Attached files

file filename
EX-32 - EXHIBIT 32 - PMFG, Inc.c11899exv32.htm
EX-31.1 - EXHIBIT 31.1 - PMFG, Inc.c11899exv31w1.htm
EX-31.2 - EXHIBIT 31.2 - PMFG, Inc.c11899exv31w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 1, 2011
OR
     
o   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 001-34156
 
PMFG, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   51-0661574
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
14651 North Dallas Parkway, Suite 500, Dallas, Texas 75254
(Address of principal executive offices)
(214) 357-6181
(Registrant’s telephone number, including area code)
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares of the registrant’s common stock outstanding on February 4, 2011, was 17,353,868.
 
 

 

 


 

TABLE OF CONTENTS
         
    Page  
    Number  
 
       
    3  
 
       
       
 
       
    5  
 
       
    5  
 
       
    6  
 
       
    7  
 
       
    9  
 
       
    10  
 
       
    26  
 
       
    36  
 
       
    37  
 
       
       
 
       
    37  
 
       
    38  
 
       
    38  
 
       
    38  
 
       
    39  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32

 

2


Table of Contents

FORWARD-LOOKING STATEMENTS
This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact contained in this Report are forward-looking statements. You should not place undue reliance on these statements. These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and future events with respect to our business and our industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements. Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:
   
adverse changes in the current global economic environment or in the markets in which we operate, including the power generation, natural gas infrastructure and petrochemical and processing industries;
   
the impact of the current global credit crisis, including the impact on the trading price of our common stock and our ability and our customers’ ability to access capital markets;
   
changes in the price, supply or demand for fuels such as natural gas, bio fuel, oil and coal;
   
changes in current environmental legislation;
   
compliance with United States and foreign laws and regulations applicable to our international operations, including export control and economic sanctions laws and regulations which are complex, change frequently and have tended to become more stringent over time;
   
changes in competition;
   
changes in demand for our products;
   
the effects of the United States’ involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts;
   
changes in our ability to conduct business outside the United States, including changes in foreign laws and regulations;
   
risks associated with our indebtedness;
   
risks associated with our product warranties;

 

3


Table of Contents

   
the redemption and conversion features of our Series A Convertible Preferred Stock (“Preferred Stock”) are classified as an embedded derivative and as such have resulted and will continue to result in volatility in our financial statements, including having a material negative impact on our net income and the derivative liability recorded, due to the fair value accounting requirement to mark-to-market the derivative liability each reporting period;
   
limitations on issuing additional equity imposed by our Preferred Stock;
   
the effects of natural disasters; and
   
loss of the services of any of our senior management or other key employees.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this and other reports we file with the Securities and Exchange Commission (the “SEC”), including the information in “Item 1A. Risk Factors” of Part I to our Annual Report on Form 10-K for the year ended June 30, 2010 and Part II of this Report. There may be other factors that may cause our actual results to differ materially from the forward-looking statements. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. We undertake no obligation to publicly update or revise any forward-looking statement.

 

4


Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.  
Financial Statements
PMFG, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
                 
    January 1,     June 30,  
    2011     2010  
    (unaudited)        
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 21,760     $ 24,271  
Restricted cash
    5,375       5,868  
Accounts receivable, principally trade — net of allowance for doubtful accounts of $851 and $886 at January 1, 2011 and June 30, 2010
    23,368       27,310  
Inventories — net
    6,873       7,220  
Costs and earnings in excess of billings on uncompleted contracts
    12,567       13,560  
Deferred income taxes
    2,066       2,066  
Other current assets
    3,281       2,011  
 
           
Total current assets
    75,290       82,306  
 
               
Property, plant and equipment — net
    8,710       7,506  
Intangible assets — net
    22,341       21,781  
Goodwill
    29,702       29,702  
Other assets
    1,094       1,786  
 
           
Total assets
  $ 137,137     $ 143,081  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current liabilities:
               
Accounts payable
  $ 12,349     $ 10,180  
Current maturities of long-term debt
    1,950       4,000  
Billings in excess of costs and earnings on uncompleted contracts
    6,028       5,424  
Commissions payable
    1,831       1,932  
Income taxes payable
          717  
Accrued product warranties
    2,361       2,480  
Customer deposits
    2,121       2,481  
Accrued liabilities and other
    5,719       7,092  
 
           
Total current liabilities
    32,359       34,306  
 
               
Long-term debt
    11,271       16,221  
Deferred income taxes
    8,602       8,548  
Derivative liability
    23,591       25,916  
Other non-current liabilities
    963       943  
 
               
Commitments and contingencies
               
 
               
Preferred stock — authorized, 5,000,000 shares of $0.01 par value; issued and outstanding, 20,640 and 21,140 shares at January 1, 2011 and June 30, 2010, respectively
           
 
               
Stockholders’ equity:
               
Common stock — authorized, 50,000,000 shares of $0.01 par value; issued and outstanding, 14,997,559 and 14,734,323 shares at January 1, 2011 and June 30, 2010, respectively
    150       147  
Additional paid-in capital
    29,307       27,240  
Retained earnings
    31,255       31,142  
Accumulated other comprehensive loss
    (1,734 )     (2,283 )
 
           
Total PMFG, Inc. stockholders’ equity
    58,978       56,246  
Noncontrolling interest
    1,373       901  
 
           
Total equity
    60,351       57,147  
 
           
Total liabilities and equity
  $ 137,137     $ 143,081  
 
           
See accompanying notes to consolidated financial statements.

 

5


Table of Contents

PMFG, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share amounts)
                                 
    Three months ended     Six months ended  
    January 1,     December 31,     January 1,     December 31,  
    2011     2009     2011     2009  
    (unaudited)     (unaudited)  
 
                               
Revenues
  $ 26,294     $ 24,529     $ 53,255     $ 55,860  
Cost of goods sold
    18,168       16,261       36,388       35,825  
 
                       
Gross profit
    8,126       8,268       16,867       20,035  
 
                               
Operating expenses
                               
Sales and marketing
    2,786       2,567       5,522       5,577  
Engineering and project management
    1,955       1,778       3,842       3,628  
General and administrative
    3,634       3,735       7,796       7,679  
 
                       
 
    8,375       8,080       17,160       16,884  
 
                       
 
                               
Operating income (loss)
    (249 )     188       (293 )     3,151  
 
                               
Other income (expense)
                               
Interest income
    5       6       19       18  
Interest expense
    (626 )     (691 )     (1,510 )     (1,902 )
Loss on extinguishment of debt
                      (1,303 )
Foreign exchange gain
    109       611       176       815  
Change in fair value of derivative liability
    7,304       (5,812 )     1,870       (8,312 )
Other expense, net
          (241 )           (241 )
 
                       
 
    6,792       (6,127 )     555       (10,925 )
 
                       
 
                               
Earnings (loss) before income taxes
    6,543       (5,939 )     262       (7,774 )
Income tax (expense) benefit
    296       18       614       (238 )
 
                       
Net earnings (loss)
  $ 6,839     $ (5,921 )   $ 876     $ (8,012 )
 
                       
 
                               
Less net income (loss) attributable to noncontrolling interest
  $ 57     $ (9 )   $ 132     $ (59 )
 
                       
Net earnings (loss) attributable to PMFG, Inc.
  $ 6,782     $ (5,912 )   $ 744     $ (7,953 )
 
                       
 
                               
Dividends on preferred stock
  $ (313 )   $ (321 )   $ (632 )   $ (415 )
 
                       
Earnings (loss) applicable to PMFG, Inc. common stockholders
  $ 6,469     $ (6,233 )   $ 112     $ (8,368 )
 
                       
 
                               
Basic earnings (loss) per common share
  $ 0.37     $ (0.47 )   $ 0.01     $ (0.63 )
 
                       
Diluted earnings (loss) per share
  $ 0.36     $ (0.47 )   $ 0.01     $ (0.63 )
 
                       
 
                               
Weighted-average shares outstanding:
                               
Basic
    14,952       13,226       14,898       13,214  
Effect of dilutive options and restricted stock
    509             536        
 
                       
Diluted
    15,461       13,226       15,434       13,214  
 
                       
See accompanying notes to consolidated financial statements.

 

6


Table of Contents

PMFG, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands, except share amounts)
                 
    Six months ended     Six months ended  
    January 1,     December 31,  
    2011     2009  
    (unaudited)  
Cash flows from operating activities:
               
Net earnings (loss)
  $ 876     $ (8,012 )
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
               
Depreciation
    799       809  
Amortization of deferred financing costs
    676       317  
Amortization of other intangible assets
    540       493  
Loss on extinguishment of debt
          1,303  
Deferred income taxes
    54       (1,134 )
Deferred rent expense
    20       (227 )
Bad debt expense
    7        
Provision for warranty expense
    561       321  
Inventory valuation reserve
    68       478  
Foreign exchange gain
    (176 )     (815 )
Change in fair value of derivative liability
    (1,870 )     8,312  
Excess tax benefits from stock-based payment arrangements
    (316 )     (30 )
Stock-based compensation
    958       809  
Changes in operating assets and liabilities:
               
Accounts receivable
    3,935       4,546  
Inventories
    341       674  
Costs and earnings in excess of billings on uncompleted contracts
    1,073       2,481  
Other current assets
    497       170  
Other assets
    175       (134 )
Accounts payable
    2,217       (3,797 )
Billings in excess of costs and earnings on uncompleted contracts
    604       415  
Commissions payable
    (101 )     (503 )
Income taxes payable
    (2,169 )     (126 )
Product warranties
    (680 )     (296 )
Accrued liabilities and other
    (1,722 )     (1,432 )
 
           
Net cash provided by operating activities
    6,367       4,622  
 
               
Cash flow from investing activities:
               
Increase (decrease) in restricted cash
    396       (548 )
Purchases of property and equipment
    (1,974 )     (197 )
Purchase of license agreement
    (1,100 )     (750 )
Proceeds from liquidation of equity method investment
          2,439  
 
           
Net cash provided by (used in) investing activities
    (2,678 )     944  
 
               
Cash flows from financing activities:
               
Net proceeds from issuance of preferred stock and warrants
          19,235  
Payment of debt issuance costs
    (158 )     (552 )
Payment of long-term debt
    (7,000 )     (24,820 )
Equity contribution from noncontrolling interest
    340       545  
Dividends paid on preferred stock
    (632 )     (415 )
Proceeds from exercise of stock options
    343        
Excess tax benefits from stock-based payment arrangements
    315        
 
           
Net cash used in financing activities
    (6,792 )     (6,007 )
Consolidated Statements of Cash Flows continued on next page.

