AAON - Earnings Call - Q2 2025

Transcript

Speaker 3

Good morning, ladies and gentlemen, and welcome to the AAON Inc. Second Quarter 2025 Earnings Release Conference Call. At this time, note that all participant lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press *0 for the operator. Also note that the call is being recorded on Monday, August 11, 2025. I would like to turn the conference over to Joseph Mondillo, Director of Investor Relations. Please go ahead, sir.

Thank you. Good morning, everyone. The press release announcing our second quarter financial results was issued earlier this morning and can be found on our corporate website, AAON.com. The call today is accompanied by a presentation that you can also find on our website, as well as on the listen-only webcast. We begin with our customary forward-looking statement policy. During the call, any statement presented dealing with information that is not historical is considered forward-looking and made pursuant to the Safe Harbor provisions of the Securities Litigation Reform Act of 1995, the Securities Act of 1933, and the Securities 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 morning detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have a duty to update our forward-looking statements. Our press release and portions of today's call use non-GAAP financial measures as defined in Regulation G. You can find the related reconciliations to GAAP measures in our press release and presentation. Joining me on today's call is Matt Tobolski, CEO and President, and Rebecca Thompson, CFO and Treasurer. Matt will start off with some opening remarks. Rebecca will follow up with a walkthrough of the quarterly results, and Matt will then finish with our outlook for the rest of the year and some closing remarks. With that, I will turn the call over to Matt.

Speaker 2

Thanks, Joe, and good morning. Starting on slide three, our second quarter results that we reported this morning fall short of our expectations and do not reflect the high standard we set for ourselves as an organization. We remain committed to providing transparency to our investors. As previously shared during our Investor Day in June, we've experienced challenges related to our ERP implementation. In this update, we want to provide a comprehensive view of where things stand today, the key factors that contributed to the recent underperformance, and most importantly, how we are moving forward. We are committed to addressing this directly and taking the necessary steps to restore your trust. I want to assure you that our confidence in the strength of our strategy remains unwavering.

While we're navigating some near-term challenges, we firmly believe that the actions we're taking today will significantly strengthen the company for the long term. We don't want that bigger picture to be lost. Given the challenges we faced, we will start with providing some incremental detail on what went wrong. Please turn to slide four. I would like to start by giving some context to the recent events. Over the past two years, and especially following our acquisition of Basics at the end of 2021, it became increasingly clear that our existing business systems required a significant upgrade to support our growing scale and complexity. On April 1, we went live with our new ERP system at our first site in Longview. We always anticipated some slowdown in production, but we saw a more prolonged impact on AAON branded equipment and coils production.

The slowdown ultimately impacted our broader operations as Tulsa procures the majority of its coils from Longview. We had a contingency plan in place, but unfortunately, both of our primary external coil suppliers were simultaneously undergoing their own ERP upgrades. This unexpected overlap significantly constrained Tulsa's ability to source coils in a timely manner, compounding the challenges we faced. The end result was that at Tulsa, while production improved month to month from April to July, the ramp was slower than expected. At Longview, production of AAON branded equipment was significantly impacted early in the quarter as teams adapted to the new system. However, as production and supporting functions gained experience and familiarity, we saw a steady improvement throughout the remainder of the quarter. I turn to slide five.

This slide illustrates how recent production rates of AAON branded equipment have trended compared to normalized levels, which we benchmarked against the first nine months of 2024. This KPI measures the consolidated production of AAON branded equipment across both the AAON Oklahoma and AAON coil product segments and measures levels of efficiency. We've overlaid the total company gross margin on the same timeline, and as you'll see, there's a strong correlation between the production efficiency metric and the gross margin performance. The biggest takeaway here is that after bottoming out in April, the total production consistently improved month to month throughout the quarter. While it's not shown here, we continue to see improvement through July. Tulsa was 6% below that benchmark pace in July, and while Longview still has some ground to make up, improvements began to accelerate starting in the second half of June.

Looking ahead, we expect production levels at both our Tulsa and Longview facilities to continue to improve from July levels. As production stabilizes and scales, we also anticipate a corresponding improvement in gross margins. Said another way, when we hit our production metrics, we deliver our corresponding gross margin targets. Please turn to slide six. Here, you can see our total backlog of AAON branded equipment, which are manufactured across both our Tulsa and Longview facilities. Bookings in Q2 and year-to-date remain strong. This, combined with the improving production trends, supports my earlier point regarding our expectation of a strong recovery in the second half of the year. While we entered the third quarter with production levels below our initial expectations, we remain confident in a solid upward trajectory and anticipate strong growth in AAON branded production over the remainder of the year.

I'd also like to point out that our backlog is favorably priced relative to input cost. Almost all of our production in Q2 was associated with orders received prior to our January 1st 3% price increase and the 6% tariff surcharge that was put in place in March. Directionally, this will begin contributing positively to both sales and margin in the third quarter, with a more meaningful impact anticipated in the fourth quarter. Please turn to slide seven. I want to take a moment to give you some more color on our ERP upgrade, both in terms of what we are looking to achieve and how we see the rollout mapping from here. Given the size and the growing complexity of our organization, including the expanded manufacturing operations, it has become evident that continuing to scale at the growth rates we target will require more sophisticated integrated systems.

