Aaon Inc (AAON) 2022 Q2 法說會逐字稿

Good day, and welcome to the AAON Inc. Second Quarter 2022 Earnings Conference Call. (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. The 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 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 and Exchange Act of 1934, each has amended. As such, it is subject to the occurrence of many events outside of AAON's control and that could cause AAON's results to differ materially from those anticipated. You're 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 the duty to update our forward-looking statements.

And with that, I'll turn over the call to Rebecca.

Thank you, Joe. I'd like to begin by discussing the comparative results of the 3 months ended June 30, 2022, versus June 30, 2021. Net sales increased 45.1% to $208.8 million from $143.9 million. The addition of BasX 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 years.

Another contributing factor to the total sales increase was the growth of our AAON Coil Products 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 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-priced 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, SG&A increased to 12.9% from 11.7% in the second quarter of 2021. Excluding BasX, SG&A expenses increased 25.6% and total 11.5% of sales, down 20 basis points from a year ago. We continue to do a good job at controlling these expenses, particularly in the inflationary environment we are in.

Income from operations decreased 18.9% to $20.5 million or 9.8% of sales from $25.2 million or 17.5% of sales in the second quarter of 2021. Our effective tax rate increased to 20.8% from 18.3% The company's estimated annual 2022 effective tax rate, excluding discrete events, is expected to be approximately 25%.

Net income decreased to $15.9 million or 7.6% of sales compared to $20.6 million or 14.3% of sales in the second quarter of 2021. Diluted earnings per share decreased by 21.1% to $0.30 per share from $0.38 per share.

Turning to the balance sheet. You'll see that we had a working capital balance of $191.2 million versus $131.3 million at December 31, 2021. Unrestricted cash totaled $17.6 million at June 30, 2022.

Our current ratio is approximately 2.4:1. Capital expenditures for the first 6 months of the year were $27.2 million. We now expect capital expenditures for the year to be approximately $73.3 million.

The reduction from our previous guidance of $100.4 million is due to our existing facilities finding ways to increase capacity under the current square footage, allowing us to push out some of our other capacity expansion projects.

The company had stock repurchases of $6.9 million during the 6 months ended June 30, 2022. Shareholders' equity per diluted share is $9.09 at June 30, 2022, compared to $8.68 at December 31, 2021.

I'd now like to turn the call over to our CEO and President, Gary Fields.

Good afternoon. Overall, we're happy with second quarter results. We improved production rates to record levels for the second straight quarter, the shift 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 were relatively stable throughout the quarter and still remain well below industry average. Today, in early August, we're still booking orders for shipment in '22. I don't think anyone else in the industry is saying not.

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 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, and 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 we're able to quickly adapt to supply chain shortages better than most others in the industry. We expect this environment will be with us for a while. But if and when things normalize, we'll definitely see operational efficiencies because of the learning curve that we've gone through.

As I mentioned at the top of my commentary, demand continues to remain strong. Organic orders in the first half of the year were up approximately 60%. Total backlog continues to grow on a sequential basis and organic backlog at the end of the second quarter was up 164% from a year ago. Furthermore, June and July bookings were strong. Everything we're hearing from our sales channel partners is demand remains robust. On a micro level, activity remains strong. This is also consistent to what we're seeing on a macro level.

The Dodge Momentum Index, which measures the number of construction projects in the planning stages and is a 12-month leading indicator for non-residential construction spending was at a 14-year high in its latest reading. The Architectural Billing Index, also a leading indicator for non-residential construction spending remains above 50, indicating architectural billings continue to grow.

The latest ABI report also cited that backlogs amongst architectural firms are currently at 7 months, which is extremely high in a historical perspective.

The pipeline of projects in the industry is strong, and we're seeing that in nonres starts and spending data. For us, the strength remains very broad based across all the verticals we sell into. That all said, we're aware of what is going on in the economy with rising interest rates, higher wages, supply chain labor shortages, and we're prepared to deal with slowdown if one comes. However, at this time, we're not seeing it in the channels we monitor.

I want to shift my focus to basics for a moment. This is an area of our company we're seeing tremendous growth, and I'm very proud of how this acquisition has progressed since closing on the deal in December. Through the first 6 months of the year, the deal has been accretive to earnings, and the second half is shaping up even better. The data center and clean room end markets, which make up a vast majority of their sales are extremely strong. Pipeline of projects extends out multiple years, giving them a tremendous amount of visibility.

