AAON Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2024

There are 11 speakers on the call.

Operator

Good afternoon, ladies and gentlemen, and welcome to the Aon, Inc. 2nd Quarter of 2024 Earnings Conference Call. At this time, all lines are in listen only mode. Following the presentation, we will conduct a question and answer session. This call is being recorded on Thursday, August 1, 2024.

Operator

I would now like to turn the conference over to Joe Mondillo, Director of Investor Relations. Please go ahead.

Speaker 1

Thank you, operator, and good afternoon, everyone. The press release announcing our Q2 financial results was issued after market close today and can be found on our corporate website, aa0n.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 Field, CEO Matt Tabalski, President and COO and Rebecca Thompson, CFO and Treasurer. Please turn to Slide 2.

Speaker 1

We begin with our customary forward looking statement policy. During the call, any statement presented dealing with information that is not historical is considered forward looking and made pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act of 1995, the Securities Act of 1933 and the Securities and Exchange Act of 1934, each as amended. As such, it is subject to the occurrence of many events outside of Aon's control and that could cause Aon's results to differ materially from those anticipated. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our press release and Form 10 Q that we filed this afternoon details some of the important risk factors that may cause our actual results to differ from those in our predictions.

Speaker 1

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.

Speaker 2

Good afternoon. Starting on Slide 3. Our Q2 performance exceeded expectations. Production issues from the Q1 were largely resolved, leading to increased volume output and productivity across all three segments. This resulted in record sales, earnings and backlog.

Speaker 2

The Basics segment had an exceptional quarter. Net sales at this segment were up 58.3% from 1 year ago and 103.7% compared to the Q1. This is especially notable considering that the reconfiguration of the production layout within the Redmond, Oregon facility, which disrupted operations in Q1, continued into Q2. The growth at Basics has been largely fueled by the data center market. Sales of our Basics branded data center equipment produced at both our Oregon and Texas facilities were up year over year 142.4%.

Speaker 2

We stated on our Q1 call that data center sales made up approximately 10% of total net sales for 2023 and about 20% of bookings. In the first half of this year, sales in this market made up 10.5% and in Q2, it was 13.7%. In our Packaged Rooftop business, which makes up most of the AAON Oklahoma segment, we are continuing to realize growth, but at a moderated rate compared to the last couple of years. Considering our volume was up 48.7% over the last 2 calendar years, along with the softening macro conditions and disruptions related to the refrigerant transition, we are pleased with the performance. All of these last few years and week to week orders are volatile.

Speaker 2

This makes production planning much more difficult. Despite this, the operations team has been performing exceptionally well. Total company backlog at the end of the quarter was a record 6 $50,000,000 up sequentially for a 3rd straight quarter. Compared to a year ago, backlog was up 23.5% and relative to the end of the Q1, it was up 16 point 4%. The increase was largely driven by the Basic segment and the data center market.

Speaker 2

With that, I'll now hand it over to Matt Tobalski, who will speak more in-depth about our operational strategy.

Speaker 3

Thank you, Terry. Please turn to Slide 4. The second quarter was an excellent quarter for the company. Many of the issues that weighed in our performance in Q1 were resolved allowing for higher volumes and greater productivity. That said, the quarter did not go without its own challenges, which puts the overall performance into an even brighter light.

Speaker 3

The disruptions related to reconfiguring the layout of Basic's facility in Oregon continued into Q2. Equipment was still being rearranged and the outsourcing of parts we would otherwise produce in house was necessary. As a result, while productivity improved from Q1, there is room for continued improvement. Despite these challenges, this segment posted record sales and record gross profit. Most of the heavy lifting and temporary disruptions related to the production layout reconfiguration and capacity expansion is behind us.

Speaker 3

We expect the new capacity will be up and running by the end of the third quarter, positioning Basics for robust growth and improved margins in the second half of the year, driven by increased throughput and operational efficiency. Basics had a strong backlog entering the back half of the year and upbeat fundamentals amongst the data center market. Furthermore, beyond what is in the backlog at basics is a robust pipeline of data center projects in which we are heavily engaged and are optimistic we'll be able to convert into bookings. I will note the timing of backlog conversion at this segment is weighted more to Q4 and beyond than it is in Q3. This brings me to the Aon Coil Products segment, which is increasingly becoming an extension of basics in a manufacturer of data center cooling equipment.

