Aaon, Inc. Q2 FY2025 Earnings Call

Good morning, ladies and gentlemen, and welcome to the AAON Inc. Second Quarter 2025 Earnings Release Conference Call. Also note that the call is being recorded on Monday, August 11, 2025. I would like to turn the conference over to Joseph Mondillo, Director of Investor Relations. Please go ahead, sir.

Thank you, and good morning, everyone. The press release announcing our second quarter financial results was issued earlier this morning and can be found on our corporate website, aaon.com. The call today is accompanied by a presentation that you can also find on our website as well as on the listen-only webcast. We begin with 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, 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 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 the Form 10-Q that we filed this morning 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 a 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 Matt Tobolski, CEO and President; and Rebecca Thompson, CFO and Treasurer. Matt will start off with some opening remarks, Rebecca will follow with a walk-through of the quarterly results, and Matt will then finish with our outlook for the rest of the year and some closing remarks. With that, I will turn the call over to Matt.

Thanks, Joe, and good morning. Starting on Slide 3, our second quarter results that we reported this morning fall short of our expectations and do not reflect the high standard we set for ourselves as an organization. We remain committed to providing transparency to our investors. As previously shared during our Investor Day in June, we've experienced challenges related to our ERP implementation. In this update, we want to provide a comprehensive view of where things stand today, the key factors that contributed to the recent underperformance, and most importantly, how we are moving forward. We are committed to addressing this directly and taking the necessary steps to restore your trust. I want to assure you that our confidence in the strength of our strategy remains unwavering. While we're navigating some near-term challenges, we firmly believe that the actions we're taking today will significantly strengthen the company for the long term. We don't want that bigger picture to be lost. But given the challenges we faced, we will start with providing some incremental detail on what went wrong. Please turn to Slide 4. I would like to start by giving some context to the recent events. Over the past 2 years and especially following our acquisition of BasX at the end of 2021, it became increasingly clear that our existing business systems required a significant upgrade to support our growing scale and complexity. On April 1, we went live with our new ERP system at our first site in Longview. We always anticipated some slowdown in production, but we saw a more prolonged impact on AAON branded equipment and coils production. The slowdown ultimately impacted our broader operations as Tulsa procures the majority of its coils from Longview. We had a contingency plan in place. But unfortunately, both of our primary external coil suppliers were simultaneously undergoing their own ERP upgrades. This unexpected overlap significantly constrained Tulsa's ability to source coils in a timely manner, compounding the challenges we faced. The end result was that at Tulsa, while production improved month-to-month from April to July, the ramp was slower than expected. At Longview, production of AAON branded equipment was significantly impacted early in the quarter as teams adapted to the new system. However, as production and supporting functions gained experience and familiarity, we saw steady improvement throughout the remainder of the quarter. Now turn to Slide 5. This slide illustrates how recent production rates of AAON branded equipment have trended compared to normalized levels, which we benchmarked against the first 9 months of 2024. This KPI measures the consolidated production of AAON branded equipment across both the AAON Oklahoma and AAON Coil Products segments and measures levels of efficiency. We've overlaid the total company gross margin on the same timeline. And as you'll see, there is a strong correlation between production efficiency metrics and the gross margin performance. The biggest takeaway here is that after bottoming out in April, total production consistently improved month-to-month throughout the quarter. And while it's not shown here, we continue to see improvement through July. Tulsa was 6% below that benchmark pace in July. And while Longview still has some ground to make up, improvements began to accelerate starting in the second half of June. Looking ahead, we expect production levels at both our Tulsa and Longview facilities to continue to improve from July levels. As production stabilizes and scales, we also anticipate a corresponding improvement in gross margins. Said another way, when we hit our production metrics, we deliver our corresponding gross margin targets. Please turn to Slide 6. Here, you can see our total backlog of AAON branded equipment, which are manufactured across both our Tulsa and Longview facilities. Bookings in Q2 and year-to-date remain strong. This, combined with the improving production trends, supports my earlier point regarding our expectation of a strong recovery in the second half of the year. While we entered the third quarter with production levels below our initial expectations, we