Good evening, ladies and gentlemen, and welcome to the AAON, Inc. Q1 2024 Earnings Conference Call. This call is being recorded on Thursday, May 2, 2024. I now would like to turn the conference over to Joseph Mondillo, Director of Investor Relations. Please go ahead.

Thank you, operator, and good afternoon, everyone. The press release announcing our first quarter financial results was issued after market close today and can be found on our corporate website, aaon.com. The call today is accompanied by a presentation that you can also find on the website as well as on the listen-only webcast. Please go to Slide 2 in the presentation. We begin our customary forward-looking statement policy. During the call, any statement presented dealing with information that is not historical is considered forward-looking and made pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act of 1995, 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 of AAON's control that could cause AAON's results to differ materially from those anticipated. You are all aware of the inherent difficulties, risks, and uncertainties in making predictive statements. Our press release and Form 10-Q that we filed this afternoon detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have the duty to update our forward-looking statements. Our press release and portions of today's call use non-GAAP financial measures as defined in Regulation G. You can find the related reconciliations to GAAP measures in our press release and presentation. Joining me on today's call is our CEO, Gary Fields; our President and COO, Matt Tobolski; and our CFO and Treasurer, Rebecca Thompson. Gary will provide some opening remarks. Matt will then provide some commentary on the operations, followed by Rebecca, who will walk through the financials and will finish with Gary, who will update you on the outlook before opening it up to Q&A. With that, I will turn the call over to Gary.

Good afternoon. Let's start on Slide 3. First quarter performance was mixed relative to our expectations. Bookings remain strong and we are in line with our expectations. This was consistent across all three of our segments. Total backlog increased for the second straight quarter compared to a year-ago it was down just 6.9%, which is positive considering how abnormally large backlog was when supply chain issues were adversely affecting our lead times. Sales and earnings were a little soft to start the year, with lighter than expected volumes. A large factor in this was the timing of backlog conversion at our AAON core products and basic segments. Order trends at both segments remained solid though, and backlogs at both increased substantially throughout the quarter. In addition, beyond what is currently in the backlog, both have significant opportunities with the data center market. Thus, while these two segments were a large reason for the soft results in the first quarter, we're very confident both will improve going forward. Despite volumes and production levels being down in the quarter, profit margins were better than we expected. We've executed well from a price cost perspective, while at the same time strategically balancing the price premium of our equipment. Now, I'd like you to turn to Slide 4. Looking forward, we remain cautiously optimistic on the near term while maintaining a bullish outlook on the long term. Our traditional markets remain stable despite high interest rates and other economic headwinds. The sentiment amongst our channel partners is positive and all indications lead us to believe there's a strong level of activity within the market. We still think orders could be volatile this year due to the refrigerant transition. However, we also think as we progress further into the year, we will approach the point in time, in which we will be unable to accept orders for R410A equipment. It is likely we see a short-term wave of orders related to projects already designed for 410A refrigerant. At the same time, we are well-positioned to take advantage of customers who are seeking the new refrigerant equipment as we are currently accepting orders for a comparable price to 410A equipment. We are also strategically positioned from a pricing and product development standpoint. Our narrower price premium makes us more competitive, and all indications suggest we will be even more competitive from a manufacturing cost perspective as the markets transition to the lower GWP refrigerant. As for product development, the advancements of our fully electric heat pump technology, Alpha Class branded products position us extremely well as the industry begins to focus more and more on electrification. Earlier this month, the Department of Energy announced a program to expedite development and adoption of cold climate commercial heat pump rooftop units. AAON already has a considerable lead in the advancement of this technology, which will allow us to capitalize on early adopters. Initially, this will most likely be large corporations with wide-ranging footprints of buildings, thereby creating a significant opportunity for us. Beyond our traditional markets, we're increasingly excited about the data center market and how we can capitalize on the growth cycle of this end market. The pipeline of work over the next several years is immense, and current activity is moving at an aggressive pace. Our engineering and sales teams are executing at a first-class rate. All the feedback we are receiving from our customers leads us to believe we are becoming the best-in-class solutions provider for both airside and liquid cooling applications. To best capitalize, we are working diligently to increase our capacity, ensuring we maximize our opportunities.

