<PAGE>



                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    FORM 10-Q

(Mark One)


[ X ]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
         SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended    October 3, 1998
                              ------------------------
                                       OR

[   ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
         SECURITIES EXCHANGE ACT OF 1934


For the transition period from  _______ to _______


Commission file number:               33-80701



                                 AAF-MCQUAY INC.
-------------------------------------------------------------------------------
             (Exact name of Registrant as Specified in Its Charter)


            Delaware                                   41-0404230
-------------------------------           ------------------------------------
(State or Other Jurisdiction of           (I.R.S. Employer Identification No.)
Incorporation or Organization)


111 South Calvert Street, Baltimore, Maryland             21202
---------------------------------------------           ---------
(Address of Principal Executive Offices)                (Zip Code)



Registrant's telephone number, including area code    (410) 528-2755
                                                      ---------------

                              Not applicable
--------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report.


Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x    No
                                      ---      ---

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 2,497 shares of Common Stock,
par value $100.00 per share, were outstanding as of November 9, 1998.



<PAGE>


                                      INDEX

                        AAF-MCQUAY INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>

                                                                                                  Page
                                                                                                  -----
<S>                                                                                                <C>
Part I -         Financial Information .....................................................       3
------

Item 1.          Financial Statements(unaudited) ...........................................       3

                 Consolidated Balance Sheets as of  -
                 September 30, 1998 and June 30,1998 .......................................       3

                 Consolidated Statements of Operations -
                 Three months ended September 30, 1998 and
                 September 30, 1997 ........................................................       4

                 Condensed Consolidated Statements of Cash Flows-Three months 
                 ended September 30, 1998 and September 30, 1997 ...........................       5

                 Notes to the Consolidated Financial Statements ............................       6

Item 2.          Management's Discussion and Analysis of Financial Condition and Results of
                 Operations ................................................................       9

Part II -        Other Information .........................................................      14
-------

Item 1.          Legal Proceedings .........................................................      14

Item 6.          Exhibits and Reports on Form 8-K ..........................................      14

                 Signatures ................................................................      15

</TABLE>





                                       2
<PAGE>



PART I:           FINANCIAL INFORMATION

         Item 1.  Financial Statements



                        AAF-McQUAY INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                    (dollars in thousands, except share data)

<TABLE>
<CAPTION>

                                                                        September 30,             June 30,
                                                                            1998                   1998
                                                                    ---------------------   --------------------
                                                                        (unaudited)
<S>                                                                <C>                      <C>
                              ASSETS:

Current assets:
     Cash and cash equivalents                                                  $  7,382               $  9,697
     Accounts receivable, net                                                    237,719                238,613
     Inventories                                                                 132,907                124,793
     Other current assets                                                          8,173                  8,423
                                                                         ---------------          -------------
          Total current assets                                                   386,181                381,526

Property, plant and equipment, net                                               148,955                145,305
Cost in excess of net assets acquired and other identifiable                     238,499                250,650
intangibles, net
Other assets and deferred charges                                                 19,610                 19,397
                                                                         ---------------          -------------
          Total Assets                                                          $793,245               $796,878
                                                                         ---------------          -------------
                                                                         ---------------          -------------
               LIABILITIES AND STOCKHOLDER'S EQUITY:

Current liabilities:
     Short-term borrowings                                                      $ 78,595               $ 60,262
     Current maturities of long-term debt                                         14,768                 28,531
     Accounts payable, trade                                                     116,185                120,775
     Accrued warranty                                                             14,852                 14,947
     Other accrued liabilities                                                    84,424                 88,713
                                                                         ---------------          -------------
          Total current liabilities                                              308,824                313,228

Long-term debt                                                                   176,960                177,083
Other liabilities                                                                 93,176                100,727
                                                                         ---------------          -------------
          Total liabilities                                                      578,960                591,038

Stockholder's equity:
     Preferred stock ($1 par value; 1,000 shares authorized,
     none issued) Common stock ($100 par value; 8,000 shares authorized,
     2,497 shares issued and outstanding)                                            250                    250
     Additional paid-in capital                                                  179,915                179,915
     Retained earnings                                                            38,516                 33,185
     Accumulated other comprehensive income                                       (4,396)                (7,510)
                                                                         ---------------          -------------
          Total Stockholder's Equity                                             214,285                205,840
                                                                         ---------------          -------------

