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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 October 2, 2010
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 November 4, 2010, was 14,954,901.
 
 

 

 


 

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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32

 

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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;
    the redemption and conversion features of our Series A Convertible Redeemable Preferred Stock (“Preferred Stock”) are classified as an embedded derivative and as such has 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 raising 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.

 

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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.

 

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PMFG, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
                 
    October 2,     June 30,  
    2010     2010  
    (unaudited)        
ASSETS
               
 
               
Current assets:
               
Cash and cash equivalents
  $ 26,310     $ 24,271  
Restricted cash
    5,305       5,868  
Accounts receivable, principally trade — net of allowance for doubtful accounts of $852 and $886 at October 2, 2010 and June 30, 2010
    22,331       27,310  
Inventories — net
    7,127       7,220  
Costs and earnings in excess of billings on uncompleted contracts
    13,849       13,560  
Deferred income taxes
    2,066       2,066  
Other current assets
    3,133       2,011  
 
           
Total current assets
    80,121       82,306  
 
 
Property, plant and equipment — net
    7,928       7,506  
Intangible assets — net
    22,611       21,781  
Goodwill
    29,702       29,702  
Other assets
    1,076       1,786  
 
           
Total assets
  $ 141,438     $ 143,081  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current liabilities:
               
Accounts payable
  $ 10,750     $ 10,180  
Current maturities of long-term debt
    4,000       4,000  
Billings in excess of costs and earnings on uncompleted contracts
    5,579       5,424  
Commissions payable
    1,900       1,932  
Income taxes payable
          717  
Accrued product warranties
    2,306       2,480  
Customer deposits
    2,966       2,481  
Accrued liabilities and other
    5,106       7,092  
 
           
Total current liabilities
    32,607       34,306  
 
               
Long-term debt
    15,221       16,221  
Deferred income taxes
    8,579       8,548  
Derivative liability
    31,350       25,916  
Other non-current liabilities
    976       943  
 
               
Commitments and contingencies
               
 
               
Preferred stock — authorized, 5,000,000 shares of $0.01 par value; issued and outstanding, 21,140 shares at October 2, 2010 and June 30, 2010
           
 
               
Stockholders’ equity:
               
Common stock — authorized, 50,000,000 shares of $0.01 par value; issued and outstanding, 14,893,929 and 14,734,323 shares at October 2, 2010 and June 30, 2010, respectively
    149       147  
Additional paid-in capital
    28,367       27,240  
Retained earnings
    24,785       31,142  
Accumulated other comprehensive loss
    (1,592 )     (2,283 )
 
           
Total PMFG, Inc. stockholders’ equity
    51,709       56,246  
Noncontrolling interest
    996       901  
 
           
Total equity
    52,705       57,147  
 
           
Total liabilities and equity
  $ 141,438     $ 143,081  
 
           
See accompanying notes to consolidated financial statements.

 

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PMFG, Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share amounts)
                 
    Three months ended     Three months ended  
    October 2,     September 30,  
    2010     2009  
    (unaudited)  
 
               
Revenue
  $ 26,961     $ 31,331  
Cost of goods sold
    18,220       19,564  
 
           
Gross profit
    8,741       11,767  
 
               
Operating expenses
               
Sales and marketing
    2,736       3,010  
Engineering and project management
    1,887       1,850  
General and administrative
    4,162       3,944  
 
           
 
    8,785       8,804  
 
           
Operating income (loss)
    (44 )     2,963  
 
               
Other income (expense)
               
Interest income
    14       12  
Interest expense
    (884 )     (1,211 )
Loss on extinguishment of debt
          (1,303 )
Foreign exchange gain (loss)
    67       204  
Change in fair value of derivative liability
    (5,434 )     (2,500 )
 
           
 
    (6,237 )     (4,798 )
 
           
 
               
Loss before income taxes
    (6,281 )     (1,835 )
Income tax benefit (expense)
    318       (256 )
 
           
Net loss
  $ (5,963 )   $ (2,091 )
 
           
 