Speaker 3

Similar to basics, this segment finished the quarter with a strong backlog and a robust pipeline of future opportunities within the data center vertical. In fact, just last week, we landed a large liquid cooling order that increased the segment's backlog by over 50%. This order is associated with a large data center company and is the 1st tranche of a multi phase multi year project. We are extremely excited where this business is headed. Like basics, the capacity expansion project at this segment is on schedule and is expected to be finished by year end, with production expected to commence early next year.

Speaker 3

The new space is allocated to Basics branded data center products and will add an incremental 200 and 5,000 square feet of manufacturing capacity, an increase in this location of roughly 50%. This will help absorb the immense growth we foresee in the data center market for both air side and liquid cooling projects. It will also help improve productivity. In fact, we've already begun to see this. In the Q2, gross margin of the segment was 41.9%, up from 24.9% in the first half of the year gross margin was 38.3%, up from 23.1% in the first half of twenty twenty three.

Speaker 3

Finally, the Aon Oklahoma segment's performance from an operational perspective was also outstanding, particularly considering softening construction environment and disruptions related to the new refrigerant regulations. Over the last couple of years, our Tulsa, Oklahoma manufacturing facility has transformed into what I described as a well oiled machine. The engineering team has never been stronger and manufacturing is as precise and efficient as it has ever been. The cost this business is facing when compared to the last couple of years are very tough and yet we've been able to maintain volumes comparable to a year ago. Furthermore, as I stated, the macro environment has become more challenging and the new refrigerant transition has created disruption.

Speaker 3

As a result, bookings have been unusually volatile this year from a week to week and month to month perspective. Bookings for this segment through the first half of the year are up from a year ago, but the increased volatility introduces challenges when it comes to production planning. All that considered the operational performance has been superb. As for the back half of the year, the operations team will have to remain nimble. While we still think demand will increase somewhat ahead of our phase out dates of our 4th NA refrigerant equipment later this year, our visibility is limited.

Speaker 3

A positive thing we have going for us is our lead times are still an industry best, which means we can likely accept orders for our 4th NA equipment later than most of our competitors. If we do see an increase in near term demand, this could position us to have a strong finish through Q4. It is important to note that this scenario could also result in a soft order book in Q4, which would result in a slow start to 2025. At this point in time, we're unsure exactly how it will play out, but the bottom line is that we expect continued volatility in the near term and we are confident we will manage through it better than most. Looking to next year, we've been producing R-54B equipment longer than any of our competitors.

Speaker 3

That means we are best prepared when it comes to inventory and production. Additionally, for us, the cost of manufacturing new refrigerant equipment versus our old refrigerant equipment is not changing at all, potentially giving us an edge as some of our competition has messaged increasing costs associated with the new refrigerant equipment. Regardless, we are already more cost competitive than we were years ago as the price premium of our higher quality equipment is the narrowest it has ever been. Beyond product evolution associated with the refrigerant transition, we continue to lead the industry in innovation and are well ahead of anyone in the development of cold climate air source heat pumps. Sales of our traditional heat pumps continued to outperform overall Aon Oklahoma sales in Q2 and sales of our cold climate heat pumps outperform traditional heat pump sales.

Speaker 3

Overall, while the near term sales of heat pumps may be volatile, we're very optimistic regarding the medium to long term. With that, I will hand it off to Rebecca to walk you through financials.

Speaker 4

Thank you, Matt. Please turn to Slide 5. Net sales increased 10.4% to $313,600,000 from $284,000,000 in the Q2 of 2023. The year over year growth was largely driven by the basic segment, which realized an increase in net sales by 58.3%, a majority of which was spurred by sales related to the data center cooling solutions. Sales at Aon Oklahoma and Aon Coil Products segments grew 3.4% and 4.3% respectively.

Speaker 4

Moving to Slide 6, gross profit increased 20.3 percent to $113,100,000 from $94,000,000 As a percentage of sales, gross profit was 36.1% compared to 33.1% in the Q2 of 2023. The realization of price increases along with the slowing of inflation for raw materials at the Aon Oklahoma and Aon Coil Products segments improved overall consolidated margin performance. Please turn to Slide 7. Selling, general and administrative expenses increased 16.9 percent to $45,900,000 from $39,300,000 in the Q2 of 2023. As a percent of sales, SG and A increased to 14.6% from 13.8%.

