Pmfg 10Q 2010 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2009


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

For the transition period from __________ to __________

Commission File Number 001-34156

PMFG, INC.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		51-0661574 (I.R.S. Employer Identification No.)

14651 North Dallas Parkway, Suite 500, Dallas, Texas 75254
(Address of principal executive offices)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

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


Large accelerated filero		Accelerated filerþ		Non-accelerated filero(Do not check if a smaller reporting company)		Smaller reporting companyo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

The number of shares of the registrant’s common stock outstanding on November 6, 2009, was 13,232,599.

TABLE OF CONTENTS


		Page
		Number
Forward-Looking Statements		3

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets at September 30, 2009 (unaudited) and June 30, 2009		4

Consolidated Statements of Operations for the three months ended September 30, 2009 and 2008 (unaudited)		5

Consolidated Statements of Cash Flows for the three months ended September 30, 2009 and 2008 (unaudited)		6

Consolidated Statements of Equity and Comprehensive Income (Loss) for the three months ended September 30, 2009 (unaudited)		7

Notes to the Consolidated Financial Statements		8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3. Quantitative and Qualitative Disclosures About Market Risk		29

Item 4. Controls and Procedures		29

PART II: OTHER INFORMATION

Item 1. Legal Proceedings		30

Item 1A. Risk Factors		30

Item 6. Exhibits		30

SIGNATURES		31
Exhibit 31.1
Exhibit 31.2
Exhibit 32

FORWARD-LOOKING STATEMENTS

This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact contained in this Report are forward-looking statements. You should not place undue reliance on these statements. These forward-looking statements include statements that reflect the current views of our senior management with respect to our financial performance and future events with respect to our business and our industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements. Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:

	•		adverse changes in the current global economic environment or in the markets in which we operate, including the power generation, natural gas infrastructure and petrochemical and processing industries;

	•		the impact of the current global credit crisis, including the impact on the trading price of our common stock and our ability and our customer’s ability to access capital markets;

	•		changes in the price, supply or demand for natural gas, bio fuel and oil;

	•		changes in current environmental legislation;

	•		increased competition;

	•		decreased demand for our products;

	•		the effects of U.S. involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts;

	•		changes in our ability to conduct business outside the United States, including changes in foreign laws and regulations;

	•		risks associated with the significant indebtedness that we incurred in connection with our acquisition of Nitram Energy, Inc., in April 2008;

	•		stockholder approval of the issuance of common stock related to our Series A convertible preferred stock issued on September 4, 2009;

	•		limitations on raising additional equity, imposed by our Series A convertible preferred stock;

	•		the effects of natural disasters; and

	•		loss of the services of any of our senior management or other key employees.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this and other reports we file with the Securities and Exchange Commission (the “SEC”), including the information in “Item 1A. Risk Factors” of Part I to our Annual Report on Form 10-K for the year ended June 30, 2009. There may be other factors that may cause our actual results to differ materially from the forward-looking statements. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. We undertake no obligation to publicly update or revise any forward-looking statement.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PMFG, Inc. and Subsidiaries

Consolidated Balance Sheets
(In thousands, except share and per share amounts)


	September 30,			June 30,
	2009			2009
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	20,805		$	17,738
Restricted cash		4,012			4,132
Accounts receivable, principally trade — net of allowance for doubtful accounts of $460 at September 30, 2009 and June 30, 2009		28,798			29,551
Inventories — net		9,913			9,354
Costs and earnings in excess of billings on uncompleted contracts		21,128			21,716
Deferred income taxes		2,818			2,816
Other current assets		2,186			2,384

Total current assets		89,660			87,691

Property, plant and equipment — net		8,073			8,465
Intangible assets — net		21,837			22,084
Goodwill		29,432			29,432
Equity method investment		2,653			2,526
Other assets		2,045			2,982

Total assets	$	153,700		$	153,180

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	18,064		$	15,647
Current maturities of long-term debt		6,820			6,820
Billings in excess of costs and earnings on uncompleted contracts		6,809			8,233
Commissions payable		2,719			2,764
Dividends payable		94			—
Income taxes payable		1,378			1,342
Accrued product warranties		1,284			1,242
Customer deposits		3,329			2,261
Accrued liabilities and other		8,242			9,135

Total current liabilities		48,739			47,444

Long-term debt		28,180			49,180
Deferred income taxes		9,563			9,559
Derivative liability		11,530			—
Other non-current liabilities		1,019			1,039
Commitments and contingencies
Preferred stock — authorized, 5,000,000 shares of $0.01 par value; issued and outstanding, 21,140 and 0 shares at September 30, 2009 and June 30, 2009, respectively		4,762			—
Stockholders’ equity:
Common stock — authorized, 25,000,000 shares of $0.01 par value; issued and outstanding, 13,223,299 and 13,078,760 shares at September 30, 2009 and June 30, 2009, respectively		132			131
Additional paid-in capital		16,178			10,186
Retained earnings		34,214			36,349
Accumulated other comprehensive loss		(1,072	)		(708	)

Total PMFG, Inc. stockholders’ equity		54,214			45,958
Noncontrolling interest		455			—

Total equity		54,669			45,958

Total liabilities and equity	$	153,700		$	153,180

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Consolidated Statements of Operations
(In thousands, except share and per share amounts)


	Three months ended
	September 30,
	2009			2008
	(unaudited)
Revenue	$	31,331		$	43,656
Cost of goods sold		19,564			32,379

Gross profit		11,767			11,277

Operating expenses
Sales and marketing		3,010			4,086
Engineering and project management		1,850			1,976
General and administrative		3,944			4,300

		8,804			10,362

Operating income		2,963			915

Other income (expense)
Interest income		12		��	78
Interest expense		(1,211	)		(1,596	)
Loss on extinguishment of debt		(1,303	)		—
Foreign exchange gain (loss)		204			(650	)
Change in fair value of derivative liability		(2,500	)		—
Other income (expense)		—			228

		(4,798	)		(1,940	)


Loss before income taxes		(1,835	)		(1,025	)
Income tax benefit (expense)		(256	)		359

Net loss	$	(2,091	)	$	(666	)


Less net loss attributable to noncontrolling interest	$	50		$	—

Net loss attributable to PMFG	$	(2,041	)	$	(666	)


Dividends on preferred stock	$	(94	)	$	—

Loss applicable to PMFG common stockholders	$	(2,135	)	$	(666	)


Basic and diluted loss per share	$	(0.16	)	$	(0.05	)


Weighted-average shares outstanding:
Basic shares outstanding		13,202			12,944
Effect of dilutive options		—			—


Diluted shares outstanding		13,202			12,944

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)


	Three months ended September 30,
	2009			2008
	(unaudited)
Cash flows from operating activities:
Net earnings (loss)	$	(2,091	)	$	(666	)
Depreciation and amortization		811			3,522
Loss on extinguishment of debt		1,303			—
Deferred income taxes		2			(4	)
Deferred rent expense		(19	)		(14	)
Bad debt expense		—			(147	)
Provision for warranty expense		73			74
Inventory valuation reserve		45			167
Foreign exchange (gain) loss		(204	)		650
Change in fair value of derivative liability		2,500			—
Stock-based compensation		550			775
Changes in operating assets and liabilities:
Accounts receivable		719			(4,632	)
Inventories		(607	)		5,325
Costs and earnings in excess of billings on uncompleted contracts		580			(2,276	)
Other current assets		198			(907	)
Other assets		(128	)		(50	)
Accounts payable		2,396			204
Billings in excess of costs and earnings on uncompleted contracts		(1,424	)		771
Commissions payable		(45	)		818
Income taxes		36			(1,031	)
Accrued product warranties		(31	)		(25	)
Accrued liabilities, customer deposits and other		(378	)		(6,134	)

