Q1 2024 Aaon Inc Earnings Call

Participants

Joseph Mondillo; Director - Investor Relations; Aaon Inc

Gary Fields; President, Chief Executive Officer, Director; Aaon Inc

Matthew Tobolski; President, Chief Operating Officer; Aaon Inc

Rebecca Thompson; Chief Financial Officer, Vice President - Finance, Treasurer; Aaon Inc

Chris Moore; Analyst; CJS Securities, Inc.

Ryan Merkel; Analyst; William Blair & Company

Julio Romero; Analyst; Sidoti & Company, LLC

D.A. Davidson

Presentation

Operator

Good evening, ladies and gentlemen, and welcome to the Aaon Inc., Q1 2024 earnings conference call. (Operator Instructions) 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.

Joseph Mondillo

Thank you, operator, and good afternoon, everyone. Saw the press release announcing our first quarter financial results was issued after market close today and can be found on our web corporate website, AON. dot com. The call today is accompanied with a presentation that you can also find on the website as well as on 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, the Securities Act of 1933 and the Securities and Exchange Act of 1934 each as amended.
As such, it is subject to the occurrence of many events outside AAON's control that could cause AAON's results to differ material materially from those anticipated. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements in our press release and Form 10-Q that we filed this afternoon detailed some of the important risk factors that may cause our actual results 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 will 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 Barsky, our 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 we'll 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.

Gary Fields

Good afternoon. Let's start on Slide 3. First quarter performance was mixed relative to our expectations. Bookings remained strong and were in line with our expectations. This was consistent across all three of our segments total backlog increased for a second straight quarter compared to a year ago, it was down just 6.9%, which is positive considering how abnormally large backlog was with supply chain issues were it adversely affecting our lead times.
Sales and earnings were a little soft to start the year due to lighter than expected volumes. A large factor to this was timing of backlog conversion at our A. on core products and basics 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 result in the first quarter. We are 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 is 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 and approach the point in time in which will we will be unable to accept orders for our forte and a equipment it is likely we see a short-term wave of orders related to projects already designed for 410 A. 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 for T&I equipment.
We are also strategically positioned from a pricing and product development standpoint, our narrower price premium makes us more competitive. And all indications tell us we're going to be even more competitive from a cost of manufacturing perspective as the markets transition to the lower GWP refrigerants.
As far as product development, the advancements of our fully electric heat pump technology, Alfa class branded products positions us extremely well as the industry begins to focus more and more on electrification. Earlier this month, the department Department of Energy announced a program to expedite development and adoption of cold climate commercial heat pump rooftop units on 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, which would potentially make this a big opportunity for us beyond our traditional markets, we are increasingly excited about the data center market and how we can capitalize on the growth cycle of this end market 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 in the midst of 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.
I'll now hand over the call to Matt to Balsky, who will speak more in depth about our operational strategy.

Matthew Tobolski

And thank you, Gary. If you will, please turn to Slide 5. We utilized this slide in our Q4 call, but the only difference being we've added a six slice to the pie, which is our data center solutions. Data center vertical has been an integral factor to the robust growth for the basic segment has realized over the last several years, we expect this market will become an even larger part of the overall organization going forward, given the current makeup of backlog and the pipeline of future opportunities over the last six to nine months with the advancements of semiconductor chip technology and the anticipation of increased computing demand fueled by artificial intelligence, data center companies have accelerated their construction plans aggressively over this time.
And 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 basis core is all about and is what sets us apart from most in the industry with assistance from the rest of our operational teams.
We have executed nearly flawlessly recently leading 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 of supplying 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 in our Longview, Texas facility. In total, the two projects will increase the overall company's total manufacturing square footage by approximately 15%. So 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 regimen expansion is expected to be finished by the end of Q3 of this year in the Longview expansion 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've had our complete portfolio of equipment offering with the new refrigerant since the start of this year. We are also well ahead of the industry with the advancement of heat commercial heat pump technology. We are the only company in the commercial market with a portfolio of fully electric heat pump powered rooftop units that are operable down to zero degrees and being the first to market with this technology is going to 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 big opportunity with national accounts.
Lastly, our already world-class sales channel continues to strengthen, which is going to 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 increased support through marketing, parts and service will further help our reps become more successful in penetrating the market altogether we expect these strategies will 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 IA on culture has never been so strong. 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 extensive opportunities we have going forward.
And with that, I will hand it off to Rebecca to walk through financials.