 

7


Table of Contents

PMFG, Inc. and Subsidiaries
Consolidated Statements of Cash Flows — Continued

(In thousands, except share amounts)
                 
    Six months ended     Six months ended  
    January 1,     December 31,  
    2011     2009  
    (unaudited)  
Net cash used in financing activities
    (6,792 )     (6,007 )
 
               
Effect of exchange rate changes on cash and cash equivalents
    592       777  
 
           
 
               
Net (decrease) increase in cash and cash equivalents
    (2,511 )     336  
 
               
Cash and cash equivalents at beginning of period
    24,271       17,738  
 
           
 
               
Cash and cash equivalents at end of period
  $ 21,760     $ 18,074  
 
           
 
               
Supplemental information on cash flow:
               
Income taxes paid
  $ 1,300     $ 1,483  
Interest paid
  $ 604     $ 1,259  
During the quarter ended January 1, 2011, holders of Preferred Stock converted 500 shares of Preferred Stock into 62,500 shares of the Company’s common stock. This was a non cash financing activity and as a result, the Company is no longer obligated to pay quarterly dividends on the converted shares of Preferred Stock.
See accompanying notes to consolidated financial statements.

 

8


Table of Contents

PMFG, Inc. and Subsidiaries
Unaudited Consolidated Statement of Equity and Comprehensive Income (Loss)
(In thousands)
                                                                 
                                    Accumulated                    
                    Additional             Other     Total     Non        
    Common Stock     Paid-in     Retained     Comprehensive     Stockholders’     Controlling     Total  
    Shares     Amount     Capital     Earnings     Loss     Equity     Interest     Equity  
 
                                                               
Balance at June 30, 2010
    14,734     $ 147     $ 27,240     $ 31,142     $ (2,283 )   $ 56,246     $ 901     $ 57,147  
 
                                                               
Comprehensive income
                                                               
Net earnings
                            744               744       132       876  
Foreign currency translation adjustment
                                    549       549               549  
 
                                                         
Total comprehensive income
                                            1,293       132       1,425  
 
                                                               
Stock grants
    101       1       956       1               958               958  
Preferred stock conversion
    63       1       454                       455               455  
Stock options exercised
    100       1       342                       343               343  
Income tax benefit related to stock options exercised
                    315                       315               315  
 
                                                               
Noncontrolling interest in subsidiary
                                                    340       340  
 
                                                               
Preferred stock dividends
                            (632 )             (632 )             (632 )
 
                                               
 
                                                               
Balance at January 1, 2011
    14,998     $ 150     $ 29,307     $ 31,255     $ (1,734 )   $ 58,978     $ 1,373     $ 60,351  
 
                                               
See accompanying notes to consolidated financial statements.

 

9


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 1, 2011
(In thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements of PMFG, Inc. and subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. References to “Company,” “we,” “us” and “our” refer to PMFG, Inc. and its subsidiaries. The consolidated financial statements of the Company as of January 1, 2011 and for the three and six months ended January 1, 2011 and December 31, 2009 are unaudited and, in the opinion of management, contain all adjustments necessary for the fair presentation of the financial position and results of operations of the Company for the interim periods. The results of operations for such interim periods are not necessarily indicative of results for a full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K for the fiscal year ended June 30, 2010.
Basis of Consolidation
The Company is the majority owner of Peerless Propulsys China Holdings LLC (“Peerless Propulsys”). The Company’s 60% equity investment in Peerless Propulsys entitles it to 80% of the earnings. Peerless Propulsys is the sole owner of Peerless Manufacturing (Zhenjiang) Co. Ltd (“PMZ”). The non-controlling interest of Peerless Propulsys is reported as a separate component on the Consolidated Balance Sheets and Consolidated Statement of Operations. On July 15, 2010, the Company formed a new wholly-owned subsidiary, Peerless Asia Pacific Pte. Ltd. (“Peerless Asia Pacific”), which replaced the former Peerless Mfg. Co. regional sales office in Singapore. This entity has been consolidated in the Company’s financial statements. The Company’s financial statements for all periods presented are consolidated to include the accounts of all wholly-owned and majority-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
Reporting Period
On July 1, 2010, the Board of Directors approved a resolution to change the Company’s fiscal year, which ended as of the last day of the month each June, to a new fiscal year, which will be comprised of either 52 or 53 weeks, commencing within seven days of the month-end. Beginning in fiscal 2011, the Company’s fiscal year end will be the Saturday closest to June 30; therefore, the fiscal year end date will vary slightly each year. In a 52 week fiscal year, each quarterly period will be comprised of 13 weeks, consisting of two four week periods and one five week period. In a 53 week fiscal year, three quarterly periods will be comprised of 13 weeks and one quarter will be comprised of 14 weeks.
Cash and Cash Equivalents
For purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Accounts Receivable
The Company’s accounts receivable are due from companies in various industries. Credit is extended based on an evaluation of the customer’s financial condition. Generally, collateral is not required except on credit extended to international customers. Accounts receivable are generally due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts which are outstanding longer than contractual payment terms are considered past due. The Company records an allowance on a specific basis by considering a number of factors, including the length of time the accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company and the condition of the industry and the economy as a whole. The Company writes off accounts receivable when they become uncollectible. Payments subsequently received on such receivables are credited back to bad debt expense in the period the payment is received.

 

10


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED
Inventories
The Company values its inventory using the lower of weighted average cost or market. The Company regularly reviews the value of inventory on hand, using specific aging categories, and records a provision for obsolete and slow-moving inventory based on historical usage and estimated future usage. In assessing the ultimate realization of its inventory, the Company is required to make judgments as to future demand requirements. As actual future demand or market conditions may vary from those projected by the Company, adjustments to inventory valuations may be required.
Depreciable Assets
Depreciation is provided in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives, principally by the straight-line method, as follows:
         
Buildings and improvements
  5 – 40 years
Equipment
  3 – 10 years
Furniture and fixtures
  3 – 15 years
Routine maintenance costs are expensed as incurred. Major improvements that extend the life, increase the capacity or improve the safety or the efficiency of property owned are capitalized. Major improvements to leased buildings are capitalized as leasehold improvements and amortized over the shorter of the estimated life or the lease term.
Long-Lived Assets
The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable and exceeds its fair value. If conditions indicate an asset might be impaired, the Company estimates the future cash flows expected to result from the use of the asset and its eventual disposition. The impairment would be measured by the amount by which the carrying value of the asset exceeds its fair value, typically represented by the discounted cash flows associated with the asset.
Intangible Assets and Goodwill
The Company records the difference between the purchase price and the fair value of the net assets acquired in a business combination as goodwill. Goodwill is not amortized; rather, it is measured for impairment annually, or more frequently if conditions indicate an earlier review is necessary. If the estimated fair value of goodwill is less than the carrying value, goodwill is impaired and written down to its estimated fair value.
Intangible assets subject to amortization include customer backlog, licensing agreements and customer relationships. These intangible assets are amortized over their useful lives based on a pattern in which the economic benefit of the respective intangible asset is realized. Intangible assets considered to have indefinite lives are trade names and design guidelines. The Company evaluates the recoverability of intangible assets annually or whenever events or changes in circumstances indicate that an intangible asset’s carrying value may not be recoverable.

 

11


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED
Convertible Redeemable Preferred Stock
The Company’s Certificate of Designations setting forth the terms of our Series A Convertible Preferred Stock (“Preferred Stock”) includes redemption rights of the holders of Preferred Stock which place redemption outside of the Company’s control. The Preferred Stock has been classified as temporary equity, outside of permanent stockholders’ equity, on the Consolidated Balance Sheets and Consolidated Statement of Equity. The Company considers the conversion rights and redemption options of the Preferred Stock to be an embedded derivative and, as a result, the fair value of the embedded derivative is included as a derivative liability on the Consolidated Balance Sheets (the “Derivative Liability”). Since the Derivative Liability had a fair value in excess of the net proceeds received by the Company from the Preferred Stock transaction at the date of issuance, no amounts have been assigned to the Preferred Stock in the allocation of proceeds. Changes in fair value of the Derivative Liability are included in other income (expense) in the Consolidated Statements of Operations and are not taxable or deductible for income tax purposes.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, trade receivables, other current assets, accounts payable and accrued expenses approximate fair value due to the short maturity of these instruments. As the Company’s debt bears interest at floating rates, the Company estimates that the carrying values of its debt at January 1, 2011 and June 30, 2010 approximate fair value.
Revenue Recognition
The Company provides products under long-term, generally fixed-priced, contracts that may extend over multiple financial periods. In connection with these contracts, the Company uses the percentage-of-completion method of accounting for long-term contracts that contain enforceable rights regarding services to be provided and received by the contracting parties, the consideration to be exchanged, and the manner and terms of settlement, assuming reasonably dependable estimates of revenues and expenses can be made. The percentage-of-completion method generally results in the recognition of reasonably consistent profit margins over the life of a contract. Amounts recognized in revenue are calculated using the percentage of construction cost completed, generally on a cumulative cost to total cost basis. Cumulative revenue recognized may be less or greater than cumulative costs and profits billed at any point during a contract’s term. The resulting difference is recognized as “costs and earnings in excess of billings on uncompleted contracts” or “billings in excess of costs and earnings on uncompleted contracts” on the Consolidated Balance Sheets.
The completed contract method is applied to contracts that do not meet threshold requirements for contract amounts or contract duration. Because of the short-term nature of these contracts, the completed contract method accurately reflects the economic substance of these contracts. Revenues under the completed contract method are recognized upon shipment of the product.
Earnings (Loss) Per Common Share
The Company calculates earnings (loss) per common share by dividing the earnings (loss) applicable to common stockholders by the weighted average number of common shares outstanding. The Company has determined that the Preferred Stock represents a participating security because holders of the Preferred Stock have rights to participate in any dividends on an as-converted basis; therefore, basic earnings per common share is calculated consistent with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC” or the “Codification”) Subtopic 260-45 Participating Securities and the Two Class Method.