               
Less net loss (income) attributable to noncontrolling interest
  $ (75 )   $ 50  
 
           
 
               
Net loss attributable to PMFG
  $ (6,038 )   $ (2,041 )
 
           
 
               
Dividends on preferred stock
  $ (319 )   $ (94 )
 
           
 
               
Loss applicable to PMFG common stockholders
  $ (6,357 )   $ (2,135 )
 
           
 
               
Basic and diluted loss per share
  $ (0.43 )   $ (0.16 )
 
           
 
               
Weighted-average shares outstanding:
               
Basic shares outstanding
    14,844       13,202  
Effect of dilutive options
           
 
           
 
 
Diluted shares outstanding
    14,844       13,202  
 
           
See accompanying notes to consolidated financial statements.

 

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PMFG, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
                 
    Three months ended     Three months ended  
    October 2,     September 30,  
    2010     2009  
    (unaudited)  
Cash flows from operating activities:
               
Net loss
  $ (5,963 )   $ (2,091 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation
    404       388  
Amortization of deferred financing costs
    535       176  
Amortization of other intangible assets
    270       247  
Loss on extinguishment of debt
          1,303  
Deferred income taxes
    31       2  
Deferred rent expense
    33       (19 )
Bad debt expense
    7        
Provision for warranty expense
    131       73  
Inventory valuation reserve
    90       45  
Foreign exchange gain
    (67 )     (204 )
Change in fair value of derivative liability
    5,434       2,500  
Excess tax benefits from stock-based payment arrangements
    32        
Stock-based compensation
    1,129       550  
Changes in operating assets and liabilities net of acquisitions:
               
Accounts receivable
    4,972       719  
Inventories
    25       (607 )
Costs and earnings in excess of billings on uncompleted contracts
    (287 )     580  
Other current assets
    147       198  
Other assets
    175       (128 )
Accounts payable
    690       2,396  
Billings in excess of costs and earnings on uncompleted contracts
    155       (1,424 )
Commissions payable
    (32 )     (45 )
Income taxes payable
    (1,985 )     36  
Product warranties
    (305 )     (31 )
Accrued liabilities and other
    (1,452 )     (378 )
 
           
Net cash provided by operating activities:
    4,169       4,286  
 
               
Cash flow from investing activities:
               
Increase in restricted cash
    545        
Purchases of property and equipment
    (775 )     (10 )
Purchase of license agreement
    (1,100 )      
 
           
Net cash used in investing activities
    (1,330 )     (10 )
 
               
Cash flows from financing activities:
               
Net proceeds from issuance of preferred stock and warrants
          19,235  
Payment of long-term debt
    (1,000 )     (21,000 )
Equity contribtuion from noncontrolling interest
    20       505  
Dividends paid on preferred stock
    (319 )      
Excess tax benefits from stock-based payment arrangements
    (32 )      
 
           
Net cash used in financing activities
    (1,331 )     (1,260 )
 
               
Effect of exchange rate changes on cash and cash equivalents
    531       51  
 
           
 
               
Net increase in cash and cash equivalents
    2,039       3,067  
 
               
Cash and cash equivalents at beginning of period
    24,271       17,738  
 
           
 
               
Cash and cash equivalents at end of period
  $ 26,310     $ 20,805  
 
           
 
               
Supplemental information on cash flow:
               
Income taxes paid
  $ 1,285     $  
Interest paid
  $ 489     $ 1,210  
See accompanying notes to consolidated financial statements.

 

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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 income (loss)
                            (6,038 )             (6,038 )     75       (5,963 )
Foreign currency translation adjustment
                                    691       691               691  
 
                                                         
Total comprehensive loss
                                            (5,347 )     75       (5,272 )
 
                                                               
Restricted stock grants
    103       1       740                       741               741  
Stock options exercised
    57       1       419                       420               420  
Income tax benefit related to stock options exercised
                    (32 )                     (32 )             (32 )
 
                                                               
Noncontrolling interest in subsidiary
                                                    20       20  
 
                                                               
Preferred stock dividends
                            (319 )             (319 )             (319 )
 
                                               
 
                                                               
Balance at October 2, 2010
    14,894     $ 149     $ 28,367     $ 24,785     $ (1,592 )   $ 51,709     $ 996     $ 52,705  
 
                                               
See accompanying notes to consolidated financial statements.

