AAON, Inc. ("the Company") engineers, manufactures and markets air-conditioning and heating equipment consisting of standardized and custom rooftop units, chillers, air-handling units, make-up units, heat recovery units, condensing units, coils and boilers. Custom units are marketed and sold to retail, manufacturing, educational, medical and other commercial industries. The Company markets units to all 50 states in the United States and certain provinces in Canada. International sales are less than five percent as the majority of all sales are domestic.

The Company sells its products to property owners and contractors through a network of manufacturers' representatives and its internal sales force. Demand for the Company's products is influenced by national and regional economic and demographic factors. The commercial and industrial new construction market is subject to cyclical fluctuations in that it is generally tied to housing starts, but has a lag factor of 6-18 months. Housing starts, in turn, are affected by such factors as interest rates, the state of the economy, population growth and the relative age of the population. When new construction is down, the Company emphasizes the replacement market.

The principal components of cost of goods sold are labor, raw materials, component costs, factory overhead, freight out and engineering expense. The principal raw materials used in The Company's manufacturing processes are steel, copper and aluminum. The Company experienced raw materials price increases of approximately 70% for steel, 18% for aluminum and 19% for copper from June 30, 2006 to June 30, 2008. The Company reviewed and adjusted current pricing strategies and created efficiencies in production and continued relationships with suppliers in order to mitigate the economic factors of increasing commodity prices. The major component costs include compressors, electric motors and electronic controls, which also increased due to increases in commodities.

Selling, general, and administrative ("SG&A") costs include the Company's internal sales force, warranty costs, profit sharing and administrative expense. Warranty expense is estimated based on historical trends and other factors. The Company's warranty on its products is: for parts only, the earlier of one year from the date of first use or 18 months from date of shipment; compressors (if applicable), an additional four years; on gas-fired heat exchangers (if applicable), 15 years; and on stainless steel heat exchangers (if applicable), 25 years. Warranty charges on heat exchangers occur infrequently.

The office facilities of the Company consist of a 337,000 square foot building (322,000 sq. ft. of manufacturing/warehouse space and 15,000 sq. ft. of office space) located at 2425 S. Yukon Avenue, Tulsa, Oklahoma (the "original facility"), and a 563,000 square foot manufacturing/warehouse building and a 22,000 square foot office building ("the expansion facility") located across the street from the original facility at 2440 S. Yukon Avenue. The Company utilizes 39% of the expansion facility and the remaining 61% is leased to a third party.

Other operations are conducted in a plant/office building at 203-207 Gum Springs Road in Longview, Texas, containing 258,000 square feet (251,000 sq. ft. of manufacturing/warehouse and 7,000 sq. ft. of office space). An additional 15 acres of land was purchased for future expansion in 2004 and 2005 in Longview, Texas.

The Company's operations in Burlington, Ontario, Canada, are located at 279 Sumach Drive, consisting of an 82,000 sq. ft. office/manufacturing facility on a 5.6 acre tract of land.

Set forth below is unaudited income statement information with respect to the Company for the periods ended June 30, 2008 and 2007:

                                         Three Months Ended                                      Six Months Ended
                               June 30, 2008             June 30, 2007                June 30, 2008             June 30, 2007
                          -------------------------------------------------      -------------------------------------------------
                                                                       (In thousands)
Net sales                   $  74,781       100%      $  70,835       100%         $ 140,237       100%      $ 129,463       100%

Cost of sales                  56,791      75.9%         55,237      78.0%           106,595      76.0%         98,143      75.8%
                          -----------------------   -----------------------      -----------------------   -----------------------
    Gross profit               17,990      24.1%         15,598      22.0%            33,642      24.0%         31,320      24.2%

Selling, general and
  administrative expenses       6,129       8.2%          5,270       7.4%            12,031       8.6%         11,017       8.5%
                          -----------------------   -----------------------      -----------------------   -----------------------
    Income from
      operations               11,861      15.9%         10,328      14.6%            21,611      15.4%         20,303      15.7%
                          -----------------------   -----------------------      -----------------------   -----------------------

Interest expense and
  other                           (16)      0.0%              3       0.0%               (19)      0.0%             (7)      0.0%
Interest income                     6       0.0%              3       0.0%                27       0.0%              6       0.0%
Other income, net                 117       0.1%             82       0.1%               247       0.2%            270       0.2%
                          -----------------------   -----------------------      -----------------------   -----------------------
Income before
  income taxes                 11,968      16.0%         10,416      14.7%            21,866      15.6%         20,572      15.9%
Income tax provision            4,208       5.6%          3,539       5.0%             7,672       5.5%          7,378       5.7%
                          -----------------------   -----------------------      -----------------------   -----------------------
      Net income            $   7,760      10.4%      $   6,877       9.7%         $  14,194      10.1%      $  13,194      10.2%
                          =======================   =======================      =======================   =======================