Net cash provided by (used in) operating activities:		4,286			(3,580	)

Cash flow from investing activities:
Purchases of property and equipment		(10	)		(244	)
Capitalized business acquisition costs		—			(60	)

Net cash provided by (used in) investing activities:		(10	)		(304	)

Cash flows from financing activities:
Net proceeds from issuance of preferred stock and warrants		19,235			—
Payment of debt issuance cost		—			(196	)
Payment of debt		(21,000	)		(1,000	)
Equity contribution from noncontrolling interest		505			—

Net cash used in financing activities		(1,260	)		(1,196	)

Effect of exchange rate changes on cash and cash equivalents		51			283

Net increase (decrease) in cash and cash equivalents		3,067			(4,797	)

Cash and cash equivalents at beginning of period		17,738			11,444


Cash and cash equivalents at end of period	$	20,805		$	6,647


Supplemental disclosures:
Interest paid	$	1,210		$	1,206
Income taxes paid	$	—		$	510

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Consolidated Statements of Equity and Comprehensive Income (Loss)

(In thousands)


										Accumulated
					Additional					Other			Total							Non
	Common Stock				Paid-in		Retained			Comprehensive			Stockholders’			Preferred Stock				Controlling			Total
	Shares		Amount		Capital		Earnings			Loss			Equity			Shares		Amount		Interest			Equity
Balance at June 30, 2009		13,079	$	131	$	10,186	$	36,349		$	(708	)	$	45,958			—	$	—	$	—		$	45,958

Net loss								(2,041	)					(2,041	)						(50	)	$	(2,091	)

Foreign currency translation adjustment											(364	)		(364	)						—		$	(364	)

Total comprehensive loss														(2,405	)						(50	)		(2,455	)

Stock awards		144		1		525								526									$	526

Stock option expense						24								24									$	24

Noncontrolling interest in subsidiary														—							505		$	505

Preferred Stock Issuance with warrants						5,443								5,443			21		4,762				$	10,205

Preferred Stock Dividends								(94	)					(94	)								$	(94	)


Balance at September 30, 2009		13,223	$	132	$	16,178	$	34,214		$	(1,072	)	$	49,452			21	$	4,762	$	455		$	54,669

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

September 30, 2009

(In thousands, except share and per share amounts)

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements of PMFG, Inc. and subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. References to “Company,” “we,” “us” and “our” refer to PMFG, Inc. and its subsidiaries. The consolidated financial statements of the Company as of September 30, 2009 and for the three months ended September 30, 2009 and 2008 are unaudited and, in the opinion of management, contain all adjustments necessary for the fair presentation of the financial position and results of operations of the Company for the interim periods. The results of operations for such interim periods are not necessarily indicative of results for a full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K for the fiscal year ended June 30, 2009.

Basis of Consolidation

The Company’s financial statements as of September 30, 2009 and for the three months ended September 30, 2009 and 2008 are consolidated to include the accounts of all wholly-owned and majority-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. In addition to the wholly-owned subsidiaries, the Company has a 40% interest in a joint venture which is presented as an investment in unconsolidated entity, and is accounted for under the equity method of accounting.

China Subsidiary

We have established a new manufacturing facility in China and continue to develop our established network of subcontractors to grow our international market share and increase profitability through Peerless Manufacturing (Zhenjiang) Co. LTD, a wholly-owned subsidiary of Peerless Propulsys China Holdings LLC, our majority-owned (60%) subsidiary. This entity has been consolidated in the Company’s financial statements. For consolidation purposes, the Company consolidates Peerless Manufacturing (Zhenjiang) Co. LTD based on financial reporting with a one month lag behind the Company’s period end, with consideration given to the effect of intervening events, if material. Revenues, expenses, gains, losses, net income or loss, and other comprehensive income of our majority-owned subsidiary are reported in the consolidated financial statements at the consolidated amounts, which include the amounts attributable to the Company’s and the non-controlling interest. The non-controlling interest is reported in the consolidated statement of financial position as a separate component of equity.

Cash and Cash Equivalents

For purposes of the statement of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

Accounts Receivable

The Company’s accounts receivable are due from companies in various industries. Credit is extended based on an evaluation of the customer’s financial condition. Generally, collateral is not required except on credit extended to international customers. Accounts receivable are generally due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than contractual payment terms are considered past due. The Company records an allowance on a specific basis by considering a number of factors,

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED

including the length of time the accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company and the condition of the industry and the economy as a whole. The Company writes off accounts receivable when they become uncollectible. Payments subsequently received on such receivables are credited back to bad debt expense in the period the payment is received.

Inventories

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

Depreciable Assets

Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives (generally 3 to 7 years), principally by the straight-line method. Routine maintenance costs are expensed as incurred. Major improvements that extend the life, increase the capacity or improve the safety or the efficiency of property owned are capitalized. Major improvements to leased buildings are capitalized as leasehold improvements and amortized over the shorter of the estimated life or the lease term.

Long-Lived Assets

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

Intangible Assets and Goodwill

The amount of recorded goodwill relates primarily to the acquisition of Nitram Energy, Inc. (“Nitram”) in fiscal year 2008 and represents the difference between the purchase price and the fair value of the net assets acquired. Goodwill is not amortized; rather, it is measured for impairment annually, or more frequently if conditions indicate an earlier review is necessary. If the estimated fair value of goodwill is less than the carrying value, goodwill is impaired and written down to its estimated fair value.

Intangible assets subject to amortization acquired as part of the Nitram acquisition include customer backlog, licensing agreements, and customer relationships. These intangible assets are amortized over their useful lives based on a pattern in which the economic benefit of the respective intangible asset is realized. Intangible assets acquired in the Nitram acquisition that the Company considers indefinite are trade names and design guidelines. The Company evaluates the recoverability of intangible assets annually or whenever events or changes in circumstances indicate that an intangible asset’s carrying value may not be recoverable.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

1. SIGNIFICANT ACCOUNTING POLICIES — CONTINUED

Convertible Redeemable Preferred Stock

The Company’s preferred stock contains redemption options which place redemption outside of the Company’s control. The preferred stock has been classified as temporary equity, outside of permanent stockholders’ equity, on the Consolidated Balance Sheets and Consolidated Statements of Equity.

Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, trade receivables, other current assets, accounts payable and accrued expenses approximate fair value due to the short maturity of these instruments. As the Company’s debt bears interest at floating rates, the Company estimates that the carrying values of its debt at September 30, 2009 and June 30, 2009 approximate fair value.

The Company considers the conversion rights and redemption rights features of the Series A Convertible Redeemable Preferred Stock embedded derivative features of the preferred stock host contract, and their fair values are included as a derivative liability on the consolidated balance sheets. Changes in fair value of the derivative liability are included in other income (expense) in the consolidated statements of operations.

Revenue Recognition

The Company provides products under long-term, generally fixed-priced, contracts that may extend over multiple financial periods. In connection with these contracts, the Company uses percentage-of-completion accounting for long-term contracts that contain enforceable rights regarding services to be provided and received by the contracting parties, the consideration to be exchanged, and the manner and terms of settlement, assuming reasonably dependable estimates of revenues and expenses can be made. The percentage-of-completion methodology generally results in the recognition of reasonably consistent profit margins over the life of a contract. Amounts recognized in revenue are calculated using the percentage of construction cost completed, generally on a cumulative cost to total cost basis. Cumulative revenue recognized may be less or greater than cumulative costs and profits billed at any point during a contract’s term. The resulting difference is recognized as “costs and earnings in excess of billings on uncompleted contracts” or “billings in excess of costs and earnings on uncompleted contracts.”

The completed contract method is applied to relatively short-term contracts where the financial statement presentation does not vary materially from the presentation under the percentage-of-completion method. Revenues under the completed contract method are recognized upon shipment of the product.

