AAON, INC. Q2 2025 earnings call

Thank you. 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 and 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 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 up with a walkthrough 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 three, 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. Given the challenges we faced, we will start with providing some incremental detail on what went wrong. Please turn to slide four. I would like to start by giving some context to the recent events. Over the past two 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 1st, 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 a steady improvement throughout the remainder of the quarter. I turn to slide five.

This slide illustrates how recent production rates of AAON branded equipment have trended compared to normalized levels, which we benchmarked against the first nine 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's a strong correlation between the production efficiency metric and the gross margin performance. The biggest takeaway here is that after bottoming out in April, the total production consistently improved month to month throughout the quarter. 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 six. 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 1st 3% price increase and the 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 seven. 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 the 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 1st. 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 was 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 manufacturer's 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 own 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. While it's too early to discuss the outlook for 2026, factoring in subsequent ERP rollouts, particularly in the quarterly go-live in Tulsa, we expect to achieve double-digit year-over-year growth in margin improvement for the year, trending towards our long-term target of 32% to 35%. Now, please turn to slide eight. 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 continued 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 account orders grew year-over-year by 163% in Q2 and around 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. 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 nine. Net sales in the quarter declined year-over-year $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 impacts 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 of 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 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 bridged 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 1st and almost none of the 6% tariff surcharge introduced in March. Please turn to slide eleven. 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 a cost 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 $27.1 million, or 86.4%, primarily driven by growth in BASX branded products of $40.1 million for a large liquid cooling project. AAON branded products declined $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 detraction 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 nine 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 remained strong. Please turn to slide 13. Sales at the BASX segment grew 20.4% due to the continued demand for the 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-designed 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 eight 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'll 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 multi-year increase in volume.

Since being awarded the initial order late last year, we've 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 demanding industry. Looking ahead to the second half of the year, we anticipate BASX branded sales will increase year-over-year approximately 40%. Our AAON brand is equally strong and critical to our long-term success. Despite prolonged softness in the non-residential 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, the 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 Tulsa and Longview facilities, ensuring that we deliver the highest quality products in a timely manner. The value we deliver 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 at 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've highlighted the key factors now incorporated into our full-year outlook.

When compared to the similar slide Rebecca Thompson 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 for 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. 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. 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 a call up for Q&A.