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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 29, 2012

OR

 

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

For the transition period from             to             

Commission File Number 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   x    No  ¨

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  x    No  ¨

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   ¨    Accelerated filer    x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    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  ¨    No  x

The number of shares of the registrant’s common stock outstanding on November 1, 2012, was 20,920,255.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

    

Page

Number

 

Forward-Looking Statements

     3   

PART I: FINANCIAL INFORMATION

  

Item 1. Financial Statements

  

Consolidated Balance Sheets at September 29, 2012 (unaudited) and June 30, 2012

     4   

Unaudited Consolidated Statements of Operations for the three months ended September  29, 2012 and October 1, 2011

     5   

Unaudited Consolidated Statements of Comprehensive Income for the three months ended September  29, 2012 and October 1, 2011

     6   

Unaudited Consolidated Statement of Equity for the three months ended September 29, 2012

     7   

Unaudited Consolidated Statement of Cash Flows for the three months ended September  29, 2012 and October 1, 2011

     8   

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

     21   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     29   

Item 4. Controls and Procedures

     29   

PART II: OTHER INFORMATION

  

Item 1. Legal Proceedings

     29   

Item 1A. Risk Factors

     29   

Item 6. Exhibits

     30   

SIGNATURES

     31   

 

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 or political environment or in the markets in which we operate, including the natural gas infrastructure, power generation, and petrochemical and processing industries;

 

   

compliance with United States and foreign laws and regulations, 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 current environmental legislation or regulations;

 

   

risks associated with our indebtedness, the terms of our credit agreements and our ability to raise additional capital;

 

   

risks associated with the concentration of ownership of our stock;

 

   

changes in competition;

 

   

changes in demand for our products;

 

   

our ability to realize the full value of our backlog and the timing of our receipt of revenue under contracts included in backlog;

 

   

risks associated with our product warranties; and

 

   

changes in the price, supply or demand for natural gas, bio fuel, oil or coal.

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, 2012 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 forward-looking statements, except to the extent required by law.

 

3


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)

 

ASSETS    September 29,
2012
    June 30,
2012
 
     (unaudited)        

Current assets:

    

Cash and cash equivalents

   $ 60,113      $ 52,286   

Restricted cash

     8,130        7,927   

Accounts receivable -trade, net of allowance for doubtful accounts of $274 and $650 at September 29, 2012 and June 30, 2012, respectively

     22,003        32,428   

Inventories, net

     6,980        6,478   

Costs and earnings in excess of billings on uncompleted contracts

     19,267        14,635   

Income taxes receivable

     4,018        4,101   

Deferred income taxes

     1,191        1,191   

Other current assets

     3,513        3,240   
  

 

 

   

 

 

 

Total current assets

     125,215        122,286   

Property, plant and equipment, net

     9,589        9,522   

Intangible assets, net

     20,456        20,731   

Goodwill

     30,429        30,429   

Other assets

     1,003        311   
  

 

 

   

 

 

 

Total assets

   $ 186,692      $ 183,279   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 19,878      $ 18,539   

Billings in excess of costs and earnings on uncompleted contracts

     12,592        11,797   

Commissions payable

     1,438        1,437   

Income taxes payable

     1,130        595   

Accrued product warranties

     2,436        2,615   

Customer deposits

     2,672        3,241   

Accrued liabilities and other

     7,534        6,795   
  

 

 

   

 

 

 

Total current liabilities

     47,680        45,019   

Deferred income taxes

     6,180        6,180   

Other non-current liabilities

     1,170        1,194   

Commitments and contingencies

    

Preferred stock – authorized, 5,000,000 shares of $0.01 par value; no shares outstanding at September 29, 2012 or June 30, 2012

     —          —     

Stockholders’ equity:

    

Common stock – authorized, 50,000,000 shares of $0.01 par value; issued and outstanding, 20,920,255 and 20,773,878 shares at September 29, 2012 and June 30, 2012, respectively

     209        208   

Additional paid-in capital

     96,418        96,072   

Accumulated other comprehensive loss

     (1,487     (1,913

Retained earnings

     34,883        35,194   
  

 

 

   

 

 

 

Total PMFG, Inc.’s stockholders’ equity

     130,023        129,561   

Noncontrolling interest

     1,639        1,325   
  

 

 

   

 

 

 

Total equity

     131,662        130,886   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 186,692      $ 183,279   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

4


Table of Contents

PMFG, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands, except per share amounts)

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 
     (unaudited)  

Revenue

   $ 32,977      $ 29,088   

Cost of goods sold

     21,585        20,380   
  

 

 

   

 

 

 

Gross profit

     11,392        8,708   

Operating expenses

    

Sales and marketing

     3,067        2,895   

Engineering and project management

     2,324        1,985   

General and administrative

     5,541        4,975   
  

 

 

   

 

 

 
     10,932        9,855   
  

 

 

   

 

 

 

Operating income (loss)

     460        (1,147

Other income (expense)

    

Interest income

     10        10   

Interest expense

     (105     (427

Loss on extinguishment of debt

     (291     —     

Foreign exchange loss

     (82     (458

Other income

     1        21   
  

 

 

   

 

 

 
     (467     (854
  

 

 

   

 

 

 

Loss before income taxes

     (7     (2,001

Income tax benefit

     1        831   
  

 

 

   

 

 

 

Net loss

   $ (6   $ (1,170
  

 

 

   

 

 

 

Less net earnings (loss) attributable to noncontrolling interest

   $ 305      $ (19
  

 

 

   

 

 

 

Net loss attributable to PMFG

   $ (311   $ (1,151
  

 

 

   

 

 

 

Loss applicable to PMFG common stockholders

   $ (311   $ (1,151
  

 

 

   

 

 

 

Basic and diluted loss per share

   $ (0.01   $ (0.07
  

 

 

   

 

 

 

Weighted-average shares outstanding:

    

Basic and diluted shares outstanding

     20,917        17,670   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

5


Table of Contents

PMFG, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 
     (unaudited)  

Net loss

   $ (6   $ (1,170

Other comprehensive income (loss):

    

Foreign currency translation adjustment

     435        (438
  

 

 

   

 

 

 

Other comprehensive income (loss)

     435        (438

Comprehensive income (loss)

     429        (1,608

Comprehensive income (loss) attributable to noncontrolling interests

     314        (12
  

 

 

   

 

 

 

Comprehensive income (loss) attributable to PMFG, Inc.