 

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PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
October 2, 2010
(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 October 2, 2010 and for the three months ended October 2, 2010 and September 30, 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.

 

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PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(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 for 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.

 

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PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED
Convertible Redeemable Preferred Stock
The Company’s Series A convertible, redeemable preferred stock (“Preferred Stock”) host contract contains redemption options 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 October 2, 2010 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.

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED
Because Preferred Stockholders do not participate in losses, 21,140 shares of preferred stock were excluded from the calculation of basic and diluted earnings per share for the three months ended October 2, 2010. Diluted earnings per common share include the dilutive effect of stock options and warrants granted using the treasury stock method. Options to acquire 119,667 shares of common stock and warrants to purchase 1,321,250 shares of common stock were omitted from the calculation of dilutive securities for the three months ended October 2, 2010 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 of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.
2. INVENTORIES
Principal components of inventories are as follows:
                 
    October 2,     June 30,  
    2010     2010  
 
               
Raw materials
  $ 4,096     $ 4,443  
Work in progress
    3,519       3,164  
Finished goods
    323       361  
 
           
 
    7,938       7,968  
Reserve for obsolete and slow-moving inventory
    (811 )     (748 )
 
           
 
  $ 7,127     $ 7,220  
 
           
3. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
The components of uncompleted contracts are as follows:
                 
    October 2,     June 30,  
    2010     2010  
 
               
Costs incurred on uncompleted contracts and estimated earnings
  $ 55,528     $ 56,176  
Less billings to date
    (47,258 )     (48,040 )
 
           
 
  $ 8,270     $ 8,136  
 
           
The components of uncompleted contracts are reflected in the consolidated balance sheets as follows:
                 
    October 2,     June 30,  
    2010     2010  
 
               
Costs and earnings in excess of billings on uncompleted contracts
  $ 13,849     $ 13,560  
Billings in excess of costs and earnings on uncompleted contracts
    (5,579 )     (5,424 )
 
           
 
  $ 8,270     $ 8,136  
 
           

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and 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. Intangible asset additions during the quarter ended October 2, 2010, consisted of $1,100 of licensing agreements acquired during the period.
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 October 2, 2010
                               
Licensing agreements
    5       3,299       (1,063 )     2,236  
Customer relationships
    13       6,890       (1,735 )     5,155  
Tradenames
    indefinite     4,729             4,729  
Design guidelines
    indefinite     10,491             10,491  
 
                         
 
                               
Total Value
          $ 25,409     $ (2,798 )   $ 22,611  
 
                         
 
                               
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 $270 and $247 were recorded to the Consolidated Statement of Operations for the three months ended October 2, 2010 and September 30, 2009, respectively. The Company’s estimated amortization for the current and each of the next five fiscal years is as follows:
         
2011
  $ 1,069  
2012
    1,005  
2013
    922  
2014
    555  
2015
    480  
2016
    405  

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
5. ACCRUED PRODUCT WARRANTIES
Accrued product warranty activity is as follows:
                 
    Three months ended     Three months ended  
    October 2,     September 30,  
    2010     2009  
 
               
Balance at beginning of period
  $ 2,480     $ 1,242  
Provision for warranty expenses
    131       73  
Warranty charges
    (305 )     (31 )
 
           
Balance at end of period
  $ 2,306     $ 1,284  
 
           
6. ACCRUED LIABILITIES AND OTHER
The components of accrued liabilities and other are as follows:
                 
    October 2,     June 30,  
    2010     2010  
 
               
Accrued start-up (commissioning) expense
  $ 1,208     $ 1,169  
Accrued compensation
    2,029       3,999  
Accrued professional expenses
    1,776       1,679  
Other
    93       246  
 
           
 
