AAON, Inc. (AAON) Earnings Call Transcript

Thank you for standing by. At this time, I would like to welcome everyone to the AAON Inc. Second Quarter 2026 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the conference over to Joe Mondillo, Director of Investor Relations. The floor is yours.

Thank you, operator, and good afternoon, everyone. The press release announcing our second quarter 2026 financial results was issued earlier this afternoon 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 our listen-only webcast. We begin with our customary forward-looking statement policy. During the call, any statement presented dealing with information that is not historical is considered forward-looking and made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995, the Securities Act of 1933 and the Securities Exchange Act of 1934, each as amended. As such, it is subject to the occurrence of many events outside of AAON's control that could cause AAON's results to differ materially from those anticipated. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our press release and Form 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 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, President and CEO; and Andy Cheung, our CFO. Matt will start off with some opening remarks, Andy will follow with a walk-through of the quarterly results, and Matt will finish up with our updated outlook for 2026. With that, I will turn the call over to Matt.

Thanks, Joe, and good afternoon. Q2 was another strong quarter, building on the momentum established in Q1 and reflecting continued execution across the business. Higher throughput across all four of our major facilities resulted in substantial volume growth, demonstrating the value of recent investments we have made across the organization, including supply chain management, lean manufacturing, operational excellence initiatives, expanded capacity and leadership development. These efforts translated into our fourth consecutive quarterly revenue record with sales increasing 101% year-over-year and 26% sequentially. EBITDA more than doubled from the prior year period, and we generated substantial earnings growth while converting backlog at a much faster pace across the enterprise. These results are tangible evidence that the investments we have made are translating into measurable operating progress. For an industrial manufacturing company, this level of organic growth and operational scaling is exceptional, and it reflects the strength of our markets, our strategy and our people. Despite the substantial increase in production rates during the first half of the year, backlog remains nearly double prior year levels. Sequentially, backlog declined because production and shipments increased significantly across the enterprise, resulting in accelerated backlog conversion. That is exactly the outcome we have been working to achieve. Customer engagement remains strong. Our pipeline of opportunities remains healthy, and backlog continues to provide meaningful visibility into future growth. Let me begin our brand discussion with BASX. The long-term market opportunity remains compelling, supported by continued investment in data center infrastructure and the differentiated solutions we provide to the market. BASX branded sales were a record, increasing 216% year-over-year in the quarter and 501% on a 2-year stack. For the first half of the year, sales were up 137% year-over-year and 570% on a 2-year stack. Achieving and sustaining this level of growth requires coordination across engineering, operations, supply chain, manufacturing and our field teams. Production increased across our facilities, and I hope all of our stakeholders appreciate the significance of what our teams have accomplished. As we have scaled at an unprecedented pace, maintaining high standards across quality, delivery and customer support has remained a major focus. We continue to see meaningful improvement as the systems, processes and teams we have been building become more mature and effective. The progress is translating into better outcomes for our customers and stronger execution across the enterprise. BASX branded bookings were below the unusually elevated levels experienced in recent quarters. However, we do not view that as a change in the long-term opportunity. These projects are large in scale and can generate quarter-to-quarter variability in booking activity and award timing. Customer engagement remains strong. Our opportunity pipeline remains healthy and backlog continues to provide substantial visibility into future growth opportunities. More importantly, our ability to support customers continues to improve as throughput increases, lead times come down and additional capacity comes online. The underlying market opportunity remains very favorable, and we continue to see substantial long-term opportunities for growth. Turning to the AAON brand. The AAON brand continued to perform exceptionally well, gaining market share despite a relatively soft commercial HVAC market. AAON branded sales increased 40% year-over-year and 5% sequentially, reflecting improved production throughput, strong demand and continued execution improvement across the business. These results point to meaningful market share gains and reinforce the strength of our product offering, sales channel and customer relationships. Increased production volumes also drove further lead time improvement during the quarter, although additional improvement remains a priority as we continue increasing throughput. Bookings of AAON branded equipment increased approximately 16% year-over-year during the quarter and were up approximately 45% on a 2-year stack. Year-to-date, bookings increased 12% year-over-year and 25% on a 2-year stack. Growth was primarily driven by continued strength in our traditional transactional business, which is particularly encouraging given the softness we experienced throughout much of last year. National account activity remained healthy and generally consistent with prior year levels. We also continue to see strong momentum with Alpha Class, our fully electric heat pump platform. Alpha Class orders increased 50% during the quarter and 54% year-to-date, and customer adoption continues to build. This platform is an important long-term growth opportunity as customers increasingly focus on electrification, sustainability and energy efficiency. Strong AAON branded bookings resulted in a 6% sequential increase in AAON branded backlog despite significantly higher production rates. As a result, we remain focused on continuing to drive throughput, work down backlog, shorten lead times and deliver for our customers. Turning now to margins. As we have discussed for several quarters, the level of demand we are experiencing has required us to scale the business rapidly. We have expanded our manufacturing footprint, brought new capacity online, invested in equipment and infrastructure, strengthened our supply chain capabilities and significantly increased talent across operations, engineering, manufacturing and support functions. These actions have been deliberate. They allow us to better serve customers, convert backlog faster, capture market share opportunities and build the operating platform required for the company AAON is becoming. Importantly, the underlying economics of the business continue to improve. Oklahoma's core operations are performing well. Memphis continues to perform meaningfully ahead of our expectations and production throughput across the enterprise continues to increase. Consolidated margins remain pressured by the mix impact of exceptionally strong growth, ramp-up activity associated with new capacity and price/cost timing dynamics. We continue to expect margin improvement through higher facility utilization, productivity gains, sourcing initiatives, improved price/cost realization and a continued maturation of recently added capacity. The key point here is that we are not simply growing revenue. We are building a stronger operating company with scale, infrastructure, systems and discipline to support higher revenue, stronger execution, improved margins, greater cash generation and durable earnings growth over time. We are confident in our ability to continue demonstrating the earnings power of this business as we move through the balance of 2026 and into 2027. And with that, I will now turn the call over to Andy.

