Participants

Joseph Mondillo; Director - Investor Relations; Aaon Inc

Gary Fields; President, Chief Executive Officer, Director; Aaon Inc

Rebecca Thompson; Chief Financial Officer, Vice President - Finance, Treasurer; Aaon Inc

Matthew Tobolski; President, Chief Operating Officer; Aaon Inc

Ryan Merkel; Analyst; William Blair & Co. LLC

Chris Moore; Analyst; CJS Securities, Inc.

Brent Thielman; Analyst; D.A. Davidson & Company

Alex Hantman; Analyst; Sidoti & Company

Timothy Wojs; Analyst; Robert W. Baird & Co., Inc.

Presentation

Operator

Good morning ladies and gentlemen, and welcome to the AAO and Inc. fourth quarter 2004 earnings conference call. (Operator Instructions) This call is being recorded on Thursday, February 27, 2025. I would now like to turn the conference over to Joseph Mondillo, Director of Investor Relations. Please go ahead.

Joseph Mondillo

Thank you, operator, and good morning, everyone. The press release announcing our fourth quarter financial results was issued earlier this morning 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 go 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, 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 all are aware of the inherent difficulties, risks, and uncertainties in making predictive statements.
Our press release informed 10-K that we filed this morning details 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-gap 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 off with some opening remarks. Rebecca will follow with a walkthrough of the quarterly results. Matt will then provide further details on the segments and about our operational strategy, and before taking questions, Gary will finish with our 2025 outlook and closing remarks. With that, I will turn the call over to Gary.

Gary Fields

Prior to diving into the results, I want to briefly address the news that we announced last week related to CEO succession. As many of you know by now, I will be stepping down as CEO at our annual stockholders meeting on May 13th. And Matt Tabosky will be taking over the role. I will remain on the Board and I also will become a special adviser to the company to ensure a smooth transition.
Years ago, I was very transparent, but a part of my strategy with the company was to put together such a strong leadership team that my services as leader will not be required any further. We've reached that point. The team that we have put together over the last several years has been tested in many ways and has proven to be incredibly capable. I can confidently say this is the strongest leadership team this company has ever seen.
Since the end of 2023, Matt has been leading the team and fully managing the day to day operations. Over this time, I took a step back from the day to day. I could not be happier how the team performed throughout this transition. Giving me the utmost confidence that this is the right timing for this. Matt is an extremely talented individual with a huge skill set. His bandwidth is incredibly large, and he is a very effective leader. I have strong conviction he will be very successful and that this transition will be extremely smooth. Now please turn to slide 3.
As we look back on 2024, it was a year of both triumphs and obstacles. Early in the year, we were coming off of a two year stretch of extremely strong organic volume growth and share gains. We said at the time that in addition to the year over year comps being tough, that 2024 was going to be a slower year due to uncertainties and challenges related to the refrigerant transition along with weaker macroeconomic conditions in the traditional non-residential construction market.
While not everything went exactly how we expected, from an organic revenue standpoint, it was a flattish year, which was generally in line with our projections. Peeling back the onion, there were a lot of puts and takes. The Basics brand had a tremendous year, driven by robust demand from the data center market and strong execution from our engineering and sales teams. The brand made a significant impact on the data center market with the industry's first large scale development and sale of a custom designed liquid cooling solution.
At the same time, sales of its airside data center cooling equipment maintained exceptional performance. Net sales of Basics branded equipment for the year were up 35.1%. And within that, Basics branded data center equipment sales were up approximately 85%. Bookings of Basics branded equipment in 2024 were up approximately 100%. This performance led to the company's total backlog finishing the year up 70%. The Aaon brand faced a more challenging year due to disruptions caused by the refrigerant transition and weaker non-residential construction activity.
These headwinds resulted in softer demand and created challenges within production planning. Despite the obstacles, sales of Aaon branded equipment were down just modestly in the low single digits. Bookings of Aaon branded equipment was up in the mid-teens and backlog at the end of the year of Aaon branded equipment was up approximately 20%. Considering the tough year over year comps combined with the headwinds, we deem the year to be a success. Please turn to slide 4.
Like the year, the fourth quarter performance was mixed. The bright shining star was that bookings were up approximately 62% and year-end backlog finished up 70% to $867.1 million. This was primarily driven by bookings of data center equipment, including the large $200 million plus liquid cooling. The equipment order we booked late last year. We anticipate a majority of the total backlog will convert to revenue in 2025, positioning us for accelerated growth this year.
Sales and earnings in the fourth quarter were softer than we were anticipating. This was primarily driven by the Aaon Oklahoma segment. The fourth quarter was the first quarter in which we only accepted orders for equipment configured with the new refrigerant. Bookings of rooftop units in October and November were sought, causing us to throttle down production more than we anticipated.
As a result, volumes were lower than expected. Margin degradation at the segment was exacerbated. The positive is this slowdown is temporary, and we believe we're closer to the end than the beginning. The severity of the downturn since October should also result in a steeper recovery for us as we deem most of this slowdown was a push out of demand compared to most of our competition, which experienced a pull forward of demand. I will now hand it off to Rebecca Thompson, who will walk through the quarterly financials in more depth.