 

12


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED
Earnings (losses) were allocated under the two class method as follows:
                                 
    Three months ended     Six months ended  
    January 1,     December 31,     January 1,     December 31,  
    2011     2009     2011     2009  
Common Stock
  $ 5,513     $ (5,912 )   $ 95     $ (7,953 )
Preferred Stock
    1,269             649        
 
                       
Total
  $ 6,782     $ (5,912 )   $ 744     $ (7,953 )
 
                       
Because holders of Preferred Stock do not participate in losses, 746,793 and 2,642,500 shares of common stock equivalents were excluded from the calculation of basic and diluted earnings per share for the three and six months ended December 31, 2009, respectively. Diluted earnings per common share include the dilutive effect of stock options and warrants granted using the treasury stock method. Options to acquire 98,308 and 107,072 shares of common stock for the three and six months ended December 31, 2009, respectively, and warrants to purchase 17,449 and 394,219 shares of common stock for the three and six months ended December 31, 2009, respectively, were omitted from the calculation of dilutive securities for the three and six months ended December 31, 2009 because they were anti-dilutive.
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because the use of estimates is inherent in the financial reporting process, actual results could differ from those estimates.
2. INVENTORIES, NET
Principal components of inventories, net are as follows:
                 
    January 1,     June 30,  
    2011     2010  
 
               
Raw materials
  $ 3,918     $ 4,443  
Work in progress
    3,428       3,164  
Finished goods
    319       361  
 
           
 
    7,665       7,968  
Reserve for obsolete and slow-moving inventory
    (792 )     (748 )
 
           
 
  $ 6,873     $ 7,220  
 
           

 

13


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
3. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
The components of uncompleted contracts are as follows:
                 
    January 1,     June 30,  
    2011     2010  
 
               
Costs incurred on uncompleted contracts and estimated earnings
  $ 53,715     $ 56,176  
Less billings to date
    (47,176 )     (48,040 )
 
           
 
  $ 6,539     $ 8,136  
 
           
The components of uncompleted contracts are reflected in the consolidated balance sheets as follows:
                 
    January 1,     June 30,  
    2011     2010  
             
Costs and earnings in excess of billings on uncompleted contracts
  $ 12,567     $ 13,560  
Billings in excess of costs and earnings on uncompleted contracts
    (6,028 )     (5,424 )
 
           
 
  $ 6,539     $ 8,136  
 
           
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets are all allocated to the Process Products segment and are not deductible for income tax purposes.
Intangible assets with indefinite lives consist primarily of design guidelines and tradenames. The cost of intangible assets is based on fair values at the date of acquisition. The Company assesses the recoverability of its definite-lived intangible assets primarily based on its current and anticipated future undiscounted cash flows.

 

14


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
4. GOODWILL AND OTHER INTANGIBLE ASSETS — CONTINUED
The carrying amount and accumulated amortization of the Company’s intangible assets at each balance sheet date are as follows:
                                 
    Weighted-Average                    
    Estimated     Gross              
    Useful Life     Carrying     Accumulated     Net Book  
    (Years)     Amount     Amortization     Value  
                         
As of January 1, 2011:
                               
Licensing agreements
    5       3,299       (1,173 )     2,126  
Customer relationships
    13       6,890       (1,895 )     4,995  
Tradenames
    indefinite       4,729             4,729  
Design guidelines
    indefinite       10,491             10,491  
 
                         
                         
Total Value
          $ 25,409     $ (3,068 )   $ 22,341  
 
                         
                                 
    Weighted-Average                    
    Estimated     Gross              
    Useful Life     Carrying     Accumulated     Net Book  
    (Years)     Amount     Amortization     Value  
 
                               
As of June 30, 2010:
                               
Licensing agreements
    5       2,199       (953 )     1,246  
Customer relationships
    14       6,890       (1,575 )     5,315  
Tradenames
    indefinite       4,729             4,729  
Design guidelines
    indefinite       10,491             10,491  
 
                         
 
                               
Total Value
          $ 24,309     $ (2,528 )   $ 21,781  
 
                         
Amortization expense of $540 and $493 was recorded to the Consolidated Statement of Operations for the six months ended January 1, 2011 and December 31, 2009, respectively. The Company’s estimated amortization for the current and each of the next five fiscal years is as follows:
         
Estimated Amortization Expense  
For the fiscal years ended  
 
       
2011 (6 months)
  $ 528  
2012
    1,005  
2013
    922  
2014
    555  
2015
    480  
2016
    405  

 

15


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
5. ACCRUED PRODUCT WARRANTIES
Accrued product warranty activity is as follows:
                                 
    Three months ended     Six months ended  
    January 1,     December 31,     January 1,     December 31,  
    2011     2009     2011     2009  
 
                               
Balance at beginning of period
  $ 2,306     $ 1,284     $ 2,480     $ 1,242  
Provision for warranty expenses
    431       248       561       321  
Warranty charges
    (376 )     (265 )     (680 )     (296 )
 
                       
Balance at end of period
  $ 2,361     $ 1,267     $ 2,361     $ 1,267  
 
                       
6. ACCRUED LIABILITIES AND OTHER
The components of accrued liabilities and other are as follows:
                 
    January 1,     June 30,  
    2011     2010  
 
               
Accrued start-up (commissioning) expense
  $ 1,568     $ 1,169  
Accrued compensation
    1,747       3,999  
Accrued professional expenses
    1,634       1,679  
Other
    770       245  
 
           
 
  $ 5,719     $ 7,092  
 
           
7. DEBT
Outstanding long-term debt obligations are as follows:
                 
    January 1,     June 30,  
    2011     2010  
 
               
Revolving credit facility
  $     $  
Term loan
    13,221       20,221  
 
           
Total long-term debt
    13,221       20,221  
Less current maturites
    (1,950 )     (4,000 )
 
           
Total long-term debt, net of current portion
  $ 11,271     $ 16,221  
 
           
On December 29, 2010, the Company entered into an amendment (the “Amendment”) to its Revolving Credit and Term Loan Agreement (the “Credit Agreement”).

 

16


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
7. DEBT — CONTINUED
The Amendment refinances the Company’s existing debt and extends the maturity date of the revolving credit facility to April 30, 2012, and the senior term loan to January 1, 2016. The Amendment also enhances the Company’s financial flexibility by relaxing the Company’s consolidated total leverage (“CTL”) and consolidated fixed charge coverage (“FCC”) ratio covenants for the remaining terms of the senior term loan and revolving credit facility. As amended, as of the last day of a fiscal quarter, the Company’s CTL ratio may be no more than 3.25 to 1.00 for the quarters ended January 1, 2011 and April 2, 2011, and 3.00 to 1.00 for the quarters ended July 2, 2011 and thereafter, and the Company’s FCC ratio may be no less than 1.15 to 1.00 for quarters ended January 1, 2011 and April 2, 2011 and 1.25 to 1.00 for quarters ended July 2, 2011 and thereafter. The Amendment also redefined the Company’s FCC to exclude certain capital expenditures from consolidated fixed charges. The Company must also maintain a minimum base adjusted net worth of not less than $65,000 plus 50% of consolidated net income for each fiscal quarter, commencing with the quarter ending on April 2, 2011. In connection with the Amendment, the Company made an additional $5,000 principal payment of the senior term loan in December 2010.
The Amendment also excludes any non-cash fair value adjustments related to the Company’s derivative liabilities associated with the Preferred Stock from consolidated net income for purposes of determining the Company’s excess cash flow each fiscal year and permits the Company to make intercompany loans and investments in its China operations and facility subject to certain limitations.
Interest rate margins on the senior term loan and revolving loans were revised effective as of December 29, 2010 (depending on the type of borrowing and determined based upon the Company’s CTL ratio) as follows: (a) for base rate term loans, from a margin of between 275 and 400 basis points to a margin of between 225 and 375 basis points; (b) for LIBOR rate term loans, from a margin of between 375 and 500 basis points to a margin of between 325 and 475 basis points; (c) for base rate revolving loans, from a margin of between 275 and 375 basis points to a margin of between 225 and 350 basis points; and (d) for LIBOR rate revolving loans, from a margin of between 350 and 475 basis points to a margin of between 300 and 450 basis points.
Interest on the senior term loan is payable quarterly, calculated on either a base or LIBOR rate per annum, at the Company’s option (5.75% at January 1, 2011 and 5.25% at June 30, 2010). The Credit Agreement requires payments on the senior term loan of equal quarterly principal installments of $650, to be paid on the first day of each fiscal quarter, commencing on April 3, 2011, with the balance of the senior term loan due at maturity.
At January 1, 2011, there was $1,610 borrowing availability after the borrowing base was adjusted for $7,914 in outstanding letters of credit. At January 1, 2011 and June 30, 2010 there were no outstanding borrowings under the revolving credit facility.
The senior term loan and any borrowings under the revolving credit facility are secured by a first lien on substantially all assets of the Company. In addition to the CTL and FCC ratio covenants, the Credit Agreement contains other covenants, including restrictions on additional debt, dividends, capital expenditures, acquisitions and dispositions. As of January 1, 2011, the Company was in compliance with all covenants in its Credit Agreement. The Company entered into a LIBOR interest rate cap transaction with respect to its senior term loan, with a notional amount of $20,000 (the “Interest Rate Cap Transaction”). The Interest Rate Cap Transaction became effective on August 15, 2008 and will terminate on April 2, 2012. Under the terms of the Interest Rate Cap Transaction, the counterparty will pay to the Company, on the first business day of each quarter, commencing on October 1, 2008, an amount equal to the greater of $0 and the product of (i) the outstanding notional amount of the Interest Rate Cap Transaction during the prior quarter, (ii) the difference between the three month LIBOR rate at the beginning of the prior quarter and 3.70% and (iii) the quotient of the number of days in the prior quarter over 360. The notional amount of the Interest Rate Cap Transaction amortized $5,000 on October 1, 2010, 2009 and 2008 and will amortize $4,500 on October 3, 2011 and the remaining $500 upon termination on April 2, 2012. As long as the counterparty makes the payments required under the Interest Rate Cap Transaction, the Company will have a maximum annual LIBOR interest rate exposure equal to the sum of 3.70% and a margin of 375 to 500 basis points, based on its CTL ratio, for the term of the Interest Rate Cap Transaction. At January 1, 2011 the Interest Rate Cap Transaction has an estimated fair market value of $0.

