UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended December 27, 2014

OR

For the transition period from                      to                     

Commission File Number 001-34156

 

PMFG, INC.

(Exact name of registrant as specified in its charter)

 

 

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  ¨

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  þ    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ

The number of shares of the registrant’s common stock outstanding on January 31, 2015, was 21,303,573.

 

 

 

 

 

 

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TABLE OF CONTENTS

 

 

 

 

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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:

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 28, 2014. There may be other factors that may cause our actual results to differ materially from the forward-looking statements. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. We undertake no obligation to publicly update or revise forward-looking statements, except to the extent required by law.

 

 

 

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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)

 

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)

 

See accompanying notes to consolidated financial statements.

 

 

 

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PMFG, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

 

See accompanying notes to consolidated financial statements.

 

 

 

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PMFG, Inc. and Subsidiaries

Consolidated Statement of Equity

(In thousands)

(unaudited)

 

See accompanying notes to consolidated financial statements.

 

 

 

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PMFG, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

 

Consolidated Statements of Cash Flows continued on next page

 

 

 

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PMFG, Inc. and Subsidiaries

Consolidated Statements of Cash Flows—Continued

(In thousands)

 

See accompanying notes to consolidated financial statements.

 

 

 

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements of PMFG, Inc. and subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America (“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 December 27, 2014 and for the three and six months ended December 27, 2014 and December 28, 2013 are unaudited and, in the opinion of management, all adjustments necessary for the fair presentation of the financial position and results of operations of the Company for the interim periods have been included and are of a normal recurring nature. 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 28, 2014.

Each of the Company’s interim reporting periods ends on the Saturday closest to the last day of the corresponding quarterly calendar period. References to “fiscal 2015” and “fiscal 2014” refer to fiscal years ended June 27, 2015 and June 28, 2014, respectively. The second quarters of fiscal 2015 and fiscal 2014 ended on December 27, 2014, and December 28, 2013, respectively.

Basis of Consolidation

The Company’s financial statements for all periods presented are consolidated to include the accounts of all wholly owned and majority-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. The Company is the majority owner of Peerless Propulsys China Holdings LLC (“Peerless Propulsys”). The Company’s 60% equity investment in Peerless Propulsys entitles it to 80% of the earnings of Peerless Propulsys. Peerless Propulsys is the sole owner of Peerless China Manufacturing Co. Ltd. (“PCMC”). The non-controlling interest of Peerless Propulsys is reported as a separate component on the Consolidated Balance Sheets and Consolidated Statements of Operations.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash balances, including restricted cash, held within and outside the United States are as follows (in thousands):

 

The Company maintains cash balances in bank accounts that normally exceed Federal Deposit Insurance Corporation insured limits. As of December 27, 2014 and June 28, 2014, cash held in the United States exceeded federally insured limits by $9.2 million and $9.1 million, respectively. The Company has not experienced any losses related to this cash concentration.

The Company had restricted cash balances of $14.5 million and $15.6 million as of December 27, 2014 and June 28, 2014, respectively. Foreign restricted cash balances were $4.5 million and $5.6 million as of December 27, 2014 and June 28, 2014, respectively. Cash balances were restricted to collateralize letters of credit and financial institution guarantees issued in the ordinary course of business and to secure the term loans and letters of credit as required under the terms of our existing Credit Agreement.

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 outstanding longer than contractual payment terms are considered past due.

 

 

 

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

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 customer’s industry and the economy as a whole. The Company writes off accounts receivable when they become uncollectible. Payments subsequently received on such receivables are credited to the allowance for doubtful accounts in the period the payment is received.

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

 

Inventories

The Company values its inventories using the lower of weighted average cost or market. The Company regularly reviews the value of inventories on hand and records a provision for obsolete and slow-moving inventory based on historical usage and estimated future usage. In assessing the ultimate realization of its inventory, the Company is required to make judgments as to future demand requirements. As actual future demand or market conditions may vary from those projected by the Company, adjustments to inventory valuations may be required.

Property, Plant and Equipment

Depreciation of property, plant and equipment is calculated using the straight-line method over a period considered adequate to depreciate the total cost over the useful lives of the assets, as follows:

 

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 remaining lease term.

In September 2013, the Company exited its leased manufacturing and office facility in Zhenjiang, China. The property was leased from the noncontrolling interest owner of Peerless Propulsys. Early termination of the lease resulted in $0.2 million of expense included in costs of goods sold in the six months ended December 28, 2013.

Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable and exceeds its fair value. If conditions indicate an asset might be impaired, the Company estimates the future cash flows expected to result from the use of the asset and its eventual disposition. The impairment would be measured by the amount by which the asset exceeds its fair value, typically represented by the discounted cash flows associated with the asset.

Goodwill and Other Intangible Assets

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

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

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

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, trade receivables, other current assets, accounts payable and accrued expenses approximate fair value due to the short maturity of these instruments. The carrying amount of the Company’s debt approximates fair value as the debt bears interest at floating market rates.

