trending? Do you see organic order trends accelerating, decelerating, or remaining steady going forward?

Well, first off since that price increase was January 1st, we expected there would be some pull-forward. We anticipated a slight decrease during the 40 to 50 days thereafter, but we have been pleasantly surprised; the bookings have been outstanding. I’ve never seen them perform as well. We actually began observing this strength late first quarter last year. I've been tracking our trailing 12-month bookings, which continue to grow. I’m pleased with the trends and remain optimistic about our performance.

Got it. Makes sense. On that point about the price increases, you announced today effective March 31st; could you talk about how much of a price increase that was and whether it's across the board for your products?

It’s a 7% increase across the board.

Got it, that's helpful. Just switching gears to labor. You talked about increased wages and new hiring initiatives. Could you touch on how headcount at Tulsa and Longview compares to last quarter?

Yes. Let me see if I can find the updated headcount. Every Tuesday I receive headcount reports. Let me get back to that in a moment. In general, I can say we’re slightly up in Longview and more significantly up in Tulsa. As of February 22, Oklahoma’s headcount was up 11% compared to a year ago, and Texas was up 17%. At the end of December 2021, we were up 7% in Oklahoma and 19% in Texas compared to a year before. Specifically, we added about 25 people in Oklahoma and about 30 in Longview over the last quarter. The turnover ratio in Oklahoma has decreased significantly due to efforts from our HR department and plant management to implement effective retention strategies. Many of our HR initiatives successfully took with the previous team members now being implemented in Longview as well, resulting in a uniform approach. As of now, headcount is not our constraining factor; material shortage continues to be our biggest challenge, though there is progress on that front too.

Got it. I appreciate the color. Good to hear about the retention rate improving. Just a quick clarification on the gross margin commentary. Gary, did you say you expect gross margin challenges in the first half but recovery to 30% in the second half?

Yes. I don’t want to label them as challenges necessarily, rather I expect gross margins to be around the 30% target. We’ve set a range of 28% to 32%. I believe we’ll be within that range for the entire year, but I see improving trends quarter-by-quarter. A lot of this will be attributed to the price increases and improvements in price-cost ratios, along with streamlining production processes. Therefore, I am very positive regarding our ability to absorb fixed costs more efficiently over time.

Great. Thanks very much for taking the questions and best of luck in 2022.

Thank you, Julio.

Great. That appears to be all the questions we have for today. Presenters, if you have any final remarks?

I think we're all set, Andrea. Thank you.

Perfect. Well, thank you so much. This concludes today's event. You may now disconnect. Have a great day.

All right. Thank you. See you all.