  $ 5,106     $ 7,093  
 
           
7. DEBT
Outstanding long-term debt obligations are as follows:
                         
            October 2,     June 30,  
    Maturities     2010     2010  
 
                       
Revolving credit facility
    2011     $     $  
Term loan
    2013       19,221       20,221  
 
                   
Total long-term debt
            19,221       20,221  
Less current maturites
            (4,000 )     (4,000 )
 
                   
Total long-term debt, net of current portion
          $ 15,221     $ 16,221  
 
                   

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
7. DEBT — CONTINUED
On September 4, 2009, the Company amended both its senior term loan and revolving credit facility to permit the issuance of the Preferred Stock and the use of available cash to pre-pay the subordinated secured term loan. The subordinated term loan was repaid in full using the proceeds from the Preferred Stock issuance and available cash. Unamortized deferred financing costs of $1,303 were recorded as a loss on extinguishment of debt on the Consolidated Statement of Operations during the three months ended September 30, 2009.
The senior term loan matures on March 31, 2013. 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 October 2, 2010 and 5.25% at June 30, 2010). Interest on the base rate option is calculated as the greater of the administrative agent’s prime rate or the federal funds effective rate plus 100 basis points plus a margin of between 275 and 400 basis points depending upon the Company’s consolidated total leverage ratio (“CTL”). Interest on the LIBOR rate option is calculated as the adjusted LIBOR rate plus a margin of between 375 and 500 basis points depending upon the Company’s CTL, subject to a LIBOR floor of 1%. The senior secured credit agreement requires quarterly principal payments on the senior term loan of $1,000 through and including April 1, 2011 and $1,500 thereafter through March 31, 2013, with the balance of the senior term loan due at maturity. The senior secured credit agreement also requires additional principal payments of the senior term loan based upon the Company’s cash flow beginning with the 2009 fiscal year, the net proceeds of certain asset sales and dispositions and the issuance by the Company of additional equity securities or subordinated debt.
The revolving credit facility matures on April 30, 2011. As of October 2, 2010, interest under the revolving credit facility is payable quarterly, calculated on either a base or LIBOR rate per annum, at the Company’s option. Interest on the base rate option for the revolving credit facility is equal to the greater of the administrative agent’s prime rate or the federal funds effective rate plus 100 basis points plus a margin of between 275 and 375 basis points depending upon the Company’s CTL. Interest on the LIBOR rate option is calculated as the adjusted LIBOR rate plus a margin of between 375 and 475 basis points depending upon the Company’s CTL, subject to a LIBOR floor of 1%. Under the revolving credit facility, the Company has a maximum borrowing availability equal to the lesser of (a) $20,000 or (b) 75% of eligible accounts receivable plus 45% of eligible inventory (not to exceed 50% of the borrowing base). At October 2, 2010, there was $757 borrowing availability after the borrowing base was adjusted for $9,726 in outstanding letters of credit. At October 2, 2010 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 and contain financial and other covenants, including restrictions on additional debt, dividends, capital expenditures, acquisitions and dispositions. They also contain covenants and events of default that, among other things, require the Company to satisfy financial tests and maintain financial ratios. At October 2, 2010, required financial ratios included a minimum fixed charge coverage ratio of 1.10 to 1.00, a maximum leverage ratio of 3.50 to 1.00 and an adjusted minimum net worth requirement at all times not less than the base adjusted net worth ($60,645 and $60,631 at October 2, 2010 and June 30, 2010, respectively). Consolidated adjusted net worth is defined under the senior term loan agreement as total common shareholders’ equity together with preferred stock which is classified as part of shareholders’ equity. For purposes of calculating financial covenants, the Preferred Stock (and each aspect and feature thereof) is deemed not to be debt or liabilities. As of October 2, 2010, the Company was in compliance with all covenants in its senior secured credit agreement.