Revenue Recognition

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

The Company provides certain products under long-term, generally fixed-priced, contracts that may extend over multiple financial periods, where revenue and cost of sales are recognized in accordance with accounting rules relating to construction-type and production-type contracts. Amounts recognized in revenue are calculated using the percentage of cost completed (i.e., cumulative cost incurred to date in comparison to the estimated total cost at completion). This method requires the Company to make estimates regarding the total costs of the project at completion, which impacts the amount of gross margin the Company recognizes in each reporting period. The Company routinely reviews its estimates relating to estimated total costs at completion and recognizes changes in those estimates as they are determined. Change orders affecting the contract amount are considered only after receipt of a legally binding agreement. Incremental costs related to change orders are included in the estimate of total costs upon the earlier of receipt of the change order or the Company’s committed purchase obligation. The percentage-of-completion method generally results in the recognition of reasonably consistent profit margins over the life of a contract. Approximately 80% of the Company’s revenue is accounted for using the percentage-of-completion accounting method.

Many of the Company’s customer contracts define events of default related to product performance and/or timing of delivery, as well as remedies for such events of default. Anticipated events of default and estimated remedies, such as those provided under liquidated damages clauses, are accounted for as reductions in revenue in the period in which the potential default is first identified and the damages can be reasonably estimated. Historically, the impact of liquidated damages has not been material to the Company’s consolidated financial position, results of operations, or cash flows. Anticipated losses on percentage-of-completion contracts are recorded in full in the period in which they become evident.

The Company typically bills customers upon the occurrence of project milestones. Cumulative revenue recognized may be less or greater than cumulative costs and profits billed at any point during a contract’s term. The resulting difference is recognized as “costs and earnings in excess of billings on uncompleted contracts” or “billings in excess of costs and earnings on uncompleted contracts” on the Consolidated Balance Sheets.

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

Pre-contract, Start-up and Commissioning Costs

The Company does not consider the realization of any individual sales order as probable prior to order acceptance. Therefore, pre-contract costs incurred prior to sales order acceptance are included as a component of operating expenses when incurred. Some of the Company’s contracts require the installation and placing in service of the product after it is distributed to the end user. The costs of start-up and commissioning and the related revenue associated with the relevant percentage of completion of these projects are recognized in the period incurred. Estimates are based on historical experience and expectation of future conditions.

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

Warranty Costs

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

Income Taxes

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

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

At December 27, 2014, the Company had $16.5 million of operating loss carry forwards, primarily in the United States and the United Kingdom. The portion attributable to the United States is available for carryover to future periods, subject to certain limitations with expirations beginning in fiscal 2034. The operating loss carryforward from the United Kingdom has no expiration. A valuation allowance of $5.6 million has been established to reduce the credits to the estimated future realization of the tax related benefit.

Earnings (Loss) Per Common Share

The Company calculates earnings (loss) per common share by dividing the earnings (loss) applicable to PMFG, Inc. stockholders by the weighted average number of common shares outstanding. Diluted earnings per common share include the dilutive effect of stock options, restricted stock units and warrants granted using the treasury stock method. For the three months ended December 27, 2014, 175,487 restricted stock units with performance and service-based restrictions were excluded from the calculation of dilutive securities because they were anti-dilutive.  Options to acquire 14,000 shares of common stock were excluded from the calculation of dilutive securities for the three months ended December 27, 2014 because they were anti-dilutive.  For the three and six months ended December 28, 2013, 72,339 restricted stock units with performance and service-based restrictions were excluded from the calculation of dilutive securities because they were anti-dilutive. Options to acquire 37,200 shares of common stock were excluded from the calculation of dilutive securities for the three and six months ended December 28, 2013 because they were anti-dilutive. Warrants to acquire 839,063 shares of common stock were excluded from the calculation of dilutive securities for the three and six months ended December 28, 2013, because they were anti-dilutive. All warrants expired on September 4, 2014.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This new guidance is effective for annual reporting periods beginning after December 15, 2016 and early adoption is not permitted. Accordingly, we plan to adopt the new guidance beginning in

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

fiscal 2017. Companies may use either a full retrospective or a modified retrospective approach to adopt this new guidance and management is currently evaluating which transition approach to use. Management is assessing the expected impact of this new guidance on our consolidated financial statements.

 

 

2. INVENTORIES

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

 

 

 

3. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

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

 

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

 

 

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS

The goodwill acquired with the purchase of Combustion Components Associates, Inc. (CCA) in fiscal 2014 is allocated to and assessed at the Environmental Systems segment, and the remaining goodwill is assessed at the Process Products segment.

Goodwill

There were no changes in the carrying amount of goodwill for the six months ended December 27, 2014.

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

Acquisition-Related Intangibles

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

 

 

Amortization expense on finite-lived intangible assets was $0.2 million for each of the three months ended December 27, 2014 and December 28, 2013. Amortization expense of finite-lived intangibles assets for the six months ended December 27, 2014 and December 28, 2013 was $0.4 million and $0.3 million, respectively. Estimated aggregate finite-lived intangible asset amortization expense for the next five years is as follows (in thousands):

 

 

 

 

5. ACCRUED PRODUCT WARRANTIES

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

 

 

 

6. ACCRUED LIABILITIES AND OTHER

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

 

In July 2013, the Company obtained short-term financing from Bank of China Limited. The financing provided for borrowings up to ¥10 million ($1.6 million) at an interest rate of 6.6%, with interest payable quarterly. All amounts outstanding were paid with cash on

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

hand in July 2014.   In December 2014, the Company borrowed ¥10 million ($1.6 million) at an interest rate of 6.4%, with interest payable monthly, due in December 2015.

