Pmfg 10Q 2009 Q2 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 December 31, 2008


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

For the transition period from to

Commission File Number 001-34156

PMFG, INC.

(Exact name of registrant as specified in its charter)


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

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

(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 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:o	Accelerated filer:þ	Non-accelerated filer:o	Smaller reporting company:o
		(Do not check if a smaller reporting company)

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

The number of shares of the registrant’s common stock issued and outstanding on February 9, 2009, was 13,080,134.

TABLE OF CONTENTS


	Page
	Number
Forward-Looking Statements		3

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets at December 31, 2008 (unaudited) and June 30, 2008		4

Consolidated Statements of Operations for the three and six months ended December 31, 2008 and 2007 (unaudited)		5

Consolidated Statements of Cash Flows for the six months ended December 31, 2008 and 2007 (unaudited)		6

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the six months ended December 31, 2008 (unaudited)		7

Notes to the Consolidated Financial Statements		8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19

Item 3. Quantitative and Qualitative Disclosures About Market Risk		30

Item 4. Controls and Procedures		30

PART II: OTHER INFORMATION

Item 1. Legal Proceedings		31

Item 1A. Risk Factors		31

Item 4. Submission of Matters to a Vote of Security Holders		32

Item 6. Exhibits		32

SIGNATURES		33
EX-10.1
EX-31.1
EX-31.2
EX-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 customers’ ability to access capital markets;

	•		changes in the price, supply or demand for natural gas;

	•		changes in current environmental legislation;

	•		increased competition;

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

	•		decreased demand for our products;

	•		risks associated with our recent acquisition of Nitram Energy, Inc., including the integration of Nitram’s operations with those of the Company and the significant indebtedness that we incurred in connection with this acquisition;

	•		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;

	•		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, 2008. 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 amount)


	December 31,			June 30,
	2008			2008
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	6,710		$	11,444
Restricted cash		2,659			2,789
Accounts receivable, principally trade — net of allowance for doubtful accounts of $862 and $625 at December 31, 2008 and June 30, 2008, respectively		39,546			37,532
Inventories — net		12,487			15,904
Costs and earnings in excess of billings on uncompleted contracts		20,801			24,468
Deferred income taxes		2,342			2,330
Other current assets		2,561			2,479

Total current assets		87,106			96,946

Property, plant and equipment — net		8,351			8,324
Intangible assets — net		22,685			27,097
Goodwill		27,420			27,875
Investment in unconsolidated entity		2,034			1,930
Other assets		4,254			4,564

Total assets	$	151,850		$	166,736


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	16,479		$	23,358
Current maturities of long-term debt		4,000			4,000
Billings in excess of costs and earnings on uncompleted contracts		5,687			6,770
Commissions payable		3,486			1,618
Income taxes payable		36			885
Accrued product warranties		1,059			1,224
Customer deposits		3,517			4,822
Accrued liabilities and other		8,587			11,935

Total current liabilities		42,851			54,612

Long-term debt		54,000			56,000
Deferred income taxes		12,200			12,196
Other non-current liabilities		969			997

Commitments and contingencies

Stockholders’ equity:
Common stock — authorized, 25,000,000 shares of $0.01 par value; issued and outstanding, 13,080,134 and 13,023,370 shares at December 31, 2008 and June 30, 2008, respectively		131			130
Additional paid-in capital		9,930			9,018
Retained earnings		33,281			33,453
Accumulated other comprehensive income (loss)		(1,512	)		330

Total stockholders’ equity		41,830			42,931

Total liabilities and stockholders’ equity	$	151,850		$	166,736

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands, except per share amounts)


	Three months ended						Six months ended
	December 31,						December 31,
	2008			2007			2008			2007
	(unaudited)						(unaudited)
Revenues	$	39,105		$	37,086		$	82,761		$	67,104
Cost of goods sold		26,826			24,668			59,205			44,301

Gross profit		12,279			12,418			23,556			22,803

Operating expenses
Sales and marketing		4,160			3,036			8,246			5,453
Engineering and project management		2,069			1,319			4,045			2,451
General and administrative		4,179			2,821			8,479			4,873

		10,408			7,176			20,770			12,777

Operating income		1,871			5,242			2,786			10,026

Other income (expense)
Interest income		45			315			123			682
Interest expense		(1,597	)		—			(3,193	)		—
Foreign exchange gain (loss)		575			(102	)		(75	)		(33	)
Other income (expense), net		(134	)		—			94			(9	)

