SECURITIES AND EXCHANGE COMMISSION

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the Fiscal Year Ended June 30, 2004
Commission File No. 0-5214

2819 Walnut Hill Lane, Dallas, Texas 75229
(Address of principal executive offices)

Registrant’s telephone number, including area code: (214) 357-6181

Securities registered pursuant to Section 12(b) of the Act:
None

Securities Registered Pursuant to Section 12(g) of the Act:

     Indicate by check mark 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2 of the Act). Yes [  ]    No [X]

     The aggregate value of the voting stock held by non-affiliates of the Registrant as of December 31, 2003 was approximately $ 31.1 million. Shares of voting stock held by executive officers, directors and holders of more than 10% of the outstanding voting stock have been excluded from this calculation because such persons may be deemed to be affiliates. Exclusion of such shares should not be construed to indicate that any of such persons possesses the power, direct or indirect, to control the Registrant, or that any such person is controlled by or under common control with the Registrant.

     Number of shares outstanding of the Registrant’s Common Stock, $1.00 par value, as of September 22, 2004 was 3,024,184.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

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TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

     Peerless Mfg. Co. (the “Company,” “Registrant,” “Peerless” or “we,” “us” or “our”) was organized in 1933 as a proprietorship and was incorporated as a Texas corporation in 1946. We have three wholly owned subsidiaries incorporated in Texas, the United Kingdom, and Barbados, respectively. Our executive offices are located at 2819 Walnut Hill Lane, Dallas, TX 75229. Our telephone number at this location is (214) 357-6181, and our website may be accessed at www.peerlessmfg.com. Our fiscal year ends on June 30. References herein to “fiscal 2002,” “fiscal 2003,” and “fiscal 2004” refer to our fiscal years ended June 30, 2002, 2003, and 2004, respectively.

     In connection with the discontinuation of our Boiler operations (see Note D – “Discontinued Operations” in our Notes to Consolidated Financial Statements), the fiscal 2004 financial information has been presented, and the prior years financial information has been restated, to report the discontinued operations in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” In addition, certain fiscal 2003 and fiscal 2002 items have been reclassified to conform to the fiscal 2004 presentation.

Operating Segments and Products

     We operate our business through two primary business segments, the first of which is our Environmental Systems business, which accounted for approximately 47% of our revenues in fiscal 2004. In this segment, we design, engineer, manufacture and sell environmental control systems, which are used for air pollution abatement. Our main product, Selective Catalytic Reduction Systems, referred to as “SCR Systems,” is used to convert nitrogen oxide (NOx) emissions from exhaust gases, caused by burning hydrocarbon fuels, such as coal, gasoline, natural gas and oil, into harmless nitrogen and water vapor. These systems are totally integrated, complete with instruments, controls and related valves and piping. In this segment, we also offer systems to reduce other pollutants, such as carbon monoxide (CO) and particulate matter (PM).

     Our other business segment is our Separation Filtration Systems business, which accounted for approximately 53% of our revenues in fiscal 2004. In this business segment, we design, engineer, manufacture and sell specialized products known as “separators” or “filters” which are used for a variety of purposes in cleaning gases and liquids as they move through piping systems. These products are used primarily to remove solid and liquid contaminants from natural gas, as well as saltwater aerosols from combustion intake air of shipboard gas turbine and diesel engines. Separators are also used in nuclear power plants to remove water from saturated steam.

     Although we manufacture and stock a limited number of products for immediate delivery, the majority of our products are custom designed based on specific customer requirements or specifications, generally pursuant to long-term fixed priced contracts. In certain cases, our products are designed by us but produced by subcontractors or contract vendors under our supervision.

     Please see Note O - “Industry Segment and Geographic Information,” in our Notes to Consolidated Financial Statements and Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report for further disclosure and discussion of financial information with respect to these two segments, Environmental Systems and Separation Filtration Systems.

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Restructuring and Organizational Realignment

     During fiscal 2002, the demand for electricity declined and the United States economy weakened. As a result, a considerable slowdown in the construction of new power plants occurred. In addition, regulatory uncertainties caused NOx reduction initiatives relating to retrofit projects to be delayed. In July 2002, as a response to these market and economic indicators, we initiated a “restructuring and organizational realignment initiative.” The goal of this initiative was to reduce costs, streamline operations, and identify certain non-critical, marginally performing operating activities, thereby positioning us with a more competitive cost structure for our overall long-term success. In connection therewith, we identified our Boiler business as a non-critical, marginally performing business segment and suspended new orders during fiscal 2003. The assets of this segment were sold during the first part of fiscal 2004, and as a result, our financial information has been restated to present this operation as a discontinued business unit.