Speaker 4

The increase relative to sales is primarily attributable to an increase in investments made in technology, professional and legal fees, increased travel and consulting expenses. Moving to Slide 8. Diluted earnings per share was $0.62 up 12.7% from a year ago. Our tax rate in the quarter was 22.1%. The company's estimated annual effective tax rate, excluding discrete events, is expected to be approximately 25%.

Speaker 4

Turning to Slide 9. Our balance sheet remains strong with a current ratio of 3.0. Cash, cash equivalents and restricted cash totaled $12,100,000 on June 30, 2024 and debt at the end of the quarter was $85,900,000 Our leverage ratio was 0.3 Year to date, cash flow from operations was $127,900,000 up from $59,900,000 in the comparable period a year ago. Capital expenditures for the first half of the year, including expenditures related to software development increased 24.4 percent to 75,400,000 dollars During the quarter, we also repurchased $100,000,000 of shares outstanding, reflecting our confidence in the long term prospects of the company and our commitment to delivering value to our shareholders. The combination of the capital investments and share repurchases led us to draw down on our revolving line of credit.

Speaker 4

We anticipate paying just over half of that off by the end of the year. All in, our financial position is strong, giving us flexibility and allowing us to continue to fully focus on growth opportunities. With that, I'd now like to turn the call back over to Gary.

Speaker 2

Please turn to Slide 10. We feel really good about our current position. The growth of the Aon Oklahoma segment in the first half of the year was below our expected targets, but I want to remind everyone that the volume of equipment at this segment was up 48.7% from 2021 to 2023. That type of volume growth is unheard of for this industry. Furthermore, we've been operating all year with normal lead times and lean backlog in this segment.

Speaker 2

That's far different than some of our competition who are still trying to catch up since the peak of the supply chain issues. All considered, including the slowing macro environment and disruptions from the refrigerant transition, the fact we have maintained comparable volumes to a year ago is terrific. The bottom line is we have the highest quality package rooftop equipment in the industry, currently selling for the smallest price premium in our history. Our sales channel continues to strengthen, and we are leading in innovation. If recent commentary coming from our competition regarding their cost of manufacturing the new refrigerant equipment is accurate, we're going to be in an even more advantageous position than we already are today.

Speaker 2

Either way, our package year when some of these external issues are behind us. Matt spoke at length regarding data center opportunities at both Basics and Aon Coil product segments, but I just want to add one comment and stress another that he mentioned. First, we are in the early stages of this cycle. The big increase in CapEx plans that our customers have announced occurred in 2024 through 2026. We are just scratching the surface.

Speaker 2

This is why we continue to speak to this pipeline of opportunity beyond what is already in our backlog, which is the comment I want to stress. I always say nothing is a guarantee until it makes its way into the backlog. However, the pipeline we refer to is not just a calculated estimate of market size or related to CapEx numbers our customers have announced. Our sales teams and engineering departments are working very closely with these customers, helping design very unique cooling solutions for the largest data centers ever built. Many of the solutions require a lot of equipment with highly customized designs due to the size of the buildings and heat being generated.

Speaker 2

The execution of everyone involved has been top notch, and I'm confident we will benefit greatly from this pipeline of opportunity. Needless to say, I'm very excited where our data center business is headed. Our updated outlook is as follows. In 2024, we are now looking for volume to be flattish. We continue to anticipate pricing will be a mid single digit contributor and that gross margin will be up year over year.

Speaker 2

For SG and A, as a percent of sales, we anticipate a 50 to 100 basis point increase. And we maintain our CapEx guidance of $125,000,000 In the back half of the year, we expect much of the year over year growth will be weighted to the 4th quarter. For the 3rd quarter, year over year sales growth of flat to up modestly and we expect GAAP earnings per share will be flat to down modestly from a year ago. In closing, I want to finish by thanking all of our employees, sales channel partners and customers. Thank you.

Speaker 2

To our shareholders, this company has never been more well managed than it is today, and we look forward to generating the returns that you expect of us. I will now open the call for Q and A.

Operator

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

Speaker 5

Hey, good afternoon guys. Terrific quarter. Maybe I will start with where Gary left off in terms of the Q4 sales stronger than Q3. Is it data center timing or is there something else that's driving that?