Earnings (Loss) Per Common Share

We calculate earnings (loss) per common share by dividing the income available to common stockholders by the weighted average number of common shares outstanding. We have determined that our convertible redeemable preferred stock represents a participating security because it has rights to participate in any dividends on an as-converted basis; therefore, we have calculated basic earnings per common share consistent with the provisions ofAccounting Standards Codification 260-45 Participating Securities and the Two Class Method. Diluted earnings per common share include the dilutive effect of stock options and warrants granted using the treasury stock method. Options to acquire 115,747 shares of common stock were excluded from the calculation of dilutive securities for the three months ended September 30, 2009 because they were anti-dilutive.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB established theFASB Accounting Standards Codification(“Codification”) which superseded all then-existing non-SEC accounting and reporting standards and made all other non-grandfathered

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009

(In thousands, except share and per share amounts)

2. RECENT ACCOUNTING PRONOUNCEMENTS — CONTINUED

non-SEC accounting literature not included in the Codification non-authoritative. The Codification is effective for interim and annual periods ending after September 15, 2009 and did not have any effect on our consolidated financial statements, but has resulted in a new method of referencing GAAP guidance throughout this and future reports.

In August 2009, the FASB issued Accounting Standards Update 2009-4, “Accounting for Redeemable Equity Instruments, Amendment to Section 480-10-S99” (“2009-4”). 2009-4 relates to distinguishing liability from equity and was considered in the recording of convertible redeemable preferred stock as described in Note 9 below.

In June 2008, the FASB issued new guidance to determine when unvested instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”). This guidance was subsequently codified as part ofASC 260 Earnings Per Share. As of July 1, 2009, the Company adopted the provisions of this guidance for the presentation of EPS data in the consolidated statements of income. All prior period EPS information presented was adjusted retrospectively to conform to the provisions of the guidance. The adoption did not result in a change in the reported EPS for prior periods presented.

In December 2007, the FASB established new accounting and reporting standards for a non-controlling interest (also called a “minority interest”) in a subsidiary and for the deconsolidation of a subsidiary. The new guidance was subsequently codified as part ofASC 810 Consolidationand clarified that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be separately reported in the consolidated financial statements. As of July 1, 2009, the Company adopted the provisions of this guidance, which did not have a material impact on the Company’s overall financial condition, results of operations, or cash flows. However, the Company did apply the guidance prospectively to non-controlling interests associated with our new manufacturing facility in China.

3. INVENTORIES

Principal components of inventories are as follows:


	September 30,			June 30,
	2009			2009
Raw materials	$	6,360		$	6,053
Work in progress		3,735			3,338
Finished goods		685			685

		10,780			10,076
Reserve for obsolete and slow-moving inventory		(867	)		(722	)

	$	9,913		$	9,354

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

4. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

The components of uncompleted contracts are as follows:


	September 30,			June 30,
	2009			2009
Costs incurred on uncompleted contracts and estimated earnings	$	101,212		$	92,824
Less billings to date		(86,893	)		(79,341	)

	$	14,319		$	13,483

The components of uncompleted contracts are reflected in the consolidated balance sheets as follows:


	September 30,			June 30,
	2009			2009
Costs and earnings in excess of billings on uncompleted contracts	$	21,128		$	21,716
Billings in excess of costs and earnings on uncompleted contracts		(6,809	)		(8,233	)

	$	14,319		$	13,483

5. ACCRUED PRODUCT WARRANTIES

Accrued product warranty activity is as follows:


	Three months ended
	September 30,
	2009			2008
Balance at beginning of period	$	1,242		$	1,224
Provision for warranty expenses		73			74
Warranty charges		(31	)		(25	)

Balance at end of period	$	1,284		$	1,273

6. ACCRUED LIABILITIES AND OTHER

The components of accrued liabilities and other are as follows:


	September 30,		June 30,
	2009		2009
Accrued start-up (commissioning) expense	$	2,899	$	3,327
Accrued compensation		2,453		2,233
Accrued professional expenses		2,062		2,462
Other		828		1,113

	$	8,242	$	9,135

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

7. DEBT

Outstanding long-term debt obligations are as follows:


			September 30,			June 30,
	Maturities		2009			2009
Senior secured credit facilities:
Revolving credit facility		2011	$	—		$	—
Term loan		2013		35,000			36,000

Total senior secured credit facilities				35,000			36,000
Subordinated secured term loan		2013		—			20,000

Total debt				35,000			56,000
Less current maturites				(6,820	)		(6,820	)

Total long-term debt			$	28,180		$	49,180

On September 4, 2009, the subordinated term loan was repaid in full using the proceeds from the Company’s preferred stock financing and available cash. Unamortized deferred financing costs of $1,303 were recorded as a loss on extinguishment of debt on the Consolidated Statement of Operations. Interest on the subordinated note was payable monthly at a rate of 15.0% per annum, with 11.5% required to be paid in cash and the remaining 3.5% payable, at the Company’s option (subject to certain limitations), in cash or by adding the amount of such additional interest to the principal balance of the subordinated term loan.

The senior term loan matures on March 31, 2013. Interest on the senior term loan is payable quarterly at a base or LIBOR rate per annum, at the Company’s option, (6.00% at September 30, 2009 and 6.25% at June 30, 2009). On September 9, 2009, the Company amended both its senior term loan and revolving credit facility to enhance the Company’s financial flexibility by relaxing certain ratio covenant requirements. Interest on the senior term loan is equal to either (a) for base rate loans, a margin of between 275 and 400 basis points based on the Company’s consolidated total leverage (“CTL”) ratio plus the higher of (1) the administrative agent’s prime rate, or (2) the federal funds effective rate (as determined in accordance with the Senior Secured Credit Agreement) plus a margin of 100 basis points, or (3) the Daily Adjusting LIBOR rate plus 100 basis points, or (b) for LIBOR rate loans, the adjusted LIBOR rate (as determined in accordance with the Senior Secured Credit Agreement) plus a margin of between 375 and 500 basis points based on our CTL ratio, subject to a LIBOR floor of 1%. Prior to the amendment, the relevant margins on the senior term loan were between 50 and 125 basis points and between 275 and 350 basis points for base rate loans and LIBOR rate loans, respectively. The Senior Secured Credit Agreement requires quarterly principal payments on the senior term loan of $1,000 through and including April 1, 2011 and $1,500 thereafter through March 31, 2013, with the balance of the senior term loan due at maturity. The Senior Secured Credit Agreement also requires additional principal payments of the senior term loan based upon the Company’s cash flow beginning with the 2009 fiscal year ($2,820 due October 1, 2009), the net proceeds of certain asset sales and dispositions and the issuance by the Company of additional equity securities or subordinated debt.

The revolving credit facility matures on April 30, 2011. As of September 30, 2009, interest under the revolving credit facility is payable quarterly at a base or LIBOR rate per annum , at the Company’s option, equal to either (a) for base rate loans, a margin of between 275 and 375 basis points based on the Company’s CTL ratio plus the higher of (1) the administrative agent’s prime rate, or (2) the federal funds effective rate (as determined in accordance with the Senior Secured Credit Agreement) plus a margin of 100 basis points, or (3) the Daily Adjusting LIBOR rate plus 100 basis points, or (b) for LIBOR rate loans, the adjusted LIBOR rate (as determined in accordance with the Senior Secured Credit Agreement) plus a margin of between 350 and 475 basis points based on our CTL ratio, subject to a LIBOR floor of 1%. Prior to the amendment, the relevant margins on the revolving

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

7. DEBT — CONTINUED

credit facility were between 25 and 100 basis points and between 225 and 300 basis points for base rate loans and LIBOR rate loans respectively. Under this revolving credit facility, the Company has a maximum borrowing availability equal to the lesser of (a) $20,000 or (b) 75% of eligible accounts receivable plus 45% of eligible inventory (not to exceed 50% of the borrowing base). There were no outstanding borrowings under the revolving credit facility at September 30, 2009 or June 30, 2009.

