10-Q: AAON Q2 Profit Plunges Amid ERP & Supply Chain Woes

AAON, Inc. reports a sharp decline in Q2 net income and gross profit margins, despite strong growth in its BASX data center cooling segment, as ERP system implementation and supply chain issues impact core HVAC operations.

Summary

• Net sales for the three months ended June 30, 2025, were $311.6 million, a slight decrease of 0.6% from $313.6 million in the prior year.
• For the six months ended June 30, 2025, net sales increased by 10.1% to $633.6 million, up from $575.7 million in the same period last year.
• Gross profit for Q2 2025 decreased by 26.8% to $82.7 million, with gross profit margin falling to 26.6% from 36.1% in Q2 2024.
• Net income for Q2 2025 plummeted by 70.3% to $15.5 million, compared to $52.2 million in Q2 2024.
• Diluted earnings per share (EPS) for Q2 2025 was $0.19, down from $0.62 in Q2 2024.
• The BASX segment experienced strong growth, with net sales up 20.4% in Q2 2025 and 59.4% in H1 2025, driven by data center liquid cooling solutions.
• AAON brand sales declined by 18.0% in Q2 2025 and 20.4% in H1 2025 due to a softer rooftop market, higher interest rates, and supply chain constraints related to refrigerant changes.
• The new Enterprise Resource Planning (ERP) system implementation at the Longview, Texas facility caused disruptions, impacting production and gross profit margins, particularly for AAON Coil Products.
• Consolidated backlog reached $995.3 million at June 30, 2025, a 53.1% increase from $650.0 million at June 30, 2024.
• Operating cash flow for the six months ended June 30, 2025, was a negative $31.0 million, a significant decline from a positive $127.9 million in the prior year period.
• Capital expenditures increased by 18.7% to $89.6 million in H1 2025, up from $75.4 million in H1 2024.
• The company increased its revolving credit facility capacity from $230.0 million to $500.0 million, with $317.3 million outstanding at June 30, 2025.
• Cash dividends declared increased to $0.10 per share for Q2 2025, up from $0.08 per share in Q2 2024.
• The 'One Big Beautiful Bill Act' (OBBBA), effective July 4, 2025, is expected to accelerate tax deductions for capital expenditures and allow immediate deduction of R&D expenses, potentially increasing tax receivables by approximately $14.7 million.

Sentiment

Score: 3

Explanation: While the BASX segment shows strong growth and backlog is robust, the significant decline in overall profitability, EPS, and operating cash flow, coupled with operational disruptions from the ERP system and supply chain issues, indicates a challenging period. Increased debt to fund operations and CapEx also weighs on sentiment.

Positives

• The BASX segment demonstrated strong demand and growth, with net sales increasing by $11.5 million (20.4%) in Q2 2025 and $50.0 million (59.4%) in H1 2025, primarily driven by data center liquid cooling solutions.
• Consolidated backlog significantly increased by 53.1% to $995.3 million at June 30, 2025, indicating strong future demand, with BASX products backlog up 27.0%.
• The company increased its cash dividends declared to $0.10 per common share for Q2 2025, up from $0.08 in Q2 2024, reflecting confidence in future cash generation.
• The company maintains a favorable liquidity position, enabling strategic purchases of materials to mitigate supply chain disruptions.
• Compliance with all financial covenants, with a leverage ratio of 1.4 to 1.0, well below the required maximum of 3 to 1.
• New Markets Tax Credit programs continue to provide low-interest financing for manufacturing expansions in Longview, Texas.
• The recently signed 'One Big Beautiful Bill Act' (OBBBA) is expected to provide tax benefits by reinstating 100% bonus depreciation and repealing mandatory capitalization of domestic R&D expenses, accelerating tax deductions.