remain confident in a solid upward trajectory and anticipate strong growth in AAON branded production over the remainder of the year. I'd also like to point out that our backlog is favorably priced relative to input cost. Almost all of our production in Q2 was associated with orders received prior to our January 1, 3% price increase and a 6% tariff surcharge that was put in place in March. Directionally, this will begin contributing positively to both sales and margin in the third quarter with a more meaningful impact anticipated in the fourth quarter. Please turn to Slide 7. I want to take a moment to give you some more color on our ERP upgrade, both in terms of what we are looking to achieve and how we see the rollout mapping from here. Given the size and the growing complexity of our organization, including expanded manufacturing operations, it has become evident that continuing to scale at the growth rates we target will require more sophisticated integrated systems. After years of planning, development, and preparation, we went live with a new ERP system at our Longview facility on April 1. Our ERP rollout strategy was very intentional. To limit disruption and manage risk, we intentionally adopted a phased rollout approach, implementing the system one location at a time and not moving on to the next site until the prior location is operating smoothly and meeting our performance expectations. We made the decision to begin the rollout at our Longview facility because it produces both AAON branded and BasX branded equipment as well as manufactures coil, a critical component not only used at Longview but also at other sites in the production of finished products. This approach allowed us to fully vet the ERP solution across our entire product portfolio, helping to reduce risk and minimize disruptions during future site implementations. Beyond product mix, when considering our organizational structure, where shared services support multiple functions across all sites, starting with Longview enables these teams to build proficiency with the new ERP solution before we proceed with additional site rollouts. This ensures that by the time we transition to Redmond, which produces only BasX branded equipment, or to our largest site, Tulsa, which primarily manufactures AAON branded products, our shared services teams will be fully up to speed and well equipped to support a smoother and more efficient go-live at these locations. We've also gained valuable insights from the Longview go-live that will help us to ensure a smoother, more efficient transition for production teams at our other sites. We brought team members from our other sites to Longview to observe best practices firsthand, and we're conducting additional training at those locations to ensure they're well prepared for their transitions. I want to remind everyone that while this transition is creating some near-term challenges, we remain confident that once fully implemented, the new system will deliver significant operational and economic benefits across the organization. We anticipate full implementation will be complete by year-end 2026. And while it's too early to discuss the outlook for 2026, factoring in subsequent ERP rollouts, particularly in the quarter when we go live in Tulsa, we expect to achieve double-digit year-over-year growth and margin improvement for the year, trending towards our long-term target of 32% to 35%. Now please turn to Slide 8. While it's important to clearly understand the challenges we faced this quarter, we must also keep sight of the strong underlying fundamentals that continue to drive our business forward. With that in mind, here are some of the positives that we've achieved in the second quarter. First, the BasX brand continued to demonstrate strength within the data center market in Q2. BasX branded data center sales were up 127% in Q2 and 269% year-to-date. Second, our liquid cooling solutions continue to gain traction in the rapidly evolving data center market as evidenced by incremental orders we secured during the quarter. Year-to-date, liquid cooling equipment accounted for approximately 40% of total BasX branded data center sales, highlighting its increasing significance within our product portfolio. Third, during the quarter, BasX announced a strategic partnership with Applied Digital, under which it will supply thermal management solutions for their AI factory, including custom-designed free cooling chillers for their data centers. This partnership resulted in a significant order, further reinforcing BasX's leadership in advanced cooling solutions. Fourth, our national account strategy within the AAON brand is gaining meaningful traction. National accounts orders grew year-over-year by 163% in Q2 and are up 90% year-to-date, reflecting the effectiveness of our targeted approach, deeper customer engagement, and the strong value proposition of our equipment, which uniquely aligns with the needs of these customers. In the first half of the year, national accounts made up approximately 35% of total AAON branded orders, up from approximately 20% a year ago. And finally, the AAON branded Alpha Class heat pump business continues to disrupt the market with its high-performance offering. Alpha Class sales grew 8% in Q2, while bookings surged approximately 61% during the same period, highlighting strong momentum and growing market adoption. I will now turn it over to Rebecca, who will walk through the financials in more detail.