Rebecca Thompson

Thank you, Gary. I'd like to begin by discussing the comparative results for the three months into December 31, 2024 versus December 31, 2023. Please turn to slide 5. Net sales were down 2.9% to $297.7 million from $306.6 million. The year over year decline was largely driven by the Aaon Oklahoma segment, which realized the decline of 16.1%. This was partially offset by the Aaon coil product segment, which realized growth of 129.9%.
Moving to slide number 6. Our gross profit decreased 30.5% to $77.6 million from $111.7 million as a percentage of sales gross profit margin was 26.1% compared to 36.4% in 2023. The decrease in gross profit margin largely reflects lower volumes in the related deleveraging of fixed costs at the Aaon Oklahoma segment. We also had a temporary decline in gross margin for the AO coil products and basic segments as we build out additional capacity for future growth. Please turn to slide 7.
Selling general and administrative expenses increased 0.7% to $48.2 million from $47.9 million in 2023. As a percentage of sales, SG&A increased to 16.2% compared to 15.6% in the same period in 2023. The increase in SGAs the percent of sales was primarily related to an increase in depreciation expense associated with investments we are making for long term growth offset by a reduction in profit sharing expenses due to the lower earnings.
Moving to slide 8. Diluted earnings per share decreased 46.4% to $0.30 per share from $0.56 per share. The fourth quarter benefited from a large excess tax benefit of $4.6 million relating to stock-based compensation compared to $2.5 million in the same period a year ago. Turning to slide 9. Our balance sheet remained strong. Cash equivalent, and restricted cash totaled $6.5 million at December 31, 2024, and total outstanding debt was $154.9 million. Our leverage ratio in the quarter was 0.57.
We had working capital balance of $313.3 million at December 301, 2024, versus $282.2 million at December 31, 2023. The increase in working capital reflects necessary inventory purchases made to accommodate production of orders in backlog for early 2025. Capital expenditures in the fourth quarter were $99.3 million, up nearly fourfold from a year ago.
The increase was primarily associated with the $63.4 million spent in December on the closing of our new facility in Memphis. In 2024, capital expenditures totaled 213.2 million, up 94.7% from 2023. In 2025, we anticipate capital expenses to be approximately $220 million. The majority of our investments will be related to getting the Memphis facility up to speed for production later this year. I'll now hand the call over to Matt Tobolski, who will speak more in depth regarding the business segments and our operational strategy.

