Good day, and welcome to the AAON Incorporated First Quarter 2023 Earnings Conference Call. Our host for today's call is Joseph Mondillo, Director of Investor Relations. At this time, all participants will be in a listen-only mode. Later we will conduct a question-and-answer session. I would now like to turn the call over to your host. Mr. Joseph Mondillo, you may begin sir.

Thank you, operator, and good afternoon, everyone. The press release announcing our first quarter financial results was issued after market closed today and can be found on our website, aaon.com. The call today is accompanied with a presentation that you can also find on our website, as well as on the listen-only webcast. Please turn to slide 2 of the presentation. 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-K, 10-Q that we filed this afternoon detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have the duty to update our forward-looking statements. Joining me on today's call is Rebecca Thompson, CFO and Treasurer; and Gary Fields, President and CEO. Gary will provide some opening remarks. Rebecca will then walk through the quarterly results and then we'll finish with Gary for some commentary on the quarter and outlook. With that, I will turn over the call to Gary.

Good afternoon. Overall, we're very pleased with our first quarter results. We reported record sales for a fifth straight quarter. Organic volume was up year-over-year 23.5%. That was against a quarter a year ago were organic volume was up 21.3%. Our operations team is doing a great job managing the robust demand by increasing production capacity quickly while maintaining solid productivity. Backlog continued to grow. Quarter mark to seven straight quarter of record backlog and a ninth straight quarter that backlog grew sequentially. Despite how successful we've been with adding production capacity, bookings continue to outpace production. The environment for us remains positive. Bookings trends are still on the rise and our channel partners are very optimistic. Thus we maintain a positive outlook for the year. I'll now hand over the call to Rebecca to go over the financial results.

Thank you, Gary. I'd like to begin by discussing the comparator results of the three months ended March 31, 2023 versus March 31, 2022. Please turn to slide 4. Net sales increased 45.5% to 266 million from 182.8 million. The largest driving factor to the growth was organic volume, which contributed 23.5%. Line growth reflected the company's strong backlog at the start of the quarter as well as a fourth straight quarter record production which reflects the company's success of attracting and retaining employees along with continuously adapting to parts shortages. In addition to volume pricing contributed 22%. Moving to slide 5. Gross profit increased 67.5% to 77.2 million from 46. 1 million. As a percentage of sales gross profit was 29% compared to 25.2% in the first quarter of 2022. The increase in gross profit was primarily due to realization of price increases, counteracting the increasing costs of materials and labor. Within the quarter we incurred some onetime expenses related to the improvement of employee benefits. This explains a majority of the contraction in gross profit margin compared to the fourth quarter of '22. Please turn to slide 6. Selling, general and administrative expenses increased 42.9% to 32.9 million from 23.1 million in the first quarter of 2022. As a percentage of sales SG&A decrease to 12.4% from 12.6% in the first quarter of 2022. The increase in dollars is primarily attributable to salaries and benefits in profit sharing, which have increased as a result of our growing headcount, employee pay increases and benefit improvements discussed above. Please turn to slide 7. Income from operations increased 92.1% to 44.2 million from 23 million in the year ago quarter. As a percent of sales operating margin expanded to 16.6% from 12.6% in the first quarter of 2022. Moving to slide…

Please turn to slide 10. As I said in my opening remarks we are very pleased with the first quarter. Our operations continued to perform well in Q1 and I continue to commend the team for their performance. Every quarter in the recent past the company is pushing more volume through our three plants that we've ever seen before. Organic volume growth was up 23.5% and on a two year stack, it was up 44.8%. We've made great strides at increasing our production capacity to allow for this growth. Total headcount was up 27.3% from a year ago, and up 10.4% from the end of 2022. We continue to do a great job at onboarding new employees. More importantly, we're efficiently integrating them into our operations so as not to disrupt productivity and profitability. We're also investing in new equipment. Sheet metal production is running at high utilization rates. We are investing in new [indiscernible] machines both to replace old machines that will enable us to increase productivity, as well as to add incremental sheet metal production. Supply chain issues continue to be a challenge. They seem to be slowly improving, but they still very much exist. This continues to weigh on productivity and output. Without them volumes most likely would be stronger and productivity certainly would be better. That said our productivity associated with dealing with these issues continues to improve. Lastly, volume growth was also a reflection of our premier sales channel and the backlog our rep partners have been able to generate for us. AAON has never been more aligned with its sales channel partners and has never supported them as much as we are now. Last month we had the grand opening of our exploration center, located at our headquarters in Tulsa. This is the latest…

[Operator Instructions] And our first question comes from Brent Thielman of DA Davidson. Your line is open.