Thank you, Matt, and good afternoon, everyone. Second quarter net sales were a record $627 million, an increase of 101% year-over-year. Growth reflected robust BASX and AAON brand performance as well as enhanced manufacturing throughput enabled by strategic capacity investments and ongoing productivity initiatives. BASX branded sales increased 216.2% year-over-year, reflecting the combination of sustained momentum in data center cooling demand, higher production output and greater utilization of recently added manufacturing capacity. AAON branded sales grew 39.3% in the second quarter, driven by a healthy backlog and improved production throughput as we work to reduce lead times at both our Tulsa and Longview facilities. Gross profit in the second quarter increased 84.3% to $152.5 million compared with $82.7 million in the prior year period, reflecting the company's strong revenue growth. Gross margin was 24.3%, down from 26.6% in the second quarter of 2025. Results reflected the impact of ramping recently added manufacturing capacity, including the Memphis facility, along with the increased use of outsourcing to support accelerated growth and ongoing inflationary cost pressures. Importantly, these factors are temporary and largely reflect deliberate investments to support long-term growth. As throughput and utilization continue to increase, productivity improves and better-priced backlog is converted, there is clear sight into gross margin improvement in the coming quarters. SG&A expenses as a percent of sales declined 570 basis points to 13.3%, demonstrating strong operating leverage as revenue growth outpaced our continued investments in the organization. On a dollar basis, SG&A increased $24.5 million to $83.6 million as the company continues to make intentional investments to drive long-term growth. Non-GAAP adjusted EBITDA increased 102.3% from the prior year period to $94.2 million. Adjusted EBITDA margin was 15.0% compared to 14.9% a year ago. Adjusted diluted earnings per share grew 213.6% to $0.69. Turning now to the segment's financials, beginning with AAON Oklahoma. Second quarter net sales increased 42% to $262.3 million, driven by strong execution against a robust beginning backlog and accelerated conversion enabled by production improvements. Results also benefited from favorable price realization and a beneficial comparison to the prior year period, which was impacted by the industry refrigerant transition and other operational challenges. AAON Oklahoma gross profit increased 18.9% to $63.6 million. Gross margin was 24.3%, a decline of 460 basis points from 28.9% in the second quarter of 2025. Overhead expenses associated with the Memphis facility impacted segment margin by $18.1 million compared with just $3 million in the prior year period. Excluding these costs, Oklahoma margins expanded approximately 60 basis points to 31.2% compared to 30.5% last year. Adjusted for Memphis overhead expenses, the increase in AAON Oklahoma gross margins was largely due to increased production rates. These gains were partially offset by elevated outsourcing levels and inflationary pressures, both of which are temporary and do not change the long-term margin profile of the segment. These factors have been addressed in recent quarters with actions embedded in backlog and new pricing actions. We expect these temporary headwinds to moderate as the year progresses. AAON Coil Products sales were $146.7 million in the second quarter, an increase of $88.2 million or 151% compared to the prior year period. Growth was driven by $126.6 million in BASX branded liquid cooling product sales, which increased 208% during the quarter. This strength was also supported by a 15.1% increase in AAON branded output within the segment. AAON Coil Products gross profit increased 130% to $23.5 million. Gross margin was 16.0% in the second quarter compared to 17.5% in the prior year period. The margin contraction reflected temporary inflationary pressures that we expect will moderate in Q3 and Q4. The segment continues to deliver strong profit growth supported by higher sales volumes that are expected to continue throughout 2026. Along with the expected margin improvement, we expect profit growth will accelerate in the second half of the year. BASX segment sales grew 221% in the second quarter to $218 million. The outsized growth was driven by sustained demand for data center solutions and a robust backlog. Increased utilization at the Memphis facility contributed meaningfully to quarterly results by expanding production capacity, accelerating backlog conversion and driving higher sales volume. BASX segment gross profit increased 244.2% to $65.3 million compared with $19 million in the prior year period. Gross margin was 30.0%, up from 27.9% in the prior year period. The improvement in margin reflected strong volume growth, partially offset by incremental resources and investments to support future growth and share gains. Lastly, a quick update on the Memphis facility. We understand the accounting treatment can make performance difficult to evaluate, and we intend to provide greater clarity going forward. When considering the facility's revenue generation to date and fully burdening results with all associated expenses, including overhead currently allocated to the Oklahoma segment, Memphis is performing exceptionally well and ahead of plan. Production and revenue have significantly outpaced expectations and margins have expanded for two straight quarters, reaching levels well ahead of where we expected them to be at this point in the facility's development. Now turning to the balance sheet. Cash, cash equivalents and restricted cash balances totaled $12.7 million on June 30, 2026, and debt at the end of the quarter was $435 million. Our leverage ratio improved to 1.48, down from 1.71 on March 31 and 1.77 on December 31. In the first half of 2026, cash flow from operations was a positive $55 million, a significant improvement compared to a $31 million use of cash in the prior year period. This was driven by higher earnings and improved working capital efficiency. Capital expenditures totaled $102.6 million year-to-date, reflecting continued investment in incremental capacity to support future growth. Looking ahead, we continue to see significant opportunities to improve productivity, profitability and working capital efficiency. We expect these initiatives to support stronger cash flow generation and continued balance sheet improvement, providing a solid foundation for sustained long-term growth. I will now hand the call back to Matt.

