Attached files

file filename
EX-23.1 - EX-23.1 - PMFG, Inc.pmfg-ex231_632.htm
EX-21.1 - EX-21.1 - PMFG, Inc.pmfg-ex211_654.htm
EX-31.2 - EX-31.2 - PMFG, Inc.pmfg-ex312_201506277.htm
EX-31.1 - EX-31.1 - PMFG, Inc.pmfg-ex311_201506276.htm
EX-32.1 - EX-32.1 - PMFG, Inc.pmfg-ex321_201506278.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

(Mark One)

x

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended June 27, 2015

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 No. 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)

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

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.01 par value per share

 

The NASDAQ Global Select Market

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  o    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  o    No  þ

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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  o

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

 

Large accelerated filer

 

¨

 

Accelerated filer

 

þ

 

 

 

 

 

 

 

Non-accelerated filer

 

¨ (Do not check if a smaller reporting company)

 

Smaller reporting company

 

¨

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

The aggregate value of the voting stock held by non-affiliates of the registrant as of December 27, 2014 was approximately $115.9 million.

The number of shares outstanding of the registrant’s common stock, $0.01 par value, as of August 20, 2015 was 21,281,290.

DOCUMENTS INCORPORATED BY REFERENCE:  None

 

 

 

 


 

Table of Contents

 

 

 

Page

 

 

 

Forward-Looking Statements

 

ii

 

 

 

Introductory Note

 

1

 

 

 

PART I

 

1

 

 

 

 

 

Item 1.

 

Business

 

1

 

 

 

 

 

Item 1A.

 

Risk Factors

 

11

 

 

 

 

 

Item 1B.

 

Unresolved Staff Comments

 

21

 

 

 

 

 

Item 2.

 

Properties

 

21

 

 

 

 

 

Item 3.

 

Legal Proceedings

 

21

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

22

 

 

 

PART II

 

23

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

23

 

 

 

 

 

Item 6.

 

Selected Financial Data

 

24

 

 

 

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

25

 

 

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

40

 

 

 

 

 

Item 8.

 

Financial Statements and Supplementary Data

 

41

 

 

 

 

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

72

 

 

 

 

 

Item 9A.

 

Controls and Procedures

 

72

 

 

 

 

 

Item 9B.

 

Other Information

 

72

 

 

 

PART III

 

73

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

73

 

 

 

 

 

Item 11.

 

Executive Compensation

 

80

 

 

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

96

 

 

 

 

 

Item 13.

 

Certain Relationships and Related Transactions and Director independence

 

98

 

 

 

 

 

Item 14.

 

Principal Accountant Fees and Services

 

99

 

 

 

PART IV

 

101

 

 

 

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

101

 

 

 

Signatures

 

104

 

 

 

Index to Exhibits

 

105

i

 


 

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (the “Form 10-K”) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, 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 Form 10-K 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:

 

·

possible harm to the price of our common stock, business or operations if the Mergers (as defined herein) are not completed;

 

·

disruptions in our business caused by the pendency of the Mergers;

 

·

failure or delay in the approval of PMFG and CECO stockholders to consummate the Mergers may jeopardize or delay the Mergers;

 

·

CECO may be unable to secure financing for the Mergers and available remedies to PMFG may be insufficient to make PMFG whole;

 

·

litigation challenging the Mergers could delay or prevent the completion of the Mergers;

 

·

adverse changes to the markets in which we operate, including the natural gas infrastructure, power generation, and refining and petrochemical processing industries;

 

·

compliance with United States and foreign laws and regulations, including export control and economic sanctions laws and regulations, which are complex, change frequently and have tended to become more stringent over time;

 

·

changes in existing environmental legislation or regulations;

 

·

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

 

·

changes in competition;

 

·

changes in demand for our products;

 

·

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

 

·

risks associated with our product warranties; and

 

·

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

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this and other reports we file with the Securities and Exchange Commission (the “SEC”), including the information in “Part I - Item 1A - Risk Factors” of this Form 10-K, and elsewhere in this Form 10-K. There may be other factors that 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.

 

 

 

ii

 


 

INTRODUCTORY NOTE

PMFG, Inc. (“PMFG”) was incorporated as a Delaware corporation on August 15, 2008 as part of a holding company reorganization.  As used in this Form 10-K, references to “Company,” “we,” “us” and “our” refer to PMFG, Inc. and its subsidiaries, unless the context requires otherwise.  Additionally, references to “PMFG” refer to PMFG, Inc. and references to “Peerless” refer to Peerless Mfg. Co., a wholly owned subsidiary of PMFG, in each case unless the context requires otherwise.

Our fiscal year end is the Saturday closest to June 30.  Therefore, the fiscal year end date varies slightly each year. In a 52-week fiscal year, each of our quarterly periods will be comprised of 13 weeks, consisting of two four-week periods and one five-week period. 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.

References in this Form 10-K to fiscal 2015, fiscal 2014 and fiscal 2013 refer to our 52-week fiscal years ended June 27, 2015, June 28, 2014 and June 29, 2013, respectively.

 

 

PART I

ITEM 1.

BUSINESS.

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 natural gas infrastructure, power generation and refining and petrochemical processing. With our acquisition in March 2014 of substantially all of the assets of Combustion Components Associates, Inc. (“CCA”), 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 pulsation dampeners and silencers. Our primary customers include original equipment manufacturers, engineering contractors, commercial and industrial companies and operators of power facilities.

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. 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.  The Process Products and Environmental Systems segments accounted for 66% and 34% of total revenue, respectively, for fiscal 2015, 76% and 24% of total revenue, respectively, for fiscal 2014, and 84% and 16% of total revenue, respectively, for fiscal 2013.

We have been in business for over 80 years and believe we succeed in winning customer orders because of the relationships we have developed over the years of our service, the long history of performance and reliability of our systems and products, our ability to deliver products in compliance with our customers’ needs and our advanced technical engineering capabilities on complex projects. We work closely with our customers to design, custom-engineer and fabricate our systems and products to meet their specific needs. Our customers include some of the largest natural gas processors, transmission and distribution companies, refiners, power generators, boiler manufacturers, compressor manufacturers and engineering and construction companies in the world. Reliable product performance, timely delivery, customer satisfaction and advanced engineering are critical in maintaining our competitive position.

The demand for energy in both developed and emerging countries, coupled with the global trend toward stricter environmental regulations, drives demand for our systems and products.  These trends stimulate investment, both in new power generation facilities, refineries and related infrastructure and in upgrading older facilities to extend their useful lives.  Further, in response to demand for cleaner, more environmentally responsible power generation, power providers and industrial power consumers are building new facilities that use cleaner fuels, such as natural gas and bio fuels.  Power providers in international and domestic markets also are upgrading and relicensing existing facilities and building new facilities that use nuclear power generation technology.  We believe we are positioned to benefit from the increased use of both natural gas and nuclear technology.

Our products and systems are marketed worldwide.  Revenue generated from outside the United States was approximately 42% in fiscal 2015, compared to 39% in fiscal 2014 and 47% in fiscal 2013.  As a result of the global demand for our products and our increased sales resources outside of the United States, we expect our international revenue will continue to be a significant percentage

1

 


 

of our consolidated revenue in the future.  International markets, and in particular emerging markets such as Latin America, Northern Africa and China, will be subject to significant variations in demand from period to period.  For additional geographical information, please see Note Q to the Notes to our Consolidated Financial Statements.

Our business strategy is to continue to pursue opportunities in high-growth international markets, capitalize on opportunities to deliver complete systems, use our technological capabilities to address a broader range of pollutants, further expand our technical expertise by investing in engineering talent and improve our manufacturing processes.  In addition to our organic growth strategies, we will maintain an outward view of the industry and pursue strategic acquisitions.  We believe these efforts will improve our financial performance and better position our company to compete globally.

Recent Developments

Proposed Merger with CECO Environmental Corp.

On May 3, 2015, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with CECO Environmental Corp., a Delaware corporation (“CECO”), and two direct wholly owned subsidiaries of CECO, Top Gear Acquisition Inc., a Delaware corporation (“Merger Sub I”), and Top Gear Acquisition II LLC, a Delaware limited liability company (“Merger Sub II” and together with Merger Sub I, collectively, the “Merger Subs”). Pursuant to the Merger Agreement, Merger Sub I will merge with and into the Company (the “First Merger”), with the Company surviving the First Merger as a wholly owned subsidiary of CECO. Immediately following consummation of the First Merger, the Company will merge with and into Merger Sub II (the “Second Merger”, and together with the First Merger, the “Mergers”), with Merger Sub II surviving the Second Merger, as a wholly owned subsidiary of CECO.

The Boards of Directors of the Company and CECO have each unanimously approved the Merger Agreement. The Merger Agreement is subject to approval by the Company’s stockholders. The Board of Directors of the Company has recommended that the Company’s stockholders adopt the Merger Agreement.

Pursuant to the terms of the Merger Agreement and subject to the conditions therein, at the effective time of the Merger (the “Effective Time”), each then issued and outstanding share of common stock (the “Company Common Stock”) of the Company (except shares owned by a subsidiary of the Company and shares held by stockholders who exercise their appraisal rights under Delaware law) will be cancelled and converted into the right to receive, at the election of the holder, subject to proration, either:

 

·

$6.85 per share in cash, without interest (the “Cash Consideration”); or

 

·

a number of shares of CECO common stock (“CECO Common Stock”), equal to a fraction (the “Exchange Ratio”), the numerator of which is $6.85 and the denominator of which is the volume-weighted average trading price as reported on the NASDAQ Global Market (the “VWAP Price”) of CECO Common Stock for the 15 consecutive trading days ending on the trading date immediately preceding the closing date of the Merger Agreement (the “Stock Consideration”); provided that the Stock Consideration is subject to a collar such that (1) if the VWAP Price is less than or equal to $10.61, then the Exchange Ratio will be 0.6456 shares of CECO Common Stock for each share of Company Common Stock, and (2) if the VWAP Price is greater than or equal to $12.97, then the Exchange Ratio will be 0.5282 shares of CECO Common Stock for each share of Company Common Stock. The net effect of this collar mechanism is that no further increase in the Exchange Ratio will be made if the CECO trading price is less than $10.61, and no further decrease in the Exchange Ratio will be made if the CECO trading price is greater than $12.97.

The Mergers are expected to close in September 2015, subject to approval of CECO stockholders and Company stockholders and other customary closing conditions.  Both CECO and the Company have scheduled stockholder meetings for September 2, 2015 to approve proposals in connection with the Mergers.

The Merger Agreement may be terminated at any time prior to the closing of the Mergers by mutual written consent of CECO and the Company. Either CECO or the Company may terminate the Merger Agreement if the Effective Time has not occurred on or before November 30, 2015, the required Company stockholder approval or CECO stockholder approval is not obtained, or the consummation of the Mergers becomes illegal or otherwise is prevented or prohibited by any governmental authority.

The Company cannot give any assurance that the Mergers will be completed.

2

 


 

Sale of Heat Exchanger Business

On March 27, 2015, we sold our heat exchanger product line including the Alco, Alco-Twin, and Bos-Hatten brands.  The product line was acquired in 2008 in connection with the purchase of Nitram Energy, Inc. and Subsidiaries (“Nitram”).  The heat exchanger product line represented approximately $6.1 million of revenue in fiscal 2015 and approximately $6.3 million of revenue in fiscal 2014.  The sale resulted in a gain of $1.2 million included in Other income (expense) in the Consolidated Statements of Operations.

Our Industry

We primarily serve the natural gas infrastructure, power generation and oil refining and petrochemical processing markets. Worldwide energy consumption is projected to continue to increase, with demand in emerging economies outside of the Organization for Economic Cooperation and Development (“OECD”) driven primarily by the rate of economic growth in those regions and demand in the developed economies being influenced primarily by price. Over the long term, increases in worldwide energy consumption drive demand for the energy infrastructure products we provide. In the short term, a variety of factors affect demand for energy infrastructure, including general economic conditions, current and anticipated environmental regulations and the level of capital spending by companies engaged in energy production, processing, transportation, storage and distribution.

Natural gas infrastructure

The natural gas industry consists of the exploration, production, processing, transportation, storage and distribution of natural gas. The International Energy Association (“IEA”) projects a pronounced shift in OECD countries away from oil and coal towards natural gas and renewables.  Natural gas continues to be the fuel of choice for the electric power and industrial sectors in many of the world’s regions, in part because of its lower carbon intensity compared with coal and oil, which makes it an attractive fuel source in countries where governments are implementing policies to reduce greenhouse gas emissions.    The U.S. Energy Information Administration (“EIA”) reports that industrial natural gas consumption has grown steadily since 2009 and is expected to increase by another 3.9% in 2016.

Natural gas delivery is a complex process that refines raw natural gas for industrial, commercial or residential uses. Initially, raw natural gas is extracted from the earth and cleansed of contaminants such as dirt and water at the well site. The natural gas is then transported through a gathering facility to a processing facility, where it is processed to meet quality standards set by pipeline and distribution companies, such as specified levels of solids, liquids and other gases.  After processing, the natural gas is transmitted for storage or through an extensive network of pipelines to consumers.

