Good afternoon, ladies and gentlemen, and welcome to the AAON, Inc. Third Quarter of 2024 Earnings Release Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]. This call is being recorded on Thursday, November 7, 2024. I would now like to turn the conference over to Joseph Mondillo, Director of Investor Relations.

Thank you, operator, and good afternoon, everyone. The press release announcing our third quarter financial results was issued after market close today and can be found on our corporate 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. Joining me on today's call is Gary Fields, CEO; Matt Tobolski, President and COO; and Rebecca Thompson, CFO and Treasurer. Please turn to Slide 2. 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 1955, the Securities Act of 1933 and the Securities and Exchange Act of 1934, each as amended. As such, it is subject to the occurrence of many events outside of AAON's control that could cause AAON's results to differ materially from those anticipated. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our press release and Form 10-Q that we filed this 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. 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. With that, I will turn the call over to Gary.

Starting on Slide 3. The third quarter was another solid quarter for AAON. Total revenue grew year-over-year 4.9% and diluted earnings per share was up 8.6%, both strong results for the quarter. Gross margin contracted 230 basis points versus the comparable quarter a year ago. We maintain the gross margin in the mid-30s is very healthy for this business. In fact, the gross margin this quarter represented one of the strongest quarters in the company's history. Likewise, adjusted EBITDA margin of 25.3% marked the third strongest quarter in company history. Overall, our operations have been performing well, which is reflected in these results. From a demand perspective, bookings in the third quarter were up year-over-year in the mid-single digits. And year-to-date, they were up approximately 27%. Demand for data center equipment remains strong. Backlog at the AAON Coil Products segment at the end of the quarter was a segment record, up approximately 63% from a year ago and backlog at the BASX segment finished close to record levels, up over 100% from a year ago. Total backlog finished at $647.7 million, up 32% from a year ago and was comparable with the total backlog at the end of the second quarter. A significant portion of the total backlog at the end of the quarter consisted of orders of data center equipment. Furthermore, subsequent to the end of the quarter, we received approximately $174.5 million of orders that, by and large, will be produced in the first half of 2025. We addressed this in a press release that we issued two weeks ago. These orders are associated with a liquid cooling solution for one data center customer and will be produced at our Longview, Texas location. In addition to these orders from this one customer, the pipeline of opportunity is very robust. While this was a big win for AAON, we foresee much more demand within the data center market going forward. AAON is becoming a leading player in the data center cooling market as a fully capable provider of highly engineered, energy-efficient solutions for its customers. With that, I will now hand it over to Matt Tobolski, who will speak more in depth about our operational strategy.

Thank you, Gary. Over the last several years, AAON has been undergoing a significant transformation. And as we have addressed on recent calls, this has continued through this year. Nearly all departments of the enterprise have been undergoing some degree of change to help position the company to sustain long-term growth at the rates and efficiency metrics we are targeting. At the same time, strong demand of data center equipment and external market factors associated with a slowing non-residential construction sector and the refrigerant transition have consumed and challenged the operations. All things considered, I could not be prouder of how the operations executed in the third quarter and year-to-date. The margins we have been able to record, which are at historically high levels, support my preconceived notion that the team has been operating at a very high level. Please turn to Slide 4. As we have spoken to this year, AAON is emerging as a prominent player in the data center space. Year-to-date through the first three quarters, bookings of equipment associated with this market have nearly doubled and made up nearly 30% of total company bookings. This compares to data center bookings in the same period in 2023, making up about 13% of total bookings. Factoring in the $174.5 million worth of orders that we received in October, this showcases the level of prominence that the data center market has within the AAON business. The success that we have had thus far in the data center market is a testament to various factors. The team collaboration across the enterprise is an integral component. Over the last year, we have taken steps to integrate various divisions of the company to leverage proficiencies and best practices and to increase the efficiency of the overall business. In addition, this highlights AAON's…