The senior term loan and any borrowings under the revolving credit facility are secured by a first lien on substantially all assets of the Company and contain financial and other covenants, including restrictions on additional debt, dividends, capital expenditures, acquisitions and dispositions. They also contain covenants and events of default that, among other things, require the Company to satisfy financial tests and maintain financial ratios. At September 30, 2009, required financial ratios included a minimum fixed charge coverage ratio of 1.40 to 1.00, a maximum leverage ratio of 3.50 to 1.00, and a minimum net worth requirement at all times not less than the base adjusted net worth. As of September 30, 2009, the Company was in compliance with all covenants in its debt agreements.

As required by the Senior Secured Credit Agreement, the Company entered into a LIBOR interest rate cap transaction with respect to the senior term loan, with a notional amount of $20,000 (the “Interest Rate Cap Transaction”). The Interest Rate Cap Transaction became effective on August 15, 2008 and will terminate on April 2, 2012. Under the terms of the Interest Rate Cap Transaction, the counterparty will pay to the Company, on the first business day of each quarter, commencing on October 1, 2008, an amount equal to the greater of $0 and the product of (i) the outstanding notional amount of the Interest Rate Cap Transaction during the prior quarter, (ii) the difference between the three month LIBOR rate at the beginning of the prior quarter and 3.70% and (iii) the quotient of the number of days in the prior quarter over 360. The notional amount of the Interest Rate Cap Transaction amortized $5,000 on October 1, 2008 and will amortize in the amount of (i) $5,000 on October 1, 2009 and October 1, 2010 and (ii) $4,500 on October 3, 2011. As long as the counterparty makes the payments required under the Interest Rate Cap Transaction, the Company will have a maximum annual LIBOR interest rate exposure equal to the sum of 3.70% and a margin of 375 to 500 basis points based on our CTL ratio, for the term of the Interest Rate Cap Transaction. At September 30, 2009 the Interest Rate Cap Transaction has an estimated fair market value of $26.

The Company’s U.K. subsidiary has a £4,200 ($6,711) debenture agreement used to facilitate issuances of letters of credit and bank guarantees. This facility was secured by substantially all of the assets of the Company’s U.K. subsidiary, and by a cash deposit of £2,511 ($4,012) at September 30, 2009, £2,511 ($4,132) at June 30, 2009, which is recorded as restricted cash on the consolidated balance sheet. At September 30, 2009, there was £3,373 ($5,390) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement. At June 30, 2009, there was £2,926 ($4,815) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement.

8. COMMITMENTS AND CONTINGENCIES

Litigation

On June 19, 2007, Martin-Manatee Power Partners, LLC (“MMPP”) filed a complaint against the Company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida. In the complaint, MMPP asserted claims for breach of contract and express warranty, breach of implied warranty and indemnification against the Company. MMPP’s claims arise out of an incident in September 2005 when an electric fuel gas start-up heater,

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

8. COMMITMENTS AND CONTINGENCIES — CONTINUED

which was a component of a fuel gas heater skid supplied by the Company to MMPP, allegedly ruptured resulting in a fire. In the complaint, MMPP did not make a specific demand for damages.

The Company’s insurance carriers have agreed to defend the claims asserted by MMPP, pursuant to reservation of rights letters issued on September 5, 2007, and have retained counsel to defend the Company. The Company’s motion to dismiss the complaint for improper venue was granted on December 11, 2007. On February 20, 2008, MMPP filed a new action in the District Court of Johnson County, Kansas, the venue referenced in the purchase order pursuant to which the skid was purchased by MMPP from the Company. In this complaint, MMPP asserted the same claims as described above. MMPP has made a demand for damages in the amount of $2,500, which it claims represents its net costs incurred related to this incident. The Company is currently appealing a ruling by the District Court, which dismissed a third party defendant, Controls International, Inc., the manufacturer of a valve used on the skid. The Company filed its appeal on July 24, 2009. The Company has recorded an accrual of $525 related to repairs performed by the Company and the applicable insurance deductible. However, at this time the Company cannot estimate any potential final range of loss resulting from this litigation as it is still in discovery. At this time, we believe that MMPP’s claims are without merit and we intend to vigorously defend this suit.

From time to time we are involved in various litigation matters arising in the ordinary course of our business. We do not believe the disposition of any current matter will have a material adverse effect on our consolidated financial position or results of operations.

Nitram Acquisition

We completed the acquisition of Nitram in April 2008. As a result of the acquisition, we are liable for the operations of Nitram and its subsidiaries because these entities are our wholly-owned subsidiaries. In connection with the Nitram acquisition, we acquired indirect ownership of Burgess-Manning, Inc. (“Burgess-Manning”). Prior to the Nitram acquisition, Burgess-Manning, Inc., a subsidiary of Nitram, made a voluntary disclosure to the Office of Foreign Assets Control (“OFAC”) regarding sales of industrial separators to Iran. The Company cannot predict the response of OFAC, the outcome of any related proceeding or the likelihood that future proceedings will be instituted against the Company. In the event that there is an adverse ruling in any proceeding, the Company may be required to pay fines and penalties.

In connection with the Company’s acquisition of Nitram and the related financing transactions, environmental site assessments were performed on both its existing manufacturing properties and Nitram’s properties in Cisco, Texas and Wichita Falls, Texas. These assessments involved visual inspection, testing of soil and groundwater, interviews with site personnel and a review of publicly available records. The results of these assessments indicated soil and groundwater contamination at the Vermont Street plant in Wichita Falls, and groundwater concerns at the Jacksboro Highway plant in Wichita Falls and the Cisco plant. Additional sampling and evaluation of the groundwater concerns at Jacksboro Highway and Cisco plants indicated levels of impact did not exceed applicable regulatory standards, and that further investigation and remediation was not required. Soil remediation at the Vermont Street Plant in Wichita Falls was completed in July 2009 and the Company will continue to monitor groundwater at the site for an additional five years. The total costs accrued are $613 at September 30, 2009 and June 30, 2009. The Company is seeking reimbursement for the cost of the remediation under our purchase agreement with Nitram’s former stockholders. Funds have been deposited into an escrow account that may be used to reimburse these costs.

Under the contract for the Nitram acquisition, $10,920 of the purchase price was placed in escrow to reimburse the Company for breach of representation and certain other claims, including potential costs, fines or penalties related

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

8. COMMITMENTS AND CONTINGENCIES — CONTINUED

to the OFAC voluntary disclosure and environmental matters. The escrow amount, less any claim amounts made by the Company or amounts paid to third parties as agreed upon by the Company and sellers, is to be released to the seller in five installments on each of October 8, 2008, January 30, 2009, April 30, 2009, July 30, 2009 and October 30, 2009. As of October 27, 2009, the Company has filed claims totaling $1,999 against the escrow. The claims made by the Company are subject to a deductible equal to one percent of the purchase price paid by the Company for the Nitram acquisition. All escrow payments have been released to the sellers, withholding $1,389 for claims, which represents the Company’s claims of $1,999, less the 1% deductible estimated of $610. The sellers have objected to the claims and the parties are currently in the process of negotiating the escrow claims.

9. SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK AND WARRANTS

On September 4, 2009, the Company issued and sold 21,140 shares of its Series A Convertible Redeemable Preferred Stock, par value $0.01 per share (the “Preferred Stock”) and warrants (the “ Warrants “) to certain accredited investors (each a “Purchaser” and collectively, the “Purchasers”) for an aggregate purchase price of $21,140 (the “Offering”). The Company and Purchasers entered into a securities purchase agreement (the “Purchase Agreement”) in connection with the Offering. The Offering was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”). The Company used the net proceeds received from the Offering and available cash to repay its debt obligations under its Subordinated Term Loan (defined below).