Matthew Tobolski

Thank you, Rebecca. Please turn to slide 10. As Rebecca stated, much of the softness in the quarter was driven by the Aaon Oklahoma segment. On the third quarter call, we cautioned that we expected a temporary lull in adoption of new 44b refrigerant equipment after we stopped accepting orders of the legacy 4,108 refrigerant equipment in September and knowing that many of the state's building codes weren't updated to allow 454b equipment until the fourth quarter.
And this was the first refrigerant transition that also had building code implications, it was difficult to gauge what the impact was going to be. The downturn in demand following the refrigerant transition proved to be steeper, causing us to slow production in the quarter more than anticipated. This resulted in lower volumes of the Aaon Oklahoma segment in the quarter. We believe the downturn is temporary and was created by the refrigerant transition timing. As such, we chose to not reduce headcount significantly to prepare for the rebound demand.
As a result, the impact was magnified from a profit margin standpoint. Bookings were strong as we rounded out the year, resulting in a double digit increase in the segment's year-end backlog. However, this proceeded a modest price increase that went into effect on January first, so some of this demand would be pull forward ahead of the price increase. The positive is this suggests there is pent up demand in the market.
Furthermore, as of the end of January, the trailing 3 months of bookings were up in the mid-teens compared to the same 3 month period a year ago, and backlog remained solid. We continue to believe as we move through the first half of the year we'll see continued improvement in demand. That said, much of the fixed cost associated with the new Medris facility will be included in the Aaon Oklahoma segment.
Until production ramps up to a certain level, which will likely not occur until Q4, this will be a drag on segment profits. In the first half of the year, we anticipate incurring cost of $5 million to $7 million with minimal revenues to offset. For the segment as a whole, we expect the first quarter will look similar to the fourth quarter and expect sequential improvements throughout most of next year. The Aaon coil product segment at an exceptional quarter.
Sales and gross profits were up 129.9% and 88.9% respectively. The strength was largely driven by the commencement of production of the new basics branded data center liquid cooling product. I'm extremely pleased with how our operations have performed here. We've added and trained a lot of people in a short period of time to scale up this operation and execute to the highest level for this customer.
Due to engineering and design modifications requested from the customer, the initial ramp up of production has been delayed a couple of months. As a result, we now expect the majority of this order will be produced and shipped in the second and third quarter of this year. That said, we should see solid sequential improvement in sales and profits in the first quarter with an acceleration starting in the second quarter.
Sales and gross profits of the basic segment were down 3% to 42.7% respectively. Over the course of last year, the facility in Oregon has been working through some growing things. There's a lot of demand and a lot of backlog, which is positive, but there's also limited capacity at this facility. This resulted in some temporary operational inefficiencies and is why the margins have been subpar for a number of quarters.
The positive is we've been working on this issue for a while and believe we're almost set up going. Where we should begin to see improvements. We are taking certain initiatives that will expand production throughput while balancing our head out appropriately.
The Memphis facility should also help greatly as we will be moving some high volume production from Redmond to this facility later this year, which will result in higher production efficiency in Redmond. We expect the first quarter will look similar to the fourth quarter and anticipate sequential improvement going forward. As we stated in the past, we expect this segment will eventually return to March as we realized in 2023. Please turn to slide 11.
I want to finish by briefly running through our strategic priorities with you and how they pertain to our tactical approach today. We see our strategy existing within three main pillars. AM's foundation is and has always been built upon the industry leader in innovation and customization, which is pillar number 1. Maintaining the industry's highest class of engineers and solving our customers' problems through configurable and customized solutions is a foundational principle across the entire organization.
We exemplify this today through various ways, most notably our highly technical, fully custom developed data center solutions and our cutting edge semi custom air source EO units. The data center liquid cooling solution that we developed last year was a product that was uniquely configured in a way the industry had never seen before.
The product we provided was the exact solution that a customer was looking for, and it was something none of our competition was able to deliver in the current time period where the scope and design of data centers are rapidly changing, these engineering and manufacturing capabilities are immensely valuable. Our air source heat pump rooftop units sold under Alpha Class product family is another example of innovation.
Today we are one of only 2 manufacturers in the industry that provide certified air source heat pump solutions that are operable down to 0 degrees. Over the course of this year, we will be introducing heat pump solutions that are operable all the way down to 20 degrees Fahrenheit. This is instrumental in filling the growing demands from customers who are attempting to decarbonize and electrify their footprints of buildings.
These are just two examples. We have other innovations and development stages that we expect will be similarly as impactful. We look forward to sharing them with you in the future. This leads me to our second pillar, which is to drive sustainable and robust organic growth. Today our annualized run rate of production of data center equipment amounts to a little over $200 million.
Given the pipeline of data center development plans and growing demand for customized solutions in its ever rapidly changing industry, we see this business growing to over $1 billion within a few years. In 2024, sales of our alphala units amounted to a little over $100 million and was up year over year by approximately 40%. With demand for this technology growing significantly in much of the country requiring a cold climate solution, we think that business can grow by multiples in the next few years.
These two catalysts alone are going to drive significant growth, and there are other initiatives we are focusing on that will also contribute to continued growth. This brings me to our final pillar, which is to be a best in class operator. Being a best in class operator to us means to consistently achieve high operational efficiencies, quality control, and on-time delivery rates, all reflected by consistent growth margins.
To achieve this, while generating the robust growth rates we are targeting, we must carefully manage both our current operations and our capacity expansion plans. In order to do that, we reorganized the company late last year. This new structure will allow us to quickly grow into approximately 1 million square feet of new manufacturing space. That we constructed and acquired last year doing so while maintaining efficiencies in target margins. With that, I will hand it back to Gary, who will walk through the outlet.