The natural gas infrastructure network in the United States can transport natural gas to nearly any location in the contiguous 48 states.  This network of more than 210 natural gas pipeline systems, consists of more than 300,000 miles of interstate and intrastate pipelines, more than 11,000 delivery points, 5,000 receipt points, and 1,400 interconnection points that provide for the transfer of natural gas, approximately 400 storage facilities and eight liquefied natural gas (“LNG”) facilities.  This network of systems delivered more than 24 trillion cubic feet of natural gas in 2011 to over 500 gas-fired power plants and over 1,200 local distribution companies that support over 71 million industrial, residential and commercial customers. This infrastructure continually undergoes maintenance and expansion upgrades to meet demand and new government regulations.

According to the EIA, the world natural gas trade, both by pipeline and by shipment in the form of LNG is poised to increase in the future.  LNG accounts for a growing share of the global natural gas trade and delivery of LNG is projected to double to approximately 20 trillion cubic feet delivered per year by 2040.  Most of the increase in liquefaction capacity is in Australia and North America, where a multitude of new liquefaction projects are expected to be developed, many of which will become operational within the next decade.  In a 2012 report, the IEA cited that China’s natural gas demand increased from 900 billion cubic feet in 2000 to around 4,600 billion cubic feet in 2011.  The EIA projects demand for natural gas in China to continue to grow about 5% per year over the next 20 years.  Our separation and filtration and silencing products are used throughout the natural gas infrastructure network.

Power generation

Power generation encompasses a broad range of activities related to the production of electricity. The primary types of fuel used to generate electricity are coal, natural gas and nuclear. In 2014, coal accounted for 39% of United States power generation, followed by natural gas (27%) and nuclear (19%). In the United States, concerns about potential environmental regulations enhance the attractiveness of natural gas-fired power plants compared to coal-fired power plants, which generally have higher pollutant emission rates than natural gas-powered plants. Natural gas-fired power plants have lower initial capital needs and are more flexible in terms of operating times than coal plants. To meet the expected surge in energy demand, many countries, including France, Spain and the United States, are relicensing and upgrading existing nuclear facilities while developing countries such as China and South Africa are

3

 


 

building additional nuclear facilities. Our products currently support natural gas and nuclear power generation markets, providing separation and/or filtration equipment, silencing equipment and SCR pollution reduction systems for natural gas power generation stations, as well as separation equipment to nuclear power generation stations.

Refining, oil production and petrochemical processing

Refining, oil production and petrochemical processing involves the producing, refining and processing of fuels and chemicals for use in a variety of applications, such as gasoline, fertilizers and plastics. In response to increasing international demand for petrochemicals and refined products, companies are producing more products from new sources, constructing new refineries and petrochemical processing facilities as well as expanding existing facilities, creating opportunities for both our Process Products and our Environmental Systems. In many cases, these new and expanded facilities must comply with stricter environmental regulations, which influence both choice of fuel and demand for systems to control exhaust emissions. These facilities use a broad range of our products and systems, including our SCR pollution reduction systems, oily water treatment systems and our separation and filtration products.

Market Opportunity

We believe a number of trends in the natural gas infrastructure, power generation, oil production, and refining and petrochemical processing markets create significant opportunities for us. These trends include:

Increasing Worldwide Dependence on Natural Gas Requires Substantial Infrastructure Investment.

According to the EIA, worldwide marketed energy consumption is expected to increase by nearly 56% from 2010 to 2040. The most rapid growth is expected in emerging economies outside the OECD, led by China. The less-developed economies, which are driving worldwide energy demand growth, will require substantial infrastructure investment as they grow. Rapid industrialization in countries such as China is straining existing power generation capacity. Manufacturing growth in these locations also will require additional energy, while consumer demand is expected to rise with increased urbanization and higher standards of living. According to the IEA’s World Energy Outlook 2012, from 2010 to 2035 investment in global natural gas supply infrastructure to support this growth in demand is projected to be approximately $8 trillion from 2011 to 2035.

New Production Technologies are Shifting the Supply and Demand Dynamics of Natural Gas and Oil.

The success of new production technologies like hydraulic fracturing and horizontal drilling have doubled the estimated amount of natural gas that can be produced economically around the world, from 400 trillion cubic meters (“tcm”) from conventional resources to over 800 tcm from all conventional and unconventional resources like shale gas. These abundant supplies that can now be developed and produced at a relatively low cost have significantly increased the attractiveness of natural gas as a fuel choice worldwide. Domestically, increased natural gas reserves provide a path for increased energy independence by the United States from foreign oil as well as a cleaner, competitively priced and reliable alternative to coal as a fuel source for electricity generation. Internationally, the same opportunity exists given the wide dispersion of natural gas resources around the world as well as the substantial growth of LNG transport further globalizing the market for natural gas.

Increasingly Stringent Emissions Standards Spur Demand for Our Products.

The United States Environmental Protection Agency (“EPA”) and other government regulators are adopting stricter environmental requirements. Regulators have identified the harmful byproducts of burning coal in power generation facilities as a primary target of these new rules. These byproducts include NOX and SO2 (sulfur dioxide) emissions, mercury and other hazardous pollutants which are byproducts of natural gas and coal-fired power plants and have the potential to cause serious respiratory conditions, harm vegetation and contribute to greenhouse gas production.

Power plants that do not meet new emissions standards must be retrofitted with pollution control equipment, most often with systems like those we provide, if they are to continue operating. The resulting retirement of significant amounts of coal-fired capacity, combined with growth in electricity demand, may necessitate the construction of additional power plants that must also be equipped with pollution control systems like those we manufacture. ICF International expects that new regulations could force coal-fired power plant closures of up to 20% of the current electrical generating capacity in the United States.

Internationally, governmental agencies are also enacting new regulations to reduce emissions from power generation facilities. For example, China, Saudi Arabia and most OECD nations have adopted regulations to reduce or control NOX emissions. The new

4

 


 

regulations require new facilities to incorporate improved NOX emission control capabilities into their designs and some existing facilities to be retrofitted to comply with these regulations.

Shift to Cleaner and More Fuel-Efficient Energy Sources.

In response to demand for cleaner, more environmentally responsible power generation, power providers are building new facilities that use cleaner, more fuel-efficient energy, including natural gas, nuclear and renewable power. In the United States, concerns about potential environmental regulations have contributed to slowed construction of proposed coal-fired plants. Natural gas has increasingly become a preferred fossil fuel in power generation due to its favorable environmental profile compared to traditional coal combustion. Since the 1990s, natural gas-fired power plants have constituted the vast majority of new power generation capacity built in the United States. At present, 223 gigawatts of new generating capacity will be needed between 2010 and 2035, with natural gas-fired plants accounting for an estimated 60% of this additional capacity. Further, reliable natural gas power generation will also play an increasingly important role in providing back-up power to growing supplies of intermittent renewable power. As an alternative energy source that is one of the least carbon-intensive fuels available, nuclear power generation is also expected to grow. According to the International Atomic Energy Agency, global nuclear capacity is projected to grow from a base of 375 gigawatts in 2010 to 803 gigawatts by 2030. Capacity expansion in Asia, led by China, represents most of these increases. As a leading provider of products and systems used in new construction of natural gas and nuclear power generation facilities, we are well positioned to capitalize on the growing global adoption of clean energy sources in power generation.

Aging nuclear plants provide an opportunity for replacement equipment.

The United States has a fleet of over 100 nuclear power plants that provide approximately 20% of the electrical power in the United States. According to the America Society of Mechanical Engineers (“ASME”), of this fleet 53 reactors will reach the end of their original 40 year operating license by 2020. Most of these plants will seek and it is expected that they will be granted an additional 20 year operating license.  Additionally there are 45 reactors that will reach their 40 year license life by 2030. Currently 73 of these nuclear reactors have had or are in process of having their license renewed.  We have a market opportunity to replace the moisture separation components within the main steam loop during the refurbishment of these units to improve performance levels for their extended life.

Advanced Age of the United States Coal-Fired Plants and Worldwide Nuclear Plants Will Require New Plants and Capital Investment to Maintain Current Output.

Coal-fired power plants are generally designed with an expected useful life of approximately 40 years and their construction and refurbishment is capital intensive. The average age of coal-fired power plants in the United States is 42 years, and more than one-quarter of the existing fleet was built in the 1950s. Similarly, the average age of the world’s operating nuclear power generation fleet is 26 years with many plants reaching the end of their original design lives. Internationally, nuclear power generation capacity is anticipated to grow on average at 2.9% per year. The majority of new nuclear capacity additions are expected to be built in non-OECD countries.  However, public skepticism has tempered widespread adoption of nuclear energy in many developed nations. Natural gas is the fuel source most likely to benefit from a shift from coal and nuclear because of its relative abundance, environmental benefits compared to other fossil fuels and lower capital cost. Furthermore, coal and nuclear plants can take more than five years for permitting and construction, while most natural gas plants can be permitted and erected in approximately two years. Newly constructed natural gas-fired power plants in the United States, with few exceptions, will be required to use SCR systems like those we manufacture to comply with environmental regulations.

Natural Gas is Well-Positioned to Capture New Infrastructure Investments to Support Global Energy Demand.

Natural gas plays a major role in most sectors of the modern economy including power generation for industrial, commercial and residential markets. Further, global uncertainties affecting the energy sector represent opportunities for natural gas. When replacing other fossil fuels for power generation, reliable natural gas generation can lead to significantly lower emissions at significantly lower capital costs. It can also help diversify energy supply and improve energy security both domestically and abroad. In order to meet an expected 50% rise in energy demand by 2035, several non-OECD countries have committed to increasing their reliance on natural gas as a cleaner energy source relative to coal.

According to the Interstate Natural Gas Association of America, energy demand in the United States and Canada through the year 2030 will require approximately $133 billion to $210 billion of new investment in infrastructure, including $108 billion to $163 billion to build an estimated 29,000 to 62,000 miles of additional natural gas pipelines and $16 billion to $25 billion for storage infrastructure investment. Internationally, the EIA estimates that approximately 77% of the world’s natural gas reserves are located in the Middle East, Eurasia, and Latin America, where pipeline systems, compressor stations and LNG storage facilities are generally less developed than the systems in North America. Consequently, new pipeline systems and the related facilities will need to be

5

 


 

constructed in these regions to transport and store natural gas. The EIA expects world liquefaction capacity for natural gas to increase from 8 trillion cubic feet in 2008 to 19 trillion cubic feet in 2035. Additionally, as known reserves of traditional natural gas are depleted, development of other resources, such as deep offshore reserves, will increase, which will require more complex infrastructure. In total, worldwide gas supply infrastructure investment is projected to be approximately $8 trillion from 2011 to 2035.

Our Competitive Strengths

We believe the following competitive strengths differentiate us from our competitors and position us well to capitalize on global energy trends:

Strong, Competitive Position in Attractive Global End Markets.

We believe we are a leading global provider of custom-engineered systems and products and have established a strong, competitive position in attractive global markets by reliably providing custom-engineered, quality systems and products to our customers. We utilize our engineering know-how to offer our customers complete systems and subsystems. Complete, fully-engineered systems generally have higher profit margins than components and we believe these systems allow us to develop longer-term, preferred supplier relationships with customers. We consider many of our systems and products to be innovative and technologically advanced. We continually seek to improve our existing systems and products and develop new systems and products. We believe our history of performance has allowed us to gain substantial market share and a lead position in some of our products. For example, we have provided more than 800 SCR systems for various industry clients that include emissions reductions of facilities that generate more than 100,000 megawatts of electric power capability. We believe we have provided more SCR systems than any other supplier of SCR systems.

Strong Reputation for Quality and Reliability with a Diverse Base of Longstanding Customer Relationships.

We have developed strong customer relationships by using our technical sales, engineering and manufacturing resources to deliver quality systems and products and by providing a high level of customer service. We focus our efforts on consistently and reliably meeting our customers’ needs with respect to system and product performance and timely delivery. We believe we have established long-term preferred supplier relationships with many of our customers. Further, we serve a diverse client base with no single customer representing more than 10% of revenue in fiscal 2015, 2014 or 2013.

Substantial Engineering and Technical Expertise.

We believe we compete most effectively in providing solutions that require a high level of complex design and engineering expertise. We currently employ approximately 90 qualified engineers with backgrounds in chemical, mechanical, industrial, structural, process and civil engineering. We believe our customers depend on our engineering and technical expertise and experience in designing complex systems to meet their individual needs. We regularly employ sophisticated computer and physical modeling programs, including advanced computational fluid dynamic modeling, to verify the performance criteria of designs prior to manufacturing our systems and products. We continue to invest in research and development to further broaden our capabilities. We also believe our patented products and proprietary know-how developed over years of industry experience provides us with a competitive advantage.

Broad Suite of Mission Critical Technologies and Products.

We offer an extensive line of systems and products that our customers rely on to meet their production goals and regulatory requirements. We believe we can advance our proprietary technologies to further broaden our portfolio of systems and products and expand our market potential. For example, we have utilized the experience and expertise gained from our SCR systems to broaden the application of our environmental control technology to address renewable and alternative fuels, such as bio fuels. We are also applying our separation technologies to a wider range of fluids such as molten sulfur and petroleum products. As we continue to broaden our line of high quality systems and products, we believe we are better able to meet our customers’ needs, enter new markets and add new customers.

Established Network of Subcontractors.