Thank you, Matt. Please turn to Slide 7. Net sales for the quarter increased 4.9% to a record of $327.3 million, up from $312 million in the third quarter of 2023. The year-over-year growth was largely driven by the BASX and AAON Coil Products segments, which realized growth of 58.8% and 36.7%, respectively, primarily related to the data center market. Sales at the AAON Oklahoma segment declined year-over-year 7.1%. The year-over-year decline at this segment largely reflects the tough year-over-year comparison, along with the previously discussed disruptions caused by the refrigerant transition. Moving to Slide 8. Gross profit decreased 1.7% to $114.2 million from $116.1 million. As a percentage of sales, gross profit was 34.9% compared to 37.2% in the third quarter of 2023. The contraction in gross margin was a result of lower volumes at the AAON Oklahoma segment and temporary inefficiencies at BASX, partially offset by strong results at the AAON Coil Products segment, which benefited from a favorable product mix and increased efficiencies. Please turn to Slide 9. Selling, general and administrative expenses decreased 5.5% to $48.6 million from $51.5 million in the third quarter of 2023. As a percent of sales, SG&A decreased to 14.9% from 16.5%. Overall, SG&A as a percent of sales continues to be elevated due to depreciation and increased investments in back-office technology and automation. Professional fees decreased due to the absence of the onetime $7.5 million settlement that occurred in the same period of 2023. Moving to Slide 10. Diluted earnings per share was $0.63, up 8.6% from a year ago. Our tax rate in the quarter was 18.4%. The company's estimated annual effective tax rate, excluding discrete events, is expected to be approximately 24.9%. Turning to Slide 11. Our balance sheet remains strong with a current ratio of 3:1. Cash, cash equivalents and restricted cash totaled $6.7 million on September 30, 2024, and debt at the end of the quarter was $55.7 million. Our leverage ratio was 0.19x. Year-to-date, cash flow from operations was $191.7 million, up from $107.1 million in the comparable period a year ago. The year-over-year improvement in year-to-date cash flow from operations reflects more efficient inventory management. Capital expenditures through the first three quarters of the year, including expenditures related to software development, increased 37.3% to $113.8 million. We also drew down $17.3 million on our revolving line of credit over this period, largely to finance the $100 million of open market stock buybacks in the second quarter. In the third quarter, we reduced the balance by $30.2 million. Overall, our financial position is strong. This gives us flexibility and allows us to continue to fully focus on investments that will drive growth and generate attractive returns. For 2024, we now have anticipate capital expenditures will be $215 million, up from our previous expectation of $125 million. With that, I'll now turn the call back over to Gary.

Please turn to Slide 12. As we approach the end of the year and begin to shift our focus to 2025, we are very pleased with the current trajectory of the company. While the traditional rooftop business has faced multiple headwinds this year, and we expect it could soften more in the immediate near term, our data center business is more than compensating. We estimate at the end of this year, we will be entering 2025 with a backlog up over 50% from a year ago, a vast majority of which will be converted in 2025. This compares to a year ago when we were entering this year with a backlog that was down year-over-year approximately 6.9%. Our data center business is clearly very strong. This is a rapidly evolving market and all considered, we are executing extremely well with product development, customer service, production and management of our capacity. On the traditional HVAC equipment side of the business, it's hard to be nearly as positive compared to data center. Nonetheless, we remain optimistic. We manufacture the highest quality, highest performing, most efficient rooftop units in the industry. Furthermore, as the industry attempts to improve the quality of their equipment, it has increased their cost of manufacturing, resulting in us becoming more cost competitive. This year, we have generated the highest gross margins in AAON's history while managing a price premium to market pricing at the lowest level in company history. We also continue to maintain our edge in product development and innovation, as noted in previous discussions regarding our heat pump technology. Our rooftop units configured with this technology have been growing at very robust rates this year. Thus, we are very optimistic with both sides of the business. Lastly, before getting into outlook and opening up the call…

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. Your first question comes from Ryan Merkel with William Blair. Your line is now open.

Hi, thanks. Good afternoon, and thanks for taking the question. I guess, first off, I wanted to start with the Oklahoma segment. And Gary, you've talked about the slowdown kind of all year, and I guess we're seeing it. And my question is, should we expect revenue in the Oklahoma segment to be down more than the 7% we saw this quarter? Or what do you mean by seeing a slowdown in 4Q and 1Q?

