Executive Summary / Key Takeaways

• BASX-Driven Transformation: AAON is rapidly morphing from a commercial HVAC manufacturer into a data center cooling specialist, with BASX segment revenue up 42% year-to-date and backlog soaring 119% to $897 million, positioning the company to capture a multi-year hyperscale data center cape cycle.

• Operational Execution Test: The April 2025 ERP rollout at Longview was a disaster, cutting AAON-branded production by 50% and compressing consolidated gross margins from 37% to 28%, but Q3 shows sequential recovery with production up 20% and management guiding for margin restoration to 32-35% by 2026.

• Two-Speed Business Reality: While BASX thrives on liquid cooling solutions and a $1 billion revenue target within 3-4 years, the legacy AAON brand faces a 12% year-to-date sales decline from refrigerant transition headwinds and soft nonresidential construction, creating a complex investment narrative of growth and decay.

• Margin Recovery Path: Current 28% gross margins reflect temporary ERP inefficiencies, $9.3 million in Memphis facility start-up costs, and tariff impacts that aren't yet fully offset by surcharges; normalized margins are in the mid-30s with clear line of sight to recovery as production stabilizes.

• Critical Execution Risks: The investment thesis hinges on successful ERP implementation at Tulsa in H2 2026, Memphis facility ramp-up to large-scale production by year-end, and management's ability to simultaneously scale BASX while stabilizing the AAON brand in a challenged commercial HVAC market.

Setting the Scene: From Rooftops to Racks

AAON, incorporated in Nevada on August 18, 1987, spent three decades building a reputation as a premium commercial HVAC manufacturer. The company engineered, manufactured, and marketed air conditioning and heating equipment from its Tulsa, Oklahoma base, serving nonresidential construction markets with semi-custom and custom rooftop units. This foundation explains the company's manufacturing DNA and vertical integration philosophy, but it also reveals the structural limitations of a business tied to cyclical commercial construction.

The pivotal moment arrived in December 2021 when AAON acquired BASX, a specialist in custom, high-performance cooling solutions for hyperscale data centers and cleanroom environments. This acquisition wasn't merely a product line extension; it was a strategic bet on the digital infrastructure megatrend. The data center cooling market is experiencing unprecedented demand driven by AI workloads, with thermal management becoming as critical as compute power itself. AAON recognized that traditional air-cooled systems couldn't handle next-generation chip densities, creating an opening for specialized liquid cooling solutions.

Today, AAON operates three distinct segments that reflect this transformation. AAON Oklahoma represents the legacy commercial HVAC business, engineering semi-custom systems and controls from Tulsa, Memphis, and Parkville facilities. AAON Coil Products manufactures heating and cooling coils primarily for internal consumption at Longview, Texas, but also produces BASX-branded equipment. BASX itself, operating from Redmond, Oregon and now Memphis, Tennessee, focuses exclusively on data center and cleanroom solutions. This structure creates a tale of two businesses: one facing macro headwinds, the other riding a secular wave.

The competitive landscape underscores AAON's niche positioning. Against giants like Lennox International (10-15% commercial HVAC market share), Trane Technologies (20-25% global share), Carrier Global (15-20% commercial share), and Johnson Controls (JCI) (15% integrated building systems), AAON's estimated 6% nonresidential share appears modest. However, this comparison misses the point. AAON isn't competing for every rooftop; it's targeting specialized applications where customization, energy efficiency, and rapid deployment command premium pricing. In data center cooling, the competitive set narrows to specialists, and AAON's first-mover advantage in liquid cooling solutions provides a temporary moat.

Industry dynamics highlight the importance of this pivot now. The commercial HVAC market is soft, with volumes down double digits year-to-date as higher interest rates delay construction starts. Industry observers believe the market is nearing bottom, but recovery remains 12-18 months out. Conversely, the data center market is booming, with construction growing 22% and AI workloads driving thermal management innovation. AAON's strategy effectively hedges cyclical commercial exposure with secular data center growth, but execution complexity has proven far greater than management anticipated.

Technology, Products, and Strategic Differentiation

AAON's competitive advantage rests on three technological pillars that differentiate it from commodity HVAC manufacturers. First, the Alpha Class air-source heat pump represents a breakthrough in cold-climate electrification. As one of only two manufacturers offering certified heat pumps operable at zero degrees Fahrenheit, AAON occupies a rarefied market position. The company's roadmap to extend operation to negative 20 degrees Fahrenheit by year-end 2025—two years ahead of the DOE's Commercial Heat Pump Challenge goal—creates a compelling value proposition for customers seeking to decarbonize building footprints.