We employ subcontractors at various locations around the world to meet our customers’ needs in a timely manner, meet local content requirements and reduce costs. Subcontractors generally perform the majority of our manufacturing for international customers, other than in China, where a majority of our supply is made in our own factory. We also utilize subcontractors in North America, primarily to add additional non-proprietary manufacturing capacity. We believe the reach of our network of subcontractors

6

 


 

expands the benefit of our internal capabilities, improves the timeliness of our delivery and achieves more competitive pricing, which improves our market position. We also believe our network of subcontractors provides us with significant scalability of resources, allowing us to maintain efficient operations and accommodate large or urgent orders, and enhances our reliability, as we can more timely and appropriately shift work in the event that any particular subcontractor is unable to meet demand at any given time.

Our Business Strategy

Our objective is to enhance our position as a leading global provider of custom-engineered systems and products designed to help ensure that the delivery of energy is safe, efficient and clean. The key elements of our strategy to achieve this goal are:

Capitalize on High-Growth International Markets.

We believe we have established a strong international presence, with physical offices in seven countries and sales representatives in 34 countries. International sales represented approximately 42%, 39% and 47% of our total revenue for fiscal 2015, 2014 and 2013, respectively.  As a result of the global demand for our products and our increased sales resources outside of the United States, 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 Latin America, Northern Africa and China, will be subject to significant variations in demand from period to period.

Expand and Diversify Product Offering to Better Meet Our Customers’ Needs.

We believe we have opportunities to further expand and diversify our technology and product offerings in related markets both through internal technology development and strategic acquisitions to meet additional needs of our customers. For example, we have taken the expertise gained from our SCR systems and have applied it to systems for alternative fuel sources, such as bio fuels. We also have expanded the applications of our separation and filtration technology to liquids such as molten sulfur and petroleum products. We continue to pursue additional avenues for expansion and diversification. By expanding our product and technology offerings, we believe we can broaden our customer base and capture additional market share.

Invest in Additional Manufacturing Capacity and Global Supply Chain Capabilities.

We have expanded our manufacturing capacity both in the United States and China.  Other initiatives will include improving the efficiency of our manufacturing operations, as well as ensuring we have developed high quality, responsive and efficient relationships with our suppliers and subcontractors within and around the countries in which we operate. We believe these supply chain initiatives will help ensure that we continue to deliver high quality products within the timeframe established by our customers, while maintaining competitive pricing.

Continue to Offer Technology Solutions that Support Increasingly Stringent Environmental Applications.

We believe a significant portion of our clients’ future capital expenditures will be driven by increasingly demanding environmental requirements. We have structured our business to provide systems and products that are designed to allow our customers to comply with changing regulatory standards. We continue to improve our product and system offerings to meet the changes in these standards as well as the changes in demand for our products and systems as new standards are implemented.

Our Systems and Products

We classify our systems and products into two broad groups consistent with our reportable segments: Process Products and Environmental Systems.  For additional financial information about our segments, please see Note Q to the Notes to the Consolidated Financial Statements.  Below is a brief description of our primary offerings for each of our segments.

7

 


 

Process Products

Our Process Products segment accounted for 66% of total revenue in fiscal 2015 compared to 76% of total revenue in fiscal 2014 and 84% of total revenue in fiscal 2013. Our separation and filtration systems and products improve efficiency, reduce maintenance and extend the life of energy infrastructure by removing liquid contaminants from gases, removing solid contaminants from gases or liquids and separating different liquids. Our separation and filtration systems and products are applied in the natural gas infrastructure, oil production, power generation, refining and petrochemical processing and other specialized industries. This segment also includes industrial silencing equipment to control noise pollution on a wide range of industrial equipment and pulsation dampeners that reduce vibration. Our Process Products systems and products include:

 

·

Liquid/Gas Separators. Equipment that consists of a variety of centrifugal separators, inertial separators and coalescing elements. These devices are sold separately, incorporated into a housing by themselves or with other separation products or as part of a complete system solution.

 

·

Solid/Gas Separators. Comprised of centrifugal separators or filter elements to separate solids from gases. These devices are sold separately, incorporated into a housing by themselves or with other separation products or as part of a complete system solution.

 

·

Liquid/Liquid Separators. Our oil/water separators are sold under the brand name of Skimovex to separate two liquids of different densities in an emulsion separation process.  These separators are primarily sold as part of a complete operating system.

 

·

Pulsation Dampeners. Gas compressors produce pulsations in the attached piping system, which can reduce compressor efficiency, cause severe damage to compressor cylinders and cause cracking in pipes and vessels. Our customers apply our Burgess-Manning branded pulsation dampeners to the suction and discharge of each compressor cylinder to reduce pulsation levels to acceptable limits.

 

·

Industrial Silencers. Our industrial silencing equipment controls noise pollution associated with a wide range of industrial processes. Our silencing products include vent and blowdown silencers, blower silencers, engine silencers, gas turbine silencers, compressor silencers and vacuum pump silencers.

Environmental Systems

Our Environmental Systems segment accounted for 34% of total revenue in fiscal 2015 compared to 24% of total revenue in fiscal 2014 and 16% of total revenue in fiscal 2013.  We design, engineer, fabricate and install highly efficient systems for combustion modification, fuel conversions and post-combustion NOX control for both new and existing sources.  Our environmental control systems are used for air pollution abatement and converting burners to accommodate alternative sources of fuel. Examples of these systems and products include:

 

·

Pollution Control Systems. Are comprised of a variety of integrated and tail end emission reduction systems for the reduction of NOX, CO and particulate matter. We supply pollution control systems for a variety of applications, including both simple cycle and combined cycle gas power plants, package boilers, process heaters, stationary internal combustion engines and other combustion sources.

 

·

Combustion Systems. Our combustion systems provide complete systems for the combustion of a variety of hydrocarbon fuels and bio-mass fuels.  We provide systems for a large variety of applications for retrofit applications and in new sources for certain applications.

Customers

Our customers are geographically diversified and our systems and products are not dependent upon any single customer or group of customers. The loss of any single customer or group of customers would not have a material adverse effect on our business as a whole. However, the custom-designed and project-specific nature of our business can cause significant variances in sales to specific customers from year to year. No single customer accounted for more than 10% of the Company’s consolidated revenue in fiscal 2015, 2014 or 2013.

We sell the majority of our separation and filtration systems and products, including gas separators, filters and conditioning systems, to gas producers, gas gathering, transmission and distribution companies, chemical manufacturers and refiners, either directly or through contractors engaged to build plants and pipelines. We also sell these products to manufacturers of compressors, turbines and nuclear and conventional steam generating equipment. We sell our marine separation and filtration systems primarily to shipbuilders. We sell our pulsation dampeners to power generation owners and operators, refiners, petrochemical processors and specialty industrial users.

8

 


 

We sell our environmental control systems and products to power generators, engineering and construction companies, heat recovery steam generator manufacturers, boiler manufacturers, refiners, petrochemical plants and others who desire or may be required by environmental regulations to reduce NOX emissions and ground level ozone, of which NOX is a precursor.

Sales and Marketing

We believe our sales and marketing efforts have helped establish our reputation for providing innovative engineering solutions and meeting our customers’ needs in a timely, cost-efficient manner.  The sales and marketing of our systems and products largely depends upon the type of offering, type of market and extent of engineering involvement in the sales cycle.

We market our products worldwide through independent sales representatives who sell on a commission basis.  These independent representatives, substantially all of whom have technical backgrounds, work in conjunction with our application engineers.  We also sell our products directly to customers through our internal sales force. Our promotional and marketing activities include direct sales contacts, participation in trade shows, an internet website, advertising in trade magazines and distribution of product brochures.

Competition

The markets we serve are highly competitive and fragmented.  We believe no single company competes with us across the full range of our systems and products.  Competition in the markets we serve is based on a number of considerations, including price, timeliness of delivery, technology, applications experience, know-how, reputation, product warranties and service.  We believe our reputation, service and technical engineering capabilities differentiate us from many of our competitors, including those competitors who often offer products at a lower price.

We believe our primary competitors for our separation and filtration systems and products include Anderson Separators Company, King Tool Company, NATCO Group (Cameron), PECO-Facet, a subsidiary of CLARCOR, Inc., Pall Corporation and Koch Industries.  We believe our primary competitors for our environmental control systems and products include Envirokinetics, Mitsubishi-Hitachi Power Systems, Hitachi Zosen Corporation, Global Power Equipment Group, Inc. and Coen Industries. While no single company competes with us in all of our product lines, various companies compete with us in one or more product lines. Some of these competitors have substantially greater sales and assets and greater access to capital than we do.

Net Bookings and Backlog

The following table shows the activity and balances related to our backlog for the fiscal 2015 and 2014 (in millions):

 

 

 

Fiscal

2015

 

 

Fiscal

2014

 

Backlog at beginning of period

 

$

115.9

 

 

$

84.2

 

Net bookings

 

 

123.9

 

 

 

159.3

 

Acquired backlog

 

 

-

 

 

 

3.0

 

Revenue recognized

 

 

(158.6

)

 

 

(130.6

)

Backlog at end of period

 

$

81.2

 

 

$

115.9

 

 

Our backlog of uncompleted orders was $81.2 million at June 27, 2015, compared to $115.9 million at June 28, 2014.  Backlog includes contractual purchase orders that are deliverable in future periods less revenue recognized on such orders to date.  The relative decrease in net bookings reflects the delay in the awards of several large projects, cancellation of planned infrastructure projects in Eastern Europe, as well as overlap of certain larger projects awarded during fiscal 2014. The delays and cancellations of planned infrastructure projects are attributed in part to the recent global decline in oil prices. Of our backlog at June 27, 2015, we estimate approximately 85% will be completed during fiscal 2016.  Orders in backlog are subject to change, delays, or cancellation by our customers.

Raw Materials

We purchase raw materials and component parts essential to our business from a number of reliable suppliers.  From time to time, we are exposed to rapid increases in raw material costs and temporary disruptions in supply, including steel and other component parts that we purchase.  We believe raw materials and component parts will be available in sufficient quantities to meet our anticipated demand for at least the next 12 months.

9

 


 

Environmental Regulations

Our operations are subject to a number of federal, state and local laws and regulations relating to the protection of the environment.

Employees

As of June 27, 2015, we employed approximately 500 full-time employees, including employees at our joint venture in China.  Excluding our employees at our joint venture in China, none of our employees is represented by a labor union or are subject to a collective bargaining agreement.  We did not experience any significant labor difficulties during fiscal 2015.  We believe our employee relations are good.

Intellectual Property

We rely on a combination of patent, trademark, copyright and trade secret laws, employee and third-party nondisclosure/confidentiality agreements and license agreements to protect our intellectual property. We sell most of our products under a number of registered trade names, brand names and registered trademarks, which we believe are widely recognized in the industry.  All of the Company’s filed and issued United States or international patents have a duration of 20 years from the earliest effective filing date and the expiration dates of these patents range from 2015 through 2034.  The Company does not consider any particular patent or intellectual property to be critical to the Company’s long-term performance.

We anticipate we may apply for additional patents in multiple countries in the future as we develop new products and processes. Any issued patents that cover our proprietary technology may not provide us with substantial protection or be commercially beneficial to us. The issuance of a patent is not conclusive as to its validity or its enforceability. If we are unable to protect our technologies or confidential information, our competitors could commercialize our technologies. Competitors may also be able to design around our patents. In addition, we may face claims that our products, services or operations infringe patents or misappropriate other intellectual property rights of others.

With respect to proprietary know-how, we rely on trade secret protection and confidentiality agreements. Monitoring the unauthorized use of our proprietary technology is difficult and the steps we have taken may not prevent unauthorized use of such technology. The disclosure or misappropriation of our trade secrets and other proprietary information could harm our ability to protect our rights and our competitive position.

Research and Development

Our research and development expenses were $1.0 million for fiscal 2015, $1.1 million for fiscal 2014 and $0.7 million for fiscal 2013. We believe we have additional opportunities for growth by developing new technologies and products that offer our clients greater performance. We also continue to support research and development to improve existing products and manufacturing methods.

Website Information

Our corporate website is located at www.peerlessmfg.com. We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) available free of charge through our website as soon as reasonably practicable after we electronically file the reports with, or furnish them to, the SEC.  Our website provides access to reports filed by our directors, executive officers and certain significant stockholders pursuant to Section 16 of the Exchange Act.  In addition, our corporate governance policies, code of conduct and charters for the standing committees of our Board are available on our website.  The information on our website is not incorporated by reference into this Form 10-K.  In addition, the SEC maintains a website, www.sec.gov, which contains reports, proxy and information statements and other information that we file electronically with the SEC.

10

 


 

Executive Officers of the Registrant

As of June 27, 2015 our executive officers were as follows:

 

Name

 

Age

 

Position with the Company

Peter J. Burlage

 

51

 

President and Chief Executive Officer

John H. Conroy

 

49

 

Executive Vice President Americas Process Products

Ronald L. McCrummen

 

50

 

Executive Vice President and Chief Financial Officer

Timothy T. Shippy

 

45

 

Vice President, Environmental Systems

David Taylor

 

50

 

Vice President, Asia Pacific

 

Peter J. Burlage joined the Company in January 1992.  Mr. Burlage has served as our President and Chief Executive Officer and a member of our Board since June 2006.  He was appointed to the role of Chairman of the Board in February 2014. He served as Executive Vice President and Chief Operating Officer from October 2005 to June 2006 and Vice President, Environmental Systems from January 2001 to October 2005.  Mr. Burlage also served as Vice President of Engineering from 2000 to 2001 and SCR Division Manager from 1997 to 2000.  Mr. Burlage earned his B.S. in Mechanical Engineering from the University of Texas, Arlington and an M.B.A. from Baylor University.