		(1,111	)		213			(3,051	)		640


Earnings (loss) before income taxes		760			5,455			(265	)		10,666
Income tax (expense) benefit		(266	)		(1,905	)		93			(3,730	)

Net earnings (loss)	$	494		$	3,550		$	(172	)	$	6,936


Basic earnings (loss) per share	$	0.04		$	0.28		$	(0.01	)	$	0.54

Diluted earnings (loss) per share	$	0.04		$	0.27		$	(0.01	)	$	0.53


Weighted-average shares outstanding:
Basic		12,958			12,821			12,951			12,812
Effect of dilutive options and restricted stock		233			194			—			156

Diluted		13,191			13,015			12,951			12,968

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)


	Six months ended December 31,
	2008			2007
	(unaudited)
Cash flows from operating activities:
Net earnings (loss)	$	(172	)	$	6,936
Depreciation and amortization		5,407			386
Deferred income taxes		(8	)		12
Deferred rent expense		(28	)		98
Bad debt expense		237			—
Provision for warranty expense		(117	)		335
Inventory valuation reserve		90			204
Foreign exchange (gain) loss		75			33
Stock-based compensation		913			610
Excess tax benefits from stock-based payment arrangements		—			(15	)
Changes in operating assets and liabilities:
Accounts receivable		(3,667	)		1,557
Inventories		3,166			(2,065	)
Costs and earnings in excess of billings on uncompleted contracts		3,624			(9,987	)
Other current assets		(83	)		98
Other assets		16			589
Accounts payable		(8,178	)		6,612
Billings in excess of costs and earnings on uncompleted contracts		(1,083	)		688
Commissions payable		1,868			554
Income taxes		(849	)		1,737
Accrued product warranties		(48	)		(16	)
Accrued liabilities, customer deposits and other		(4,964	)		1,898

Net cash provided by (used in) operating activities:		(3,801	)		10,264

Cash flow from investing activities:
Increase in restricted cash		(616	)		—
Purchases of property and equipment		(636	)		(569	)
Post closing purchase price adjustment		455			—

Net cash used in investing activities:		(797	)		(569	)

Cash flows from financing activities:
Payment of debt issuance cost		(196	)		27
Payment of long-term debt		(2,000	)		15

Net cash used in financing activities		(2,196	)		42

Effect of exchange rate changes on cash and cash equivalents		2,060			68

Net increase (decrease) in cash and cash equivalents		(4,734	)		9,805

Cash and cash equivalents at beginning of period		11,444			17,015


Cash and cash equivalents at end of period	$	6,710		$	26,820


Supplemental disclosures:
Interest paid	$	2,578		$	—
Income taxes paid	$	510		$	—

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

(In thousands)


										Accumulated
					Additional					Other			Total
	No. of		Common		Paid-in		Retained			Comprehensive			Stockholders’
	Shares		Stock		Capital		Earnings			Income (Loss)			Equity
	(unaudited)
Balance at July 1, 2008		13,024	$	130	$	9,018	$	33,453		$	330		$	42,931

Comprehensive income
Net loss from continuing operations								(172	)					(172	)
Foreign currency translation adjustment											(1,842	)		(1,842	)

Total comprehensive income														(2,014	)

Stock awards		24		1		638								639

Restricted stock awards		32				250								250

Stock option expense						24								24


Balance at December 31, 2008		13,080	$	131	$	9,930	$	33,281		$	(1,512	)	$	41,830

See accompanying notes to consolidated financial statements.

PMFG, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2008

(Amounts 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 (the “Company”) 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. The consolidated financial statements of the Company as of December 31, 2008 and for the three and six months ended December 31, 2008 and December 31, 2007 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, 2008.

Holding Company Reorganization and Stock Conversion

On August 15, 2008, the Company completed a holding company reorganization. In the reorganization, Peerless Mfg. Co., a Texas corporation, became a wholly-owned subsidiary of PMFG, Inc., a newly formed Delaware corporation. Shareholders of Peerless Mfg. Co. received two shares of common stock of PMFG, Inc. for each outstanding share of common stock of Peerless Mfg. Co. held prior to the reorganization. As a result, the reorganization also had the effect of a two-for-one stock split. The Company’s business, operations and management did not change as a result of the holding company reorganization. Under SEC Rules, PMFG, Inc. is a successor registrant to Peerless Mfg. Co.

The share data and per share data included in these consolidated financial statements for all periods presented have been retroactively adjusted to give effect to this reorganization.