Results of Operations

Key events impacting our cash balance, financial condition, and results of operations for the six months ended June 30, 2008, include the following:
o An increase in sales on product lines due to commercial construction growth and market share gains, and effective moderation of commodity costs with purchase agreements and pricing strategies.
o The Company remained the leader in the industry for environmentally-friendly, energy efficient and quality innovations, utilizing R410A refrigerant and phasing out pollutant causing R22 refrigerant. The phase out of R22 began in early 2004. The Company also utilizes a high performance composite foam panel to eliminate over half of the heat transfer from typical fiberglass insulated panels. The Company continues to utilize sloped condenser coils, and access compartments to filters, motor, and fans. All of these innovations increase the demand for the Company's products thus increasing market share.
o In February 2006, the Board of Directors initiated a program of semi-annual cash dividend payments. Cash payments of $5.0 million were made in 2007, and $2.9 million were made in January 2008. Dividends were declared in the second quarter of 2008 and accrued. Payment of cash dividends occurred in July 2008 in the amount of $2.8 million.
o Stock repurchases of Company stock from employee's 401(k) savings and investments plan was authorized in 2005. Stock repurchases of Company stock from directors was authorized in 2006. Stock repurchases of Company stock from the open market was authorized in 2007. Total purchases resulted in cash payments of $17.3 million. This cash outlay is partially offset by cash received from options exercised by employees as a part of an incentive bonus program. The cash received in the six months ended June 30, 2008 from options exercised was approximately $0.4 million.
o Purchases of equipment to create efficiencies remained a priority. The Company's capital expenditures were $1.4 million. Equipment purchases create significant efficiencies, lower production costs and allow continued growth in production. The Company currently estimates it will spend approximately $7.0 million to $10.0 million on capital expenditures in 2008 for continued growth.

Net Sales

Net sales increased $4.0 million or 5.6% to $74.8 million from $70.8 million for the three months, and increased $10.7 million or 8.3% to $140.2 million from $129.5 million for the six months ended June 30, 2008, compared to the same periods in 2007. Increased sales were attributable to an increase in volume of product sold related to the Company's new and redesigned products being favorably received by its customers, active marketing by sales representatives and from certain pricing strategies implemented on 90% of the Company's product lines. Management anticipates continued growth throughout 2008.

Gross Profit

Gross profit increased $2.4 million or 15.4% to $18.0 million from $15.6 million for the three months, and increased $2.3 million or 7.3% to $33.6 million from $31.3 million for the six months ended June 30, 2008, compared to the same periods in 2007. Gross margins were 24.1% compared to 22.0% for the three months, and 24.0% compared to 24.2% for the six months ended June 30, 2008 and 2007, respectively. The increase in gross margins for the three months and slight decrease for the six months was a result of pricing strategies implemented, higher sales volume and production and labor efficiencies.

Steel, copper and aluminum are high volume materials used in the manufacturing of the Company's products, which are obtained from domestic suppliers. The Company experienced raw materials price increases of approximately 70% for steel, 18% for aluminum and 19% for copper from June 30, 2006 to June 30, 2008, causing increased inventory costs. The Company also purchases from other domestic manufacturers certain components, including compressors, electric motors and electrical controls used in its products. The suppliers of these components are significantly affected by the rising raw material costs, as steel, copper and aluminum are used in the manufacturing of their products; therefore, the Company is also experiencing price increases from component part suppliers. The Company continues to monitor these costs and price units accordingly. The Company instituted several price increases to customers from 2005 to 2008 in an attempt to offset the continued increases in steel, copper and aluminum. The Company attempts to limit the impact of price increases on these materials by entering into cancelable fixed price contracts with its major suppliers for periods of 6-12 months.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $0.8 million or 15.1% to $6.1 million from $5.3 million for the three months, and increased $1.0 million or 9.1% to $12.0 million from $11.0 million for the six months ended June 30, 2008, compared to the same periods in 2007. The increase was primarily caused by an increase in selling related expenses, warranty expense related to increased sales, profit sharing due to increased net income and an overall increase in general and administrative expenses.

Other Income

Other income was $117,000 and $82,000 for the three months, and $247,000 and $270,000 for the six months ended June 30, 2008 and 2007, respectively. Other income is attributable primarily to rental income from the Company's expansion facility. All expenses associated with the facility that are allocated to the rental portion of the building are included in other income. The Company plans to continue to rent the expansion facility until it is needed for increased capacity. Other income also includes foreign currency gains and losses that result from operations in Canada.

Analysis of Liquidity and Capital Resources

The Company's working capital and capital expenditure requirements are generally met through net cash provided by operations and the revolving bank line of credit.

Cash Flows Provided by Operating Activities. Net cash provided by operating activities increased in the six months ended June 30, 2008 by $6.8 million from the six months ended June 30, 2007. The increase was due primarily to changes in net income and inventory.

Cash Flows Used in Investing Activities. Cash flows used in investing activities were $1.4 million and $7.2 million for the six months ended June 30, 2008 and 2007, respectively. The decrease in cash flows used in investing activities in 2008 was primarily related to lower capital expenditures of $1.4 million for additions to manufacturing facilities, machinery and equipment compared to $7.2 million for the same period in 2007. Capital expenditures in 2007 related to building renovations and machinery and equipment to further automate production. Management utilizes cash flows provided from operating activities to fund capital expenditures that are expected to spur growth and create efficiencies. The Company is currently in line with budgeted capital expenditures of approximately $7.0 million to $10.0 million in 2008 for equipment requirements. The Company expects its cash requirements to be provided from cash flows from operations.