Well, we've always had seasonality. And for the last few years, we've had such a tremendous backlog because we didn't have production capacity, and we weren't able to produce in the shorter lead times. Now we're able to produce at a much faster rate. So the backlog impacts it substantially. So there could be just a slight bit more softening in Q4 and Q1 because the backlog is -- again, we've burned it down pretty good. But the pipeline is very strong. Sales channel partners tell us things are beginning to turn around. I had cited three reasons that I felt like the pipeline for that business was challenged, the refrigerant transition, the election and interest rates. Well, election is behind us. I think we did fine there. Interest rates went down another 25 basis points today. I think that points well. And the refrigerant transition will be behind us any moment now. I mean we cannot produce equipment past December 31 with the old refrigerant. And since we don't have any of our equipment going into inventory like a distributorship, then we are already shipping 454B equipment, and we will be shipping exclusively that. So I think just this -- the timing of these events has been pretty much the way I projected going back a year ago. And hopefully, that answers what you were looking for.

Yes, it does. And a quick follow-up because you said that you think 1Q '25 earnings will be down year-over-year. Is that, again, due to the Oklahoma business and some of the softness we're talking about? Or is there anything in there for data centers?

The data centers is very robust. The data centers, the thing is there, the Longview facility in order to produce that at the rates to make up for the slowing down in Oklahoma. It's just coming online here in a few weeks. So I don't expect to flip the lights on and produce at 100% capability right away. So I think it will take a quarter to speed that up.

And Ryan, just to clarify, we don't anticipate a year-over-year decline in Q1. We're messaging a potential quarter-over-quarter decline from Q4 to Q1, with just a modest decrease from Q4 to Q1, but it will be up.

Okay, thanks for that clarification. And then let me ask one on data centers before I turn it over. The $175 million order, which I appreciate is not in the backlog, by the way, why was that order so big? And was that a new customer?

So it is an existing customer, but with this specific customer, it is the first exposure into the liquid cooling realm with that customer. The reason it is so large is it is a basically a large-scale deployment of a liquid cooling AI supporting process kind of with exposure across their fleet. So it's not a single facility, but it's providing product to support a large build-out of AI capacity across the overall enterprise for that customer. And one thing I would just note is we obviously messaged the $174 million order. But even subsequent to that, I mean, the last week, we've tallied on another $34 million in liquid cooling orders as well. So the demand around liquid cooling and the kind of strength with the product development continues to kind of showcase the value that AAON provides.

And that leads to my last question here. When you say that, that order is a fraction of the pipeline, I think a lot of us are wondering, are there other big chunky orders out there that you have visibility to in the $100 million area? Or should we not be thinking about it that way? There's just a long pipeline of lots of kinds of orders?

Yes. I mean, certainly, the kind of the single tranche, $170-plus million order is -- it's certainly a little bit more of the unique kind of scale of orders. But I would just say, I mean, we have tremendous visibility into numerous orders that are $20-plus million orders within the liquid cooling and air side space. So the fundamental volume is large orders. The $174 million certainly is one large tranche that's pretty unique. But in aggregate, we have substantially more visibility and pipeline to kind of overall order volume.

Very good. Thanks so much. Appreciate it. I'll pass it on.

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

Hi, good afternoon, guys. Thanks for taking a couple. And maybe just one on the rooftop. Just have all the states passed the necessary legislation for the new refrigerants?

Yes. At this point, the regulations are supporting the refrigerant transition. So we're less than two months away from the mandatory cutover date. And so from a regulation standpoint, the states are prepared for that January 1 date.

Got it. And I know this is probably a difficult one. But since some of these solutions can be hybrid on the data center side. But if you were to look out three to four years and kind of parse the air cooled versus liquid cooled, any sense as to what percentage of the data center revenue would be on the liquid cooled side?

