AAON, Inc. (NASDAQ:AAON) Q4 2023 Earnings Call Transcript
AAON, Inc. (NASDAQ:AAON) Q4 2023 Earnings Call Transcript February 28, 2024
AAON, Inc. beats earnings expectations. Reported EPS is $0.56, expectations were $0.53. AAON, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon, ladies and gentlemen, and welcome to the AAON, Inc. Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] This call is being recorded on Thursday, February 29, 2024. I would now like to turn the conference over to Joe Mondillo. Thank you. Please go ahead.
Joseph Mondillo: Thank you, operator, and good afternoon, everyone. The press release announcing our fourth 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. 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 1995, Securities Act of 1933, and the Securities and Exchange Act of 1934, each as amended.
As such, it is subject to the occurrence of many events outside of AAON's control that could cause AAON's results to differ materially from those anticipated. You are all aware of the inherent difficulties, risks, and uncertainties in making predictive statements. Our press release and Form 10-K 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. Joining me on today's call is Gary Fields, CEO; Matt Tobolski, President and COO; and Rebecca Thompson, CFO and Treasurer.
Gary will start the call off with some opening remarks. Matt will then provide some details about our operations and market trends. Rebecca will follow with a walk-through of the quarterly results. And before taking questions, Gary will finish with our 2024 outlook and closing remarks. With that, I will turn over the call to Gary.
Gary Fields: Thanks, Joe. Thank you, everyone, for joining us on our call today. If you will, please turn with me to Slide 3. Overall, we're very pleased with our 2023 results. 2023 marked our 35th anniversary as a company and it lined up with some outstanding achievements. Most notably, we surpassed a $1 billion of sales for the first time in Company history. Net sales in the year grew 31.5%, which followed a year in 2022 when we recorded organic growth of 46.8%. Over the last two years, organic volume was up 46.6%, including being up 14.5% in 2023. This is incredible performance for this industry. Along with the strong sales growth, we recognized solid margin expansion in 2023, reflecting not only the operating leverage from the increased volume, but also significant enhancements in operational efficiencies.
Net income for the year grew over 75%, resulting in a second straight year of record earnings. Since 2021, we have more than tripled net income. Altogether, I am very proud of how our team performed in the last calendar year. Please turn to Slide 4. We finished the year with strong results. Organic net sales in the fourth quarter was up 20.4%, and gross profit was up 42.3%. Our BASX segment realized a record quarter, both in sales and profits. Net sales in the segment were up 33.6%, and gross profit was up 70.3%. AAON Oklahoma also performed very well. Net sales in this segment were up 23.4%, and gross profit was up 45.3%. Gross profit margin for the Company came in at 36.4%, up year-over-year nearly 560 basis points, and down only modestly from the seasonally strong third quarter.
Despite the impact that holidays had on productivity in the fourth quarter, we were able to further improve operational efficiencies on top of the gains we recognized in the third quarter. This resulted in our strongest fourth quarter of earnings in Company history. Bookings and backlog also trended positively in the quarter. Bookings were up quarter-over-quarter for the second straight quarter and were the strongest since the first quarter of 2022. Bookings also outpaced production, resulting in a quarter-over-quarter increase in backlog. All around, it was a strong finish to the year. Please turn to Slide 5. 35 years ago, our founder, Norm Asbjornson, created AAON with one mission to manufacture the best HVAC equipment in the world for the best value.
At the time, the total addressable market for premium semi-custom equipment was very small, as much of the market consisted of basic equipment. This wasn't because the commercial real estate market was not interested in more sophisticated equipment. It was because of the exorbitant price that premium equipment carried. To be competitive, Norm determined it required a revolutionary engineering and manufacturing process compared to common industry practices at the time. It has taken the Company decades to perfect this unique way of manufacturing. Currently, our equipment is the most price competitive than it's ever been. At the same time, we continue to lead in innovation, performance, and quality. This progression has expanded our total addressable market across the HVAC industry immensely.