Gary Fields

Please turn to slide 12. Prior to walking through the 2025 outlook, I want to take a step back and talk about where we are in our business cycle and where we are going. Matt did a good job of speaking to where we are going, but I want to frame where we are from a higher level perspective. The last 5 years we've experienced a tremendous amount of growth, growing organic revenue at a CAGR of 17%. It hasn't been a straight line though, which it never is in business.
In 2020, we had an exceptional year. 2021 was flattish. 2022 and 2023 were phenomenal. And 2024 was flatish. Last year was an unusual year, largely disrupted by an unprecedented government regulation that the industry had never experienced. The positive is most of the impact of that regulation is behind us. I point this out because sometimes we get overly focused on 3 months' worth of financials and sometimes lose the forest for the trees.
We are at the early stages of another multi-year period of robust growth. The fundamentals of both of our brands, Aaon and Basics, are extremely strong. Basics has a huge tailwind for data center development and its leveraging of its unique engineering and custom design capabilities. Aaon also is in a strong position. Our semi custom designed equipment is at the highest quality, best performing, most energy efficient equipment in the industry. Our advanced development of heat pump technology is revolutionary.
Moreover, we're proving we can build our traditional equipment more efficiently than anyone, which is reflected in a narrowing price premium and strong margins. Given the backlog and the fundamentals, we see both brands accelerating in growth over the next several years, resulting in annual growth similar to our trailing 5-year CAGR. We are investing and positioning this business for the long term. The recent reorg and investments that we have made into the business to give you confidence that we will not only be able to absorb this robust growth but do so efficiently.
With that, I will now walk you through our 2025 outlook. Please turn to slide 13. For the year, we anticipate sales growth in the mid to high 10s at a gross margin similar to what we realized in 2024. SG&A as a percent of sales will realize a decline of 25 to 50 basis points. CapEx will be approximately $220 million. For the first quarter, due to general seasonality, lasting impacts of the refrigerant transition, and ramp up costs related to Memphis, we anticipate sales and earnings will be modestly down from the fourth quarter.
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 Sido and Company's virtual Small capp conference on March 13th and William Blair's conference in June. I hope to see some of you there at these events. Thank you, and I will now open the call for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Ryan Merkel, William Blair.

Ryan Merkel

Hey everyone, good morning. Thanks for the questions. I wanted to start with the first quarter outlook for the Oklahoma sales. I think you said flat sales versus what you just reported in 4Q. And is the reason that you're seeing that is it still pushouts because there's an inventory of R410 in the channel? Is that the main reason?

Gary Fields

Well, that's certainly got a, an impact on it, Brian. We did book very nice right there at the end of the year, but the lead time being what it is, it's towards the end of the first quarter before those accelerated bookings start hitting the plant floor. So working off of the backlog. We'll say earlier in the month, earlier in Q4, that's why the run rate is still, not accelerated. 410 had a whole lot to do with it. We kept that off like we said back in September. So everything that we have in the backlog now is 454b and it is taking just a moment to get that momentum back.

Ryan Merkel

Okay. And then in in the quarter, basic sales down year is a little bit of a surprise. I didn't catch the reason, why is that just given the big backlog.

Matthew Tobolski

Yeah, so on a on a basic perspective, I think the the one thing Ryan, we have to to really frame looking forward is thinking about this more on the basics brand and so the ACP, the strong growth in ACP that is really driven by Bas branded equipment. So when we look at Bass as a whole, we're definitely seeing strong growth coming out of that overall business.
Within the segment reporting, so the basic segment as reported today is really reflective of Redmind production, and there's just fundamental limitations of capacity within that facility that are really kind of the throttle of what you're going to see from a from an overall sales perspective in that segment. But the demand, to your point, the demand, the backlog from a basic branded product is extremely strong.

Ryan Merkel

I got it. So yeah, you're saying basics as a whole if you include coil are still strong.

Matthew Tobolski

Correct. And that's really, we talk about the kind of business unit realignment and and kind of future reporting. It's really trying to reflect that because as we go forward, the basic brand is going to really be the Redmond facility, the vast majority of Longview, and really the bulk of Memphis from a ramp up perspective, that is all for Basics branded products.

Ryan Merkel

Okay. One more and I'll pass it on. The outlook for mid-teens to high 10s growth in '25, that that's a little below what I was thinking. Can you just unpack some of the assumptions there? I was thinking, data centers, both Basics and coil could be up, 75-80%. Again, just given that backlog, and I think you mentioned you convert a lot of that. And then I was thinking then the Oklahoma side you'd be up low single digits, mid single digits. So correct me if you know what am I missing on that.

Matthew Tobolski

Yeah, I'd say the big driver is, Oklahoma, I'll say is the sort of piece that is offsetting that dynamic growth in the data center space and so Gary's comment earlier coming off of the Q4 bookings into Q1. You're going to see a little bit of an expected reduction from Q4 to Q1 when you look at the bookings conversion to sales in Q1 plus traditional seasonality in that segment. So in Q1 we're just starting off at a weaker point than would be would be normal from in that segment.
And as we look, there's still uncertainty exactly how the commercial market, the macroeconomic market and non-res really recovers throughout the year. And so we're just putting a little bit of caution in there with uncertainty around the Oklahoma segment.
And so that's really where the kind of put and take is on the overall guide from top line revenues. Yes, to your point, very strong expectations of growth within the data center segment with a little bit of softness coming off of that in the Oklahoma segment.