     We believe as a result of these initiatives, including the redirection of our resources to focus on our two remaining segments, we are positioned to maximize our current operational efficiencies and have the flexibility to meet our customers’ current and anticipated needs. Even though our restructuring and organizational realignment initiatives are complete, we continue to look for ways to improve our operational efficiencies and performance.

Manufacturing and Outsourcing

     Our products are fabricated utilizing a combination of in-house manufacturing, subcontractors and contract vendors. In both fiscal 2003 and 2004, manufacturing outsourced to subcontractors accounted for a significant percentage of our costs of good sold (approximately 39% in fiscal 2003 and 41% in fiscal 2004). We believe the use of outsourcing relationships provides us with flexibility to rapidly expand our manufacturing capacity without significantly increasing our capital expenditures. Our subcontractors generally manufacture products on a fixed-price basis for each project. We regularly review our subcontractor and contract vendor relationships to ensure competitive pricing , quality and workmanship standards and on-time delivery performance.

     We maintain significant in-house manufacturing capabilities and generally manufacture products whose complexity may preclude their production by our subcontractors and contract vendors and where necessary, to protect our proprietary technology.

Customers

     Our Environmental Systems are sold to power producers, power developers, engineering and construction companies, heat recovery steam generator manufacturers, boiler manufacturers, refineries, petrochemical plants and others who desire or may be required by environmental regulations to reduce NOx emissions and ground level ozone to which NOx is a precursor.

     Gas separators, filters and conditioning systems produced by our Separation Filtration Systems business are sold to gas producers and gas gathering, transmission and distribution companies, chemical manufacturers and oil refineries, either directly or through contractors engaged to build plants and pipelines, and to manufacturers of compressors, turbines, and nuclear and conventional steam generating equipment. Marine separation and filtration systems are sold primarily to shipbuilders.

     We market our products worldwide through independent representatives who sell on a commission basis under the general direction of an officer of Peerless. We also sell products directly to customers through our internal sales force. Our business activity and revenues historically have not been seasonal.

     We are not dependent upon any single customer or group of customers in either of our two business segments. The custom-designed and project-specific nature of our business can cause year-to-year

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variances in our major customers. During fiscal 2004, one customer accounted for approximately 10% of our revenues, and in fiscal 2003 and 2002, different customers accounted for approximately 16% and 15% of our total revenues, respectively.

     Sales to international customers have been an integral part of our business for more than 40 years. During fiscal 2004, foreign sales amounted to approximately $25.1 million, or 42.0% of our revenues, compared to sales of approximately $25.0 million, or 38.5% of our revenues during fiscal 2003, and $20.6 million, or 21.7% of our revenues in fiscal 2002. Our global offices and worldwide independent sales rep network allows us to sell to most geographic regions. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Our Operating Results and Other Risk Factors” and Item 7A - “Quantitative and Qualitative Disclosures About Market Risk” of this Report.

Backlog

     Our backlog of uncompleted orders as of June 30, 2004, was approximately $34 million, compared to $40 million as of June 30, 2003. Backlog has been calculated under our customary practice of including incomplete orders for products that are deliverable in future periods, but that may be changed or cancelled. Approximately 70% of our backlog is scheduled to be completed during our next fiscal year ending June 30, 2005. For further discussion on our backlog, please see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Backlog” of this Report.

Competition

     We have several domestic and international competitors with capital and revenues that are larger and smaller than ours in the manufacturing and selling of Environmental Systems and Separation Filtration Systems. Management believes that experience, performance, reliability and warranty service are the prime competitive factors in our markets. We believe that we strongly compete in all these areas.

Patents, Licenses and Product Development

     We believe that we are an industry leader in designing, engineering and manufacturing efficient, dependable Environmental Systems. We also consider ourselves to be highly skilled in the technology required to design and manufacture high efficiency vapor/liquid separation equipment and systems for the oil and gas industry and filtration equipment for the marine market. Our expenditures for new product development and improvements were approximately $241,000 in fiscal year 2004, $316,000 in fiscal 2003, and $576,000 in fiscal 2002.