In fiscal 2014, the Company accrued $0.6 million of deferred consideration in connection with the CCA acquisition. The Company assessed the remaining liability to CCA as of December 27, 2014 and reduced the liability accordingly. The $0.3 million adjustment is included in other income and expense in the Consolidated Statement of Operations.

 

 

7. DEBT

Outstanding long-term debt obligations are as follows (in thousands):

 

 

In September 2012, the Company entered into a Credit Agreement (the “Credit Agreement”) with Citibank, N.A., as administrative agent and other financial institutions party thereto. The Credit Agreement provides for, among other things, revolving credit commitments of $30.0 million to be used for working capital and general corporate purposes, term loan commitments of $2.0 million used for the purchase of equipment for a manufacturing facility in Denton, Texas (“Term Loan A”) and term loan commitments of $10.0 million used to fund the construction of the Denton facility (“Term Loan B”). All borrowings and other obligations of the Company are guaranteed by substantially all of its domestic subsidiaries and are secured by substantially all of the assets of the Company.

 

The revolving credit facility under the Credit Agreement will terminate on September 30, 2015, and all revolving credit loans mature on that date. Under the revolving credit facility, the Company has a maximum borrowing availability equal to the lesser of (a) $30.0 million or (b) the sum of 80% of eligible accounts receivable plus 50% of eligible inventory plus 100% of the cash amount held in a special collateral account less a foreign currency letter of credit reserve. At December 27, 2014, there were no outstanding borrowings and approximately $6.5 million of outstanding letters of credit under the Credit Agreement, leaving the Company with approximately $1.4 million of available capacity for additional borrowings and letters of credit under the Credit Agreement.

 

The Company is required to make quarterly principal payments on the term loans. The Credit Agreement also requires the Company to maintain an interest rate protection agreement with respect to at least 50% of the aggregate outstanding principal amount of the term loans. As of December 27, 2014, the remaining maturities on long-term debt are as follows:

 

Interest on all loans must generally be paid quarterly. Interest rates on term loans use floating rates plus  ¹⁄₂ of 1% up to 2%, plus a margin of between 0 to 75 basis points based upon the Company’s consolidated funded debt to consolidated EBITDA for the trailing four consecutive fiscal quarters. The rate at December 27, 2014 was 2.9%.

 

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

At December 27, 2014, the Company was required to maintain a Consolidated Total Leverage Ratio (“CTL”) not to exceed 1.75 to 1.00. The CTL ratio is calculated as the ratio of the Company’s aggregate total liabilities to the sum of the excess of the Company’s total assets over its total liabilities as each is determined on a consolidated basis in accordance with GAAP.

 

Under the Credit Agreement, as amended, capital expenditures are limited to (a) those made in connection with the new manufacturing facility in Denton, Texas; (b) those made in connection with the new manufacturing facility in China, not to exceed $13.0 million; and (c) $3.0 million of other capital expenditures in any fiscal year plus any amounts below $3.0 million of expenditures from the immediately preceding fiscal year. The Credit Agreement also contains other covenants, including restrictions on additional debt, dividends, capital expenditures, acquisitions and dispositions.

 

In fiscal 2014, the Company obtained an amendment to the Credit Agreement. Pursuant to the amendment, if the Debt Service Coverage Ratio (“DSC”) is less than 1.50 to 1.00 as of the end of any fiscal quarter, the Company must deposit and maintain cash in a blocked collateral account (to which only the administrative agent under the Credit Agreement has access) in an aggregate amount equal to the greater of (a) $10.0 million or (b) the sum of (i) the aggregate principal amount of all revolving credit and swing line loans outstanding under the Credit Agreement, plus (ii) 100% of the undrawn face amount of all performance-related letters of credit outstanding under the Credit Agreement, plus (iii) 30% (subject to upward adjustment) of the undrawn face amount of all warranty-related letters of credit outstanding under the Credit Agreement, plus (iv) $3.0 million, less (v) all term loan principal payments made on or after March 29, 2014. The Company may withdraw the cash in the collateral account when it achieves a DSC of at least 1.50 to 1.00 as of the end of a subsequent fiscal quarter, so long as no default or borrowing base deficiency then exists. The DSC ratio is calculated as the ratio of the Company’s consolidated EBITDA, as defined in the Credit Agreement, less certain restricted cash payments, capitalized expenditures and taxes to the Company’s consolidated fixed charges, which is the sum of the Company’s current maturities of long-term debt and the amount of cash paid for interest on a trailing 12 month basis. At December 27, 2014, the Company’s DSC ratio was below 1.50 to 1.00, requiring restricted cash of $10.0 million to be on deposit with Citibank, N.A.

 

In July 2013, the Company’s subsidiary in China entered into a loan agreement with Bank of China Limited. The loan agreement provides for a loan commitment of ¥43.0 million ($6.9 million) to fund the construction of a manufacturing facility in Zhenjiang, China. The loan is secured by PCMC’s property, plant and equipment. The loan matures on December 20, 2017. At December 27, 2014, there was an outstanding borrowing of ¥33.0 million ($5.3 million). Beginning June 20, 2014, the Company is required to make semi-annual principal payments on the loan which will be paid using cash on hand in China. Interest rates use floating rates as established by The People’s Bank of China. The rate at December 27, 2014 was 7.0%. The loan agreement also contains covenants, including restrictions on additional debt, dividends, acquisitions and dispositions. At December 27, 2014, PCMC was in compliance with all of its debt covenants. PCMC had bank guarantees of $0.5 million and $0.8 million at December 27, 2014 and June 28, 2014, respectively, secured by $0.5 million and $0.8 million of restricted cash balances.