John H. Conroy joined the Company in July 2010.  Mr. Conroy has served as our Executive Vice President, Americas Process Products since February 2014.  From July 2010 to February 2014, Mr. Conroy served as Vice President of Engineering and Product Development.  Prior to joining the Company, Mr. Conroy served as the General Manager of Red Hawk Texas from 2008 to 2010, an operating division of United Technologies (UTC).  Prior to his tenure at Red Hawk, Mr. Conroy served as President from 2004 to 2008 and VP-Engineering from 2002 to 2004 of Forney Corporation, a subsidiary of UTC.  Mr. Conroy earned his B.S. in Chemical Engineering from the University of California, Berkeley and an M.B.A. from Southern Methodist University.

Ronald L. McCrummen joined the Company in April 2011 as our Executive Vice President and Chief Financial Officer.  Prior to joining the Company, Mr. McCrummen was the Senior Vice President and Chief Accounting Officer of Dean Foods, Inc. from 2004 until November 2010.  Prior to his tenure at Dean Foods he served as a partner of Ernst & Young, LLP from 1998 until 2004.  Mr. McCrummen is a certified public accountant and holds a B.S. in Business Administration and Accounting from St. Louis University.

Timothy T. Shippy joined the Company in July 1996.  Mr. Shippy has been Vice President, Environmental Systems since February 2014.  From April 2010 to February 2014, Mr. Shippy served as Director, Environmental Systems.  Mr. Shippy previously served as our Sales Manager, Product Manager, and Sales Engineer.  Mr. Shippy earned his B.S. in Civil Engineering from Texas A&M University and an M.B.A. from Baylor University.

David Taylor joined the Company in April 1988. Mr. Taylor was named our Vice President, Asia Pacific in 2010.  Prior to that time, Mr. Taylor served as our Vice President of Separation Systems since 2000. He has served in a variety of engineering, sales and management positions since joining the Company.  From 1997 through 1999, Mr. Taylor served as Director of Sales and Engineering in our Singapore office in support of our Asia Pacific operations and resumed responsibility for our Asia Pacific operations in July 2004. Mr. Taylor earned his B.S. in Mechanical Engineering from Southern Methodist University.

 

 

ITEM 1A.

RISK FACTORS.

In evaluating the Company, the factors described below should be considered carefully.  The occurrence of one or more of these events could significantly and adversely affect our business, prospects, financial condition, results of operations and cash flows.

Pending Merger with CECO

If the Mergers are not completed, the price of our common stock and future business and operations could be harmed.

If the Mergers are not completed, we may be subject to material risks, including:

 

·

if our board of directors seeks another merger or business combination, Company stockholders cannot be certain that we will be able to find a party willing to offer equivalent or more attractive consideration than the Merger Consideration CECO has agreed to provide in the Mergers;

 

·

failure to complete the Mergers may result in negative publicity and a negative impression of the Company in the investment community;

11

 


 

 

·

the price of Company common stock may decline to the extent that the current market price of Company common stock reflects a higher price than it otherwise would have based on the assumption that the Mergers will be completed;

 

·

certain of our costs related to the Mergers, such as legal, accounting and certain financial advisory fees, must be paid even if the Mergers is not completed;

 

·

the diversion of management attention from our day-to-day business and the unavoidable disruption to its employees and its relationships with clients as a result of efforts and uncertainties relating to the Mergers may detract from our ability to grow revenue and minimize costs, which, in turn, may lead to a loss of market position that the Company could be unable to regain if the Mergers do not occur; and

 

·

under the Merger Agreement, PMFG is subject to certain restrictions on the conduct of its business prior to completing the Mergers, which may affect its ability to execute certain of its business strategies.

Whether or not the Mergers are completed, the pendency of the transaction could cause disruptions in our business, which could have an adverse effect on our businesses and financial results.

These disruptions could include the following:

 

·

current and prospective employees may experience uncertainty about their future roles with the combined company or consider other employment alternatives, which might adversely affect our ability to retain or attract their respective key managers and other employees;

 

·

current and prospective customers of the Company may experience variations in levels of services as the companies prepare for integration or may anticipate change in how they are served and may, as a result, choose to discontinue their service with PMFG or choose another provider; and

 

·

the attention of management of  the Company may be diverted from the operation of the businesses toward the completion of the Mergers.

PMFG and CECO must each obtain approval of their respective stockholders to consummate the Mergers, which approvals, if delayed or not obtained, may jeopardize or delay the consummation of the Mergers.

The Mergers are conditioned on, among other things, (a) the adoption of the Merger Agreement by the affirmative vote of the holders of a majority of the outstanding shares of PMFG common stock entitled to vote at the PMFG Special Meeting and (b) the approval of the Share Issuance (as defined in the Merger Agreement) by the affirmative vote of a majority of the votes present, in person or by proxy, and entitled to vote at the CECO Special Meeting. If the PMFG stockholders do not adopt the Merger Agreement or the CECO stockholders do not approve the Share Issuance, then CECO and PMFG cannot complete the Mergers.

If the Merger Agreement is terminated by either CECO or the Company because the Company stockholders did not adopt the Merger Agreement at the PMFG Special Meeting, then in certain circumstances the Company may be required to pay up to $1.6 million of costs and expenses incurred by CECO in connection with the Merger Agreement and related transactions. If the Merger Agreement is terminated by either CECO or the Company because the CECO stockholders did not approve the share issuance by CECO contemplated by the Merger Agreement at the CECO Special Meeting, then in certain circumstances CECO may be required to pay up to $1.0 million of costs and expenses incurred by the Company in connection with the Merger Agreement and related transactions.

If the financing contemplated by CECO cannot be secured, the Mergers may not be completed and the termination fee and other damages available to PMFG may be insufficient to make PMFG whole.

CECO has obtained a Commitment Letter dated May 3, 2014, from Bank of America, N.A. and Merrill Lynch, Pierce, Fenner & Smith Incorporated to CECO (the “Commitment Letter”). The Commitment Letter provides for (a) an additional senior secured amortizing term loan facility in the aggregate principal amount of $27.1 million, (b) an amendment to CECO’s existing credit facility, to allow for the Mergers under that credit facility, and (c) replacement facilities to refinance the senior credit facilities under the credit facility, if the amendment to the credit facility and additional term loan facility is not obtained.  Currently, CECO expects to finance the cash requirement for the Mergers through the proposed amended and restated credit agreement in lieu of the Commitment Letter. The amended and restated credit agreement is expected to provide for senior credit facilities consisting of: (a) revolving credit commitments in the aggregate amount of $80 million and (b) a term loan commitment in the aggregate amount of $170 million. The closing of the financing through both the Commitment Letter and the proposed amended and restated credit agreement is subject to customary closing conditions.

12

 


 

If financing cannot be obtained, the Mergers may not be completed. Due to the fact that there is no financing condition in the Merger Agreement, if CECO is unable to obtain funding from its financing sources for the cash required in connection with the Mergers, CECO could be in breach of the Merger Agreement and may be liable to PMFG for damages or a termination fee of $9.6 million.  PMFG’s recovery of damages or of the termination fee may be insufficient to cover PMFG’s expenses, business costs and other lost opportunities to make PMFG whole.

Litigation challenging the Mergers could delay or prevent the completion of the Mergers.

PMFG and members of the PMFG Board, CECO, Merger Sub I, Merger Sub II have been named as defendants in three lawsuits, which were filed on May 17, 2015, June 29, 2015 and July 17, 2015 (the “Lawsuits”). In the Lawsuits, the plaintiffs seek, among other things (a) to enjoin the completion of the Mergers on the agreed-upon terms, (b) rescission, to the extent already implemented, of the Merger Agreement or any of the terms therein, and (c) costs and disbursements and attorneys fees, as well as other equitable relief as the respective courts deem proper. Other litigation may be filed by other stockholders of PMFG also challenging the Mergers.

One of the conditions to the Mergers is that no temporary restraining order, preliminary or permanent injunction, or other order (as defined in the Merger Agreement) issued by any court of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Mergers shall be in effect; nor shall there be any statute, rule, regulation or order enacted, entered or enforced that prevents or prohibits the consummation of the Mergers. Consequently, if the plaintiffs in any of these actions secure injunctive or other relief prohibiting, delaying or otherwise adversely affecting the defendants’ ability to consummate the Mergers, then such injunctive or other relief may prevent the Mergers from becoming effective within the expected time frame or at all. If consummation of the Mergers is prevented or delayed, it could result in substantial costs to PMFG. In addition, PMFG could incur significant costs in connection with such lawsuits, including costs associated with the indemnification of PMFG’s directors and officers.

Failure to complete the Mergers as a result of insufficient stockholder vote or other factors could result in a material decline in the market value of the Company’s common stock and incremental costs.

The closing price of the Company’s common stock increased from $4.62 per share on the trading day preceding the announcement of the Mergers to $6.18 per share on July 30, 2015. We believe a significant portion of the increase in market value can be attributed to the pending Mergers. Should the Mergers be delayed or fail to close, a negative impact on the market value of the Company’s common stock could result.

Further, depending on the reasons that the Mergers are delayed or fails to close could require the Company to reimburse CECO for certain costs incurred related to the Mergers.

The Merger Agreement subjects the Company to restrictions on its business activities during the pendency of the Mergers.

The Merger Agreement subjects the Company to restrictions on its business activities and obligates us to generally operate our business in the ordinary course in all material respects during the pendency of the Mergers. These restrictions could prevent us from pursuing attractive business opportunities that arise prior to the completion of the Mergers and are outside the ordinary course of business, and otherwise have an adverse effect on our results of operations, cash flows and financial position.

Industry

Changes in the price, supply or demand for natural gas could have an adverse impact on sales of our separation and filtration systems and products and our operating results.

A large portion of our Process Products business is driven by the construction of natural gas infrastructure.  Increased demand for natural gas may result in the construction of additional infrastructure.  Higher prices of natural gas, while beneficial to exploration activities and the financing of new projects, can adversely impact the demand for natural gas.  Excess supply could negatively impact the price of natural gas, which could discourage spending on related capital projects.

Changes in the power generation industry could have an adverse impact on sales of our environmental control systems and products and our operating results.

The demand for our environmental control systems and products depends in part on the continued construction of new power generation and related facilities and the retrofitting of existing facilities.  The power generation industry is cyclical and has experienced periods of slow or no growth.  Any change in the power generation industry that results in a decrease in new construction

13

 


 

or refurbishing of power plants, in particular natural gas facilities, could have a material adverse impact on our Environmental Systems segment’s revenue, cash flow and our results of operations.

Changes in current environmental legislation and regulatory standards could have an adverse impact on the sale of our environmental control systems and products and on our operating results.

Our Environmental Systems business is primarily driven by capital spending by our customers to comply with laws and regulations governing the discharge of pollutants into the environment or otherwise relating to the protection of the environment or human health. These laws include U.S. federal statutes such as the Resource Conservation and Recovery Act of 1976, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Clean Water Act, the Clean Air Act, the Clean Air Interstate Rule, the Utility and Boiler MACT Rules, the Cross-State Air Pollution Rule and the regulations implementing these statutes, as well as similar laws and regulations at state and local levels and in other countries. These U.S. laws and regulations may change and other countries may not adopt similar laws and regulations. Despite the EPA’s recent adoption of stricter pollution standards, the interplay between the judicial system and the EPA instills uncertainty.  Our business may be adversely impacted by an unfavorable court ruling or to the extent that other regulations requiring the reduction of NOX emissions are repealed, amended, implementation dates delayed, or to the extent that regulatory authorities reduce enforcement due to a complicated legal, political and economic environment.

We are subject to United States and foreign laws and regulations including export control and economic sanctions laws and regulations.  These regulations are complex, change frequently and have become more stringent over time.  Implementing compliance with the requirements of any new or amended U.S. or foreign laws and regulations as well as failure to comply with any laws and regulations could adversely affect our results of operations, financial condition and our strategic objectives.

As a result of our global operations, we face a variety of special United States and international legal and compliance risks, in addition to the risks of our domestic business. These federal, state and local laws, regulations and policies are complex, change frequently, have tended to become more stringent over time and increase our cost of doing business. These laws and regulations include, but are not limited to, environmental, health and safety regulations, data privacy requirements, international labor laws, anti-corruption and bribery laws such as the United States Foreign Corrupt Practices Act and U.K. Bribery Act, and trade sanctions laws and regulations. In the event new laws and regulations are enacted or existing laws are amended, implementing compliance with such new or amended laws may result in a loss of revenue, increased costs of doing business and a change to our strategic objectives, all of which could adversely affect our results of operations and cash flows. In addition, we are subject to the risk that we, our affiliated entities or their respective officers, directors, employees and agents may take action determined to be in violation of any of these laws. An actual or alleged violation could result in substantial fines, sanctions, civil or criminal penalties, debarment from government contracts, curtailment of operations in certain jurisdictions, competitive or reputational harm, litigation or regulatory action and other consequences that might adversely affect our results of operations, financial condition or strategic objectives.

Litigation against us could be costly and time consuming to defend.