Thank you, Matt. Please turn to Slide 9. Net sales in the quarter declined year-over-year by $2 million or 0.6% to $311.6 million. The modest overall decline was driven by a 20.9% decline in AAON branded sales, which was nearly fully offset by a 90% increase in BasX branded sales. The decline in AAON branded sales was driven by the impact of lingering supply chain disruptions in early April and coil supply shortages at the end of the quarter due to our ERP implementation. The gross margin was 26.6%, down 950 basis points. The contraction in margin was largely due to lower production volume of AAON branded equipment sales at the AAON Oklahoma and AAON Coil Products segments. Our new Memphis facility incurred $3 million in costs during the quarter with minimal sales to offset this cost to the AAON Oklahoma segment. Non-GAAP adjusted EBITDA was 14.9%, down 1,120 basis points, and non-GAAP adjusted EPS was $0.22, down 64.5% from the previous year. Also noteworthy, we hosted a national sales meeting in April that incurred costs of approximately $1.6 million. While we did not flag this as a one-time event, the last national sales meeting we hosted was in 2021. We also have elevated depreciation and amortization as well as technology consulting fees, creating higher SG&A as a result of our ERP implementation. Please turn to Slide 10. On this slide, we bridge the second-quarter sales and gross margin performance to the same quarter last year, highlighting the primary drivers of the year-over-year change. We estimate the Longview ERP implementation and supply chain disruptions in early April impacted total sales by approximately $35 million or 11.1%. Together, these two issues impacted gross profit by approximately $20 million. Also worth noting, pricing had a minimal impact on overall sales and gross profit for the quarter. Through Q2, we have recognized only a small portion of the 3% price increase implemented on January 1 and almost none of the 6% tariff surcharge introduced in March. Please turn to Slide 11. Looking at the segment financials and starting with AAON Oklahoma, net sales in the segment declined 18%. This decline was driven by lingering supply chain disruptions related to the refrigerant transition at the beginning of the quarter as well as coil supply shortages towards the end of the quarter due to our ERP implementation at the Longview, Texas facility, which slowed production of coils for our Tulsa plant. Despite the year-over-year decline, production improved consistently month-to-month throughout the quarter, a trend that continued through July. Production efficiency in July was 6% below pre-Q4 2024 levels. Lower production volumes were the primary factor in the gross margin, contracting 970 basis points. Also contributing to the segment's contraction of gross margin, the Memphis plant incurred costs of $3 million. Along with improving production rates, AAON Oklahoma entered August with a strong backlog. Please turn to Slide 12. AAON Coil Products sales grew by $27.1 million or 86.4%, primarily driven by growth in basic brand products of $40.1 million for a large liquid cooling project. AAON branded products declined by $13 million due to disruptions caused by the change in ERP systems. The ERP implementation significantly impacted both production volumes and efficiencies of AAON branded equipment, serving as the primary driver of the 1,990 basis point contraction in segment gross margin. Since April, production of AAON branded equipment at the Longview facility has improved significantly. Using the average production rate over the first 9 months of 2024 as a benchmark, production of AAON branded equipment in April was down approximately 50%. At the end of July, we were down 37%. For BasX branded production at this segment, the impact of the ERP implementation was considerably less, largely because of the uniformity of units within the orders. Thus, production performed relatively well and the backlog remains strong. Please turn to Slide 13. Sales at the BasX segment grew 20.4% due to the continued demand for data center solutions. Gross margin contracted 60 basis points from a year ago due primarily to higher indirect costs for warehouse personnel, partially offset by lower material costs. Gross margin increased sequentially for the second consecutive quarter, reflecting continued operational improvements since we initiated targeted efforts late last year. Please turn to Slide 14. Cash, cash equivalents and restricted cash balances totaled $1.3 million on June 30, 2025, and debt at the end of the quarter was $317.3 million. Our leverage ratio was 1.4. Year-to-date, cash flow used in operations was $31 million compared to cash flow provided by operations of $127.9 million in the comparable period a year ago. Year-to-date, cash flow from operations largely reflects increased investments in working capital. Capital expenditures through the first half of the year, including expenditures related to software development, increased 18.7% to $89.6 million. We had net borrowings of debt of $162.1 million over this period, largely to finance the investments in working capital, capital expenditures, and $30 million in open market stock buybacks that we executed in the first quarter. Overall, our financial position remains strong. This gives us the flexibility and allows us to continue to focus on investments that will drive growth and generate attractive returns. For 2025, we continue to anticipate capital expenditures will be $220 million. I will now turn the call over to Matt.