Secular trends, such as decarbonization, electrification, driven by market demand shifts and new regulations, has expanded our total addressable market even more. Not too long ago, AAON was known as a niche player in this industry. Being competitive on price has led to us being a mainstream solution. As I previously mentioned, Norm's mission 35 years ago was to provide the best HVAC equipment in the world for the best value. That mission remains true today, and the value of the equipment has never been more compelling. I'll now hand over the call to Matt Tobolski, who will speak more in depth about our operational strategy.
Matt Tobolski: Thank you, Gary. If you turn to Slide 6, last November, we issued a press release announcing several changes to the management structure of the Company. It's been a couple of months since making those changes, and I wanted to start off by providing you with an update. Historically, AAON has had two locations, with the vast majority of sales being generated out of our flagship Tulsa location. We now have a location in Parkville, Missouri, and with the acquisition of BASX, a location in Redmond, Oregon. Over the last year or so, we began integrating common departments across all locations. The goal was to promote collaboration and the sharing of best practices with the intent of maximizing the operational sophistication of the Company.
These recent organizational changes will accelerate this integration process, as well as improve our ability to manage the overall enterprise. Furthermore, the locations are beginning to overlap operationally. One notable example of this is allocating some BASX production to our Longview, Texas facility. This began last year, but it will escalate upon the completion of our Longview manufacturing expansion project, which is expected to be complete by the end of this year. These leadership changes will be a huge benefit as production across the locations further emerge. Two months into the change, I could not be more pleased with how things have progressed. In a short period of time, the teams have never been more collaborative and more energized.
I'm confident that these changes will have a meaningful impact in the near-term under our current footprint. Although just as important, you should be aware that the intent of this is with long-term in mind. These changes will better position us in the future to grow out of the current footprint in the most efficient way possible. If you will, please turn to Slide 7. I want to touch on some of the main tranches of our operational strategy. As you can see, we have a multifaceted approach when it comes to driving growth. This includes investing profits back into the business, incrementally providing support to our sales channel, developing market-leading products, leveraging secular market trends, and focusing on expanding our parts business.
We have several large capital outlays that we are currently in the process of making. Capacity is being increased across all four of our locations. The two main projects are at our Longview, Texas, and Redmond, Oregon facilities. In Longview, we're increasing manufacturing square footage by roughly 50%. This is slated to be finished by the end of this year. And at Redmond, square footage will increase by approximately 15%, with this expected to be finished by the end of third quarter. Both projects will yield much larger percentage increases in sales capacity due to expected increases in productivity. We have several other ongoing projects, and one that I'd like to highlight is the fact that we're building an additional training academy at our Tulsa location.
This will be a state-of-the-art facility that will be utilized to train and certify our reps. This is expected to be finished in early 2025. Now, let's transition to our sales channel. As we've spoken to in the past, we have never been more aligned with our channel partners and have never provided them with as much support and resources as we do today. Building this new academy in Tulsa is a perfect example. Likewise, last year, we hosted the grand opening of our Exploration Center, a one-of-a-kind facility at our headquarters that showcases our products alongside market alternative equipment. This is a powerful resource for our sales reps to utilize to help sell the value proposition of AAON equipment, a value proposition that is apparent once a customer walks through that facility.
Something that we've also beginning to focus on much more is what we call the complete customer experience. Historically, AAON was primarily a product development company solely focused on designing and manufacturing some of the best HVAC equipment in the world. We want to continue to hold true to that reputation, but we want to also be known for providing a premium customer experience from day one of the sales process through the entire lifecycle of the equipment, including installation, operation, and maintenance. This is an opportunity and one that we're now addressing and adding resources to take advantage of. We're also investing in sales and marketing. Marketing is something that AAON hasn't previously spent a lot of resources on. Although our premium equipment now offers the most compelling value than ever, AAON is still a small company in an industry with much larger players and brands.