 

The Company’s U.K. subsidiary has a debenture agreement used to facilitate issuances of letters of credit and bank guarantees of £6.0 million ($9.3 million) at December 27, 2014 and £6.0 million ($10.2 million) at June 28, 2014. This facility was secured by substantially all of the assets of the Company’s U.K. subsidiary, a protective letter of credit issued by the Company to HSBC Bank and a cash deposit of £1.9 million ($2.9 million) at December 27, 2014 and £1.8 million ($3.0 million) at June 28, 2014, which is recorded as restricted cash on the Consolidated Balance Sheets. At December 27, 2014, there was £4.9 million ($7.6 million) of outstanding stand-by letters of credit and bank guarantees under this debenture agreement. At June 28, 2014, there was £4.6 million ($7.9 million) of outstanding stand-by letters of credit and bank guarantees under this debenture agreement.

 

The Company’s German subsidiary has a debenture agreement used to facilitate issuances of letters of credit and bank guarantees of €4.8 million ($5.8 million) at December 27, 2014 and €4.8 million ($6.6 million) at June 28, 2014. This facility is secured by substantially all of the assets of the Company’s German subsidiary and by a cash deposit of €0.7 million ($0.8 million) at December 27, 2014 and €0.9 million ($1.2 million) at June 28, 2014, which is recorded as restricted cash on the Consolidated Balance Sheets. At December 27, 2014, there was €2.1 million ($2.6 million) of outstanding stand-by letters of credit and bank guarantees under this debenture agreement. At June 28, 2014, there was €2.8 million ($3.8 million) of outstanding stand-by letters of credit and bank guarantees under this debenture agreement.

 

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

The Company’s subsidiary in Singapore had bank guarantees of $0.8 million and $1.5 million at December 27, 2014 and June 28, 2014, respectively. At December 27, 2014 and June 28, 2014, these guarantees are secured with a cash deposit of $0.2 million and $0.6 million, respectively, and a protective letter of credit issued by the Company to Citibank.

 

 

8. COMMITMENTS AND CONTINGENCIES

Under the contract for the Nitram acquisition, the Company had certain rights to indemnification from the selling stockholders for claims relating to breach of representations and certain other claims, including litigation costs and damages. In September 2014, the Company reached a final settlement with the Nitram selling stockholders to reimburse the Company for previously incurred warranty and environmental cleanup costs of approximately $0.8 million and resolve all outstanding matters. The Company recorded $0.4 million as an offset to cost of goods sold and the remainder was offset to general and administrative expense in the Consolidated Statement of Operations.

From time to time the Company is involved in various litigation, claims and assessment matters arising in the ordinary course of business. The Company accrues for contingencies when losses are both probable and reasonably estimable.

 

 

9. STOCK-BASED COMPENSATION

The following information represents the Company’s grants of stock-based compensation to employees and directors during the six months ended December 27, 2014 and December 28, 2013 (in thousands, except share amounts):

 

The stock granted to the members of the Board of Directors vested upon grant, therefore the fair value amount was recognized as expense at the time of grant. The compensation expense for the restricted stock awards granted to officers and other employees in fiscal 2015 and fiscal 2014 is recognized over a three-year vesting period. The compensation expense is based on the fair value of the awards on the grant date, net of forfeitures.

In July 2013 and July 2014, the Company also awarded restricted stock units (“RSUs”), which are subject to both service and performance conditions, to some of the officers of the Company. The fair value of the RSUs is based on the probability of the performance condition being achieved on the date of grant. The actual number of shares that are eligible to vest is determined based on the Company’s performance during the performance period, which is a year from the date of grant, against established metrics and could range from 0% to 200% of the number of units originally granted. The RSUs are issuable based on the one year performance period and cliff vest on the third anniversary of the grant date subject to the continued employment of the grantee. The Company recognizes compensation expense for the RSUs based upon management’s determination of the potential likelihood of achievement of the performance conditions at each reporting date, net of estimated forfeitures.

The Company recognized $0.8 million and $0.6 million of stock-based compensation expense in the six months ended December 27, 2014 and December 28, 2013, respectively. The Company recognized $0.3 million and $0.1 million of stock-based compensation expense in the three months ended December 27, 2014 and December 28, 2013, respectively.

 

 

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PMFG, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

10. DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

Derivative Financial Instruments

The Company has entered into interest rate swap agreements that effectively convert the interest rates on the long-term debt issued under the Credit Agreement from floating to fixed rates. The following table summarizes the interest rate agreements in effect as of December 27, 2014 (in thousands):

 

The swap agreements are recorded as an asset or liability in the Consolidated Balance Sheets at fair value, with the change in fair value recorded as interest expense within the Consolidated Statements of Operations.

The Company is exposed to market risk under these arrangements due to the possibility of interest rates on the term loans under the Credit Agreement declining to below the rates on the interest rate swap agreements. Credit risk under these arrangements is believed to be remote as the counterparty to the interest rate swap agreements is a major financial institution; however, if the counterparty to the derivative instrument arrangements becomes unable to fulfill its obligations to the Company, the financial benefits of the arrangements may be lost.