Total Liabilities and Stockholder's Equity                                      $793,245               $796,878
                                                                         ---------------          -------------
                                                                         ---------------          -------------

</TABLE>


                 See Notes To Consolidated Financial Statements



                                       3
<PAGE>





                        AAF-McQUAY INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (unaudited)
                             (dollars in thousands)



<TABLE>
<CAPTION>

                                                                                    Three months ended
                                                                         --------------------------------------
                                                                             September 30,        September 30,
                                                                                 1998                 1997
                                                                         --------------------------------------

<S>                                                                      <C>                     <C>
Net Sales                                                                      $ 251,400            $  245,126
Cost of Sales                                                                    183,865               178,039
                                                                         ---------------         -------------
Gross Profit                                                                      67,535                67,087
Operating Expenses:
     Selling, general and administrative                                          55,839                55,207
      Restructuring                                                                  751                     0
     Amortization of intangible assets                                             2,902                 2,900
                                                                         ---------------         -------------
                                                                                  59,492                58,107
                                                                         ---------------         -------------
Income from operations                                                             8,043                 8,980

Interest expense, net                                                              6,506                 6,558
Other (income) expense, net                                                       (4,812)                 (152)
                                                                         ---------------         -------------
Income before income taxes                                                         6,349                 2,574
Minority interest (earnings) loss                                                    (10)                  126
Income taxes                                                                       1,529                 1,158
                                                                         ---------------         -------------
Net income                                                                        $4,830                $1,290
                                                                         ---------------         -------------
                                                                         ---------------         -------------


</TABLE>

                 See Notes To Consolidated Financial Statements


                                       4
<PAGE>




                        AAF-McQUAY INC. AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (unaudited)
                             (dollars in thousands)


<TABLE>
<CAPTION>

                                                                                   Three months ended
                                                                         -------------------------------------
                                                                              September 30,      September 30,
                                                                                  1998              1997
                                                                         -------------------------------------
<S>                                                                      <C>                     <C>       
Cash flows from operating activities
      Net income                                                               $    4,830           $    1,290
      Adjustments to reconcile to cash from
           operating activities:
      Depreciation and amortization                                                 6,858                6,688
      Foreign currency transaction (gains) losses                                   (259)                  183
      Changes in operating assets and liabilities                                (13,060)               (3,681)
                                                                         ---------------         -------------

Net cash from operating activities                                                (1,631)                4,480

Cash flows from investing activities:
      Capital expenditures, net                                                   (5,241)               (3,637)
                                                                         ---------------         -------------
Net cash from investing activities                                                (5,241)               (3,637)

Cash flows from financing activities:
      Net borrowing (repayments) under short-term
        borrowing arrangements                                                    18,333                 4,911
      Payments on long-term debt                                                 (13,886)               (2,720)
                                                                         ---------------         -------------
Net cash from financing activities                                                 4,447                 2,191

Effect of exchange rate changes on cash                                              110                   156
                                                                         ---------------         -------------
Net increase (decrease) in cash and cash equivalents                              (2,315)                3,190
Cash and cash equivalents at beginning of period                                   9,697                10,827
                                                                         ---------------         -------------

Cash and cash equivalents at end of period                                    $    7,382           $    14,017
                                                                         ---------------         -------------
                                                                         ---------------         -------------

</TABLE>


                 See Notes To Consolidated Financial Statements

                                       5
<PAGE>

Notes to the Consolidated Financial Statements (unaudited)

Note 1.  Basis of Presentation:

     The consolidated financial statements include the accounts of the Company
and all of its wholly-owned subsidiaries. All inter-company transactions have
been eliminated. The accompanying unaudited consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim reporting and with the instructions to Form 10-Q and Article 10 of
Regulation S-K. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K (the "Annual Report") for the year ended
June 30, 1998. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have
been included. The accompanying financial statements reflect the statements of
operations for the three months ended September 30, 1998 and September 30, 1997,
the balance sheets at September 30, 1998, and June 30, 1998, and the
consolidated statements of cash flows for the three months ended September 30,
1998 and September 30, 1997.

     The operating results for the three months ended September 30, 1998 are not
necessarily indicative of the operating results that may be expected for the
full year ending June 30, 1999. The Company's period end is the closest Saturday
to September 30. For clarity in presentation all periods presented herein are
shown to end on the 30th of the month.