We think that small investments in marketing will go a long way for us. By getting our name and brand out there more and educating the market about the attractive value proposition of our premium equipment, we expect it will assist our sales rep's success in penetrating the market quicker. This is just another example of how we're incrementally providing support to our sales channel partners. Earlier, Gary mentioned that one of our core missions is to design and manufacture the best HVAC equipment in the world. As we enter 2024, we are leading the industry with two product developments. First, we have been accepting orders for new 454B refrigerant equipment since January 1. Most of the industry won't be offering new refrigerant equipment until the second half of this calendar year.
Second, last year, we introduced our newly branded Alpha Class equipment. The Alpha Class is an air-source heat pump powered rooftop unit that is operable down to zero degrees Fahrenheit. No other competitor in the marketplace has such an offering. Most other air-source heat pumps on the market today are operable just down to 25 degrees Fahrenheit to 30 degrees Fahrenheit, giving us an advantage in this ever-increasing part of the market. Sales of this equipment still make up a small percentage of the total sales, but bookings in the second half of 2023 have nearly doubled when compared to the first half of the year for Alpha products, so there is solid momentum thus far. We expect our Alpha Class to fully leverage several secular trends that AAON has already been benefiting from.
Again, with an increased focus on decarbonization, electrification, and energy efficiency, as well as the accelerated impact from government regulations, AAON's superior-performing, highly energy efficient equipment is well-positioned to take advantage of such trends. Lastly, I want to touch on AAON's parts and service. Normally, we don't talk much about service because AAON doesn't have a direct service business. However, our reps do provide service that we indirectly benefit from. As we touch on parts, our parts business will be one of AAON's fastest-growing business segments going forward. It will also be our most profitable business. Part sales grew 26.3% in 2023, and we anticipate a strong double-digit growth rate in 2024. We are making several investments to help support this growth.
In 2023, parts made up 5.8% of total sales, and we think that we can double this portion of the business in three to four years, at which time it should represent closer to 10% of sales. Now, as we touch on service, as part of our initiative of improving the all-around customer experience, we intend to be much more focused on making sure our reps are providing a premium level of service to our customers. Like most OEM rep firms in any other industry, our reps know the equipment and their customer more than anyone else in the field. As such, to provide the best customer experience, we will instill upon them to provide the best service possible in this offering. In the end, our customers and reps, as well as our business and brand, will benefit substantially.
Before handing it off to Rebecca, I will close with this. I'm extremely proud to be part of and help lead this organization. While the growth we've realized over the last two years has been incredible, there is still a lot of work to be done to realize the full potential of this organization. The team has never been more energized, and I look forward to continuing to build upon what we've already accomplished. And with that, I will hand it off to Rebecca, who will walk through financials.
Rebecca Thompson: Thank you, Matt. I'd like to begin by discussing the comparative results of the three months ended December 31, 2023, versus December 31, 2022. Please turn to Slide 8. Net sales were up 20.4% to $306.6 million from $254.6 million. Along with the healthy backlog that we entered the quarter with, increased productivity resulted in volume growth of 9.3%. Adjusting total sales for inflation on a per-day, per-production employee basis, sales in the fourth quarter were the best in over two years, reflecting the recognized productivity gains. Pricing was largely the other contributor to growth. On a per-segment basis, BASX net sales in the quarter grew 33.6%, AAON Oklahoma grew 23.4%, while AAON Coil Products declined 17.9%.
Moving to Slide 9. Our gross profit increased 42.3% to $111.7 million from $78.5 million. As a percentage of sales, gross profit margin was 36.4% compared to 30.8% in 2022. The year-over-year improvement in gross profit margin was driven by incremental pricing, improved productivity, and higher volumes leveraging our fixed costs. Please turn to Slide 10. Selling, general, and administrative expenses increased 49.8% to $47.9 million from $31.9 million in 2022. As a percentage of sales, SG&A increased to 15.6% of total sales compared to 12.5% in the same period in 2022. The increase in SG&A was due to higher warranty expense and profit-sharing expenses from our increased sales and earnings. Other increases are a result of increased depreciation and amortization and consulting expenses related to investments we're making in back-office technology.