Rebecca Thompson

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 are driven by the A. and coil products and basic segments, which realized total sales declines of 27.4% and 9.3% respectively. Both segments had strong backlogs entering the quarter compared to a year ago.
So the revenue declines that both were largely based on timing of backlog conversion to a on Oklahoma segment realized an increase in total sales of 4%. Volumes at 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 an 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. Improvement in gross profit margin was primarily a result of increased pricing and moderating cost 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 the net results 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 in a range of 25% to 26%.
Starting to slide 10, our balance sheet remains strong. Cash, cash equivalents and restricted cash totaled $28.4 million. Our March 31, 2024 debt at the end of the quarter was 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 $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 cash position. All in 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.

Joseph Mondillo

Operator, I think we may have some drop, Gary, potentially.

Operator

Yes.

Joseph Mondillo

I'm just going to I'm just going to finish out the closing remarks and then we can open it up to Q&A. Can we please turn to slide 11? All in all we feel very good where we are currently. For the last several years, we've made major strides in transforming this company from a niche application based provider to a mainstream solutions provider for the last two years, we've really 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 to product development has yet to be fully realized.
We have the best product by far the best, but for 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 a little 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 Aon in a time when the economy is slowing and we're proceeding in election. We expect growth to temporarily moderate. But for the reasons previously stated that this does not concern me it.
If I have any questions any concern at all? It will be we can it would be we can we can we can we continue to build capacity quick 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 in a mid single digit contributor and that gross margin will be up year over year for SG&A as a percent of sales, we now anticipate a 50 basis points to 100 basis points 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 moderate modestly down.
In closing, we just wanted 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 for us.
We can now open up the call for Q&A. Operator?

Question and Answer Session

Operator

Chris Moore, CJS.

Chris Moore

Thanks, guys. Thanks for taking a couple of questions. Jim, maybe we could start with basic so obviously, it looks like the timing, our basics backlog conversion and contributed to a softer quarter. It's hard to gauge on kind of quarter to quarter on on basics. Can you give any sense in terms of, you know, basics as a as a piece of the backlog as a percentage. Has that changed much over the last year or just kind of how we should be thinking about that?

Matthew Tobolski

Yes, of course, Chris, a great question. And certainly from a contribution of basic from the backlog, I guess the simple way to kind of look at it. We talked during the last quarter call kind of on the '23 kind of performance, which was basically as a whole in '23 was approximately 10% of the overall revenue within the enterprise, but contributed 20% to bookings for the year for, I should say sorry, 20% of that bookings for the year. And as we look forward and kind of this quarter and beyond, we're continuing to see that if not more contribution from the basics backlog.
And so we certainly see there being a lot of strength within the basics backlog and really also kind of helping drive the coil products business data along the as well as we kind of start to really engage to get the basics product built down there as we continue the expansion with data center products. So it certainly is going to become more and more relevant going forward as a percentage of the overall revenue of Aon and definitely see it contributing, it's substantially greater growth kind of on a year annualized basis compared to legacy business.

Gary Fields

Yes, done as we've gone through. So I think we have stated before that basics had been about 10% of our total revenues and we expected of at some point not too far in the future, that would be closer to 20% because they were growing so rapidly.

Chris Moore

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 improve further improve at the point in time this year that customers no longer able to order equipment with the or for 10 A. refrigerant, you have give a kind of a best guess as to when that point?