The economic impact of this technology is measurable. Heat pump sales exceeded $100 million in 2024, up 40% year-over-year, while bookings surged 46% year-to-date in 2025. This growth occurs despite a soft commercial HVAC market, indicating genuine technology-driven share gains. The significance of this lies in the fact that these aren't replacement cycles; they're displacement of fossil fuel heating systems driven by regulatory pressure and ESG mandates. AAON's ability to operate efficiently in extreme cold climates removes the primary barrier to heat pump adoption in northern states, expanding its addressable market beyond traditional HVAC boundaries.

Second, BASX's liquid cooling solutions for data centers represent a proprietary advantage that competitors cannot easily replicate. Management describes a uniquely configured system that "the industry had never seen before," designed to meet a specific customer's exact requirements when competition failed to deliver. This wasn't incremental innovation; it was a ground-up rethinking of thermal management architecture for AI workloads. The solution addresses a critical pain point as chip densities exceed 1,000 watts per square foot, rendering traditional air cooling obsolete.

The strategic value of this technology extends beyond the initial sale. Liquid cooling equipment accounted for 40% of BASX's data center sales year-to-date, with a single large order contributing $46.5 million in Q3 2025 alone. This concentration risk is mitigated by the solution's custom nature, which creates switching costs and customer lock-in. When a hyperscaler designs its data center around AAON's thermal architecture, ripping it out becomes cost-prohibitive. The technology enables pricing power that sustains BASX's 27% gross margins even as the company scales production.

Third, vertical integration in engineering and manufacturing provides a structural cost and speed advantage. AAON designs and produces its own coils, controls, and core components, reducing dependency on external suppliers and enabling rapid customization cycles. This integration proved critical during the refrigerant transition, as the company could modify designs quickly without waiting for third-party component availability. In data center projects where time-to-market determines ROI, AAON's ability to deliver custom solutions in weeks rather than months creates a compelling value proposition that transcends price.

The national account strategy amplifies these technological advantages. National account bookings grew 96% in Q3 2025 and 92% year-to-date, representing 35% of total bookings. These large customers value consistency, reliability, and single-source accountability—attributes that AAON's integrated manufacturing model delivers. The strategy also smooths demand volatility, providing a stable base load that supports capacity utilization across facilities. For investors, this translates to more predictable revenue streams and improved overhead absorption, directly impacting margin recovery.

Financial Performance & Segment Dynamics: Evidence of Strategy Under Stress

AAON's financial results in 2025 reveal a company undergoing simultaneous expansion and contraction, with segment performance diverging dramatically. The consolidated numbers mask a more nuanced story: nine-month revenue of $1.02 billion declined 11.9% year-over-year, while gross margin compressed from 37.1% to 28.0%. These headline figures, however, reflect temporary operational disruptions rather than structural deterioration.

The AAON Oklahoma segment embodies the execution crisis. Nine-month sales fell 11.9% to $586 million as the ERP implementation at Longview disrupted coil supply, forcing production throttling. Gross margin collapsed from 37.1% to 28.0%, a 910 basis point decline that management attributes to three factors: volume deleverage from lower production, $9.3 million in Memphis facility start-up costs, and tariff impacts not yet fully offset by surcharges. The implication is stark: without these temporary headwinds, normalized margins are in the mid-30s, implying a 500-600 basis point recovery opportunity as operations stabilize.

Q3 sequential trends provide evidence of recovery. AAON Oklahoma sales grew 4.3% year-over-year and 28.1% quarter-over-quarter, with production at both Tulsa and Longview facilities up over 20%. Management confirmed Tulsa achieved "full recovery" by quarter-end and was "running ahead of target," while Longview production remained about 20% below target but improved sequentially. This trajectory suggests the worst of the ERP disruption is behind, though margin recovery will lag volume recovery due to fixed cost absorption dynamics.

The AAON Coil Products segment illustrates the BASX growth engine's power and the operational challenges of scaling. Nine-month sales surged 145% to $223 million, driven by $152 million in BASX liquid cooling products that didn't exist in the prior year period. However, gross margin plummeted from 37.1% to 25.4%, a 1,170 basis point decline that management attributes to "slower production from the ERP system implementation." The segment manufactures both AAON-branded coils and BASX-branded data center equipment at Longview, and the ERP disruption disproportionately impacted coil production while BASX equipment "performed exceptionally well."

This divergence highlights AAON's operational bottleneck. The coil business, which supplies Tulsa's rooftop unit production, suffered from ERP-induced inefficiencies, while the data center business, running on parallel processes, thrived. Management targets 30% gross margins for this segment long-term, implying 450 basis points of expansion from current levels as ERP issues resolve and production scales. The $46.5 million liquid cooling order in Q3 demonstrates pricing power and demand visibility, supporting margin recovery assumptions.