   $ 115      $ (1,596
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

6


Table of Contents

PMFG, Inc. and Subsidiaries

Consolidated Statement of Equity

(In thousands)

(unaudited)

 

     Common
Shares
     Stock
Amount
     Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Total
Stockholders’
Equity
    Non
Controlling
Interest
     Total
Equity
 

Balance at June 30, 2012

     20,774       $ 208       $ 96,072       $ 35,194      $ (1,913   $ 129,561      $ 1,325       $ 130,886   

Comprehensive income

                    

Net (loss) earnings

              (311       (311     305         (6

Foreign currency translation adjustment

                426        426        9         435   
               

 

 

   

 

 

    

 

 

 

Total comprehensive income

                  115        314         429   

Stock grants, net of forfeitures

     146         1         346             347           347   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at September 29, 2012

     20,920       $ 209       $ 96,418       $ 34,883      $ (1,487   $ 130,023      $ 1,639       $ 131,662   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

7


Table of Contents

PMFG, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 
     (unaudited)  

Cash flows from operating activities:

    

Net loss

   $ (6   $ (1,170

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     679        665   

Amortization of deferred finance charges

     15        92   

Stock-based compensation

     347        973   

Bad debt expense

     805        17   

Inventory valuation reserve

     (43     (33

Provision for warranty expense

     414        345   

Loss on extinguishment of debt

     291        —     

Loss on disposal of property

     19        —     

Foreign exchange loss

     82        458   

Changes in operating assets and liabilities:

    

Accounts receivable

     9,741        6,005   

Inventories

     (456     (239

Costs and earnings in excess of billings on uncompleted contracts

     (4,566     (1,985

Other current assets

     (107     224   

Accounts payable

     1,357        76   

Billings in excess of costs and earnings on uncompleted contracts

     795        1,048   

Commissions payable

     1        (466

Income taxes

     618        (848

Product warranties

     (593     (478

Accrued liabilities and other

     (165     (406
  

 

 

   

 

 

 

Net cash provided by operating activities:

     9,228        4,278   

Cash flows from investing activities:

    

Decrease in restricted cash

     6        1,757   

Purchases of property and equipment

     (481     (473

Advance payment of license agreement

     —          (248
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (475     1,036   

Cash flows from financing activities:

    

Payment of debt

     —          (650

Payment of debt issuance costs

     (630     —     

Payment of deferred consideration costs

     (14     —     
  

 

 

   

 

 

 

Net cash used in financing activities

     (644     (650

 

Consolidated Statements of Cash Flows continued on next page

 

8


Table of Contents

PMFG, Inc. and Subsidiaries

Consolidated Statements of Cash Flows – Continued

(In thousands)

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 
     (unaudited)  

Effect of exchange rate changes on cash and cash equivalents

     (282     (1,492
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     7,827        3,172   

Cash and cash equivalents at beginning of period

     52,286        12,905   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 60,113      $ 16,077   
  

 

 

   

 

 

 

Supplemental information on cash flow:

    

Income taxes received

   $ 842      $ —     

Interest paid

   $ 175      $ 366   

See accompanying notes to consolidated financial statements.

 

9


Table of Contents

PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

PMFG, Inc. and SubsidiariesNotes to Consolidated Financial Statements September 29, 2012

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 September 29, 2012 and for the three months ended September 29, 2012 and October 1, 2011 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, 2012.

Each of the Company’s interim reporting periods ends on the Saturday closest to the last day of the corresponding quarterly calendar period. The first quarter of 2013 and 2012 ended on September 29, 2012, and October 1, 2011, respectively. References to “fiscal 2013” and “fiscal 2012” refer to fiscal years ended June 29, 2013 and June 30, 2012, respectively.

Basis of Consolidation

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. 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 China Manufacturing Co. Ltd (“PCMC”), formerly known as Peerless Manufacturing (Zhenjiang) Co. Ltd. The non-controlling interest of Peerless Propulsys is reported as a separate component on the Consolidated Balance Sheets and Consolidated Statements of Operations.

Cash and Cash Equivalents

For purposes of the 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.

The Company maintains cash balances in bank accounts that normally exceed Federal Deposit Insurance Corporation insured limits. As of September 29, 2012, cash held in the United States exceeded federally insured limits by $24.5 million. The Company has not experienced any losses related to this cash concentration.

The Company had restricted cash balances of $8.1 million and $7.9 million as of September 29, 2012 and June 30, 2012, respectively. Foreign restricted cash balances were $8.1 million and $7.8 million as of September 29, 2012 and June 30, 2012, respectively. Cash balances were restricted to collateralize letters of credit and financial institution guarantees issued in the normal course of business.

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.

 

10


Table of Contents

PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

1. SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

 

Accounts 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 to the allowance for doubtful accounts in the period the payment is received.

Changes in the Company’s allowance for doubtful accounts are as follows (in thousands):

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Balance at beginning of period

   $ 650      $ 600   

Bad debt expense

     805        17   

Accounts written off

     (1,181     (46
  

 

 

   

 

 

 

Balance at end of period

   $ 274      $ 571   
  

 

 

   

 

 

 

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.

Property, Plant and Equipment

Depreciation of property, plant and equipment is calculated using the straight-line method over a period considered adequate to depreciate the total cost over the useful lives of the assets, 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 whenever events or changes in circumstances indicate that the carrying amount 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 asset exceeds its fair value, typically represented by the discounted cash flows associated with the asset.

 

11


Table of Contents

PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

1. SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

 

Goodwill and Other Intangible Assets

Goodwill represents the difference between the purchase price and the fair value of the net assets acquired upon acquisition. Goodwill is not amortized, however, it is measured at the reporting unit level to test for impairment annually, in the fourth quarter, or more frequently if conditions indicate an earlier review is necessary. A discounted future cash flow analysis is primarily used to determine whether impairment exists. If the fair value of a reporting unit is less than the carrying amount, then the Company writes down goodwill to its estimated fair value.