Thank you, Gary. If you will, please turn to Slide 5. We utilize this slide in our fourth-quarter call, but the only difference being we've added a sixth slice of the pie which is our data center solutions. The data center vertical has been an integral factor in the robust growth that the basic segment has realized over the last several years. We expect this market will become an even larger part of the overall organism going forward, given the current makeup of backlog and the pipeline of future opportunities. Over the last 6 to 9 months, with the advancements of semiconductor chip technology, and the anticipation of increased computing demand fueled by artificial intelligence, data center companies have aggressively accelerated their construction plans. During this time, our engineering and operational teams have been diligently working with customers, helping them design solutions to fulfill their ambitious goals. Given the capacity and density of these new AI data centers, customers are looking for providers who can develop unique airside and liquid cooling solutions. This type of custom engineering is exactly what the basic core is all about. And it's what sets the business apart from most in the industry. With assistance from the rest of AM's operational teams, we have executed nearly flawlessly recently, leaving big impressions with some of the biggest customers in the industry. From my point of view, considering our success in this market to date, we are positioned to be the best-in-class provider for this market. In preparation for the increased demand our data center customers require, we've been aggressively investing in new capacity. The two primary projects that have been underway since last year include expansions of our Redmond facility and our Longview, Texas facility. In total, the two projects will increase the company's total manufacturing square footage by approximately 15%. Given the scale of some of the orders we anticipate, we expect the increased capacity in terms of revenue to be much greater than 15%. Both projects are on schedule. The Redmond expansion is expected to be finished by the end of Q3 of this year. The Longview expansion is expected to be complete by the end of this year. The rest of our growth strategy is also progressing. Our product development continues to lead the industry. Currently, much of the industry is consumed with meeting the upcoming low GWP refrigerant requirements. Meanwhile, we have had our complete portfolio of equipment offering with the new refrigerant since the start of this year. We're also well ahead of the industry with the advancement of heat pump technology. We are the only company in the commercial market with a portfolio of fully electric heat pump-powered rooftop units that operate down to zero degrees. AAON being the first to market with this technology will position us to fully benefit from the increasing demand to decarbonize and electrify buildings. Our complete portfolio of rooftop units, including the cold climate heat pump configurations, provide us with a significant opportunity with national accounts. Lastly, our already world-class sales channel continues to strengthen, which will be integral to our continued growth and market share goals. The consolidation of the channel is helping accelerate the sharing of best practices in our entry support through marketing, parts, and service will further help our reps become more successful in penetrating the market. Altogether, we expect these strategies to allow us to continue to gain market share over the coming years. In conclusion, we have a sound growth strategy that the team is executing upon. The one AAON culture has never been stronger. Operations are running at some of the highest efficiency levels in years. And overall, I could not be more pleased with the progress we've been making and the extent of opportunities we have going forward. With that, I will hand it off to Rebecca to walk through your financials.