     During the first quarter of fiscal year 1999, the Company made a change in
accounting estimate related to its warranty provision. The Company increased its
warranty provision by $2.5 million due to recent activity related to new product
introductions and discontinued product lines.

Note 2.  Inventories:

     Inventories consist of the following:
     (dollars in thousands)


<TABLE>
<CAPTION>

                                                                          September 30,             June 30,
                                                                               1998                  1998
                                                                         ---------------         -------------
<S>                                                                      <C>                     <C>    
      FIFO Cost:
            Raw Materials                                                       $ 54,998              $ 46,513
            Work-in-process                                                       27,583                33,493
            Finished goods                                                        46,567                40,961
                                                                         ---------------         -------------
                                                                                 129,148               120,967
            LIFO adjustment                                                        3,759                 3,826
                                                                         ---------------         -------------
                                                                                $132,907              $124,793
                                                                         ---------------         -------------
                                                                         ---------------         -------------

</TABLE>


Note 3.  Comprehensive Income:

     In the first quarter of fiscal year 1999, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income."
SFAS 130 requires disclosure of total non-stockholder changes in equity in
interim periods and additional disclosures of the components of non-stockholder
changes in the equity on an annual basis. Total non-stockholder components in
equity includes all changes in equity during a period except those resulting
from investments by and distribution to stockholders.




                                       6
<PAGE>




The components of comprehensive income for the first quarters of fiscal years
1999 and 1998 were as follows:

<TABLE>
<CAPTION>


                                                                         September 30,           September 30,
                                                                             1998                   1997
                                                                         ---------------         -------------
<S>                                                                      <C>                      <C>        
      Net income                                                             $     4,830          $     1,290
      Foreign currency translation adjustment                                      3,114                 (488)
                                                                         ---------------         -------------
      Total comprehensive income                                             $     7,944          $       802
                                                                         ---------------         -------------
                                                                         ---------------         -------------

</TABLE>


Note 4.  Income Taxes:

     The tax provisions for the three month periods ended September 30, 1998 and
1997 are based on the estimated effective tax rates applicable for the full
years, and after giving effect to significant unusual items related specifically
to the interim periods. The difference between the Company's reported tax
provision, for the three months ended September 30, 1998 and 1997, and the tax
provision computed based on U.S. statutory rates is primarily attributable to
nondeductible goodwill amortization and unbenefitted foreign losses.
Additionally, the Company's effective tax rate for the quarter ended September
30, 1998 reflects the effect of the indemnification settlement agreement and the
IRS settlement described below which was recognized as income for financial
reporting purposes but is not taxable for income tax purposes. The Company
estimates that its effective income tax rate for the year ended June 30, 1999
will be 45%.

     During the first quarter of fiscal year 1999, as a result of the
indemnification settlement agreement and the IRS settlement described below, the
Company realized certain deferred tax benefits related to periods prior to the
acquisition by OYL. The effect of realizing these tax benefits was to reduce net
deferred tax liabilities and goodwill by $9.7 million.

Note 5.  Restructuring:

     As described in Note 9 of the Annual Report, the Company commenced a
restructuring of its Filtration Products Group in the fourth quarter of fiscal
year 1998. The Company continues to implement actions in accordance with the
restructuring plan. In addition, the Company restructured its German operations
of the Filtration Products Group during the first quarter of fiscal year 1999,
recording a charge of $0.8 million which primarily represents severance
accruals.

Note 6.  Contingencies:

     Indemnification.

     The purchase agreement between OYL and the former owners of the Company
contained certain indemnifications relating to specified contingencies that
existed as of the acquisition date relating to certain environmental, tax and
litigation matters. On July 8, 1998, the Company and the former owners entered
into a settlement agreement in resolution of certain disputes which were pending
before the American Arbitration Association in Dallas, Texas, concerning the
interpretation of the indemnification obligation. As a result of the settlement
agreement, the Company paid $10.5 million of the $11.5 million promissory note
due to the former shareholders, discussed in Note 7 of the Consolidated
Financial Statements, and the parties agreed to discharge claims and
entitlements under the indemnification provisions in the purchase agreement. The
residual balance of the promissory note has been reclassified to other
liabilities for specified contingencies that existed as of the acquisition date.