Ryan Merkel

And can we just put a finer point on that? I, maybe you don't want to give too much detail, but is the Oklahoma segment going to be more flat in 25?

Matthew Tobolski

We're not bifurcating down to segment guidance at this point, but definitely it's just, again, when we start off kind of in that Q1, we're starting off in Q1, obviously it's going to put us a little behind from a year over year perspective.

Ryan Merkel

Got it. All right, thanks, I'll pass it on.

Operator

Chris Moore, CJS Securities.

Chris Moore

Hey, good morning, guys. First, congratulations both to Gary and to Matt. Job well done. Maybe we can start on on data center. Obviously been some talk of bigger players, canceling or or downsizing data center construction. What are you hearing from customers, potential customers, on that front?

Matthew Tobolski

Yeah, I mean, obviously there's been a lot of noise in the market around kind of what the data center outlook looks like. What I would say just from a fundamental visibility that we have, the market continues to be strong. It continues to strengthen. When we look at the pipeline visibility that we see in the marketplace as a whole, we see capital expenditures remaining strong and in a lot of areas actually increasing.
And so from our perspective, everything we're seeing in the marketplace, everything we're seeing in in various stages of conversation within the data center market and channel, the outlook, the strength, and the investments continue to remain strong.
I really, I think a lot of conversation around the deep state conversation. Really, we continue to be firm believers and really subscribe to the mindset that the ability to create more effective models creates demand, it creates a higher adoption of AI and will actually be continuing to strengthen the investment versus the adverse.

Chris Moore

Got it. That's helpful. And you mentioned a $1 billion dollar target. Is that a 3 to 4 year goal? Is that a 5 year goal just any way to frame that.

Matthew Tobolski

Yeah, I mean, we use it, I'll repeat the words as we say, it's a few years basically is what we see as being able to get that to a billion dollars and so that's in the 3 to 4 year range is kind of where we see that target at.

Chris Moore

Got it. That's helpful. And maybe just a question on on on rooftop on on pricing. So how much more expenses expensive is your R54b solution than the legacy 410A that's that's currently being sold? Just trying to get understanding if it's if if there's a big price delta or it has to do with, building code changes that that would. Influence people to continue to buy the R-410A for a while.

Gary Fields

So for us, the 410A is behind us. We don't, we don't sell into a distribution channel where we pre-stocked and preloaded a big parking lot full of units. So, there is no 410A left at at Aaon that that ended at the end of December. 454b is no more expensive from us. We had a 3% price increase that went into effect January first, that was just our annual price increase for everything that, due to inflation, we'll say, but nothing specific to 454b has emerged.

Chris Moore

Got it. No, I understood you're not selling the 410A anymore, but distributors can, and I'm just wondering if you were going up against the 410A when trying to sell the 454B is is really kind of what I was getting after.

Gary Fields

So not materially, Chris, okay, the the people that buy units for a standard product like that are not our target client, never have been. It's never been material to our business. I'm not going to tell you that we don't lose a project from time to time to it, but it's not really measurable what we would lose to 410A because it's not ever been our target client that buys that style of unit.
So not only the More innovative, application strategies that we've put in the market for the, for several years in like Doa units and humidity control and building pressurization control and effective filtration, those have been our marquee applications, but the air source heat pump is gaining a lot of share within the units that we're building today. And those are all built specifically for a project as well.

Chris Moore

Very helpful. Maybe just one last on price. So you guys have much more pricing flexibility than than the average company on the 454b from a from a market standpoint, any sense in terms of where you're priced versus the other 454bs at this stage? Now you said you raise prices 3% in the year.

Gary Fields

Yeah, we're just now getting into that season where we have good comparative data. Oftentimes, and I've stated this many times in the K through 12 market, which historically has been 20% plus of our utilization of our units. Bid forms oftentimes will be on basis of design, and then they'll list a matrix of other manufacturers and what their pricing is.
Those bids have gone back to their normal cadence of in February, March, April bids resulting in, June and July deliveries. So we're very soon and in fact is on next quarter's talk, I think we'll have empirical data to support where we're at with that, but we've not yet seen anything material in that regard.

Chris Moore

Got it, very helpful. I'll jump back online. Thanks guys.

Operator

(Operator Instructions) Brent Thielman, D.A. Davidson.

Brent Thielman

Hey, thanks, good morning, Gary or Matt, just on the potential kind of billion dollars in data center revenue here over the next few years, could you talk about the current capacity coupled with kind of Memphis coming online permit you to do that? Is there more you need to spend to get there? And then also just to refresh on the timeline that Memphis asset becomes available to you.