Thank you, Rebecca. Up until now, we've intentionally placed extra emphasis on the quarter and the challenges we faced, particularly around the ERP rollout because it's important that you fully understand what happened. That said, what matters most is where we go from here. Starting on Slide 15. As shown here, our adjusted backlog remains strong, up 72% compared to a year ago. At this stage, the BasX brand is the primary growth engine of the company, fueled by exceptionally strong demand from the data center market and the unique custom design solutions that we provide our customers. We are now producing BasX branded products at all of our major facilities, including our newest site in Memphis, which we purchased just 8 months ago. Aside from effectively managing the ERP rollout, bringing this facility fully online is our top operational priority. By year-end, this facility will significantly expand the capacity of BasX branded manufacturing by nearly doubling its square footage. At that point, we will be well positioned operationally to fully capitalize on the robust demand for the data center market. While we've seen strong growth in BasX branded production thus far, our full potential remains constrained by current capacity limitations, a challenge we are actively working to overcome. The Longview facility, which is represented by our AAON Coil Products segment, is equally as important to our growth strategy with the BasX brand. At Longview, we are currently manufacturing a uniquely designed liquid cooling product for a hyperscaler. We've been steadily ramping production of this product throughout the first half of the year, positioning our manufacturing operations for a multiyear increase in volume. Since being awarded the initial order late last year, we received additional follow-on orders and are actively collaborating with this customer to develop new designs for their next-generation data centers. Overall, the outlook of our BasX brand remains very strong. We produce the most sophisticated customized thermal management equipment in what is a rapidly evolving and technically demanded industry. Looking ahead to the second half of the year, we anticipate BasX branded sales will increase year-over-year by approximately 40%. Our AAON brand is equally strong and critical to our long-term success. Despite prolonged softness in the nonresidential construction market, our bookings have remained strong, particularly in the second quarter, when they grew by double digits year-over-year. The recent strength in bookings highlights the value of our products and signals an opportunity to further leverage our pricing power. At the end of the second quarter, backlog of AAON branded equipment was up 93% from a year ago and up 22% from the end of March. Our top priority right now within the AAON brand is to put our customers first by continuing to ramp up production at both the Tulsa and Longview facilities, ensuring that we deliver the highest quality products in a timely manner. The value we deliver to our customers through our premium quality, high-performance equipment has never been more compelling, and we're seeing that reflected in strong demand even in a soft market environment. You can particularly see this with our national account strategy, with year-to-date orders to these customers up significantly. Given the progress we're making in production and the strength of our backlog, we expect AAON branded sales to increase significantly in the second half of the year, with quarter-over-quarter growth anticipated in both Q3 and Q4. Please turn to Slide 16. Due to the greater-than-expected impact of the ERP implementation on our second quarter results and the resulting effect we now anticipate in the second half of the year, we are revising our full year 2025 outlook lower. We now anticipate full year sales growth in the low teens and a gross margin of 28% to 29%. Adjusted SG&A as a percentage of sales is now expected to be between 16.5% and 17%, and we continue to expect CapEx to be approximately $220 million. Please turn to Slide 17. On this slide, we highlight the key factors now incorporated into our full year outlook. When compared to the similar slide Rebecca walked through for the second quarter, you'll notice it reflects an expectation of accelerated volume growth in the second half of the year. This is not as strong as we were previously expecting due to lower production rates entering the third quarter, but it's still strong sequential growth. You'll also notice favorable price/cost dynamics are expected to accelerate meaningfully in the second half. At the same time, it also factors in additional ERP-related headwinds that we previously were not anticipating. Please turn to Slide 18. Here, we illustrate and quantify what the full-year outlook implies for the second half of the year. Despite the temporary challenges we are facing, we still expect a significant jump from the first half to the second half. Furthermore, if we take a step back, you can see the trajectory is positive looking back to the beginning of 2024. We are addressing the challenges we face head-on and are firmly on the path to recovery. Lastly, I want to direct your attention to the table in the bottom right corner. The year-over-year growth that we now anticipate in Q3 and Q4 implies sequential growth throughout the rest of the year. Through year-end, we expect production rates to improve and the adverse impacts of the new ERP system implementation to lessen. Before I hand it off for Q&A, it's important to note that the core fundamentals of this company have never been stronger. And once we move past these temporary obstacles, we'll be in an even stronger position to deliver long-term value for our customers and our shareholders. I know these results are disappointing. And believe me, I share in that disappointment. But in the broader context, this remains an incredibly exciting time for our company. The future is bright, and we are well positioned to emerge from this period even stronger. With that, I will now open the call up for Q&A.