     In addition, as a result of the indemnification settlement agreement and
the IRS settlement described above, the Company expects to receive payments from
certain former shareholders of approximately $5.0 million in fiscal year 1999.
Approximately $2.1 million of the payments to be received from the former
shareholders will be utilized to fund obligations relating to the IRS
settlement. In conjunction with this settlement, the Company has recognized $2.9
million in other income in the first quarter of fiscal year 1999.


                                       7
<PAGE>


     Environmental Matters:

     The Company is subject to potential liability under the Comprehensive
Environmental Response, Compensation, and Liability Act of 1980, as amended
(CERCLA), and other federal, state and local statutes and regulations governing
the discharge of pollutants into the environment and the handling and disposal
of hazardous substances and waste. These statutes and regulations, among other
things, impose potential liability on the Company for the cost of remediation of
contamination arising from the Company's past and present operations and from
former operations of other entities at sites later acquired and now owned by the
Company. Many of the Company's facilities have operated for many years, and
substances which are or might be considered hazardous were generated, used, and
disposed of at some locations, both on- and off-site. Therefore, it is possible
that environmental liabilities in addition to those described in note 14 of the
Annual Report may arise in the future. The Company records liabilities if, in
management's judgment, environmental assessments or remedial efforts are
probable and the costs can be reasonably estimated. These accrued liabilities
are not discounted. Such estimates are adjusted if necessary based upon the
completion of a formal study or the Company's commitment to a formal plan of
action.

     The Company is currently a plaintiff in several legal suits, assessing
insurance coverage, or pursuing other actions in an attempt to recover the cost
associated with above liabilities. No amounts have been recorded in the
accompanying Consolidated Balance Sheets relating to any such possible
recoveries.

     Income Tax:

     The Internal Revenue Service ("IRS") has completed its examination of the
Company's tax returns for the years 1987 through 1994 and has issued a final
executed closing agreement which was received by the Company in September.

     Litigation:

     The Company is involved in various lawsuits in the ordinary course of
business. These lawsuits primarily involve claims for damages arising out of the
use of the Company's products. The Company is also involved in litigation and
administrative proceedings involving employment matters and commercial disputes.
Some of these lawsuits include claims for punitive as well as compensatory
damages. The Company is insured for product liability claims for amounts in
excess of established deductibles and accrues for the estimated liability on a
case-by-case basis up to the limits of the deductibles. All other claims and
lawsuits are also handled on a case-by-case basis.

     The Company does not believe that the potential liability from the ultimate
outcome of environmental, income tax and litigation matters will have a material
adverse effect on the Company.


                                       8
<PAGE>



Item 2.            Management's Discussion and Analysis of Financial Condition
                            and Results of Operations

     Results of Operations:

     Net Sales

     Consolidated net sales for the first quarter of fiscal year 1999 were
$251.4 million. This represents an increase of $6.3 million, or 2.6%, from
$245.1 million for the first quarter of fiscal year 1998. The Commercial Air
Conditioning and Refrigeration Group reported a net sales increase of $9.2
million, or 5.8%, which was offset by a decrease in net sales of $1.5 million,
or 1.7%, in the Filtration Products Group for the quarter as compared to the
prior year. The following table presents the Company's revenues by business
segment. The first quarter of fiscal year 1999 reflects a 14 week period as
compared to a 13 week period for the first quarter of 1998.


<TABLE>
<CAPTION>

                                                                          September 30,           September 30,
                                                                              1998                    1997
                                                                         ---------------         -------------
                                                                                 (dollars in thousands)
<S>                                                                      <C>                     <C>
Net sales:
  Commercial Air Conditioning and Refrigeration                           $      166,756         $     157,584
  Filtration Products                                                             88,444                89,938
  Eliminations/other                                                              (3,800)               (2,396)
                                                                         ---------------         -------------
     Total                                                                $      251,400         $     245,126
                                                                         ---------------         -------------
                                                                         ---------------         -------------

</TABLE>


     The Commercial Air Conditioning and Refrigeration Group's net sales
increased $9.2 million, or 5.8%, to $166.8 million for the first quarter of
fiscal year 1999 versus the first quarter of fiscal year 1998. This increase was
attained despite the sale of the industrial fan business in October of 1997
which contributed $5.8 million in the first quarter of fiscal year 1998.
Excluding the fan business, net sales increased $15.0 million, or 9.9%, year
over year for the first quarter.