We are from time to time subject to legal proceedings and claims that arise in the ordinary course of business, such as claims brought by our customers in connection with commercial disputes and employment claims made by our current or former employees. Litigation may result in substantial costs and may divert management’s attention and resources, which may seriously harm our business, financial condition, results of operations and cash flow. In addition, legal claims that have not yet been asserted against us may be asserted in the future.

Our business could be negatively impacted by security threats, including cybersecurity threats, and other disruptions.

We may face various security threats, including cyber threats, threats to our infrastructure, and threats from terrorist acts, as well as the potential for business disruptions associated with these threats.  Although we utilize a combination of tailored and industry standard security measures and technology to monitor and mitigate these threats, we cannot guarantee that these measures and technology will be sufficient to prevent security threats from materializing.

We may be subject to cyber-based attacks and other attempts to threaten our information technology systems, including attempts to gain unauthorized access to our proprietary information and attacks from computer hackers, viruses, malicious code and other security problems.  Due to the evolving nature of these security threats, the impact of any future incident cannot be predicted.

The costs related to cyber or other threats or disruptions may not be fully insured or indemnified by other means.  Occurrence of any of these events could adversely affect our internal operations, the services we provide to customers, the value of our intellectual property, our future financial results, our reputation or our stock price.

14

 


 

In addition, from time to time we may replace and/or upgrade current financial, human resources and other information technology systems.  These activities subject us to inherent costs and risks associated with replacing and updating these systems, including potential disruption of our internal control structure, substantial capital expenditures, demands on management time and other risks of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems.  Our systems implementations and upgrades may not result in productivity improvements at the levels anticipated, or at all.  In addition, the implementation of new technology systems may cause disruptions in our business operations.  Such disruption and any other information technology system disruptions, and our ability to mitigate those disruptions, if not anticipated and appropriately mitigated, could have a material adverse effect on us.

Regulations related to “conflict minerals” may force us to incur additional expenses, may make our supply chain more complex and may result in damage to our reputation with customers.

On August 22, 2012, under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), the SEC adopted new requirements for companies that use certain minerals and metals, known as conflict minerals, in their products, whether or not these products are manufactured by third parties.  These requirements will require companies that are subject to the rules to conduct due diligence, and disclose and report the findings of these inquiries.  The implementation of these new requirements could adversely affect the sourcing, availability and pricing of minerals used in the manufacture of certain components incorporated in our products.  In addition, we will incur additional costs to comply with the disclosure requirements, including costs related to determining the source of any of the relevant minerals and metals used in our products.  Since our supply chain is complex, we may not be able to sufficiently verify the origins for these materials and metals used in our products through the diligence procedures that we implement, which may harm our reputation.  In such event, we may also face difficulties in satisfying customers who require that all of the components of our products are certified as conflict mineral free.

Products and Customers

Competition could result in lower revenue, decreased margins and loss of market share.

We operate in highly competitive markets worldwide and contracts for our systems and products are generally awarded on a competitive basis.  We face competition from potential new competitors that in some cases face low barriers to entry, specialized competitors that focus on competing with only one of our systems or products and low cost competitors that are able to produce similar systems and products for less.  Competition could result in not only a reduction in our revenue, but also may lower the prices we can charge for our systems and products and reduce our market share.  To remain competitive we must be able to anticipate and respond quickly to our customers’ needs and enhance and upgrade our existing systems and products to meet those needs.  We also must be able to price our systems and products competitively and make timely delivery of our systems and products.  Our competitors may develop less expensive or more efficient systems and products, may be willing to charge lower prices in order to increase market share and may be better equipped to make deliveries to customers on a timelier basis.  Some of our competitors have more capital and resources than we do and may be better able to take advantage of market opportunities or adapt more quickly to changes in customer requirements.  In addition, despite increased market demand, we may not be able to realize higher prices for our systems and products because we have competitors that use cost-plus pricing and do not set prices in accordance with market demand.

Customers may cancel or delay projects.  Our backlog may not be indicative of our future revenue.

Customers may cancel or delay projects for reasons beyond our control.  Our orders generally contain cancellation provisions which permit us to recover our costs in the event a customer cancels an order.  If a customer cancels an order, we may not realize the full amount of revenue included in our backlog and may encounter difficulty in recovering our costs incurred prior to cancellation.  If projects are delayed, the timing of our revenue could be affected and projects may remain in our backlog for extended periods of time.  Revenue recognition occurs over long periods of time and is subject to unanticipated delays.  Relatively large orders received in any given quarter may cause fluctuations in the levels of our quarterly backlog because the backlog in that quarter may reach levels that may not be sustained in subsequent quarters.  As a result, our backlog may not be indicative of our future revenue.

Changes in our product mix can have a significant impact on our profit margins.

Some of our products have higher profit margins than others.  Consequently, changes in the product mix of our sales from quarter-to-quarter or from year-to-year can have a significant impact on our reported profit margins.  Some of our products also have a much higher internally manufactured cost component.  Therefore, changes in product mix from quarter-to-quarter or from year-to-year can have a significant impact on our reported margins through a change in our manufacturing costs and specifically in our manufacturing costs as a percentage of revenue.

15

 


 

A significant portion of our accounts receivable are related to large contracts from customers in the same markets, which increases our exposure to credit risk.

We monitor the credit worthiness of our customers.  Significant portions of our sales are to customers who place large orders for custom systems and products and whose activities are related to the power generation, natural gas infrastructure and refining and petrochemical processing markets.  As a result, our exposure to credit risk is affected to some degree by conditions within these markets and governmental and political conditions.  We attempt to reduce our exposure to credit risk by requiring progress payments and letters of credit.  However, unanticipated events that affect our customers could have a materially adverse impact on our operating results.

Our systems and products could be subject to product liability claims, patent infringement claims and/or other litigation, which could adversely affect our financial condition and results of operations and harm our business reputation.

We manufacture systems and products that create exposure to product liability claims, breach of contract claims and litigation.  If our systems and products are not properly manufactured or designed, personal injuries or property damage could result, which could subject us to claims for damages.  The costs associated with defending product liability claims and payment of damages could be substantial.  It is also possible that our products could be subject to patent infringement claims by third parties, which could require us to modify the design of our products, obtain a license of that technology and/or expose us to costly disputes and litigation.  Our reputation and our business could also be adversely affected by all such claims, whether or not successful, and such claims could lead to decreased demand for our systems and products.

Our insurance policies may not cover all claims against us or may be insufficient to cover such claims.

We may be subject to breach of contract claims or product liability claims for personal injury and property damage.  We maintain insurance coverage against these and other risks associated with our business.  However, this insurance may not protect us against liability from some kinds of events, including events involving losses resulting from business interruption.  We cannot assure that our insurance will be adequate in risk coverage or policy limits to cover all losses or liabilities that we may incur.  Moreover, we cannot assure that we will be able in the future to maintain insurance at levels of risk coverage or policy limits that we deem adequate.  Any future damages caused by our systems and products that are not covered by insurance or are in excess of policy limits could have a material adverse effect on our financial condition and results of operations.

Currency fluctuations may reduce profits on our foreign sales or increase our costs, either of which could adversely affect our financial results.

A significant portion of our consolidated revenue is generated outside the United States.  Consequently, we are subject to fluctuations in foreign currency exchange rates.  Translation losses resulting from currency fluctuations may adversely affect the profits from our operations and have a negative impact on our financial results.  Foreign currency fluctuations may also make our systems and products more expensive for our customers, which could have a negative impact on our revenue.  In addition, we purchase some foreign-made products directly and through our subcontractors.  Due to the multiple currencies involved in our business, foreign currency positions are partially offset and are netted against one another to reduce exposure.  We cannot assure that fluctuations in foreign currency exchange rates will not make these products more expensive to purchase.  Increases in our direct or indirect costs of purchasing these products could negatively impact our financial results if we are not able to pass those increased costs on to our customers.

Foreign exchange loss totaled $(0.9) million, $(0.8) million, and $(0.1) million for fiscal 2015, 2014, and 2013, respectively. As a percentage of revenue, foreign exchange loss was (0.6)%, (0.6)% and (0.1)% in fiscal 2015, 2014, and 2013, respectively.

Our business is subject to risks of terrorist acts, acts of war, political unrest, public health concerns, labor disputes and natural disasters.

Terrorist acts, acts of war, political unrest, public health concerns, labor disputes or national disasters may disrupt our operations, as well as those of our customers.  These types of acts have created, and continue to create, economic and political uncertainties and have contributed to global economic instability.  Future terrorist activities, military or security operations or natural disasters could weaken the domestic and global economies and create additional uncertainties, thus forcing our customers to reduce their capital spending, or cancel or delay already planned construction projects, which could have a material adverse impact on our business, operating results and financial condition, including loss of sales or customers.

16

 


 

Manufacturing and Procurement

We have significant investments in our manufacturing facilities. Operating these facilities inefficiently or below capacity could negatively impact our financial results.

During fiscal 2014, we began manufacturing operations at newly constructed facilities located in Denton, Texas and Zhenjiang, China. Neither plant has achieved the expected capacity or efficiency rates, resulting in a negative impact on our gross profit. Efforts to improve the utilization and efficiencies are ongoing. Changes to our manufacturing flow and personnel during the facility transitions could negatively impact our ability to meet customer delivery expectations or could result in higher than expected manufacturing costs. Many of our contracts include financial penalties for failure to meet contractual delivery commitments, as well as limit our ability to recover cost overruns. Such costs, if incurred, would negatively impact our gross margin.

Our industry has experienced shortages in the availability of skilled workers.  Any difficulty we experience replacing or adding qualified personnel could adversely affect our business.

Our operations require the services of employees with technical training and related experience, including certified welders.  As a result, our operations depend on the continuing availability of qualified employees.  Our industry has experienced shortages of workers with the necessary skills.  If we should suffer any material loss of these employees to competitors, or be unable to employ additional or replacement personnel with the requisite level of training and experience, our operations could be adversely affected.  A significant increase in the wages paid to these workers by other employers could result in a reduction in our workforce, increases in wage rates, or both.

Our customers may require us to perform portions of our projects in their local countries.

Some countries have regulations requiring, and some customers prefer, a certain degree of local content be included in projects destined for installation in their country.  These requirements and preferences may require us to outsource significant functions to manufacturers in foreign countries or otherwise to establish manufacturing capabilities in foreign countries.  These requirements may negatively impact our profit margins and present project management issues.

Our ability to conduct business outside the United States may be adversely affected by factors outside of our control and our revenue and profits from international sales could be adversely impacted.

Because we manufacture and sell our products and services worldwide, our business is subject to risks associated with doing business internationally. Revenue generated outside the United States represented 42%, 39% and 47% of our consolidated revenue during fiscal 2015, 2014 and 2013, respectively.  Our operations and earnings throughout the world have been, and may in the future be, affected from time to time in varying degrees by a number of factors, including changes in foreign laws and regulations, regional economic uncertainty, political instability, customs and tariffs, government sanctions, inability to obtain export licenses, unexpected changes in regulatory requirements, difficulty in collecting international accounts receivable, difficulty in enforcement of contractual obligations governed by non-U.S. law and fluctuations in foreign currency exchange rates and tax rates.  The likelihood of the occurrence and the overall effect on our business vary from country to country and are not predictable.  These factors may result in a decline in revenue or profitability or could adversely affect our ability to expand our business outside of the United States and may impact our ability to deliver our products and collect our receivables.

Our systems and products are covered by warranties.  Unanticipated warranty costs for defective systems and products could adversely affect our financial condition and results of operations and reputation.  In addition, an increase in the number of systems we sell compared to individual products that our customers use as components in other systems, may increase our warranty costs.

We offer warranty periods of various lengths to our customers depending upon the specific system or product and terms of the customer agreement. Among other things, warranties require us to repair or replace faulty systems or products. We have received warranty claims in the past. While we continually monitor our warranty claims and provide a reserve for estimated warranty issues on an on-going basis, an unanticipated claim could have a material adverse impact on our results of operations. In some cases, we may be able to recover a portion of our warranty cost from a subcontractor if the subcontractor supplied the defective product or performed the service. However, this recovery may not always be possible. The need to repair or replace systems and products with design or manufacturing defects could temporarily delay the sale of new systems and products, reduce our profits, cause us to suffer a loss and could adversely affect our reputation. Furthermore, average warranty costs for complete systems are higher than warranty costs for individual products that our customers use as components in other less complex systems. As a result, our transition to offering more complete systems may increase our warranty costs.

Warranty expense totaled $1.1 million, $1.2 million and $1.9 million for fiscal 2015, 2014, and 2013, respectively. As a percentage of revenue, warranty expense was 0.7%, 0.9% and 1.4% in fiscal 2015, 2014, and 2013, respectively.

17

 


 

If actual costs for our projects with fixed-price contracts exceed our original estimates or if we are required to pay liquidated damages due to late delivery, our profits will be reduced or we may suffer losses.

The majority of our contracts are fixed-price contracts from which we have limited ability to recover cost overruns.  Because of the large scale and long-term nature of our contracts, unanticipated cost increases may occur as a result of several factors, including:

 

·

increases in cost or shortages of components, materials or labor;

 

·

errors in estimates or bidding;

 

·

unanticipated technical problems;

 

·

variations in productivity;

 

·

required project modifications not initiated by the customer; and

 

·

suppliers’ or subcontractors’ failure to perform.

In addition to increasing costs, these factors could lead to “hold backs” by our customers impacting our cash flow negatively and also could delay delivery of our products.  Our contracts often provide for liquidated damages for late delivery.  Unanticipated costs, such as liquidated damages that we are required to pay in the case of late delivery, could negatively impact our profits.

