AAON, Inc.

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AAON, Inc.

2425 South Yukon Avenue
Tulsa, Oklahoma 74107
U.S.A.
(918) 583-2266
Fax: (918) 583-6094
Web site: http://www.aaon.com

Public Company
Incorporated: 1987 as Diamond Head Resources, Inc.
Employees: 556
Sales: $62.8 million (1996)
Stock Exchanges: NASDAQ
SICs: 3585 Refrigeration & Heating Equipment

AAON, Inc. designs, manufactures, sells, and services heating and air conditioning equipment for commercial rooftop use. It targets a niche market for those who want a semicustomized unit that costs less than a totally customized unit but meets the needs of each individual customer. Typically, AAON’s units cost about five to ten percent more than standard mass produced units, but they offer lower cost of operation and maintenance. Its CP/AAON subsidiary manufactures a variety of heating/cooling coils used in the heating, ventilation, and air conditioning (HVAC) industry and provides coils to AAON as well as to other manufacturers. AAON’s customers include national chains such as Target, Wal-Mart, Kmart, and Home Depot, and various school districts, shopping malls, and other local institutions and facilities. Buildings serviced by AAON’s rooftop equipment usually have ten or fewer stories. AAON has about eight percent of the rooftop market and two percent of the coil market.

Origins and Founders

AAON’s roots can be traced to 1928 when the John Zink Company (JZC) was started in Tulsa, Oklahoma to produce equipment for the oil industry. John Zink decided to diversify his firm’s operations by making, installing, and servicing heating and, especially, air conditioning equipment for the mansions of Tulsa’s wealthy oil men. Then in 1968 JZC’s HVAC division began producing rooftop heating and air conditioning equipment for commercial customers. In 1970 McDonald’s Restaurants became the first main customer for the rooftop units. Wal-Mart followed in 1971.

After founder John Zink died, his son negotiated the acquisition of JZC in 1972 by the Sunbeam Corporation. In 1981 the Sunbeam Corporation in turn was purchased by Allegheny International, Inc. Then in June 1987 Lone Star Technologies, Inc. purchased JZC, but its leaders decided to get out of the HVAC industry, for that division was doing only about $16 million in annual sales, while the rest of JZC was running about $100 million in annual sales. With Wal-Mart and McDonald’s its only customers, HVAC was just a sidelight for JZC.

Corporate Changes During the 1980s

Two months later, on August 18, 1987, a shell company called Diamond Head Resources, Inc. was incorporated in Nevada by its founders, Jack M. Gertino of Salt Lake City, Wayne M. Rogers, Tod W. Anderson, and Jonathan A. Lewis. These individuals and other investors raised money through Diamond Head stock offerings during 1987 and early 1988. This money was raised for a potential business opportunity to be selected later; thus it was described as a blind pool or blank check offering.

In August 1988 AAON, Inc. was incorporated in Oklahoma for the purpose of acquiring the heating and air conditioning division of the John Zink Company, which took place the following month. AAON paid $9,219,000 for that acquisition, including $7,035,000 cash and the assumption of liabilities worth $2,184,000. Tulsa residents were willing to invest in the new company in part because the oil industry in Oklahoma was hurting. The rest of the John Zink Company was purchased by Koch Industries.

The corporate name AAON had no particular meaning; it was chosen so the company would be listed at the beginning of phone directories. It was pronounced “aye-on.”

In June 1989 Diamond Head Resources acquired AAON, Inc. of Oklahoma, which became a wholly owned subsidiary. This deal was described as a “reverse acquisition,” as if AAON had acquired Diamond Head. The ownership of Diamond Head’s stockholders was reduced in this transaction to 20 percent, and AAON’s stockholders became the owners of 80 percent of Diamond Head, which changed its name to AAON, Inc., a Nevada corporation. AAON became a publicly traded company at this time.

AAON’s first officers and directors included the following men, who retained their corporate positions in 1997. Norman H. Asbjornson, a professional engineer educated at Montana State University and the University of Nebraska, was the firm’s president, treasurer, and director. He had worked for American Standard’s Commercial Air-Conditioning Division from 1960 to 1972, Singer Corporation’s Climate Control Division from 1972 to 1977, Nortek (a heating/air conditioner maker) from 1977 to 1987, and then the John Zink Company’s HVAC Division until it was acquired by AAON. He was the key person who alerted others that the HVAC division was up for sale.