Speaker 2

It's production capacity coming on board primarily for data centers. So the orders for rooftop units, they've been just steady, not strengthening. Maybe they're up over last year, but not enough to press on very hard. But the data center bookings have been tremendous. We'll have a little bit of a struggle to getting the of it built in Q3 for any material amount because of both getting parts and pieces in and getting production facilities ready to go.

Speaker 2

The production facilities are coming along nicely and on schedule as we said in the earlier part of the call.

Speaker 5

Got it. That's helpful. And in terms of both Oregon and Texas, it sounds like you're getting there. Did you say earlier in the call that you're talking about increasing data center capacity even further beyond that or did I miss that?

Speaker 2

Well, the additions that we've got going in Oregon will give us considerable more production capacity there. The new addition in Longview, which is 245,000 Square Foot, is currently 100% allocated to data center because of the pipeline of work and the backlog of work that we have.

Speaker 5

Got it. And maybe just the last one for me. So obviously, very strong quarter for Basics. Operating margin was 28.5%. Matt talked about productivity issues that are winding down.

Speaker 5

You were at the 34% range at the end of Q2 excuse me, Q3 and Q4 last year. Can you get back up to there in Q3? Or is that more of a Q4 kind of target?

Speaker 3

Yes, getting there in Q3 still definitely has some headwinds against it. And really kind of some of the depression we saw in Q2 is during the rearrangement, not just productivity challenges, but also with the rearrangement of some of the fabrication equipment. There was a lot more outsourcing kind of in there. So obviously there's some cost pressures that come off of that. So that's going to continue waiting through Q3 and definitely kind of Q4 and beyond is where it's kind of really start getting back towards the normalized margin profile.

Speaker 5

Terrific. I will leave it there. Thanks guys.

Operator

Your next question comes from Ryan Merkel with William Blair. Your line is open.

Speaker 6

Hey, everyone. Congrats on the nice quarter.

Speaker 2

Thank you.

Speaker 6

I wanted to ask about the transition to the R454 equipment. What is the big risk exactly? Is it that customers are going to buy R410A and not move as quickly to the new systems? And then the follow-up is, when is this risk over? Is it 2Q 'twenty five?

Speaker 6

So really we just have to worry about 4Q and 1Q?

Speaker 2

Well, we cannot ship current refrigerant, meaning 410A beyond December 31. So all equipment that we ship beginning January 1 has to be 454B. Part of the hesitation on the part of our customers is many states have not yet put building codes in place to allow the utilization of 454. Those building codes historically are put in place in October, every 3rd year is when they update it. So in October, we anticipate that the vast majority of municipalities entities will be able to utilize the new refrigerant.

Speaker 2

Then comes the next part of the equation that really I didn't anticipate quite so well, I guess. Some buildings have to modify the building slightly in order to use the new refrigerant. They have to put in refrigerant purge kind of systems if the refrigerant could get inside the building. So it's not all buildings. It's very complex how it works.

Speaker 2

But there are instances where putting the new equipment with 454 on causes the building to be modified. So some of these people have been rethinking what they're doing, and we anticipate there could be a little bit of a surge possibly in 410A equipment here towards the end of the, call it, useful life of it. And all of this will be behind us as far as order bookings and even shipments of January 1st.

Speaker 6

Right. But you also make R-410A, so you could if that's what the market wants and the rest of the year you could make that?

Speaker 2

We can throughout 2024, then it becomes kind of a cat and mouse game. If you anticipate a certain number of orders and you have inventory of parts for that and you have a staffing for run rates that will allow you to build it before December 31, wonderful. But then you're going to have to determine exactly when that cutoff is in order to not put at risk the ability to produce it before December 31. So we've published that table of when we're cutting off certain products. We already our longest lead products that the components are more specialized, they're very large tonnage, they're low volume in number of units.

Speaker 2

We've already cut that off. There is no more 410A for that. We have additional milestones later this month, but I think somewhere in October is our final cutoff on 410.

Speaker 6

I appreciate all that. I know it's a little confusing here.

Speaker 2

And I'm talking about taking orders. We won't take orders beyond those dates.

Speaker 6

Right. Okay. And then the other question I had was just on basics. I mean a really nice quarter well above what we were thinking. So it sounds like 3Q, the basics growth rate will slow relative to 2Q and then 4Q once the production comes online, it should accelerate again.

Speaker 6

And then am I right that the basics growth rate just given the backlog should also accelerate into 2025?