Matthew Tobolski

Yeah, when we think of, yeah, when we think of kind of the total capacity that'll be in place, I mean, obviously within the rein segment, we sort of said that in the the low to mid $200 million is really kind of where that facility sweet spot is from a capacity standpoint. We have longview facility that we've added and if you really just look at that from a potential capacity of that facility. It's, more than 2 ex the space dedicated to data center production compared to Redmond, so more or less double that.
And then Memphis is basically equal to the combination of those two, and so you start looking at that and you're talking about overall capacity sitting in the, $11.5 billion dollar range once that's online. So the capacity investment in Memphis is really to support that that objective that we see with headroom on top of that. In terms of when it comes online, we look at Memphis and we'll be, first, we're aggressive at trying to get production pull to push out of there. We actually built the first units at the beginning of the month in February.
I say that with excitement but also caution because obviously when we say we built units in Memphis we really assembled units in Memphis and so we had a lot of parts coming from a lot of places but really working aggressively to ramp that facility up so that by Q4. The equipment, the support equipment and the team is really built out to be running, not at that full capacity, but definitely with a meaningful impact to financials by the end of the year.

Brent Thielman

Got it, really helpful, Matt. Yeah, maybe just on basics I guess specific to the Oregon facility just sounds like you just essentially have some things to work through in efficiencies right now.

Gary Fields

Could you just clarify when you think.

Brent Thielman

That business sort of returns to the margins you sort of expect out of it.

Matthew Tobolski

Yeah, I mean, in that segment from, today's reporting perspective, we expect we're going to see sequential quarter over quarter improvement in margin throughout '25. The reality is there's just when you attempt to put too much product through a facility, there's actually a negative implication versus a positive in terms of your ability to effectively manufacture and the incredible demand for the product and really the target for us to deliver on expectations from a lead time and a shipping perspective, we push that facility very hard to turn products for customers.
And productivity in terms of number of units produced was certainly up in that last quarter, but it felt strained obviously from it. It resulted in strains from a financial perspective. So we really think throughout the calendar year we're going to see improvement and getting into 2026 we're going to be getting closer to being in that normalized margin rate that we're targeting.

Brent Thielman

Got it. Just last one, Matt or Gary, I guess, we're sort of 2/3 of the way through the first quarter. I just want to come back to rooftop and.

Gary Fields

Did you discuss the order.

Brent Thielman

Visibility you're starting to see for the new product? Is it still a wait and see in terms of that coming in, excuse me, the new refrigerant product? I'm just trying to get a sense since we're a good way to quarter.

Gary Fields

No, it's beginning to accelerate. We, were in Orlando at HR, just visiting with a lot of our sales channel partners. We didn't have any display there. But the general tenor was we're going to be seeing increasing orders on the normal seasonal basis that we had in years back.
So I guess the way to frame that up is we're confident that we've got the right product at the right price for the rooftops and we'll reassume our growth profile here shortly.

Matthew Tobolski

And just to add one piece to that too, in the prepared remarks, I want to just kind of reiterate one comment we made, which is when we look at the three months ending January 2025 compared to the year previous, so November, December, January bookings, they're up mid-teens year over year and so the normalization, the growth profile in there is certainly starting to reassume and it kind of tells you where we're at from a competitiveness perspective marketplace.
Where we caution that Q1 softness again really is about backlog conversion that bookings cadence doesn't really start hitting as Gary mentioned on the first question until the latter part of Q1 and really makes the meaningful impact in Q2. So we definitely see that product positioned well. It's just getting past that refrigerant transition to get the sales back to a normalized growth profile.

Gary Fields

And just to add one more thing to that. Going back a few years ago, when we, we'll say the markets were relatively normal with lead times, bid activity, and so forth in their seasonality, we would see in the range of 20% variance from the low to the high. And the bookings always led that by approximately 1 25%. Well, here we are at about 17% on that booking's time frame that converts into units in Q2. So that historic roughly 20% seasonality increase for Q2 and Q3 looks to be valid once again.

Brent Thielman

But really helpful color. Thank you, guys.

Operator

Julia Romero, Sidoti and Company.

Alex Hantman

Good morning. This is Alex Hantman on for Julia. Thanks for taking questions. I know we spoke about, more efficient models driving more data center demand. But I was curious if you could talk a little bit about demand for denser data centers. I know those are, typically a little bit better suited to liquid cooling so I would just love to have your take on that.

Matthew Tobolski

Yeah, certainly in the data center space and really around the model development side, so the machine learning aspects of AI that is pretty much all higher density compute that's that's basically producing those models and so that higher density compute is pushing everything towards liquid cooling from a server perspective in that space.
I always like to to really make sure we hammer this home because I think it's a little bit misunderstood kind of in the overall market perspective, but Even when we have a true pure play as we would call it, liquid cool data center, which is what we're supporting with that Longview product, there is still a great amount of airside cooling required in that data center, and so it drives growth, that investment in AI, that investment in the machine learning side at higher densities is driving growth both in liquid cooling and airside cooling. But definitely, yeah, we're seeing a huge push into higher densities within that AI space.

Alex Hantman

Great, thank you for the color. And I know we talked a little bit on the call about you know decarbonization and that sort of end market potential. Previously, I think you also mentioned you know clean rooms, so could we just get a little bit of an update on, the development of that end market?

Matthew Tobolski

Yeah, the premium product, a cleaner market primarily been a data center, a basics driven product, so a lot of products from the Basic brand have gone into the clean room space, both in the semiconductor, the pharmaceutical, as well as the EV and battery production facilities. I would say just as a macro perspective that market has been a little bit lumpy and so it definitely has, some ups and downs from a quarter by quarter productivity standpoint.
Those projects tend to be large scale programs, and they, they're not quite as consistent in growth rate of data centers and so you definitely see a little more volatility in the orders, bookings, and conversion, but we continue to see strong investment in the onshoring within the chip market as well as build out of battery facilities that that we that we continue to support.

Alex Hantman

Great, appreciate the. Call there. We'll jump back into the queue.

Operator

Timothy Wojs, Baird.

Timothy Wojs

Good morning, everybody, maybe just on, Gary, on pricing with the new R-454b system, it sounds like you took some pricing Q1 but really just to kind of offset inflation. So could you just kind of articulate where you are, in terms of the strategy around what you're going to do with price specifically for our 454b.

Gary Fields

Yes. We're going to monitor it a bit longer. We'd like for bookings to strengthen a bit before we hit a price increase that could potentially be related to 454b. I think with the uncertainty of the impact of tariffs, there may be price increases to offset additional cost for that. They may not be 454b specific, but we will be monitoring that. We have a lot of capacity room in the Tulsa facility where we build the rooftop units, which is primarily where the 454b impact is at.
And we want to get that plant loaded back up strongly and if we have an opportunity to increase our price and that's our margin as a result of what others have for pricing pressure related to 454b, then I think we would very likely do that. It's interesting. I tried to figure out where their cost that they're declaring for 454b might be occurring, and I said early on that the monitoring and mitigation device, the refrigerant leak monitoring mitigation device that's required for 454b units was something that we had invented.
In our own facilities and invented one for us, perfected it, got it UL certified, and we're manufacturing it at a very low cost relative to what we could go purchase them for. Presumably, others are buying that component as opposed to having developed their own at this point in time.
One or two others on their calls have cited that device as being one of the reasons that they've gone up. So, I applaud our team for being innovative enough to come up with that device early, get it developed, get it certified, and Put it into our system at a a very advantageous price. So that was one of the areas that I've seen others cite as to the their price increase. And so that explains a little bit why we don't need the price increase possibly, and they do. But, I want to make sure that we get strong bookings and once we get the bookings cadence going in the direction we need to go, then we'll look at being a bit more opportunistic in price increase.

Timothy Wojs

Okay, that's helpful and then I guess just from a, is there a way to kind of quantify. Any of the inefficiencies with some of the increased capacity at Longview and just some of the inefficiencies that you saw at basics like because they're up, is there a number that you can put on it in terms of what those costs were in the fourth quarter and in 2025?

Gary Fields

Well, I'll take the first stab at this and then let mat. Fill in a few more details. While we were ramping up and while we are ramping up Longview, there's certain things that we build and produce internally that we didn't have. Enough capacity yet to produce because the new machinery was still coming online. So we were outsourcing, we, we'll say powder coke would be one of those in particular.
We didn't have a powder cook facility in Longview, so we were outsourcing that. Well, you can visualize making all these big panels and they're fairly large pieces of sheet metal, boxing them up, shipping them down the road, even though it's only a few miles, but you still have the logistics of doing that, having them powder coated, bringing them back, certain percentage of them are damaged.
Not usable because of the transportation logistics and then just the overall inefficiency of that process. So that was one in particular. In Memphis, as Matt spoke to earlier, we produced units there, but we have no manufacturing equipment yet commissioned and operating there. So it's strictly assembly.
So we've either built components at other existing plants that we own or in some cases we've outsourced some of that as well and brought it in and we did that in order to meet our delivery requirements with some of those clients. So that, the combination of the two puts pressure on the margins. But Matt, go ahead and tell us more about, Redmond in particular.

Matthew Tobolski

Well, and I was going to touch on one more thing in in in the longview space and really with the growth rates that you see in Q4 and Longview and really what we're talking about into to the basically Q2 and Q3 with all the ramp up of production, you also have a lot of pressures and the fact that you need to on board and train personnel ahead of what you're producing and so all of that basically puts strain from an indirect overhead perspective as you're basically getting those team members up to speed and efficient in production.
So all of that creates margin strain that definitely as we get to the volumes and we're in a more normalized state in Longview. You'll definitely see margins improve from a reduction of the inefficiencies and the extra labor cost, but also just fundamental leverage. You're going to get a lot of leverage in overhead as we get to some of those higher volumes. So Longview definitely going into Q2 and Q3 is going to see some great improvement in overall margin in Redmond, yeah, to Gary's point, similar to Memphis, similar to Longview. With the demand and the product we were trying to get through, we just, we had to leverage some outsourcing as well as a lot of just inefficiencies and basically getting projects out the door from a delivery expectation to our customers, there's one thing that we hold really strong, and that is monitoring our commitments to our customers and so.
Sometimes to get deliveries out when we're a little bit behind, it takes a little bit of extra work, AKA cost to get that done. So we've leveraged outsource partners inside the Redmond space as well and and some logistics just trying to get all of that product produced that was expected. We have and we're kind of really at a point where all the equipment that was getting installed in Redmond is now installed. It is now operational, and really now we start to get the incremental leverage of efficiency off of these equipment installations, so.
Really, as we look forward, we do see kind of quarter by quarter improvements in that regiment segment, getting all that outsource and efficiency behind us, getting the equipment performance expectations, and really the great part is, we've made the decision that Redmond is going to get to a certain point. In terms of its overall throughput capacity, and we're going to basically maintain that it's not going to be a continuous growth driver, which means we then convert from a capital programs perspective to efficiency programs and so there'll be a lot of effort throughout '25 to drive efficiency and therefore drive margin improvement throughout the calendar year.

Timothy Wojs

Okay. Okay, that's helpful. And then I have two other ones. Just the first is what is the year over year increase in DNA going to be just given the CapEx and where does that kind of land?
And then the second one is just given the data center reporting in terms of where the stuff is landing from a production perspective, I mean. I I think it's actually pretty difficult for investors to kind of follow what's going on so is is there a potential or a thought process about maybe just kind of having the rooftop business be a segment and then having data center be a segment because I think just some of the complexity of the reporting right now is is is kind of weighing a little bit on on what's happening.

Matthew Tobolski

So tell you what, I will answer your second first because I know Rebecca is going to get you the solid answer on the first piece, yeah, so on your second question, I mean that is exactly why we announced the reorg, kind of into this business unit philosophy going in at 2025.
We have some limitations in our systems today to allow the full reporting of that, but as we get through 2026, our goal is to do exactly what you're asking, which is to do financial reporting really around the Aaon business unit, which is the rooftop and the commercial split systems. And then reporting around the basic segment and in doing so you'll be able to understand the the basics revenue across and basically the drivers of revenue and profitability that comes from all of our production sites and so that that is definitely the target for the end of 2025 going into 206 to get very. Easier to understand financial reporting around all those segments. And then Rebecca?

Rebecca Thompson

Yeah, so can you repeat your first question just so I believe it was about the DNA.

Timothy Wojs

Yeah, just what's the, because I think DNA in the like if you look at the, I think the DNA number was probably up $6 million or something like that, $7 million year every year. I guess what is that supposed to be up in '25 as you bring on Longview and Memphis, and just where does that land on the P&L in terms of SG&A or costs.

Rebecca Thompson

So it's going to land in both COGS and SGNA. A lot of the Memphis GDNA, that's going to be mostly in your cost goods sold, and that's part of the drag on the gross margin that we alluded to in the earnings call, as far as like some of the fixed costs that are happening before we have the offset revenue.
But we also have, as we've kind of also noticed or alluded to in many of the calls, investments in some of the back office technology, catching up and doing automation. So you're going to see continued increases in DDNA within the SGNA portion of the income statement as well related to those investments. So I would think that the Increase in DDNA in the next year. It could be consistent with our increase.

Timothy Wojs

Okay, sounds good. I'll talk to you guys in a bit thank you.

Operator

Thank you. Alright, so I don't see any further questions at this time. I will now hand the call over to Joseph Mondillo. Please go ahead.

Joseph Mondillo

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

Operator

Thank you, ladies and gentlemen, today's conference call has concluded. You may now disconnect.