     To protect our intellectual property rights, we depend upon a combination of patents, trademarks, internal controls and non-disclosure and confidentiality agreements with our employees, subcontractors, contract vendors, customers and others having business dealings with the Company. We have existing patents and patent applications pending on certain products and processes that are important to our business. These include patents on vane designs, separator profiles, environmental controls equipment, marine/separator filtration systems and pressure testing capabilities. In addition, most of our products are proprietary and are sold utilizing our proven technology and knowledge of the applications.

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Employees

     At June 30, 2004, we had 181 employees (196 employees at June 30, 2003). Our employees by location is as follows:

     None of our employees are represented by a labor union or are subject to a collective bargaining agreement. We have not experienced any material labor difficulties during the past year and we believe our employee relations are good.

Raw Materials

     We purchase raw materials and component parts essential to our business from established sources and have not experienced any unusual problems in purchasing required materials and parts. We believe that raw materials and component parts will be available in sufficient quantities to meet our anticipated demand. However, there can be no assurance that we will continue to find our raw materials in quantities or at prices satisfactory to us.

Environmental Regulation

     We do not believe that our compliance with federal, state or local statutes or regulations relating to the protection of the environment has had any material effect upon capital expenditures, earnings or our competitive position. Our manufacturing processes do not emit substantial foreign substances into the environment.

     Environmental regulations related to NOx and ozone emissions have a significant impact on the demand for our Environmental Systems. See also Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Forward Looking Statements and Factors That May Affect Our Operating Results and Other Risk Factors” of this Report. For geographic information see Note O – “Industry Segment and Geographic Information,” of our Notes to Consolidated Financial Statements attached to this Report.

Available Information

     Our Internet website is http://www.peerlessmfg.com. Peerless makes available free of charge through its Internet website (under “Investor Relations”) the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and Proxy Statements and all amendments to those reports as soon as reasonable practicable after they are electronically filed with (or furnished to) the Securities and Exchange Commission (SEC). Reports, Proxy Statements and other information regarding the Company also are contained on the SEC’s Internet website, http://www.sec.gov.

     Peerless has posted its Code of Conduct for Directors and Employees and other corporate governance related policies, and charters for its Audit, Compensation and Nomination Committees on its website, http://www.peerlessmfg.com. This information is available in print to any shareholder who

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requests it by writing to the Company at 2819 Walnut Hill Lane, Dallas, Texas 75229, attention: Ms. Susan Banner.

ITEM 2. PROPERTIES.

     Our executive offices and research and development facilities are owned, and are located in Dallas, Texas. We own and operate manufacturing and warehousing facilities in Abilene, Denton and Dallas, Texas. We also lease sales and marketing facilities in Dallas, Texas, Halstead – Essex, England and Singapore. See table below for additional details on our locations.

     During fiscal year 2003, in connection with restructuring initiatives, we consolidated our Dallas manufacturing operations into our Abilene manufacturing facility.

     While we believe our office and manufacturing facilities are adequate and suitable for our present and future requirements, we will continue to periodically review our space requirements and consolidate and dispose, lease or sublet facilities we no longer require and acquire new space, if our needs dictate.

     Pursuant to the terms of our revolving credit facility, we have agreed not to pledge as collateral our facilities for any obligations . Please see Item 7 - - “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” of this Report.

ITEM 3. LEGAL PROCEEDINGS

     From time to time we are involved in various litigation matters arising in the ordinary course of our business. We do not believe the disposition of any current matter will have a material adverse effect on our consolidated financial position or results of operations. For further discussion on various litigation matters, please see Note J – “Contingencies,” of our Notes to Consolidated Financial Statements of this Report.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters require disclosure.

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PART II

Unless otherwise indicated, the share, per share and dividend per share information reflected in this report have been adjusted to reflect the Registrant’s two-for-one stock split in the form of a stock dividend effected on October 18, 2001.

     Our common stock, par value $1.00 per share, is listed on the Nasdaq National Market under the symbol “PMFG.” The following table sets forth, for the periods indicated, the range of the daily high and low closing bid prices for our common stock as reported by Nasdaq.

     The last reported sale price of our common stock on NASDAQ on September 22, 2004 was $14.45 per share. As of that date, there were approximately 125 record holders of common stock. Cash dividends may be paid, from time to time, on our common stock as our Board of Directors deems appropriate after consideration of our continued growth rate, operating results, financial condition, cash requirements, compliance with the financial and other restrictive covenants of our bank credit facility, and such other factors as the Board of Directors deems appropriate. The Company did not pay cash dividends in either fiscal year 2004 or 2003. The Company did not repurchase any of its common stock during fiscal 2004, nor does the Company have an approved repurchase program.