Increasing costs for manufactured components and raw materials, such as steel, may adversely affect our profitability.

We use a broad range of manufactured components and raw materials in our products, primarily raw steel and steel-related components.  Rapid increases in the costs for these components and materials or temporary disruptions in supply could increase our operating costs and adversely affect our profit margins.

Our use of subcontractors may reduce our ability to deliver products within the committed delivery timetables and within the design requirements.

Our global customer base and product demand requires that we utilize a global network of subcontractors. While we believe our established network provides the Company a competitive advantage, it exposes the Company to manufacturing delays, cost overruns, and quality aspects which are in large part outside of the Company’s direct control. We have developed processes to select, communicate and monitor the work flow, costs and product quality of our subcontractors, but could be adversely affected by project delays, cost overruns and substandard products developed by our subcontractors.

We are subject to environmental laws and regulations governing remediation of facilities currently or formerly owned or operated by us.

Our operations are subject to a number of federal, state and local laws and regulations relating to the protection of the environment.  We previously owned a facility which our assessment indicated soil and groundwater contamination were present.  Soil remediation at the site was completed in 2009 and we have continued to monitor the site, in cooperation with the Texas Commission on Environmental Quality.  Future remediation at this site, or our other current or former facilities, could result in a significant financial obligation to perform the required clean-up which would have an adverse impact on our operations.

Capital and Liquidity

Our financing agreements may be insufficient to meet the operational and strategic needs of the Company.

We entered into our Senior Secured Credit Agreement (the “Senior Credit Agreement”) in September 2012 which consists of a $2 million secured term A loan, a $10 million secured term B loan and a $30 million secured revolving credit line.  The revolving credit facility of our Senior Credit Agreement includes both financial and non-financial covenants that may limit our ability to purchase capital equipment, pay dividends, enter into strategic transactions, or enter into certain other agreements. The revolving credit facility of our Senior Credit Agreement requires that the eligible collateral, primarily accounts receivable and inventory, exceed the balances outstanding, which include the unexpired letters of credit and bank guarantees. Further, the revolving credit facility of our Senior Credit Agreement and subsidiary debenture agreements require that we restrict a portion of our cash balances in relationship to the unexpired letters of credit and bank guarantees. Our European subsidiaries currently have debenture agreements in place that support short-term working capital needs, as well as provide letters of credit and bank guarantees for issuance to customers and suppliers.  As of June 27, 2015 we had $4.2 million available for borrowing on letters of credit under our Senior Credit Agreement and $6.6 million available for letters of credit under the subsidiary debenture agreements. The ability to provide performance letters of credit and bank guarantees is required as a condition of being awarded certain contracts, as well as receipt of payments in advance of

18

 


 

shipping.  Accordingly, our inability to provide letters of credit and bank guarantees could negatively impact future contract awards and cash flow related to projects in process.

Failure to comply with the covenants in our financing agreements could negatively impact our liquidity and cost of our financing agreements.

Our Senior Credit Agreement includes covenants and collateral requirements. Failure to comply with any of the covenants or lack of sufficient collateral could reduce or eliminate our ability to borrow money or obtain letters of credit and bank guarantees under the revolving credit facility of our Senior Credit Agreement. Under these circumstances, we may not have sufficient working capital, access to capital markets, or other resources to satisfy our debt and other obligations.

During the fourth quarter of fiscal 2014, we obtained an amendment to the Credit Agreement.  Pursuant to the amendment, if the Debt Service Coverage Ratio (“DSC”), as discussed further in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, is less than 1.50 to 1.00 as of the end of any fiscal quarter, we 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 (1) the aggregate principal amount of all revolving credit and swing line loans outstanding under the Credit Agreement, plus (2) 100% of the undrawn face amount of all performance-related letters of credit outstanding under the Credit Agreement, plus (3) 30% (subject to upward adjustment) of the undrawn face amount of all warranty-related letters of credit outstanding under the Credit Agreement, plus (4) $3.0 million, less (5) all term loan principal payments made on or after March 29, 2014.   We may withdraw the cash in the collateral account when we achieve 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 Company understands that, upon consummation of the Mergers, all outstanding loans and other obligations under the Credit Agreement will be paid in full, all outstanding letters of credit will be cash collateralized (or backed by new letters of credit issued under the CECO credit agreement) and the Credit Agreement will be terminated. If that doesn’t occur, an event of default will result under the Credit Agreement.

We have experienced operating losses and negative cash flow in recent periods, and have limited liquidity resources, which could impair our ability to grow and adversely affect our operations.

We have recently experienced operating losses and negative cash flow. If we are unable to return to profitability, we may not be able to take advantage of new opportunities, adequately respond to competitive pressures or fully execute our business plan. Under our Senior Secured Credit Agreement, our liquidity is limited. Working capital requirements and tax consequences may limit our ability to repatriate existing cash balances from our foreign operations. We depend on letters of credit issued under our Senior Secured Credit Facility and funds generated from operating activities to sustain and grow our business. If we are unable to return to profitability, it could undermine our ability to pursue growth opportunities and could limit the working capital available to our business, harming our operating results.

Our financial performance may vary significantly from period to period, making it difficult to estimate future revenue.

Our revenue and earnings have varied in the past and are likely to vary in the future.  Our contracts generally stipulate customer-specific delivery terms and may have contract cycles of a year or more, which subjects these contracts to many factors beyond our control.  In addition, contracts that are significantly larger in size than our typical contracts tend to have a greater impact on our operating results.  Furthermore, as a significant portion of our operating costs are fixed, an unanticipated decrease in our revenue, a delay or cancellation of orders in backlog, or a decrease in the demand for our products, may have a significant impact on our operating results.  Therefore, our operating results may be subject to significant variations and our operating performance in any period may not be indicative of our future performance.

Changes in billing terms can increase our exposure to working capital and credit risk.

We sell our systems and products under contracts that allow us to either bill upon the completion of certain agreed upon milestones, or upon actual shipment of the system or product.  We attempt to negotiate progress-billing milestones on large contracts to help us manage working capital and to reduce the credit risk associated with these large contracts.  Consequently, shifts in the billing terms of the contracts in our backlog from period to period can increase our requirement for working capital and can increase our exposure to credit risk.

19

 


 

The concentration of ownership of our common stock may result in significant movement in the trading value of our common stock in the event a single stockholder or group of stockholders purchases or sells our common stock

As of August 20, 2015 six stockholders individually reported an ownership position greater than five percent of our outstanding common stock. In the aggregate these six stockholders own greater than 50 percent of our outstanding common stock. This concentration of share ownership, combined with the relative illiquidity of our common stock, could result in significant decrease in the trading value of our common stock should one of more of those stockholders decide to reduce their ownership position.

Provisions of our charter documents and Delaware law could discourage a takeover that individual stockholders may consider favorable or the removal of all current directors and management.

Some provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that individual stockholders may consider favorable or the removal of our current management.

Delaware law may discourage, delay or prevent someone from acquiring or merging with us. As a result, our stock price may decrease and stockholders might not receive a change of control premium over the then-current market price of the common stock.

Our certificate of incorporation contains a “blank check” preferred stock provision. Blank check preferred stock enables our Board, without stockholder approval, to designate and issue additional series and classes of preferred stock with such dividend rights, liquidation preferences, conversion rights, terms of redemption, voting or other rights, including the right to issue convertible securities with no limitation on conversion, as our Board may determine, including rights to dividends and proceeds in a liquidation that are senior to the common stock. These provisions may have the effect of making it more difficult or expensive for a third party to acquire or merge with us which could adversely affect the market price of the common stock and the voting and other rights of the holders of common stock.

The limited liquidity for our common stock could affect your ability to sell your shares at a satisfactory price.

Our common stock is relatively illiquid. As of July 30, 2015, we had 21,281,290 shares of common stock outstanding. The average daily trading volume in our common stock, as reported by the NASDAQ Global Select Market, for the 50 trading days ending on July 30, 2015 was approximately 103,000 shares. A more active public market for our common stock may not develop, which could adversely affect the trading price and liquidity of our common stock. Moreover, a thin trading market for our stock could cause the market price for our common stock to fluctuate significantly more than the stock market as a whole. Without a larger float, our common stock is less liquid than the stock of companies with broader public ownership and, as a result, the trading prices of our common stock may be more volatile. In addition, in the absence of an active public trading market, stockholders may be unable to liquidate your shares of our common stock at a satisfactory price.

The market price of our common stock may be volatile or may decline regardless of our operating performance.

The market price of our common stock has experienced, and may continue to experience, substantial volatility. During the period beginning June 29, 2014 through June 27, 2015, the price of our common stock on the NASDAQ Global Select Market ranged from a low of $3.93 to a high of $6.82 per share. We expect our common stock to continue to be subject to fluctuations. Broad market and industry factors may adversely affect the market price of our common stock, regardless of our actual operating performance.

We do not plan to pay cash dividends on our common stock in the foreseeable future. As a result, investors must look solely to stock appreciation for a return on their investment in our common stock.

We do not anticipate paying cash dividends on our common stock in the foreseeable future. We currently intend to retain any future earnings to support our operations and growth. Additionally, our Senior Credit Agreement restricts the payment of dividends. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock.

Issuance of shares under our stock incentive plan or in connection with transactions will dilute current stockholders.

Pursuant to our 2007 Stock Incentive Plan, we are authorized to grant options and other stock awards for up to 1,800,000 shares to our officers, employees, directors and consultants. As of June 27, 2015 there were 911,081 shares of our common stock reserved for future issuance under our stock incentive plans. Stockholders will incur dilution upon exercise or issuance of any stock awards under our stock incentive plans. In addition, if we raise additional funds by issuing additional common stock, or securities convertible into or exchangeable or exercisable for common stock, or if we use our securities as consideration for future acquisitions or investments, further dilution to our existing stockholders will result, and new investors could have rights superior to existing stockholders.

20

 


 

 

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS.

None.

 

 

ITEM 2.

PROPERTIES.

We own and lease office, manufacturing and warehousing facilities in various locations.  Please see Note I to the Notes to our Consolidated Financial Statements for information on assets that secure the Company’s borrowings and other obligations.  Our principal facilities are described in the following table.

 

 

 

Approximate

 

 

 

Location

 

Sq. Footage

 

 

General Use

Owned:

 

 

 

 

 

 

Denton, Texas

 

 

80,000

 

 

Manufacturing

Wichita Falls, Texas

 

 

128,000

 

 

Manufacturing

Zhenjiang, China

 

 

175,000

 

 

Manufacturing, engineering, R&D and administration

 

 

 

 

 

 

 

Leased:

 

 

 

 

 

 

Dallas, Texas

 

 

30,000

 

 

Corporate office

Orchard Park, New York

 

 

18,000

 

 

Sales, engineering and administration

Dubai, United Arab Emirates

 

 

4,000

 

 

Sales, engineering and administration

Essex, United Kingdom

 

 

6,000

 

 

Sales, engineering and administration

Singapore

 

 

3,600

 

 

Sales, engineering and administration

Monroe, Connecticut

 

 

12,000

 

 

Sales, engineering and administration

 

 

ITEM 3.

LEGAL PROCEEDINGS.

Since the public announcement of the proposed Mergers on May 4, 2015, CECO, Merger Sub I, Merger Sub II, PMFG and the members of the PMFG Board have been named as defendants in three lawsuits related to the Mergers, which were filed by alleged stockholders of PMFG on May 17, 2015, June 29, 2015 and July 17, 2015. The first filed lawsuit, which is a derivative action that also purports to assert class claims, was filed in the District Court of Dallas County, Texas (the “Texas Lawsuit”). The second and third filed lawsuits, which are class actions, were filed in the Court of Chancery of the State of Delaware and have now been consolidated into a single action (the “Delaware Lawsuit,” and collectively with the Texas Lawsuit, the “Lawsuits”).  In the Lawsuits, the plaintiffs generally allege that the Mergers fail to properly value PMFG, that the individual defendants breached their fiduciary duties in approving the Merger Agreement, and that those breaches were aided and abetted by CECO, Merger Sub I and Merger Sub II.

In the Lawsuits, the plaintiffs allege, among other things, (a) that the PMFG Board breached its fiduciary duties by agreeing to the Mergers for inadequate consideration and pursuant to a tainted process by (1) agreeing to lock up the Mergers with deal protection devices that, notwithstanding the ability of PMFG to solicit actively alternative transactions, prevent other bidders from making a successful competing offer for PMFG, (2) participating in a transaction where the loyalties of the PMFG Board and management are divided, and (3) relying on financial and legal advisors who plaintiffs allege were conflicted; (b) that those breaches of fiduciary duties were aided and abetted by CECO, Merger Sub I, Merger Sub II and PMFG, and (c) that the disclosure provided in the registration statement filed by CECO on June 9, 2015 was inadequate in a number of respects.

In the Lawsuits, the plaintiffs seek, among other things, (a) to enjoin the defendants from completing the Mergers on the agreed-upon terms, (b) rescission, to the extent already implemented, of the Merger Agreement or any of the terms therein, and (c) costs and disbursements and attorneys’ and experts’ fees, as well as other equitable relief as the courts deem proper.