 

17


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
7. DEBT — CONTINUED
The Company’s U.K. subsidiary has a debenture agreement used to facilitate issuances of letters of credit and bank guarantees of £5,444 ($8,492) at January 1, 2011 and £4,700 ($7,083) at June 30, 2010. This facility was secured by substantially all of the assets of the Company’s U.K. subsidiary and by a cash deposit of £3,350 ($5,226) at January 1, 2011 and £2,850 ($4,258) at June 30, 2010, which is recorded as restricted cash on the Consolidated Balance Sheets. At January 1, 2011, there was £4,413 ($6,883) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement. At June 30, 2010, there was £2,658 ($4,209) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement. There are no amounts outstanding under the U.K. subsidiary’s debenture agreement at January 1, 2011 or June 30, 2010.
8. COMMITMENTS AND CONTINGENCIES
Litigation
In June 2010, the Company received notice from a customer claiming approximately $9,100 in repair costs associated with four heat exchangers sold by Alco Products, a division of Nitram, in 2006 prior to the Company’s acquisition of Nitram. The customer requested reimbursement for the repair costs pursuant to Alco Products’ warranty obligations under the terms and conditions of the purchase order. The Company is in the process of assessing the validity of the claim and has notified the Nitram insurance carrier and the selling stockholders of Nitram of this claim. The Company believes if any valid claim exists, the Company is entitled to be indemnified by the Nitram selling stockholders pursuant to the terms of the Nitram acquisition agreement for any amounts that are paid by the Company in connection with such claim. At this time, the Company cannot estimate any potential range of loss that may result from this asserted claim as the Company is still investigating the merits of the claim and the facts and circumstances surrounding the claim. No amount has been accrued in the financial statements for this claim as of January 1, 2011. At this time, no lawsuit has been filed by the customer.
On June 19, 2007, Martin-Manatee Power Partners, LLC (“MMPP”) filed a complaint against the Company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida. In the complaint, MMPP asserted claims for breach of contract and express warranty, breach of implied warranty and indemnification against the Company. MMPP’s claims arise out of an incident in September 2005 when an electric fuel gas start-up heater, which was a component of a fuel gas heater skid supplied by the Company to MMPP, allegedly ruptured, resulting in a fire. In the complaint, MMPP did not make a specific demand for damages.
The Company’s insurance carriers have agreed to defend the claims asserted by MMPP, pursuant to reservation of rights letters issued on September 5, 2007 and have retained counsel to defend the Company. The Company’s motion to dismiss the complaint for improper venue was granted on December 11, 2007. On February 20, 2008, MMPP filed a new action in the District Court of Johnson County, Kansas, the venue referenced in the purchase order pursuant to which the skid was purchased by MMPP from the Company. In this complaint, MMPP asserted the same claims as described above. MMPP has made a demand for damages in the amount of $2,500, which it claims represents its net costs incurred related to this incident. The Company is currently appealing a ruling by the District Court, which dismissed a third party defendant, Controls International, Inc., the manufacturer of a valve used on the skid. The Company filed its appeal on July 24, 2009. On June 18, 2010, the Kansas Court of Appeals affirmed the decision of the District Court, granting the motion for dismissal of Controls International, Inc. The Company filed a motion for rehearing with the Kansas Court of Appeals and filed a petition for review with the Kansas Supreme Court on July 2, 2010, requesting the reconsideration and reversal of the Kansas Court of Appeals decision to dismiss Controls International, Inc. The Kansas Court of Appeals denied the motion for rehearing. As of June 30, 2010 and January 1, 2011 Consolidated Balance Sheets, the Company has recorded an accrual of $100 related to the insurance deductible as a component of its warranty liability and has also reserved $487 against retention receivables related to the MMPP jobs. At this time, the Company cannot estimate any potential final range of loss resulting from this litigation as it is still in discovery. At this time, management believes that MMPP’s claims are without merit and intends to vigorously defend this suit.

 

18


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
8. COMMITMENTS AND CONTINGENCIES — CONTINUED
In April 2008, Burgess-Manning, Inc., a subsidiary of Nitram, made a voluntary disclosure to the Office of Foreign Assets Control (“OFAC”) regarding sales of industrial separators to Iran. The Company cannot predict the response of OFAC, the outcome of any related proceeding or the likelihood that future proceedings will be instituted against the Company. In the event that there is an adverse ruling in any proceeding, the Company may be required to pay fines and penalties.
In connection with the Company’s acquisition of Nitram and the related financing transactions, environmental site assessments were performed on both its existing manufacturing properties and Nitram’s properties in Cisco, Texas and Wichita Falls, Texas. These assessments involved visual inspection, testing of soil and groundwater, interviews with site personnel and a review of publicly available records. The results of these assessments indicated soil and groundwater contamination at the Vermont Street plant in Wichita Falls and groundwater concerns at the Jacksboro Highway plant in Wichita Falls and the Cisco plants. Additional sampling and evaluation of the groundwater concerns at Jacksboro Highway and Cisco plants indicated levels of impact did not exceed applicable regulatory standards and that further investigation and remediation was not required. Soil remediation at the Vermont Street Plant in Wichita Falls was completed in July 2009 and the Company will continue to monitor groundwater at and near the site for an additional five years. The total costs accrued are $175 at January 1, 2011 and June 30, 2010, which have been discounted using a rate of 3.25%. The Company is seeking reimbursement for the cost of the remediation under our purchase agreement with Nitram’s former stockholders. Funds have been deposited into an escrow account that may be used to reimburse these costs.
Under the contract for the Nitram acquisition, the Company has certain rights to indemnification against the selling stockholders for claims relating to breach of representation and certain other claims, including litigation costs and damages. The Nitram selling stockholders previously placed $10,920 of the purchase price in escrow to reimburse the Company for breach of representation and certain other claims. The escrow amount, less any claim amounts made by the Company or amounts paid to third parties as agreed upon by the Company and sellers, was released to the seller in five installments on each of October 8, 2008, January 30, 2009, April 30, 2009, July 30, 2009 and October 30, 2009. Certain claims made by the Company against the escrow are subject to a deductible equal to one percent of the purchase price paid by the Company for the Nitram acquisition. Prior to the final escrow payment release on October 30, 2009, the Company had filed claims with the sellers relating to environmental matters and indemnification for breach of representations and warranties of the Nitram purchase agreement, totaling approximately $1,998 against the escrow, and a total of $1,388 was withheld from the escrow releases, which represents the Company’s claims, less the one percent deductible, estimated at $610. Following the final escrow release in October 2009, the Company has made additional claims directly against the selling stockholders under the terms of the Nitram acquisition agreement totaling approximately $9,500, related to the customer warranty dispute for the four Alco Products heat exchangers and other environmental matters. The sellers have objected to the claims made by the Company and the parties are currently in the process of negotiating the various claims.
From time to time the Company is involved in various litigation matters arising in the ordinary course of its business. The Company accrues for its litigation contingencies when losses are both probable and reasonably estimable.

 

19


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
9. SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK AND WARRANTS
On September 4, 2009, the Company issued and sold 21,140 shares of Preferred Stock, par value $0.01 per share, and attached warrants to certain accredited investors (each a “Purchaser” and collectively, the “Purchasers”) for an aggregate purchase price of $21,140 (the “Offering”). The Company and each Purchaser entered into a securities purchase agreement (the “Purchase Agreement”) in connection with the Offering. The Offering was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Company used the $19,235 net proceeds received from the Offering and available cash to repay all of the Company’s outstanding indebtedness under its subordinated term loan.
Preferred Stock
The terms, rights, obligations and preferences of the Preferred Stock are set forth in the Certificate of Designations of the Preferred Stock (the “Certificate of Designations”) filed with the Secretary of State of the State of Delaware on September 4, 2009.
The Preferred Stock is immediately convertible, at the option of the holder, into shares of common stock at an initial conversion price of $8.00 per share, subject to certain anti-dilution adjustments (the “Conversion Price”). The Conversion Price will be adjusted for stock splits, dividends and the like and in the event the Company issues and sells its equity securities at a price below the Conversion Price. In addition, in some circumstances, the holders of Preferred Stock will be entitled to participate in an offering by the Company of its equity securities or securities convertible into or exchangeable for its equity securities, subject to certain exceptions including any public offering of its common stock.
Holders of the Preferred Stock are entitled to quarterly dividends at an annual rate of 6.0%. In the event the Company fails to fulfill its obligations under the Preferred Stock, the dividend rate will increase to an annual rate of 8.0%. All dividends will be cumulative and compound quarterly and may be paid, at the option of the Company, in cash or common stock, or a combination of the two. If the Company elects to issue shares of common stock as dividend payments, the value per share will be equal to 85% of the volume weighted average price per share (“VWAP”) of the common stock for the fifteen days preceding, but not including, the date of such payments. The Company paid $415 and $632 of cash dividends during the six months ended December 31, 2009 and January 1, 2011, respectively.

 

20


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
9. SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK AND WARRANTS — CONTINUED
At any time after five years from the date of issuance, the Preferred Stock is redeemable, in whole or in part, at the option of the holders or the Company. The purchase price per share for redemptions will be equal to the original price per share of the Preferred Stock, plus any accumulated and unpaid dividends. Redemption payments may be made, at the option of the Company, in cash or common stock, or a combination of the two. The Company does not consider exercise of the redemption option probable and, therefore, no accretion is recorded to account for redemption. If the Company elects to make redemption payments in common stock, the value per share will be equal to 85% of the VWAP of the common stock for the fifteen trading days preceding, but not including, the redemption date.
Beginning on September 4, 2011, the Company may require the conversion of any and all outstanding shares of Preferred Stock, provided that the VWAP of the common stock exceeds 200% of the Conversion Price for twenty of the immediately preceding thirty consecutive trading days.
Upon any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of Preferred Stock are entitled to a liquidation preference (the “Liquidation Preference”) equal to:
    the greater of:
    the price per share the holder paid for the Preferred Stock; or
    the amount the holder would have received upon a liquidation, if the holder had converted their shares immediately prior thereto;
    plus any accumulated and unpaid dividends.
A change in control of the Company will be deemed to be a liquidation and will entitle the holders of Preferred Stock to receive the Liquidation Preference. In the event of certain change in control transactions, the Liquidation Preference will be payable, at the option of the Company, in cash or in common stock, or a combination of the two. If the Company elects to pay in common stock, the value per share will be equal to 85% of the VWAP of the common stock for the fifteen trading days preceding, but not including, the date of liquidation.
Warrants
The warrants entitle the holders to purchase 50% of the number of shares of common stock that may be obtained upon conversion of the Preferred Stock, or 1,321,250 shares. The Warrants have a five-year term and became exercisable on March 4, 2010. The exercise price is equal to the closing bid price of the common stock on September 3, 2009, or $10.56, and is not subject to anti-dilution protection, except in the case of stock splits and dividends.
Other Obligations
As required by the Purchase Agreement, the Company filed a registration statement following the closing of the offering to register the shares of common stock issuable upon conversion of the Preferred Stock and exercise of the Warrants. The registration statement was declared effective on November 25, 2009. In certain circumstances, should the registration cease to become effective, the Company would be liable for damages equal to 1% per month of the aggregate purchase price paid by the Purchasers. At January 1, 2011, the Company does not consider this liability to be probable and has not recorded any amount on the Consolidated Balance Sheets.