     See Item 12 – Security Ownership of Beneficial Owners and Management and Related Shareholder Matters section of this Report for information relating to our equity compensation plans.

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ITEM 6. SELECTED FINANCIAL DATA

     The following table sets forth selected financial data regarding our results of operations and financial position as of and for each of the years in the five-year period ended June 30, 2004, which are derived from our audited consolidated financial statements. Our consolidated financial statements and notes thereto as of June 30, 2004 and 2003, and for the years ended June 30, 2004, 2003 and 2002, and the report of Grant Thornton LLP thereon, are included in Item 8 of this Report. The selected financial data should be read in conjunction with Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included in Item 8 of this Report. The share, earnings (loss) per share, dividends per share, and book value per share amounts have been adjusted to give effect to the two-for-one stock split effected on October 18, 2001. Certain earnings per share amounts may not total due to rounding.

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ITEM 6. SELECTED FINANCIAL DATA — CONTINUED

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

     We are a global company providing environmental and separation filtration products for the abatement of air pollution and the removal of contaminants from gases and liquids through our two principal business segments – Environmental Systems and Separation Filtration Systems. During fiscal year 2004, we discontinued the operations of our Boiler business. See Item 1 – “Business – Restructuring and Organizational Realignment” and Note D – “Discontinued Operations” in our Notes to Consolidated Financial Statements of this Report for additional discussion on the discontinuance of this business unit.

     Environmental Systems. This business segment represented approximately 47%, 58%, and 69% of our fiscal 2004, 2003, and 2002 revenues, respectively. The main product of the Environmental Systems segment is Selective Catalytic Reduction Systems, referred to as “SCR Systems”. These environmental control systems are used for air pollution abatement and convert NOx emissions from exhaust gases caused by burning hydrocarbon fuels such as coal, gasoline, natural gas and oil, into harmless nitrogen and water vapor. Along with the SCR Systems, this segment also offers systems to reduce other pollutants such as CO and particulate matter. These systems are totally integrated, complete with instruments, controls and related valves and piping.

     Separation Filtration Systems. This business segment represented approximately 53%, 42%, and 31% of our fiscal 2004, 2003, and 2002 revenues, respectively. The Separation Filtration Systems segment produces specialized products known as “separators” or “filters” which are used for a variety of purposes in cleaning gases and liquids as they move through piping systems. These products are used primarily to remove solid and liquid contaminants from natural gas as well as saltwater aerosols from combustion intake air of shipboard gas turbine and diesel engines. In addition, separators are also used in nuclear power plants to remove water from saturated steam.

     Boilers. In this discontinued business segment, we designed, engineered, manufactured and sold packaged boilers and other steam generating equipment. This equipment is used to produce steam, which is used for heating, drying, driving steam engines and a variety of other applications. See also Item 1 – “Business – Restructuring and Organizational Realignment” of this Report for additional discussion on the discontinuance of this business unit during fiscal 2004.

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Forward-Looking Statements

     From time to time, we make oral and written statements that may constitute “forward-looking statements” (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1996 or by the Securities and Exchange Commission in its rules, regulations and releases, including statements regarding our expectations, hopes, beliefs, intentions, projections or strategies regarding the future. We desire to avail ourselves of the “safe harbor” provisions in the Private Securities Litigation Reform Act of 1996 for forward-looking statements made from time to time, including, but not limited to, the forward-looking statements made in this Report, as well as those made in our other filings with the SEC. Forward-looking statements contained in this Report are based on management’s current plans and expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. In the preparation of this Report, where such forward-looking statements appear, we have sought to accompany such statements with meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those described in the forward-looking statements. Such factors include, but are not limited to, the “Factors That May Affect Our Operating Results and Other Risk Factors,” as set forth starting on page 21 of this Report.

     All forward-looking statements included in this Report are based on information available to us on the date hereof, and we expressly disclaim any obligation to release publicly any updates or changes in the forward-looking statements, whether as a result of changes in events, conditions, or circumstances on which any forward-looking statement is based.