Thank you, Andy. We entered the second half of the year with strong momentum across the business. Production throughput has increased significantly. Backlog remains at elevated levels despite record revenue conversion and demand across both brands continues to be healthy. Importantly, the backlog we are converting today carries a more favorable margin profile than the backlog during the first half of the year. Combined with higher production volumes, improving facility utilization, pricing actions, sourcing initiatives and continued operational improvements, we believe the building blocks for margin improvement are firmly in place. Turning to our outlook for 2026. We now expect sales growth of 55% to 60%, gross margin of 25% to 26%, SG&A expense of 13% to 14% of sales, and depreciation and amortization expense of $95 million to $100 million. Our updated outlook reflects stronger-than-expected production, backlog conversion and execution across the enterprise. While we continue to see operational improvement across the business, our consolidated margin outlook reflects the mix impact of exceptionally strong growth from recently added capacity, continued ramp-up activity and price/cost timing. As we sit here more than halfway through the year, I want to provide a few thoughts on how we're thinking about the business beyond 2026. First, we continue to feel extremely positive about the long-term outlook for both the AAON and BASX brands. Both businesses continue to gain market share, supported by differentiated products, strong customer relationships, our industry best sales channel and highly engineered solutions that are difficult to replicate. Second, we continue to see substantial opportunity to improve margins over time. The drivers are straightforward and well understood, higher utilization of recently added capacity, improved fixed cost absorption, increased productivity, continued sourcing improvements and pricing actions already embedded within our backlog. We expect to see progress through the balance of the year and a more meaningful benefit as we move into 2027. Third, we see a significant opportunity to improve cash generation. We have already started to see encouraging progress with operating cash flow improving meaningfully during the first half of the year. As margins improve, growth investments begin to normalize and working capital efficiency continues to improve, we expect cash generation to become a more visible component of the AAON story. The business has undergone significant transformation over the past several years. We have expanded capacity, strengthened leadership, invested in supply chain and manufacturing capabilities, broadened our product portfolio and built the operational infrastructure necessary to support a much larger company. Those investments are increasingly showing up in the results. Today, we are seeing stronger throughput, faster backlog conversion, improved sales growth, expanding operating leverage and improving cash flow. These are the outcomes we expected to see as the investments we have made across the business matured. The key point is that we are not simply growing revenue. We are building a stronger operating company with the scale, infrastructure, systems and discipline to support higher revenues, stronger execution, improved margins, greater cash generation and durable earnings growth over time. We still have work ahead, particularly around margin improvement, but the direction is clear. The long-term opportunity remains strong and the actions required to improve margins and cash generation are underway. We are proud of what the team has accomplished, confident in the opportunity ahead and focused on demonstrating the earnings power of this business as we move through the balance of 2026 and into 2027. In closing, I want to thank our employees, customers, sales channel partners and shareholders for their continued support. Our employees have accomplished an extraordinary amount. The growth we are delivering today is a direct result of their efforts, discipline and commitment to serving customers while building a stronger company. We remain focused on execution, disciplined in our approach and excited about the opportunities ahead. And with that, I will open the call up for questions.