     North American net sales increased 1.6% in the first quarter of fiscal year
1999, or 7.0% excluding the industrial fan business, compared to the first
quarter of fiscal year 1998. This sales increase is primarily attributable to
increased sales in air handling systems. Strong market demand for air handling
rooftop, self contained and new air handling products continued to grow
resulting in increased sales of $9.3 million for the first quarter of fiscal
year 1999 as compared to the first quarter of fiscal year 1998. Additionally,
the service organization had a net sales increase of $1.1 million for the first
quarter of fiscal year 1999 as compared to the first quarter of fiscal year 1998
due to strong demand for replacement parts and retrofit demand. These net sales
increases were offset by a 4.4% decrease in chiller products for the first
quarter of fiscal year 1999 as compared to the first quarter of fiscal year 1998
primarily due to reduced centrifugal chiller sales. Centrifugal chiller net
sales decreased in the export markets, especially the Asian regions. As a result
of the weak economic conditions in the Asian markets, management believes that
sales to this area will continue to slow. The decrease in centrifugal chiller
net sales was partially offset by increased demand for air cooled chiller
products and increased compressor sales. Terminal products net sales remained
flat for the first quarter of fiscal year 1999 as compared to the first quarter
of fiscal year 1998 as volume growth in terminal products was offset by an
overall decline in the unit ventilator market.

     International net sales volume increased 16.3% in the first quarter of
fiscal year 1999 versus the comparable period of the prior fiscal year. Domestic
chiller product sales increases experienced in Italy, France and the United
Kingdom and strong export sales in Italy and the United Kingdom resulted in a
net sales increase of $5.1 million for the first quarter of fiscal year 1999 as
compared to the first quarter of fiscal year 1998. International net sales
increases also resulted from two refrigeration contracts and the establishment
of a sales office in Dubai.



                                       9
<PAGE>

     Backlog for the Commercial Air Conditioning and Refrigeration Group was
$125.5 million at the end of the first quarter of fiscal year 1999 as compared
to $144.7 million and $138.5 million at the end of the first quarter and fiscal
year end 1998, respectively. The decrease results from normal volatility in
order flow, continued softness in the Asian markets and the timing of shipments.
Additionally, terminal products backlog is down due to decreased unit ventilator
market conditions.

     The Filtration Products Group's net sales decreased $1.5 million, or 1.7%,
to $88.4 million for the first quarter of fiscal year 1999 versus the first
quarter of fiscal year 1998. Compared to the first quarter of fiscal year 1998,
domestic net sales remained flat and international net sales decreased 1.5% in
the first quarter of fiscal year 1999. In the domestic markets, net sales
increases in air filtration product markets were offset by reductions in the
environmental product business resulting from the recent reorganization which
focuses on core products. European net sales increased 13.6% for the first
quarter of fiscal year 1999 compared to the first quarter of fiscal year 1998.
This increase resulted from volume increases in air filtration products in all
regions, increased volume of air pollution control systems in France and
machinery filtration systems in the European markets. Asia sales decreased $4.4
million for the first quarter of fiscal year 1999 as compared to the first
quarter of fiscal year 1998. This decrease is attributable to the continuing
weak economic conditions in the Asian markets and a Korean project in the first
quarter of fiscal year 1998 which was not repeated in the current year.
Management expects sales growth in the Asian market to continue slowing due to
the economic conditions being experienced in the region. Latin American
environmental product sales decreased $1.2 million during the first quarter of
fiscal year 1999 versus the comparable period of fiscal year 1998 due to soft
market demand.

     Gross Profit

     Consolidated gross margin was $67.5 million or 26.9% of sales for the first
quarter of fiscal year 1999 versus $67.1 million or 27.4% of sales for the first
quarter of fiscal year 1998. In the Commercial Air Conditioning and
Refrigeration Group, gross profit as a percentage of sales was 25.4% in the
first quarter of fiscal year 1999 as compared to 25.8% of sales in the first
quarter of fiscal year 1998. Gains in gross margin resulting from price
increases and product mix of air handling products were partially offset by
unfavorable manufacturing variances and lower margin sales of chiller and
terminal products. The Filtration Products Group's gross profit as a percentage
of sales decreased in the first quarter from 29.4% in fiscal year 1998 to 28.4%
in fiscal year 1999. This decrease resulted from margin rate deterioration in
Asia due to competitive price pressures and product mix in Latin America more
than offsetting favorable gains in product mix in Europe.