After years of planning, development, and preparation, we went live with a new ERP system at our Longview facility on April 1. Our ERP rollout strategy was very intentional. To limit disruption and manage risk, we intentionally adopted a phased rollout approach, implementing the system one location at a time and not moving on to the next site until the prior location was operating smoothly and meeting our performance expectations. We made the decision to begin the rollout at our Longview facility because it produces both AAON branded and Basics branded equipment, as well as manufacturer's coil, a critical component not only used at Longview but also at other sites in the production of finished products. This approach allowed us to fully vet the ERP solution across our entire product portfolio, helping to reduce risk and minimize disruptions during future site implementations.

Beyond product mix, when considering our organizational structure, where shared services support multiple functions across all sites, starting with Longview enables these teams to build proficiency with the new ERP solution before we proceed with additional site rollouts. This ensures that by the time we transition to Redmond, which produces only Basics branded equipment, or to our largest site, Tulsa, which primarily manufactures AAON branded products, our shared services teams will be fully up to speed and well-equipped to support a smoother and more efficient go-live at these locations. We've also gained valuable insights from the Longview go-live that will help us to ensure a smoother, more efficient transition for production teams at our other sites. We brought team members from our other sites to Longview to observe best practices firsthand, and we're conducting additional training at those locations to ensure they're well-prepared for their own transitions.

I want to remind everyone that while this transition is creating some near-term challenges, we remain confident that once fully implemented, the new system will deliver significant operational and economic benefits across the organization. We anticipate full implementation will be complete by year-end 2026. While it's too early to discuss the outlook for 2026, factoring in subsequent ERP rollouts, particularly in the quarterly go-live in Tulsa, we expect to achieve double-digit year-over-year growth in margin improvement for the year, trending towards our long-term target of 32% to 35%. Now, please turn to slide eight. While it's important to clearly understand the challenges we faced this quarter, we must also keep sight of the strong underlying fundamentals that continue to drive our business forward. With that in mind, here are some of the positives that we've achieved in the second quarter.

First, the Basics brand continued to demonstrate strength within the data center market in Q2. Basics branded data center sales were up 127% in Q2 and 269% year-to-date. Second, our liquid cooling solutions continued to gain traction in the rapidly evolving data center market, as evidenced by incremental orders we secured during the quarter. Year-to-date, liquid cooling equipment accounted for approximately 40% of total Basics branded data center sales, highlighting its increasing significance within our product portfolio. Third, during the quarter, Basics announced a strategic partnership with Applied Digital, under which it will supply thermal management solutions for their AI factory, including custom-designed free cooling chillers for their data centers. This partnership resulted in a significant order, further reinforcing Basics' leadership in advanced cooling solutions. Fourth, our national account strategy within the AAON brand is gaining meaningful traction.

National account orders grew year-over-year by 163% in Q2 and around 90% year-to-date, reflecting the effectiveness of our targeted approach, deeper customer engagement, and the strong value proposition of our equipment, which uniquely aligns with the needs of these customers. In the first half of the year, national accounts made up approximately 35% of total AAON branded orders, up from approximately 20% a year ago. Finally, the AAON branded Alpha Class heat pump business continues to disrupt the market with its high-performance offering. Alpha Class sales grew 8% in Q2, while bookings surged approximately 61% during the same period, highlighting strong momentum and growing market adoption. I will now turn it over to Rebecca, who will walk through the financials in more detail.

Speaker 3

Thank you, Matt. Please turn to slide nine. Net sales in the quarter declined year-over-year $2 million, or 0.6%, to $311.6 million. The modest overall decline was driven by a 20.9% decline in AAON branded sales, which was nearly fully offset by a 90% increase in Basics branded sales. The decline in AAON branded sales was driven by the impacts of lingering supply chain disruptions in early April and coil supply shortages at the end of the quarter due to our ERP implementation. The gross margin was 26.6%, down 950 basis points. The contraction of margin was largely due to lower production volume of AAON branded equipment sales at the AAON Oklahoma and AAON coil products segments. Our new Memphis facility incurred $3 million in costs during the quarter, with minimal sales to offset this cost to the AAON Oklahoma segment.

Non-GAAP adjusted EBITDA was 14.9%, down 1,120 basis points, and non-GAAP adjusted EPS was $0.22, down 64.5% from the previous year. Also noteworthy, we hosted a national sales meeting in April that incurred costs of approximately $1.6 million. While we did not flag this as a one-time event, the last national sales meeting we hosted was in 2021. We also have elevated depreciation amortization, as well as technology consulting fees, creating higher FG&A as a result of our ERP implementation. Please turn to slide ten. On this slide, we bridged the second quarter sales and gross margin performance to the same quarter last year, highlighting the primary drivers of the year-over-year change. We estimate the Longview ERP implementation and supply chain disruptions in early April impacted total sales by approximately $35 million, or 11.1%. Together, these two issues impacted gross profit by approximately $20 million.

Also worth noting, pricing had a minimal impact on overall sales and gross profit for the quarter. Through Q2, we have recognized only a small portion of the 3% price increase implemented on January 1 and almost none of the 6% tariff surcharge introduced in March. Please turn to slide eleven. Looking at the segment financials and starting with AAON Oklahoma, net sales in the segment declined 18%. This decline was driven by lingering supply chain disruptions related to the refrigerant transition at the beginning of the quarter, as well as coil supply shortages towards the end of the quarter due to our ERP implementation at the Longview, Texas, facility, which slowed production of coils for our Tulsa plant. Despite the year-over-year decline, production improved consistently month to month throughout the quarter, a trend that continued through July. Production efficiency in July was 6% below pre-Q4 2024 levels.