[Operator Instructions] Your first question comes from Ryan Merkel with William Blair.

I want to start with the data center orders in the quarter. They're a little bit weaker than I think some of us were expecting. So Matt, just put a finer point on that, if you would. I know you mentioned the pipeline is healthy. And then could you provide any color on if you think orders will improve in the third quarter?

Certainly, great question, one we anticipated was going to come out today. So just I want to start off maybe by stepping back for 1 second and just looking at the kind of trajectory that we've had in our data center bookings over the last four quarters. So at a high level, when we look at the momentum that we have going into this quarter, the prior four quarters had a book-to-bill approaching 3 over that time period. So we've had exceptionally strong bookings as we've been ramping up capacity. And we think about it from the standpoint of that trajectory that we see really highlights that, that differentiated offering that we have in the data center space has certainly been resonating within the marketplace. And so there's been a lot of great momentum, a lot of great trajectory and tremendous amount of pipeline opportunity. Now when we look at the size and the scale of the orders, it's important to kind of go back and recognize that these tend to be large orders. And so there is potential, as we talked about in prior quarters, and really highlighted that there's potential for there to be a little bit of lumpiness around how that flows through to actual backlog and bookings. But really just at a high level, the amount of activity that we have in the data center space, the amount of volume we're putting through, there's a tremendous amount of momentum that we have around our products and our orders. And really, it's a timing conversation around how that pipeline opportunity is converting to overall bookings. But the pipeline itself is the strongest that it's ever been. And it would be important to highlight that it's not just strength with existing customers. There's the great strength of our existing customer base, but our pipeline continues to expand in terms of diversification of our overall customer base. And so really from an outlook perspective, we're incredibly excited about the opportunity. We've seen acceleration in conversations and activity with our sales channel and engagement in the overall market. So while this quarter certainly had a little bit lighter bookings, we don't see that as indicative of anything in the overall market opportunity for our product.