     Operating Expenses

     Operating expenses were $59.5 million or 23.7% of sales for the first 
quarter of fiscal year 1999 as compared to $58.1 million or 23.7% of sales 
for the first quarter of fiscal year 1998. Expense reductions resulting from 
Company-wide cost containment measures and the reorganization of the 
Filtration Products Group were offset by volume related expense increases in 
the Commercial Air Conditioning and Refrigeration Group during the first 
quarter of fiscal year 1999 including commission expense increases from 
changes in distribution pricing and warranty expense increases related to new 
product introductions in the chiller business and a discontinued product 
line. The Filtration Products Group incurred expenses, primarily severance, 
related to the restructuring of its German operations. Research and 
development remained consistent year over year for the first quarter. The 
Company continues to incur certain strategic expenses to enhance its position 
in the global market and costs associated with upgrading software systems to 
enhance business performance.

     Income from Operations

     Income from operations for the first quarter of fiscal years 1999 and 1998
was $8.0 million and $9.0 million, respectively. As a percentage of sales,
income from operations was 3.2% for the first quarter of fiscal year 1999 and
3.7% for the first quarter of fiscal year 1998. The Commercial Air Conditioning
and Refrigeration Group had a decrease in income from operations from $5.3
million, or 3.4% of sales, to $3.8 million, or 2.3% of sales, for the first
quarter of fiscal year 1999 as compared to the first quarter of fiscal year


                                       10
<PAGE>

1998, respectively, as a result of the warranty expenses noted above. The
Filtration Products segment had an increase in income from operations to $4.5
million, or 5.1% of sales, in the first quarter of fiscal year 1999 from $4.3
million, or 4.8% of sales, in the first quarter of fiscal year 1998.

     Net Interest Expense and Other (Income) Expense

     Net interest expense was $6.5 million in the first quarter of fiscal year
1999 as compared to $6.6 million for the first quarter of fiscal year 1998. Net
other income for the first quarter of fiscal year 1999 was $4.8 million compared
to $0.2 million in the first quarter of fiscal year 1998. The Company recorded
$2.9 million in other income as a result of favorable developments in the IRS
audit and the tax indemnification settlement with former shareholders of the
Company as described in Note 6. The Company also recorded a $1.5 million gain
related to the termination of a pension plan in Canada. The remaining components
of other income and expenses resulted from foreign currency gains and equity
affiliate transactions.

     Liquidity and Capital Resources

     The Company's liquidity needs are provided by cash generated from operating
activities and supplemented when necessary by short-term credit facilities.
During the first quarter of fiscal year 1999, funds used by operating activities
were $1.6 million as compared to net cash provided by operations of $4.5 million
in the prior fiscal year for the comparable period. The decrease in operating
cash provided for the first quarter of fiscal year 1999 reflects higher working
capital requirements, primarily increased investment in inventory. During the
first quarter of fiscal year 1999, cash used in investing activities was $5.2
million, reflecting increased capital spending on the information technology
enhancement project. As a result of a settlement agreement reached with the
former shareholders of the Company regarding certain indemnification matters,
the Company retired the $11.5 million promissory note due to the former
shareholders on July 8, 1998 by making a cash payment of $10.5 million. Total
payments on long-term debt were $13.9 million. Cash of $18.3 million was
provided by net borrowing under short-term borrowing arrangements for long term
debt repayment and working capital requirements during the quarter.

     During the first quarter of fiscal year 1999, the Company amended its bank
credit facility, effective as of June 30, 1998, to restate certain financial
covenants. At the end of the first quarter of fiscal year 1999, the Company had
approximately $39 million in additional borrowing capacity under the amended
revolving credit facility.