Effective as of August 23, 2015, PMFG and the other defendants entered a memorandum of understanding with the plaintiffs in the Delaware Lawsuit regarding the settlement of the Delaware Lawsuit. In connection with this memorandum of understanding, PMFG agreed to make certain additional disclosures to PMFG’s stockholders in order to supplement those contained in the joint proxy statement/prospectus. After PMFG enters into a definitive agreement with the plaintiffs in the Delaware Lawsuit, the proposed settlement will be subject to notice to the class, Court approval, and, if the Court approves the settlement, the settlement, as outlined in the memorandum of understanding, will resolve all of the claims that were or could have been brought in the Delaware Lawsuit, including all claims relating to the Mergers, the Merger Agreement and any disclosure made in connection therewith including any such claims against CECO, Merger Sub I or Merger Sub II, but will not affect any stockholder’s rights to pursue appraisal rights.

21

 


 

On August 24, 2015, PMFG made a filing with the SEC on Form 8-K satisfying its obligations under the memorandum of understanding to make additional disclosures to supplement the joint proxy statement/prospectus relating to the Mergers, dated as of July 31, 2015.

The memorandum of understanding was not, and should not be construed as, an admission of wrongdoing or liability by any defendant.

 

 

ITEM 4.

MINE SAFETY DISCLOSURES.

Not applicable.

 

 

22

 


 

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is traded on the NASDAQ Global Select Market under the symbol “PMFG.”  The table below sets forth the reported high and low sales prices for our common stock, as reported on the NASDAQ Global Select Market for the periods indicated.

 

 

 

Fiscal Year

 

High

 

 

Low

 

2014

 

First Quarter

 

$

8.30

 

 

$

6.71

 

 

 

Second Quarter

 

 

9.09

 

 

 

6.95

 

 

 

Third Quarter

 

 

9.23

 

 

 

5.55

 

 

 

Fourth Quarter

 

 

6.18

 

 

 

4.11

 

 

 

 

 

 

 

 

 

 

 

 

2015

 

First Quarter

 

$

5.80

 

 

$

4.55

 

 

 

Second Quarter

 

 

6.82

 

 

 

4.82

 

 

 

Third Quarter

 

 

5.90

 

 

 

3.93

 

 

 

Fourth Quarter

 

 

6.75

 

 

 

4.20

 

 

Number of Holders

As of July 30, 2015, there were approximately 75 holders of record of our common stock.

Dividends

We did not pay cash dividends on our common stock in fiscal 2015, 2014 or 2013.  Cash dividends may be paid on our common stock, from time to time, as our Board deems appropriate after consideration of our continued growth rate, operating results, financial condition, cash requirements and other related factors.  Additionally, our Senior Credit Agreement contains restrictions on our ability to pay dividends based on satisfaction of certain performance measures and compliance with other conditions.    Our ability to comply with these performance measures and conditions may be affected by events beyond our control.  A breach of any of the covenants (including financial covenant ratios) contained in our Senior Credit Agreement could result in a default under the Senior Credit Agreement.  Any defaults under our Senior Credit Agreement could prohibit us from paying any dividends.

Stock Repurchase

We did not repurchase any of our common stock in fiscal 2015, 2014 or 2013.  Additionally, we do not have a stock repurchase program.

23

 


 

ITEM 6.

SELECTED FINANCIAL DATA.

The following table summarizes certain selected financial data that should be read in conjunction with “Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included in “Item 8.  Financial Statements and Supplementary Data” of this Form 10-K.

 

 

 

Fiscal

 

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

 

(Amounts in thousands, except per share amounts)

 

Operating results:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

158,643

 

 

$

130,650

 

 

$

133,892

 

 

$

135,318

 

 

$

121,794

 

Cost of goods sold

 

 

113,046

 

 

 

94,754

 

 

 

87,092

 

 

 

94,083

 

 

 

83,387

 

Gross profit

 

 

45,597

 

 

 

35,896

 

 

 

46,800

 

 

 

41,235

 

 

 

38,407

 

Operating expenses

 

 

52,002

 

 

 

46,505

 

 

 

42,457

 

 

 

40,760

 

 

 

37,083

 

Loss on impairment of intangibles (1)

 

 

406

 

 

 

6,327

 

 

 

3,525

 

 

 

-

 

 

 

3,551

 

Loss on impairment of goodwill (1)

 

 

-

 

 

 

20,304

 

 

 

-

 

 

 

-

 

 

 

-

 

Operating income (loss)

 

 

(6,811

)

 

 

(37,240

)

 

 

818

 

 

 

475

 

 

 

(2,227

)

Other income (expense) (2)

 

 

(891

)

 

 

(2,355

)

 

 

(835

)

 

 

(2,518

)

 

 

5,005

 

Earnings (loss) before income taxes

 

 

(7,702

)

 

 

(39,595

)

 

 

(17

)

 

 

(2,043

)

 

 

2,778

 

Income tax benefit (expense)

 

 

(520

)

 

 

1,277

 

 

 

(1,471

)

 

 

1,005

 

 

 

3,083

 

Net earnings (loss)

 

 

(8,222

)

 

 

(38,318

)

 

 

(1,488

)

 

 

(1,038

)

 

 

5,861

 

Less net earnings (loss) attributable to noncontrolling

   interest

 

 

250

 

 

 

66

 

 

 

592

 

 

 

(62

)

 

 

112

 

Net earnings(loss) attributable to PMFG, Inc.

 

 

(8,472

)

 

 

(38,384

)

 

 

(2,080

)

 

 

(976

)

 

 

5,749

 

Dividends on preferred stock

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(722

)

Earnings (loss) applicable to PMFG, Inc. common

   stockholders

 

$

(8,472

)

 

$

(38,384

)

 

$

(2,080

)

 

$

(976

)

 

$

5,027

 

Diluted earnings (loss) per share

 

$

(0.40

)

 

$

(1.82

)

 

$

(0.10

)

 

$

(0.05

)

 

$

0.28

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

 

21,274

 

 

 

21,086

 

 

 

20,930

 

 

 

18,810

 

 

 

16,662

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

 

June 27,

2015

 

 

June 28,

2014

 

 

June 29,

2013

 

 

June 30,

2012

 

 

July 2,

2011

 

Financial position:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Working capital (3)

 

$

17,010

 

 

$

17,348

 

 

$

17,877

 

 

$

16,727

 

 

$

25,384

 

Current assets

 

 

102,873

 

 

 

104,834

 

 

 

108,473

 

 

 

122,286

 

 

 

81,139

 

Total assets

 

 

162,493

 

 

 

167,223

 

 

 

180,111

 

 

 

183,279

 

 

 

140,709

 

Current liabilities

 

 

66,806

 

 

 

49,725

 

 

 

33,471

 

 

 

45,019

 

 

 

37,231

 

Long-term debt, net of current portion

 

 

2,900

 

 

 

14,149

 

 

 

8,719

 

 

 

-

 

 

 

9,971

 

Total liabilities

 

 

74,881

 

 

 

69,751

 

 

 

48,225

 

 

 

52,393

 

 

 

55,668

 

Stockholders' equity (4)

 

 

87,612

 

 

 

97,472

 

 

 

131,886

 

 

 

130,886

 

 

 

85,041

 

 

 

(1)

Operating expenses for fiscal 2015, 2014, 2013 and 2011 include charges of $406, $26,631, $3,525 and $3,551, respectively, related to impairment losses on intangibles and goodwill.  See Note F to our Consolidated Financial Statements.

(2)

Other income (expense) in fiscal 2015 includes a gain of $1,238 related to the sale of the heat exchanger product line. Other income (expense) in fiscal 2011 includes a gain of $6,681 related to the change in the fair value of the derivative liability associated with the convertible preferred stock sold in September 2009.

(3)

The Company defines working capital as the net balance of accounts receivable, costs and earnings in excess of billings on uncompleted projects, billings in excess of costs and earnings on uncompleted projects and accounts payable.

(4)

The increase in our stockholders’ equity in fiscal 2012 resulted primarily from the public offering, and the increase in our stockholders’ equity in fiscal 2011 resulted primarily from the conversion of preferred stock to common stock during the year and our net earnings for the year.

 

 

24

 


 

ITEM 7.

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 as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes thereto contained in “Item 8. Financial Statements and Supplementary Data” of this report. This overview summarizes the MD&A, which includes the following sections:

 

·

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

 

·

Critical Accounting Policies and Estimates – a discussion of accounting policies that require critical judgments and estimates.

 

·

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

 

·

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

This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in Part I, Item 1A of this report.  These factors can cause actual results for future periods, including fiscal 2016, to differ materially from those disclosed in, or implied by, these forward-looking statements.

Recent Developments

Merger Agreement with CECO Environmental Corp.

On May 3, 2015, the Company entered the Merger Agreement with CECO, the Merger Subs. Pursuant to the Merger Agreement, Merger Sub I will merge with and into the Company, with the Company surviving the First Merger as a wholly owned subsidiary of CECO. Immediately following consummation of the First Merger, the Company will merge with and into Merger Sub II, with Merger Sub II surviving the Second Merger, as a wholly owned subsidiary of CECO.

The Boards of Directors of the Company and CECO have each unanimously approved the Merger Agreement. The Merger Agreement is subject to approval by the Company’s stockholders. The Board of Directors of the Company has recommended that the Company’s stockholders adopt the Merger Agreement.

Pursuant to the terms of the Merger Agreement and subject to the conditions therein, at the Effective Time, each then issued and outstanding share of Company Common Stock (except shares owned by a subsidiary of the Company and shares held by stockholders who exercise their appraisal rights under Delaware law) will be cancelled and converted into the right to receive, at the election of the holder, subject to proration, either:

 

·

Cash Consideration; or

 

·

the “Stock Consideration”; provided that the Stock Consideration is subject to a collar such that (1) if the VWAP Price is less than or equal to $10.61, then the Exchange Ratio will be 0.6456 shares of CECO Common Stock for each share of Company Common Stock, and (2) if the VWAP Price is greater than or equal to $12.97, then the Exchange Ratio will be 0.5282 shares of CECO Common Stock for each share of Company Common Stock. The net effect of this collar mechanism is that no further increase in the Exchange Ratio will be made if the CECO trading price is less than $10.61, and no further decrease in the Exchange Ratio will be made if the CECO trading price is greater than $12.97.

The Mergers are expected to close in September 2015, subject to approval of CECO stockholders and Company stockholders and other customary closing conditions.  Both CECO and the Company have scheduled stockholder meetings for September 2, 2015 to approve proposals in connection with the Mergers.

The Merger Agreement may be terminated at any time prior to the closing of the Mergers by mutual written consent of CECO and the Company. Either CECO or the Company may terminate the Merger Agreement if the Effective Time has not occurred on or before November 30, 2015, the required Company stockholder approval or CECO stockholder approval is not obtained, or the consummation of the Mergers becomes illegal or otherwise is prevented or prohibited by any governmental authority.

The Company cannot give any assurance that the Mergers will be completed.

25

 


 

Sale of Heat Exchanger Business

On March 27, 2015, we sold our heat exchanger product line including the Alco, Alco-Twin, and Bos-Hatten brands.  The product line was acquired in 2008 in connection with the purchase of Nitram Energy, Inc. and Subsidiaries (“Nitram”).  The heat exchanger product line represented approximately $6.1 million of revenue in fiscal 2015 and approximately $6.3 million of revenue in fiscal 2014.  The sale resulted in a gain of $1.2 million included in Other income (expense) in the Consolidated Statements of Operations.

Our Business

General

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 recent acquisition of substantially all of the assets of CCA, we expanded the markets we serve to include industrial and utility industries. We offer a broad range of separation and filtration products, SCR systems, 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.  The percentage of revenue generated from outside the United States was approximately 42% in fiscal 2015 compared to 39% in fiscal 2014. As a result of the global demand for our products and our increased sales resources outside of the United States, 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 Latin America, Northern Africa and China, 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 such products in a cost-effective manner and within the time frames established with our customers. Our gross profit during any particular period may be impacted by several factors, primarily shifts in our product mix, material cost changes, and warranty costs. Shifts in the geographic composition of our 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 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.

The following table sets forth the percentage of revenue related to our Process Products and Environmental Systems, respectively:

 

 

 

Fiscal

 

 

Fiscal

 

 

Fiscal

 

 

 

2015

 

 

2014

 

 

2013

 

Process Products

 

 

66

%

 

 

76

%

 

 

84

%

Environmental Systems

 

 

34

%

 

 

24

%

 

 

16

%

 

 

 

100

%

 

 

100

%

 

 

100

%

 

Key Drivers of Product Demand

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

With a shift to cleaner, more environmentally responsible power generation, power providers and industrial power consumers are building new facilities that use cleaner fuels, such as natural gas, nuclear technology and renewable resources. In developed markets, natural gas is increasingly becoming one of the energy sources of choice.  We supply product offerings throughout the entire

26

 


 

natural gas infrastructure value chain and believe the expansion of natural gas infrastructure will drive growth of our Process Products segment 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 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 environmental and combustion 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.

27

 


 

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates, judgments, and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.  We believe that our most critical accounting policies and estimates related to the following:

 

Estimate Description

Judgment and/or Uncertainty

Potential Impact if Results Differ

Revenue Recognition

 

 

 

 

 

We provide products under long-term, generally fixed-priced, contracts that may extend up to 18 months or longer in duration.  Approximately 80% of our revenue is accounted for using the percentage-of-completion accounting method.