Okay. That's helpful. And just a quick follow-up there just because it's an important topic. Was there a large order that slipped because of a timing issue? Or is it just the lumpiness that you talked about and the pipeline is still healthy?

Yes, it's just lumpiness. There's no specific order pushout or movement. There's -- again, it's just really lining up the overall bookings in a given quarter.

All right. And then moving to gross margin. You cut the gross margin for the year 200 basis points. And my question is, I'm curious what changed versus when we spoke to you in May. It almost seems like you accelerated throughput and you were willing to eat the higher cost, but just tell us what happened.

Well, let's maybe kind of unpack this for a bit. And so when we look about -- look at margin as a whole and looking at Q1 to Q2, I want to start off by saying, operationally, the margin in the Oklahoma segment is improving and the BASX Redmond segment is improving and the Memphis segment is improving, and there's a little bit of pressure from a price cost perspective in the ACP segment. But I want to start by framing there that the progression that we see operationally is improvement in the overall margin profile of this business. Now what is driving that conversation is the accelerated backlog conversion that we have within our Memphis site. And so from a mix perspective, the increasing revenue volume that we're driving through Memphis, while ramping that facility is at a lower margin point than the Oklahoma segment. And so as we're driving more volume through that Memphis segment, on a consolidated basis, it's pulling the margin down, but providing a net positive impact to the business. And more importantly, it's helping us build a stronger foundation to continue serving data center customers. And so us pushing a little bit harder in our Memphis site and really ramping this facility is giving us a foundation to then drive more business through, allowing us to turn on more production lines and continue growing the overall volume through our Memphis site. And so that mix conversation is one of the biggest drivers of kind of that consolidated margin coming down in the quarter.

I see. So of the 200 basis point cut, it was mix and lower-margin data centers accelerating and then it was price cost and then still a bit of outsourcing.

Correct. I mean we think about bringing up the top line outlook for the year up about 20%. Obviously, the vast majority of that is coming through Memphis. And so there's a lot of drive that we're getting in throughput through Memphis. But obviously, it is burdened by a little bit more ramp pressure in outsourcing other things. Again, this facility, just a point of reference, in the quarter, Q2, we did roughly half of the total year 2025 revenue that BASX did out of Redmond. And so in one quarter, a brand-new facility did almost half of what an established mature facility was doing. And so there's inherently going to be some pressures to margin kind of as we ramp that from a productivity standpoint, onboarding new staff and really outsourcing some of the production as a lot of the new equipment continues to come online throughout that facility. And so really, that is the bigger pressure. It's just not a fundamental structural pricing issue. It's just ramping a large facility from scratch.

Your next question comes from David Tarantino with KeyBanc Capital Markets.

Could you give us some color on what the sales outlook now embeds between AAON and BASX branded product sales? And maybe some thoughts on what's informing the confidence on your ability to deliver that growth relative to the capacity ramp that's ongoing?

Yes. No, great question. And so from a kind of a branded perspective, the 2026 guide is assuming approximately 20% growth year-over-year in the AAON brand. And so then backing in, that implies that BASX will again more than double in the year. And so just in perspective, the overall data center market last year and this year is growing around 30%. And so more than doubling BASX, again, after having 140% growth rate the prior year, continue showing a good growth outperforming the overall market. So really strong acquisition from a market share perspective. When we look at confidence in supporting and executing that growth, you've seen us be intentional and disciplined around trying to not overcommit too much growth until we see the sort of legs get below it in the Memphis site. And so as we get more and more run time in Memphis, we get more and more visibility and confidence in that rate of ramp. And that's really what helps guide our approach to that backlog conversion and the messaging around the overall growth rates. You take that and kind of add in all the investments we've been making in our operational model and execution within manufacturing, within lean manufacturing process, continuous improvement in supply chain discipline. And really, it's making meaningful results in the overall ability for us to execute. Now I will say there's certainly a level of caution that is growing this rate in this environment certainly has a little bit of pressures. And so when we look at the implied growth rate in the back half of the year, obviously, it's not some acceleration beyond Q2 in the back half of the year. It's showing a relatively moderate kind of performance in the back half. And that's just recognizing that this rate of growth is going to have some level of pressures, whether it be supply chain or operationally. But that's embedded into our outlook, that's embedded into our guidance. And really, from our standpoint, we're intentional and we're also clear-eyed about some of the realities about growing this fast.

