Good day, and welcome to the AAON Inc. Second Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Joe Mondillo, Director of Investor Relations. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. A press release announcing our second quarter 2022 financial results was issued after market close today and can be found on our corporate website aaon.com. Joining me on the call this afternoon is Gary Fields, our President and CEO; and Rebecca Thompson, our CFO and Treasurer. Shortly, I’ll be handing the call off to Rebecca, for her to go through the second quarter results. Gary will then provide further insight on the quarter along with commentary on our outlook, and then we’ll open up the call for Q&A. Prior to that though, 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 Form 10-Q that we filed this afternoon details some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note, that we do not have the duty to update our forward-looking statements. And with that, I’ll turn the call over to Rebecca.

Thank you, Joe. I'd like to begin by discussing the comparative results for the three months ended June 30, 2022 versus June 30, 2021. Net sales increased 45.1% and to $208.8 million from $143.9 million. The addition of basic sales of $24.6 million was the largest contributing factor to our growth. As noted in our earnings release, revenue synergies from this acquisition have materialized faster than expected and are expected to have significant growth in the coming year. Another contributing factor to the total sales increase was the growth of our AAON Coil Product segment realized. Organic unit volumes at the segment increased 43.3% due to the new manufacturing capacity added to our Longview, Texas facility in early 2021. And as well as strong market demand for the electric powered split systems this facility produces. Our gross profit increased 12.5% to $47.4 million from $42.1 million. As a percentage of sales, gross profit was 22.7%, compared to 29.3% in the second quarter of 2021. The contraction in gross margin was primarily due to higher cost materials. While the cost of some materials have stabilized, we continue to see volatility in the cost of our component parts, and we continue to experience supply disruptions that create additional cost to the business. On a positive note, gross margin improved sequentially throughout the quarter as we work through lower price backlog and began to see some of our higher price backlog hit the production floor. While we expect supply disruptions will continue through the second half of the year, we believe pricing will offset those costs and help drive gross margin expansion in the second half of the year. Selling, general and administrative expenses increased 59.4% to $26.9 million from $16.9 million in the second quarter of 2021. As a percentage of sales,…

Good afternoon. Overall, we're happy with second quarter results. We improved production rates to record levels for the second straight quarter and shipped the most amount of product in any quarter in company history. At the same time, our backlog still increased modestly from the end of the first quarter. Demand remains strong, and we continue to book slightly more than we're producing. This positions us well headed into the second half of the year. Another positive is that our lead times are relatively stable throughout the quarter and still remain well below industry average. Today, in early August, we're still booking orders for shipment in 2022. I don't think anyone else in the industry is saying that. Gross margins were a little lighter than we were anticipating. Price cost was the biggest headwind to gross margins in the quarter, difference between pricing of the equipment we ship versus the cost of materials and wages was the largest of any quarter in recent inflationary cycle. The good news is that it began to shift in a positive way in June, we expect it will continue throughout the rest of the year. Pricing of orders in the backlog is much greater than the pricing of the orders that were shipped in the first half of the year. Furthermore, raw material prices have turned down since peaking earlier in the year. So we continue to expect substantial margin expansion in the second half of the year. We continue to face issues with supply chain. However, we're doing a very good job managing these challenges. I have to recognize our operational team for reaching record production rates for second quarter. In this environment, it is certainly very commendable. The flexibility of our custom manufacturing operations and engineering team provide us an advantage as…

And we will now begin the question-and-answer session. [Operator Instructions] And our first question today will come from Julio Romero with Sidoti & Company. Please go ahead.

Good afternoon Julio.

Hey good afternoon Gary, good afternoon Rebecca.

Good afternoon.

So, I wanted to start on the sales growth in the second quarter. The organic growth of 28%. I appreciate you're giving us the volume number. I was hoping you could expand on how much of the remaining 18% we can attribute to price versus mix?

Well, I don't have it broken out exactly that way. The mix, I didn't really see too much difference here. So, looking at total sales, I think it was almost -- not quite even between organic growth, pricing, and the acquisition. The three of them are very, very close to equal percentages.

Okay. No, I appreciate that. Turning to basics. I would love to hear you expand on the strategic benefit of manufacturing that product in Longview and what geographic regions are you looking to potentially play off instance?