Results of Operations – Consolidated

     Revenues. For fiscal 2004, revenues decreased approximately $5.1 million, or 7.9% to $59.8 million from $64.9 million in fiscal 2003. Domestic revenues decreased approximately $5.2 million, or 13.0%, from $39.9 million in fiscal 2003 to $34.7 million in fiscal 2004. Foreign revenues increased approximately $100,000, or 0.4%, from $25.0 million in fiscal 2003 to $25.1 million in fiscal 2004. The decline in domestic revenues was mainly attributable to the decline in our Environmental Systems sales, which continues to be impacted by the slow-down in new merchant power construction and regulatory uncertainties. The increase in our foreign revenues related primarily to the increase in our Separation Filtration Systems sales in Europe and the Middle East through our UK subsidiary, partially offset by a decrease in these systems sales in Latin America. See Item 7 – “Results of Operations – Segments” of this Report for further discussion of revenues.

     For fiscal 2003, revenues decreased approximately $30.0 million, or 31.6%, to $64.9 million from $94.9 million in fiscal 2002. Domestic revenues decreased approximately $34.4 million, or 46.3%, from $74.3 million in fiscal 2002 to $39.9 million in fiscal 2003. Foreign revenues increased approximately $4.4 million, or 21.4%, from $20.6 million in fiscal 2002 to $25.0 million in fiscal 2003. The decline in domestic revenues was mainly attributable to the decline in our Environmental Systems sales. The increase in foreign revenues related primarily to the increase in our Separation Filtration Systems sales through our UK subsidiary. We believe the decline in the construction of new power plants, regulatory uncertainties, and the economic climate all contributed to the significant decline in our domestic revenues during the period. See Item 7 – “Results of Operations – Segments” of this Report for further discussion of revenues.

     Gross Profit Margin. Our margins, during a particular period, may be impacted by three primary factors: (1) sales volume, (2) shifts in our product mix and, (3) start-up and warranty costs. Certain products have higher margins than others; as a result, shifts in the composition of our sales can have a significant impact on our margins either at the selling margin level or through a negative or positive impact on our manufacturing absorption. For fiscal 2004, our gross profit margin increased $1.8 million, or 10.6%, from $17.0 million in fiscal 2003 to $18.8 million in fiscal 2004. Gross profit margin, as a percentage of sales, increased from 26.2% for fiscal 2003 to 31.5% for fiscal 2004. Our margins during

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the fiscal 2004 were favorably impacted by a significant reduction in our start-up and warranty costs, which decreased $2.5 million, or 71.4%, from $3.5 million in fiscal 2003 to $1.0 million in fiscal 2004, which resulted from our project execution quality control program. This improvement was offset by a higher unabsorbed manufacturing factor during the period due to our decreased sales volume. In addition to the foregoing, our margins were negatively impacted by shifts in our product mix, as our Environmental Systems revenues declined from 58% of our total revenues in fiscal 2003 to 47% in fiscal 2004. The negative impact associated with the decline in our Environmental Systems revenue during fiscal 2004, was partially offset by the 103% increase in our nuclear/marine revenues.

     For fiscal 2003, our gross profit margins decreased $13.0 million, or 43.3%, from $30.0 million in fiscal 2002 to $17.0 million in fiscal 2003. Gross profit margins, as a percentage of sales, decreased from 31.6% for fiscal 2002 to 26.2% for fiscal 2003. Our reported margins during fiscal year 2003 were impacted primarily by two factors, our manufacturing absorption factor, which was impacted by the 46.3% decrease in our domestic revenues, and a shift in our product sales mix, as our Environmental Systems revenues, which historically have higher gross profit margins, represented only 57.8% of our total revenues compared to 69.1% for fiscal 2002. In addition to the two primary factors, our margins during fiscal 2003 were also impacted by start-up costs on several SCR system projects being higher than we initially budgeted and increased competition in the marketplace.

     Operating Expenses. For fiscal 2004, operating expenses from continuing operations decreased by approximately $1.5 million or 9.1%, from $16.4 million for fiscal 2003 to approximately $14.9 million for fiscal 2004. Operating expenses, as a percentage of sales, were 25.0% for fiscal 2004, compared to 25.3% for fiscal 2003. On a comparative basis, and as a percentage of revenues, our sales and marketing expenses increased from 9.1% to 10.3%, our engineering and project management expenses decreased from 8.0% to 6.9%, and our general and administrative expenses (including restructuring expenses in fiscal 2003) decreased from 8.2% to 7.8%. The increase in our sales and marketing expenses, as a percentage of revenues, related primarily to an increase in our commission expense during the period, which is directly related to the increase in our Separation Filtration Systems revenues, which generally tends to have a higher commission rate than our Environmental Systems revenues. The decrease in engineering and project management expenses is attributed to our restructuring and realignment initiative started last year and due to the decline in our Environmental Systems revenues, which generally are more engineering intensive than our Separation Filtration Systems sales. The decrease in general and administrative expenses related primarily to the costs in fiscal 2003 associated with our restructuring, which savings were partially offset by the higher public company related expenses in fiscal 2004. The higher public company related expenses are expected to continue as the Company continues to manage the increased expense of compliance with corporate governance requirements enacted by the SEC, as well as the Nasdaq stock market.