Cash Flows Used in Financing Activities. Cash flows used in financing activities were $15.5 million and $2.6 million for the six months ended June 30, 2008 and 2007, respectively. The increase of cash used in financing activities primarily relates to the continued repurchase of the Company's stock, borrowings under the revolving credit facility and cash dividends paid to stockholders.

The Company repurchased shares of stock from employees' 401(k) savings and investment plan and other incentive plans, the open market and directors for the six months ended June 30, 2008, in the amount of approximately $17.3 million for 844,798 shares of stock. There were shares of stock repurchased for a total of $2.9 million for the same period in 2007.

The Company received cash from stock options exercised of approximately $394,000 and classified the tax benefit of stock options exercised of approximately $229,000 in financing activities for the six months ended June 30, 2008. The cash received for options exercised and income tax effect partially offset the stock repurchase and dividend payments for the six months ended June 30, 2008. The cash received from stock options exercised for the same period in 2007 was $1.0 million and the tax benefit of stock options exercised was $1.8 million.

The Company's revolving credit facility provides for maximum borrowings of $15.2 million which is provided by the Bank of Oklahoma, National Association. Under the line of credit, there is one standby letter of credit totaling approximately $1.3 million. The letter of credit is a requirement of the Company's workers compensation insurance which has been renewed and will expire December 31, 2008. Interest on borrowings is payable monthly at the Wall Street Journal prime rate less 0.5% or LIBOR plus 1.6%, at the election of the Company (4.06% at June 30, 2008). No fees are associated with the unused portion of the committed amount. At June 30, 2008, the Company had $4.1 million borrowed under the revolving credit facility and had no borrowings outstanding under the revolving credit facility at December 31, 2007. Borrowings available under the revolving credit facility at June 30, 2008, were $9.8 million. The credit facility requires the Company to maintain certain financial ratios. The total liabilities to tangible net worth ratio has been waived for the period ended June 30, 2008, and was revised in the renewed line of credit agreement that matures July 30, 2009. The Company is in compliance with all other financial ratio covenants.

Management believes the Company's bank revolving credit facility, or comparable financing, and projected cash flows from operations will provide the necessary liquidity and capital resources to the Company for fiscal year 2008 and the foreseeable future. The Company's belief that it will have the necessary liquidity and capital resources is based upon its knowledge of the heating, ventilation, and air conditioning ("HVAC") industry and its place in that industry, its ability to limit the growth of its business if necessary, its ability to authorize dividend cash payments, and its relationship with its existing bank lender. For information concerning the Company's revolving credit facility at June 30, 2008, see Note 6 to the Company's Consolidated Financial Statements, Revolving Credit Facility.

In February 2006, the Board of Directors authorized a semi-annual cash dividend payment. Cash dividends were declared in December 2007 and were paid in January 2008 in the amount of $2.9 million. Cash dividends of $2.8 million and $2.5 million were declared and accrued for in June 2008 and 2007, and paid in July 2008 and 2007, respectively. Prior to 2006, no cash dividends had been declared or paid. Board of Director approval is required to determine the date of declaration for each semi-annual payment.

On July 12, 2007, the Company's Board of Directors approved a three-for-two stock split of AAON's outstanding stock for shareholders of record as of August 3, 2007. The stock split was treated as a 50% stock dividend which was distributed on August 21, 2007. As a result of the stock split, the Company adjusted the dividend paid per share to $0.16. The applicable share and per share data for all periods included herein has been restated to reflect the stock split.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because these estimates and assumptions require significant judgment, future actual results could differ from those estimates and could have a significant impact on the Company's results of operations, financial position and cash flows. The Company reevaluates its estimates and assumptions on a monthly basis.

There have been no significant changes in critical accounting policies or management estimates since the year ended December 31, 2007. A comprehensive discussion of the Company's critical accounting policies and management estimates is included in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2007.

New Accounting Pronouncements

In September 2006, the FASB released SFAS No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value and establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. Although SFAS 157 applies to (and amends) the provisions of existing authoritative literature, it does not, of itself, require any new fair value measurements or establish valuation standards. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Adoption of SFAS 157 did not have a material impact on the Company's Consolidated Financial Statements.

In February, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which creates an alternative measurement treatment for certain financial assets and financial liabilities. SFAS 159 permits fair value to be used for both the initial and subsequent measurements on an instrument by instrument basis, with changes in the fair value to be recognized in earnings as those changes occur. This election is referred to as the fair value option. SFAS 159 also requires additional disclosures to compensate for the lack of comparability that will arise from the use of the fair value option. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Adoption of SFAS 159 did not have a material impact on the Company's Consolidated Financial Statements. The Company did not elect the fair value option for any assets or liabilities.

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", "will", and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Important factors that could cause results to differ materially from those in the forward-looking statements include (1) the timing and extent of changes in raw material and component prices, (2) the effects of fluctuations in the commercial/industrial new construction market, (3) the timing and extent of changes in interest rates, as well as other competitive factors during the year, and (4) general economic, market or business conditions.