Lower production volumes were the primary factor in the gross margin, contracting 970 basis points. Also contributing to the segment's contraction of gross margin, the Memphis plant incurred a cost of $3 million. Along with improving production rates, AAON Oklahoma entered August with a strong backlog. Please turn to slide 12. AAON coil product sales grew $27.1 million, or 86.4%, primarily driven by growth in Basics branded products of $40.1 million for a large liquid cooling project. AAON branded products declined $13 million due to disruptions caused by the change in ERP systems. The ERP implementation significantly impacted both production volumes and efficiencies of AAON branded equipment, serving as the primary driver of the 1,990 basis point detraction in segment gross margin. Since April, production of AAON branded equipment at the Longview facility has improved significantly.

Using the average production rate over the first nine months of 2024 as a benchmark, production of AAON branded equipment in April was down approximately 50%. At the end of July, we were down 37%. For Basics branded production at this segment, the impact of the ERP implementation was considerably less, largely because of the uniformity of units within the orders. Thus, production performed relatively well, and the backlog remained strong. Please turn to slide 13. Sales at the Basics segment grew 20.4% due to the continued demand for the data center solutions. Gross margin contracted 60 basis points from a year ago, due primarily to higher indirect costs for warehouse personnel, partially offset by lower material costs. Gross margin increased sequentially for the second consecutive quarter, reflecting continued operational improvements since we initiated targeted efforts late last year. Please turn to slide 14.

Cash, cash equivalents, and restricted cash balances totaled $1.3 million on June 30, 2025, and debt at the end of the quarter was $317.3 million. Our leverage ratio was 1.4. Year-to-date cash flow used in operations was $31 million compared to cash flow provided by operations of $127.9 million in the comparable period a year ago. Year-to-date cash flow from operations largely reflects increased investments in working capital. Capital expenditures through the first half of the year, including expenditures related to software development, increased 18.7% to $89.6 million. We had net borrowings of debt of $162.1 million over this period, largely to finance the investments in working capital, capital expenditures, and $30 million in open market stock buybacks that we executed in the first quarter. Overall, our financial position remains strong.

This gives us the flexibility and allows us to continue to focus on investments that will drive growth and generate attractive returns. For 2025, we continue to anticipate capital expenditures will be $220 million. I will now turn the call over to Matt.

Speaker 2

Thank you, Rebecca. Up until now, we've intentionally placed extra emphasis on the quarter and the challenges we faced, particularly around the ERP rollout, because it's important that you fully understand what happened. That said, what matters most is where we go from here. Starting on slide 15, as shown here, our adjusted backlog remains strong, up 72% compared to a year ago. At this stage, the Basics brand is the primary growth engine of the company, fueled by exceptionally strong demand from the data center market and the unique custom-designed solutions that we provide our customers. We are now producing Basics branded products at all of our major facilities, including our newest site in Memphis, which we purchased just eight months ago. Aside from effectively managing the ERP rollout, bringing this facility fully online is our top operational priority.

By year-end, this facility will significantly expand the capacity of Basics branded manufacturing by nearly doubling its square footage. At that point, we'll be well-positioned operationally to fully capitalize on the robust demand for the data center market. While we've seen strong growth in Basics branded production thus far, our full potential remains constrained by current capacity limitations, a challenge we are actively working to overcome. The Longview facility, which is represented by our AAON coil product segment, is equally as important to our growth strategy with the Basics brand. At Longview, we are currently manufacturing a uniquely designed liquid cooling product for a hyperscaler. We've been steadily ramping production of this product throughout the first half of the year, positioning our manufacturing operations for a multi-year increase in volume.

Since being awarded the initial order late last year, we've received additional follow-on orders and are actively collaborating with this customer to develop new designs for their next-generation data centers. Overall, the outlook of our Basics brand remains very strong. We produce the most sophisticated, customized thermal management equipment in what is a rapidly evolving and technically demanding industry. Looking ahead to the second half of the year, we anticipate Basics branded sales will increase year-over-year approximately 40%. Our AAON brand is equally strong and critical to our long-term success. Despite prolonged softness in the non-residential construction market, our bookings have remained strong, particularly in the second quarter when they grew by double digits year-over-year. The recent strength in bookings highlights the value of our products and signals an opportunity to further leverage our pricing power.

At the end of the second quarter, the backlog of AAON branded equipment was up 93% from a year ago and up 22% from the end of March. Our top priority right now within the AAON brand is to put our customers first by continuing to ramp up production at both Tulsa and Longview facilities, ensuring that we deliver the highest quality products in a timely manner. The value we deliver our customers through our premium quality, high-performance equipment has never been more compelling, and we're seeing that reflected in strong demand, even in a soft market environment. You can particularly see this with our national account strategy, with year-to-date orders to these customers up significantly.