Thank you, Matt. Please turn to Slide 6. Net sales declined 1.4% to $262.1 million from $266 million. Volumes were down 5.7% partially offset by pricing which contributed 4.3%. The decline in volumes was driven by the AAON coil products and basic segments, which realized total sales declines of 27.4% and 9.3%, respectively. Total segments had strong backlogs entering the quarter compared to a year ago, so the revenue declines at both were largely based on timing of backlog conversion. The AAON Oklahoma segment realized an increase in total sales of 4%, although volumes in this segment were down modestly, which was a result of a much smaller backlog at the beginning of the quarter compared to a year ago. This segment also endured some volatility in orders throughout the quarter, resulting in the almost flat backlog and also partially contributing to the lower volumes. Moving to Slide 7, gross profit increased 19.6% to $92.2 million from $77.2 million. As a percentage of sales, gross profit was 35.2% compared to 29% in the first quarter of 2023. The improvement in gross profit margin was primarily a result of increased pricing and moderating material cost inflation offset slightly by higher labor costs. Please turn to Slide 8. Selling, general, and administrative expenses increased 37.5% to $45.3 million from $32.9 million in the first quarter of 2023. As a percentage of sales, SG&A increased to 17.3% from 12.4%. The increase relative to sales is primarily attributable to the lower volumes, increased employee compensation, incremental investments we've made in technology, and increased professional legal fees. Overall, SG&A expenses were in line with our expectations. Moving to Slide 9, diluted earnings per share was $0.46, slightly up from a year ago. Included in this net result was an excess tax benefit of $4.4 million from the share-based compensation within the quarter. For the remainder of the year, we anticipate an effective tax rate excluding discrete events to be in the range of 25% to 26%. Turning to Slide 10, our balance sheet remains strong. Cash, cash equivalents, and restricted cash totaled $28.4 million on March 31, 2024. Debt at the end of the quarter stood at zero. Cash flow from operations in the first quarter was $92.4 million, up from $4.8 million in the comparable quarter a year ago. Working capital at the end of the first quarter declined by $15.1 million or 5.4% from a year ago resulting in better cash conversion. Capital expenditures, including expenditures related to software development, increased 33% to $38.7 million. Even with the higher CapEx budget, we were fully able to pay down our line of credit and finance the quarterly dividend while marginally increasing our cash position. All in all, our financial position is strong, allowing us to fully capitalize on growth opportunities. With that, I'll now turn the call back over to Gary.

Operator, I think we may have dropped Gary potentially.

Yes, I believe there are multiple speakers.

I'm just going to finish out the closing remarks, and then we can open it up to Q&A.

Okay.

Please turn to Slide 11. All in all, we feel very good about where we are currently. Over the last several years, we've made major strides in transforming this company from a niche application-based provider to a mainstream solutions provider. In the last two years, we've realized substantial growth and have captured market share. In our view, though, we've just started to scratch the surface. Many of the changes we've made from a business management perspective to sales and marketing and product development have yet to be fully realized. We have the best product by far and the best value. These changes will leverage that and propel our share gains further. To add to that, the magnitude of opportunities we have within the data center market leaves me with little doubt we will be able to achieve our long-term goal of 10% plus annual revenue growth. In the near term, following two very strong years for AAON, during a time when the economy is slowing, we expect growth to temporarily moderate, but for the reasons previously stated, this does not concern me at all. If I have any concern at all, it would be whether we can continue to build capacity quickly enough in an efficient manner to keep up with the growth we foresee. In 2024, we are now looking for volume to be down low single digits to flat. We anticipate year-over-year comps for volume would improve throughout the year with much of the improvement occurring in the second half. We continue to anticipate pricing will be a mid-single-digit contributor and that gross margin will increase year-over-year. For SG&A as a percentage of sales, we now anticipate a 50 basis point to a 100 basis point increase, and we maintain our CapEx guidance of $125 million. For the second quarter, we anticipate sales will be comparable to the same period a year ago, and EPS will be modestly down. In closing, we just want to finish by thanking all of our employees, sales channel partners, and customers. Thank you to our shareholders; this company has never been more well-managed than it is today, and we look forward to generating returns that you expect from us. We can now open up the call for Q&A, operator.

Your first question comes from Chris Moore from CJS.

Terrific. Hey, thanks, guys. Thanks for taking a couple of questions. Maybe we could start with basics. It looks like the timing of basics backlog conversion contributed to a softer quarter. It's harder to gauge kind of quarter-to-quarter on basics. Can you give any sense in terms of basics as a piece of the backlog as a percentage? Has that changed much over the last year, or how we should be thinking about that?

Yes, Chris, Matt would take that one.

Yes, of course. Yes, Chris, great question. Certainly from a contribution viewpoint, basics in the backlog is the simple way to look at it. We talked during the last quarter call about the 2023 performance, which indicated that basics as a whole in '23 was approximately 10% of the overall revenue within the enterprise, but contributed 20% to bookings for the year. As we look forward in this quarter and beyond, we continue to see that, if not more, contribution from the basics backlog. So we certainly see a lot of strength within the basics backlog, which is helping drive the coil products business down in Longview as we start to really engage to get the basics products built down there as we continue the expansion with data center products. It is going to become more relevant going forward as a percentage of the overall revenue of AAON, and we definitely anticipate it contributing substantially greater growth on an annualized basis compared to the legacy business.