Gary Fields

It's going to be a bit dependent on lead time for this reason, you cannot deliver equipment with for 10 A., our type of equipment beyond December 31. So if you say well, I want to have a two or three week buffer between December 31 and the last unit at produce just to make sure I don't have some kind of step milestone moment and you have roughly a 10 week lead time. So let's just put that at 12 weeks of just back at 12 weeks from the end of the year, and that's got to be the absolute cut-off.
Well, we're going to trying to push people towards a cut off ahead of that so that we don't end up with a problem. The problem could be, and I've heard other manufacturers talk about this. If we get a surge of orders, people wanted to get for 10 a. the last minute, then the lead times could easily bump out and then where you add so this is a it's kind of an unusual situation that we've not really encountered before when we had a refrigerant change before there was no building codes associated with at this time, there's building codes next set necessary in order to utilize the new refrigerant while there's also additional expense in the buildings.
And I think that's driving some people that say well, I'll just go ahead and get for 10 a. because I don't have to have this additional expense for these refrigerant management out strategies that are required by this new code. So just to summarize that, I would say somewhere in August, we're probably going to see a surge.

Chris Moore

Got it. That's very helpful. And maybe just a last one to kind of 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 from that perspective. The My understanding is that the new refrigerant requirements are really not going to cost. And any more you have the new safety device that you'll have to it include with Apple, you're manufacturing that internally. So it sounds like from a competitive standpoint, you should be in really good position for this changeover. And am I looking at that correctly?

Gary Fields

Yes, I think so. And as we went through unit by unit of that. That holds true for vast majority. There's there's cases in there where we lost capacity when we converted. And so you've got to add something to get more capacity. That's not across the board. It's not prevalent, but it does appear here and there on certain size units. But I think mostly the way we portrayed that is correct.

Chris Moore

Yes. Alright. I appreciate it, guys. I'll jump back in line.

Operator

Ryan Merkel, William Blair.

Ryan Merkel

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

Gary Fields

Well, actually, each month had something just a little different at those two factories on that. So we saw January wasn't too bad towards the end of January. We had some weather events of that that hit us more in basics than it did anywhere else. But more prevalently was it hit some of our customers and our customers asked us to slow down on certain projects just a little bit that, hey, we don't have anywhere to put this equipment. Can you slow down just a little.
So there was some weather event in there. And then I don't want to discount entirely the impact of the construction going on at both of those locations. Both of them have substantial construction going on. What's going on in Longview is probably less disruptive because it's outside of the building we're using now, but it's somewhat disruptive.
But in Oregon, they have disrupted the two primary buildings up there. One of them has had a reasonable disruption in rearranging what we're doing in there, getting it ready to move into the new building that we're building. And it's just it's not without impact. It's not substantial it's not prolonged. It's not something we're going to put up with me for a very long time, but we did see a little bit related to that.

Ryan Merkel

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

Gary Fields

Well, each segment reported. So you can see that on both of those two segments that I just spoke of ACP and basics were both below 2023. The growth, while it was marginal was in Tulsa and Tulsa, just it has no disruptions of any magnitude a little bit of weather related for some of our cause. We had customers saying you're shipping too early to us with this weather, we're having weather delays. Can you slow down a little that happened across the whole enterprise, but Tulsa was less impacted by. Does that answer your question, Ryan?

Ryan Merkel

Yes, I think so. Income maybe the follow on would be it sounds like I think you said second quarter sales flat, so we're not seeing a lot of improvement in 2Q. When do you expect at these timing of backlog issues or the production issues that you talked about when do you see that getting back to normal?

Gary Fields

Well, my personal perspective is that it will be improving through Q2, but it will be Q. three before it's relatively normal.

Ryan Merkel

Got it. All right.

Gary Fields

Thanks.

Operator

Julio Romero, Sidoti & Company.

Julio Romero

Thanks, and good afternoon. On maybe 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 adding more than expected capacity parts and volumes were a little depressed due to the issues you just outlined.

Gary Fields

Matt, do you have any perspective on that?

Matthew Tobolski

Yes, I wouldn't I wouldn't say that the I wouldn't say the impact of volumes on the ACT and basic segments provided excess capacity apart, let's say, the parts growth is really parts demand and also from just a kind of a year-over-year comp. And also, you know, from from last year to this year, just also a normalization of supply chain has really also kind of made it easier to transact parked in any kind of global sense.
There's a lot of noise that kind of supply chain created in terms of being able to actually manage parts sales that's really stabilized now. So it's really just driven by demand of parts, nothing to do with the kind of slower volumes off any of the sites.