 

21


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
9. SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK AND WARRANTS — CONTINUED
So long as at least $5,000 of the Preferred Stock remains outstanding, the Purchasers are entitled to participate in an offering by the Company of its equity securities or securities convertible into or exchangeable for its equity securities, subject to certain exceptions, including any public offering of common stock. The Purchase Agreement contains customary representations, warranties and covenants by the parties. In addition, each Purchaser made representations and other agreements with the Company regarding the Purchaser’s beneficial ownership and group status under Rule 13(d) of the Securities Exchange Act of 1934, as amended, as a result of the Offering.
Initial Accounting
Under the initial accounting, the Company separated the Preferred Stock instrument into component parts of the Preferred Stock host contract, the warrants and the Derivative Liability which reflected the redemption and conversion rights of the Purchasers and the Company. The Company estimated the fair value of each component as of the date of issuance and allocated net proceeds initially to the fair value of the Derivative Liability, with any remaining net proceeds allocated to the warrants, as paid-in-capital, and to Preferred Stock, as temporary equity.
At September 4, 2009, the fair value of the Derivative Liability exceeded the net proceeds received by the Company from the Preferred Stock issuance. Therefore, the Derivative Liability was recorded at the amount of the net proceeds, and no value was assigned to the Preferred Stock host contract or the warrants. The following is a summary of the proceeds from the issuance of the Preferred Stock and the initial accounting of the issuance:
         
Cash proceeds from preferred stock issuance
  $ 21,140  
Transaction costs
    (1,905 )
 
     
Net proceeds from preferred stock issuance
  $ 19,235  
 
     
 
       
Fair value of derivative liability
  $ 19,235  
Preferred Stock/temporary equity (relative fair value)
     
Warrant/Equity (relative fair value)
     
 
     
Net fair value of preferred stock, derivative liability and warrants
  $ 19,235  
 
     
Preferred Stock Conversions
During the quarter ended January 1, 2011, holders of Preferred Stock converted 500 shares of Preferred Stock into 62,500 shares of the Company’s common stock. Subsequent to January 1, 2011, some of the Preferred Stock holders exercised their conversion rights, converting 18,840 shares of Preferred Stock into 2,355,000 shares of the Company’s common stock.
See note 12 for discussion of subsequent fair value adjustments.
10. STOCKHOLDER RIGHTS PLAN
On August 15, 2008, the Company adopted a new stockholder rights plan. The new rights plan replaced a previous rights plan, which was adopted in May 2007 and terminated in August 2008.
Stockholders of record at the close of business on August 15, 2008 received a dividend distribution of one right for each share of common stock outstanding on that date. The rights generally will become exercisable and allow the holder to acquire the Company’s common stock at a discounted price if a person or group (other than certain institutional investors specified in the rights plan) acquires beneficial ownership of 20% or more of the Company’s outstanding common stock. Rights held by those that exceed the 20% threshold will be void.

 

22


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
10. STOCKHOLDER RIGHTS PLAN — CONTINUED
The rights plan also includes an exchange option. In general, after the rights become exercisable, the Board of Directors may, at its discretion, effect an exchange of part or all of the rights (other than rights that have become void) for shares of the Company’s common stock. Under this option, the Company would issue one share of common stock for each right, subject to adjustment in certain circumstances.
The Board of Directors may, at its discretion, redeem all outstanding rights for $0.001 per right at any time prior to the time the rights become exercisable. The rights will expire on August 15, 2018, unless earlier redeemed, exchanged or amended by the Board of Directors.
11. STOCK-BASED COMPENSATION
The following information represents the Company’s grants of stock-based compensation to employees and directors during the six months ended January 1, 2011 and December 31, 2009:
                                 
    Six months ended  
    January 1,     December 31,  
    2011     2009  
    Number of     Fair     Number of     Fair  
Grant Type   Shares Granted     Value of Grant     Shares Granted     Value of Grant  
 
                               
Common stock
    36,000     $ 523       36,000     $ 315  
Restricted stock
    64,887     $ 968       111,550     $ 1,038  
The Company recognizes compensation expense for restricted stock awards over the four-year vesting period based on the fair value of the awards on the grant date, net of forfeitures. The fair value of stock and restricted stock awards is based on the fair market value of the Company’s stock on the date of grant.
12. FAIR VALUE MEASUREMENTS
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company utilizes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable.
    Level 1 — Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes for transactions in active exchange markets involving identical assets.
 
    Level 2 — Quoted prices for similar assets and liabilities in active markets; quoted prices included for identical or similar assets and liabilities that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. These are typically obtained from readily-available pricing sources for comparable instruments.
 
    Level 3 — Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting entity’s own beliefs about the assumptions that market participants would use in pricing the asset or liability, based on the best information available in the circumstances.

 

23


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
12. FAIR VALUE MEASUREMENTS — CONTINUED
As discussed above, the Company considers the conversion rights and redemption options of the Preferred Stock to be embedded derivatives, and, as a result, the fair value of the Derivative Liability is reported on the Consolidated Balance Sheets. The Company values the Derivative Liability using a Monte Carlo simulation which contains significant unobservable, or Level 3, inputs. The use of valuation techniques requires the Company to make various key assumptions for inputs into the model, including assumptions about the expected behavior of the Preferred Stock holders and expected future volatility of the price of the Company’s common stock. At certain common stock price points within the Monte Carlo simulation, the Company assumes holders of Preferred Stock will convert their shares of Preferred Stock into shares of the Company’s common stock. Subsequent to January 1, 2011, some of the Preferred Stock holders exercised their conversion rights, converting 18,840 shares of Preferred Stock into 2,355,000 shares of the Company’s common stock. To more closely model the subsequent observed conversions of the Preferred Shares, in estimating the fair value of the derivative liability at January 1, 2011, Management reduced the common stock price point within the Monte Carlo simulation at which stock conversion would be presumed to occur. In estimating the fair value at January 1, 2011, the Company estimated future volatility by calculating a blended volatility rate which considered the historic volatility of the Company’s stock and the historic volatility of the stock of a selected peer group over a five year period. For the six months ended January 1, 2011, a decrease in fair value of $1,870 was recorded in Other income (expense) in the Consolidated Statements of Operations.
The Company values its Interest Rate Cap using a Modified Black-Scholes valuation methodology and market data derived from published market data sources. For the six months ended January 1, 2011, a decrease in fair value of $1 was recorded as a component of interest expense in the Consolidated Statement of Operations.
Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):
                                 
    January 1,                    
    2011     Level 1     Level 2     Level 3  
 
                               
Derivatives related to conversion and redemption rights
  $ (23,591 )   $     $     $ (23,591 )
 
                               
Interest Rate Cap
  $     $     $     $  
The following is a summary of changes to fair value measurements using Level 3 inputs (as reclassified) during the six months ended January 1, 2011:
         
Balance, June 30, 2010
  $ (25,916 )
Change in fair value of derivative liability
    1,870  
Preferred stock conversion
    455  
 
     
Balance, January 1, 2011
  $ (23,591 )
 
     
13. SEGMENT INFORMATION
The Company has two reportable segments: Process Products and Environmental Systems. The Process Products segment produces various types of separators and filters used for removing liquids and solids from gases and air. The segment also includes industrial silencing equipment to control noise pollution on a wide range of industrial processes and heat transfer equipment to conserve energy in many industrial processes and in petrochemical processing. The main product of the Environmental Systems segment is its Selective Catalytic Reduction Systems, referred to as “SCR systems.” These environmental control systems are used for air pollution abatement and converting nitrogen oxide (NOx) emissions into nitrogen and water, and reducing air pollution from exhaust gases caused by burning hydrocarbon fuels such as coal, bio-fuels, natural gas and oil. Along with the SCR Systems, this segment also offers systems to reduce other pollutants such as carbon monoxide (CO) and particulate matter. The Company combines these systems with other components, such as instruments, controls and related valves and piping to offer its customers a totally integrated system.

 

24


Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

January 1, 2011
(In thousands, except share and per share amounts)
13. SEGMENT INFORMATION — CONTINUED
Segment profit and loss is based on revenues less direct expenses of the segment before allocation of general, administrative, research and development costs. All inter-company transfers between segments have been eliminated. The Company allocates all costs associated with the manufacture, sale and design of its products to the appropriate segment. Segment information and reconciliation to operating profit for the three and six months ended January 1, 2011 and December 31, 2009 are presented below. The Company does not allocate Corporate level general and administrative expenses, assets, expenditures for assets or depreciation expense on a segment basis for internal management reporting, and therefore this information is not presented.
                                 
    Three months ended     Six months ended  
    January 1,     December 31,     January 1,     December 31,  
    2011     2009     2011     2009  
 
                               
Revenues
                               
Process Products
  $ 19,259     $ 19,409     $ 41,358     $ 42,110  
Environmental
    7,035       5,120       11,897       13,750  
 
                       
Consolidated
  $ 26,294     $ 24,529     $ 53,255     $ 55,860  
 
                       
 
                               
Operating income (loss)
                               
Process Products
  $ 2,905     $ 3,045     $ 6,079     $ 7,637  
Environmental
    480       878       1,424       3,193  
Corporate level expenses
    (3,634 )     (3,735 )     (7,796 )     (7,679 )
 
                       
Consolidated
  $ (249 )   $ 188     $ (293 )   $ 3,151  
 
                       

 

25


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our results of operations and financial condition should be read together with our consolidated financial statements and the notes thereto included in Item 1 of this Report. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in this and other reports we file with the Securities and Exchange Commission (the “SEC”), including the information in “Item 1A. Risk Factors” of Part I to our Annual Report for the year ended June 30, 2010 and Part II of this report. These factors could cause our actual results for future periods to differ materially from those experienced in, or implied by, these forward-looking statements.
We begin this discussion with an overview of our Company to give you an understanding of our business and the markets we serve. This overview is followed by a discussion of our results of operations for the three and six months ended January 1, 2011 and December 31, 2009, including a discussion of significant period-to-period variances. We also include information regarding our two reportable business segments: Process Products and Environmental Systems. We then discuss our financial condition at January 1, 2011 with a comparison to June 30, 2010. This discussion includes information regarding our liquidity and capital resources, including cash flows from operating, investing and financing activities.
Overview
We are a leading provider of custom-engineered systems and products designed to help ensure that the delivery of energy is safe, efficient and clean. We primarily serve the markets for power generation, natural gas infrastructure, refining and petrochemical processing. We offer a broad range of separation and filtration products, selective catalytic reduction, turbine emission exhaust and silencing systems, and other complementary products including specialty heat exchangers, pulsation dampeners and silencers. Our primary customers include equipment manufacturers, engineering contractors and operators of power plants.
Our products and systems are marketed worldwide. In each of the last three fiscal years, approximately 35% of our revenues are from international sales. We expect our international sales to continue to be an increasingly important part of our business.
Recent Developments
Subsequent to the quarter ended January 1, 2011, the holders of 18,840 shares of Preferred Stock elected to convert their Preferred Stock into 2,355,000 shares of the Company’s common stock. In connection with these conversions, we paid the holders of Preferred Stock cash payments for accrued and unpaid dividends on the converted shares of $63.
On July 15, 2010, we formed a new wholly-owned subsidiary, Peerless Asia Pacific Pte. Ltd. (“Peerless Asia Pacific”), which replaced the former Peerless Mfg. Co. regional sales office in Singapore. The coordination of Peerless Asia Pacific with Peerless Manufacturing (Zhenjiang) Co. Ltd (“PMZ”), our majority-owned business venture in China, will provide a stronger foundation to execute projects throughout the Asia Pacific region.
Critical Accounting Policies
See the Company’s critical accounting policies as described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II of our Annual Report on Form 10-K for the year ended June 30, 2010. Since the date of that report, there have been no material changes to our critical accounting policies.