Another JZC manager who moved to AAON was Robert G. Fergus. A professional engineer who worked for JZC from 1980 to 1988, he joined AAON as its vice-president when it was first organized.

A third key person was William A. Bowen, who had worked for a North Carolina bank from 1955 to 1979, and then became the president, CEO, and board chairman of Tulsa’s First National Bank and Trust Company. While serving as the president of the Tulsa Economic Development Foundation in 1987 and 1988, Bowen was instrumental in organizing investors to start AAON. He became the new firm’s vice-president of finance and a director.

AAON’s other founders included Secretary/Director John B. Johnson, Jr., a Tulsa attorney since 1961; Director Richard E. Minshall, president of Tulsa’s Capital Advisors, Inc. since 1978; and Anthony Pantaleoni, a partner in the law firm of Fulbright Jaworski & Reavis McGrath in New York City.

AAON bought its Tulsa manufacturing plant and offices in late 1988 for $650,000. After extensive changes costing almost $1.9 million, the company began using the refurbished facilities in early 1989. The heavy industrial manufacturing and warehouse spaces totaled 172,000 square feet, and the offices were situated in an additional 12,000 square feet. The plant, located on 12 acres at 2425 South Yukon, featured two main assembly lines. From February to August 1989 the company built a new paint booth facility.

The firm in the late 1980s made two main lines of products. In late 1988 it began manufacturing its RE Series of air conditioners. The new machines were available in 19 different cooling sizes, ranging from two to 63 tons. A ton in the air conditioning industry was defined as the ability to reduce the temperature of one ton of water by 1°F in one hour.

AAON began building in late 1989 its RF Series with six cooling capacities, ranging from 60 to 140 tons. It was approved by the Electrical Testing Laboratories of Cortland, New York, a step that was not required by law but helped to increase product credibility and sales.

In its early years AAON manufactured rooftop units for two main customers, both retained from the John Zink Company era. In 1989 sales to Wal-Mart were $16 million, up from $5 million in both 1987 and 1988. McDonald’s bought $12 million worth of products in 1989 as well as in 1988. About 89 percent of AAON’s 1989 annual sales of $31.3 million were made to McDonald’s and Wal-Mart.

In its first year of operations, AAON faced a major challenge. The firm that supplied its coils failed, leaving many machines half finished at the Tulsa plant. AAON was able to survive with the help of the Bank of Oklahoma, which increased its loan to the struggling new company from $5 million to $9 million. Because the Bank of Oklahoma believed in AAON during this crisis, AAON remained a loyal customer of the bank.

Developments in the 1990s

In 1991 AAON lost one of its main customers. McDonald’s canceled orders for any new rooftop units but continued to buy replacement parts. The loss of such a major customer reduced sales by about $10 million per year.

In December 1991 AAON, Inc. of Nevada created a new subsidiary called CP/AAON, a Texas corporation, to acquire most of the assets of Coils Plus, Inc. of Longview, Texas. Coils Plus had been founded in 1984 to design and make new and replacement coils for the HVAC industry. AAON acquired this Texas company to make coils instead of upgrading its Tulsa plant because of inadequate sewage services in Tulsa.

Some of the company’s directors, officers, and employees received the opportunity on March 11, 1992 to take advantage of AAON’s new stock option plan. By March 5, 1997 AAON had granted options to 29 individuals, including eight officers or directors and 21 employees.

AAON expanded significantly in 1993. First, in January, its subsidiary CP/AAON purchased a 110,000-square-foot facility near its former plant in Longview, Texas, and moved into the newly renovated plant a couple months later. AAON was producing four types of rooftop units in 1993. Production of models in its RE Series continued, but they were replaced gradually by the more efficient models of the RH Series. The RF Series was still manufactured. Fourth, the company was starting to make the RG Series, a heat pump version of the RH Series.

In 1993 AAON’s American customers included Wal-Mart, Kmart, Target, Mervyn’s, Shopko, Discovery Zone, Meijer, Home Depot, Boston Chicken, Braum’s, QuikTrip, Mazzio’s, and Leaps and Bounds. The company also initiated overseas sales in 1993. It began delivering equipment to Cifra, Mexico’s largest retailer. AAON also began shipping specially designed cooling units to the Middle East in 1993. These units were designed so that several could fit in one freight container, thus reducing shipping costs, a major expense for customers in the Middle East.