Intangible assets subject to amortization include licensing agreements, customer relationships and acquired sales order backlog. These intangible assets are amortized over their estimated 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 include trade names and design guidelines. The Company evaluates the recoverability of indefinite lived intangible assets annually, in the fourth quarter, or whenever events or changes in circumstances indicate that an intangible asset’s carrying amount may not be recoverable. The Company uses the market and income approach methods to determine whether impairment exists.

Fair Value of Financial Instruments

The carrying amounts 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.

Revenue Recognition

The Company recognizes revenue, net of sales taxes, from product sales or services provided when the following revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

The Company provides certain products under long-term, generally fixed-priced, contracts that may extend over multiple financial periods, where revenue and cost of sales are recognized in accordance with accounting rules relating to construction-type and production-type contracts. Amounts recognized in revenue are calculated using the percentage of cost completed, generally on a cumulative cost to total cost basis. This method requires the Company to make estimates regarding the total costs of the project, which impacts the amount of gross margin the Company recognizes in each reporting period. The Company routinely reviews its estimates relating to total estimated contract profit or loss and recognizes changes in those estimates as they are determined. The percentage-of-completion method generally results in the recognition of reasonably consistent profit margins over the life of a contract. Anticipated losses on these contracts are recorded in full in the period in which they become evident. 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.

Contracts that are considered short-term in nature and require less product customization are accounted for under the completed contract method. Revenue under the completed contract method is recognized upon shipment of the product.

Pre-contract, Start-up and Commissioning Costs

The Company does not consider the realization of any individual sales order as probable prior to order acceptance.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

1. SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

 

Therefore, pre-contract costs incurred prior to sales order acceptance are included as a component of operating expenses when incurred. Some of the Company’s contracts require the installation and placing in service of the product after it is distributed to the end user. The costs associated with the start-up and commissioning of these projects are estimated and recorded in cost of goods sold in the period in which the revenue is recognized. Estimates are based on historical experience and expectation of future conditions.

Warranty Costs

The Company provides to its customers product warranties for specific products during a defined period of time, generally less than 18 months after shipment of the product. Warranties cover the failure of a product to perform after it has been placed in service. The Company reserves for estimated future warranty costs in the period in which the revenue is recognized based on historical experience, expectation of future conditions, and the extent of backup concurrent supplier warranties in place. Warranty costs are included in the costs of goods sold.

Income Taxes

The Company utilizes the asset and liability approach in its reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount more likely than not to be realized. Income tax related interest and penalties are included in income tax expense. The Company recognizes in its financial statements the impact of a tax position taken or expected to be taken in a tax return, if that position is “more likely than not” of being sustained upon examination by the relevant taxing authority, based on the technical merits of the position.

The Company is required to estimate income taxes in each jurisdiction in which it operates. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. In the event that actual results differ from these estimates, the Company’s provision for income taxes could be materially impacted.

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. Diluted earnings per common share include the dilutive effect of stock options and warrants granted using the treasury stock method. Options to acquire 43,200 shares of common stock and warrants to acquire 839,063 shares of common stock were omitted from the calculation of dilutive securities for the three months ended September 29, 2012, because they were anti-dilutive. Options to acquire 55,200 shares of common stock and warrants to acquire 1,310,673 shares of common stock were omitted from the calculation of dilutive securities for the three months ended October 1, 2011, 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 revenue and expenses during the reporting period. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

2. INVENTORIES

Principal components of inventories are as follows (in thousands):

 

     September 29,
2012
    June 30,
2012
 

Raw materials

   $ 3,278      $ 2,991   

Work in progress

     3,521        3,330   

Finished goods

     370        341   
  

 

 

   

 

 

 
     7,169        6,662   

Reserve for obsolete and slow-moving inventory

     (189     (184
  

 

 

   

 

 

 
   $ 6,980      $ 6,478   
  

 

 

   

 

 

 

3. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

The components of uncompleted contracts are as follows (in thousands):

 

     September 29,
2012
    June 30,
2012
 

Costs incurred on uncompleted contracts and estimated earnings

   $ 75,190      $ 64,503   

Less billings to date

     (68,515     (61,665
  

 

 

   

 

 

 
   $ 6,675      $ 2,838   
  

 

 

   

 

 

 

The components of uncompleted contracts are reflected in the Consolidated Balance Sheets as follows (in thousands):

 

      September 29,
2012
    June 30,
2012
 

Costs and earnings in excess of billings on uncompleted contracts

   $ 19,267      $ 14,635   

Billings in excess of costs and earnings on uncompleted contracts

     (12,592     (11,797
  

 

 

   

 

 

 
   $ 6,675      $ 2,838   
  

 

 

   

 

 

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS

All goodwill and other intangible assets are allocated to the Process Products segment. Goodwill is not deductible for income tax purposes.

Goodwill

There were no changes in the carrying amount of goodwill for the three months ended September 29, 2012.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS – CONTINUED

 

Acquisition-Related Intangibles

Acquisition-related intangible assets are as follows (in thousands):

 

     Weighted
Average
Estimated
Useful Life
(Years)
   Gross Value
September 29, 2012
     Accumulated
Amortization
    Net Book
Value
September 29, 2012
     Gross Value
June 30, 2012
     Accumulated
Amortization
    Net Book
Value
June 30, 2012
 

Design guidelines

   Indefinite    $ 6,940       $ —        $ 6,940       $ 6,940       $ —        $ 6,940   

Customer relationships

   11      7,940         (2,934     5,006         7,940         (2,769     5,171   

Trade names

   Indefinite      4,729         —          4,729         4,729         —          4,729   