Julio Romero

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

Matthew Tobolski

It's a fantastic question. Yes. Yes, I would say at a high level, that's sort of where we are we specialize in providing kind of value value add to our customers. And so that does afford us the opportunity to really put us in unique positions with our customers and develop solutions that really provide us a far better opportunity within those customers. And so that is actually actively in our prepared remarks when we talk about the engagement of our engineering and operations teams.
That's exactly what they've been doing. And it's really developing unique in really and solutions tailored for a given owner's kind of business models. And that's one of the great benefits of being a manufacturer with that kind of custom DNA, where we can can really solution something for the owners and then convert that to a mass produce products and really add a lot of value.
So definitely, it's what we're most excited about. We certainly see opportunity to really ingrain ourselves in kind of their growth story and really be able to kind of be at the forefront of enabling that.

Julio Romero

Excellent. I'll pass it on. Thanks very much.

Operator

D.A. Davidson.

D.A. Davidson

Hey, thanks and good evening. More actually, just kind of following up on that. Could you actually talk about the opportunity on the liquid cooling side for basics? And are you beginning to see orders for that specific market?

Matthew Tobolski

Yes, it's a interesting line, and I'll say the the surge in AIM., it's really cause the industry to kind of really kind of look at how do you develop and deploy capacity to the marketplace. That also has flexibility to kind of serve more traditional cloud compute as well as AI and kind of how do you blend your development strategy around that?
And we've really been working pretty heavily in that kind of market where we're developing solutions and then really working with customers too, to solve the air side and liquid side kind of conundrum and how we kind of go forward. And that is that has already gotten us to a point where we've got orders in hand and really substantial opportunities in the liquid cooling realm.
And really the of it's been kind of crafting solutions that really do provide flexibility in the deployment. So we see that actually as a really good, strong suit because it provides, you know, a better opportunity to deploy products where you don't necessarily know exactly what that future demand and that given location is going to look like and in those demos that greater flexibility really is attractive to the overall end user mean kind of as they look to deploy capital.
So we're excited to be seeing the conversion to actually orders off of the liquid cooling efforts. We're doing and really, from a pipeline perspective, extremely optimistic on kind of what that's going to mean for the enterprise as a whole.

D.A. Davidson

Okay. And then and a lot of the focus in the commentary has been just around some of it delays as opposed to the long view in basics. I guess my question would be was that core and sort of a on Oklahoma rooftop business, what you would have expected this quarter or were there some delays in timing there as well?

Gary Fields

I think it's been relatively close, maybe just a slight bit softer than what we expected of it. We thought that we would see more seasonality in that business than what we had seen in recent years. And I believe that's mostly what we saw in the first quarter was the fact that Q1 historically has been a softer quarter for that product. The last few years, we've had exceptions for various reasons.
There was times when we had extraordinary lead time and others didn't that. We got past some of that seasonality of you know, there was buying habits that changed. There was just a whole lot going on. I think we're in a relatively normal cadence of business now. And our sales channel partners have strong backlogs themselves that they're processing, strong pipelines that they're processing and sending to us. And so while it was just a touch softer than what we may have expected, it wasn't entirely unexpected.

D.A. Davidson

Okay. And then just some of the pent-up or built-up sort of orders here, I suppose with basics, long view, does that I mean, I'll start to flow into the second half. I mean, should we see a huge catch-up year for 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?

Matthew Tobolski

Yes, we certainly see the kind of second half orders conversion to revenue definitely being strong in those segments. And really that's also kind of going to be aided by the As Gary mentioned, there's a lot of disruption in the projects that are going on at both sites. And so we also look forward to Redmond site wrapping up in the Q3 timeframe and a lot of you at the end of the year, you know, that's really going to help also kind of fuel some of that growth and kind of clean up some of the noise that's kind of happening on those sites. So we definitely do see that kind of second half kind of helping to accelerate kind of from a from a volume and a overall revenue perspective kind of at those sites kind of given those constraints.

D.A. Davidson

Okay. Thanks, Matt. Appreciate it.

Operator

Yes, yes, there are no further questions. I will now turn the call over to Joseph.

Joseph Mondillo

I'd 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 and have a great rest of the day, and we look forward to speaking with you in the future. Thank you.

Operator

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