Got it.

Yes. One other thing, Chris, I think we've stated before that basics had been about 10% of our total revenue, and we expected at some point not too far in the future, that would be closer to 20% because they were growing so rapidly.

Got it. No, that makes sense for sure. I think one of the things you talked about, Gary, in your prepared remarks was that the order flow will further improve at the point in time when customers are no longer able to order equipment with the R410A refrigerant. Do you have kind of a best guess as to when that point is?

It's going to be a bit dependent on lead time. For this reason, you cannot deliver equipment with 410A, our type of equipment, beyond December 31. So if you say, 'Well, I want to have a 2 or 3-week buffer between December 31 and the last unit I produced just to make sure I don't have any issues,' and you have roughly a 10-week lead time, let's just put that at 12 weeks, and that has to be the absolute cutoff. We are going to try and push people towards a cutoff ahead of that so that we don't end up with a problem. The problem could be, and I've heard other manufacturers mention this, if we get a surge of orders for people wanting 410A at the last minute, then the lead times could easily extend, and then we'd be in trouble. This is a kind of unusual situation that we've not really encountered before. When we had a refrigerant change before, there were no building codes associated with it. This time, there are building codes necessary to utilize the new refrigerant, while there are also additional expenses in the buildings, which I think is driving some people to say, 'Well, I'll just go ahead and get 410A because I don't have to have this additional expense for these refrigerant management strategies required by this new code.' So just to summarize, I would say somewhere in August, we are probably going to see a surge.

Got it. That’s very helpful. And maybe just last one to follow up on the point you just made in terms of the increased costs. It sounds like you guys are in really good shape from that perspective. My understanding is that the new refrigerant requirements are not really going to cost AAON much more. You have the new safety device that you'll have to include with manufacturing that internally. So it sounds like from a competitive standpoint, you should be in a really good position for this changeover. Am I looking at that correctly?

Yes, I think so. As we went through unit by unit, that holds true for the vast majority. There are cases where we lost capacity when we converted. So, you've got to add something to get that more capacity. That's not across the board, but it does appear here and there on certain sized units. Mostly, we believe the way we portrayed that is correct.

All right. I appreciate it, guys. I will jump back in line.

Your next question is from Ryan Merkel from William Blair. Please go ahead.

Thanks. Good afternoon, Gary. It sounds like the big issue this quarter is the timing of backlog conversion. Can you unpack what happened with production this quarter, and when did the production issues hit you exactly?

Well, actually, each month had something just a little different at those two factories. We saw January wasn't too bad. Towards the end of January, we had some weather events that hit us more in basics than it did anywhere else. More prevalently, it affected some of our customers who asked us to slow down on certain projects just a little bit. They said, 'Hey, we don't have anywhere to put this equipment; can you slow down just a little?' There was some weather event in there. I don't want to discount the impact of the construction going on at both of those locations. Both have substantial construction happening. What's going on in Longview is probably less disruptive because it's outside of the building we are currently using, but it's somewhat disruptive. In Oregon, there was significant disruption in rearranging what we were doing in one of the two primary buildings as we get ready to move into the new building we're building, and it’s just not without impact. It's not substantial. It’s not prolonged. It's not something we are going to put up with for a long time, but we did see a little bit related to that.

And are you able to quantify the sales impact from some of these issues in the quarter?

While each segment reported, you can see both of those two segments that I just spoke of, ACP and basics, were below 2023’s growth. While it was marginal, growth was in Tulsa. The Tulsa site had no disruptions of any magnitude, just a little weather-related for some cases where customers said, 'You're shipping too early to us. With the weather we're having, we have delays. Can you slow down a little?' That happened across the whole enterprise. But Tulsa was less impacted by it. Does that answer your question, Ryan?

Yes, I think so. I think maybe the follow-on would be, it sounds like you said second quarter sales are flat. So we are not seeing a lot of improvement in Q2. When do you expect that these timing of backlog issues or the production issues that you talked about will get back to normal?

Well, I believe it will be improving through Q2, but it will be Q3 before it is relatively normal.