Licensing agreements

   5      2,199         (1,943     256         2,199         (1,833     366   

Acquired backlog

   0.7      6,801         (6,801     —           6,801         (6,801     —     
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
      $ 28,609       $ (11,678   $ 16,931       $ 28,609       $ (11,403   $ 17,206   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Amortization expense of $0.3 million was recorded to the Consolidated Statements of Operations for both the three months ended September 29, 2012 and October 1, 2011. The Company’s estimated amortization for each of the next five fiscal years is as follows (in thousands):

 

    Estimated Amortization Expense        

for the Fiscal Years Ended

June 29, 2013

     $ 1,027

June 28, 2014

        660

June 27, 2015

        585

July 02, 2016

        510

July 01, 2017

        509

CEFCO Licensing Agreement

In July 2010, the Company entered into the CEFCO Process Manufacturing License Agreement (the “License Agreement”) with CEFCO Global Clean Energy, LLC, a Texas limited liability company (“CEFCO”). In November 2011, the Company announced the successful completion of large scale prototype tests associated with the first two pollution control modules of the CEFCO processing equipment. The Company and CEFCO are seeking a sponsor to conduct a pilot program at a potential customer facility to complete additional testing of the CEFCO technology. The Company advanced $1.1 million to CEFCO at the inception of the License Agreement. The Company has recorded certain additional costs incurred related to the construction and testing of a scaled version of the technology as advances on future payments due under the License Agreement. As of September 29, 2012 and June 30, 2012, $3.5 million was included in Intangibles, net. Amortization of the License Agreement will be recognized over the life of the License Agreement (10 years) commencing after the initial sale, construction and commissioning of a full scale version of the CEFCO processing equipment.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

5. ACCRUED PRODUCT WARRANTIES

Accrued product warranty activity is as follows (in thousands):

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Balance at beginning of period

   $ 2,615      $ 2,575   

Provision for warranty expenses

     414        345   

Warranty charges

     (593     (478
  

 

 

   

 

 

 

Balance at end of period

   $ 2,436      $ 2,442   
  

 

 

   

 

 

 

6. ACCRUED LIABILITIES AND OTHER

The components of accrued liabilities and other are as follows (in thousands):

 

     September 29,
2012
     June 30,
2012
 

Accrued start-up and commissioning expense

   $ 363       $ 363   

Accrued compensation

     2,459         2,562   

Accrued professional expenses

     2,917         1,871   

Deferred consideration related to Burgess Manning GmbH acquisition

     1,401         1,375   

Other

     394         624   
  

 

 

    

 

 

 
   $ 7,534       $ 6,795   
  

 

 

    

 

 

 

7. DEBT

In September 2012, the Company entered into a new Credit Agreement (the “Credit Agreement”) with Citibank, N.A., as administrative agent and other financial institutions party thereto. The Credit Agreement provides for, among other things, revolving credit commitments of $30.0 million to be used for working capital and general corporate purposes, term loan commitments of $2.0 million to be used for the purchase or refinancing of equipment for a new manufacturing facility in Denton, Texas (“Term Loan A”) and term loan commitments of $10.0 million to fund the construction of the new Denton facility (“Term Loan B”). All borrowings and other obligations of the Company are guaranteed by substantially all of its domestic subsidiaries and are secured by substantially all of the assets of the Company. The Company had no outstanding long-term debt obligations as of September 29, 2012.

The Company recorded $1.0 million of deferred financing costs in the three months ended September 29, 2012, related to the new Credit Agreement. Upon termination of the previous senior secured credit agreement, the Company wrote off $0.3 million in unamortized deferred financing costs as a loss on extinguishment of debt for the three months ended September 29, 2012.

The revolving credit facility under the Credit Agreement will terminate on September 30, 2015, and all revolving credit loans mature on that date. Under the revolving credit facility, the Company has a maximum borrowing availability equal to the lesser of (a) $30.0 million or (b) the sum of 80% of eligible accounts receivable plus 50% of eligible inventory plus 100% of the cash amount held in a special collateral account less a foreign currency letter of credit reserve. At September 29, 2012, the Company had no outstanding borrowings and approximately $9.1 million of outstanding letters of credit under the Credit Agreement, leaving the Company with approximately $2.2 million of available capacity for additional borrowings and letters of credit under the Credit Agreement.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

7. DEBT – CONTINUED

 

The term loan commitments expire 18 months after the date of the Credit Agreement. Beginning June 30, 2014, the Company is required to make quarterly principal payments on the term loans that were incurred during that 18-month period. Term Loan A matures in 2019 and Term Loan B matures in 2022. The Credit Agreement also requires the Company to at all times maintain an interest rate protection agreement with respect to at least 50% of the aggregate outstanding principal amount of the term loans.

Interest on all loans must generally be paid quarterly. Interest rates on term loans use floating rates plus  1/2 of 1% up to 2%, plus a margin of between 0 to 75 basis points based upon the Company’s consolidated funded debt to consolidated EBITDA for the trailing four consecutive fiscal quarters.

At September 29, 2012, the Company was required to maintain a Consolidated Total Leverage Ratio (“CTL”) not to exceed 1.75 to 1.00 and a Debt Service Coverage Ratio (“DSC”) of not less than 1.50 to 1.00. The CTL ratio is calculated as the ratio of the Company’s aggregate total liabilities to the sum of the excess of the Company’s total assets over its total liabilities as each is determined on a consolidated basis in accordance with generally accepted accounting principles. The DSC ratio is calculated as the ratio of the Company’s consolidated EBITDA less certain restricted cash payments, capitalized expenditures and taxes to the Company’s consolidated fixed charges, which is the sum of the Company’s current maturities of long-term debt and the amount of cash paid for interest on a trailing twelve month basis. The Credit Agreement also contains other covenants, including restrictions on additional debt, dividends, capital expenditures, acquisitions and dispositions. At September 29, 2012, the Company was in compliance with its debt covenant requirements.