And your first question will be from Timothy Wojs at Baird.

Thanks for all the details. Maybe just to start, I guess on the guidance in the second half kind of coming down more than you think, could you just, I guess, maybe bridge us a little bit versus the prior guidance that you have versus what you have now? And how much of that is the ERP implementation? And how much of that is just lower volumes and the under absorption associated with that?

Yes, thanks for the question. So as we look at the kind of revision to the back half of the year on the guidance side, primarily the drivers there are going to be around the ACP performance and the sort of ERP impacts that come with that. And so with that, we ended July with a 37% performance against our efficiency metric. But just to quantify, that was at a production level, total production level that was down about 20%. So we finished off July being 20% of where we want to be from a top line revenue perspective on AAON branded product inside of the Longview segment. And we're seeing that accelerate. We're seeing that improve, but just kind of meaningfully considering that impact on the back half of the year. And then when we kind of switch over to a lesser extent on the Tulsa side, while Tulsa is certainly performing substantially better than the ACP segment, we did start the quarter at a lower performance point just with that coil impact that we had. And so really, that's reflecting to a lesser extent, also the lower starting point that we're ramping off of within the Tulsa segment.

Okay. Okay. And I guess when you look at kind of what's implied, I think it's probably something in the low 30s for gross margins in Oklahoma in the back half of the year, yet you're probably going to get close to the revenue numbers that you had in the first half of '24. So I guess what is the difference outside of a few million dollars and things like Memphis kind of ramping between that kind of maybe low 30s number and something that was closer to 36% or 37%?

Yes, great question. And so we think about the Tulsa side of the business, and I just want to start off that nothing has drastically changed kind of on the overall performance of that segment. There are some incremental costs that we've invested within the organization with enhancements to our end-of-line test procedures, some investments in additional laboratory work, and really driving some of our innovation. But when we look at that, we're talking about tens of basis points, not hundreds of basis points. So when we really think about what are the primary drivers in the overall margin on the Tulsa segment, Memphis and the startup cost certainly is going to be one of those big cost drivers that's going to kind of add on top of those incremental costs. And then on top of that, we have been producing BasX products within the Tulsa segment. And so that production that we're temporarily doing there just to basically provide more capacity for the BasX brand, that capacity, that manufacturing is temporarily putting some strains on the overall efficiency metrics within the segment. So that really is kind of what's putting the pressure points on there. But when we look at it from an overall kind of Tulsa perspective, we truly believe that gets back into that long-term target and that 32% to 35% on an annualized basis within that margin profile.

Okay. And then I guess the last question I have, just data center backlog. I know it's been pretty good the last couple of quarters, but it was flat sequentially. Anything you would kind of highlight or call out there? I know that that business can kind of be lumpy. But just if you could spend a minute just on the health of the data center business and how you're positioned there, I think that would be helpful.

Yes. So from a data center perspective, I just want to start off by saying it remains incredibly strong. The activity, the engagement we have within the market remains incredibly strong. And so just to put it in perspective, the overall top line sales were up year-over-year 127% in the quarter. So when we look at that flat backlog, it obviously suggests good strength in that quarter, which means good activity on the overall booking side. And that activity and that engagement have been at least, if not stronger in both July and August. But when we step back and think about the data center market, a key aspect there is we've got to have capacity to sell. And so we have just begun selling into that Memphis investment that we had as a kind of a production capacity perspective. And we're going to start seeing the ability to sell that capacity meaningfully impact the backlog going forward. But when we look at kind of where we stand right now, while we're ramping up production in Memphis, we also have to be realistic when we book orders to make sure that we are providing delivery within the customers' expectations. And so we're going to see that Memphis facility really provide a meaningful capacity increase at the later half or later portion of this year and continuing to accelerate within 2026. And you'll start seeing orders that are basically filling that facility start to come to fruition. And just to maybe also give you a little bit of context, we look at the ACP performance, we look at the segment sales and really the bookings perspective on that liquid cooling order. I mentioned in the prepared commentary, but I just want to reiterate here that we continue to have active engagement with that customer, not just in the current orders and follow-on orders, but also working with them actively to develop the next-generation liquid cooling solutions for their data centers. And so we've kind of brought this up multiple times in the past, but it's a dynamically evolving market with new technology. And so the customization, the unique value proposition that the BasX brand provides to that data center market really resonates in that rapidly evolving and dynamically moving market. And so we're going to continue seeing good strength in bookings kind of coming off of all the engagement we're having within that market today.

Next question will be from Thielman at D.A. Davidson.

Matt, maybe just picking up off that last question on just the BasX brand visibility in data center. I mean, could you just talk about the significance of the Applied Digital partnership for the future of BasX and orders, how that fits in?

Brent, that's a great question. Applied Digital is essentially a dedicated AI data center developer. They are focused on creating high-performance, next-generation AI infrastructure, which aligns well with the BasX brand. This synergy allows us to develop solutions that enhance performance in that sector. When we consider the AI data center as a whole, we have thermal management systems outside, specifically chillers, and airside solutions inside such as chilled water fan coil units and CDUs. We are actively discussing all three of these components with the customer and have already secured orders for two of them, including crucial high-performance chillers that are vital for efficient heat rejection in AI data centers. Our team is working closely with the customer to design a solution tailored for AI workloads. While we are focused on their facility currently under construction in North Dakota, they are also expanding in the region. We are fully engaged in these efforts and collaborations. This marks just the initial phase of a long-term relationship with the customer as we help them manage their thermal loads while they implement AI capacity nationwide.