Got it. All right. Thanks. Pass it on.

Your next question comes from Julio Romero from Sidoti & Company. Please go ahead.

Thanks. Hi, good afternoon. Maybe switching to parts a little bit. It was nice to see the parts sales growth of 10% in the quarter. Was that performance in parts partially due to having more than expected capacity for parts, while volumes were a little depressed due to the issues you just outlined?

Matt, do you have any perspective on that?

Yes. I wouldn't say that the impacts of volumes on the ACP and basics segments provided excess capacity of parts. I'd say the parts growth is really driven by parts demand. Furthermore, this reflects normalization of supply chain issues that had previously created a considerable amount of noise in managing part sales. The situation has stabilized now, which allowed us to see a demand increase. Thus, it is driven by demand for parts, nothing to do with the smaller volumes off any of the sites.

Okay. Understood. And then maybe if we could talk about data centers. As you guys are assisting some of these data center customers, is there any opportunity to provide sticky products or solutions that can embed you with those data center customers for the longer term?

That's a fantastic question. At a high level, that's where we specialize in providing value-add to our customers. This gives us the opportunity to be uniquely positioned with our customer base and develop tailored solutions that provide us with a better opportunity within those clients. In our prepared remarks, we discussed the engagement of our engineering and operations teams, which is exactly what they have been doing. It is about developing unique solutions tailored for customer business models. Being a manufacturer with that custom DNA enables us to convert such tailored solutions into mass-produced products and can really add a lot of value for both us and our customers. We are excited about the opportunities this presents and certainly see the potential to deeply embed ourselves in their growth stories.

Excellent. I will pass it on. Thanks very much.

Our next question comes from Brent Thielman from D.A. Davidson. Please go ahead.

Hey, thanks. Good evening. Matt, actually, just kind of following up on that, could you talk about the opportunity on the liquid cooling side for basics? Are you beginning to see orders for that specific market?

Yes. It’s an interesting one. The surge in AI has really caused the industry to examine how to develop and deploy capacity that also has the flexibility to serve traditional cloud computing as well as AI, and how to blend development strategy around that. We have been actively engaged in this market where we are developing solutions and working with customers to resolve both airside and liquid cooling issues. We have already received orders and see substantial opportunities in the liquid cooling arena. Tracking solutions to provide greater flexibility for product deployment add significant value, which overall end users find attractive as they look to invest capital in their infrastructure. We are excited about the conversion into orders from the liquid cooling efforts and have a positive outlook for the enterprise as a whole.

Okay. And then a lot of the focus in your commentary has been on some of the delays with Longview and basics. My question is, was the core AAON Oklahoma rooftop business, what you would have expected this quarter, or were there some delays in timing?

I think it's been relatively close, maybe just a slight bit softer than what we expected. We thought we would see more seasonality in that business than we've seen in recent years. I believe that is mostly what we saw in the first quarter; the fact that Q1 historically has been a softer quarter for that product. In recent years, we've had exceptions for various reasons. There were times when housing demand dictated that we got past that seasonality. Our sales channel partners have strong backlogs that they're processing, and they are sending those to us. While it was a touch softer than what we may have expected, it was not entirely unexpected.

Okay. And then just some of the pent-up or built-up orders with basics in Longview, will those start to flow into the second half? Should we see a huge catch-up here? How do we think about that? I know you've got your expectations for the second quarter. It sounds like it won't happen, but when does that ultimately flow?

Yes, we certainly expect the second half orders to convert to revenue strongly in those segments. Additionally, the ongoing construction at both sites will help clean up some of the noise and disruptions implicated these segments. As we look forward to Redmond being completed in Q3 and Longview at the end of the year, we anticipate that will also drive growth and help clear up prior backlogs.

Okay. Thanks, Matt. I appreciate it all.

There are no further questions. I will now turn the call over to Joseph.

I would like to thank everyone for joining on today's call. If anyone has any questions over the coming days and weeks, please feel free to reach out to myself. Have a great rest of the day, and we look forward to speaking with you in the future. Thank you.

Ladies and gentlemen, this concludes the call for today. Thank you for calling in. Please go ahead and disconnect your lines.