Speaker 3

Yes, certainly the kind of, you mentioned, kind of a little bit of deceleration in growth. Certainly, Q3 is not going to be showing a huge backlog conversion. But really backlog conversion is going to focus Q4, kind of when a lot of that capacity is kind of online within Oregon. And then really kind of as that production capacity gets in full swing kind of help ramp that up, kind of sequentially throughout 2025.

Speaker 6

Got it. Sounds good. Thank you.

Speaker 3

Thank you.

Operator

Your next question comes from Julio Romero with Sidoti and Company. Your line is open.

Speaker 7

Yes. Hi. This is Alex on for Julio. Great quarter. Thanks for taking questions.

Speaker 7

I wanted to follow-up. Yes, of course. Last quarter, you spoke about devoting some engineering and operations resources to develop more tailored sticky retention opportunities in data center. Could you give us an update on those developments?

Speaker 3

Yes, I mean certainly some of the I'll say the resources that are really focusing on developing the creative and really innovative solution in the data center market, really reflecting that the single order we mentioned kind of after quarter close that technically booked inside the Aon Coil product site, but that was a collaborative custom engineered solution for one of our data center customers within the liquid cooling space. They really tailored to a unique operating strategy and overall build strategy for that customer. And so that kind of engagement and really collaboration with our customers it's kind of the lifeblood of how basics operates. And so that's really driving continued pipeline visibility activity and really backlog conversion as well.

Speaker 7

Great. Yes, thank you for the color there. And following what seems like a very successful Base X acquisition, could you comment on how you're thinking about M and A these days and what might be in the pipeline?

Speaker 2

Don't have anything in the pipeline at the moment. Basics was very strategic. There was a long history with the former owners and myself, so it made it fairly certain what the outcome would be. We went on kind of a proactive search to see if there was anything out there that would work in a strategic manner similarly. We've come up empty handed so far.

Speaker 2

But we keep our ear to the ground and we listen and multiple investment bankers talk to us frequently about deals they've got running around. And we just have not yet found anything that would fit us in a strategic manner. We don't have any reason at all to purchase anyone other than that.

Speaker 7

Okay, great. Yes, I appreciate. That's all from us. Thank you.

Operator

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

Speaker 8

Hey, thanks. Good evening, all. Gary, I want to come back just to the expectations through the rest of the year. It sounds like essentially all of the growth is being driven by the ramp up at basics and kind of the data center product. Can you help me kind of flush out how you're thinking about the Rooftop business from a sales perspective over the next couple of quarters?

Speaker 8

Because it sounds like maybe you think you have some headwind overall there.

Speaker 2

Yes. I think that's reasonable. Rooftop sales were up 4%, which is mostly price, right? So the volume was flattish, which when you look at 48% growth stacked over the last 2 years, it's pretty good to hang on to that. But to keep it going and growing, it's been difficult.

Speaker 2

You may recall going back to nearly this time last year, I projected that it was going to be difficult. I said the refrigerant transition was going to make it chaotic. I thought interest rates were going to have a bearing on it. I thought the election was going to have a bearing on it. And unfortunately, it looks like my projections were correct.

Speaker 2

So I think that as we get some interest rate relief, which all of us anticipate probably coming this fall, As we get the election behind us, those 2 are clear. The refrigerant transition is behind us really January 1, but how fast the market rebounds and accelerates, that's yet to be seen. It's just really chaotic right now for our customer base. So I think the next couple of quarters with regards to rooftops, I'm not real excited about anything at this moment saying here's a clear path to things getting back to growing like they were for the next couple of quarters. So yes, what you said is correct.

Speaker 2

However, the data center business is very, very strong as evidenced by what we booked and the other conversations we're having with these clients about what they want to book. And when we get that facility online in Texas, it's a rare thing. I mean, I've been running this business nearly 8 years, and I have not put any production facility in place yet that on day 1, it was totally booked up until this one. When we get this facility up and running, Q1 of 'twenty five, it's fully sold out.

Speaker 8

Got it. Now Dewey noted on calling a choppy year here, Gary. Well put. I guess just as a follow-up just related to Longview, kind of 2 part question. Can you help us understand what drove the really strong margin this quarter and what's sustainable for that kind of business going forward?

Speaker 8

And then it looked like year to date, you actually produced more data center product there last year than you did this year. Does that really reverse in a significant way in the second half or more into 2025?