The derivatives recorded at fair value in the Company’s Consolidated Balance Sheets were (in thousands):

 

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.

A summary of derivative assets and liabilities measured at fair value on a recurring basis is as follows (in thousands):

 

The fair value of the interest rate swaps is determined based on the notional amounts of the swaps and the forward LIBOR curve relative to the fixed interest rates under the swap agreements. The Company classifies these instruments in Level 2 because quoted

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Notes to the Consolidated Financial Statements—Unaudited

December 27, 2014

 

market prices can be corroborated utilizing observable benchmark market rates at commonly quoted intervals, observable current and forward commodity market prices on active exchanges, and observable market transactions of spot currency rates and forward currency prices.

 

 

11. SEGMENT INFORMATION

The Company has two reportable segments: Process Products and Environmental Systems. The Process Products segment produces various types of separation and filtration equipment 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 Environmental Systems segment designs, engineers and installs highly efficient systems for combustion modification, fuel conversions and post-combustion nitrogen oxide (NOx) control for both new and existing sources. These environmental control systems are used for air pollution abatement and converting burners to accommodate alternative sources of fuel. System applications include Selective Catalytic Reduction (“SCR”) systems and Selective Non-Catalytic Reduction (“SNCR”) systems.

The Company allocates all costs associated with the manufacture, sale and design of its products to the appropriate segment. Segment profit and loss is based on revenue less direct expenses of the segment before allocation of general and administrative costs. The Company does not allocate general and administrative expenses (“reconciling items”), assets, or expenditures for assets on a segment basis for internal management reporting; therefore this information is not presented. Segment information and a reconciliation to consolidated operating income (loss) for the three and six months ended December 27, 2014 and December 28, 2013 are presented below (in thousands):

 

 

 

 

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

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

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 28, 2014. These factors could cause our actual results for future periods to differ materially from those experienced in, or implied by, these forward-looking statements.

Our Business

We are a leading provider of custom-engineered systems and products designed to help ensure that the delivery of energy is safe, efficient and clean. We primarily serve the markets for natural gas infrastructure, power generation and refining and petrochemical processing. With the acquisition of substantially all of the assets of Combustion Components Associates, Inc. (“CCA”) in March 2014, we expanded the markets we serve to include industrial and utility industries. We offer a broad range of separation and filtration products, selective catalytic reduction (“SCR”) systems, selective non-catalytic reduction (“SNCR”) systems, low emissions burner and related combustion systems and other complementary products including heat transfer equipment, pulsation dampeners and silencers. Our primary customers include original equipment manufacturers, engineering contractors, commercial and industrial companies and operators of power facilities.

Our products and systems are marketed worldwide. Revenue generated from outside of the United States represented 41% of total revenue in the six months ended December 27, 2014 compared to 45% in the six months ended December 28, 2013. As a result of the global demand for our products and the breadth of our global sales and support resources, we expect our international revenue will continue to be a significant percentage of our consolidated revenue in the future. International markets, and in particular emerging markets such as China, India, Latin America, and Northern Africa, will be subject to significant variations in demand from period to period.

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

We have two reporting segments: Process Products and Environmental Systems. The Process Products segment produces specialized systems and products that remove contaminants from gases and liquids, improving efficiency, reducing maintenance and extending the life of energy infrastructure. The segment also includes industrial silencing equipment to control noise pollution on a wide range of industrial processes and heat transfer equipment to conserve energy in many industrial processes and in petrochemical processing. The Environmental Systems segment designs, engineers and installs highly efficient systems for combustion modification, fuel conversions and post-combustion nitrogen oxide (NOx) control for both new and existing sources. These environmental control systems are used for air pollution abatement and converting burners to accommodate alternative sources of fuel. System applications include combustion systems, SCR systems and SNCR systems.

Key Drivers of Product Demand

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

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

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

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

Critical Accounting Policies

See the Company’s critical accounting policies as described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II of our Annual Report on Form 10-K for the year ended June 28, 2014. Since the date of that report, there have been no material changes to our critical accounting policies.

Results of Operations

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

 

Cost of goods sold includes manufacturing and distribution costs for products sold. The manufacturing and distribution costs include material, direct and indirect labor, manufacturing overhead, depreciation, sub-contract work, inbound and outbound freight, purchasing, receiving, inspection, warehousing, internal transfer costs and other costs of our manufacturing and distribution processes. Cost of goods sold also includes the costs of commissioning the equipment and warranty-related costs. Operating expenses include sales and marketing expenses, engineering and project management expenses and general and administrative expenses which are further described below.

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Quarter Ended December 27, 2014 Compared to Quarter Ended December 28, 2013

Revenue. We classify revenue as domestic or international based upon the origination of the order. Revenue generated by orders originating from within the United States is classified as domestic revenue, regardless of where the product is shipped or where it will eventually be installed. Revenue generated by orders originating from a country other than the United States is classified as international revenue. International revenue was approximately 40% and 41% of consolidated revenue in the quarters ended December 27, 2014 and December 28, 2013, respectively.