References to “Company,” “we,” “us” and “our” refer to (a) PMFG, Inc. and its subsidiaries after the holding company reorganization, and (b) Peerless Mfg. Co. and its subsidiaries prior to the holding company reorganization, in each case unless the context requires otherwise. Additionally, references to “PMFG” refer to PMFG, Inc. and references to “Peerless” refer to Peerless Mfg. Co., in each case unless the context requires otherwise.

Acquisition of Nitram Energy, Inc.

On April 30, 2008, the Company acquired all of the outstanding common stock of Nitram Energy, Inc. (“Nitram”). At June 30, 2008, the Company had estimated the purchase price to be $63,110 subject to post-closing working capital adjustments. During the six months ended December 31, 2008, the Company identified an additional $455 post-closing working capital adjustment that reduced the estimated purchase price to $62,655, and caused an adjustment to reduce goodwill to $27,420. The Company anticipates that the purchase price and allocation of the purchase price will be finalized during the year ending June 30, 2009. Nitram is the parent company of Burgess-Manning, Inc., Bos-Hatten, Inc., and Alco Products, a division of Nitram. Nitram’s results of operations have been included in the Company’s consolidated financial statements from the date of acquisition.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

1. SIGNIFICANT ACCOUNTING POLICIES — Continued

Consolidation

The Company consolidates the accounts of its subsidiaries which are wholly owned. All inter-company accounts and transactions have been eliminated in consolidation. The Company considers its inter-company foreign transactions to be long-term in nature, and as a result records the corresponding foreign currency transaction gains and losses as a component of other comprehensive income. 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.

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, 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

On October 1, 2007, the Company voluntarily elected to change its method of valuing its inventory to the lower of weighted-average cost or market. Prior to that date, the Company valued its inventory at the lower of cost or market, with cost determined by the first-in, first-out (FIFO) method, including material, labor and factory overhead. The new method of accounting was adopted to more closely follow the flow of costs.

Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections,” issued by the Financial Accounting Standards Board (the “FASB”) in May 2005, requires that voluntary changes in an accounting principle are to be applied retrospectively to prior financial statements. The effect of the change was immaterial to the Company’s consolidated results of operations for the three and six months ended December 31, 2007. Therefore, retroactive application has not been presented.

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 valuation may be required.

Long-Lived Assets

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of 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.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

1. SIGNIFICANT ACCOUNTING POLICIES — Continued

Intangible Assets and Goodwill

The amount of recorded goodwill relates primarily to the Nitram acquisition 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 amount may not be recoverable.

The domestic and international economies are currently experiencing a significant recession and there has also been an increase in credit restrictions in the global financial markets. Management is uncertain as to the depth or length of this uncertainty. Our current assessment does not indicate any impairment. Management will continue to evaluate and monitor the economic environment and will evaluate any impact to its intangible assets and goodwill.

Revenue Recognition

The Company provides products under long-term, generally fixed-priced, contracts that may extend up to 18 months, or longer, in duration. In connection with these contracts, the Company follows the guidance contained in AICPA Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”). SOP 81-1 requires the use of 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 revenues are calculated using the percentage of construction cost completed, generally on a cumulative cost to total cost basis. Cumulative revenues 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.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

1. SIGNIFICANT ACCOUNTING POLICIES — Continued

Earnings (Loss) Per Share

Basic earnings (loss) per common share is computed by dividing net earnings (loss) by the weighted-average number of common shares outstanding during each period presented. Diluted earnings (loss) per common share give effect to the assumed exercise of stock options when dilutive.

For the three months ended December 31, 2008, common stock equivalents comprised of no stock options and 37,258 shares of restricted stock have been excluded from the diluted weighted-average common shares because they were anti-dilutive. For the six months ended December 31, 2008, common stock equivalents comprised of 207,948 stock options and 124,037 shares of restricted stock have been excluded from the diluted weighted-average common shares because they were anti-dilutive. No stock options or restricted stock were excluded in the calculation of diluted weighted-average common shares for the three and six months ended December 31, 2007.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), that serves to define fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. The Company adopted SFAS 157 effective July 1, 2008 with no effect to its results of operations or financial position. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Examples of items to which this FSP applies include, but are not limited to, reporting units measured at fair value in the first step of a goodwill impairment test and long-lived assets (asset groups) measured at fair value for an impairment assessment (e.g. inventory impairment assessments). This FSP defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities to July 1, 2009. The Company is currently evaluating the impact, if any, of SFAS 157 related to nonfinancial assets and nonfinancial liabilities on its results of operations and financial position.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). Under the provisions of SFAS 159, companies may elect to measure specified financial instruments and warranty and insurance contracts at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings. The election, called the “fair value option,” enables companies to reduce the volatility in reported earnings caused by measuring related assets and liabilities differently, and is simpler than using the complex hedge accounting requirements in FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), to achieve similar results. The Company adopted SFAS 159 effective July 1, 2008 with no effect to its results of operations or financial position.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141R”), which requires most identifiable assets, liabilities, non-controlling interests, and goodwill acquired in a business combination to be recorded at “full fair value.” SFAS 141R applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under SFAS 141R, all business combinations will be accounted for by applying the acquisition method. SFAS 141R is prospectively effective for business combinations for which the acquisition