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
7. DEBT — CONTINUED
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 October 2, 2010 the Interest Rate Cap Transaction has an estimated fair market value of $0.
The Company’s U.K. subsidiary has a debenture agreement used to facilitate issuances of letters of credit and bank guarantees of £5,444 ($8,621) at October 2, 2010 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 ($5,305) at October 2, 2010 and £2,850 ($4,258) at June 30, 2010, which is recorded as restricted cash on the consolidated balance sheet. At October 2, 2010, there was £4,310 ($6,825) 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 October 2, 2010 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 claim is in its early stages and 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 October 2, 2010. 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.

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
8. COMMITMENTS AND CONTINGENCIES — CONTINUED
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. 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.
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 October 2, 2010 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

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
8. COMMITMENTS AND CONTINGENCIES — CONTINUED
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 against the selling stockholders under the terms of the Nitram acquisition agreement totaling approximately $9,500, related to a customer warranty dispute and 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.
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 $319 of cash dividends during the quarter ended October 2, 2010.

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(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.
The NASDAQ Marketplace rules limit the number of shares of common stock that may be issued in a private placement at a discount to the then current market price without obtaining stockholder approval. As a result, the aggregate number of shares of common stock that could have been issued upon the conversion or redemption of the Preferred Stock or payment of the dividends or Liquidation Preference would have been limited to 19.99% of the outstanding shares of common stock (the “Issuance Limitation”), unless stockholder approval was obtained. The Company agreed to seek stockholder approval of this matter and to increase the number of authorized shares of common stock by 25 million shares. At the annual meeting of the Company, held on November 19, 2009, the Company’s stockholders approved, by the required votes needed, a proposal to permit the issuance of common stock in excess of the Issuance Limitation and to increase the number of authorized shares of common stock by 25 million shares.
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 will become exercisable nine months after their issuance. 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.

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
9. SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK AND WARRANTS — CONTINUED
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 June 30, 2010, the Company does not consider this liability to be probable and has not recorded any amount on the Consolidated Balance Sheets.
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 and warrants
  $ 19,235  
 
     
See note 12 for discussion of subsequent fair value adjustments.

 

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Table of Contents

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
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 connection with the holding company reorganization.
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.
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 three months ended October 2, 2010 and September 30, 2009:
                                 
    Three months ended  
    October 2,     September 30,  
    2010     2009  
    Number of     Fair Value     Number of     Fair Value  
Grant Type   Shares Granted     of Grant     Shares Granted     of Grant  
 
                               
Stock
    36,000     $ 523       36,000     $ 315  
Restricted stock
    67,800     $ 1,006       99,881     $ 873  
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.

 

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PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
12. FAIR VALUE MEASUREMENTS — CONTINUED
    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.
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 extreme 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. In estimating the fair value at October 2, 2010, 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 three months ended October 2, 2010, an increase in fair value of $5,434 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 three months ended October 2, 2010, 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):
                                 
    October 2,                    
    2010     Level 1     Level 2     Level 3  
Derivatives related to conversion and redemption rights
  $ (31,350 )   $     $     $ (31,350 )
 
 
Interest Rate Cap
  $     $     $     $  
The following is a summary of changes to fair value measurements using Level 3 inputs (as reclassified) during the three months ended October 2, 2010:
         
Balance, June 30, 2010
  $ (25,916 )
Change in fair value of derivative liability
    (5,434 )
 
     
Balance, October 2, 2010
  $ (31,350 )
 
     

 

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PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

October 2, 2010
(In thousands, except share and per share amounts)
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.
Segment profit and loss is based on revenue 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 months ended October 2, 2010 are presented below. The Company does not allocate general and administrative expenses (“reconciling items”), 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  
    October 2,     September 30,  
    2010     2009  
Revenues
               
Process Products
  $ 22,099     $ 22,701  
Environmental
    4,862       8,630  
 
           
Consolidated
  $ 26,961     $ 31,331  
 
           
Operating income
       
Process Products
  $ 3,174     $ 4,592  
Environmental
    944       2,315  
Reconciling items
    (4,162 )     (3,944 )
 
           
Consolidated
  $ (44 )   $ 2,963  
 
           