Thank you, Matt. As a follow-up, I’d like to discuss the outlook for the remainder of the year as we approach the fourth quarter. It appears there are some challenges, but it still suggests strong top-line growth in the high 20s. Could you elaborate on what you are anticipating for the fourth quarter, particularly regarding the significant growth expected toward the end of the year?

Yes. As we review the guidance for Q4, we are anticipating an acceleration from Q3 to Q4. The implied growth we mentioned earlier suggests year-over-year growth in the high 20s for our top line, with margins returning to the low 30s. We're addressing the operational challenges we've encountered with the ERP implementation. We also have significant visibility in our backlog for both the AAON and BasX brands going into the latter half of the year. This indicates continued strong performance in the ACP segment of the BasX brand and a recovery in the AAON brand within the ACP segment. We're ramping up operations in Tulsa significantly, which contributes to our visibility in both the AAON segment and the Tulsa segment with AAON branded products. This growth is accompanied by a positive pricing dynamic. In Q2, we barely realized the 3% price increase and did not see much of the 6% tariff surcharge, but these factors will start to influence our performance in Q3 and Q4, aiding top line growth and gross margin expansion. In the BasX segment, we expect stability similar to Q2, while also driving efficiency for margin improvements. Additionally, we'll soon see operations in Memphis commence. However, we are still accounting for the ERP impacts within the Longview segment, so we are cautious about our recovery process. We started Q3 for the Tulsa segment at a lower point than desired, but we anticipate a strong production ramp for the remainder of the year, which will support the guidance we've set for the back half of the year.

Okay. Appreciate that. Matt, maybe just one more. I mean, fairly strong bookings here in the AAON branded product. Maybe just your read on that. Is this a direct result of the share capture strategy you've obviously discussed for several quarters now. Are there other elements to that, that we ought to think about in terms of driving those bookings? Just be curious your read on the bookings strength in that product line.

Yes. So as we think about the AAON brand and especially within Tulsa, the rooftop segment, I want to start off by saying, obviously, the market remains in a challenged position. So the overall nonres market, probably sitting near the bottom of the cycle, but certainly, it's been a tough market within that side. So when you look at our bookings relative to that market dynamic, it certainly is showcasing an outperform relative to the kind of macro environment there. And really, we talk about a lot of the things that we're focusing on that are helping that from a share capture standpoint. But really the biggest driver that we've talked a lot about with the intentional investments we made comes down to our national account strategy. And we've invested heavily within internal resources to support that strategic initiative and really help bolster that from a growth driver for the organization. And when you marry up that national account strategy with best-in-class heat pump technology in the Alpha class, we're really seeing just unique opportunities for us to be able to capture opportunity and share within the marketplace. And so as we look at that and we think about the overall performance, when we see that kind of share dynamic, obviously, in the backlog growth, it also does have us review and really kind of look at the opportunity to leverage price within that environment as well. And so as we think about the opportunity going forward, we're showing that the value proposition, the pricing of our product and really the positioning in the marketplace is really resonating and providing opportunity to continue reviewing pricing strategy going forward.

Next question will be from Ryan Merkel at William Blair.

I guess, first off, Matt, what's your confidence level that the new guide captures the downside risk from the ERP? And in the press release, you mentioned taking immediate actions to shore things up. Talk about that a little bit.

Yes, we have taken considerable time to ensure that our guidance for the second half adequately addresses the risk factors we see while providing a target that is realistic and has some upside potential. Our analysis considers our current trajectory, visibility, and performance recovery, all of which have been incorporated into our guidance to allow for positive outcomes. While we experienced production rate issues in the ACP segment and disruptions in Tulsa, which were disappointing, both segments are showing strong recovery metrics. For example, in July, Tulsa was just 6% below its target efficiency rate by month’s end. We are observing the recovery signs we anticipated, despite the initial impact being larger than expected, but the recovery process is clearly visible. Regarding our immediate responses to supply chain issues, we faced some unfortunate events as our ERP system affected coil production in our Longview segment, leading to impacts in Tulsa. Once we noticed supply chain constraints from third-party vendors, our supply chain team quickly mobilized onsite resources to manage the situation effectively and reduce impacts on operations. This proactive approach has put the Tulsa segment in a much better position coming out of July. The ability to address challenges swiftly is a strong point for AAON, as our team has acted upon every issue, gathering resources and devising strategies to prevent recurrence. I want to emphasize that while the effects of the ERP implementation in Longview were beyond our expectations, the decision to proceed with that site was deliberate to stress test the ERP system comprehensively. We wanted to evaluate a location that produces both brands of coils to thoroughly assess our operations and identify potential weaknesses. By doing so, we anticipate avoiding similar issues during future implementations as we've already addressed and adapted to them. While the go-live performance didn't meet our expectations, the lessons learned and our operational strategy give us significant confidence in our future capabilities.