The BASX segment validates the strategic pivot. Nine-month sales increased 42% to $209 million, with gross margins holding steady at 26.4% despite rapid scaling. The segment's backlog reached $897 million, up 119% year-over-year and 44% quarter-over-quarter, providing revenue visibility that traditional HVAC businesses lack. This growth occurs as the Memphis facility ramps, with initial production already contributing and large-scale production expected by year-end. The critical factor is that BASX's custom solutions command premium pricing in a supply-constrained market, while the modular design enables faster deployment than traditional built-up systems.

Cash flow dynamics reflect the investment phase. Year-to-date operating cash flow turned negative due to working capital investments in inventory and receivables to support backlog fulfillment. However, management anticipates cash flow turning "significantly positive" in Q4 2025 as payments arrive on large orders. This pattern is typical for manufacturing companies scaling production on large contracts, but it introduces near-term liquidity risk if execution falters. The company's strong balance sheet, with debt-to-equity of just 0.09, provides cushion, but investors should monitor working capital efficiency as production accelerates.

Outlook, Management Guidance, and Execution Risk

Management's revised 2025 guidance reflects a sober assessment of operational challenges while maintaining long-term ambition. Full-year sales growth is now expected in the "mid-teens" with gross margin of 28% to 28.5%, down from prior expectations but up sequentially from Q2 trough levels. Adjusted SG&A is targeted at 16.5% to 17% of sales, while capital expenditures are reduced to $180 million from $220 million due to project timing shifts into 2026.

The guidance assumptions reveal management's view of the cycle. The mid-teens growth target implies Q4 acceleration driven by "continued production recovery and pricing actions implemented earlier this year." This assumes ERP issues are largely resolved, Memphis ramps as planned, and tariff surcharges fully offset cost increases by year-end. The margin target of 28-28.5% suggests sequential improvement but acknowledges that Memphis start-up costs and residual inefficiencies will prevent a full recovery to normalized mid-30s margins until 2026.

The BASX revenue target of "over $1 billion within a few years" (specifically 3-4 years) provides the clearest lens on valuation. With current annualized BASX revenue around $280 million, this implies a 35-40% CAGR, requiring both market share gains and capacity expansion. The Memphis facility, adding 800,000 square feet of manufacturing space, is designed to support this growth. Management expects the facility to become a "positive contributor" to financials by end of 2026, after absorbing start-up costs in 2025. This timeline is critical: if BASX growth decelerates or Memphis ramp delays, the entire investment thesis weakens.

The ERP rollout schedule presents the most significant execution risk. Longview went live April 1, 2025, causing "more prolonged impact on AAON branded equipment and coils production" than anticipated. Memphis went live November 1, 2025, with Redmond scheduled for H1 2026 and Tulsa for H2 2026. The phased approach—vetting the system at one location before moving to the next—reduces risk but extends disruption. Tulsa is the largest and most complex facility, representing the core AAON brand. Any repeat of Longview's issues could derail 2026 margin recovery and revenue targets.

Management commentary suggests confidence born of lessons learned. Matthew Tobolski noted that Longview's struggles "allowed us to fully vet the ERP solution across our entire product portfolio, helping to reduce risk and minimize disruptions during future site implementations." The Q3 sequential improvement at Longview, with production "nearing full recovery by quarter-end," supports this optimism. However, investors should remain skeptical until Tulsa's rollout proves smooth, as this represents the final and most critical test of the system's scalability.

Risks and Asymmetries: What Could Break the Thesis

The investment narrative faces three primary risks that could materially alter the risk/reward profile. First, ERP execution risk at Tulsa remains the single largest variable. While Longview's recovery provides a template, Tulsa's scale and complexity are greater. A failed rollout would repeat the 2025 production disruptions, compress margins further, and delay the BASX growth trajectory. The asymmetry is negative: downside from another failure is substantial, while upside from a smooth go-live is already partially priced into recovery expectations.

Second, tariff policy uncertainty creates margin volatility beyond management's control. The 6% surcharge implemented in April 2025 has not yet fully offset cost increases, with management acknowledging the gap should close by year-end. However, continuous changes in tariff policy could force repeated price adjustments, testing customer acceptance. In a soft commercial HVAC market, pricing power is limited. The risk is that AAON must absorb cost increases, permanently impairing margins. Conversely, if tariffs stabilize and surcharges stick, margin recovery accelerates.