     For fiscal 2003, operational expenses decreased $4.6 million, or 21.9%, from $21.0 million for fiscal 2002 to $16.4 million for fiscal 2003. Operating expenses as a percentage of revenue were 25.3% for fiscal 2003 and 22.2% for fiscal 2002. On a comparative basis, and as a percentage of revenues, our sales and marketing expenses increased from 7.8% to 9.1%, our engineering and project management expenses increased from 7.8% to 8.0%, and our general and administrative expenses increased from 6.6% to 8.2%. The decrease in the amount of total operating expenses during fiscal 2003 was due to the implementation of our restructuring and organizational realignment initiative. As the steps in this initiative were phased-in over the year, we did not realize the full benefit of this initiative until the second half of the fiscal year. In connection with this initiative, we incurred approximately $500,000 in severance payments and related costs. In addition, included in our operating expenses in fiscal 2003 was an additional provision for doubtful accounts of approximately $650,000, which related primarily to a customer that had declared bankruptcy (see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contingencies,” of this Report for further discussion).

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     Other Income and Expense. For fiscal 2004, other income and expense items changed by approximately $751,000, from income of approximately $727,000 for the fiscal 2003 to expense of $24,000 for fiscal 2004. During fiscal 2003, we recognized a gain of approximately $473,000 on the sale of our Wylie, Texas real property and other assets. We also realized foreign currency exchange losses associated with our UK operations of approximately $101,000 during fiscal 2004 compared to exchange gains of approximately $146,000 in fiscal 2003.

     For fiscal 2003, other income and expense items changed by approximately $317,000 from an addition to income of approximately $410,000 for fiscal 2002 to an addition to income of $727,000 for fiscal 2003. During fiscal 2003, we recognized a gain of approximately $473,000 on the sale of our Wylie, Texas real property and other assets and recognized a gain of approximately $267,000 in fiscal 2002 on the sale of our Carrollton, Texas real property and other assets. We also realized foreign currency exchange gains of approximately $146,000 during fiscal 2003 compared to exchange gains of approximately $84,000 in fiscal 2002.

     Income Taxes. The Company’s effective income tax rate for continuing operations was approximately 37.6%, 30.5% and 34.9% in fiscal 2004, 2003 and 2002, respectively. The increased rate in fiscal 2004 is due primarily to our increased state income tax expense during the year and reduced foreign tax related benefits. The decrease in our expense during fiscal 2003 related primarily to our lower effective foreign tax rate. The increased foreign tax related benefits during fiscal 2002, were offset by a higher state income tax burden during that year. For further discussion related to our income taxes, please see Note M – “Income Taxes,” to our Notes to Consolidated Financial Statements attached to this Report.

     Net Earnings from Continuing Operations. As a result of the above factors, our net earnings from continuing operations increased by approximately $1.5 million, or 166.7%, from approximately $911,000, or 1.4% of sales, for fiscal 2003, to approximately $2.4 million, or 4.0% of sales, for fiscal 2004. Basic earnings per share increased from $0.30 per share for fiscal 2003, to $0.80 per share for fiscal 2004. Diluted earnings per share increased from $0.30 per share for fiscal 2003, to $0.79 per share for fiscal 2004.

     For fiscal year 2003, net earnings from continuing operations decreased $5.2 million, or 85.2%, from $6.1 million for fiscal year 2002 to $911,000 in fiscal 2003. Basic earnings per share decreased from $2.04 per share for fiscal 2002, to $.30 per share for fiscal 2003. Diluted earnings per share decreased from $1.97 per share for fiscal 2002, to $.30 per share for fiscal 2003.