The following summarizes consolidated revenue (in thousands):

 

Total revenue increased $11.3 million, or 38.2%, to $40.9 million in the second quarter of fiscal 2015 compared to the same period in fiscal 2014. The higher revenue in fiscal 2015 reflects the increased demand for our environmental systems application and the addition of CCA, which was acquired in March 2014. Additionally, activity in EMEA resulted in stronger revenue in our Process Products segment for the second quarter of fiscal 2015 when compared to the same fiscal quarter in fiscal 2014. During the first quarter of fiscal 2014, we ceased manufacturing operations at two facilities and began manufacturing activities at two new facilities. The transition disrupted our manufacturing capabilities during the second quarter of fiscal 2014 as it was necessary to shut down and dismantle equipment to be moved and reinstalled in new facilities.

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

 

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Gross profit in the second quarter of fiscal 2015 increased $4.7 million compared to the same period in fiscal 2014. The increase in fiscal 2015 gross profit is attributed to the higher revenue in the period and improved margins year-over-year.    Included in cost of goods sold for fiscal year 2014 is $471,000 of non-recurring restructuring costs related to the closure of a manufacturing plant in Texas and the relocation of the fabrication activities to the remaining plants in Texas.  Operational improvement initiatives first implemented in the latter half of fiscal 2014 combined with an improvement in product mix are resulting in higher relative gross margins when compared to fiscal 2014.

 

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

 

Operating expenses increased $3.7 million, or 37.8%, for the second quarter of fiscal 2015 compared to the same period in fiscal 2014. The increase in operating expenses primarily relates to the additional operating expenses of CCA, which was acquired in March 2014 and higher costs associated with investments in process improvement initiatives and information technology. Operating expenses as a percentage of revenue decreased from period to period on higher revenue. The change in operating expenses in the second quarter of fiscal 2015 compared to the same period in fiscal 2014 is as follows:

 

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

 

Total other expense was a net expense of $0.4 and $0.5 million in the second quarter of fiscal 2015 and 2014, respectively.

Income Taxes. Our effective income tax rates were (12.1)% and (39.7)% for the quarters ended December 27, 2014 and December 28, 2013, respectively. Our effective tax rate differs from the statutory rate primarily because of earnings generated in tax jurisdictions where the Company has net operating loss carryforward credits.

Net Earnings (loss). For the three months ended December 27, 2014, the net loss was ($1.1) million, a decrease of $1.8 million compared to a net loss of ($2.9) million in the three months ended December 28, 2013.  The decrease in the net loss is a result of higher revenue and relatively fixed operating costs.  Basic and diluted loss per share attributable to our common stockholders decreased to ($0.06) per share for the three months ended December 27, 2014, from a loss of ($0.14) per share for the three months ended December 28, 2013.

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Results of Operations – Segments

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

Process Products

The Process Products segment produces specialized systems and products that remove contaminants from gases and liquids, improving efficiency, reducing maintenance and extending the life of energy infrastructure. The segment also includes industrial silencing equipment to control noise pollution on a wide range of industrial processes and heat transfer equipment to conserve energy in many industrial processes and in petrochemical processing. Process Products represented 64% and 82% of our revenue in the quarters ended December 27, 2014 and December 28, 2013, respectively. The relative mix of Process Products revenue declined compared to the second quarter of fiscal 2014 because of the acquisition of CCA to our Environmental Systems segment and the growing demand for environmental systems solutions.

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

 

Process Products revenue increased $2.1 million, or 8.6%, to $26.4 million in the second quarter of fiscal 2015, compared to the second quarter of fiscal 2014. The increase in revenue is attributed to increased demand for steam separators utilized in nuclear power generation and oily water separation solutions for the oil production industry.

Process Products operating income for the second quarter of fiscal 2015 increased $0.7 million compared to the second quarter of fiscal 2014, primarily as a result of the increase in revenue. The gross profit as a percent of revenue was 26.7% in the second quarter of fiscal 2015 compared to 25.6% in the prior year. As our sales and marketing and engineering resources are largely fixed in nature, the higher revenue in the quarter resulted in higher segment profitability.

Environmental Systems

The Environmental Systems segment designs, engineers and installs highly efficient systems for combustion modification, fuel conversions and post-combustion NOx control for both new and existing sources. These environmental control systems are used for air pollution abatement and converting burners to accommodate alternative sources of fuel. System applications include SCR systems, combustion systems and SNCR systems. The Environmental Systems segment represented 36% and 18% of our consolidated revenue in the quarters ended December 27, 2014 and December 28, 2013, respectively. With the increase in demand for environmental system solutions, we anticipate the Environmental Systems segment will continue to be significant as a percentage of our consolidated revenue.

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

 

Environmental Systems revenue increased $9.2 million to $14.6 million in the second quarter of fiscal 2015 compared to the second quarter of fiscal 2014, because of the increase in demand for our Environmental Systems solutions and the contribution of $2.5 million of revenue during the quarter from the acquisition of CCA in March 2014. The gross profit as a percent of revenue was 39.5% in the second quarter of fiscal 2015 compared to 35.9% in the prior year. The higher margin reflects the relative complexity of certain large projects in process during the current quarter.

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Environmental Systems operating income for the second quarter of fiscal 2015 increased $2.4 million compared to the second quarter of fiscal 2014. As a percentage of revenue, operating income increased to 25.8% in the second quarter of fiscal 2015 compared to 25.4%, in the second quarter of fiscal 2014.