Given the progress we're making in production and the strength of our backlog, we expect AAON branded sales to increase significantly in the second half of the year, with quarter-over-quarter growth anticipated in both Q3 and Q4. Please turn to slide 16. Due to the greater than expected impact of the ERP implementation on our second quarter results and the resulting effect we now anticipate in the second half of the year, we are revising our full year 2025 outlook lower. We now anticipate full-year sales growth in the low teens at a gross margin of 28% to 29%. Adjusted SG&A as a percentage of sales is now expected to be between 16.5% and 17%, and we continue to expect CapEx to be approximately $220 million. Please turn to slide 17. On this slide, we've highlighted the key factors now incorporated into our full-year outlook.

When compared to the similar slide Rebecca Thompson walked through for the second quarter, you'll notice it reflects an expectation of accelerated volume growth in the second half of the year. This is not as strong as we were previously expecting due to lower production rates entering the third quarter, but it's still strong sequential growth. You'll also notice favorable price-cost dynamics are expected to accelerate meaningfully in the second half. At the same time, it also factors in additional ERP-related headwinds that we previously were not anticipating. Please turn to slide 18. Here, we illustrate and quantify what the full-year outlook implies for the second half of the year. Despite the temporary challenges we are facing, we still expect a significant jump from the first half to the second half.

Furthermore, if we take a step back, you can see the trajectory is positive looking back to the beginning of 2024. We are addressing the challenges we face head-on and are firmly on the path to recovery. Lastly, I want to direct your attention to the table in the bottom right corner. The year-over-year growth that we now anticipate for Q3 and Q4 implies sequential growth throughout the rest of the year. Through year-end, we expect production rates to improve and the adverse impacts of the new ERP system implementation to lessen. Before I hand it off for Q&A, it's important to note that the core fundamentals of this company have never been stronger. Once we move past these temporary obstacles, we'll be in an even stronger position to deliver long-term value for our customers and our shareholders.

I know these results are disappointing, and believe me, I share in that disappointment. In the broader context, this remains an incredibly exciting time for our company. The future is bright, and we are well-positioned to emerge from this period even stronger. With that, I will now open a call up for Q&A.

Speaker 3

Thank you, sir. Ladies and gentlemen, if you do have any questions at this time, please press star followed by one on your touchtone phone. You will then hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by two. If you're using a speaker phone, we ask that you please lift the handsets first before pressing any keys. Please go ahead and press star one now if you have any questions. Your first question will be from Timothy Walsh at Baird. Please go ahead, Timothy.

Good morning. Thank you. Thanks for all the details. Maybe just to start, on the guidance in the second half, kind of coming down more than you think, could you maybe bridge us a little bit versus the prior guidance that you have versus what you have now and how much of that is the ERP implementation and how much of that is just lower volumes and the under-absorption associated with that?

Speaker 2

Good morning, Tim, and thanks for the question. As we look at the kind of revision to the back half of the year on the guidance side, primarily the drivers there are going to be around the ACP performance and the sort of ERP impacts that come with that. With that, we ended July with a 37% performance against our efficiency metric. Just to quantify, that was at a production level, total production level that was down about 20%. We finished off July being 20% of where we want to be from a top-line revenue perspective on AAON branded products inside of the Longview segment. We're seeing that accelerate and improve, but just kind of meaningfully considering that impact on the back half of the year.

When we switch over to a lesser extent on the Tulsa side, while Tulsa is certainly performing substantially better than the ACP segment, we did start the quarter at a lower performance point just with that coil impact that we had. That is reflecting to a lesser extent also the lower starting point that we're ramping off of within the Tulsa segment.

Okay. Okay. When you look at kind of what's implied, I think it's probably something in the low 30% for gross margins in Oklahoma in the back half of the year. Yet you're probably going to get close to the revenue numbers that you had in the first half of 2024. What is the difference, you know, outside a few million dollars and things like Memphis kind of ramping between that kind of maybe low 30% number and something that was closer to 36% or 37%?

Yeah, great question. We think about the Tulsa side of the business and just want to start off that nothing has drastically changed on the overall performance of that segment. There are some incremental costs that we've invested within the organization with enhancements to our end-of-line test procedures, some investments in additional laboratory work, and really driving some of our innovation. When we look at that, we're talking about tens of basis points, not hundreds of basis points. When we really think about what are the primary drivers in the overall margin on the Tulsa segment, Memphis and the startup cost certainly is going to be one of those big cost drivers that's going to add on top of those incremental costs. On top of that, we have been producing Basics products within the Tulsa segment.

That production that we're temporarily doing there just to basically provide more capacity for the Basics brand, that capacity, that manufacturing is temporarily putting some strains on the overall efficiency metrics within the segment. That really is what's putting the pressure points on there. When we look at it from an overall Tulsa perspective, we truly believe that gets back into that long-term target and that 32% to 35% on an annualized basis within that margin profile.

Okay. I guess the last question I have, just data center backlog, I know it's been pretty good the last couple of quarters, but it was flat sequentially. Anything you would kind of highlight or call out there? I know that that business can kind of be lumpy, but just if you could spend a minute just on the health of the data center business and how you're positioned there, I think that'd be helpful. Thanks.