The Company’s U.K. subsidiary has a debenture agreement used to facilitate issuances of letters of credit and bank guarantees of £6.0 million ($9.7 million) at September 29, 2012 and £6.0 million ($9.4 million) at June 30, 2012. This facility was secured by substantially all of the assets of the Company’s U.K. subsidiary and by a cash deposit of £4.1 million ($6.6 million) at September 29, 2012 and £4.1 million ($6.4 million) at June 30, 2012, which is recorded as restricted cash on the Consolidated Balance Sheets. At September 29, 2012, there was £5.7 million ($9.2 million) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement. At June 30, 2012, there was £5.9 million ($9.3 million) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement.

The Company’s German subsidiary had debenture agreements used to facilitate issuances of letters of credit and bank guarantees of €4.8 million ($6.1 million) at September 29, 2012 and €4.8 million ($6.0 million) at June 30, 2012. This facility is secured by substantially all of the assets of the Company’s German subsidiary and by a cash deposit of €1.1 million ($1.4 million) at September 29, 2012 and €1.1 million ($1.4 million) at June 30, 2012, which is recorded as restricted cash on the Consolidated Balance Sheets. At September 29, 2012, there was €3.5 million ($4.5 million) of outstanding stand-by letters of credit and bank guarantees under the debenture agreements. At June 30, 2012, there was €3.5 million ($4.4 million) of outstanding stand-by letters of credit and bank guarantees under the debenture agreements.

8. COMMITMENTS AND CONTINGENCIES

Litigation

In June 2010, the Company received notice from a customer claiming approximately $9.1 million 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 “Alco Claim”). 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 has not received sufficient information to assess the validity of the Alco Claim and has notified the Nitram insurance carrier and the selling stockholders of Nitram. The Company believes if any valid claim exists, the Company is entitled to be indemnified by 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.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

8. COMMITMENTS AND CONTINGENCIES – CONTINUED

 

At this time, the Company cannot estimate any potential range of loss that may result from the Alco Claim as the Company has not received sufficient information to assess its validity. No amount has been accrued in the financial statements for the Alco Claim as of September 29, 2012 or June 30, 2012. At this time, the Company has not been notified that any lawsuit has been filed by the customer.

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 facility in Wichita Falls and groundwater concerns at the Jacksboro Highway facility in Wichita Falls and the Cisco facilities. Additional sampling and evaluation of the groundwater concerns at Jacksboro Highway and Cisco facilities 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 facility in Wichita Falls was completed in July 2009 and the Company will continue to monitor groundwater at and near the site. The total costs accrued are $0.2 million at September 29, 2012 and June 30, 2012, and are related to the costs of monitoring and the preparation of environmental reports. The Company is seeking reimbursement for the full cost of the remediation and ongoing and future monitoring activities under the indemnification provisions of our purchase agreement with Nitram’s selling stockholders in the amount of $0.6 million. Funds were 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 $10.9 million of the purchase price in escrow to reimburse the Company for indemnification 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 sellers in five installments. 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 in October 2009, the Company had made claims relating to environmental matters and indemnification for breach of representations and warranties of the Nitram purchase agreement, totaling approximately $2.0 million against the escrow, and a total of $1.4 million was withheld from the release of the escrow amount, which represents the Company’s claims, less the one percent deductible, estimated at $0.6 million. 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 $9.5 million, related to the Alco Claim and the 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. The Company does not currently believe it will have additional losses or claims against the former Nitram stockholders that are in excess of the amounts already claimed or accrued.

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.

Others Matters

In March 2012, the Company entered into an agreement to construct a new 80,000 square foot manufacturing facility located in Denton, Texas. The contract amount is $9.8 million and construction of the facility began in August 2012.

During the quarter ended September 29, 2012 the Company entered into an agreement related to a customer warranty claim. The agreement provided for the payment of cash, replacement of product within an established time frame, as needed, and a discount on future purchase orders received from the customer. The cash payment and estimated cost of future product replacement has been accrued or paid as of September 29, 2012. The discount on future purchase orders, if any, will be recognized in future periods.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

9. STOCKHOLDER RIGHTS PLAN

On August 15, 2008, the Company adopted a stockholder rights plan. 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, such as Schedule 13G filers) 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.

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.

10. STOCK-BASED COMPENSATION

The following information represents the Company’s grants of stock-based compensation to employees and directors during the three months ended September 29, 2012 and October 1, 2011(in thousands, except share amounts):

 

     Three months ended  
     September 29,
2012
     October 1,
2011
 

Grant Type

   Number of
Shares
Granted
     Fair Value
of Grant
     Number of
Shares
Granted
     Fair Value
of Grant
 

Stock

     36,000       $ 291         36,000       $ 765   

Restricted stock

     110,377         894         38,438         816   

The fair value of the stock granted to the Board of Directors is recognized immediately. 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.

11. 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 from exhaust gases caused by burning hydrocarbon fuels such as coal, gasoline, natural gas and oil. Along with the SCR Systems, this segment 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.

 

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PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 29, 2012

 

11. SEGMENT INFORMATION – CONTINUED

 

The Company allocates all costs associated with the manufacture, sale and design of its products to the appropriate segment. Segment profit and loss is based on revenue less direct expenses of the segment before general and administrative costs. The Company does not allocate general and administrative expenses (“reconciling items”), assets, or expenditures for assets on a segment basis for internal management reporting; therefore this information is not presented. Segment information and reconciliation to operating profit for the three months ended September 29, 2012 and October 1, 2011 are presented below (in thousands).

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Revenue:

    

Process Products

   $ 28,715      $ 24,235   

Environmental Systems

     4,262        4,853   
  

 

 

   

 

 

 
   $ 32,977      $ 29,088   
  

 

 

   

 

 

 

Operating income (loss):

    

Process Products

   $ 5,380      $ 3,352   

Environmental Systems

     621        476   

Corporate and other unallocated expenses

     (5,541     (4,975
  

 

 

   

 

 

 
   $ 460      $ (1,147
  

 

 

   

 

 

 

 

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PMFG, Inc. and Subsidiaries

September 29, 2012

 

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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand PMFG, Inc., our operations, and our present business environment. MD&A is provided to supplement – and should be read in conjunction with – our unaudited consolidated financial statements and the accompanying notes thereto contained in “Item 1. Financial Statements” of this report. This overview summarizes the MD&A, which includes the following sections:

 

   

Our Business – a general description of our business and the key drivers of product demand.