Six Months Ended December 27, 2014 Compared to Six Months Ended December 28, 2013

Results of Operations – Consolidated

Revenue. The following table summarizes consolidated revenue (in thousands):

 

For the six months ended December 27, 2014, total revenue increased $27.5 million, or 46.9%. Domestic revenue increased $19.0 million, or 59.0%, in the six months ended December 27, 2014 when compared to the same period last year. International revenue increased $8.6 million, or 32.2% in the six months ended December 27, 2014 when compared to the same period last year.  The year over year growth in revenue in the United States is largely attributable to higher domestic demand for environmental solutions and the acquisition of CCA.  Year over year higher demand for oily water separation solutions in the EMEA region and nuclear power generation in the U.S. and Europe led to an increase in our Pressure Products segment.

Gross Profit. The following table summarizes revenue, cost of goods sold, and gross profit (in thousands):

 

Gross profit increased $9.8 million in the six months ended December 27, 2014 compared to the six months ended December 28, 2013. Gross profit, as a percentage of revenue, increased to 32.1% for the six months ended December 27, 2014 compared to 30.4% for the six months ended December 28, 2013. During the six months ended December 28, 2013 we incurred margin deterioration as we transitioned to our new manufacturing facilities in Denton, Texas and Zhenjiang, China.  We did not experience similar issues in the six months ended December 27, 2014 resulting in higher gross profit as a percentage of revenue.

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

 

Operating expenses increased $5.0 million in the six months ended December 27, 2014 compared to the six months ended December 28, 2013. As a percentage of revenue, operating expenses decreased to 30.3% for the six months ended December 27, 2014, from 35.9% in the same period in fiscal 2014. Our operating expenses are largely fixed in nature, operating expenses as a percentage of revenue decreased significantly from period to period on higher revenue. The following table summarizes the change in operating expenses:

 

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

 

For the six months ended December 27, 2014, total other expense was $0.4 million, a decrease of $0.7 million from $1.1 million for the six months ended December 28, 2013. The six months ended December 27, 2014 reported a gain on foreign currency translation of $0.1 million, driven largely by movements in the euro and U.S. dollar relative to the British pound, compared to a loss on foreign currency translation of $0.5 million, driven largely by movements in the euro and U.S. dollar relative to the British pound for the six months ended December 28, 2013. During the six months ended December 27, 2014 we reduced a liability for deferred consideration in connection with the CCA acquisition by $0.3 million based on a change in the estimated obligation.

Income Taxes: Our effective income tax rates were 34.8% and (4.3)% for the six months ended December 27, 2014 and December 28, 2013, respectively. For the six months ended December 27, 2014, the effective tax rate was impacted by earnings in foreign taxing jurisdictions that do not have the benefit of net operating loss carryforward credits. For the six months ended December 28, 2013, our effective tax rate was impacted by the blend of taxable income in some state and foreign taxing jurisdictions and permanent differences and taxable losses in the United States which recognized no tax benefit.

Net Earnings (loss). For the six months ended December 27, 2014, net income was $0.8 million, an increase of $5.3 million compared to net loss of ($4.5) million in the six months ended December 28, 2013.  The increase in net income is a result of higher revenues and relatively fixed operating costs.

Basic and diluted earnings (loss) per share attributable to our common stockholders increased to income of $0.03 per share for the six months ended December 27, 2014, from a loss of $(0.22) per share for the six months ended December 28, 2013.

Results of Operations – Segments

Process Products

Our Process Products segment represented 64% and 83% of our revenue for the six months ended December 27, 2014 and December 28, 2013, respectively. The following table summarizes Process Products revenue and operating income (in thousands):

 

Process Products revenue increased by $6.1 million, or 12.4%, in the six months ended December 27, 2014 when compared to the six months ended December 28, 2013.  The increase in revenue is attributed to increased demand for nuclear applications in the United States and Europe and oily water separation applications destined for the EMEA region.

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Process Products operating income in the six months ended December 27, 2014 increased by $1.8 million compared to the six months ended December 28, 2013. As a percentage of Process Products revenue, operating income was 10.6% in the six months ended December 27, 2014 compared to 8.3% in the same period last year. We have undertaken a number of initiatives to minimize the impact of cost overruns and inefficiencies in our U.S. manufacturing facilities.  While certain of these initiatives are ongoing, the negative impact on gross profit was largely mitigated in the quarter when compared to recent quarters.  As our sales and marketing and engineering resources are largely fixed in nature, the higher revenue in the six months resulted in higher segment profitability.     The Process Products segment was also negatively impacted in fiscal 2014 by transition costs and manufacturing inefficiencies as we began fabrication in new manufacturing facilities in Denton, Texas and Zhenjiang, China.

Environmental Systems

Our Environmental Systems segment represented 36% and 17% of our revenue for the six months ended December 27, 2014 and December 28, 2013, respectively. The following table summarizes Environmental Systems revenue and operating income (in thousands):

 

Revenue from Environmental Systems increased $21.4 million in the six months ended December 27, 2014, when compared to the six months ended December 28, 2013, because of demand for our Environmental Systems solutions and the contribution of $9.1 million of revenue during fiscal 2015 from the acquisition of CCA. The higher margin reflects the relative complexity of certain large projects in process during the current period.

Environmental Systems operating income as a percentage of revenue in the six months ended December 27, 2014 increased to 24.0%, compared to 22.8% for the six months ended December 28, 2013. The increase in operating income as a percentage of revenue reflects the positive impact on segment profitability of fixed operating costs being leveraged on higher revenue.