Yeah. From a data center perspective, I just want to start off by saying it remains incredibly strong. The activity, the engagement we have within the market remains incredibly strong. Just to put it in perspective, the overall top-line sales were up year-over-year, 127% in the quarter. When we look at that flat backlog, obviously suggesting good strength in that quarter, which means good activity on the overall booking side. That activity and that engagement has been at least, if not stronger, in both July and August. When we step back and think about the data center market, a key aspect there is we've got to have capacity to sell. We have just begun selling into that Memphis investment that we have as a kind of a production capacity perspective. We're going to start seeing the ability to sell that capacity meaningfully impact the backlog going forward.

When we look at kind of where we stand right now, while we're ramping up production in Memphis, we also have to be realistic when we book orders to make sure that we are providing delivery within customers' expectations. We're going to see that Memphis facility really provide a meaningful capacity increase at the later half or later portion of this year and continuing to accelerate within 2026. You'll start seeing orders that are basically filling that facility start to come to fruition. Just to maybe also give you a little bit of context, we look at the ACP performance, we look at the segment sales and really the bookings perspective on that liquid cooling order.

I mentioned in the prepared commentary, but just want to reiterate here that we continue to have active engagement with that customer, not just in the current orders and follow-on orders, but also working with them actively to develop the next generation liquid cooling solutions for their data centers. We've kind of brought this up multiple times in the past, but it's a dynamically evolving market with new technology. The customization, the unique value proposition that the Basics brand provides to that data center market really resonates in that rapidly evolving and dynamically moving market. We're going to continue seeing good strength in bookings kind of coming off of all the engagement we're having within that market today.

Okay. Okay. Sounds good. Appreciate the time. I'll hop back in queue. Thanks.

Thanks.

Speaker 3

Next question will be from Aaron Hillman at D.A. Davidson. Please go ahead.

Yeah, thanks. Good morning. Hey, Matt. Maybe just picking up off that last question on just the Basics brand visibility in data center. Could you just talk about the significance of the Applied Digital partnership for the future of Basics and orders, you know, how that fits in?

Speaker 2

Yeah, good morning, Brent. Great question. Applied Digital, you know, it is pretty much a pure-play AI data center developer. Really, as a data center developer, they're actively engaged in developing sort of really high-performance next-generation AI infrastructure. That really resonates with the Basics brand and being able to really create solutions that optimize performance within that segment. When we look at that and we think about an AI data center as a whole and you think about kind of where we play inside that data center, we've got the, let's say, the thermal management systems that are going to be outside, which in this case are chillers. We've got the airside solutions that are going to be inside, so basically, chilled water fan coil walls or craw units, and then CDUs. With that customer, we're engaged in conversations in all three of those aspects.

We already have orders for two of the three of those pieces, including high-performance chillers that are really important as we think about how we're going to manage high-efficiency heat rejection inside of these AI data centers. Our team collaborated very actively with that customer to develop a solution that is optimum for AI workloads. When we look at their deployment plans, we're obviously talking about their facility that they're currently building in North Dakota, but they're continuing to expand across the region. From our perspective, we're actively engaged in all of those pursuits and all those collaborations. This really is, first, I'll say, first phase of or first step in a long relationship with that customer managing their thermal loads as they deploy AI capacity across the country.

Okay. All right. Appreciate that, Matt. Maybe just as a follow-up, you know, look, you look over the course of the rest of this year, you've certainly embedded some challenges here into the outlook. Just trying to get a sense, especially as we look into the fourth quarter, Matt. I mean, still implying, you know, reasonably strong growth here on the top line, you know, high 20s. Maybe if you could just talk a little more about what you are, you've used this comment sort of push in terms of the outlook. What are you embedding as we get into the fourth quarter? We're talking about fairly significant growth, you know, towards the end of the year here.

Yeah, we certainly, as we look at the guidance that's implied for Q4 and really as a whole, we're showing acceleration quarter over quarter from Q3 to Q4. When we look at the implied growth that we kind of talked about in the prepared commentary, we're talking about year-over-year growth in the high 20%, kind of implied in that from a top-line perspective, and getting back into a margin profile in the 30%, the low 30%. Certainly building upon and kind of working your way out of the challenges that we've had operationally as we've gone live with this ERP system. When we think about kind of what's built into that, I want to first start off with we have a lot of visibility in the backlog. The back half of this year, we have a lot of visibility both in the AAON brand and the Basics brand.

Implied in there is certainly strong continued performance, or I should say continued performance within the ACP segment on the Basics brand. Recovery quarter over quarter in the AAON brand at the ACP segment. We're building up within Tulsa, and we're going to be ramping in Tulsa substantially quarter over quarter with that backlog. We've got a lot of visibility in the AAON segment and the Tulsa segment, or sorry, the Tulsa segment with the AAON branded products that we're going to see accelerating throughout the year. All of that is sitting there with positive price dynamics in it. As we mentioned in the prepared commentary, Q2 barely touched on the 3% price increase and almost none of the 6% tariff surcharge. All of that starts to come into play in Q3 and Q4, which is helping provide some strength, obviously, in top line as well as gross margin expansion.

Beyond that, the Basics segment, we're expecting to see kind of stability on sort of what it performed at in Q2, but increasing efficiency. Keep driving for margin improvement in the Basics segment. Throw on top of that, we're going to start seeing Memphis come online. That's what's baked into it. Obviously, from a, you know, where the caution lies or what the, as you kind of call the cushion, I mean, obviously, we're still factoring in the ERP impacts within the Longview segment as we're recovering. We're baking in, obviously, the recovery off of the impacts that we had. Really also taking in the fact that Q3 for the Tulsa segment, we started off at a lower point than we wanted to.