Speaker 2

Well, I know the answers to every one of those questions. I think Matt's just one notch closer to it than me. I'd like for him to answer those.

Speaker 3

Yes. With respect to the margin profile, certainly the margin uptake we saw in Q2 really one of the big things is being driven by productivity as well as product mix. We had a pretty strong run of data center products we're building out of there for one of our customers with legacy Aon product. And that product mix and the overall kind of productivity through there really helped flush out that good strong margin profile in the quarter. Certainly though as we look forward to your second half of that question, yes, definitely we see an uptick in sort of the percentage of revenue coming out of Longview driven by data centers in the latter half of this year.

Speaker 3

So there's definitely a lot of activity in conversion of that order that booked kind of after quarter end. We expect to convert at a high probability of that backlog within Q4 of this year. So there certainly is a lot of drive in the data center market kind of coming through this back half.

Speaker 8

Okay. Very good. Thank you.

Operator

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

Speaker 9

Hi, everybody. Good afternoon. Good afternoon. Hey, Gary, just on the orders in the backlog, I was just kind of curious if you could give us a little bit of kind of added color on what you're seeing on the data center side. It sounds like it's several orders, but I guess I want to kind of confirm that and just maybe what parts of the business or what products are you seeing some of the bookings and the backlog kind of growing?

Speaker 2

Yes. With regards to the data center portion, it is multiple customers. Many of these customers have been on board with this for a good while. And as we've increased our production capabilities and have prospects of more production capabilities, they've began booking. As I said, the new building in Longview is essentially booked full right now, and it doesn't come online until January 1.

Speaker 2

But that fits their schedule. The type of products, they're both air cooled and liquid cooled. And we have developed some unique solutions for certain clients on a collaborative basis for their liquid cooling needs. And we continue to excel with our air cooled. So we're strong in both.

Speaker 2

I would look for liquid cooling to grow at a more rapid rate than air cooling going forward, but air cooled is not going away and it's not going down.

Speaker 9

Okay. Okay, that's helpful. And then maybe just on Oklahoma, it does sound like there is going to be a little bit more volatility on the top line in the back half of 'twenty four. How would you kind of think about the margins as you kind of chop through that? Is it just a situation where you have to kind of manage through it, keep the employee base, keep everything, you just get a little bit more productive?

Speaker 9

Or are there levers you can pull where you can still kind of maintain this kind of 37% to 38% gross margin?

Speaker 2

Well, those are great questions and we discuss them frequently. At this point in time, we're able to run at a rate that allows these margins to continue. If the bookings don't strengthen here soon, then we will have to make some adjustments for that segment. I don't know historically, you could just cut off hiring because there's enough turnover at the low end of the kind of the entry level end of the employment. But we don't have much turnover now.

Speaker 2

We're a preferred place to work and these people they come and they stay and the turnover is so low. So there's other ways, other levers we can pull if need be. We're not at a point of making that kind of decision yet. Bookings are decent. They're just not as strong as what we'd like.

Speaker 2

And like I say, we kind of mentioned this in the call earlier, you'll run along for a few days at the 1st part of the month and you go, oh my goodness, this is not good. And then it will start strengthening and then the month finishes out pretty darn decent. And for whatever reason, I don't know of one rep that gets paid on an end of the month basis. So it's not like they're doing it for that. But for some reason, they kind of clean their desk off towards the end of the month and send the orders in.

Speaker 2

I wish they'd be a little more regular cadence to it. But we continue to manage through that. And I look for it to be just a little chaotic for another 1 or 2 quarters.

Speaker 9

Okay. Okay, understood. And then just as you kind of think about the pricing on 454, I think there's been some chatter in the marketplace. A couple of your competitors have talked about maybe 8% to 10% type price increases next year. When does when do you kind of solidify what you'll do with price?

Speaker 9

Is that kind of something where you go out with one big increase? Or do you think you kind of slowly kind of price into what the where the market's going through next year?

Speaker 2

Well, the 2 or 3 things. First off, right now we've got great margins and the pressures on those margins are minimal. There's more pressure related to run rate than there is to material cost at today's analysis. So if we want to keep our margins, we need to keep the run rate up there where it's at now or grow the run rate. That takes care of a lot of the fixed cost.