     Discontinued Operations. Our net loss from discontinued operations for the year ended June 30, 2004 was approximately $364,000 compared to a net loss of $1.3 million for the year ended June 30, 2003. The expense in the 2004 fiscal year related primarily to costs associated with the start-up and commissioning of projects that were not commissioned by June 30, 2003. The Company has established a reserve (approximately $300,000 at June 30, 2004), based on its estimate of these costs given the most current information available and historical experience. While we believe our reserve is adequate and the judgment applied is appropriate, due to a number of factors, our estimated liability could differ from our actual costs incurred (see “Critical Accounting Policies – Product Warranties” of this Report). Also included in our net loss for the year ended June 30, 2004 was a net gain related to the disposal of our Boiler operation of approximately $92,000 ($140,000 gain less taxes of $48,000). Basic and diluted loss per share from discontinued operations was ($0.12) per share for fiscal 2004, compared to a loss of ($0.43) per share for fiscal 2003.

     Our net loss from discontinued operations for fiscal 2002 was approximately $1.7 million. Our basic loss per share from discontinued operation in fiscal 2002 was ($0.57) per share. Our diluted loss per share from discontinued operations in fiscal 2002 was ($0.55) per share. See also Note D – “Discontinued Operations” to our Notes to Consolidated Financial Statements of this Report for further discussion of discontinued operations.

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     Net Earnings (Loss). As a result of the above factors, our net earnings increased approximately $2.4 million from a net loss of $379,000, or (0.6)% of sales, for fiscal 2003, to approximately $2.0 million, or 3.4% of sales, for fiscal 2004. Basic earnings per share increased from a loss of ($0.13) per share for fiscal 2003, to earnings of $0.68 per share for fiscal 2004. Diluted earnings per share increased from a loss of ($0.13) per share for fiscal 2003, to earnings of $0.67 per share for fiscal 2004.

     Our net loss was approximately $379,000, or (0.6)% of sales, for fiscal 2003, compared to net earnings of approximately $4.4 million, or 4.6% of sales for fiscal 2002. Basic earnings per share decreased from $1.47 per share for fiscal 2002, to a loss of ($0.13) per share for fiscal 2003. Diluted earnings per share decreased from $1.43 per share for fiscal 2002, to a loss of ($0.13) per share for fiscal 2003.

Results of Operations – Segments

     Currently we are organized along two lines of business: Environmental Systems, and Separation Filtration Systems. The Company had three reportable segments – Environmental Systems, Separation Filtration Systems, and Boilers in fiscal 2003 and 2002. The Boiler segment was discontinued and its assets sold during the first quarter of fiscal 2004. See Note D – “Discontinued Operations” in the Notes to our Consolidated Financial Statements for further discussion on the Boiler segment. Segment information for fiscal 2002 has been restated on a comparable basis with fiscal 2003 and 2004.

     Revenues. The following table displays revenues by reportable segment (dollars in thousands).

     Revenues from our Environmental Systems decreased $9.4 million, or 25.1%, in fiscal 2004, and decreased $28.0 million, or 42.7%, in fiscal 2003. Our Environmental Systems segment continues to be impacted by the slow-down in new power plant construction and regulatory uncertainties. We expect that spending for NOx reduction systems will increase in 2005 – 2008 as regulatory compliance deadlines come into effect over the next 5 years. We have experienced and continue to expect an increase in request for proposals, as users begin to implement their compliance plans. In addition, while the construction of new power plants has significantly declined over the past several years, we believe this portion of the Environmental Systems business will show improvement in 2006 – 2007, as older plants are retired/or modified and new plants are built to meet the growing demand for electricity both domestically and internationally.

     Separation Filtration Systems revenues increased by approximately $4.3 million, or 15.8% in fiscal 2004 and decreased by approximately $2.0 million, or 6.8% in fiscal 2003. We saw our domestic Separation Filtration Systems revenues increase by approximately $4.2 million, or 84.5% in fiscal 2004, compared to a decrease of $6.7 million, or 57.7% for fiscal 2003. The increase in our domestic revenues during fiscal 2004 can be attributed primarily to an increase in our nuclear/marine sales, which increased by $3.6 million, or 102.9%. The increase related primarily to life extension projects at several nuclear power plants and increased military spending. The decline in our domestic sales during fiscal 2003 related primarily to the economic weakness in the US economy. Our international revenues increased $100,000, or 0.6% in fiscal 2004, compared to an increase of $4.7 million, or 26.8% in fiscal 2003. The

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increase in our international revenues during fiscal 2004 can be attributed to an increase in our UK sales of approximately $2.5 million, which was offset by a decline in our Latin American sales of approximately $2.4 million, due to the