Since acquiring the business, the revenue synergies have even surprised me. From the end of '21 to the end of the second quarter, backlog at BasX has increased nearly threefold. Furthermore, subsequent to the end of the second quarter, the business booked a single order were $16.2 million.

We plan on leveraging the capacity in our new facility in Longview to manufacture this product for the basics for this specific customer. This will not only help leverage overhead costs associated with this facility, but it will position us better from a strategic regional manufacturing perspective. It's quite expensive to ship product from Redmond, Oregon to the East Coast. Now we can better attack that region from a pricing standpoint when we build it in the South Central in Longview, Texas.

There's other projects in the pipeline that are significant size that we have commitments for and looking forward to getting firm purchase orders secured on those soon. This will help maximize BasX' chance of winning future work using this Longview facility to regionally assist us in deliveries.

I want to touch briefly on our parts business. Parts still make up a small percentage of sales at just 7%, but it's something we've been focusing a lot on both internally and with our channel partners, we've been having a great success. Parts sales in the second quarter were up 32%. That was a quarterly record for the company. Moreover, the 32% growth was against a comp of 42% growth realized in the second quarter of '21. So compared to 2 years ago, parts sales were up 88% this past quarter. Parts generate very good gross margins for the company. So growing this business will continue to be a strong focus for us.

Before finishing up and handing off the call for Q&A, I'd just like to update you on our capital investment plans. I'm sure you noticed Rebecca said that we reduced our CapEx budget for '22 by 27% compared to what we were previously targeting. This by no means is an indication of slowing growth. As I've been saying, demand is robust, and we do not see material signs of a slowdown. Moreover, we continue to target double-digit organic sales growth for the next several years. The fact is we are regularly challenging the team to look at ways of increasing production capacity and maximizing efficiency in our existing facilities. In recent history, we've done a great job with this, and we continue to do so. I want to commend the group that calls themselves space force. They've reallocated hundreds of thousands of square feet in our -- all of our facilities for this.

So the reduction in our 2022 CapEx budget is merely us finding ways to increase capacity in our existing space. I want to assure you, we are regularly monitoring our capacity versus our growth projections, making sure that we've got adequate room for growth. We've detailed plans over the next several years to increase capacity, so we're able to continue to absorb the robust growth that we anticipate. We just took a little pause on it right now because we've discovered additional capacity in the existing facilities.

So in closing, I want to reiterate, we feel very good as we head into the second half of the year. Size of the backlog and most important. This is very important. The profitability of the backlog. We've got 2 price increases that we have not yet realized in the first 2 quarters of the year that are just right here with us in Q3 and Q4. This positions us for robust sales and earnings growth. Bookings remained strong through July. Pipeline remains very positive. So barring a severe recession, our outlook for the foreseeable future has never been stronger.

I want to finish by thanking all of our employees, sales channel partners and customers. Your support is immense and very much appreciated. So now I'll open it up for Q&A.

(Operator Instructions) And our first question today will come from Julio Romero with Sidoti & Company.

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 10% 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 3 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 offense in.

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 BasX' 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 would have in the financial backing of the mother ship of AAON, that 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 BasX' products.

So this first opportunity came up. The salesman actually worked for my former company that I was at before AAON, the one I was with 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 AAON equipment in some of their ancillary areas but never in the core data hall. And now that we had BasX, 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 plant. So they save $4,400 per truckload. And it takes -- you can put 2 of these units on 1 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 very custom design. But once you build the first one, then you just repeat hundreds, if not thousands, of times to build this product. Well, that fits the Longview manufacturing culture very, very well. And this also allows BasX 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. Any way to think about where you are with capacity utilization at Longview?

With the commitment we have from this client, plus 2 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 '23 and '24. One of our clients is talking to us about exclusively delivering to them in '24. 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 tap out what that building could do. But that leave 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 1 facility might be.

Well, when we built that building, we started in production there at February of 2021. So we really finished at about January 1, '21. We built it with 3 sides that were permanent tilt walls on one side that was a temporary metal wall. And the idea was that 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.

(Operator Instructions) Our next question will come from Brent Thielman with D.A. Davidson.