     As a result of approaches received from interested parties, OYL has
appointed BancAmerica Robertson Stephens as its financial advisor to pursue a
sale process which may or may not result in a sale of the Company. The
short-term credit facilities provided to two subsidiaries of the Company and
supported by letters of credit from OYL (17 million for J&E Hall Limited
(U.K.) and $6.0 million for AAF-McQuay Canada Inc.) were extended from an
expiration date of September 30, 1998 to December 31, 1998. In addition, the
Company has secured certain domestic letter of credit facilities totaling $13.5
million that are supported by a letter of credit from OYL which expires on March
21, 1999. Each of these support arrangements may be extended for additional time
periods with the consent of OYL and the banks providing the facilities. The time
period of any extension will depend upon a number of factors, including the
status of the sale process described earlier. Certain executive compensation
programs may be triggered as a result of a sale.

     On an ongoing basis the Company strives to evaluate its various businesses
and product lines with the objective to enhance shareholder value. Consistent
with this strategy, the Company intends to pursue global business opportunities
that are synergistic with the Company's core businesses or exit low value added
or non-synergistic operations.

     Management believes, based upon current levels of operations and forecasted
earnings, that cash flow from operations, together with borrowing capacity
available under the Amended Credit Facility, will be adequate to make payments
of principal and interest on debt, to permit anticipated capital expenditures
and to fund working capital requirements and other cash needs for the
foreseeable future. Nevertheless, the Company expects to remain leveraged to a
significant extent and expects its debt service obligations to continue to be


                                       11
<PAGE>

substantial. If the Company's sources of funds were to fail to satisfy the
Company's requirements, the Company may need to amend or refinance its existing
debt or obtain additional financing. There is no assurance that any such new
financing alternatives would be available, and, in any case, such new financing
(if available) would be expected to be more costly and burdensome than the debt
agreements currently in place.

   Year 2000

    The Company established a formal Year 2000 program during the fiscal year
ending June 30, 1998, which began with a worldwide assessment and development of
a central data base containing an inventory of the risk elements associated with
the Year 2000 issue for each of the Company's operations. The Company also
appointed an overall project coordinator and established an executive review
process. Prior to establishing a formal Year 2000 management process, the
Company had already decided to replace substantially all of its old systems with
new state-of-the-art Enterprise Resource Planning (ERP) systems. The Company
currently estimates expenditures for the new systems will aggregate
approximately $25.0 million (having incurred approximately $18.8 million as of
September 30, 1998). Expenditures for additional remedial actions beyond those
required to install new systems will be managed by the individual business units
and recognized in operating expenses. The Company's management believes that
modernizing its information systems is critical for the Company's stable and
efficient growth, and it is the basis of the Company's strategy for resolving
its Year 2000 issues.

    During May 1998, the Company began its review of the products it
manufactures and sells, and though testing is not complete, the Company believes
that its products, including the control systems provided by the Company, will
be Year 2000 compliant. The Company has also identified third parties upon whom
the Company is dependent for products or services, and commenced actions during
fiscal year ending June 30, 1998, to ensure those products and services are
compliant and will not be interrupted as a result of Year 2000.

    The scheduled Year 2000 activities and current status are summarized in the
chart below:

<TABLE>
<CAPTION>

         -------------------------------------------------------------------------------------------------------------
         ACTIVITY                           STATUS                     STARTING             ENDING
         -------------------------------------------------------------------------------------------------------------
        <S>                               <C>                       <C>                   <C>
         Assessment and inventory           Complete                   September 1997       January 1998
         -------------------------------------------------------------------------------------------------------------
         Coordinator and Executive review   Complete                   February 1998        May 1998
         process
         -------------------------------------------------------------------------------------------------------------
         Industrial Refrigeration ERP       Complete                   January 1997         April 1998
         -------------------------------------------------------------------------------------------------------------
         Filtration Products  ERP           In Process                 April 1997           February 1999
         -------------------------------------------------------------------------------------------------------------
         Commercial Air Conditioning ERP    In Process                 September 1997       April 1999
         -------------------------------------------------------------------------------------------------------------
         Product compliance                 In Process                 May 1998             TBD
         -------------------------------------------------------------------------------------------------------------
         Materials suppliers                In Process                 June 1998            TBD
         -------------------------------------------------------------------------------------------------------------
         Other IT issues including third    Scheduled                  September 1998       TBD
         parties
         -------------------------------------------------------------------------------------------------------------
         Equipment and facilities           Scheduled                  September 1998       TBD
         -------------------------------------------------------------------------------------------------------------

</TABLE>


The Year 2000 activities are currently on schedule, and the Company anticipates
successful implementation of the scheduled ERP projects and systems upgrades.