Preferred Stock

The terms, rights, obligations and preferences of the Preferred Stock are set forth in the Certificate of Designations of Series A Convertible Preferred Stock (the “Certificate of Designations”) filed with the Secretary of State of the State of Delaware on September 4, 2009.

The Preferred Stock is immediately convertible, at the option of the holder, into shares of Common Stock at an initial conversion price of $8.00 per share, subject to certain anti-dilution adjustments (the “Conversion Price”). The Conversion Price will be adjusted for stock splits, dividends and the like and in the event the Company issues and sells its equity securities at a price below the Conversion Price. No adjustment will be made for one or more equity offerings of up to an aggregate of $10 million within twelve months of the issuance of the Preferred Stock. In addition, holders of the Preferred Stock are entitled to quarterly dividends at an annual rate of 6.0%. In the event the Company fails to fulfill its obligations under the Preferred Stock, the dividend rate will increase to an annual rate of 8.0%. All dividends will be cumulative and compound quarterly and may be paid, at the option of the Company, in cash or Common Stock, or a combination of the two. If the Company elects to issue shares of Common Stock as dividend payments, the value per share will be equal to 85% of the volume weighted average price per share (“VWAP”) of the Common Stock for the fifteen days preceding, but not including, the date of such payments.

At September 30, 2009, accrued dividends totaling $94 were recorded and are due December 31, 2009.

At any time after five years from the date of issuance, the Preferred Stock is redeemable, in whole or in part, at the option of the holders or the Company. The purchase price per share for redemptions will be equal to the original price per share of the Preferred Stock, plus any accumulated and unpaid dividends. Redemption payments may be made, at the option of the Company, in cash or Common Stock, or a combination of the two. If the Company elects to make redemption payments in Common Stock, the value per share will be equal to 85% of the VWAP of the Common Stock for the fifteen trading days preceding, but not including, the redemption date.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

9. SERIES A CONVERTIBLE PREFERRED STOCK AND WARRANTS — CONTINUED

Beginning on the second anniversary of the Closing, the Company may require the conversion of any and all outstanding shares of Preferred Stock, provided that the VWAP of the Common Stock exceeds 200% of the Conversion Price for twenty of the immediately preceding thirty consecutive trading days.

Upon any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of Preferred Stock are entitled to a liquidation preference (the “Liquidation Preference”) equal to:

•	the greater of:

	-	the price per share the holder paid for the Preferred Stock; or

	-	the amount the holder would have received upon a liquidation, if the holder had converted their shares immediately prior thereto; and

•

plus any accumulated and unpaid dividends.

A change in control of the Company will be deemed to be a liquidation and will entitle the holders of Preferred Stock to receive the Liquidation Preference. In the event of certain change in control transactions, the Liquidation Preference will be payable, at the option of the Company, in cash or in Common Stock, or a combination of the two.

If the Company elects to pay in Common Stock, the value per share will be equal to 85% of the VWAP of the Common Stock for the fifteen trading days preceding, but not including, the date of liquidation.

The NASDAQ Marketplace rules limit the number of shares of Common Stock that may be issued in a private placement at a discount to the then-current market price without obtaining stockholder approval. As a result, the aggregate number of shares of Common Stock that will be issued upon the conversion or redemption of the Preferred Stock or payment of the dividends or Liquidation Preference will be limited to 19.99% of the outstanding shares of Common Stock on September 4, 2009 (the “Issuance Limitation”), unless stockholder approval is obtained. The Company has agreed to seek stockholder approval of this matter and to increase the number of authorized shares of Common Stock by 25 million shares. The Company is seeking this required stockholder approval at its annual meeting to be held on November 19, 2009.

Warrants

The Warrants entitle the holders to purchase 50% of the number of shares of Common Stock that may be obtained upon conversion of the Preferred Stock, or 1,321,250 shares. The Warrants have a five-year term and will become exercisable six months after their issuance. The exercise price is equal to the closing bid price of the Common Stock on September 3, 2009, or $10.56, and is not subject to anti-dilution protection, except in the case of stock splits and dividends.

Other Obligations

Pursuant to the Purchase Agreement, the Company filed a registration statement within 30 days following the closing of the Offering to register the shares of Common Stock issuable upon conversion of the Preferred Stock and exercise of the Warrants. Should the Company not have the registration declared effective, or if the registration is declared effective, but ceases to become effective, the Company would be liable for damages equal to 1% per month of the aggregate purchase price paid by the Preferred Stock holders. The Company does not consider this liability to be probable and has not recorded any amount on the Consolidated Balance Sheet. So long as at least $5 million of the Preferred Stock remains outstanding, the Purchasers are entitled to participate in any offering by the Company of its equity securities or securities convertible into or exchangeable for its equity securities, subject to certain exceptions, including any public offering of Common

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

9. SERIES A CONVERTIBLE PREFERRED STOCK AND WARRANTS — CONTINUED

Stock. The Purchase Agreement contains customary representations, warranties and covenants by the parties. In addition, each Purchaser made representations and other agreements with the Company regarding the Purchaser’s beneficial ownership and group status under Rule 13(d) of the Securities Exchange Act of 1934, as amended, as a result of the Offering.

Amendment to Credit Agreement

In connection with the Offering, the Company amended the Revolving Credit and Term Loan Agreement, dated April 30, 2008, between Peerless Mfg. Co., PMC Acquisition, Inc., the Company, Comerica Bank and other lenders party thereto (the “ Amendment “) to permit the terms of the Preferred Stock and to permit use of available cash to pay the Senior Subordinated Loan Agreement, dated April 30, 2008, between Peerless Mfg. Co., PMC Acquisition, Inc., the Company and Prospect Capital Corporation (the “Subordinated Term Loan”).

Additionally, the subordinated term loan of $20,000 was repaid in full using the proceeds from the Company’s private placement of preferred stock and warrants and available cash.

Original Accounting

Under the original accounting, the Company recorded the relative fair value of the preferred stock host contract as temporary equity. The net value of the preferred stock at the date of issuance was recorded as temporary equity on the balance sheet in the amount of $4,762 net of transaction costs of approximately $1,900. Additionally, an embedded derivative was identified for the conversion and redemption rights and recorded at a fair value of $9,030.

Additionally, under the original accounting, the Company recorded the fair value of the warrants as permanent equity. The net value of the warrants at the date of issuance was recorded as equity on the balance sheet in the amount of $5,443.


Cash proceeds from preferred stock issuance	$	21,140
Transaction costs		(1,905	)

Net proceeds from preferred stock issuance		19,235


Fair value of derivative liability	$	9,030

Preferred Stock/temporary equity (relative fair value)		4,762
Warrant/Equity (relative fair value)		5,443

Net fair value of preferred stock and warrants	$	19,235

10. STOCKHOLDER RIGHTS PLAN

On August 15, 2008, the Company adopted a new stockholder rights plan. The new rights plan replaced the Peerless rights plan, which was adopted in May 2007 and terminated in connection with the holding company reorganization. The terms of the new stockholder rights plan are substantially similar to the terms of the previous rights plan.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

10. STOCKHOLDER RIGHTS PLAN — CONTINUED

Stockholders of record at the close of business on August 15, 2008 received a dividend distribution of one right for each share of common stock outstanding on that date. The rights generally will become exercisable and allow the holder to acquire the Company’s common stock at a discounted price if a person or group (other than certain institutional investors specified in the rights plan) acquires beneficial ownership of 20% or more of the Company’s outstanding common stock. Rights held by those that exceed the 20% threshold will be void.