Again, we're going to see that strong production ramp throughout the back half of the year, helping to really top up that or the guidance that we provided for the back half of the year.

Okay. Appreciate that, Matt. Maybe just one more. I mean, fairly strong bookings here on the AAON branded product. Maybe just your read on that. It's a direct result of the share capture strategy you've obviously discussed for several quarters now. Are there other elements to that that we have to think about in terms of driving those bookings? Just be curious to read on the booking strength in that product line.

Yeah. As we think about the AAON brand, and especially within Tulsa, the rooftop segment, I want to start off by saying, obviously, the market remains in a challenged position. The overall non-res market, you know, probably sitting near the bottom of kind of the cycle, but certainly, it's been a tough market within that side. When you look at our bookings relative to that market dynamic, it certainly is showcasing an over or an outperform relative to the kind of macro environment there. We talk about a lot of the things that we're focusing on that are helping that from a share capture standpoint, but really, the biggest driver that we've talked a lot about with the intentional investments we made comes down to our national account strategy.

We've invested heavily within internal resources to support that strategic initiative and really help bolster that from a growth driver for the organization. When you marry up that national account strategy with, you know, best-in-class heat pump technology in the Alpha Class, we're really seeing just unique opportunities for us to be able to capture opportunity and share within the marketplace. As we look at that and we think about the overall performance, when we see that kind of share dynamic, obviously, in the backlog growth, it also does, you know, have us review and really kind of look at the opportunity to leverage price within that environment as well. As we think about the opportunity going forward, we're showing that the value proposition, the pricing of our product, and really the positioning in the marketplace is really resonating and providing opportunity to continue reviewing pricing strategy going forward.

Okay. Great. Thank you. I'll pass it on.

Speaker 3

Next question will be from Ryan Merkel at William Blair. Please go ahead, Ryan.

Hey, all. Thanks for the questions. I guess that first off, Matt, what's your confidence level that the new guide captures the downside risk from the ERP? In the press release, you mentioned taking immediate actions to shore things up. Talk about that a little bit.

Speaker 2

Yeah. Certainly from what's provided in that back-half guidance, we've spent a lot of time ensuring that we adequately cover the risk factors that we see and make sure that we're providing a target that is achievable and obviously has some upside potential to it. When we look at the effort we've put in, kind of where we stand from a trajectory standpoint, a visibility standpoint, and kind of where we're at from a performance and recovery standpoint, all of that's baked in adequately inside that guide to be able to provide upside against it. We certainly see that the impacts that we saw in terms of production rates within the ACP segment and then also the impacts that kind of spilled over into Tulsa certainly were not what we wanted to see.

From a recovery standpoint, both segments we look at from a metric standpoint are showing strong recovery that we talked about on the call, with Tulsa being in July 6% below its target efficiency rate at the end of the month. We certainly are seeing all the signs in the recovery that we expected to see, albeit the impact not as, or the impact lower than we wanted to see in the first place, but certainly the recovery and the path of recovery is very visible for us. When we look at the immediate actions we took and really kind of relating to some of the supply chain spillover, it was certainly an unfortunate chain of events as the ERP system began to impact our coil production within our Longview segment, thus impacting Tulsa.

As soon as the supply chain constraints were observed from our third-party vendors, our supply chain team was very proactive in getting boots on the ground, getting resources in place to tactically manage what was happening at those sites, and really getting the visibility to respond and mitigate the impacts to the overall operation. That activity is certainly part of the driver where we see the Tulsa segment sitting in a much stronger position coming out of July. The ability to react to challenges is certainly one of the strengths of AAON. As these things have come up, our team has jumped on every single issue that's come up, got the resources in place, seek to understand what the drivers were, and make sure that we create strategies to prevent them from happening again.

I just want to kind of stress when we look at the ERP as a whole, certainly the impacts in Longview were larger than we wanted to see as an organization. The decision to go live in Longview really was very intentional to stress test the ERP as a whole.

It was done to look at a site that manufactures both brands of products that manufacture coils so that we can truly test the system in all of the ways that we operate this business to, you know, stress test, to break as much as possible any of the things that we could possibly break so that when we go live in future locations, those same issues aren't going to come up because we've already been able to see them, resolve them, and build the system or adapt the system to make sure that the organization can perform as expected in the future go-lives. Just to stress, you know, as much as the performance at the go-live wasn't what we wanted, the lessons learned and the operational strategies provide us a lot of confidence and sort of the ability to perform going forward.

Perfect. That's helpful. I want to put the 4Q guide into a little context with revenue up high 20s. I don't think ERP issues will be totally back to normal at that point. Just a little context on what's assumed there. What does it assume about growth for Oklahoma?

Yeah. So I mean, Oklahoma, maybe just kind of looking at it from across the board, I mean, Oklahoma, you're going to see quarter-over-quarter strength on top-line bookings as we kind of keep accelerating production capacity within that facility against that backlog. I always like to point out and stress that ramping up production, it certainly is a calculated approach. We can't just go from 0 to 60 from a production perspective in Tulsa. We'll see quarter-over-quarter strengthening of the overall production rates in Tulsa, and that's baked into the guidance from an overall recovery perspective. In the coil product segment, the ERP is, the guide assumes there's some lingering effect into Q4 within the ACP segment. While it's improving, we certainly have some consideration in there just as it continues to recover off of that performance. That is baked into the guide from a Q4 perspective.