 

   

Results of Operations – an analysis of our Company’s consolidated and reporting segment results of operations for the three month periods presented in our consolidated unaudited financial statements.

 

   

Liquidity, Capital Resources and Financial Position – an analysis of cash flows; aggregate contractual obligations; foreign currency exposure; and an overview of financial position.

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, 2012. These factors could cause our actual results for future periods to differ materially from those experienced in, or implied by, these forward-looking statements.

Our Business

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 natural gas infrastructure, power generation and refining and petrochemical processing. We offer a broad range of separation and filtration products, Selective Catalytic Reduction Systems (“SCR 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 facilities.

Our products and systems are marketed worldwide. Revenue generated from outside the United States was approximately 54% in the three month period ended September 29, 2012 compared to 39% in the three month period ended October 1, 2011. As a result of global demand for our products and our increased sales resources outside of the United States, we expect our international sales will continue to be a significant percentage of our consolidated revenue in the future.

We believe our success depends on our ability to understand the complex operational demands of our customers and deliver systems and products that meet or exceed the indicated design specifications. Our success further depends on our ability to provide such products in a cost-effective manner and within the time frames established with our customers. Our gross profit during any particular period may be impacted by several factors, primarily shifts in our product mix, material cost changes, and warranty costs. Shifts in the geographic composition of our sales also can have a significant impact on our reported margins.

We have two reporting segments: Process Products and Environmental Systems. 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. 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 primary product of our Environmental Systems business is SCR Systems. SCR Systems are integrated systems, with instruments, controls and related valves and piping. Our SCR Systems convert nitrogen oxide into nitrogen and water, reducing air pollution and helping our customers comply with environmental regulations.

 

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PMFG, Inc. and Subsidiaries

September 29, 2012

 

Key Drivers of Product Demand

We believe demand for our products is driven by the increasing demand for energy in both developed and emerging markets, coupled with the global trend towards increasingly restrictive environmental regulations. These trends should stimulate investment in new power generation facilities and related infrastructure, and in upgrading existing facilities.

With a shift to cleaner, more environmentally responsible power generation, power providers and industrial power consumers are building new facilities that use cleaner fuels, such as natural gas, nuclear technology, and renewable resources. In developed markets, natural gas is increasingly becoming one of the energy sources of choice. We supply product offerings throughout the entire natural gas infrastructure value chain and believe the expansion of natural gas infrastructure will drive growth of our process products and the global market for our SCR Systems for natural-gas-fired power plants.

Despite existing concerns over safety and government regulations related to the construction of new nuclear power facilities and the re-commissioning of existing facilities, we believe rising nuclear capacity utilization rates and concerns about energy security and emissions will drive the increase for nuclear power generation, both domestically and internationally. China and India are expected to lead the global expansion of nuclear power generation growth. Recommissioning of existing nuclear facilities in the United States and France also will contribute to product demand.

These market trends will drive the demand for both our separation/filtration products and our SCR Systems, creating significant opportunities for us. We face strong competition from numerous other providers of custom-engineered systems and products. We, along with other companies that provide alternative products and solutions, are affected by a number of factors, including, but not limited to, global economic conditions, level of capital spending by companies engaged in energy production, processing, transportation, storage and distribution, as well as current and anticipated environmental regulations.

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, 2012. Since the date of that report, there have been no material changes to our critical accounting policies.

Results of Operations

The following summarizes our Consolidated Statements of Operations as a percentage of revenue:

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Net revenue

     100.0     100.0

Cost of goods sold

     65.5        70.1   
  

 

 

   

 

 

 

Gross profit

     34.5        29.9   

Operating expenses

     33.2        33.9   
  

 

 

   

 

 

 

Operating income (loss)

     1.3        (4.0

Other expense, net

     (1.4     (2.9
  

 

 

   

 

 

 

Loss before income taxes

     (0.1     (6.9

Income tax benefit

     0.0        2.8   
  

 

 

   

 

 

 

Net loss

     (0.1 )%      (4.1 )% 
  

 

 

   

 

 

 

 

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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, depreciation, 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 and warranty related costs. Operating expenses include sales and marketing expenses, engineering and project management expenses and general and administrative expenses which are further described below.

 

   

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 expenses – include payroll, employee benefits, stock-based compensation and other employee-related costs and costs associated with executive management, finance, human resources, information systems and other administrative employees. General and administrative costs also include board of director compensation and expenses, facility costs, insurance, audit fees, legal fees, professional services and other administrative fees.

Revenue. 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, regardless of where the product is shipped or where it will eventually be installed. Revenue generated by orders originating from a country other than the United States is classified as international revenue. International revenue was approximately 54% and 39% of consolidated revenue in the three month periods ended September 29, 2012 and October 1, 2011, respectively. The following summarizes consolidated revenue (in thousands):

 

     Three months ended  
     September 29,     October 1,  
     2012      % of Total
Revenue
    2011      % of Total
Revenue
 

Domestic

   $ 15,260         46.3   $ 17,767         61.1

International

     17,717         53.7     11,321         38.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 32,977         100.0   $ 29,088         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenue increased $3.9 million or 13.4% to $33.0 million in the quarter ended September 29, 2012, compared to prior year. The acquisition of Burgess Manning GmbH in November 2011 contributed $2.6 million of revenue for the quarter ended September 29, 2012. Additional increases in international revenue are attributable to growth in Asia resulting from both an increase in demand and our strategic decision to increase our sales focus on the international markets. Our international sales have traditionally been weighted toward Process Products, although there is increased quote activity related to Environmental Systems products and solutions.