The rights plan also includes an exchange option. In general, after the rights become exercisable, the Board of Directors may, at its discretion, effect an exchange of part or all of the rights (other than rights that have become void) for shares of the Company’s common stock. Under this option, the Company would issue one share of common stock for each right, subject to adjustment in certain circumstances.

The Board of Directors may, at its discretion, redeem all outstanding rights for $0.001 per right at any time prior to the time the rights become exercisable. The rights will expire on August 15, 2018, unless earlier redeemed, exchanged or amended by the Board of Directors.

11. STOCK-BASED COMPENSATION

The following information represents the Company’s grants of stock-based compensation to employees and directors during the three months ended September 30, 2009 and 2008:


	Three months ended September 30,
	2009				2008
	Number of				Number of
	Shares		Fair Value		Shares		Fair Value
Grant Type	Granted		of Grant		Granted		of Grant
Stock		36,000	$	315		24,000	$	638
Restricted stock		99,881	$	873		32,758	$	872

The Company recognizes compensation expense for restricted stock awards over the four-year vesting period based on the fair value of the awards on the grant date, net of forfeitures. The fair value of stock and restricted stock awards is based on the fair market value of the Company’s stock on the date of grant.

12. FAIR VALUE MEASUREMENTS

The Company defines Fair Value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company utilizes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

12. FAIR VALUE MEASUREMENTS — CONTINUED

	•		Level 1 — Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes for transactions in active exchange markets involving identical assets.

	•		Level 2 — Quoted prices for similar assets and liabilities in active markets; quoted prices included for identical or similar assets and liabilities that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. These are typically obtained from readily-available pricing sources for comparable instruments.

	•		Level 3 — Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting entity’s own beliefs about the assumptions that market participants would use in pricing the asset or liability, based on the best information available in the circumstances.

The Company considers the conversion and redemption rights features of the Series A Convertible Preferred Stock to be embedded derivative features of the preferred stock host contract. The liabilities associated with these features are included as a derivative liability on the Consolidated Balance Sheet. The Company values these features using a Monte Carlo simulation and significant unobservable inputs. For the 3 months ended September 30, 2009, an increase in fair value of $2,500 was recorded to other expense in the Consolidated Statement of Operations.

The Company values its Interest Rate Cap using a Modified Black-Scholes valuation methodology and market data derived from published market data sources. For the 3 months ended September 30, 2009, a decrease in fair value of $12 was recorded as a component of interest expense in the Consolidated Statement of Operations.

Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):


	September 30,
	2009			Level 1		Level 2		Level 3

Derivatives related to conversion and redemption rights	$	(11,530	)	$	—	$	—	$	(11,530	)

Interest Rate Cap	$	26		$	—	$	26	$	—

The following is a summary of changes to fair value measurements using Level 3 inputs during the three months ended September 30, 2009:


Balance, July 1, 2009	$	—
Issuance of derivative instruments	$	(9,030	)
Change in fair value of derivative liability		(2,500	)

Balance, September 30, 2009	$	(11,530	)

13. SEGMENT INFORMATION

The Company has two reportable segments: Process Products and Environmental Systems. The Nitram acquisition is included in the Process Products segment. The Process Products segment produces various types of separators and filters used for removing liquids and solids from gases and air. The segment also includes industrial silencing equipment to control noise pollution on a wide range of industrial processes and heat transfer equipment to conserve energy in many industrial processes and in petro-chemical processing. The main product of the Environmental Systems segment is its Selective Catalytic Reduction Systems, referred to as “SCR systems.” These

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2009
(In thousands, except share and per share amounts)

13. SEGMENT INFORMATION — CONTINUED

environmental control systems are used for air pollution abatement and converting nitrogen oxide (NOx) emissions
from exhaust gases caused by burning hydrocarbon fuels such as coal, bio-fuels, natural gas and oil. Along with the SCR Systems, this segment also offers systems to reduce other pollutants such as carbon monoxide (CO) and particulate matter. The Company combines these systems with other components, such as instruments, controls and related valves and piping to offer its customers a totally integrated system.

Segment profit and loss is based on revenue less direct expenses of the segment before allocation of general, administrative, research and development costs. All inter-company transfers between segments have been eliminated. The Company allocates all costs associated with the manufacture, sale and design of its products to the appropriate segment. Segment information and reconciliation to operating profit for the three months ended September 30, 2009 and 2008 are presented below. The Company does not allocate general and administrative expenses (“reconciling items”), assets, expenditures for assets or depreciation expense on a segment basis for internal management reporting, and therefore this information is not presented.


	Three months ended,
	September 30,
	2009			2008
Revenues
Process Products	$	22,701		$	37,187
Environmental		8,630			6,469

Consolidated	$	31,331		$	43,656


Operating income
Process Products	$	4,592		$	3,427
Environmental		2,315			1,788
Reconciling items		(3,944	)		(4,300	)

Consolidated	$	2,963		$	915

14. SUBSEQUENT EVENTS

The Company has evaluated subsequent events through November 9, 2009, which is the date the financial statements were issued, and has concluded that no such events or transactions took place which would require disclosure herein.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

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

The following discussion of our results of operations and financial condition should be read together with our consolidated financial statements and the notes thereto included in Item 1 of this Report. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in this and other reports we file with the Securities and Exchange Commission (the “SEC”), including the information in “Item 1A. Risk Factors” of Part I to our Annual Report for the year ended June 30, 2009. These factors could cause our actual results for future periods to differ materially from those experienced in, or implied by, these forward-looking statements.

We begin this discussion with an overview of our Company to give you an understanding of our business and the markets we serve. The overview also includes a brief summary of recent developments regarding our acquisition of Nitram. This overview is followed by a discussion of our results of operations for the three months ended September 30, 2009 and 2008, including a discussion of significant period-to-period variances. We also include information regarding our two reportable business segments: process products and environmental systems. We then discuss our financial condition at September 30, 2009 with a comparison to June 30, 2009. This discussion includes information regarding our liquidity and capital resources, including cash flows from operating, investing and financing activities.

All share and per share amounts in this Report, including in this discussion and in our consolidated financial statements, have been retroactively adjusted to give effect to the holding company reorganization, including the two-for-one exchange of PMFG common stock for Peerless common stock.

Overview

We are a leading provider of custom-engineered systems and products designed to help ensure that the delivery of energy is safe, efficient and clean. We primarily serve the markets for power generation, natural gas infrastructure, and refining and petrochemical processing. We offer a broad range of separation and filtration products, selective catalytic reduction, turbine emission exhaust and silencing systems, and other complementary products including specialty heat exchangers, pulsation dampeners and silencers. Our primary customers include equipment manufacturers, engineering contractors and operators of power plants.

Our products and systems are marketed worldwide. In each of the last three fiscal years, more than 35% of our revenues have been generated from outside the United States. We expect our international sales to continue to be an increasingly important part of our business.

On September 4, 2009, we issued and sold shares of Series A convertible preferred stock and warrants in a private placement for an aggregate purchase price of $21,140. We used the net proceeds and available cash to repay all outstanding indebtedness under our subordinated term loan. In accordance with NASDAQ rules, the aggregate number of shares of common stock that may be issued upon the conversion or redemption of the preferred stock or upon dividend or liquidation payments is limited to 19.99% of the outstanding shares of our common stock on September 4, 2009, unless the requisite stockholder approval is obtained. In connection with this private placement, we have agreed to seek stockholder approval of this matter and to increase the number of authorized shares of common stock by 25 million shares. We are seeking this required stockholder approval at our annual meeting of stockholders to be held on November 19, 2009.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

On September 9, 2009, in recognition of the weak global business environment, we amended our senior secured tem loan agreement to adjust certain of the financial covenant requirements. The amendment enhances our financial flexibility by relaxing certain of the required financial covenants for the remaining terms of the senior term loan and revolving credit facility. In connection with the amendment, the interest rate margins on the senior term loan and revolving credit facility were revised as follows: (a) for prime rate term loans, the margin is between 275 and 400 basis points; (b) for LIBOR rate term loans, the margin is between 375 and 500 basis points; (c) for prime rate revolving loans, the margin is between 275 and 375 basis points; and (d) for LIBOR rate revolving loans, the margin is between 350 and 475 basis points.