    Failure by the Company to complete successfully the planned ERP projects and
systems upgrades or a failure by the Company's third party suppliers and/or
service providers to produce or deliver critical components or to transport
services could cause disruption in the Company's ability to manufacture and/or
deliver timely its products to its customers, which could result in increased
expenses, reduced billings and potential litigation. The precise costs
associated with such risks are difficult to predict at this time. The Company
currently does not have a contingency plan in place in the event it does not
complete all phases of the Year 2000 program. The Company plans to continue to
evaluate the status of completion of its Year 2000 program and determine whether
a contingency plan is necessary.

      Forward-Looking Statements

      When used in this report by management of the Company, from time to time,
the words "believes," "anticipates," and "expects" and similar expressions are
intended to identify forward-looking statements that involve certain risks and
uncertainties. A variety of factors could cause actual results to differ
materially from 


                                       12
<PAGE>


those anticipated in the Company's forward-looking statements, some of which
include risk factors previously discussed in this and other SEC reports filed by
the Company. These risk factors include, but are not limited to, general
economic conditions, environmental laws and regulations, the weakening Asian
markets, unforeseen competitive pressures, warranty expenses, market acceptance
of new products, unseasonably cool spring or summer weather, a slow down in the
chiller market, unforeseen difficulties in maintaining mutually beneficial
relationships with strategic initiatives partners, the Year 2000 issue, and the
potential sale process. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date thereof. The
Company undertakes no obligation to publicly release the results of any events
or circumstances after the date hereof to reflect the occurrence of
unanticipated events.


                                       13
<PAGE>


PART II: OTHER INFORMATION

Item 1.  Legal Proceedings

         The Internal Revenue Service ("IRS") has completed its examination of
the Company's tax returns for the years 1987 through 1994 and has issued a final
executed closing agreement which was received by the Company in September.

Item 6.  Exhibits and Reports on Form 8-K

               (a)  Exhibits

<TABLE>
<CAPTION>

                Number                      Description
                ------                      -----------
                <S>                         <C>
                Exhibit 27                  Financial Data Schedule ( filed herewith)

                Exhibit 10.1                Severance Agreement dated September 8, 1998 with Joseph B. Hunter

                Exhibit 10.2                Divestment Incentive Program Agreement dated September 8, 1998 with Gerald L. Boehrs*
                
                Exhibit 10.3                Divestment  Incentive  Program  Agreement  dated  September  8, 1998 with  Michael  J.
                                            Christopher*
                
                Exhibit 10.4                Divestment  Incentive  Program  Agreement  dated  September  8,  1998  with  Andrew R.
                                            Morrison*
                

</TABLE>


              * Portions of the document have been omitted pursuant to a
              request for confidential treatment. The full documents have
              been filed separately.

              (b)  Reports on Form 8-K

                   There were no reports filed on Form 8-K during the period.



                                       14
<PAGE>



SIGNATURES
----------

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



                                            AAF-MCQUAY INC.





DATE   November 10, 1998            By:     /S/   ANDREW R. MORRISON
     -------------------                    ------------------------
                                            Andrew R. Morrison
                                            Chief Financial Officer


DATE   November 10, 1998                    /S/   BRUCE D. KRUEGER
     --------------------                   ------------------------
                                            Bruce D. Krueger Controller
                                            (Principal Accounting Officer)



                                       15
<PAGE>


                                             Exhibit Index

<TABLE>
<CAPTION>


Number                                    Description
------                                    -----------
<S>                                       <C>
     Exhibit 27                           Financial Data Schedule ( filed herewith)

     Exhibit 10.1                         Severance Agreement dated September 8, 1998 with Joseph B. Hunter

     Exhibit 10.2                         Divestment Incentive Program Agreement dated September 8, 1998 with Gerald
                                          L. Boehrs*

     Exhibit 10.3                         Divestment Incentive Program Agreement dated September 8, 1998 with Michael
                                          J. Christopher*

     Exhibit 10.4                         Divestment Incentive Program Agreement dated September 8, 1998 with Andrew
                                          R. Morrison*

</TABLE>


* Portions of the document have been omitted pursuant to a request for
confidential treatment. The full documents have been filed separately.



                                       16