Gary, good to hear the gross margins you see coming back here nicely in the second half. 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 to 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 2 full quarters of production needs, and so we had, let's say, a fixed price through the first 2 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 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 1 price increase was 8% just by itself. And then we had one in late March that was 7%. I don't think Q3 will get anything material of that 7%, but it will be vastly built on the 8%, which very little of Q2 was built on that 8% price increase. Does that help you kind of [understand]?

Yes. Really helpful, Gary. Appreciate that. And on June, I mean, were you -- are you closing in on the sort of target gross margins that you talked about? I'm just curious (inaudible). Sounds like a huge (inaudible)...

Closing in. Not quite. Not quite there. Q3 has a remote chance of being there, but it's probably going to be -- I'd anticipate it not quite reaching in Q3, but Q4 is absolutely going to reach and towards the upper end of that range, actually.

Yes. And Gary, I noticed that you made a mention that the margins looked great at BasX that they've been able to kind of reprice maybe some or all of their backlog. What is it about that business and ability to do that, that you can't necessarily do in the core?

The core business is our clients provide a purchase order to us for a fixed cost at the advertised price today, it's effective. And we hold to that. Whereas BasX, they're dealing with the end user itself. Most of the time, they're not going through a sales channel partner that's going through contractor base. And it's just a different strategy of go-to-market. So you're much closer to the end user in BasX business model.

That being said, they're able to set things in price because they have such a long duration. For instance, this $16.2 million contract, they do want it pretty quick, relatively as quick as we can build it, which is going to be Q1 of '23. Maybe a little bit of it in Q4 of '22. But they have committed to us all the way through what they need for 2024. Well, they're not writing purchase orders to us yet because we need to negotiate what that price is. If we see an escalation in cost, then we have a formula we've discussed with them about how we very transparently -- so that we can maintain our margins.

Well, that's just the difference in dealing with the end user that's actually purchasing the equipment as opposed to a mechanical contractor that purchased it from our sales channel partner and sells it to a general contractor who sells it to an owner. So there's just 2 or 3 steps that are removed in BasX process that allow that to happen. I hope that's clear to that (inaudible) too cloudy for you.

It's good, Gary. I appreciate it. Any thoughts on chip plant legislation, what that might mean for the company core or BasX?

Yes. So Intel themselves have been a longtime client of BasX and some of their people there, other chip manufacturers as well. We're doing some clean room work with them now. We're looking at more -- we're looking at doing makeup air units and things for them.

Basically, they'd like for us to do probably more than we can. So that is going to be where -- I was talking about some of these more complex equipment that the Redmond facility is capable of building that we're not capable of building in any of the legacy AAON plants. So that's why moving some of the simple product that they were building in Redmond to an AAON plant is so sensible because it gives them manufacturing space and capacity for these very complex units. These makeup air units for a chip manufacturer. They're monstrous, and they've got just an immense amount of piping and controls -- and I mean, they're like giant equipment rooms. They assemble in 2 or 3 pieces, maybe 4 pieces sometimes. And in Redmond, they have the ability to put that whole thing together in one piece on the plant floor so that they make sure everything fits and aligns and all of that. We just can't do that in our other facilities.

Our next question will come from Jon Braatz with Kansas City Capital.

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, our production -- our Director of Manufacturing sends me a report that how many units came off of what line. How many total units are 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 will say short some parts this that and the other. Well, then 1 or 2 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 2, 3 days at the most, but I'm not seeing things weeks or months. And I get this report, I'm looking at them here, 6:08, 6:22, 6:04, just after 6:00 every night. And I just eagerly anticipate that report, and 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 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 0.75% 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 on 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 BasX. When you acquired BasX, 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, BasX basically 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 BasX relative to when you acquired them?

Well, let's, okay, let's do 2 -- you had 2 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 BasX 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 for many years, we had a very, very small footprint of 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 us with BasX 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, been very, very confident and 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 BasX, we can do this, we're getting these opportunities.

Now let's talk about the revenue synergy to it. So BasX was, we'll say, roughly $100 million of anticipated revenue for '22. 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. BasX revenue.

I'm sorry, that was gross profit. Yes, $45.5 million.

So they've done $45.5 million, 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. 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.

41.9% increase in units sold for Longview.

Yes, but that still 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 2 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 '23. 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.

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. Bye.

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