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(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. The overview also includes a summary of the issuance of our Preferred Stock and Warrants and a brief summary of recent developments regarding our acquisition of Nitram. This overview is followed by a discussion of our results of operations for the three months ended October 2, 2010 and September 30, 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 October 2, 2010 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 have been generated from outside the United States. We expect our international sales to continue to be an increasingly important part of our business.
Recent Developments
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.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(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  
    October 2,     September 30,  
    2010     2009  
Net revenues
    100.0 %     100.0 %
Cost of goods sold
    67.6       62.4  
 
           
Gross profit
    32.4       37.6  
Operating expenses
    32.6       28.1  
 
           
Operating income
    (0.2 )     9.5  
Other income (expense)
    (23.1 )     (15.3 )
 
           
Earnings before income taxes
    (23.3 )     (5.8 )
Income tax expense
    1.2       (0.8 )
 
           
Net earnings (loss)
    (22.1 )%     (6.6 )%
 
           
Less net earning (loss) attributable to noncontrolling interest
    0.3       (0.1 )
 
           
Net earnings (loss) attributable to PMFG, Inc.
    (22.4 )     (6.5 )
Dividends on preferred stock
    (1.2 )     (0.3 )
 
           
Earnings (loss) applicable to PMFG, Inc. common stockholders
    (23.6 )%     (6.8 )%
 
           
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 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 October 2, 2010 Compared to Three Months Ended September 30, 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.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(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  
    October 2,     September 30,  
    2010     % of Total     2009     % of Total  
 
                               
Domestic
  $ 16,490       61.2 %   $ 21,577       68.9 %
International
    10,471       38.8 %     9,754       31.1 %
 
                       
Total
  $ 26,961       100.0 %   $ 31,331       100.0 %
 
                       
Total revenues decreased $4,370, or 13.9%, for the three months ended October 2, 2010 compared to the three months ended September 30, 2009 as domestic revenues decreased $5,087, or 23.6%, and international revenues increased $717, or 7.4%. The decrease in the domestic revenues can be attributed to a decrease in domestic power consumption which has impeded the progress of new projects which would require several of our product lines, particularly our environmental products. The overall decline in revenues was partially 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. 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  
    October 2,     September 30,  
    2010     % of Total     2009     % of Total  
 
                               
Revenues
  $ 26,961       100.0 %   $ 31,331       100.0 %
Cost of goods sold
    18,220       67.6 %     19,564       62.4 %
 
                       
Gross profit
  $ 8,741       32.4 %   $ 11,767       37.6 %
 
                       
For the three months ended October 2, 2010, our gross profit decreased $3,026, or 25.7%, compared to the three months ended September 30, 2009. Our gross profit, as a percentage of revenues, decreased to 32.4% for the three months ended October 2, 2010 compared to 37.6% for the same period a year ago. The decrease in gross profit as a percentage of revenues during the three months ended October 2, 2010 primarily related to changes in our product mix and increased pricing pressure in the current quarter.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
Operating Expenses. The following summarizes operating expenses:
                                 
    Three months ended  
    October 2,     September 30,  
    2010     % of Total     2009     % of Total  
 
                               
Sales and marketing
  $ 2,736       10.1 %   $ 3,010       9.6 %
Engineering and project management
    1,887       7.0 %     1,850       5.9 %
General and administrative
    4,162       15.5 %     3,944       12.6 %
 
                       
Total
  $ 8,785       32.6 %   $ 8,804       28.1 %
 
                       
Operating expenses decreased $19 or 0.2% for the three months ended October 2, 2010 compared to the same period a year ago. As a percentage of revenues, these expenses increased to 32.6% during the three months ended October 2, 2010 from 28.1% during the three months ended September 30, 2009 due to a decrease in revenues during the current period. Our sales and marketing expenses decreased $274 during the three months ended October 2, 2010 compared to the same period in the previous year primarily due to reduced commissions and other selling related expenses associated with lower revenues in the current quarter. Our engineering and project management expenses increased $37 for the three months ended October 2, 2010 compared to the three months ended September 30, 2009. General and administrative expenses increased $218 during the three months ended October 2, 2010 compared to the same period a year ago partially due to an increase in software amortization expense of $95.
Other Income and Expense. The following summarizes other income and expense:
                                 