Gross Profit. Our gross profit during any particular period may be impacted by several factors, primarily revenue volume, shifts in our product mix, material cost changes, warranty, start-up and commissioning costs. Shifts in the geographic composition of our revenue also can have a significant impact on our reported margins. The following summarizes revenue, cost of goods sold and gross profit (in thousands):

 

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September 29, 2012

 

     Three months ended  
     September 29,     October 1,  
     2012      % of Total
Revenue
    2011      % of Total
Revenue
 

Revenue

   $ 32,977         100.0   $ 29,088         100.0

Cost of goods sold

     21,585         65.5     20,380         70.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Gross profit

   $ 11,392         34.5   $ 8,708         29.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Gross profit in the three month period ended September 29, 2012 increased $2.7 million compared to the comparable period of the prior year, and increased as a percentage of revenue from 29.9% in the prior year to 34.5% in the current year. The increase in gross profit as a percentage of revenue during the three months ended September 29, 2012, compared to the comparable period in the prior year related to changes in product and geographic mix, as well as increased focus on manufacturing costs. Gross profit percentage in the three months ended October 1, 2011 was further dampened by cost overruns on certain projects which were not present in the current period.

Operating Expenses. The following summarizes operating expenses (in thousands):

 

     Three months ended  
     September 29,     October 1,  
     2012      % of Total
Revenue
    2011      % of Total
Revenue
 

Sales and marketing

   $ 3,067         9.3   $ 2,895         10.0

Engineering and project management

     2,324         7.0     1,985         6.8

General and administrative

     5,541         16.9     4,975         17.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 10,932         33.2   $ 9,855         33.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating expenses increased $1.1 million or 10.9% for the three months ended September 29, 2012 compared to prior year. As a percentage of revenue, these expenses decreased to 33.2% during the three months ended September 29, 2012 from 33.9% during the three months ended October 1, 2011.

Our sales and marketing expenses increased $0.2 million primarily due to increased selling related expenses associated with higher revenue. Our engineering and project management expenses increased $0.3 million for the three months ended September 29, 2012 compared to the three months ended October 2, 2011 in line with the increased revenue. General and administrative expenses increased $0.6 million during the three months ended September 29, 2012 compared to the same period a year ago primarily due to a write off of a customer receivable that was identified to be uncollectible in the current period, and increased costs of maintaining foreign offices partially offset by lower stock-based compensation expense.

 

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Other Income and Expense. The following summarizes other income and expense (in thousands):

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Interest income

   $ 10      $ 10   

Interest expense

     (105     (427

Loss on extinguishment of debt

     (291     —     

Foreign exchange gain (loss)

     (82     (458

Other income (expense), net

     1        21   
  

 

 

   

 

 

 

Total other income (expense)

   $ (467   $ (854
  

 

 

   

 

 

 

For the three months ended September 29, 2012, total other income and expense was a net expense of $0.5 million compared to $0.9 million in the prior year. Interest expense decreased $0.3 million from the prior year due to lower average debt balances outstanding. A $0.3 million write off of deferred financing charges associated with the refinancing of our senior secured credit agreement was recognized in the three months ended September 29, 2012. A loss on foreign exchange of $0.1 million was recognized in the quarter ended September 29, 2012 compared to $0.5 million in the prior year, primarily as a result of changes in the exchange rates of the Canadian dollar relative to the U.S. dollar and the euro relative to the British pound.

Income Taxes. Our effective income tax rates were 20.7% and 41.5% for the three months ended September 29, 2012 and October 1, 2011, respectively. For the quarter ended September 29, 2012, the effective tax rate was impacted by increased profits of our foreign subsidiaries which have a lower tax rate than the United States. For the quarter ended October 1, 2011 the effective tax rate varied from statutory rates because of income tax credits for our research and development expenditures.

Results of Operations – Segments

We have two reporting segments: Process Products and Environmental Systems.

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. 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. Process Products represented 87% and 83% of our revenue in the three months ended September 29, 2012 and October 1, 2011, respectively.

The following summarizes Process Products revenue and operating income (in thousands):

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Revenue

   $ 28,715      $ 24,235   

Operating income

     5,380        3,352   

Operating income as % of revenue

     18.7     13.8

Process Products revenue increased $4.5 million or 18.5% to $28.7 million in the three months ended September 29, 2012, compared to prior year. The acquisition of Burgess Manning GmbH in November 2011 contributed $2.6 million of revenue in the

 

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three months ended September 29, 2012. Additional revenue growth for the current year resulted from increased pressure product and nuclear revenue in Asia driven by our continued focused sales efforts in that region.

Process Products operating income for the three months ended September 29, 2012 increased $2.0 million, or 60.5%, compared to prior year. The increase in operating income in the three months ended September 29, 2012 was primarily a result of increased revenue in the segment. As a percentage of revenue, operating income was 18.7% and 13.8% for the three months ended September 29, 2012 and October 1, 2011, respectively. The increase in operating income as a percentage of revenue during the current year is attributed to a change in product mix as well as an increased focus on manufacturing 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 13.0% and 17.0% of our revenue in the three months ended September 29, 2012 and October 1, 2011, respectively.

The following summarizes Environmental Systems revenue and operating income (in thousands):

 

     Three months ended  
     September 29,
2012
    October 1,
2011
 

Revenue

   $ 4,262      $ 4,853   

Operating income

     621        476   
  

 

 

   

 

 

 

Operating income as % of revenue

     14.6     9.8
  

 

 

   

 

 

 

Environmental Systems revenue decreased $0.6 million or 12.2% to $4.3 million in the three months ended September 29, 2012, compared to prior year. The lower revenue reflects a decline in bookings in late fiscal 2011 and early fiscal 2012. Demand for SCR Systems has been dampened by continued delays in the implementation of published environmental regulations.

Environmental Systems operating income for the three months ended September 29, 2012 increased $0.1 million in comparison to the prior year. As a percentage of revenue, operating income increased to 14.6% during the three months ended September 29, 2012, from 9.8% for the three months ended October 1, 2011 as a result of lower selling and engineering costs relative to revenue.

General and Administrative Expenses

General and administrative expenses include those related to the corporate office, as well as general and administrative costs of international subsidiaries. General and administrative expenses increased $0.6 million or 11.4% in the quarter ended September 29, 2012 in comparison to the prior year. The increase was primarily due to the write off of a customer receivable that was identified to be uncollectible in the current period, and increased costs of maintaining foreign offices partially offset by lower stock-based compensation expense.