Hey, Gary. Hey, I just I mean looks like still robust orders in backlog here. I didn't see a breakdown [indiscernible] on product basics make maybe it's a good just talk to what you're seeing in terms of underlying demand on both sides there and either business line, Gary, and then also what are the sort of the strongest end market drivers for the company today, considering this huge book of business you're building?

Well, the pace at basics is a little more brisk than the pace at legacy. But there's good strong bookings at both. When I look back historically, going back, say five quarters if I take out the effect of a price increase having pull forward, then bookings overall, were at the highest level related to bill that they had been in all those quarters. And legacy stayed just about pace with that. We're still not able to produce as much as we're able to book. So the backlog continues to just accumulate a little bit at a time. I will say that it's coming more in parity for two reasons. Well, one particular reason is the increase in output volume. I mean, that's really the key thing. The bookings have not really bent over anything at all. So we're just continuing to increase production. We've got more things in place now. Our headcount is up. It continues to accumulate. And we're layering in people at the same pace that we're able to get more parts. So as there's been a lot of talk and a lot of business publications recently about the supply chain issues easing, if not being a non-issue. I don't want to call them a non-issue. I'll just say that the big sticking points are behind this. Now we just fight with some kind of small things from time to time, but they are still a bit disruptive.

Okay, and Gary, one of the questions that dovetails nicely into the next one, but one of the questions we seem to get is when eventually industry lead times normalized whenever that is, can AAON sustain the market share gains that you've ultimately seen? I just love to get your response perspective on that.

Yes. We've had sales meetings, we had an eastern half of the United States, United States sales meeting in March, we had a western half about last week or week before excuse me. So we had all the sales channel partners together. In between those two sales meetings, we had a meeting with the principals, introducing them to the grand opening of the new marketing center. All of them assure us that while we did gain some business because of lead time, that those customers now appreciate the value even more since they've got this equipment on their buildings and being able to sustain those customers long term is very probable. So I don't think that as lead times come together, that it's going to be as impactful. It won't be impactful in a negative way. But we did gain because of lead time initially. Now the next thing is, is that with the regulations that took effect January 1, 2023, all of our competitors had to raise the energy efficiency of their equipment considerably to get over that threshold. AAON had been over that threshold for a long time and had been priced according to that. In order to meet these 2023 regulations, there's more cost content in the units to do it. So a lot of the price premium had been associated with the difference in energy efficiency, and now they're much closer to us. So that's narrowed the price premium. So then, the other value items that are innate to the AAON equipment become more visible standalone on themselves. So there's fewer things that you have to evaluate. There is less premium difference. And so for all these reasons, I think that our trajectory is sustainable.

That's great. Just the last one, understanding the investment ____ people you've had to make to support the growth and future growth for that matter. But as you move into 2024, do you anticipate being sort of improved SG&A leverage from what you're talking about doing this year?

Yes. It's probable that we'll get some leverage on that. But with the growth trajectory we're on, we're going to have to stay very aggressive at CapEx. What we're putting in place this year solves a lot of problems. But if we continue to grow at this rate, for the reason that it takes about three years to plan, and then get into production a new facility we will have to continue to invest there. So some of that hits, SG&A and some of the planning processes and so forth. But the other thing to bear in mind is that we utilize a profit sharing plan for our employees. everyone below the senior leadership team level is eligible for profit sharing and that's 10% of our pre-tax profits. So as we become more profitable, there's more attributed to SG&A because of that one event right there. So we will get some leverage eventually, but I don't look for it to be significant or right away.