Contingencies

From time to time we are involved in various litigation, claims and assessment 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.

Decline in Oil Prices

We traditionally have about one quarter of our products sold to customers in the oil industry, either at the upstream production point or downstream refinery or petro chemical processing plants.  This key end market segment has been impacted by the recent decline of oil prices.  Depending on the severity and duration of the decline in oil prices, we could see a negative impact on new project awards related to oil production projects, particularly in the Canadian and Latin American markets.

Net Bookings and Backlog

The following table shows the activity and balances related to our backlog for the six months ended December 27, 2014 and December 28, 2013 (in millions):

 

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Backlog includes contractual purchase orders for products that are deliverable in future periods less revenue recognized on such orders to date. Our backlog increased $9.4 million from December 28, 2013 to $107.1 million at December 27, 2014. The increase in backlog reflects the relative strength in bookings in comparison to the prior year. Approximately $7 million of the backlog value is subject to customer-driven delays attributed to uncertainties surrounding the extent and duration of recent declines in oil prices.  Excluding these projects, for which the timeline for completion is uncertain, we expect approximately 85%  of the backlog as of December 27, 2014 will be recognized as revenue over the next 12 months.

Financial Position

Assets. Total assets increased by $6.6 million, or 3.9%, from $167.2 million at June 28, 2014, to $173.8 million at December 27, 2014. On December 27, 2014, we held cash, including restricted cash, and cash equivalents of $38.6 million, had working capital of $53.2 million and a current liquidity ratio of 1.9-to-1.0. This compares with cash, including restricted cash, and cash equivalents of $42.8 million, working capital of $55.1 million, and a current liquidity ratio of 2.1-to-1.0 at June 28, 2014.

Liabilities and Equity. Total liabilities increased by $7.1 million, or 10.3%, from $69.8 million at June 28, 2014 to $76.9 million at December 27, 2014. The increase in our total liabilities is attributed to an increase in accounts payable, billings in excess of costs and earnings on uncompleted contracts and other accrued liabilities.

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 invoice 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 December 27, 2014, the balance of these working capital accounts was $21.2 million compared to $17.3 million at June 28, 2014, reflecting an increase of our investment in these working capital items of $3.9 million.

Many of our customers require bank letters of credit or other forms of financial guarantees to secure progress payments and performance. Such letters of credit and guarantees are issued under various bank and financial institution arrangements (see Note 7  in the Notes to the Consolidated Financial Statements). As of December 27, 2014 and June 28, 2014, we had outstanding letters of credit and bank guarantees of $18.0 million and $20.4 million, respectively.

Our cash and cash equivalents were $38.6 million as of December 27, 2014, compared to $42.8 million at June 28, 2014, of which $14.5 million and $15.6 million were restricted as collateral for stand-by letters of credit and bank guarantees at December 27, 2014, and June 28, 2014, respectively.

During the six months ended December 27, 2014, cash used in operating activities was $0.7 million compared to cash used in operating activities of $0.9 million for the six months ended December 28, 2013. Our cash used in operating activities primarily reflects an increase of our investment in working capital.

Cash used in investing activities was $0.9 million for the six months ended December 27, 2014, compared to cash used in investing activities of $8.4 million for the six months ended December 28, 2013. Cash used in investing activities during the six months ended December 27, 2014, primarily related to additions to our manufacturing facility in Zhenjiang, China, offset in part by reductions in restriced cash. Cash used in investing activities during the six months ended December 28, 2013, primarily related to construction costs incurred to date on our manufacturing facilities in Denton, Texas and Zhenjiang, China.

Cash used in financing activities during the six months ended December 27, 2014 was $1.4 million compared to cash provided by financing activities of $12.0 million during the six months ended December 28, 2013. The cash used in financing activities for the six months ended December 27, 2014 was due to the payment of long-term debt. The cash provided by financing activities for the six months ended December 28, 2013 primarily consisted of proceeds from long-term debt as we drew on our construction term loan and the equity contribution from a non-controlling interest in our China subsidiary, offset by a payment of long-term debt.

As a result of the events described above, our cash and cash equivalents during the six months ended December 27, 2014, decreased by $3.1 million compared to an increase of $3.1 million during the six months ended December 28, 2013.

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

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risk exposures from those disclosed in Item 7A of Part II of our Annual Report on Form 10-K for the year ended June 28, 2014.

 

 

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information related to the Company (including its consolidated subsidiaries) that is required to be disclosed in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

The Company’s management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of these disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated by the SEC under the Securities Exchange Act of 1934) as of the end of the period covered by this Report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective in ensuring that all information required to be disclosed in this Report has been recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Additionally, based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures were effective in ensuring that all material information required to be filed in this Report has been accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, in a timely fashion to allow decisions regarding required disclosures.

Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls could be circumvented by the individual acts of some persons or by collusion of two or more people. The Company’s controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met. Notwithstanding the foregoing, the Company’s disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.

During the last fiscal quarter, there have been no changes in the Company’s internal control over financial reporting, or in other factors, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

We are involved, from time to time, in various litigation, claims and proceedings arising in the ordinary 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 28, 2014.

 

 

 

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Item 6. Exhibits

The following exhibits are filed as part of this report.

 

 

 

 

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SIGNATURES

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

 

 

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