And then just to follow up on that last comment. Is that supply chain pressures and/or other pressures that you're seeing today? Or is that just conservatism?

I mean I'd say there's always challenges that pop up. I mean, Q1 and Q2, there's certainly been a variety of issues we've tackled and continue to tackle. So there's nothing new or meaningful that's in there, but it's just a reality of this market that we're not wanting to dismiss the reality of some of the supply chain sensitivities and operation in this kind of environment today.

Okay. Great. And then maybe back on gross margins. Could you just give us the key buckets driving the second half improvement versus the first half, particularly between the better absorption and maybe improving price cost? And then maybe kind of give us some color on how these should progress between both 3Q and 4Q?

So at a high level, the biggest driver of margin improvement in the back half is price cost. That certainly is the biggest driver. We messaged this back in the Q1 call as well. But at the very end of last year, we certainly noticed some price cost challenges that we intentionally took action on from a pricing perspective. And so the backlog that we have today is at a substantially different price point than the backlog that we executed in Q1 and Q2. And so that certainly is the biggest driver of margin improvement in the back half. But certainly, beyond that, productivity gains will certainly continue to be a positive from an overall margin perspective. Looking at Memphis as an example, as there's more run time, productivity gains will begin to materialize in overall margin profile. But the progression from Q2 is really improving in Q3, but Q4 certainly is the back half load of that overall margin improvement.

Your next question comes from Noah Kaye with Oppenheimer.

Maybe just double-clicking on margins. Can you help us understand the margin trends in ACP where we saw sequentially lower margins and liquid cooling was, I think, over 85% of the segment. So how should that segment, particularly the liquid cooling side of it, profile from a margin perspective? What happened in the quarter? And what is sort of embedded for improvement from here?

Yes. The biggest driver in the ACP segment -- well, first off, the biggest driver in the segment margin kind of quarter-over-quarter was really on price cost, driven by inflation. So whether it's the kind of raw materials kind of inflationary pressures, a lot of freight pressure from a costing perspective, really, those are the biggest drivers in the quarter. And to be frank, we were behind on pricing actions to recover those. And so there's been a lot of work done in the ACP segment around pricing to basically make sure that inflationary pressure is captured properly. And I would just say, as we continue investing in our organization sophistication, whether in Andy's organization from a finance perspective or our supply chain organization, we're getting more and more visibility, which is allowing us to make more and more forward-looking actions to stay ahead of these inflationary pressures. And so this sophistication and investments we're making to really drive improvements in our operating model will continue to make meaningful impact in the overall margin profile to help capture this ahead of time. But the reality is we were behind on the overall pricing against the inflationary cost. And those actions have been taken and continue to be monitored and taken appropriately going forward to capture that.

Noah, I would also just add that given the actions that we've taken, we're probably going to be towards the end of the year for us to see some meaningful rebound there. There's a bit of a backlog there as well. But we knew what it is, and we've been taking action. So I think to Matt's point, now that we have a more sophisticated view of our costing, product costs, so now we will be able to do more timely actions. But we knew that a lot of the actions already in place.

Very helpful. And then I guess just to double-click on David's point. So I think you talked about 4Q being kind of where some of the margin improvement is weighted towards. So should we not assume kind of fairly ratable sequential margin improvement in 3Q and 4Q. And I think we can get there within 120 bps or so improvement quarter-over-quarter for the next couple of quarters. Do you think it's going to be more back-end weighted?

Yes, you'll see modest improvement in Q3, but really Q4 is going to be where the more noticeable improvement is going to be weighted.