From a Basics perspective, it's operating kind of near its capacity within the Redmond location. Basics as a whole, you're not going to see a lot of acceleration of growth off of the Basics segment as we report, but you will see acceleration in the Basics brand as we begin bringing on capacity within Memphis. Memphis is considered to start coming online in that Q4 guide as well in a more meaningful fashion.

Got it. All right. Last one for me. You're going to exit 4Q with a gross margin, you know, 30%, 31%. You quantified the ERP, you know, impact this year of $55 million. We have to set a model for 2026. I know you don't want to talk about that, but in the script, you mentioned double-digit top line and margin improvement. Can you give us some sort of sense of how much margin lift we could see in 2026? I know it's a bit early, but it would be helpful, any color.

Yeah. Certainly, you know, we're not getting into too much detail on 2026 yet, but when we look at the overall performance from a 2025 to 2026 perspective, you know, we do see the top line growth that we guided or we provided that insight to in the overall prepared commentary. You know, our Q4 implied margin sitting at the 30% to 31%. What we're basically implying in 2026 is, you know, nearing that long-term target of 32% to 35%. That is factoring in, you know, while we've gone through, I'll say, the hardest implementation in the Longview facility in terms of its, you know, first site and really stress testing the system, 2026 obviously will still have the additional go-lives within the Basics and the Tulsa segment.

There is consideration kind of in that margin profile approaching 32% to 35% from a long-term guide perspective and some stress from the kind of future rollouts.

All right, thanks for the call. I'll pass it on.

Speaker 3

Thank you. Next question will be from Chris Moore at CKS. Please go ahead, Chris.

Hey, good morning, guys. Yeah, it looks like booking's pretty good on AAON. Maybe you could just talk overall about the prolonged softness in rooftop. I mean, what are you thinking about the market overall in the next 16 to 18 months? Is it, you know, interest rates? Is it, you know, just any thoughts you might have in the overall market?

Speaker 2

Yeah, so from a kind of overall macro perspective, if we look at everyone else that's released for Q2 results, everyone is signaling obviously volumes are down kind of in the non-res market, which we would agree with. If we look at this from an overall macro perspective, there is certainly softness probably in the 10% volumes, down 10% volume as an overall industry perspective in the non-res market. To put that in context, though, when we look at the bookings trend, we certainly look like we're at the bottom of the trough. We don't see it as a continued kind of deceleration and decline. We see ourselves certainly nearing the bottom if not at the bottom as an industry within that segment. That's kind of what we're seeing. We see certainly the interest rates obviously are a driver.

Also, I mean, interest rates at the end of the day, if they're stable, eventually we get used to how to operate inside those interest rate environments. It's really the getting to a stable perspective that is, I'd say, the big driver. Getting past some of the volatility, whether it be tariffs, whether it be interest rates, once we get to a normal operating cadence as an industry, the industry fundamentally figures out how to operate inside that new cost structure. A lot of the deceleration that we've seen, a lot of the conversations that we've seen really have centered around just the uncertainty kind of in that near-term perspective. As we look 12, 16, 18 months out, getting to a more stable operating condition, we expect to see the market as a whole, beyond the upswing coming out of that.

I would just point out, though, that as much as we talk about the softness in the macro market, to your comment, the bookings you see within AAON certainly showcase a different performance level against that overall dynamic. Again, that is really a lot of the strategy that we've had, whether it be the Alpha Class product with bookings up above 60% in a quarter or national accounts that are showing tremendous strength in bookings. Those really are the opportunities for AAON when we think about the non-res market to continue outperforming that market and acquire market share.

Got it. Very, very helpful. Maybe just going back to investor day, you talked about, in a more normalized situation, gross margins 29% to 32% for Basics, a little bit below rooftop. Just trying to understand it. Is there something fundamentally different in the rooftop market that allows a higher margin, or is it just a function of the rapid growth in Basics, fully leveraging the facilities? Is there a point where you ever see them at parity or Basics will likely be lower, kind of long-term?

No, that's a great question, Chris. Really, when we think about the margins, there's nothing that says we can't get to parity on the overall margin profile. The reason the commentary came, and really we give that commentary regarding Basics at investor day and today as well, is just as we think about its growth rate, there's inherent pressures that are created in investing ahead of that capacity. When we think about these strong year-over-year growth rates, we're having to put the engineering resources, the overhead resources, a lot of the manufacturing staff ahead of the overall revenue to be able to support that revenue going forward. That creates some strains. Growing 40% year over year over year creates some strains just in operational dynamics.

Certainly, we look at as those growth rates, I don't want to say temper, but as we get this capacity online, we're able to start leveraging some of that. There's nothing to say we can't get our margins on parity with the overall rooftop segment. This hyper-growth stage certainly has some pressures there.

Helpful. All right, we'll leave it there. Thanks, guys.

Speaker 3

Thank you. A reminder, ladies and gentlemen, to please press star one if you have any questions. Next question will be from Julio Romero at Sadotti & Company. Please go ahead.

Good morning. This is Alex on for Julio. Thanks for taking questions.

Good morning.