Perfect. That's helpful. And then I want to put the 4Q guide into a little context with revenue up high 20s. I don't think ERP issues will be totally back to normal at that point. So just a little context on what's assumed there? And then what does it assume about growth for Oklahoma?

In Oklahoma, we expect to see quarter-over-quarter growth in top line bookings as we continue to increase production capacity at that facility to address the backlog. It's important to note that ramping up production is a strategic process, and we can't quickly surge production in Tulsa. Therefore, we anticipate gradual improvements in overall production rates there, which are included in our guidance for overall recovery. Regarding the Coil Products segment, the guidance accounts for some ongoing impact in Q4 from the ERP issues within the ACP segment. While we are seeing improvements, we are taking these factors into consideration as it continues to recover, which is reflected in our Q4 guidance. For BasX, operations at the Redmond location are currently near capacity, so we don't expect significant growth from this basic segment in the near term. However, as we start bringing on additional capacity in Memphis, we expect to see growth in the BasX brands, with Memphis beginning to contribute more significantly in our Q4 guidance.

All right. Last one for me. So you're going to exit 4Q with a gross margin of 30%, 31%. You quantified the ERP impact this year, $55 million. We have to set a model for '26, and I know you don't want to talk about that. But in the script, you mentioned double-digit top line and margin improvement. Can you give us some sort of sense of how much margin lift we could see in '26? I know it's a bit early, but it would be helpful. Any color?

Yes. So certainly, we're not getting into too much detail on '26 yet. But when we look at the overall performance from a '25 and '26 perspective, we do see the top line growth that we guided or we provided that insight to in the overall prepared commentary. Our Q4 implied margin sitting at the 30% to 31%, what we're basically implying in 2026 is nearing that long-term target of 32% to 35%. And that is factoring in while we've gone through, I'll say, the hardest implementation in the Longview facility in terms of its first site and really stress testing the system, '26, obviously, we will still have the additional go-lives within the basics and the Tulsa segment. And so there is consideration kind of in that margin profile approaching 32% to 35% from a long-term guide perspective and some stress from the kind of future rollouts.

Next question will be from Chris Moore at CJS.

Yes. So it looks like bookings is pretty good on AAON. Maybe you could just talk overall about the prolonged softness in rooftop. I mean what are you thinking about the market overall in the next 6 to 18 months? Is it interest rates? Is it just any thoughts you might have on the overall market?

Yes. From a macro perspective, if we examine the Q2 results from others, it’s clear that volumes in the non-residential market are down, and we agree. Overall, there seems to be about a 10% decline in volumes across the industry in this segment. In terms of bookings, it appears we're at the bottom of the trough. We don't anticipate further deceleration or decline; rather, we're approaching or may be at the bottom of the market. Interest rates are definitely a factor, but once they stabilize, we usually adapt to operating in those environments. Thus, the key factor is achieving stability amidst various uncertainties like tariffs and interest rates. Once we reach a normal operating condition, the industry tends to learn how to function within the new cost structure. Much of the deceleration we've witnessed and discussions we've had center on the uncertainties in the near term. Looking 12 to 18 months ahead, we anticipate a market upswing as it stabilizes. However, despite the softness in the macro market, the bookings at AAON highlight a stronger performance against that backdrop. This success can largely be attributed to our strategy, such as our Alpha Class product with bookings up over 60% this quarter and robust performance from national accounts. These represent significant opportunities for AAON to continue outperforming the non-residential market and gain market share.

Understood. That's very helpful. Going back to Investor Day, you mentioned that in a typical situation, BasX has gross margins between 29% and 32%, which is slightly below rooftop. I want to understand if there is something fundamentally different in the rooftop market that allows for higher margins, or if it is simply due to the rapid growth of BasX fully utilizing the facilities. Is there a possibility for them to reach parity in margins, or is BasX likely to remain lower in the long term?

That's a great question, Chris. And really, when we think about the margins, there's nothing that says we can't get to parity on the overall margin profile. The reason the commentary came and really we give that commentary regarding BasX at Investor Day and kind of today as well is just as we think about its growth rate, there's inherent pressures that are created in investing ahead of that capacity. And so when we think about these strong year-over-year growth rates, we're having to put the engineering resources, the overhead resources, a lot of the manufacturing staff ahead of the overall revenue to be able to support that revenue going forward. And so that creates some strains. Growing 40% year-over-year creates some strains just in operational dynamics. But certainly, we look at as those growth rates, I don't want to say tempered, but as we get this capacity online, we'll be able to start leveraging some of that. There's nothing to say we can't get our margins on parity with the overall rooftop segment. Just this hyper growth stage certainly has some pressures there.