Yes. I mean it's going to be a transition for sure. So the -- it's not going to be day one, all of a sudden, we flip a switch and have this massive liquid cooling kind of turnover. So three to four years out, you're really still going to be predominantly airside cooling. But I want to frame one thing up as well. When you think about liquid cooling, a pure-play liquid cooling data center still has a substantial amount of air cool requirement, I think, 20%-plus. So as you think about the flip to a higher concentration of liquid cooling with this large-scale investment going on in AI/ML, just mathematically speaking, it's still -- even if you went to a today, flip the switch and all that new demand with liquid cooling, the demand is growing so much that the airside cooling is still growing in that backdrop. So when we look at three to four years out, you're probably looking -- you might be approaching 40%, 50% of the overall cooling demand being around liquid cooling if the investment cycle continues around the AI/ML investment.

That makes perfect sense. And then one more. Just on the gross margin, BASX 27.9, obviously, down significantly year-over-year. You're still building out capacity. Looking -- as you get there and volume starts to ramp, do you expect the BASX gross margin to be the highest of the three segments?

I don't know if I go as far as to say the highest of the three segments, but I think the Oklahoma segment provides a good target of where we're trying to work towards within the BASX segment. In the -- to your comment on the Q3 numbers, I mean not only the build-out of capacity, but there's still -- if you imagine kind of all our talk around the investments we're making within Longview and talking about the Memphis facility and that build-out, the goal is to really start leveraging a geographically diverse manufacturing fleet. And so as we start to leverage that, we can really optimize manufacturing efficiency and drive margins at those sites. Within the Oregon site today, the volumes going through there, it requires a tremendous amount of collaboration, but also some outsourcing that puts pressures on margin, where once we get the manufacturing fleet kind of fully in operation, that outsourcing really starts to kind of pull back and allows us to really in-source as much as possible, getting that kind of additional tailwind around margin.

Perfect. Thanks, Matt. I will leave it there. Thanks, guys.

Your next question comes from Brent Thielman with D.A. Davidson. Your line is now open.

Hi, good evening, guys. Congrats on all the activity here. I wanted to come back to just thinking about the sheer magnitude of things you've got in orders and going to be revenue in here in the next few quarters. But I was thinking about your comment that you may be down into the first quarter on a sequential basis -- on the basis. Does that mean the bulk of this sort of new orders is going to revenue in the second quarter? I'm just trying to understand how this is going to sequence over the next -- first half of the year.

Yes. So great question. And when you think about the historic seasonality we have in the rooftop business, coupled with the kind of macro and secular dynamics that are happening right now, the Oklahoma segment certainly is having downward pressures Q4 and Q1 being offset by the ACP and BASX segment. But when we talk about the kind of growth in revenue in that backlog, it definitely is accelerating quarter-over-quarter. And so you're going to -- when you think about Q1 to Q2, you've got the seasonality softening on the Oklahoma segment that's providing an uplift in revenue. Add on top of that, the acceleration of conversion of that backlog around the data center space. And certainly, that's where Q2 is going to have a substantially stronger performance compared to Q1 from a top line revenue perspective.

Yes. Matt, what about just the core BASX business, especially as you wrap up the projects there at that facility. How do you sort of think about the sequencing of revenue from there? Is it going to take some time to work through the kinks? Just curious because it would seem to me you've got a pretty full pipeline there.

Yes. And so one thing to consider, and this is something that as we go forward, we really have to start thinking about BASX differently than we think about it today. And the reason I say that is the BASX brand is truly going to leverage the geographically diverse manufacturing fleet. So when we talk about BASX today, it's tied to Redmond. The walls are only so big within that Oregon facility. And so we naturally hit kind of a point where that facility is at its revenue kind of cap, and we focus on, at that point, driving efficiency and basically margin upstep kind of from there. But when you think about BASX as a whole, our big intention with the Longview expansion with this Memphis project, it is to be manufacturing that BASX branded product across that area. And so we may [indiscernible] facilities to optimize the manufacturing fleet and really drive manufacturing efficiency going forward. So it's kind of -- the true root answer to your question is BASX as a whole is going to really be seeing strong acceleration, leveraging that diverse manufacturing fleet. The today's style of reporting of BASX is obviously only -- can only grow so much within our geographic walls in Redmond until we kind of help further, further provide the explanation of BASX going forward. And so that's definitely from a reporting perspective, something we're very cognizant of is really identifying the true BASX revenue that's manufactured across the fleet.