Negatives

• Net income for the three months ended June 30, 2025, decreased significantly by 70.3% to $15.5 million, from $52.2 million in the prior year period.
• Gross profit margin declined substantially to 26.6% in Q2 2025 from 36.1% in Q2 2024, and to 26.7% in H1 2025 from 35.7% in H1 2024.
• Earnings per share (EPS) saw a sharp decline, with diluted EPS at $0.19 in Q2 2025 compared to $0.62 in Q2 2024, and $0.54 in H1 2025 compared to $1.09 in H1 2024.
• The AAON brand experienced an 18.0% decrease in net sales in Q2 2025 and a 20.4% decrease in H1 2025, attributed to a softer rooftop market, higher interest rates, and supply chain constraints.
• The implementation of a new ERP system caused disruptions, particularly impacting the AAON Coil Products segment with decreased net sales and gross profit margins.
• Operating activities resulted in a net cash outflow of $31.0 million for the six months ended June 30, 2025, a significant reversal from a $127.9 million inflow in the prior year.
• Interest expense, net, increased substantially to $6.8 million in H1 2025 from $0.6 million in H1 2024, reflecting higher debt levels.
• Selling, general and administrative (SG&A) expenses increased by $13.3 million in Q2 2025 and $19.3 million in H1 2025, partly due to Memphis plant incentive fees and technology consulting fees.
• The company continues to face challenges in a tight labor market, especially for skilled and unskilled production labor.

Risks

• Market conditions and customer demand for products are subject to fluctuations, particularly in the cyclical new construction and replacement markets.
• The timing and extent of changes in raw material and component prices, such as copper, galvanized steel, stainless steel, and aluminum, can impact costs and profitability.
• Changes in U.S. or foreign trade policies, including additional tariffs or global trade conflicts, could increase material costs and impact supply availability.
• Inflationary cost pressures could adversely affect product demand and overall business profitability.
• Ongoing supply chain challenges related to specific manufacturing parts could be exacerbated by trade conflicts.
• A tight labor market and the ability to hire and retain skilled and unskilled production labor pose a challenge to increasing production capacity.
• The successful implementation and adoption of the new ERP system are critical, as disruptions have already impacted production and financial results.
• The company is exposed to interest rate risk, with a one percentage point increase in interest rates potentially decreasing annual income before taxes by approximately $3.2 million.
• Noncompliance with regulations and contractual provisions related to New Markets Tax Credit arrangements could result in the recapture of tax benefits and indemnification obligations.
• The company is involved in various claims and lawsuits incidental to its business, which could have an adverse effect on financial position, results of operations, or cash flows if not resolved favorably.

Future Outlook

The company expects to continue passing along increased costs from tariffs to customers, though this could adversely affect demand. Future increases in material, parts, components, or labor costs, along with supply chain disruptions, are anticipated to negatively impact financial performance. The 'One Big Beautiful Bill Act' (OBBBA), effective July 4, 2025, is expected to accelerate tax deductions for capital expenditures in the second half of 2025 and allow immediate deduction of 2025 R&D expenses, which will increase tax receivables and decrease deferred tax assets. The capital expenditure program for 2025 is estimated at approximately $220.0 million. Management believes current cash, projected cash flows, the revolving credit facility, and access to capital markets will meet working capital, capital expenditure, and liquidity needs for 2025 and the foreseeable future. Performance obligations for uncompleted contracts are typically expected to be satisfied within one year or less.

Management Comments

• "We continue to see strong demand and growth of the BASX brand with increases in net sales of $51.7 million and $156.3 million for the three and six months ended June 30, 2025, respectively. This growth is primarily driven by data center demand for our liquid cooling solutions."
• "The AAON brand has experienced challenges with a softer rooftop market due to macroeconomic factors like higher interest rates and slowing construction starts. Additionally, the refrigerant change that went into effect on January 1, 2025 created supply chain constraints for components with the new refrigerant that challenged the first quarter and lingered into the second quarter."
• "The Company went live with its new Enterprise Resource Planning (ERP) system on April 1, 2025 at its Longview, Texas facility. The adoption of this new system has caused some disruptions due to changes in processes."
• "We continue to invest in the future growth of the Company as evidenced by our $89.6 million in capital expenditures in 2025, an increase of $14.1 million or 18.7% when compared to 2024."
• "We value the independent sales channel as we think it is a more effective way of increasing market share."
• "Despite efforts to mitigate the potential business impacts of trade conflict, supply chain challenges, and a tight labor market, future increases in the cost of materials, parts, components, or labor, in addition to supply chain disruptions, while temporary, could negatively impact our consolidated financial position, results of operations, and cash flows."