I understand. Okay, thank you for taking the questions I'll pass it on.

Our next question comes from [indiscernible] from Oppenheimer. Your line is open.

Good afternoon, everyone.

Good afternoon, John.

Gary can you talk a little bit about your pricing for the remainder of the year? I think you've been increasing prices 1% per month. What do you see for the remainder of the year?

We increase prices 1% per month through April. When May 1 occurred, we did not. We hit the pause button. Our RFP and a team has done a real good job of projecting where our financial performance will be. And they've gone back and calibrated that against actuals so that we know that their algorithms are very accurate or as accurate as possible in a projection theme. And with that, we're certain that we have achieved the financial performance that we've always set as our goals. And with price increases that are in place now we believe that the gross margin will continue to increase quarter-over-quarter throughout the year so that when we end the year it'll end at the highest gross margin as a total year that we've had. We also believe that the total year will end up in parity or slightly north of what it was in Q4 of '22.

Okay. What are you seeing on the competitive front in terms of pricing? Are your competitors continuing to raise pricing?

Only seen one recently that announced another price increase. I haven't seen anything else. But people put price increases in late in the fall or earlier in first quarter coming into effect about now. But those were more or less in line with the accumulation of our 1% price increases per month.

Okay. Okay. And then lastly, in the quarter revenues from basics was about 30 million and I think that was down from 39 million in the fourth quarter. Is that just a reflection of seasonality or is there anything else?

No, that was supply chain. It was a timing issue, because everything that we revenue from them is on a whip schedule. And we had equipment that we couldn't quite finish, because we had little bits and pieces that had not arrived in time. So it's a little bit of a kind of a stair stepping process. You got to a big unit that's waiting on a few parts in order to get to that complete stage. I look for their revenue to be increasing throughout the year.

Okay. Okay. And is there anything you can say about their backlog versus last year?

I don't have the exact percentages in front of me, but it's a tremendous increase. The opportunities just keep coming our way and they keep landing these things. A lot of their backlog has requirements for shipping out in the future a bit not in accordance with standard lead time. But longer than that, because people want to secure that position, because their critical path to their project being completed on time. So I think that everything we dreamed about when we bought basics as far as how it would occur, with our balance sheet, coupled with their appreciation in the marketplace, those have all come to fruition. And it's just, it's probably one of the most outstanding transactions that I've ever been involved in.

Okay. All right. That's good. Thank you much.

Yes.

Our next question comes from Chris Moore from CJS Securities. Your line is open.

Hey good afternoon, guys. Thanks for taking a couple questions.

Certainly.

All right, so maybe the 135 million in CapEx I think roughly 100 million of that is for capacity expansion, can you just kind of help with the math in terms of the additional capacity on a on a relative basis that this investment will make or provide?

Yes. So we'll dissect it by the four different facilities. So we'll start with the smallest facility Parkville, Missouri, where we manufacture electronics that are control items for our unitary equipment, predominantly. The expansion there will more than double their output capabilities. When we move to the next location, Redmond Oregon basics, we are building some things that while they had doubled the facility right before we purchased them in practice wasn't quite finished when we got them, they found a way to improve productivity a lot by building [indiscernible] out a little bit of an annex building to move one of their processes that was taking up some space that would be better utilized if they were in their own annex facility. So that has the ability to probably raise their production above what they already had another double digit percentage, but I'd say low to middle, maybe 20% - 25%. In long view two years ago, we put a new building in place and you've seen the revenue of the coil products, a uncoil products and longer, you've seen it go up substantially. We had in our mind, in our planning a five to seven year runway before we would have to build the mirror image half of the building. As you recall, we built three permanent walls and one temporary wall. Well, with basics acquisition and being able to move one of their significant datacenter products down there for manufacture, which we've started doing. That used up a lot of our surplus. And so that building actually it wasn't out of capacity ceiling, but it was coming much quicker than we wanted. So we're starting to build the other half of that building. That will give us let's say right now that building is probably capable of…

Got it. So is the back of the envelope is that we talking about an additional 400 million to 500 million in capacity from this investment.

Yes.

Okay.