Got it. Appreciate it. I guess my last one is understanding you've got a little bit of a lull here in the rooftop business in the short term. I guess my question around it is, is any of this induced by the refrigerant change? Or is this really just kind of a consequence more of, look, there's a lot of things going on in the end markets right now and customers are just taking a step back.

I think all three factors that I've been talking about for in excess of a year now are pressuring the rooftop business. The refrigerant transition is certainly one of the larger of those. I think the interest rates have kept construction starts down. If we look at ABI, it's been down for like 20 months in a row or something like that. So once these interest rates, the impact of them lowering the interest rates starts to materialize into more starts, be more opportunities and the refrigerant transition will be behind us here shortly. So the headwinds don't seem to have a whole lot of duration to them.

Appreciate that, Gary. I'll pass it on.

Your next question comes from Timothy Wojs with Baird. Your line is now open.

Hi, everybody. Good evening. Nice job. Maybe just -- I want to dig on one point that you said in the press release. So bear with me, there's a little bit of math. But over half of your backlog right now is for data centers, and that's going to be produced and shipped in 2025. So if I just use 51% of that, that implies $325 million or so of that backlog is going to be for data centers in 2025. And then if we add the $175 million order you announced in October that adds up to at least $500 million in data center revenue next year. So I guess, is that math right? And I guess if it is, just how do you kind of -- how are you kind of set up from a capacity perspective to just kind of make sure that you can handle that type of growth?

Yes. So one thing I'll touch on, just with the data center revenue -- sorry, backlog that is there today, there is still a portion of that that will be manufactured past '25. So we have some stuff in our backlog that's going to be 18 months out. So not all of that is going to convert for what's in backlog today in 2025. But certainly, the $174 million, we messaged that's going to be primarily converted within the first half of '25. And we still have then capacity that we're selling in the latter half of '25 around liquid cooling products. So while not providing direct guidance, I'll just say your sentiment and what you're thinking is certainly in the realm of kind of what we see within the data center space going forward. And when we look at how do we support that, I mean, it's a fantastic question when you think about that's tremendous growth around that segment and managing that from a manufacturing and efficiency perspective is critical. So we've already wrapped up the fundamental Redmond project is wrapped up. We're still doing some work in Oregon, but the big stair step of that investment is wrapped up and is now producing product. So that was a 15% gain in square footage, which has more headroom compared to overall revenue, not a 1:1 square footage to revenue. We go to the Longview site and by the end of the year, we'll have that wrapped up. We're already setting up and actually priming production lines within that facility today. So when we hit 2025 and that facility is turned over, we're sequentially bringing those production lines on throughout the calendar year, which is providing a tremendous amount of additional capacity. So you're going to see sequential capacity in Longview coming online really from Q1, Q2 into Q3. And right as we're sitting there in Q3 is when we anticipate really starting to be able to get some inertia within the Memphis facility and producing product kind of in earnest towards the latter half of the year in '25. So all that to say, that capacity from an investment perspective, really from today throughout the end of '25 is going to be a continuous increase in capacity throughout the calendar year that's going to really allow us to support that bookings growth.

Okay. That's really helpful. Thanks. I guess on Oklahoma, Gary, just kind of if you can maybe just talk a little bit about the decision to maybe put through a little less price than your competitors are doing? Because by my math, I mean, you effectively won't have much of a premium now, at least on an initial cost basis relative to your peers. And so I guess, how do you intend to push that in terms of marketing and sales just given the efficiency or just the much more bigger efficiency that you have relative to standardized product?