Under this method, the contractually agreed upon revenue is recognized over the life of the contract based on the relationship of costs incurred to date to the estimated aggregate costs to be incurred over the contract term.

The percentage-of-completion method generally results in the recognition of reasonably consistent profit margins over the life of a contract.  However, changes in estimated total costs can impact margins from period to period.  Changes in total estimated costs are reflected in the computation of the percentage of completion when such changes are identified and can be reasonably estimated.  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.

Cumulative revenue recognized may be less or more than cumulative amounts 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.”

Considerable management judgment and experience is necessary to estimate the aggregate amount of costs that will ultimately be incurred related to a project.  Such cost estimates include material, subcontractor, labor, delivery, and start-up costs.

We continually update our estimates of costs and the status of each project.

A number of internal and external factors, including labor rates, plant utilization factors, future material prices, changes in customer specifications, manufacturing defects and delays, as well as other factors can affect the ultimate costs.

The impact of revisions in contract estimates is recognized on a cumulative basis in the period in which the revisions are made. Such revisions may result in inconsistent profit margins over the life of the contract.

 

 

 

28

 


 

Estimate Description

Judgment and/or Uncertainty

Potential Impact if Results Differ

Allowance for Doubtful Accounts

 

 

 

 

 

We maintain an allowance for doubtful accounts to reflect estimated losses resulting from the inability of customers to make required payments.

On an on-going basis, we evaluate the collectability of accounts receivable based on historical collection trends, current economic factors, and the assessment of collectability of specific accounts.

Considerable management judgment is necessary in determining whether a receivable will be collectible based on a customer’s potential inability to pay.

In making such determination, management evaluates the age of the outstanding balance, evaluation of the customer’s current and past financial condition and related credit scores, recent payment history, current economic environment, and discussions with the customer.

Bad debt expense totaled $0.3 million in fiscal 2015 and $0.1 in fiscal 2014 and $1.2 million in fiscal 2013. As a percentage of revenue, the bad debt expense was 0.2%, 0.1%, and 0.9% in fiscal 2015, 2014, and 2013, respectively.

The impact of a 100 basis point increase or decrease in bad debt expense would be approximately $1.6 million in fiscal 2015.

 

 

 

Product Warranties

 

 

 

 

 

We provide our customers with 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.

In general, our warranty agreements require us to repair or replace defective products during the warranty period at no cost to the customer.  

To the extent such defects arise as a result of subcontracted work, we may have the ability to recover a portion or all of the cost of repairs incurred during the warranty period.

We record an estimate of costs to be incurred in the future for product warranties based on both known claims and historical experience.

Such estimates also include expectations with regard to applicability and enforceability of back-up concurrent supplier warranties in place.  

Warranty expense totaled $1.1 million, $1.2 million and $1.9 million in fiscal 2015, 2014, and 2013, respectively. As a percentage of revenue, the warranty expense was 0.7%, 0.9% and 1.4% in fiscal 2015, 2014 and 2013, respectively.

The impact of a 100 basis point increase or decrease in warranty costs would be approximately $1.6 million in fiscal 2015.

 

 

 

29

 


 

Estimate Description

Judgment and/or Uncertainty

Potential Impact if Results Differ

Goodwill and Intangible Assets

 

 

 

 

 

Our goodwill and intangible assets result primarily from acquisitions. Intangible assets include licensing agreements and customer relationships with finite lives, as well as trademarks and design guidelines with indefinite lives.

Intangible assets with indefinite lives and goodwill are allocated to and evaluated at the reporting segment level for potential impairment at least annually, or earlier if an indicator of impairment exists, to ensure that the carrying value is recoverable.

A perpetual trademark or design guideline is impaired if its book value exceeds its estimated fair value. Our goodwill is evaluated for potential impairment if the book value of its reporting unit exceeds its estimated fair value.

Amortizing intangible assets are only evaluated for impairment upon a significant change in the operating environment. If an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is generally based on discounted cash flows.

In the fourth quarter of fiscal 2015, we completed our annual impairment testing using the methods described above and concluded there was no impairment related to our goodwill and $0.4 million of impairment related to our other intangible assets with an indefinite life.

Our goodwill and intangible net assets totaled $26.2 million as of June 27, 2015.

Considerable management judgment is necessary to initially value intangible assets upon acquisition and to evaluate those assets and goodwill for impairment going forward. We determine fair value using widely accepted valuation techniques including discounted cash flows, market multiple analyses, and relief from royalty analyses. Assumptions used in our valuations, such as forecasted growth rates and our cost of capital, are consistent with our internal projections and operating plans.

We believe that a trademark and/or design guideline has an indefinite life if it has a history of strong sales and cash flow performance that we expect to continue for the foreseeable future. Determining the expected life of a trademark and/or design guideline requires considerable management judgment and is based on an ongoing evaluation of a number of factors including competitive environment, trademark and product history, and anticipated future product demand.

We believe the assumptions used in valuing our intangible assets and in our impairment analysis are reasonable, but variations in any of our assumptions may result in different calculations of fair value that could result in a material impairment charge.

At June 27, 2015 the fair value of our Process Products segment, which is also the reporting unit, exceeded its related carrying value by approximately $5.1 million or 7%.  Increasing our discount rate by 25 basis points would not have resulted in an impairment charge. The terminal revenue growth rate utilized in calculating the fair value (4.0%) is dependent on our ability to meet internal projections and operating plans, as well as other factors and assumptions.

At June 27, 2015, the fair value of our Environmental Systems segment, which is also the reporting unit, exceeded its related carrying value by $19.7 million or 55%.  The terminal revenue growth rate utilized in calculating the fair value (4.0%) is dependent on our ability to meet internal projections and operating plans, as well as other factors and assumptions.

At June 27, 2015, the carrying value of our trade names and design guidelines were each impaired by $0.2 million to reduce the carrying value to fair value.  

Adverse changes to the assumptions related to royalty, growth, or discount rates could result in future impairments.

 

 

 

Income Taxes

 

 

 

 

 

A liability for uncertain tax positions is recorded to the extent a tax position taken or expected to be taken in a tax return does not meet certain recognition or measurement criteria.

A valuation allowance is recorded against a deferred tax asset if it is more likely than not that the asset will not be realized.

At June 27, 2015 our liability for uncertain tax positions, including accrued interest, was $1.5 million and our valuation allowance was $7.2 million.

Considerable management judgment is necessary to assess the inherent uncertainties related to the interpretations of complex tax laws, regulations, and taxing authority rulings, as well as to the expiration of statutes of limitations in the jurisdictions in which we operate.

Additionally, several factors are considered in evaluating the realizability of our deferred tax assets, including the remaining years available for carryforward, the tax laws for the applicable jurisdictions, the future profitability of the specific business units, and tax planning strategies.

Our judgments and estimates concerning uncertain tax positions may change as a result of evaluation of new information, such as the outcome of tax audits or changes to or further interpretation of tax laws and regulations. Our judgments and estimates concerning realizability of deferred tax assets could change if any of the evaluation factors change.

If such changes take place, there is a risk that our effective tax rate could increase or decrease in any period, impacting our net earnings.

30

 


 

Recent Accounting Pronouncements

In April 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. This new guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This new guidance will be effective for the Company beginning in fiscal 2017. We are currently evaluating the impact of this standard on our consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements- Going Concern (Subtopic 205-40) Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.”  This update provides guidance on management’s responsibility to evaluate whether there is substantial doubt about the ability to continue as a going concern and to provide related interim and annual footnote disclosures.  The amendments in this ASU are effective for reporting periods ending after December 15, 2016.  We do not believe the adoption of this update will have a material impact on our financial statements.

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued a comprehensive new revenue recognition model that requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance will replace most existing revenue recognition guidance in U.S. GAAP. On July 9, 2015, the FASB deferred the effective date of the new revenue recognition standard by one year. Based on the FASB’s revised effective date, the new revenue standard will be effective beginning in our fiscal year 2019. Early adoption in our fiscal year 2018 is permitted. We are evaluating the effect the new revenue standard will have on our consolidated financial statements and related disclosures.

 

Results of Operations - Consolidated

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

 

 

 

Fiscal

 

 

 

Fiscal

 

 

 

Fiscal

 

 

 

 

2015

 

 

 

2014

 

 

 

2013

 

 

Net revenue

 

 

100.0

 

%

 

 

100.0

 

%

 

 

100.0

 

%

Cost of goods sold

 

 

71.3

 

 

 

 

72.5

 

 

 

 

65.0

 

 

Gross profit

 

 

28.7

 

 

 

 

27.5

 

 

 

 

35.0

 

 

Operating expenses

 

 

33.0

 

 

 

 

56.0

 

 

 

 

34.3

 

 

Operating income (loss)

 

 

(4.3

)

 

 

 

(28.5

)

 

 

 

0.7

 

 

Other income (expense)

 

 

(0.6

)

 

 

 

(1.8

)

 

 

 

(0.7

)

 

Earnings (loss) before income taxes

 

 

(4.9

)

 

 

 

(30.3

)

 

 

 

0.0

 

 

Income tax benefit (expense)

 

 

(0.3

)

 

 

 

1.0

 

 

 

 

(1.1

)

 

Net earnings (loss)

 

 

(5.2

)

%

 

 

(29.3

)

%

 

 

(1.1

)

%

Less net earnings (loss) attributable to noncontrolling interest

 

 

0.2

 

 

 

 

0.1

 

 

 

 

0.4

 

 

Net earnings (loss) attributable to PMFG, Inc.

 

 

(5.4

)

%

 

 

(29.4

)

%

 

 

(1.5

)

%

 

Cost of goods sold includes manufacturing and distribution costs for products sold.  The manufacturing and distribution costs include material, direct and indirect labor, manufacturing overhead, depreciation, sub-contract work, inbound and outbound freight, purchasing, receiving, inspection, warehousing, internal transfer costs and other costs of our manufacturing and distribution processes.  Cost of goods sold also includes the costs of commissioning the equipment and warranty related costs.

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

 

·

Sales and marketing expenses - include payroll, employee benefits, stock-based compensation and other employee-related costs associated with sales and marketing personnel.  Sales and marketing expenses also include travel and entertainment, advertising, promotions, trade shows, seminars and other programs and sales commissions paid to independent sales representatives.

 

·

Engineering and project management expenses - include payroll, employee benefits, stock-based compensation and other employee-related costs associated with engineering, project management and field service personnel.  Additionally, engineering and project management expenses include the cost of sub-contracted engineering services.

 

·

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

31

 


 

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.  The following summarizes consolidated revenue (in thousands):

 

 

 

Fiscal

 

 

% of

 

 

Fiscal

 

 

% of

 

 

Fiscal

 

 

% of

 

 

 

2015

 

 

Total

 

 

2014

 

 

Total

 

 

2013

 

 

Total

 

Domestic

 

$

91,863

 

 

 

57.9

%

 

$

80,045

 

 

 

61.3

%

 

$

70,986

 

 

 

53.0

%

International

 

 

66,780

 

 

 

42.1

%

 

 

50,605

 

 

 

38.7

%

 

 

62,906

 

 

 

47.0

%

Total

 

$

158,643

 

 

 

100.0

%

 

$

130,650

 

 

 

100.0

%

 

$

133,892

 

 

 

100.0

%

 

For fiscal 2015, total revenue increased $28.0 million, or 21.4%, compared to fiscal 2014, as a result of higher revenue from our Process Products segment in the Europe, Middle East and Africa (EMEA) and Asia Pacific (APAC) regions combined with higher revenue from our Environmental Systems segment.  The higher revenue from our Process Products segment resulted from year over year increased demand for our oily water separation solutions in the EMEA and APAC regions. Stringent air pollution regulations, pending changes in regulation and increased demand for natural gas power generation in the United States drove increased demand for our environmental systems and products.  In March 2014, we acquired substantially all the assets of Combustion Components Associates, Inc. (“CCA”).  In fiscal 2015, the full year of revenue from CCA was $7.0 million higher than the revenue generated from the acquisition in the fourth quarter of fiscal 2014.    

For fiscal 2014, total revenue decreased $3.2 million, or 2.4%, compared to fiscal 2013. Domestically, lower revenue in our Process Products segment was partially offset by higher revenue in our Environmental Systems segment. The net increase in domestic revenue in fiscal 2014 when compared to the prior fiscal year was $9.1 million.  International revenue decreased $12.3 million in fiscal 2014 compared to fiscal 2013.

Additional detail on the year-over-year change by product category is as follows (in thousands):

 

 

 

Change in

 

 

 

fiscal 2015

 

Process Products systems

 

 

 

 

Separation and filtration equipment

 

$

3,237

 

Silencer and heat transfer equipment

 

 

3,096

 

Environmental Systems

 

 

21,660

 

 

 

$

27,993

 

 

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, 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):

 

 

 

Fiscal

 

 

% of

 

 

Fiscal

 

 

% of

 

 

Fiscal

 

 

% of

 

 

 

2015

 

 

Revenue

 

 

2014

 

 

Revenue

 

 

2013

 

 

Revenue

 

Revenue

 

$

158,643

 

 

 

100.0

%

 

$

130,650

 

 

 

100.0

%

 

$

133,892

 

 

 

100.0

%

Cost of goods sold

 

 

113,046

 

 

 

71.3

%

 

 

94,754

 

 

 

72.5

%

 

 

87,092

 

 

 

65.0

%