This is something that when we were looking at the acquisition, I described to the Board two things that I believe would occur. One was that there were clients that really appreciated basics knowledge and abilities, but they just didn't have enough foundation under them if something was to go wrong. They didn't have a disaster recovery plan that made sense, particularly, because they didn't have a dedicated additional facility. So I knew in my heart that when we got this company with having the financial backing of the mother ship of Aaon, but these companies would be more comfortable, but also having additional manufacturing facilities. We had space both in Tulsa and Longview that we could dedicate to manufacturing basics products. So this first opportunity came up. The salesman actually worked for my former company that I was at before, Aaon when I was flip for 30 years. He contacted this and said that he had a hyperscale data center client that he had been doing business with 15 years that had used Aon equipment in some of their ancillary areas, but never in the core data hall. Now that we had basics, they wanted to explore that. So we all met in Redmond, Oregon everything went really well. And coming out of that was that the majority of their facilities are in the Midwest and the East. So we explored the possibility. I'd already started preparing an area of the new building in Longview to manufacture this kind of equipment and made the commitment to them that the timing was going to be good that we could build this order there. So when you look at the whole breadth of the order, not the $16.2 million, but the whole thing that they have committed to us, then we were able to save them a significant amount in freight. A load of freight to go from Redmond, Oregon to this project is about -- I think it was $8,400 versus $4,000 going from Longview to this plan. So they save $4,400 per truckload. And it takes -- you can put two of these units on one truck. So it's considerable. It's considerable. Now they have multiple facilities in the Midwest and the East that they we will build this product. But the other thing is, this product is relatively simple. It's a very custom design. But once you build the first one, then you just repeat hundreds, if not thousands of times to build this product. While that fits the Longview manufacturing culture very, very well. And this also allows basics to free up that space had they built it in Redmond, they would have used up that space there. But Redmond has the capability of building much, much more complex equipment for some of their other customers. So this was just beneficial all the way around.

Great. I appreciate that color. Anyway to think about where you are with capacity utilization at Longview?

With the commitment we have from this client, plus two other clients that are similarly positioned that are in very late stages of discussion. This could put the Longview -- the new Longview facility at close to 100% utilization for 2023 and 2024. And one of our clients is talking to us about exclusively delivering to them in 2024. They want to secure that capacity. So if we secure these clients, again, I'm very hopeful we're in the late stages of negotiations with them. Then that would pretty much top out what that building could do. But that leaves space in Tulsa that we can use. We have a good amount of space here that we've – we could build the same product. Of course, Redmond can still build it. So we're not tapped out in growth. Just that one facility might be. Well, when we built that building, we started in production there February of 2021. So we really finished at about January 1 of 2021. We built it with three sides that were permanent tilt walls on one side that was a temporary metal wall. And the idea was when we saw – that we were going to use up the capacity or get close to it, then we can double the building. So we're well prepared. We could probably stand that up in about 18 to 20 months. And if we secure these other orders before the end of the year, which is very likely that we will then we'll very likely start construction on the other half of that building right away so that we don't end up at 100% utilization before we get the new building finished.

Great. Thanks very much. I’ll pass it on.

[Operator Instructions] Our next question will come from Brent Thielman with D.A. Davidson. Please go ahead.

Good afternoon, Brent

Hi, good afternoon. Gary, good to hear gross margins, you see coming back here nicely in the second half. I was just trying to get a sense on the quarter itself just relative to the first quarter you were down a bit, especially looks like in the sort of core business. Is there a way to kind of bucket what's the difference in terms of the quarter-on-quarter comparison because I would have thought, you'd see a little better comparison growth in the first quarter.

Yes. It's actually fairly vivid. The price increase that we put into effect January 1. We had so much pull forward on that, that we ended up with almost two full quarters of production needs and so we had, let's say, a fixed price through the first two quarters. There was no real appreciation of significance of the price that was on the plant floor. But we continue to have materials increase, freight being one of them, components being the other throughout the quarter. So I think our labor, our annual labor increase went into effect right out the very first of the second quarter. So that was significant because we have -- normally, we have an annual labor adjustment across the board on the company. This past year, we had a labor adjustment first part of Q4, because cost of living was going up so much. We wanted to make sure we secured our people. So I'm not remorseful about that for this reason. How many manufacturers have you talked to that have got a head count that's plus 20% versus a year ago, not a lot. So this one key issue that we spent more money on our labor, but that allowed us to get this production, which helped with absorption of some overhead, but it did come at a penalty. Right about probably the second week of June, we started getting this higher-priced work on the plant floor. And so we saw good significant improvement in June, and that's why we're quite confident that we've got this improvement because our costs are relatively stable starting – in second quarter, they stabilized. And they have not worsened any, but our sale price is going up considerably. That January 1st price increase was 8% just by itself. And then…

Got it. Very interesting. Thank you for taking the questions. I'll pass it on.

Yes.

And our next question will come from Jon Braatz with Kansas City Capital. Please, go ahead.

Good morning Gary. Good afternoon, Gary and Rebecca.

Hi, there. How are you?

Pretty good, pretty good. Gary, did any -- did the supply chain issues that you have pressure your volumes at all? Were you at times unable to get some product out the door? And would volumes have been a little bit better in the second quarter?

Not significantly, Jon. The way it works, and I'll share this with you, every day at a bit after 6:00 o’clock our production -- our Director of Manufacturing sends me a report that how many units came off of what line? How many total units he shipped and what the total dollar volume is. Okay? That's in the Tulsa plant. And I get the same thing from the Longview plant. Well, we have expected dollars per day. And when I see it right on that, I don't have any questions. When I see it under that, I usually put a question mark and then I get a report back that I'll say, short some parts this, that and the other. Well, then one or two days later, I see a great big number coming in. So they had some number of units that were 99.9% completed, waiting on this 0.1% part, they couldn't send it to shipping, so it wouldn't qualify for this report. So I'm seeing things delayed two, three days at the most.

Okay.

But I'm not seeing things weeks or months.

Yes.