Other 1993 developments included 1) starting a cross-training program to increase worker flexibility, 2) spending about $1 million for replacement coils for units under warranty, and 3) completing a one-for-four reverse stock split, which retired almost $2 million of the firm’s subordinated debt.

AAON had been listed on the NASDAQ Small Cap with the symbol AAON in December 1990. The company announced in November 1993 that its common stock would be traded on the NASDAQ National Market under the symbol AAON. NASDAQ’s system of several competing dealers or market makers for the same stocks helped AAON stock become more visible and liquid. Fourteen market makers, including Salt Lake City’s Alpine Securities Corporation, dealt with AAON stock when it first was sold on the NASDAQ National Market.

The First Analysis Securities Corporation (FASC) of Chicago in February 1994 gave AAON’s stock a “strong buy” rating for several reasons. First, AAON had a large backlog of orders at the end of 1993 and had recently added a third assembly line. FASC also pointed out: “No other HVAC manufacturer is using AAON’s semicustom approach . . . the energy efficiency of AAON’s complete product line is the highest in the industry, according to data certified by the American Refrigeration Institute . . . the company has enjoyed a reputation among its customers for manufacturing a quality product and providing attentive customer service.”

In January 1995 AAON introduced a new product, a desic-cant heat recovery wheel called AAONAIRE. Designed for the company’s RH, RF, and RG units, this technology increased the capacity of AAON’s rooftop units by as much as 50 percent without any additional energy costs. The AAONAIRE patent was pending in 1997. AAONAIRE was created to meet the requirements of the 1990 U.S. Clean Air Act for better air quality in commercial buildings. That legislation resulted from so-called “sick-building syndrome,” characterized by a cluster of symptoms such as headaches, colds, and eye and respiratory tract problems first reported in the 1970s.

In March 1995 CP/AAON expanded with the purchase of property and a 26,000-square-foot building next to its plant in Texas. The Tulsa plant also was enlarged to 332,000 square feet in 1995.

The firm’s 1995 financial performance slipped from 1994. Revenues declined 16 percent from 1994 to $67.3 million, while net earnings decreased 61 percent to $2.1 million. In its 1995 Annual Report the company cited three reasons for this downturn. First, raw materials, such as aluminum and copper, cost more than in 1994. Second, price increases on coils made by CP/AAON resulted in seven percent fewer orders. Third, there was a major reduction in sales to AAON’s two large national customers. AAON in 1995, as it had done previously, compensated to some extent by strengthening its sales force, which had success with an increasingly diverse group of customers, such as shopping malls, schools, and individual office buildings. From 1994 to 1995, orders from these company representatives increased from 49 percent of AAON’s business to 65 percent. Thus the company shifted away from relying on the big national contracts.

That trend continued in 1996, when the company’s biggest customer, Target Stores, accounted for just 14 percent of total sales, down from 17 percent in 1995. Also in 1996 AAON developed some new tools and methods to help its sales representatives. Product displays featuring actual units were sent around the nation. For the first time, sales personnel had access to display software that included the firm’s many coil options, so they could sell coils as well as AAON’s rooftop units. To keep Target Stores and other customers satisfied, AAON provided repair parts through six independent parts distributors and through its Tulsa manufacturing plant.

In 1996 AAON sold four lines of products, including the previously mentioned RH, RF, and RG Series. It also marketed its new HA Series, which was produced in nine sizes from four to 50 tons and featured horizontal discharge units for either ground or rooftop use. It began in 1997 replacing the RH Series with the RK units, which had rotary scroll compressors instead of the old piston compressors found in the RH products. AAON also had a patent pending on a new high efficiency blower developed for the RK Series.

The firm in 1996 emphasized adding equipment to improve productivity. For example, it found a way to make gas furnace components more efficiently. CP/AAON installed automatic equipment to process sheet metal at its Texas plant. The Tulsa plant added new production lines in 1996 to handle the increasing demand for AAON’s larger capacity units. It should be noted that the company’s assembly lines for nonstandardized equipment did not move, unlike the moving lines for mass produced units. That set form of production was one reason AAON’s units were somewhat more expensive than standard equipment. Mass produced equipment sold for about $350 per ton of cooling capacity. Totally customized units sold for around $2,000 per ton. AAON’s semi customized products sold for about $400 per ton.