Third, BASX customer concentration and market timing risk could derail the growth story. The $46.5 million liquid cooling order represents significant revenue concentration, and the data center build cycle, while strong, is ultimately cyclical. If hyperscaler capex slows or competitive solutions emerge, BASX's 119% backlog growth could decelerate rapidly. The asymmetry here is that BASX success is essential to offset AAON brand decline; any slowdown would expose the company to a declining core business without sufficient growth engine compensation.

A fourth risk involves the commercial HVAC market's cyclicality. Management believes the market is "nearing the bottom" with bid activity up substantially, but order conversion remains soft. If the recovery timeline extends beyond 12-18 months, AAON Oklahoma's revenue base could erode faster than BASX can scale, creating a revenue gap that pressures overhead absorption and delays margin recovery. The company's national account strategy and Alpha Class heat pump momentum provide some insulation, but not immunity.

On the positive side, asymmetries exist that could drive upside surprises. If Memphis ramps faster than expected and achieves operational efficiencies sooner, BASX margins could expand beyond the 27% baseline, accelerating earnings growth. The data center market's shift to liquid cooling could accelerate, creating a tipping point where AAON's first-mover advantage translates to dominant market share. Tariff policies could normalize, allowing the 6% surcharge to become pure margin expansion. Each of these scenarios would drive meaningful upside to the current guidance framework.

Valuation Context: Pricing the Transformation

Trading at $77.88 per share, AAON commands a market capitalization of $6.36 billion and an enterprise value of $6.40 billion. The stock trades at 4.86 times revenue and 30.53 times EBITDA, premiums to traditional HVAC multiples but discounts to pure-play data center infrastructure names. The valuation reflects a market pricing the BASX transformation while penalizing operational misexecution.

Gross margin of 26.88% on a trailing basis significantly understates normalized earnings power. Management's guidance for 28-28.5% in 2025 and long-term target of 32-35% suggests 500-800 basis points of margin recovery potential. If achieved, this would drive EBITDA margins from the current 3.99% operating margin (depressed by ERP issues) toward the mid-teens, justifying the EV/EBITDA multiple. The key question is whether investors should pay today for margins that may not materialize until 2026.

Balance sheet strength provides valuation support. Debt-to-equity of 0.09 and a current ratio of 3.04 indicate minimal financial risk, while the 0.51% dividend yield reflects a shareholder-friendly capital allocation policy. The company's ability to self-fund the Memphis facility expansion without issuing equity demonstrates financial discipline, but the $180 million capex budget (22% of revenue) highlights the investment intensity of the transformation.

Peer comparisons contextualize the premium. Lennox International (LII) trades at 3.32 times sales with 33% gross margins and 21% operating margins, reflecting its scale and efficiency but also its exposure to residential cyclicality. Trane Technologies (TT) commands 4.13 times sales with 36% gross margins and 20% operating margins, justifying a premium for global diversification and service revenue. Carrier Global (CARR) trades at just 2.04 times sales with 27% gross margins, penalized for slower growth. AAON's 4.86 times sales multiple positions it as a growth story, but the company must deliver BASX scale and margin recovery to avoid multiple compression.

The valuation's sensitivity to execution is high. If BASX achieves the $1 billion revenue target and overall margins recover to 32%, EBITDA could approach $400 million by 2028, implying a forward EV/EBITDA multiple of 16x—reasonable for a data center infrastructure play. Conversely, if ERP issues persist and commercial HVAC remains depressed, margins could stagnate in the high-20s, making the current multiple appear rich. The market is effectively pricing in a successful transformation with limited margin for error.

Conclusion: Execution as the Final Hurdle

AAON's investment thesis centers on a simple but difficult proposition: can a 37-year-old commercial HVAC manufacturer successfully transform into a data center cooling leader while navigating an operational crisis of its own making? The evidence is mixed but trending positive. BASX's 119% backlog growth and unique liquid cooling technology demonstrate market validation and pricing power. The sequential recovery at Longview and Tulsa proves the ERP issues are solvable. The balance sheet provides ample firepower to fund the transformation.

However, the path is narrow. The company must execute flawlessly on the Memphis ramp, complete the Tulsa ERP rollout without incident, and time the commercial HVAC recovery to offset AAON brand headwinds. Margin recovery to the 32-35% target is not guaranteed; it requires operational discipline that 2025's performance calls into question. The tariff environment adds external volatility beyond management's control.

For investors, the risk/reward is asymmetric at $77.88. If execution succeeds, the stock could re-rate toward data center infrastructure multiples as BASX becomes the dominant revenue driver. If execution falters, multiple compression and earnings disappointment create meaningful downside. The next 12 months are critical: Memphis must deliver, Tulsa must avoid Longview's pitfalls, and BASX must maintain its torrid growth. The transformation is real; whether the execution matches the ambition will determine shareholder returns.