Well, one of the things to kind of take note of is several of our competitors have announced that they're building inventory to put in their distributor channel that is 410A. And one of those competitors stated that they could be putting new 410A equipment in for about 9 more months. So while that's still out there, we're not going to see the real price difference because they're not getting a preponderance of 454B equipment out there yet. So it's not going to be instantaneous that we see this glaring difference in pricing show up. It's going to take a quarter or two. We're monitoring it very closely. When we have competed with the others on 454B, we have found them to be much closer to our price or above our price. So I just -- I want to get the momentum back into this business and not try and get the margins out of line. The margins are very, very good right now. And we've produced enough 454B equipment already to know that our margins are solid on it as well. So we will be monitoring that, Tim. I don't want to leave money on the table. Our equipment is definitely a value statement that is easily defined, and we intend to get paid for the value.

Okay. No, it's helpful. I understand that. Okay, good. Go ahead. Thanks, guys. Appreciate it. See you next week.

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

Thanks. Hi, good afternoon, everyone. Could you give us some flavor in terms of the margin profile of that $175 million liquid cooling order? And is it fair to assume that order is going to be part of the Coil segment, or would it be BASX?

Yes. So from a margin perspective, I would just say, I mean, it's going to be in line with what we historically have seen in the BASX segment kind of before all the disruption. Obviously, there's opportunity to get margin expansion kind of given that volume, the manufacturing efficiencies that come with that there provides headroom in there. But we're not guiding they're going to be as strong as kind of what we've been posting in the Oklahoma segment just because there's going to be pressures on that margin during the initial ramp-up. And then as we get into a steady state, there's going to be opportunity for actually some upside. So I would use kind of a 2023 BASX margin profile as kind of a rough expectation of really where we expect to see that come. And yes, it will -- that revenue will show up in our reporting within the Coil Products segment.

Okay. Got it. So 2023 BASX margin. But wouldn't the majority of that order be kind of in 1 quarter in 2Q, as you said earlier? Or am I not thinking about that correctly?

It will ramp up. I mean you'll see that revenue kind of sequentially realistically, even a little bit in Q4. So you'll see it kind of in Q4 ramp up in Q1 and then ramp up more in Q2. So it will be sequential. But certainly, there's going to be a high density of that sitting in Q2. That obviously is going to provide some margin upside just around leverage.

Got you. Got you there. And then on the new production facility in Tennessee, you said you expect to have it running kind of towards end of the year '25. Can you just give us an idea of kind of the expected contribution of that facility on an annualized basis?

Yes. I mean it certainly has a lot of room to really impact the revenue within AAON. And so we haven't really kind of put to paper publicly at least where the revenue potential is. But what I would just say is if you step back and think about what does 787,000 square feet mean relative to the data center footprint that exists inside AAON today, and it's roughly doubling the available square footage to produce data center products. And so that's kind of the guidance we're giving is if you look at that and look at Redmond, you look at the ACP site with the expansion, all in, you're getting roughly a doubling of that square footage to be able to kind of revenue data center products going forward. So there's definitely upside to be able to really impact the market with that coming online.

Good context there. And maybe getting ahead of myself, but is that going to be also a Coil segment facility, or would it be different?

So near term, it will likely reported into Oklahoma. But obviously, on the long term, we're going to work through reporting to be able to clearly articulate the BASX versus AAON segments from their impact to the enterprise as a whole.

Understood. And then just one more for me, if I could. Maybe it's Rebecca, you said earlier that the annual tax rate -- effective tax rate for this year is expected to be 24.9%. So does that imply kind of a high 30s tax rate we should be looking at for the fourth quarter?

No. So the annual -- each of the quarters reflects discrete events, mainly our excess tax benefit that lowers it below the 24%. So it won't be like year-to-date, you take 24% and back out to get a higher rate in fourth quarter. It'd be 24%. I assume we'll have another excess tax benefit in Q4. So it might likely end up less than 24% when you add in some of those discrete events. So you would look at your fourth quarter results times that 24% tax rate and factor in what discrete events could be.

Okay, good clarification there. Thanks very much, guys. I'll pass it on.

There are no further questions at this time. I will now turn the call over to management for closing remarks.

I'd like to thank everyone for joining us 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. Thank you.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.