    Three months ended  
    October 2,     September 30,  
            % of             % of  
    2010     Revenues     2009     Revenues  
 
                               
Interest income
  $ 14       0.1 %   $ 12       %
Interest expense
    (884 )     (3.3 )%     (1,211 )     (3.9 )%
Loss on extinguishment of debt
          %     (1,303 )     %
Foreign exchange gain (loss)
    67       0.2 %     204       0.7 %
Change in fair value of derivative liability
    (5,434 )     (20.2 )%     (2,500 )     (8.0 )%
 
                       
Total other income (expense)
  $ (6,237 )     (23.1 )%   $ (4,798 )     (15.3 )%
 
                       
For the three months ended October 2, 2010, total other income (expense) items increased by $1,439, compared to the three months ended September 30, 2009. The change was primarily due to an adjustment in the fair value of our Derivative Liability of $5,434 this quarter compared to $2,500 for the three months ended September 30, 2009. This increase in other expense was partially offset by a reduction of $327 in our interest expense compared to the same period a year ago and the write off of $1,303 in debt issuance costs associated with the extinguishment of subordinated term debt in September 2009 that was not replicated this quarter.
Income Taxes. Our effective income tax rate was 5.1% and (14.0%) for the three months ended October 2, 2010 and September 30, 2009, respectively. Our effective rate for the three months ended October 2, 2010 and September 30, 2009 was impacted by a non-taxable benefit to adjust our Derivative Liability in the amounts of $5,434 and $2,500, respectively.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
Net Earnings (Loss). Our net loss increased by $3,872 to $5,963 during the three months ended October 2, 2010, from a net loss of $2,091 during the same period in the previous year. Basic and fully diluted loss per share was $0.43 per share for the three months ended October 2, 2010, compared to basic and diluted loss of $0.16 per share for the three months ended September 30, 2009. The increase in the current year loss and per share loss resulted primarily from the increase in the fair value adjustment of the Derivative Liability and reduced revenues in the current period compared to the three months ended September 30, 2009.
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 82.0% and 73.0% of our revenues for the three months ended October 2, 2010 and September 30, 2009, respectively.
The following summarizes Process Products revenues and operating income:
                 
    Three months ended  
    October 2,     September 30,  
    2010     2009  
 
               
Revenues
  $ 22,099     $ 22,701  
Operating income
  $ 3,174     $ 4,592  
 
               
Operating income as % of revenues
    14.4 %     20.2 %
Process Products revenues decreased by $602, or 2.7%, during the three months ended October 2, 2010 compared to the three months ended September 30, 2009.
Process Products operating income for the three months ended October 2, 2010 decreased $1,418, or 30.9%, compared to the same period a year ago. As a percentage of Process Products revenues, operating income was 14.4% and 20.2% for the three months ended October 2, 2010 and September 30, 2009, respectively. The decrease in operating income as a percentage of revenues during the three months ended October 2, 2010 is primarily related to external pricing pressures and a change in our product mix.
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 18.0% and 27.0% of our revenues for the three months ended October 2, 2010 and September 30, 2009, respectively.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
The following summarizes Environmental Systems revenues and operating income:
                 