As a result of the Nitram acquisition on April 30, 2008, Nitram’s results of operations have been included in our consolidated financial statements from the date of acquisition. Purchase accounting for this acquisition resulted in the allocation of a portion of the purchase price to Nitram’s net assets, including tangible and intangible assets. This allocation resulted in increases to the fair value of Nitram’s inventory and backlog by $4,606 and $6,489, respectively. Of these amounts, $2,258 of this inventory cost was expensed in the last two months of fiscal 2008 and the remaining $2,348 was expensed in fiscal 2009, with $1,823 expensed in the 3 months ended September 30, 2008. Backlog of $2,734 was amortized in the last two months of fiscal 2008, and the remaining $3,755 was amortized in fiscal 2009, with $2,702 expensed in the three months ended September 30, 2008. The above expenses increased our reported cost of goods sold for the respective periods. For a further discussion of our allocation of the purchase price to the fair value of the assets acquired and liabilities assumed in the Nitram acquisition, see Note D to our consolidated financial statements included our Annual Report on Form 10-K for the year ended June 30, 2009.

Critical Accounting Policies

See the Company’s critical accounting policies as described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II of our Annual Report on Form 10-K for the year ended June 30, 2009. Since the date of that report, there have been no material changes to our critical accounting policies.

Results of Operations

The following summarizes our consolidated statements of operations as a percentage of revenues:


	Three months ended
	September 30,
	2009			2008
Revenues		100.0	%		100.0	%
Cost of goods sold		62.4	%		74.2	%

Gross profit		37.6	%		25.8	%
Operating expenses		28.1	%		23.7	%

Operating income		9.5	%		2.1	%
Other expense		(15.3	)%		(4.4	)%

Loss before income taxes		(5.8	)%		(2.3	)%
Income tax benefit (expense)		(0.8	)%		0.8	%

Net loss		(6.6	)%		(1.5	)%
Less net loss attributable to noncontrolling interest		0.1	%		—	%

Net loss attributable to PMFG, Inc.		(6.5	)%		(1.5	)%
Dividends on preferred stock		(0.3	)%		—	%

Income applicable to PMFG common stockholders		(6.8	)%		(1.5	)%

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

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

Operating expenses include sales and marketing expenses, engineering and project management expenses, and general and administrative expenses.

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

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

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

Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008

Results of Operations — Consolidated

Revenues.We classify revenues as domestic or international based upon the origination of the order. Revenues generated by orders originating from within the United States are classified as domestic revenues. Revenues generated by orders originating from a country other than the United States are classified as international revenues. The following summarizes consolidated revenues:


	Three months ended September 30,
	2009		% of Total			2008		% of Total
	($ in thousands)
Domestic	$	21,577		68.9	%	$	28,331		64.9	%
International		9,754		31.1	%		15,325		35.1	%

Total	$	31,331		100.0	%	$	43,656		100.0	%

Total revenues decreased $12,325, or 28.2%, for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 as domestic revenues decreased $6,754, or 23.8%, and international revenues decreased $5,571, or 36.4%. The decrease in both the domestic and international revenues can be attributed to the weak global business environment.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

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


	Three months ended September 30,
	2009		% of Revenues			2008		% of Revenues
	($ in thousands)
Revenues	$	31,331		100.0	%	$	43,656		100.0	%
Cost of goods sold		19,564		62.4	%		32,379		74.2	%

Gross profit	$	11,767		37.6	%	$	11,277		25.8	%

For the three months ended September 30, 2009, our gross profit increased $490, or 4.3%, compared to the three months ended September 30, 2008. Our gross profit, as a percentage of revenues, increased to 37.6% for the three months ended September 30, 2009 compared to 25.8% for the same period a year ago. The increase in gross profit as a percentage of revenues during the three months ended September 30, 2009 primarily related to the amortization of inventory and backlog associated with the Nitram acquisition included in fiscal 2009, with no corresponding expense in the current year. The improved gross profit was partially offset by the decrease in total revenues experienced this quarter.

Operating Expenses.The following summarizes operating expenses:


	Three months ended September 30,
	2009		%of Revenues			2008		%of Revenues
	($ in thousands)
Sales and marketing	$	3,010		9.6	%	$	4,086		9.4	%
Engineering and project management		1,850		5.9	%		1,976		4.5	%
General and administrative		3,944		12.6	%		4,300		9.8	%

Total	$	8,804		28.1	%	$	10,362		23.7	%

Operating expenses decreased $1,558, or 15.0%, for the three months ended September, 30, 2009 compared to the same period a year ago. As a percentage of revenues, these expenses decreased to 28.1% during the three months ended September 30, 2009 from 23.7% during the three months ended September 30, 2008. Our sales and marketing expenses decreased $1,076 during the three months ended September 30, 2009 compared to the same period in the previous year primarily due to commissions and other selling related expenses associated with the lower revenues in the current quarter, combined with cost control actions taken by management in response to the weak global environment. Our engineering and project management expenses decreased $126 for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 primarily due to decreased support activities associated with decreased revenues in the current quarter and cost control actions taken by management. General and administrative expenses decreased $356 during the three months ended September 30, 2009 compared to the same period a year ago primarily due to cost-cutting initiatives instituted by management.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

Other Income and Expense.The following summarizes other income and expense:


	Three months ended September 30,
	2009			% of Revenues			2008			% of Revenues
	($ in thousands)
Interest income	$	12			—	%	$	78			0.2	%
Interest expense		(1,211	)		(3.9	)%		(1,596	)		(3.7	)%
Loss on extinguishment of debt		(1,303	)		(4.2	)%		—			—	%
Foreign exchange gain (loss)		204			0.7	%		(650	)		(1.5	)%
Change in fair value of derivative liability		(2,500	)		(8.0	)%		—			—	%
Other income (expense), net		—			—	%		228			0.5	%

Total other income (expense)	$	(4,798	)		(15.3	)%	$	(1,940	)		(4.4	)%

For the three months ended September 30, 2009, total other income (expense) items increased by $2,858, compared to the three months ended September 30, 2008 primarily due to the recognition of $1,303 deferred financing costs on the subordinated term loan which was paid off out of preferred stock proceeds and available cash, and a $2,500 fair value adjustment of the derivative liability, offset by $204 of foreign exchange gains.

Income Taxes.Our effective income tax rate was (14%) and 35% for the three months ended September 30, 2009 and 2008, respectively. Our effective rate for the three months ended September 30, 2009, was impacted by a non-deductible charge to adjust our derivative liability in the amount of $2,500.

Net Earnings (Loss).Net loss increased by $1,375 to a net loss of $2,041 during the three months ended September 30, 2009, from net loss of $666 during the same period in the previous year. Basic and diluted loss per share increased from a loss of $0.05 per share for the first three months of fiscal 2009, to a loss of $0.16 per share for the first three months of fiscal 2010. The increase in the current year loss and the per share loss resulted primarily from interest expense related to the write off of capitalized debt issuance costs associated with the senior subordinated debt, and the fair value adjustment of the derivative liability.

Results of Operations — Segments

We have two lines of business: Process Products and Environmental Systems. Revenues and operating income in this section are presented on a basis consistent with accounting principles generally accepted in the United States of America (“US GAAP”). Certain corporate level expenses have been excluded from our segment operating results and are analyzed separately.