Industry Context

The company operates in the commercial and industrial HVAC market, which is influenced by cyclical factors such as interest rates, inflation, and construction activity. The data center market is experiencing rapid growth, driving demand for specialized cooling solutions, which benefits the BASX segment. The broader HVAC industry is also undergoing a transition due to new refrigerant regulations, creating supply chain challenges. The company's reliance on an independent manufacturer representative network for its AAON products differentiates its go-to-market strategy from many larger competitors who control their sales channels, aiming to leverage entrepreneurial talent and a solutions-based mindset.

Legal Proceedings

• The company is involved from time to time in claims and lawsuits incidental to its business, including alleged violations of contract, product liability, warranty, environmental, regulatory, personal injury, intellectual property, employment, and tax laws.
• Management does not believe these matters will have a material adverse effect on the company's financial position, results of operations, or cash flows.

Related Party Transactions

• Sales of units to an entity operated by a board member's immediate family, which also acts as one of the company's Representatives, leading to payments for third-party products.
• Purchases of supplies from entities controlled by two board members and a member of the company's executive management team.
• Periodic part sales and payments to a board member related to a consulting agreement, which expired in May 2024.
• Periodic rental of space partially owned by a board member for various company meetings.
• Leasing flight time of an aircraft partially owned by the President and CEO and another member of senior leadership.

Stakeholder Impact

• Shareholders: Experienced lower net income and EPS, but received increased cash dividends and benefited from ongoing stock repurchase programs. Potential for future tax benefits from the OBBBA.
• Employees: Received annual merit raises (3.3% in March 2024, 4.0% in March 2025) and participate in profit sharing, 401(k) matching, and self-insured medical plans. Face challenges in a tight labor market.
• Customers: Subject to increased product prices (3.0% price increase in January 2025, 6.0% surcharge in April 2025) due to inflation and tariffs, which could impact demand. May experience delays due to supply chain constraints and ERP implementation disruptions.
• Suppliers: May pass on increased costs resulting from tariffs. The company is actively expanding its vendor list to manage supply chain challenges.
• Creditors: The company has increased its debt levels but remains in compliance with all financial covenants, indicating continued ability to meet obligations.

Next Steps

• Evaluate the impact of the 'One Big Beautiful Bill Act' (OBBBA) and reflect any required adjustments in the third quarter ended September 30, 2025.
• Continue to implement human resource initiatives to retain and attract labor to further increase production capacity.
• Manage supply chain challenges through strong vendor relationships and expanding the list of available vendors.
• Proceed with the capital expenditure program for 2025, estimated to be approximately $220.0 million, for additional infrastructure, machinery, and production space.
• Satisfy performance obligations relating to uncompleted in-process contracts, typically within one year or less.

Key Dates

Recommendation

The company is navigating a challenging period marked by a significant decline in net income and gross profit margins, primarily due to a softer rooftop HVAC market, supply chain issues related to refrigerant changes, and disruptions from a new ERP system implementation. This has led to a negative operating cash flow for the first half of 2025 and increased reliance on debt. However, the BASX segment, focused on data center cooling solutions, is demonstrating robust growth and a substantial increase in backlog, indicating strong demand in this specialized market. The company is also actively investing in future capacity and managing labor and supply chain issues. Given the mixed performance—strong growth in one segment offset by significant challenges and profitability declines in others—a 'Hold' recommendation is appropriate. Investors should monitor the successful integration of the ERP system, the recovery of the AAON brand, and the continued performance of the high-growth BASX segment before considering a stronger position.

Keywords

HVAC, Data Center Cooling, Cleanroom Systems, Air Handling Units, Commercial HVAC, Industrial HVAC, SEC Filing, Quarterly Report, Earnings, Revenue, Gross Profit, Supply Chain, Tariffs, ERP System, Capital Expenditures, Stock Repurchase, Dividends, New Markets Tax Credit, BASX, AAON