    Three months ended  
    October 2,     September 30,  
    2010     2009  
 
               
Revenues
  $ 4,862     $ 8,630  
Operating income
  $ 944     $ 2,315  
 
               
Operating income as % of revenues
    19.4 %     26.8 %
Revenues from Environmental Systems decreased $3,768, or 43.7%, during the three months ended October 2, 2010 compared to the same period in the previous year. The decrease in the Environmental Systems segment revenue for the three months ended October 2, 2010, is attributable to decreased demand driven by a reduction in domestic power consumption.
Environmental Systems operating income for the three months ended October 2, 2010 decreased $1,371, or 59.2%, compared to the three months ended September 30, 2009. As a percentage of Environmental Systems revenues, operating income decreased to 19.4% during the three months ended October 2, 2010 from 26.8% for the same period in the prior year. The decrease in operating income as a percentage of revenues is due to a more competitive pricing environment. Additionally, lower revenues in the current quarter and the inelastic nature of some of the segment’s operating costs, resulted in a decrease in operating income as a percentage of revenues for the three months ended October 2, 2010 compared to the same period in the prior year.
Corporate Level Expenses
Corporate level general and administrative expenses were $4,162 and $3,944 for the three months ended October 2, 2010 and September 30, 2009, respectively. These expenses are excluded from our segment operating results. See “Operating Expenses” above for additional discussion.
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 $90,000 at October 2, 2010, 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.
Financial Position
Assets. Total assets decreased by $1,643, or 1.1%, from $143,081 at June 30, 2010, to $141,438 at October 2, 2010. On October 2, 2010, we held cash and cash equivalents of $26,310, had working capital of $47,514 and a current liquidity ratio of 2.5-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.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
Liabilities and Equity. Total liabilities increased by $2,799, or 3.3%, from $85,934 at June 30, 2010 to $88,733 at October 2, 2010. The increase in our total liabilities is attributed to the fair value adjustment of the Derivative Liability and an increase in our trade accounts payable. This increase was offset by the payment of employee bonuses in the three months ended October 2, 2010 that were accrued at June 30, 2010, and principal reduction of our senior term loan.
The decrease in our stockholder’s equity of $4,442, or 7.8%, from $57,147 at June 30, 2010 to $52,705 at October 2, 2010 is primarily attributable to our net loss for the three months ended October 2, 2010. Our ratio of debt (total liabilities)-to-equity increased from 1.5-to-1.0 at June 30, 2010 to 1.7-to-1.0 at October 2, 2010.
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 October 2, 2010, the balance of these working capital accounts was $19,851 compared to $25,266 at June 30, 2010, reflecting a decrease of our investment in these working capital items of $5,415.
Our cash and cash equivalents were $26,310 as of October 2, 2010 compared to $24,271 at June 30, 2010. During the three months ended October 2, 2010, cash provided by operating activities was $4,169 compared to cash provided by operating activities of $4,286 for the three months ended September 30, 2009. Cash provided by operating activities primarily related to changes in accounts receivable in the current period and accounts payable in the prior year.
Cash used in investing activities was $1,330 for the three months ended October 2, 2010, compared to $10 for the three months ended September 30, 2009. Cash used in investing activities during the three months ended October 2, 2010 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 $545.
Cash used in financing activities during the three months ended October 2, 2010 was $1,331 compared to cash used in financing activities of $1,260 during the same period in the previous year. The cash used in financing activities for the three months ended October 2, 2010 primarily related to principal payment on the senior term loan and the payment of cash dividends to our Preferred Stock holders.
As a result of the events described above, our cash and cash equivalents during the three months ended October 2, 2010 increased by $2,039 compared to an increase of $3,067 during the three months ended September 30, 2009.
We believe we maintain adequate liquidity to support existing operations and planned growth over the next 12 months.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
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 October 2, 2010, we had $19,221 of outstanding borrowings under this Agreement. Currently we have an interest rate cap transaction with a notional amount of $10,000, or 52% 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 three months ended October 2, 2010.
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, 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.
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.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
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 three months ended October 2, 2010, 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.
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 October 2, 2010, 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.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(In thousands, except share and per share amounts)
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.

 

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PMFG, Inc. and Subsidiaries
October 2, 2010
(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: November 9, 2010
  /s/ Peter J. Burlage
 
Peter J. Burlage
   
 
  President and Chief Executive Officer    
 
  (Principal Executive Officer)    
 
       
Date: November 9, 2010
  /s/ Henry G. Schopfer, III
 
   
 
  Henry G. Schopfer, III    
 
  Chief Financial Officer    
 
  (Principal Financial and Accounting Officer)    

 

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