Process Products

The Process Products segment produces specialized systems and products that remove contaminants from gases and liquids, improving efficiency, reducing maintenance and extending the life of energy infrastructure. Process Products represented 72.5% and 85.2% of our revenues for the three months ended September 30, 2009 and 2008, respectively.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

The following summarizes Process Products revenues and operating income:


	Three months ended September 30,
	2009			2008
	($ in thousands)
Revenues	$	22,701		$	37,187
Operating income	$	4,592		$	3,427

Operating income as % of revenues		20.2	%		9.2	%

Process Products revenues decreased by $14,486, or 39.0%, during the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Domestic and international revenues decreased compared to the prior year period. The decrease in revenues, both domestically and internationally, can be attributed to the weak global environment.

Process Products operating income for the three months ended September 30, 2009 increased $1,165, or 34.0%, compared to the same period a year ago. As a percentage of Process Products revenues, operating income was 20.2% and 9.2% for the three months ended September 30, 2009 and 2008, respectively. The increase in operating income as a percentage of revenues during the three months ended September 30, 2009 is primarily related to the improved gross profit as a percentage of revenue in the current period, partially offset by the decrease in revenues. The improved gross profit as a percentage of revenue in the current year is attributable to the Nitram backlog and inventory costs included in fiscal 2009 costs that were not replicated in the current year.

Environmental Systems

The primary product of our Environmental Systems business is selective catalytic reduction systems, which we refer to as SCR systems. SCR systems are integrated systems, with instruments, controls and related valves and piping. Our SCR systems convert nitrogen oxide, or NOx, into nitrogen and water, reducing air pollution and helping our customers comply with environmental regulations. Environmental Systems represented 27.5% and 14.8% of our revenues for the three months ended September 30, 2009 and 2008, respectively.

The following summarizes Environmental Systems revenues and operating income:


	Three months ended September 30,
	2009			2008
	($ in thousands)
Revenues	$	8,630		$	6,469
Operating income	$	2,315		$	1,788

Operating income as % of revenues		26.8	%		27.6	%

Revenues from environmental systems increased $2,161, or 33.4%, during the three months ended September 30, 2009 compared to the same period in the previous year. A portion of the higher revenue is the result of increased international sales of NOx reduction solutions.

Environmental Systems operating income for the three months ended September 30, 2009 increased $527, or 29.5%, compared to the three months ended September 30, 2008. As a percentage of environmental systems revenues, operating income decreased to 26.8% during the three months ended September 30, 2009 from 27.6% for the same period in the prior year.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

Corporate Level Expenses

Corporate level general and administrative expenses were $3,944 and $4,300 for the three months ended September 30, 2009 and 2008, respectively. These expenses are excluded from our segment operating results. See “Operating Expenses” above for additional discussion.

Contingencies

Backlog

Our backlog of uncompleted orders was $61,000 at September 30, 2009, compared to $73,000 at June 30, 2009. Backlog has been calculated under our customary practice of including incomplete orders for products that are deliverable in future periods but that could be changed or cancelled. We believe the decrease in our backlog can be attributed to the weak global economy.

Financial Position

Assets.Total assets increased by $520, or 0.3%, from $153,180 at June 30, 2009, to $153,700 at September 30, 2009. On September 30, 2009, we held cash and cash equivalents of $20,805, had working capital of $40,921 and a current liquidity ratio of 1.8-to-1.0. This compares with cash and cash equivalents of $17,738, working capital of $40,247, and a current liquidity ratio of 1.8-to-1.0 at June 30, 2009.

Liabilities and Equity.Total liabilities decreased by $8,191, or 7.6%, from $107,222 at June 30, 2009 to $99,031 at September 30, 2009. The decrease in our total liabilities is attributed to the repayment of all outstanding indebtedness under our subordinated term loan partially offset by the increase in the derivative liabilities associated with the sale of the Series A convertible preferred stock.

The increase in our equity of $8,711, or 19.0%, from $45,958 at June 30, 2009 to $54,669 at September 30, 2009 is primarily attributable to an increase in additional paid-in capital related to warrants issued in the preferred stock transaction on September 4, 2009, and an increase in temporary equity attributable to the preferred stock issuance of 21,140 shares. Our ratio of debt (total liabilities)-to-equity improved from 2.3-to-1.0 at June 30, 2009 to 1.8-to-1.0 at September 30, 2009.

Liquidity and Capital Resources

Because we are engaged in the business of manufacturing systems, our progress billing practices are event-oriented rather than date-oriented and vary from contract to contract. We typically bill our customers upon the occurrence of project milestones. Billings to customers affect the balance of billings in excess of costs and earnings on uncompleted contracts or the balance of costs and earnings in excess of billings on uncompleted contracts, as well as the balance of accounts receivable. Consequently, we focus on the net amount of these accounts along with accounts payable, to determine our management of working capital. At September 30, 2009, the balance of these working capital accounts was $25,053 compared to $27,387 at June 30, 2009, reflecting a decrease of our investment in these working capital items of $2,334. Generally, a contract will either allow for amounts to be billed upon shipment or on a progress basis based on the attainment of certain milestones.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

Our cash and cash equivalents were $20,805 as of September 30, 2009 compared to $17,738 at June 30, 2009. During the three months ended September 30, 2009, cash provided by operating activities was $4,286 for the three months ended September 30, 2009 compared to cash used in operating activities of $3,580 for the three months ended September 30, 2008, primarily related to changes in accounts payable in the current period and accounts receivable in the prior year.

Cash used in investing activities was $10 for the three months ended September 30, 2009, compared to $304 for the three months ended September 30, 2008. Cash used during the three months ended September 30, 2009 and 2008 related primarily to purchases of property and equipment.

Cash used in financing activities during the three months ended September 30, 2009 was $1,260 compared to $1,196 during the same period in the previous year. The cash used in financing activities for the three months ended September 30, 2009 primarily related to $20,000 principal payments on the subordinated term loan offset by net proceeds from preferred stock issuance of $19,235 and the noncontrolling interest’s investment of $505 in our China subsidiary.

As a result of the events described above, our cash and cash equivalents during the three months ended September 30, 2009 increased by $3,067 compared to a decrease of $4,797 during the three months ended September 30, 2008.

We believe we maintain adequate liquidity to support existing operations and planned growth over the next 12 months.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary market risk exposures are interest rate risk and foreign currency exchange rate risk. During the three months ended September 30, 2009, there were no material changes in our primary market risk exposures.

Item 4. Controls and Procedures

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

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

Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls could be circumvented by the individual acts of some

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

persons or by collusion of two or more people. The Company’s controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met.

During the quarter ended September 30, 2009, there have been no changes in the Company’s internal control over financial reporting, or in other factors, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

There have been no material changes in our risk factors from those disclosed in Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended June 30, 2009.

Item 6. Exhibits

The following exhibits are filed as part of this report.


Exhibit
Number		Exhibit
31.1		Rule 13a — 14(a)/15d — 14(a) Certification of Chief Executive Officer.

31.2		Rule 13a — 14(a)/15d — 14(a) Certification of Chief Financial Officer.

32		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.

PMFG, Inc. and Subsidiaries
September 30, 2009
(In thousands, except share and per share amounts)

SIGNATURES

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


	PMFG, INC.
Date: November 9, 2009	/s/ Peter J. Burlage
	Peter J. Burlage
	President and Chief Executive Officer (Principal Executive Officer)


Date: November 9, 2009	/s/ Henry G. Schopfer, III
	Henry G. Schopfer, III
	Chief Financial Officer (Principal Financial and Accounting Officer)

EXHIBIT INDEX


Exhibit
Number		Exhibit
31.1		Rule 13a — 14(a)/15d — 14(a) Certification of Chief Executive Officer.

31.2		Rule 13a — 14(a)/15d — 14(a) Certification of Chief Financial Officer.

32		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	8th grade Avg

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