One of AAON’s challenges in the 1990s was to deal with the federal government’s ban on chlorofluorocarbons (CFCs) in air conditioners. CFCs originated in the 1930s and for many years were considered safe. But by the 1990s many scientists concluded that such man-made chemicals were at least partially responsible for reducing the protective ozone layer in the atmosphere. Like some other companies, AAON began using R-22, a hydrochlorofluorocarbon, instead of CFCs. According to AAON Engineering Manager Hank Bierwirth, in 1997 AAON was cooperating with Allied Chemical to test R-410A, a blend of two refrigerants favored to some degree by the Environmental Protection Agency. He said the new chemical probably would be phased in to replace R-22 after the turn of the century.

To aid customers seeking just the right cooling/heating coils, CP/AAON designed a Windows-based software program. Customers entered the specifications they needed, such as physical size and thermal capacity, and the program helped them decide what they required. Customers using this “Performance Program” software were able to receive updated versions. CP/AAON and AAON personnel used computer-aided design and manufacturing software to ensure that customers got what they needed.

AAON employed more individuals as the decade continued. On March 1, 1994 the firm had 369 employees and 120 temporary workers. That grew to 480 employees and 94 temporaries by March 1, 1996 and then to 556 employees and 157 temporaries by March 1, 1997. No AAON employees were represented by unions.

Although AAON knew of no particular hostile takeover attempt aimed at its assets, the firm’s board of directors decided in 1997 to prepare for such a possibility. It unanimously approved an amendment to its Articles of Incorporation that required holders of two-thirds of outstanding shares to approve of any major changes, if the majority of the board did not agree to such changes. Nevada law required a majority vote of shares to make substantial changes in a company, so this proposal made it more difficult for someone to attempt a merger or other major changes.

Another change in the company’s structure was designed to prevent a hostile takeover. In 1997 AAON’s board voted to elect seven members on a staggered schedule. Two of those directors would be on the board until 1998; two would serve until 1999; and three directors would continue until 2000.

AAON made these changes realizing that their competitors in the HVAC industry were much larger companies. For example, Carrier Corporation, a subsidiary of United Technologies Corporation, in 1991 had sales of $3.8 billion, 37 percent of the HVAC industry, and employed almost 30,000 persons. Other major players in this industry included the Trane Company, a subsidiary of American Standard, Inc.; Lennox Industries, Inc.; and York International Corporation.

In April 1997 Jerry Levine in his report on AAON for BlueStone Capital Investment & Merchant Banking gave several reasons for his “buy” rating of AAON stock. Although AAON’s growth in 1995 and 1996 was hurt by higher costs of raw materials, loss of business from two national accounts, and other factors, Levine concluded those “problems have finally been resolved and it would appear that AAON is now poised to again embark on a period of excellent revenue and earnings growth.” He mentioned that more of AAON’s sales were coming from its representatives and that national accounts even showed some positive signs. For example, Dillards Department Stores was a new national account.

AAON’s Tulsa plant in 1996 was operating at only 27 percent of its estimated capacity. That was good evidence that the company could handle increased demands, which did occur in the first quarter of 1997. Revenues from January to March 1997 increased 25.6 percent and net income increased 70.9 percent over 1996 figures. If such short-term gains were maintained or increased in the long term, AAON’s future looked positive.

In a telephone interview on September 18, 1997, CFO William Bowen reported that the firm was doing quite well. In fact, he said AAON had a “wonderful problem,” a large backlog of orders, especially for larger capacity units. One way AAON responded in 1997 was to purchase for about $2 million a new machine from the Salvagnini Company in northern Italy. AAON looked all over the world to find this equipment. Bowen said this sheet metal assembly device could be programmed to take plain sheets of metal automatically and fold them into boxes and cut holes for input and output pipes and other accessories. AAON planned to purchase a second Salvagnini device after the first one was completely operational in late 1997. AAON used such investments in cutting-edge technology to meet its current demands and also prepare for long-term success in the future.