Speaker 2

It keeps that margin where it's at. So all of that looks real good for us. If we are a premium to these people now, which we are, and they go up 8% to 10%, we don't have to, that premium largely goes away. And when you look at the value proposition of our equipment versus theirs, it becomes very intriguing to purchase AAON equipment versus the others because you get so much more value for it. And if it's not a cost thing, then we can see some real strengthening to the bookings.

Speaker 2

We're not absolutely sold that that's what's going to happen. But as these competitors talk, they become more and more certain about them going to have a price increase related to the refrigerant, and we become more and more certain we're not. We have produced a decent amount of the equipment now, so we've got empirical data to support the analytics that pricing analytics we have in the company. And we've built the equipment And it's a really interesting story that I want to watch how it unfolds here. I cannot imagine how much fun it would be to be in the sales channel again like my old days if I wasn't a price premium.

Speaker 2

That would be outrageously fun.

Speaker 9

I look forward to watching it too. So thanks for the time. I'll turn

Speaker 4

it back.

Operator

Your next question comes from Jon Braatz with Kansas City Capital. Your line is open.

Speaker 10

Good afternoon, everyone.

Speaker 3

Hello, Jon.

Speaker 10

Good afternoon. Hello.

Speaker 2

Matt, I have a question.

Speaker 10

And Gary touched on it a little bit on your liquid cooling solution for the data market, data center market. Can you talk a little bit about how that market is evolving? And maybe what your competitive position within that segment of the market is and maybe pricing and margin for that product versus air cooled?

Speaker 3

Yes, of course. So when we get down to kind of where the product is kind of positioned and where that competitive advantage comes from, it's really driven by the ability for us to really kind of custom tailor solutions to applications. And when we think about the evolution inside the data center market around AI, we're driving pretty substantial increases in overall density from an IT compute perspective. But we're also we're driving the need for, I'd say, higher capacity heat rejection solutions. And so moving towards these larger and really highly configured solutions is really the sweet spot for us to be in as an organization from developing solutions and crafting solutions.

Speaker 3

And so the market is evolving in a way that's really positioning the basic products in a much stronger light in kind of this changing dynamic. And as the data center kind of infrastructure and design concepts are changing, the overall kind of infrastructure, how we want to deploy data centers and data center cooling, the engineering know how and resources that our teams be able to provide to customers is really helping drive value in that sort of design architecture and evolution. And so it's strengthening bonds with existing customers. Gary mentioned we're working with some new customers a lot of new customers, but we're also working with existing customers where that engineering know how and sort of thought process is really providing a very strong relationship and a really sticky relationship kind of going forward. As we think about pricing, there certainly is more price content living inside of a liquid cool data center right now from a price per kW perspective, as well as there's still as we deploy liquid cool data centers, air side doesn't go away.

Speaker 3

So we still have air side cooling in combination with liquid cooling for a variety of ancillary equipment. And so the overall kind of project opportunity for us continues to evolve and get larger from a central pricing standpoint. And then just on the margin side, it's comparable margin to what we're doing today. So it's what we're selling at today. It's not markedly different from kind of a margin expectation perspective.

Speaker 10

Okay. Matt, thank you very much. Appreciate the color.

Speaker 3

Yes, of course.

Operator

There are no further questions at this time. Joe Mondillo, please continue.

Speaker 1

All right. I'd like to thank everyone for joining on today's call. If anyone has any questions over the coming days 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.

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Key Takeaways

  • Aon’s Q2 performance exceeded expectations, delivering record sales, earnings and a record backlog of $650 million as production disruptions from Q1 were largely resolved.
  • The Basics segment posted net sales up 58.3% year-over-year (103.7% versus Q1), driven by a 142.4% surge in data center equipment sales, which accounted for 13.7% of Q2 net sales.
  • Capacity expansion projects in Redmond, Oregon and the new 245,000 sq ft Texas facility (AAon Coil Products) are on schedule, with the latter fully allocated to data center cooling and expected online by early 2025.
  • AAon Oklahoma’s packaged rooftop business maintained flat volumes amid soft macro conditions and refrigerant transition volatility, leveraging industry-leading lead times, R-454B readiness and growing cold-climate heat pump sales.
  • Financially, Q2 net sales rose 10.4% to $313.6 million, gross margin improved to 36.1%, diluted EPS increased 12.7% to $0.62, year-to-date operating cash flow reached $127.9 million, and $100 million of shares were repurchased.
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Earnings Conference Call
AAON Q2 2024
00:00 / 00:00