First question. Good morning. First question was just circling back to backlog. I know it's up significantly year over year. Could you comment a little bit on the margin profile and pricing embedded in the backlog? I'm asking if these orders are sort of protected with price increases and tariff surcharges, or there's still some risk of margin compression on fulfillment.

Speaker 2

Yeah, I'll bifurcate that conversation between the two brands because there's definitely some different dynamics that exist between the two different brands. As we look at the AAON segment or AAON brand as the first starting point, that backlog certainly is favorably priced relative to the Q2 results. Really getting down to that comment that was made in commentary that we just started to see that 3% January 1 price increase start hitting the overall revenue profile in Q2. When we look at that backlog from an AAON perspective, we've got a 3% price plus a 6% tariff surcharge that we're going to see meaningfully impact the overall results in the back half of the year. We see that being accretive to the margin.

When we look at the overall price-cost dynamic, that price, as we see it today with all the visibility we have on supply chain, there certainly is some additional kind of margin opportunity that exists inside that backlog. On the AAON brand, that's kind of the visibility we have in that, we're buying, essentially our supply chain team is actively buying the overall input cost or input products to be able to manufacture that. A lot of visibility into what that dynamic looks like. On the Basics side of the business, certainly from a margin profile, there are escalation clauses that exist in the vast majority of the backlog that is extended. There's opportunity if dynamics were to change drastically to be able to address that with our customer base.

We also have a lot of visibility into what the input costs are and really are securing longer-term supply contracts to support that. We see that basically being more margin neutral on what is built into that overall pricing in the backlog for the Basics side.

Great, thank you for the context. One more from us, just changing gears a little bit. Curious if you're seeing any positive sentiment from customers as a result of the One Big Beautiful Bill Act. Maybe any implications for stronger demand as a result of bonus depreciation or other aspects of the bill.

Yeah, I would say, I mean, certainly from an investment perspective and especially investment in the U.S. from a manufacturing, from a warehousing, from an overall capital investment standpoint, there is certainly some benefit that is improving sentiment. I wouldn't say, you know, a light switch flips kind of when that's a bit villain in the place, but certainly provided some positive trajectory, which really, as I mentioned before, when we're sitting kind of on, I'll say, the bottom of what we see as the bottom of the cycle, you know, any positive moving sentiment, say, overall positive going forward.

Thank you very much.

Speaker 3

Thank you. Next question will be from John Batts at Kansas Capital. Please go ahead, John.

Morning, everyone.

Good morning.

Matt, I know you don't want to talk too much about 2026, but can you give us a little sense on how the P&L for Memphis might look in 2026 versus 2025, sort of the delta between years?

Speaker 2

Just to clarify, you mean specifically kind of the cost drag versus the positive kind of contribution?

Yes, yes.

Obviously, when we acquired the Memphis facility and really since we started building out the overall facility, a lot of that investment, whether it be in people and staff or capital investments, they're certainly all coming ahead of the overall revenue. While we are generating some revenue in Memphis in 2025, it's not offsetting kind of the overall cost structure of basically standing up that facility. As we look into 2026 and as we think about orders like Applied Digital that we're going to be manufacturing primarily in the Memphis facility, we're going to start generating substantially more revenue to be able to offset those costs. The way we look at Memphis in 2025 to 2026 is really going from a cost drag to an overall kind of drag on the overall financials to a positive contributor in the financials.

Really, when we think about what's happening in 2026, the growth of the Basics brand, that growth is going to come through Memphis in 2026. The demand we have for data centers, the relationships as we continue to develop these integrated solutions, all that's going to be what's driving the 2026 growth in Memphis and really allow it to become a positive contributor to the overall financial statement.

All right. Thank you. Maybe a question for Joe. In your presentation, you mentioned management will provide regular updates on implementation progress. What does that mean?

I would just say that as we hit certain milestones that are significant to informing you all, we will take that approach. There's nothing in the sand today as far as exactly what and when we will be providing that information, but as we hit certain milestones, we will provide those updates.

If you reach those milestones, you might say something between conference calls? Is that how you should understand it?

Potentially, or a conference, or, like I said, there's no set game plan to that, but we will provide regular updates when we hit certain milestones. We're trying to be as transparent as possible in an environment that is certainly impacting the financials like you've seen.

Okay. One last question. Rebecca, there was a significant investment in working capital in the quarter, in the first half. How do you see that playing out in the second half as operations get a little bit stronger?

Speaker 0

We still have some working capital needs to support the Basics brand. Like Matt talked about, this upcoming job with Applied Digital, to the extent we have to make those investments prior to all of the production coming online. Plus, you do have our Memphis facility that we do need to stock up, make the investments to supply with inventory at that location. That's primarily been what most of those investments have been. I anticipate maybe through, I don't know, mid-Q3, back half of the year, they should start to ease.

Okay. All right. Thank you, Rebecca.

Speaker 3

Thank you. At this time, Mr. Mondillo, we have no other questions registered. Please proceed.

Okay. Thanks, everyone, for joining the call today. If anyone has any questions over the coming days and weeks, please feel free to reach out to us. Have a great rest of the day, and we look forward to speaking with you in the future. Thanks.

Thank you, sir. Ladies and gentlemen, this does indeed conclude the conference call for today. Once again, thank you for attending. At this time, we ask that you please disconnect your lines.