Back at the envelope that's probably a good number to use. Yes, sir.

Got it. And just the last one for me, you talked a lot about bookings. But they continue to outpace production. Can you maybe just give a little sense of the degree to how much you're still outpacing production compared to recent quarters?

Yes. So as I kind of touched on a little bit early on, when we looked at the whole business, including basics, which is now fully integrated into the thought process of the whole company, we had a huge price increase went into effect first quarter of of '22 caused a lot of pull forward. But if I normalize that, then I would say that bookings versus billings are really close to the highest level they've ever been in Q1 of '23. They just continued to increase quarter-over-quarter throughout the year. So we're gaining momentum, while you hear all these signs of things slowing down. There is nothing slowing down for us. But at the same time we've gained production capacity. So you're seeing a great thing here an opportunity for us to grow at a very robust rate. I do believe that that'll begin to bend over a little bit for two reasons. I think the market will slow down just a little bit overall. I think our chances at continuing to book at a brisk rate are very, very high. But our production continues to increase. We had planning procedures to add considerable people, the first half of the year, which would allow us to continue to accelerate. And if seasonality happens to reemerge, which we've not really seen in a very long time. But if seasonality happens to emerge, then we could burn some of this backlog down, which would actually be a good thing, because we would shorten our lead times up even a bit more.

Very helpful. Jump back on line, thanks Gary.

[Operator Instructions] And our next question comes from Julio Romero from Sidoti & Company. Your line is open.

Thanks. Hey, good afternoon, Gary, Rebecca.

Good afternoon Julio.

Hey, good afternoon. So I'm just wanted to ask you another one about pricing. Curious about the decision not to continue to pass along any price increases in May. Are you starting to see some pushback from customers on price? And I'm asking that because that kind of seems to be different from the message of managing price to market rather than cost.

Well, we looked at the market, and we believe we've reestablished a gap between us and them. We are demanding a premium for the equipment. What makes it a little hard for your side of the table to see is how much of that price increases in the backlog that's yet to materialize in the financials through the financial performance of the company. So we got to be way out in front of this thing and see where we're at. We know that we are, again, a premium to the market, and we know that the premium is less than it used to be. But it's continues to be justifiable. So we considered market pricing as well as financial performance when we made this decision.

Got it. Yes, but no, that makes sense. Maybe turning to the parts business. I know you said more to come when supply chain eases. Maybe just give us a sense of how much pent up demand is there for parts and how much of that will be able to flow through when supply chain does ease?

Well, parts business is growing at a very brisk rate. If we didn't grow the equipment business at such a brisk rate, then the percentages would be quite a bit more in line with our expectations. As supply chain begins to normalize, which it's already begun to normalize, it's just not totally there. But it's doing much better we will see continued acceleration in the parts business. I don't believe we'll hit our goal percentage of equipment sales to part sales ratio in '23. I think that might be a worthy goal to set for '24, though.

Got it. Maybe just last one for me. I just have a broader question about the operating environment. Just if you could talk about how the operating environment has changed relative to your last call in February?

Well I don't think there's been much change in the operating environment since then. Supply chain issues had already begun to ease maybe towards the end of Q3 going into Q4 last year. Electronics were still a little bit sticky. Those have become less sticky. Now it's just miscellaneous parts and pieces that aren't great big dollar volume things, just had not historically been sticky at all and they're kind of related to people's labor, how much labor they can get as opposed to the materials they can get. So there is still some of these smaller manufacturers that we source pressure sensors and refrigeration valves and things like that they just continue to, they are increasing their deliveries to us. But it's not to the point where you can just take your eye off of it and say, hey, I ordered 1000 of these and I know I'm going to get 1000 of them in normal lead time. So it is getting better. I look for it to continue to improve throughout '23 and I'm hopeful that we're not talking about supply chain issues in '24.

Are we all. Thanks very much for taking the questions.

Yes.

And I see no further questions in queue. I'll turn the call back over to our host.

I'd like to thank everyone for joining 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 everyone and we look forward to speaking with you in the future. Thank you.

Bye, bye.

The meeting has now concluded. Thank you for joining and have a pleasant day.