And I get this report I'm looking at them here, 608, 622, 604, just after 6:00 o’clock every night. And I just eagerly anticipate that report and mostly, mostly the numbers are what I expect. And we've increased production even more in August than what we did, July increased production over June. And August has increased again. Now part of this is tempered by price, because we're getting that 8% higher price on a lot of this. So I have to go back and do some, I call it, napkin math, to get me back to see what my actual volume growth is, but we're certainly getting volume growth, too. We've gotten more people on the plant floor; we've gotten them up to speed where they're productive now. And so, that's why we're very confident that we've turned the corner on the worst part of this. And the other thing, I don't know how much of this we described in the Q. I think we described it -- we had an 8% price increase in January, a 7% in March, but starting June 1, we were going up 1% per month, until further notice. Well, what this amounted to is, once we got the 8% on the plant floor and got the 7% on the plant floor, I felt like that we had caught up and maybe even got a little ahead of the price/cost scenario with gross margin, that we should be towards the upper end of our range is my anticipation, from everything that we're projecting. Well, as that occurred, I said, well, if we're at 9% inflation rate, that's almost -- that's what, 75% a year. I'd like to stay just a little ahead of that. I want to go up 1% a month. So, I'm trying -- I think we're between the guardrails on the range of gross margin that we anticipate is our preferred range. We're going to end the year probably towards the higher end of that range. But that 1% per month is going to keep us there from now and out. And especially with materials, steel, copper and aluminum have all subsided in pricing, components have not, however. Motors, compressors, variable frequency drives, all the electrical stuff. It's still going up. But when you take it in total, and I just did this analysis with our people earlier today, we're kind of flattish on material cost right now at this point in the game.

That's good, good. A couple of questions on Basic. When you acquired Basics, you had expressed the hope that as part of AAON, you will be able to work with larger customers, larger data centers. Number one question, are you seeing that coming to fruition? And then secondly, Basic was doing sort of about $100 million in revenue, something like that. Given the strength of their business, what's happening in Longview? How do you see that revenue potential now at Basics relative to when you acquired them?

Well, let's -- okay, let's do two -- you had two questions there. So, I'll bifurcate them. So, the first one is, absolutely. So this data center customer that gave us the $16.2 million order for a basic product. For 15 years, they've been buying AAON for their ancillary areas, but they've never bought AAON or AAON affiliated for their core data hall. So, we're still supplying them legacy AAON equipment for their building pressurization and humidity control. But now, we're providing them equipment for the core data hall. And that was the target. That was the whole concept was that these customers that we had had for many years, we had a very, very small footprint, the participation of their HVAC needs, and now we can take care of a huge tranche of their needs. So, there's the first customer that signed up with this with Basics as a result of that. Now, we've got multiple other customers that are in the same scenario. Those are some of the negotiations. I feel very confident that we're going to have a favorable outcome, because they've been AAON customers for many years. I’ve been very, very confident AAON now -- respectful of what AAON has done for them, and we have a mutual respect for each other. And now that we're in this business, and we've proven that with Basics, we can do this, we're getting these opportunities. Now let's talk about the revenue synergy to it. So Basics was, let's say roughly $100 million anticipated revenue for 2022 and I think that's still going to be relatively close. I think they might be right in that range, as you saw, they did -- they've done, what, nearly half of that so far this year. What have they done so far, Rebecca?

12 million.

No, no, for the year, Basics revenue?

Sorry, that was gross profit. Yes, $45.5 million.

So they've done $45.5 billion, and they're accelerating. So they're probably going to end up just north of $100 million. Now when we build this BasX product in Longview, it won't go on BasX P&L because it's built in the Longview plant.

Yes.

It will go on their P&L. So we'll be giving commentary to that to show you what that is. But right now, the Longview plant is also growing tremendously. What's our volume this quarter on Longview? You segment that out.

Yes, we do.

Should have been about $27 million, $26 million, $27 million, or is it? While Rebecca is looking for that, so the thing is as Longview is running on pace to do $100 million, which is doubling their business. But this opportunity to build these computer room air handling units there is going to double that.

Yes. Okay.

41.9% increase in units sold for Longview.

Yes. But that's still you didn’t give me the volume of -- we're running at a pace to do just ride out $100 million in Longview in the legacy product. And then this new product, it won't have a material impact on 2022, we're going to build prototype units for testing next week. And we're going to bring that owner in to review those because there's two different ways that we've explored building it and from a cabinet construction methods. And we're going to make some decisions on it, and then we'll probably get everything together supply chain wise, and we might deliver some units in December, but I don't really look to deliver too much before that. They really don't need units until May of 2023. They're looking at how they can store before that. We'd like to materially build that order in January and February. And then that allows us to really get the year started building $8 million, $10 million a month of those kind of products in addition to the $10 million or so of legacy products.

Yes, yes. Okay. Okay. All right. Sounds great. Gary, thank you very much.

Thank you, Jon.

There are no further questions at this time. This will conclude the question-and-answer session. I'd like to turn the conference back over to the company for any closing remarks.

All right. Thanks, Cole. 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. Have a great rest of the day, and we look forward to speaking with you in the future. Thanks.

Thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.