Moving to Slide 11. Diluted earnings per share increased 19.1% to $0.56 per share from $0.47 per share. This marked the strongest fourth quarter of EPS in the Company's history. Turning to Slide 12. You'll see our balance sheet remains strong. Cash, cash equivalents, and restricted cash totaled $9 million at December 31, 2023, and outstanding debt on our revolver at the end of the quarter was $38.3 million. Within the quarter, we paid down approximately $40.1 million on our line of credit, lowering our leverage ratio to 0.15 from 0.33 at the end of the third quarter and down from 0.46 at the end of 2022. We had a working capital balance of $282.2 million at December 31, 2023 versus $203.5 million at December 31, 2022. Capital expenditures in 2023 were $104.3 million, up 93.1% from a year ago.
As Matt addressed, we have several large capital projects that will increase production capacity, improve productivity, and support future growth. Several of the projects from 2023 will carry over into 2024. This will make for another heavy CapEx year. In 2024, we anticipate capital expenditures to be approximately $125 million. We consistently engage in a rigorous analysis of our capital projects. All the projects included in the budget will help our growth and generate very compelling returns. With that, I'd now like to turn the call back over to Gary.
Gary Fields: As I stated in my opening remarks, bookings in the fourth quarter improved sequentially for a second straight quarter and outpaced production in the fourth quarter. As a result, we realized a modest quarter-over-quarter increase in the backlog. Year-over-year, backlog was down modestly, but this was intentional to right-size lead times. For several months now, our lead times have been back to normal. Conversely, much of the industry still seems to be focused on bringing lead times down from elevated levels. Overall, the market environment seems to be resilient, despite what the headlines and some of the macroeconomic indicators have been signaling for some time now. Month-to-month, bookings have been steady, and sentiment amongst our sales channel remains positive.
Furthermore, the pipeline of large projects, particularly at our BASX and AAON Coil Products segments is robust. Certain verticals, such as data centers, manufacturing, and education remain strong, while some of our traditional markets, such as office buildings and retail, are soft. The non-residential construction market seems to be slowing as a whole, but it's definitely bifurcated. In addition to a slowing construction market, there's the uncertainty of how the market, especially the replacement market, will behave related to the refrigerant transition. So far, two months into this year, this doesn't seem to have had an impact yet. That said, we still anticipate, for at least a short period of time in the middle part of the year, that some customers may choose to delay replacing their units, waiting for new refrigerant equipment.
If this does happen, it will be a much bigger impact to the overall market than to us, as most of our equipment has been configurable with the new refrigerant since January 1 of this year. Given that, we are in an advantageous position if the market chooses to shift to new refrigerant equipment early in the year. There's also a possibility that much of that market overlooks the long-term maintenance cost of buying equipment with the old refrigerant, and we see a much more muted effect. Either way, we're prepared with respect to manufacturing capabilities and with respect to our supply chain of the new refrigerant components. All considered, we anticipate 2024 will be a slower growth year than we've experienced in the last couple of years. Not only do we have tougher comps that we are facing, but the economy and the non-residential construction sector is softer than a year ago.
Turning to the outlook. Please turn to Slide 14. For 2024, we anticipate pricing will be a mid-single-digit contributor to sales growth, and we look for volume growth to be in the low single digits. We'd expect gross margin will be up year-over-year, mainly due to the favorable comp in the first quarter. For SG&A, as a percentage of sales, we look for these expenses to be modestly up compared to 2023. As Rebecca stated, CapEx will be in the $125 million range. I would also like to remind you of the seasonality that we typically see in the first quarter. We expect both sales and earnings in the first quarter will be down when compared to the fourth quarter of 2023. Year-over-year, we expect both sales and earnings in the first quarter to be up modestly.
In closing, I want to finish by thanking all of our employees, sales channel partners, and customers. I also want to announce that we will be attending Sidoti & Company's Virtual Small-Cap Conference on March 13, Wolf Research's Small and Mid-Cap Conference in New York on June 4, and Wells Fargo's Industrials Conference in Chicago on June 12. I hope to see some of you at these events. Thank you, and I will now open up for Q&A.
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