 

26


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Results of Operations
The following summarizes our consolidated statements of operations as a percentage of revenues:
                                 
    Three months ended     Six months ended  
    January 1,     December 31,     January 1,     December 31,  
    2011     2009     2011     2009  
Net revenues
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of goods sold
    69.1       66.3       68.3       64.1  
 
                       
Gross profit
    30.9       33.7       31.7       35.9  
Operating expenses
    31.8       32.9       32.2       30.2  
 
                       
Operating income
    (0.9 )     0.8       (0.5 )     5.7  
Other income (expense)
    25.8       (25.0 )     1.0       (19.6 )
 
                       
Earnings before income taxes
    24.9       (24.2 )     0.5       (13.9 )
Income tax expense
    1.1       0.1       1.1       (0.4 )
 
                       
Net earnings (loss)
    26.0 %     (24.1 )%     1.6 %     (14.3 )%
 
                       
Less net earnings attributable to noncontrolling interest
    0.2             0.2        
 
                       
Net earnings (loss) attributable to PMFG, Inc.
    25.8       (24.1 )     1.4       (14.3 )
Dividends on preferred stock
    (1.2 )     (1.3 )     (1.2 )     (0.7 )
 
                       
Earnings (loss) applicable to PMFG, Inc. common stockholders
    24.6 %     (25.4 )%     0.2 %     (15.0 )%
 
                       
Cost of goods sold includes manufacturing and distribution costs for products sold. The manufacturing and distribution costs include material, direct and indirect labor, manufacturing overhead, sub-contract work, inbound and outbound freight, purchasing, receiving, inspection, warehousing, internal transfer costs, and other costs of our manufacturing and distribution processes. Cost of goods sold also includes the costs of commissioning the equipment, contract related charges and warranty related costs.
Operating expenses include sales and marketing expenses, engineering and project management expenses, and general and administrative expenses.
Sales and marketing expenses include payroll, employee benefits, stock-based compensation and other employee-related costs associated with sales and marketing personnel. Sales and marketing expenses also include travel and entertainment, advertising, promotions, trade shows, seminars and other programs, and sales commissions paid to independent sales representatives.
Engineering and project management expenses include payroll, employee benefits, stock-based compensation and other employee-related costs associated with engineering, project management and field service personnel. Additionally, engineering and project management expenses include the cost of sub-contracted engineering services.
General and administrative costs include payroll, employee benefits, stock-based compensation and other employee-related costs associated with executive management, finance, accounting, human resources, information systems, and other administrative employees. General and administrative costs also include facility costs, insurance, audit fees, legal fees, reporting expense, professional services, and other administrative fees.
Three Months Ended January 1, 2011 Compared to Three Months Ended December 31, 2009
On July 1, 2010, the Board of Directors approved a resolution to change our fiscal year, which ended as of the last day of the month each June, to a new fiscal year, which will be comprised of either 52 or 53 weeks, commencing within seven days of the month-end. Beginning in fiscal 2011, our fiscal year end will be the Saturday closest to June 30; therefore, the fiscal year end date will vary slightly each year. In a 52 week fiscal year, each of our quarterly periods will be comprised of 13 weeks. In a 53 week fiscal year, three of our quarterly periods will be comprised of 13 weeks and one quarter will be comprised of 14 weeks. We believe this change in fiscal year will reduce financial variability by making the quarterly periods more consistent in length.

 

27


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Results of Operations — Consolidated
Revenues. We classify revenues as domestic or international based upon the origination of the order. Revenues generated by orders originating from within the United States are classified as domestic revenues. Revenues generated by orders originating from a country other than the United States are classified as international revenues. The following summarizes consolidated revenues:
                                 
    Three months ended  
    January 1,     December 31,  
    2011     % of Total     2009     % of Total  
 
                               
Domestic
  $ 16,521       62.8 %   $ 17,110       69.8 %
International
    9,773       37.2 %     7,419       30.2 %
 
                       
Total
  $ 26,294       100.0 %   $ 24,529       100.0 %
 
                       
Total revenues increased $1,765, or 7.2%, for the three months ended January 1, 2011 compared to the three months ended December 31, 2009 as domestic revenues decreased $589, or 3.4%, and international revenues increased $2,354, or 31.7%. The decrease in the domestic revenues can be attributed to a decrease in domestic power consumption which has impeded the progress of new projects and impacted several of our product lines, particularly our environmental products. The decline in domestic revenues as a percentage of the total was offset by an increase in international revenues. This increase in international revenues was the result of a combination of growth in the Asian and South American markets and our strategic decision to increase our focus in the international markets.
Gross Profit. Our gross profit during any particular period may be impacted by several factors, primarily sales volume, shifts in our product mix, material cost changes, and warranty and start-up (commissioning) costs. Shifts in the geographic composition of our sales can also have a significant impact on our reported margins. The following summarizes revenues, cost of goods sold, and gross profit:
                                 
    Three months ended  
    January 1,     December 31,  
    2011     % of Total     2009     % of Total  
 
                               
Revenues
  $ 26,294       100.0 %   $ 24,529       100.0 %
Cost of goods sold
    18,168       69.1 %     16,261       66.3 %
 
                       
Gross profit
  $ 8,126       30.9 %   $ 8,268       33.7 %
 
                       
For the three months ended January 1, 2011, our gross profit decreased $142, or 1.7%, compared to the three months ended December 31, 2009. Our gross profit, as a percentage of revenues, decreased to 30.9% for the three months ended January 1, 2011 compared to 33.7% for the three months ended December 31, 2009. The decrease in gross profit as a percentage of revenues during the three months ended January 1, 2011 primarily related to increased pricing pressure, changes in our product mix, and increased contract-related and warranty charges in the current quarter.

 

28


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Operating Expenses. The following summarizes operating expenses:
                                 
    Three months ended  
    January 1,     December 31,  
    2011     % of Total     2009     % of Total  
 
                               
Sales and marketing
  $ 2,786       10.6 %   $ 2,567       10.5 %
Engineering and project management
    1,955       7.4 %     1,778       7.2 %
General and administrative
    3,634       13.8 %     3,735       15.2 %
 
                       
Total
  $ 8,375       31.8 %   $ 8,080       32.9 %
 
                       
Operating expenses increased $295 or 3.7% for the three months ended January 1, 2011 compared to the three months ended December 31, 2009. As a percentage of revenues, these expenses decreased to 31.8% during the three months ended January 1, 2011 from 32.9% during the three months ended December 31, 2009 due to an increase in revenues during the current period. Our sales and marketing expenses increased $219 during the three months ended January 1, 2011 compared to the three months ended December 31, 2009 primarily due to increased commissions and other selling related expenses associated with higher revenues in the current quarter. Our engineering and project management expenses increased $177 for the three months ended January 1, 2011 compared to the three months ended December 31, 2009 due to CEFCO business and product development. General and administrative expenses decreased $101 during the three months ended January 1, 2011 compared to the three months ended December 31, 2009.
Other Income and Expense. The following summarizes other income and expense:
                                 
    Three months ended  
    January 1,     Dec 31,  
            % of             % of  
    2011     Revenues     2009     Revenues  
Interest income
  $ 5       %   $ 6       %
Interest expense
    (626 )     (2.4 )%     (691 )     (2.8 )%
Foreign exchange gain (loss)
    109       0.5 %     611       2.5 %
Gain (loss) on change in fair value of derivative liability
    7,304       27.8 %     (5,812 )     (23.7 )%
Other expense, net
          %     (241 )     (1.0 )%
 
                       
Total other income (expense)
  $ 6,792       25.8 %   $ (6,127 )     (25.0 )%
 
                       
For the three months ended January 1, 2011, total other income (expense) items increased by $12,919, compared to the three months ended December 31, 2009. The change was primarily due to a gain on the Derivative Liability of $7,304 this quarter compared to loss on the liability of $5,812 for the three months ended December 31, 2009.
Income Taxes. Our effective income tax rate was 4.5% and 0.3% for the three months ended January 1, 2011 and December 31, 2009, respectively. Our effective income tax rate for the three months ended January 1, 2011 and December 31, 2009, was impacted by $7,304 of gain and $5,812 of loss, respectively, recorded to reflect the change in fair value of our Derivative Liability, which is not a taxable item for income tax purposes.
Net Earnings (Loss). Our net earnings were $6,839 during the three months ended January 1, 2011, compared to a net loss of $5,921 during the three months ended December 31, 2009 which is an increase in earnings of $12,760. Basic and fully diluted earnings per share were $0.37 and $0.36 per share, respectively, for the three months ended January 1, 2011, compared to basic and diluted loss of ($0.47) per share for the three months ended December 31, 2009. The increase in the current year earnings and per share earnings resulted primarily from the decrease in the fair value of the Derivative Liability and increased revenues in the current period compared to an increase in the fair value of the Derivative Liability for the three months ended December 31, 2009.