Next question will be from Julio Romero of Sidoti & Company.

This is Alex on for Julio. First question was just circling back to backlog. I know it's up significantly year-over-year. Could you comment a little bit on the margin profile and pricing embedded in the backlog? And really, I'm asking if these orders are sort of protected with price increases and tariff surcharges or there's still some risk of margin compression on fulfillment?

Yes. I’ll separate the discussion between the two brands because they have different dynamics. Starting with the AAON brand, the backlog is well-priced compared to the Q2 results. We have just started to see the impact of the 3% price increase that took effect on January 1, which is beginning to reflect in our revenue for Q2. The AAON backlog includes a 3% price increase along with a 6% tariff surcharge, both of which will significantly affect our results in the latter half of the year and should enhance our margins. Given our current visibility into the supply chain, we believe there are additional margin opportunities within that backlog. Our supply chain team is actively procuring the necessary input materials to support manufacturing, providing us with good transparency into the situation. On the BasX side, there are escalation clauses in most of the backlog that allow us to adjust pricing based on changing circumstances. We also have a clear view of input costs and are securing longer-term supply contracts to back that up. Therefore, we expect the margins on the BasX side to remain neutral given the pricing structure in the backlog.

Great color. And then one more from us, just changing gears a little bit. Curious if you're seeing any positive sentiment from customers as a result of the One Big Beautiful Bill Act. Maybe any implications for stronger demand as a result of bonus depreciation or other aspects of the bill?

Yes, I would say that from an investment perspective, particularly in the U.S. regarding manufacturing, warehousing, and overall capital investment, there is definitely an improvement in sentiment. While it wasn’t an immediate shift when the bill was enacted, it has created a positive trajectory. As I mentioned earlier, when we are at what we consider the bottom of the cycle, any positive movement in sentiment is encouraging for future growth.

Next question will be from John Bats at Kansas Capital.

Matt, I know you don't want to talk too much about 2026, but can you give us a little sense on how the P&L for Memphis might look in 2026 versus 2025, sort of the delta between the years?

Just to clarify, Jon, you mean specifically kind of the cost drag versus the positive kind of contribution?

Yes, yes.

Yes. So obviously, when we acquired the Memphis facility and really since we started building out the overall facility, a lot of that investment, whether it be in people and staff or capital investments, they're certainly all coming ahead of the overall revenue. And so while we are generating some revenue in Memphis in 2025, it's not offsetting kind of the overall cost structure of basically standing up that facility. As we look into 2026 and as we think about orders like Applied Digital that we're going to be manufacturing primarily in the Memphis facility, we're going to start generating substantially more revenue to be able to offset those costs. And so the kind of way we look at Memphis in 2025 to 2026 is really going from a cost drag to an overall kind of drag on the overall financials to a positive contributor in the financials. And really, when we think about what's happening in '26, I mean, the growth of the BasX brand, that growth is going to come through Memphis in 2026. And so the demand we have for data centers, the relationships as we continue to develop these innovative solutions, all that's going to be what's driving the 2026 growth in Memphis and really allow it to become a positive contributor to the overall financial statement.

I would just say that as we hit certain milestones that are significant to informing you all, we will take that approach. There's nothing in the sand today as far as exactly what and when we will be providing that information. But as we hit certain milestones, we will provide those updates.

So Joe, if you reach those milestones, you might say something between conference calls. Is that how I should understand it?

Potentially or a conference or I mean, like I said, there's no set game plan to that, but we will provide regular updates when we hit certain milestones. We're trying to be as transparent as possible in an environment that is certainly impacting the financials like you've seen.

Okay. And one last question. Rebecca, there was a significant investment in working capital in the quarter in the first half. How do you see that playing out in the second half as operations get a little bit stronger?

Well, we'll still have some working capital needs to support the BasX brand. And like Matt talked about this upcoming job with Applied Digital to the extent we have to make those investments prior to like all of the production coming online, plus you do have our Memphis facility that we do need to stock up, make the investments to supply with inventory at that location. So that's primarily been what most of those investments have been. I anticipate maybe through, I don't know, mid-Q3 back half of the year, they should start to ease.

And at this time, Mr. Mondillo, we have no other questions registered. Please proceed.

Okay. Thanks, everyone, for joining the call today. If anyone has any questions over the coming days and weeks, please feel free to reach out to us. Have a great rest of the day, and we look forward to speaking with you in the future. Thanks.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines.