Hello, everyone. Please stand by. Your event is about to begin. Welcome to the AAON, Inc. First Quarter 2022 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question and answer session. At that time, if you have a question, you will be asked to press star one on your touch tone phone. If you are listening to the live event via the web and would like to ask a question on the telephone, please dial in using the instructions provided to you. Then press star one. As a reminder, this event is being recorded. For those of you listening through the web, you can access the presentation handouts at the bottom of your screen. I would like to turn this event over to your host, Mr. Joseph Mondillo, Director of Investor Relations. Mr. Mondillo, please go ahead.
Thank you, Operator. Good afternoon, and thank you for joining us for AAON's first quarter 2022 earnings conference call. A press release announcing our first quarter 2022 financial results was issued after market close today and can be found on our corporate website, aaon.com. A recording of this call will also be posted on our website following the call. Joining me on the call today are Gary Fields, our President and CEO, and Rebecca Thompson, our CFO. Shortly, I'll be handing the call off to Rebecca for her to go through the first quarter results. Gary will then provide further insight on the quarter along with our current outlook and then we'll open up the call to Q&A. Prior to that, though, 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 Private Securities Litigation Reform Act of 1995, the Securities Act of 1933, and the Securities 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 afternoon detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have the duty to update our forward-looking statements. With that, I'll turn the call over to Rebecca.
Thank you, Joe. I'd like to begin by discussing the comparative results of the three months ended March 31st, 2022 versus March 31st, 2021. Net sales increased 57.8% to $182.8 million from $115.8 million. Organic volume growth contributed approximately 21.3% to net sales, and the acquisition of BasX Solutions contributed 18.1%, with the remainder coming mainly from price increases. A record backlog at the beginning of the quarter, along with improved production rates, drove the robust volume growth. Record production rates in the first quarter reflect an easing of supply chain issues, greater production capacity, and strong performance from our operational team. Our gross profit increased 38.9% to $46.1 million from $33.2 million.
As a percentage of sales, gross profit was 25.2% compared to 28.6% in the first quarter of 2021. Gross margin benefited from a $1.8 million non-cash income related to extending the useful lives of some of our equipment. Excluding this item, gross margin was 24.2%. Compared to the first quarter of 2021, gross margin was impacted by higher material costs along with multiple wage increases and supply chain issues that continued to adversely affect operational efficiencies. On a sequential basis, gross margin improved substantially from the fourth quarter of 2021. We are still not where we want to be, but the first quarter was in line with our internal expectations, and we are on track to achieving target margin, target margins later this year.
Selling general and administrative expenses increased 56.9% to $23.1 million from $14.7 million in 2021. As a percentage of sales, SG&A decreased 12.6% from 12.7% in the first quarter of 2021. Including BasX, SG&A expenses totaled 9.7% of sales, down 300 basis points from a year ago. Overall, we are doing a good job at managing our operating expenses, particularly in the inflationary environment we are in. Income from operations increased 24.6% to $23 million or 12.6% of sales from $18.5 million or 15.9% of sales in 2021. Our effective tax rate increased to 20.9% from 11.4%.
The effective tax rate in Q1 of 2021 was unusually low due to excess tax benefits related to stock awards of $2.9 million versus $0.5 million in the current quarter. The company's estimated annual 2022 effective tax rate, excluding discrete events, is expected to be approximately 24.9%. Net income increased to $18.1 million or 9.9% of sales, compared to $16.4 million or 14.1% of sales in the first quarter of 2021. Diluted earnings per share increased by 10% to $0.33 per share from $0.30 per share. Looking at the balance sheet, you'll see that we had a working capital balance of $169.5 million versus $131.3 million at December 31st, 2021.
Unrestricted cash totaled $5.6 million at March 31st, 2022. Our current ratio is approximately 2.5 to 1. Our capital expenditures were $14 million for the quarter. We continue to expect capital expenditures for the year to be approximately $100.4 million. The company had stock repurchases of $3.3 million during the three months ended March 31st, 2022. Shareholders equity per diluted share is $8.90 at March 31, 2022, compared to $8.68 at December 31st, 2021. I'd now like to turn the call over to our CEO and President, Gary Fields.
Good afternoon. Well, first off, I'd like to state that I'm very happy with the first quarter's performance. In general, the overall results were in line with our internal expectations. With the organic sales, excluding price increases and BasX, sales were up over 20%. This definitely reflected the strong backlog we entered the year with, but it's also reflecting how well we are performing. I'd very much like to commend our operations team as our production rates were the highest level of any quarter in the history of the company. Supply chain issues have eased some, but it's definitely still an issue. We're also ramping up our headcount, which comes with challenges. All considered, record production levels certainly reflect how well this team is performing.
Margins were down year-over-year, but they were in line with our internal expectations and what we indicated on our fourth quarter call. Sequentially, we saw considerable improvement. We're still not where we need to be but we're on track to returning to target margins later this year. Considering what we're seeing with material costs, this is a very positive aspect. To give you a sense, our material and freight cost, excluding the effect of organic volumes being up, were up approximately 50%. In other words, if our volumes were flat from a year ago, our material and freight costs would have been up 50%. All things considered, I was happy to see the sequential improvement in gross margins. We're also doing a good job at managing our SG&A expenses, as Rebecca just walked you through.
Now the backlog, March 31st, it was $461.4 million. That's up from $260 million at the end of December and $96.7 million at the end of first quarter 2021. Organically, the backlog was up 305% from a year ago. Orders in the quarter were up year-over-year 150% organically, which represented an acceleration from the 67% growth we recognized in the fourth quarter and the 55% growth we saw in the year of 2021. In fact, the year-over-year comp in this past quarter was the toughest we've seen in two years, and we still recognized significant acceleration in growth. This growth is certainly much greater than what the market is growing at, so we're definitely taking market share. Let me tell you what's enabling that.
Key driver is lead time. Our lead times are by far the best in the industry. Another testament to how well our operations are performing. All the work we've done over the last 18 months with inventory management, productivity improvements, and increasing our manufacturing capacity, including both plant and equipment and labor, is paying off. Lead times are a big factor to the share of the gains we're seeing. There's also a handful of other factors that are playing a role. Our sales channel is performing at a very high level. The quality of our sales channel partners has never been better. The alliance between us and them is as strong as it's ever been. We're supporting them with more products and services than ever before, so we've never been this well aligned with our sales channel in the history of the company. It's the best it's ever been.
We still have a little bit of work to do there. We're working on that every day to improve that sales channel. The heavy lifting's behind this, but we've got just a little tweaking to do here and there. You know, new products are a bit of a factor. The last two calls, we talked about our water-source heat pumps and low ambient air source heat pumps. Both have been very well received by the market so far. As you may recall, we redesigned and introduced a second line of water-source heat pumps that we call ProFit. Those heat pumps were to be backwardly compatible with the large installed base out there for replacement. Been very well received, m oving along nicely with that.
Decarbonization efforts have really picked up the interest in our cold climate capable air source heat pumps. The macro environment is trending very positively for us. Replacement demand continues to be very strong. Pent-up demand from 2020 downturn and a focus on indoor air quality continue to be factors. We're also starting to see stimulus dollars drive accelerated demand within the educational vertical. New construction demand is accelerating after a slow 2021. ABI has been above 50, the benchmark for growth, for 14 straight months, including the latest reading of 58, which is the highest since May of last year. According to the American Institute of Architects, projects backlog at architecture firms are also at an all-time high. New construction demand is improving. That's where our lead times are helping us as well. Some of these are fast-track projects.
Overall demand for all the verticals continue to be fairly broad-based and consistent to what we've talked about in the recent past. Another factor driving growth, although not within our backlog, is our parts business. Parts sales in the first quarter were up 36.1% to the highest level of any first quarter in company history. First quarter is usually a soft quarter for parts, and it begins to accelerate towards the end of the quarter. We're in line with the quarterly average we saw in the last three quarters of 2021. We're really off to a great start with our parts business. Lastly, I wanna talk about our acquisition of BasX. We're now almost six months since closing on the acquisition, and we are very pleased with how things have progressed thus far. Their backlog and order trends are strong.
Revenue synergies seem to be progressing quicker than we even thought. Like us, they're being challenged a bit with supply chain issues and inflation, but overall, they're managing well. We're optimistic heading into the second quarter. Our backlog is strong. Our capacity and production rates are rising. Price cost is improving. Supply chain issues are easing. In general, using first quarter as a benchmark, we foresee sales margins and earnings will improve throughout the year with the bulk of the improvement occurring in the back half. I'd like to open it up to questions and answers.
Thank you. The floor is now open for questions and answers. If you would like to ask a question and have already dialed in, simply press star one on your telephone keypad. If you are only listening to the live event via the web and would like to ask questions on the telephone, please dial in using the instructions provided, then press star one. We have our first question. Caller Julio Romero.
Good afternoon, Julio.
Hey, good afternoon, Gary and Rebecca. I guess to start, you know, the organic order growth is staggering. Just talk about what the drivers of that order growth were and, you know, what particular product lines are seeing the surge.
Well, it's absolutely broad-based, product family-wise. Having the production facility that we built in Longview, we just had an immense amount of production capability there that we're beginning to realize now. The final month of the quarter, we ran about $8 million in finished product out that quarter, that month. That's gotta be $2-$3 million higher than we'd ever run in previous years. Having that production capability, I've always said that the Longview product was more sensitive to lead time than the Tulsa product. We've been able to pull that lead time down very attractive, and that's proven true. We're getting some very, very large orders for modular data centers. These are. They look a little bit like a shipping container that we build for AAON split systems in Longview for.
We used to get those orders in tranches of about 60 units at a time. Now we're getting orders for 200 units at a time. Being able to deliver and be reliable with that's a big deal. In Tulsa, we've, you know, been building out our infrastructure here for the last few years. We finally got enough materials, and we got head count. You know, I'll just give you an idea on the head count, Julio. Our head count in the legacy business is up 17% year-over-year. That's 457 people that we've added in the legacy business year-over-year. Those people were by and large on the plant floor, and so that's what's helping us with the lead times. Now, decarbonization and indoor air quality are also big drivers.
We have another question from Brent Thielman, D.A. Davidson.
Good afternoon, Gene.
Hey, Gary, it's Brent Thielman, D.A. Davidson.
Oh, it's Brent. Okay. There we go.
Not sure why Gene showed up there, but it's me.
Yeah.
Hey, thanks for taking the questions. Hey, can you just talk about, Gary, I caught the end of your commentary that you expect to see this sort of book of business really ramp up in the second half of the year.
Yeah.
We just haven't seen this level book of business before. How do we get our heads wrapped around, you know, kinda converting this backlog over the course of the rest of the year?
Well, I think the percentage growth we saw Q4 to Q1, that's not sustainable at that same acceleration rate. We were severely constrained in fourth quarter because we didn't have materials. That's what disrupted our revenue. I think I stated before our revenue would have been up, you know, fairly substantially in Q4 if we could have gotten materials. October and November were just a wreck with that. About mid-December, it started thawing out pretty nice. We started getting a flow of those materials, and really each month we've built considerable. I think that the pace that we're running is gonna pick up another. It'll be a small double-digit pace that we'll pick up for Q2 in revenue production.
We've obviously got the backlog to support that. Like you said, we need to burn that backlog down. Orders are still pretty strong. It's amazing actually. Where we've been able to manage our lead times on this is in this pandemic era, people have gotten accustomed to ordering things much further out than what they normally would. Their normal pace was they say, "Well, you know, your lead time is 12 weeks, so I'll put a couple weeks pad on it and I'll order it 14 weeks ahead." Well, we've got projects that people are ordering they don't want till Q4, and they're priced attractive enough to be able to do that.
We're placing orders to the best of our ability where people want them, and that's allowed us to keep our lead times in check, and we've actually been able to take advantage of some, you know, quick ship kind of project needs. Hopefully, that answers it. If I need to add something else, clear it up for me.
No, that's great, Gary. You know, I take from that commentary that you're comfortable with this backlog level, given all the things you've put in place here in the last few years to support it. I mean, it seems to me you're comfortable here and don't see a need to necessarily draw it down.
Well, I would like to draw it down just because I like to see the revenue, you know? But I don't wanna draw it down from the fact that, you know, I'm not getting orders in the door. You know, if you go back two or three quarters ago, one of you guys asked me when I was gonna rein in the orders, and I said, "Well, that's a great question. Y'all know I'm a horseman, so I'm gonna use a horseman's term. Heck, no, I'm not gonna rein in the orders. I'm gonna lay the spurs to production." Well, that's what we did, and, you know, gently, though. You know, production has taken this very well. The preparations have been here for a good while to do this, Brent. It's the materials that were giving us the biggest issue.
Now, with the new leader in our HR efforts, Casey Kidwell, just doing a phenomenal job getting people in the door for us and getting our retention rates improved so much. Our turnover rates are way down since some of the things that he's brought in here and that's material. Because if you can get people to stay here 90 days to six months, then they tend to stay here for a very, very long time. We were having tremendous difficulty prior to him getting people to stay the first month, let alone 90 days. This turnover rate's gone down. Well, now those people become more efficient and we measure this by the number of people on the plant floor and how much they produce on a daily basis. We've got that metric in mind.
We look at it every day. That, that's one of our efficiency measures that our production team uses and they've been able to add people and keep that number relatively linear. When we add people, we get that much more dollars per day on a fairly linear basis. We were going over this earlier today. Our target hiring is to hire another probably 250 people in the two locations throughout this later spring and early summer. We look for that to increase the production on a linear basis daily, 'cause those 250 people are all going on the plant floor. We're not looking to add any overhead personnel at all.
Okay. Really helpful, Gary. Just getting back to the 28%-32% margin sort of by the end of the year.
Yep.
Is the overriding factor there that, you know, you've got these price increases out there that you should realize over the course of the next few quarters that catches up to the costs you're experiencing in the business? Maybe just kinda help me understand-
Yeah, that's.
your confidence in getting back to that level, especially with so much going on out there right now?
Yeah. We've debated that considerably and, you know, our historic algorithm for inputs and outputs has been challenged with things that are outside the box, you know, abnormal with the way costs have been. To the best of our ability to forecast, and things have begun to stabilize, you know, while they're elevated, they're stabilized, and that makes it more predictable. Now that they've begun to stabilize, at least, you know, in our viewpoint they have, we feel fairly confident in our forecasting and what we're doing. We're gonna have sequential margin percentage improvement each quarter throughout this year, and that's primarily because we've got a handle on our cost. We know where we're going with that with a fairly high degree of confidence.
We've got this backlog that we know what price level it is and how much of that's on the plant floor at exactly which day. We've gone through that algorithm. We're very confident that we're gonna be improving. We're not gonna get to that target level next quarter, but we're gonna get closer to it. I think that the second half of the year we're gonna be right in the center of that range. I feel good about, you know, somewhere around 29%-30% for the last part of the, you know, last half of the year. You know, bear in mind we're doing everything we can to increase the production rate too.
I don't wanna get too excited about that because, you know, there are still some challenges out there that we deal with on a day-to-day basis. Barring anything different than what's occurred in the last several months, you know, we've learned how to navigate a lot of potholes, and this team has just done a phenomenal job of doing that and getting units out the door. Yeah, I'm confident we're on a growth top line, a growth bottom line of a good solid number throughout the year.
Yep. Appreciate that. Last one, I guess, just on the SG&A, you know, especially as the sales dollars pick up here. Do you expect to see a little better leverage over that as we t he advance through the years is 12.5 odd%. Good, good ballpark?
No, I think we'll get some leverage on that. I haven't got an exact figure that we believe it's gonna improve, but Rebecca and I had a discussion about that earlier, and she's done some preliminary work on that. We believe that we're gonna begin to get some leverage on it because we're holding hard and fast on as much of the overhead aspects of the company as we can. Like I said, we're gonna be adding production workers, not overhead workers. When we add production workers, then that's where that leverage occurs.
Okay. Well, I'll pass it on to someone else. Thanks so much for taking the questions.
Certainly.
We have caller Julio Romero. He got it back online.
Yeah. Julio, we lost you a while ago.
I never left. I don't know why. I must have gotten dropped from the queue somehow.
Okay.
They dropped me for Gene, I guess.
All right.
Just to follow up here, I know you've worked to qualify more vendors and improve supply chain. Are there any other levers you can pull to maybe-
Uh-uh.
further improve supply chain? You know, you've obviously got a good balance sheet.
Well,
Just thinking about how you can de-risk it in the future.
I was wondering how we were gonna fit this in here, Julio. You just gave me the perfect entrée. For the history of the company, 30 years, there's a fan manufacturer down the road here about 50 or 60 miles that we had purchased fan wheels from. They're a great company. When we bought BasX, one of the things that BasX did was manufacture their own fan wheels. We were looking at the process and how it's not all that complex. It's very much within our wheelhouse of abilities.
A bit over a year ago, even before we closed on BasX, I went to Acme and said, "I'd like to purchase from you all of the tooling, the design documentation, the work documentation, you know, the rights to build these fans." I said, "You don't build them for anyone else. You build them only for us." There was maybe two or three part numbers that they used themselves, but the bulk of it, they were building strictly for us. I said, "I'd like to buy that from you. Would you price that?" They did, eventually. We closed that transaction last week. We will be transitioning, moving all the production equipment in here to our plant. I think the anticipation is that somewhere late Q3, early Q4, we will be building our fan wheels.
Well, over the last few years, we've been purchasing nearly 40,000 fan wheels a year, 35,000-40,000 from them. Of course, you see we're growing. This is just one more place that we can control the destiny of the delivery, the quality, and so forth of that product, plus gain the margin. You know, this is not an expensive product, so we're not talking anything that's gonna be material to the bottom line. It'll help it a little bit, but the main thing is the vulnerability of someone else supplying. While they're a great company and we had no reason to doubt that, it was just something that was in our wheelhouse of abilities to add that to the vertical thought process of we manufacture units, we don't assemble units.
Sounds exciting. Just one more for me. There was a comment in the press release about BasX, and you've learned that revenue synergies are better than initially estimated. Can you expand on that at all?
Well, the part that I see is some of these clients that they had were kind of constraining how much they would grant them in an order, you know, how much they wanted to risk with them, because it was a huge percentage of their annual production, for instance. Now that they're part of a larger foundation, then they're looking at that purchase from BasX as a percentage of the whole enterprise, not as a percentage of BasX. They have already attained orders for much higher dollar volume per order than anything that they'd ever experienced in the history of the company. You know, fact is their backlog is up, you know, nearly the same percentage as our legacy company. It's up almost 300% year-over-year.
By the way, their head count is up 75% year-over-year. They've been able to get people there too, and produce. That was one aspect of it. The other aspect was that there were people in AAON's legacy sales channel that had entrées to some of the customer base that is traditionally BasX's customer base. We've been able to leverage those relationships and collaborate and land some work that was both the legacy company provided equipment on it and the new company, BasX, provided. That's where we've leveraged some of that. Purchasing. You know, the legacy company buys a tremendous amount of steel, for instance.
We were looking at their steel purchasing, and they were not able to use that purchasing power that we had until, you know, we got a hold of them. We've been able to improve their cost basis on, you know, steel, is just one thing. I'm sure there's others that are less significant to me or, you know, not quite as visible. But that's where I was going with that in that statement. Does that clear it up?
It does. Thanks very much for taking the questions.
Certainly.
At this point, we do not have any other questions from participants.
All right.
Okay. Thank you.
Yeah. Joe, go ahead and close it out for us, please.
I'm sorry. I'd like to thank everyone for joining today's call. If anyone has any further questions in the coming days and weeks, please reach out to myself. Thanks, and we look forward to speaking with everyone next time.