 

29


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Results of Operations — Segments
We have two lines of business: Process Products and Environmental Systems. Revenues and operating income in this section are presented on a basis consistent with accounting principles generally accepted in the United States of America (“US GAAP”). Certain corporate level expenses have been excluded from our segment operating results and are analyzed separately.
Process Products
The Process Products segment produces specialized systems and products that remove contaminants from gases and liquids, improving efficiency, reducing maintenance and extending the life of energy infrastructure. Process Products represented 73.2% and 79.1% of our revenues for the three months ended January 1, 2011 and December 31, 2009, respectively.
The following summarizes Process Products revenues and operating income:
                 
    Three months ended  
    January 1,     December 31,  
    2011     2009  
 
               
Revenues
  $ 19,259     $ 19,409  
Operating income
  $ 2,905     $ 3,045  
 
               
Operating income as % of revenues
    15.1 %     15.7 %
Process Products revenues decreased by $150, or 0.8%, during the three months ended January 1, 2011 compared to the three months ended December 31, 2009.
Process Products operating income for the three months ended January 1, 2011 decreased $140, or 4.6%, compared to the three months ended December 31, 2009. As a percentage of Process Products revenues, operating income was 15.1% and 15.7% for the three months ended January 1, 2011 and December 31, 2009, respectively. The decrease in operating income as a percentage of revenues during the three months ended January 1, 2011 is primarily related to the external pricing pressures of the global market, a shift in our product mix from premium separators to lower margin standard models, and increased warranty costs.
Environmental Systems
The primary product of our Environmental Systems business is selective catalytic reduction systems, which we refer to as SCR systems. SCR systems are integrated systems, with instruments, controls and related valves and piping. Our SCR systems convert nitrogen oxide, or NOx, into nitrogen and water, reducing air pollution and helping our customers comply with environmental regulations. Environmental Systems represented 26.8% and 20.9% of our revenues for the three months ended January 1, 2011 and December 31, 2009, respectively.

 

30


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
The following summarizes Environmental Systems revenues and operating income:
                 
    Three months ended  
    January 1,     December 31,  
    2011     2009  
 
               
Revenues
  $ 7,035     $ 5,120  
Operating income
  $ 480     $ 878  
 
               
Operating income as % of revenues
    6.8 %     17.1 %
Revenues from Environmental Systems increased $1,915, or 37.4%, during the three months ended January 1, 2011 compared to the three months ended December 31, 2009. The increase in the Environmental Systems segment revenue for the three months ended January 1, 2011, is attributable to completion of backlogged projects not seen in the previous fiscal year.
Environmental Systems operating income for the three months ended January 1, 2011 decreased $398, or 45.3%, compared to the three months ended December 31, 2009. As a percentage of Environmental Systems revenues, operating income decreased to 6.8% during the three months ended January 1, 2011 from 17.1% for the three months ended December 31, 2009. A more competitive pricing environment, the inelastic nature of some of the segment’s operating costs, and an increase in contract-related costs resulted in a decrease in operating income as a percentage of revenues for the three months ended January 1, 2011 compared to the three months ended December 31, 2009.
Corporate Level Expenses
Corporate level general and administrative expenses were $3,634 and $3,735 for the three months ended January 1, 2011 and December 31, 2009, respectively. These expenses are excluded from our segment operating results. See “Operating Expenses” above for additional discussion.
Six Months Ended January 1, 2011 Compared to Six Months Ended December 31, 2009
Results of Operations — Consolidated
Revenues. The following table summarizes consolidated revenues:
                                 
    Six months ended  
    January 1,     December 31,  
    2011     % of Total     2009     % of Total  
 
                               
Domestic
  $ 33,011       62.0 %   $ 38,687       69.3 %
International
    20,244       38.0 %     17,173       30.7 %
 
                       
Total
  $ 53,255       100.0 %   $ 55,860       100.0 %
 
                       
We classify revenue as domestic or international based upon the origination of the order. Revenue generated by orders originating from within the United States is classified as domestic revenue. Revenue generated by orders originating from a country other than the United States is classified as international revenue.

 

31


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
For the six months ended January 1, 2011, total revenues decreased $2,605, or 4.7%, compared to the six months ended December 31, 2009. Domestic revenues decreased $5,676, or 14.7%, in the six months ended January 1, 2011 when compared to the six months ended December 31, 2009. International revenues increased $3,071, or 17.9%, in the six months ended January 1, 2011 when compared to the six months ended December 31, 2009. The decline in domestic revenues was offset by an increase in international revenues. This increase was the result of a combination of growth in the Asian and South American markets and our strategic decision to increase our focus in the international markets.
Gross Profit. The following table summarizes revenues, cost of goods sold, and gross profit:
                                 
    Six months ended  
    January 1,     December 31,  
    2011     % of Total     2009     % of Total  
 
                               
Revenues
  $ 53,255       100.0 %   $ 55,860       100.0 %
Cost of goods sold
    36,388       68.3 %     35,825       64.1 %
 
                       
Gross profit
  $ 16,867       31.7 %   $ 20,035       35.9 %
 
                       
For the six months ended January 1, 2011, our gross profit decreased $3,168, or 15.8%, compared to the six months ended December 31, 2009. Our gross profit, as a percentage of revenues, decreased to 31.7% during the six months ended January 1, 2011 compared to 35.9% for the six months ended December 31, 2009. The decrease in gross profit as a percentage of revenues during the six months ended January 1, 2011 primarily related to changes in our product mix, increased pricing pressure, warranty and contract-related charges.
Operating Expenses. The following table summarizes operating expenses:
                                 
    Six months ended  
    January 1,     December 31,  
    2011     % of Total     2009     % of Total  
 
                               
Sales and marketing
  $ 5,522       10.4 %   $ 5,577       10.0 %
Engineering and project management
    3,842       7.2 %     3,628       6.5 %
General and administrative
    7,796       14.6 %     7,679       13.7 %
 
                       
Total
  $ 17,160       32.2 %   $ 16,884       30.2 %
 
                       
For the six months ended January 1, 2011, our operating expenses increased by $276 compared to the six months ended December 31, 2009. As a percentage of revenue, these expenses increased to 32.2% in the six months ended January 1, 2011 from 30.2% in the six months ended December 31, 2009. Our sales and marketing expenses decreased $55 in the six months ended January 1, 2011 compared to the six months ended December 31, 2009 primarily due to a reduction in commissions and other sales related expenses associated with reduced revenues. Our engineering and project management expense increased $214 in the six months ended January 1, 2011 compared to the six months ended December 31, 2009 due to engineering associated with our agreement with CEFCO business and product development. Our general and administrative expenses increased $117 in the six months ended January 1, 2011 compared to the six months ended December 31, 2009.

 

32


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Other Income and Expense. The following table summarizes other income and expenses:
                                 
    Six months ended  
    January 1,     Dec 31,  
            % of             % of  
    2011     Revenues     2009     Revenues  
Interest income
  $ 19       %   $ 18       %
Interest expense
    (1,510 )     (2.8 )%     (1,902 )     (3.4 )%
Loss on extinguishment of debt
          %     (1,303 )     (2.3 )%
Foreign exchange gain (loss)
    176       0.3 %     815       1.5 %
Gain (loss) on change in fair value of derivative liability
    1,870       3.5 %     (8,312 )     (14.9 )%
Other expense, net
          %     (241 )     (0.4 )%
 
                       
Total other income (expense)
  $ 555       1.0 %   $ (10,925 )     (19.6 )%
 
                       
For the six months ended January 1, 2011, other expense decreased by $11,480, from expense of $10,925 for the six months ended December 31, 2009 to income of $555 in income for the six months ended January 1, 2011. The decrease in other expense is primarily attributable to the change in the fair value of our Derivative Liability associated with the conversion and redemption features of our Preferred Stock and the write off of $1,303 of deferred financing charges associated with the subordinated term debt that was extinguished in September 2009. The decrease also included a reduction of interest expense of $392 offset by a reduced gain related to foreign currency transactions of $176 during the six months ended January 1, 2011 compared to a gain on foreign currency transactions of $815 for the six months ended December 31, 2009. The reduction in interest expense was largely the result of extinguishing $20,000 of subordinated term debt in September 2009. The foreign exchange gain for the six months ended December 31, 2009 includes $523 of accumulated foreign currency translation adjustments that were recognized upon the liquidation of our joint venture in Japan.
Income Taxes. Our effective income tax rate was 234.5% and (3.1%) for the six months ended January 1, 2011 and December 31, 2009, respectively. Our effective income tax rate for the six months ended January 1, 2011 and December 31, 2009, was impacted by $1,870 of gain and $8,312 of loss, respectively, recorded to reflect the change in fair value of our Derivative Liability, which is not a taxable item for income tax purposes.
Net Earnings. Our net loss decreased by $8,888 from a net loss of $8,012 in the six months ended December 31, 2009, to net earnings of $876 in the six months ended January 1, 2011. The primary reason for the decrease in the loss was $1,870 of gain related to the change in fair value of the derivative liability for the six months ended January 1, 2011 and $8,312 of expense related to the change in fair value of the derivative liability for the six months ended December 31, 2009.
Basic and diluted earnings per share increased to $0.01 per share for the six months ended January 1, 2011, from a loss of ($0.63) per share for the six months ended December 31, 2009.
Results of Operations — Segments
Process Products
Our Process Products segment represented 77.7% and 75.4% of our revenues for the six months ended January 1, 2011 and December 31, 2009, respectively.

 

33


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
The following table summarizes Process Products revenues and operating income:
                 
    Six months ended  
    January 1,     December 31,  
    2011     2009  
 
               
Revenues
  $ 41,358     $ 42,110  
Operating income
  $ 6,079     $ 7,637  
 
               
Operating income as % of revenues
    14.7 %     18.1 %
Process Products revenues decreased by $752 or 1.8%, in the six months ended January 1, 2011 when compared to the six months ended December 31, 2009. The decrease in Process Products revenue is primarily attributable to varying economic conditions around the world and project timing delays to accommodate our customers which postponed revenue recognition.
Process Products operating income in the six months ended January 1, 2011 decreased by $1,558 compared to the six months ended December 31, 2009. As a percentage of Process Products revenues, operating income was 14.7% in the six months ended January 1, 2011 compared to 18.1% in the six months ended December 31, 2009. The decrease in operating income and operating income as a percentage of sales is primarily related to external pricing pressures, a change in our product mix, and warranty charges.
Environmental Systems
Our Environmental Systems segment represented 22.3% and 24.6% of our revenues for the six months ended January 1, 2011 and December 31, 2009, respectively.
The following table summarizes Environmental Systems revenues and operating income:
                 
    Six months ended  
    January 1,     December 31,  
    2011     2009  
 
               
Revenues
  $ 11,897     $ 13,750  
Operating income
  $ 1,424     $ 3,193  
 
               
Operating income as % of revenues
    12.0 %     23.2 %
Revenues from Environmental Systems decreased $1,853, or 13.5% in the six months ended January 1, 2011, when compared to the six months ended December 31, 2009. The decrease in Environmental Systems revenue for the six months ended January 1, 2011, is attributable to decreased demand driven by a reduction in domestic power consumption.
Environmental Systems operating income in the six months ended January 1, 2011 decreased $1,769 or 55.4% compared to the six months ended December 31, 2009. The decrease was attributable to the decreased revenue in the six months ended January 1, 2011 combined with an increase in contract-related charges.