 

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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 in the Notes to the Consolidated Financial Statements.

Net Bookings and Backlog

The following table shows the activity and balances related to our backlog for the three months ended and as of September 29, 2012 and October 1, 2011 (in millions):

 

     Three Months Ended  
     September 29,
2012
    October 1,
2011
 

Backlog at beginning of period

   $ 99.9      $ 89.0   

Net bookings

     24.7        26.1   

Revenue recognized

     (33.0     (29.1
  

 

 

   

 

 

 

Backlog at end of period

   $ 91.6      $ 86.0   
  

 

 

   

 

 

 

Our backlog was approximately $91.6 million at September 29, 2012, compared to $99.9 million at June 30, 2012. At September 29, 2012, approximately 85% of our backlog related to Process Products sales orders with the balance pertaining to Environmental Systems sales orders. Backlog includes contractual purchase orders for products that are deliverable in future periods less revenue recognized on such orders to date. Of our backlog at September 29, 2012, we estimate approximately 80% of the revenue related to our existing backlog will be recognized in the next 12 months. Orders in backlog are subject to change, delays or cancellation by our customers.

Financial Position

Assets. Total assets increased by $3.4 million, or 1.9%, from $183.3 million at June 30, 2012, to $186.7 million at September 29, 2012. On September 29, 2012, we held cash, including restricted cash, and cash equivalents of $68.2 million, had working capital of $77.5 million and a current liquidity ratio of 2.6-to-1.0. This compares with cash, including restricted cash, and cash equivalents of $60.2 million, working capital of $77.3 million, and a current liquidity ratio of 2.7-to-1.0 at June 30, 2012.

Liabilities and Equity. Total liabilities increased by $2.6 million, or 5.0%, from $52.4 million at June 30, 2012 to $55.0 million at September 29, 2012. The increase in our total liabilities is primarily attributed to an increase in accounts payable.

The increase in our stockholder’s equity of $0.8 million, or 0.6%, from $130.9 million at June 30, 2012 to $131.7 million at September 29, 2012 is attributable to stock awards and an increase in Other Comprehensive Income partially offset by our net loss for the three months ended September 29, 2012. Our ratio of debt (total liabilities)-to-equity was 0.4-to-1.0 at September 29, 2012 and June 30, 2012.

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

 

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amount of these accounts, along with accounts payable, to determine our management of working capital. At September 29, 2012, the balance of these working capital accounts was $8.8 million compared to $16.7 million at June 30, 2012, reflecting a decrease of our investment in these working capital items of $7.9 million.

Many of our customers require bank letters of credit or other forms of financial guarantees to secure progress payments and performance. Such letters of credit and guarantees are issued under various bank and financial institution arrangements (see Note 7 of Item 1 in the Notes to the Consolidated Financial Statements). As of September 29, 2012 and June 30, 2012, we had outstanding letters of credit and bank guarantees of $23.0 million and $22.1 million, respectively.

Our cash and cash equivalents were $68.2 million as of September 29, 2012 compared to $60.2 million at June 30, 2012, of which $8.1 million and $7.9 million were restricted as collateral for stand-by letters of credit and bank guarantees at September 29, 2012 and June 30, 2012, respectively. During the three months ended September 29, 2012, cash provided by operating activities was $9.2 million compared to cash provided by operating activities of $4.3 million for the three months ended October 1, 2011.

Cash used in investing activities was $0.5 million for the three months ended September 29, 2012, compared to cash provided by investing activities of $1.0 million for the three months ended October 1, 2011. Cash used in investing activities during the three months ended September 29, 2012 primarily related to purchases of property and equipment, partially offset by a reduction in cash restricted to serve as collateral against open letters of credit. Cash provided by investing activities during the three months ended October 1, 2011 primarily related to a reduction in cash restricted to serve as collateral against open letters of credit, partially offset by cash used to purchase property and equipment and to invest in the CEFCO manufacturing license agreement.

Cash used in financing activities during the three months ended September 29, 2012 was $0.6 million compared to cash used in financing activities of $0.7 million during the three months ended October 1, 2011. The cash used in financing activities for the three months ended September 29, 2012 primarily consisted of payment of debt issuance costs for new credit facility. The cash used in financing activities for the three months ended October 1, 2011 consisted of payment of long-term debt.

As a result of the events described above, our cash and cash equivalents during the three months ended September 29, 2012 increased by $7.8 million compared to an increase of $3.2 million during the three months ended October 1, 2011.

We are beginning construction of new manufacturing facilities in the United States and China. These facilities are intended to support anticipated future growth in product demand both domestically and internationally. We currently believe the China manufacturing facility will be primarily focused on projects within China. We intend to fund the construction of the facilities and acquisition of related equipment using both cash on hand and additional debt.

We believe we maintain adequate liquidity and the capacity to enter into letters of credit and guarantees to support existing operations and planned growth over the next 12 months.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risk exposures from those disclosed in Item 7A of Part II of our Annual Report of Form 10-K for the year ended June 30, 2012.

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. Notwithstanding the foregoing, the Company’s disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.

During the three months ended September 29, 2012, 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

We are 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, 2012.

 

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September 29, 2012

 

Item 6. Exhibits

The following exhibits are filed as part of this report.

 

Exhibit No.

 

Exhibit Description

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 Certifications of Chief Executive Officer and Chief Financial Officer.
101.INS†   XBRL Report Instance Document
101.SCH†   XBRL Taxonomy Extension Schema Document
101.CAL†   XBRL Taxonomy Calculation Linkbase Document
101.LAB†   XBRL Taxonomy Label Linkbase Document
101.PRE†   XBRL Presentation Linkbase Document
101.DEF†   XBRL Taxonomy Extension Definition Linkbase Document

 

Indicates furnished herewith.

 

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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: November 8, 2012  

/s/ Peter J. Burlage

 

Peter J. Burlage

President and Chief Executive Officer

(Principal Executive Officer)

Date: November 8, 2012  

/s/ Ronald L McCrummen

 

Ronald L. McCrummen

Executive Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)

 

31