 

34


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Corporate Level Expenses
Corporate level expenses were $7,796 and $7,679 for the six months ended January 1, 2011 and December 31, 2009, respectively. Corporate level general and administrative expenses are excluded from our segment operating results. See “Operating Expenses” above for additional discussion on these expenses.
Contingencies
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. See Note 8 of the consolidated financial statements.
Backlog
Our backlog of uncompleted orders was approximately $99,000 at January 1, 2011, compared to $96,000 at June 30, 2010. Backlog has been calculated under our customary practice of including incomplete orders for products that are deliverable in future periods but that could be changed or cancelled. Of our backlog at January 1, 2011, we estimate approximately 80% will be completed during the next twelve months.
Financial Position
Assets. Total assets decreased by $5,944, or 4.2%, from $143,081 at June 30, 2010, to $137,137 at January 1, 2011. On January 1, 2011, we held cash and cash equivalents of $21,760, had working capital of $42,931 and a current liquidity ratio of 2.3-to-1.0. This compares with cash and cash equivalents of $24,271, working capital of $48,000, and a current liquidity ratio of 2.4-to-1.0 at June 30, 2010.
Liabilities and Equity. Total liabilities decreased by $9,145, or 10.6%, from $85,934 at June 30, 2010 to $76,786 at January 1, 2011. The decrease in our total liabilities is attributed to the principal reduction of our senior term loan and by the fair value adjustment of the Derivative Liability offset by an increase in our trade accounts payable.
The increase in our stockholder’s equity of $3,204, or 5.6%, from $57,147 at June 30, 2010 to $60,351 at January 1, 2011 is attributable to our net earnings for the six months ended January 1, 2011, stock compensation awards, stock option activity, and the conversion of 500 shares of preferred stock. Our ratio of debt (total liabilities)-to-equity decreased from 1.5-to-1.0 at June 30, 2010 to 1.3-to-1.0 at January 1, 2011.
Liquidity and Capital Resources
Because we are engaged in the business of manufacturing systems, our progress billing practices are event-oriented rather than date-oriented and vary from contract to contract. Generally, a contract will either allow for amounts to be billed upon shipment or on a progress basis based on the attainment of certain milestones. We typically bill our customers upon the occurrence of project milestones. Billings to customers affect the balance of billings in excess of costs and earnings on uncompleted contracts or the balance of costs and earnings in excess of billings on uncompleted contracts, as well as the balance of accounts receivable. Consequently, we focus on the net amount of these accounts, along with accounts payable, to determine our management of working capital. At January 1, 2011, the balance of these working capital accounts was $17,558 compared to $25,266 at June 30, 2010, reflecting a decrease of our investment in these working capital items of $7,708.
Our cash and cash equivalents were $21,760 as of January 1, 2011 compared to $24,271 at June 30, 2010. During the six months ended January 1, 2011, cash provided by operating activities was $6,367 compared to cash provided by operating activities of $4,622 for the six months ended December 31, 2009. Cash provided by operating activities primarily related to changes in accounts receivable in the current period and accounts payable in the prior period.

 

35


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Cash used in investing activities was $2,678 for the six months ended January 1, 2011, compared to cash provided by investing activities of $944 for the six months ended December 31, 2009. Cash used in investing activities during the six months ended January 1, 2011 related primarily to purchases of property and equipment and intangible assets. This was partially offset by a reduction in cash restricted to serve as collateral against open letters of credit of $396.
Cash used in financing activities during the six months ended January 1, 2011 was $6,792, compared to cash used in financing activities of $6,007 during the six months ended December 31, 2009. The cash used in financing activities for the six months ended January 1, 2011 primarily related to principal payments on the senior term loan and the payment of cash dividends to our Preferred Stock holders. During the quarter ended January 1, 2011, holders of Preferred Stock converted 500 shares of Preferred Stock into 62,500 shares of the Company’s common stock. As a result, we are no longer obligated to pay quarterly dividends on the converted shares of Preferred Stock.
As a result of the events described above, our cash and cash equivalents during the six months ended January 1, 2011 decreased by $2,511 compared to an increase of $336 during the six months ended December 31, 2009.
We believe we maintain adequate liquidity to support existing operations and planned growth over the next 12 months.
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk.
Interest Rate Risk
We are subject to interest rate risk on outstanding borrowings under our Senior Secured Credit Agreement, which bears interest at a variable rate. At January 1, 2011, we had $13,221 of outstanding borrowings under this Agreement. Currently we have an interest rate cap transaction with a notional amount of $5,000, or 37.8% of our variable rate debt. This cap instrument complies with our obligation under our Senior Secured Credit Agreement.
Foreign Currency Risk
Our exposure to currency exchange rate fluctuations has been, and is expected to continue to be, modest as foreign contracts payable in currencies other than United States dollars are performed principally in the local currency and therefore provide a “natural hedge” against currency fluctuations. The impact of currency exchange rate movements on inter-company transactions has historically been immaterial. We did not have any currency derivatives outstanding as of, or during the six months ended January 1, 2011.
Derivative Liability Risk
We have not entered into financial instruments for speculative or trading purposes. However, the conversion rights and redemption options of our Preferred Stock are classified as an embedded derivative, and as a result, are marked to market to reflect fair value of the embedded derivative at each reporting period. The fair value of the embedded derivative is influenced by a variety of factors, including the actual and anticipated behavior of the holders of the Preferred Stock, the expected volatility of our common stock price and our common stock price as of the fair value measurement date. Some of these factors are outside of our control. As a result, changes in these factors may have a material impact on our net income and the Derivative Liability recorded on our Consolidated Balance Sheets. Consequently, our financial statements may vary periodically based on factors other than the Company’s revenues and expenses. Changes in the estimated fair value of the embedded derivative do not have an impact on our cash flows.

 

36


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
Item 4.   Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information related to the Company (including its consolidated subsidiaries) that is required to be disclosed in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
The Company’s management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of these disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated by the SEC under the Securities Exchange Act of 1934) as of the end of the period covered by this Report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective in ensuring that all information required to be disclosed in this Report has been recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Additionally, based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures were effective in ensuring that all material information required to be filed in this Report has been accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, in a timely fashion to allow decisions regarding required disclosures.
Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls could be circumvented by the individual acts of some persons or by collusion of two or more people. The Company’s controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met.
During the six months ended January 1, 2011, there have been no changes in the Company’s internal control over financial reporting, or in other factors, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1.   Legal Proceedings
On June 19, 2007, Martin-Manatee Power Partners, LLC (“MMPP”) filed a complaint against the Company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida. In the complaint, MMPP asserted claims for breach of contract and express warranty, breach of implied warranty and indemnification against the Company. MMPP’s claims arise out of an incident in September 2005 when an electric fuel gas start-up heater, which was a component of a fuel gas heater skid supplied by the Company to MMPP, allegedly ruptured resulting in a fire. In the complaint, MMPP did not make a specific demand for damages.

 

37


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
The Company’s insurance carriers have agreed to defend the claims asserted by MMPP, pursuant to reservation of rights letters issued on September 5, 2007 and have retained counsel to defend the Company. The Company’s motion to dismiss the complaint for improper venue was granted on December 11, 2007. On February 20, 2008, MMPP filed a new action in the District Court of Johnson County, Kansas, the venue referenced in the purchase order pursuant to which the skid was purchased by MMPP from the Company. In this complaint, MMPP asserted the same claims as described above. MMPP has made a demand for damages in the amount of $2,500, which it claims represents its net costs incurred related to this incident. The Company appealed the ruling by the District Court, which dismissed third party defendant, Controls International, Inc., the manufacturer of a valve used on the skid. The Company filed its appeal on July 24, 2009. On June 18, 2010, the Kansas Court of Appeals affirmed the decision of the District Court, granting the motion for dismissal of Controls International, Inc. The Company filed a motion for rehearing with the Kansas Court of Appeals and filed a petition for review with the Kansas Supreme Court on July 2, 2010, requesting the reconsideration and reversal of the Kansas Court of appeals decision to dismiss Controls International, Inc. The Kansas Court of Appeals denied the motion for rehearing. At January 1, 2011, we have accrued $100 for the applicable insurance deductible relating to this claim. However, at this time the Company cannot estimate any potential final range of loss resulting from this litigation, as it is still in discovery. At this time, we believe MMPP’s claims are without merit and we intend to vigorously defend this suit.
We are also involved, from time to time, in various litigation, claims and proceedings arising in the normal course of business that are not expected to have any material effect on the financial condition of the Company.
Item 1A.   Risk Factors
There have been no material changes in our risk factors from those disclosed in Item 1A of Part I of our Annual Report on 10-K for the year ended June 30, 2010.
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
On October 11, 2010, a holder of Preferred Stock converted 500 shares of Preferred Stock into 62,500 shares of the Company’s common stock. The converted shares of Preferred Stock had an original issue price of $1,000 per share and were converted at a conversion price of $8.00 per share of Common Stock. The conversion was exempt from registration under Section 3(a)(9) of the Securities Act of 1933. The Company did not receive any cash proceeds from the conversion of the Preferred Stock.
Item 6.   Exhibits
The following exhibits are filed as part of this report.
         
Exhibit    
Number   Exhibit
       
 
  31.1    
Rule 13a – 14(a)/15d – 14(a) Certification of Chief Executive Officer.
       
 
  31.2    
Rule 13a – 14(a)/15d – 14(a) Certification of Chief Financial Officer.
       
 
  32    
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.

 

38


Table of Contents

PMFG, Inc. and Subsidiaries
January 1, 2011
(In thousands, except share and per share amounts)
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.
         
  PMFG, INC.
 
 
Date: February 9, 2011  /s/ Peter J. Burlage    
  Peter J. Burlage   
  President and Chief Executive Officer
(Principal Executive Officer) 
 
     
Date: February 9, 2011  /s/ Henry G. Schopfer, III    
  Henry G. Schopfer, III   
  Chief Financial Officer
(Principal Financial and Accounting Officer) 
 

 

39