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

2. RECENT ACCOUNTING PRONOUNCEMENTS — Continued

date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company will adopt
SFAS 141R on July 1, 2009.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”(“SFAS 161”). SFAS 161 requires additional disclosures about the objectives of the derivative instruments and hedging activities, the method of accounting for such instruments under SFAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on our financial position, financial performance, and cash flows. SFAS 161 is effective for the Company beginning January 1, 2009. The Company expects no potential impact on its financial statements as a result of adoption of
SFAS 161.

In April 2008, the FASB issued FASB Staff Position FAS 142-3,“Determination of the Useful Life of Intangible Assets”(“FSP FAS 142-3”), to revise the factors that an entity should consider to develop renewal or extension assumptions used in determining the useful life of a recognized intangible asset. The purpose of FSP FAS 142-3 is to improve consistency between the period of expected cash flows used to measure the fair value of a recognized intangible asset and the useful life of the intangible asset as determined under SFAS No. 142. FSP FAS 142-3 is effective for financial statements issued for years beginning after December 15, 2008 and for interim periods within those years with early adoption not permitted. FSP FAS 142-3 is effective for the Company beginning July 1, 2009. The Company is currently assessing the potential impact that adoption of FSP FAS 142-3 may have on its financial statements.

In May 2008, the FASB issued SFAS No. 162,“The Hierarchy of Generally Accepted Accounting Principles”(“SFAS 162”). SFAS 162 supersedes Statement on Auditing Standards No. 69,“The Meaning ofPresent Fairly in Conformity with Generally Accepted Accounting Principles”(“SAS 69”). The guidance in this new standard, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements in conformity with GAAP, is not materially different from the guidance contained in SAS 69. There is no impact on the financial statements as a result of its adoption on November 15, 2008.

3. INVENTORIES

Principal components of inventories are as follows:


	December 31,			June 30,
	2008			2008
Raw materials	$	7,442		$	6,804
Work in progress		4,935			9,041
Finished goods		739			684

		13,116			16,529
Reserve for obsolete and slow-moving inventory		(629	)		(625	)

	$	12,487		$	15,904

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

4. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

The components of uncompleted contracts are as follows:


	December 31,			June 30,
	2008			2008
Costs incurred on uncompleted contracts and estimated earnings	$	77,669		$	154,142
Less billings to date		(62,555	)		(136,444	)

	$	15,114		$	17,698

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


	December 31,			June 30,
	2008			2008
Costs and earnings in excess of billings on uncompleted contracts	$	20,801		$	24,468
Billings in excess of costs and earnings on uncompleted contracts		(5,687	)		(6,770	)

	$	15,114		$	17,698

5. ACCRUED PRODUCT WARRANTIES

Accrued product warranty activity is as follows:


	Three months ended						Six months ended
	December 31,						December 31,
	2008			2007			2008			2007
Balance at beginning of period	$	1,273		$	947		$	1,224		$	641
Provision for warranty expenses		(191	)		19			(117	)		335
Warranty charges		(23	)		(6	)		(48	)		(16	)

Balance at end of period	$	1,059		$	960		$	1,059		$	960

6. ACCRUED LIABILITIES AND OTHER

The components of accrued liabilities and other are as follows:


	December 31,		June 30,
	2008		2008
Accrued start-up (commissioning) expense	$	3,544	$	3,426
Accrued compensation		1,539		3,070
Accrued professional, legal and other expenses		1,722		3,507
Nitram Subchapter S tax deposit		728		728
Interest payable		872		681
Other		181		523

	$	8,586	$	11,935

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

7. DEBT

Outstanding long-term debt obligations are as follows:


				December 31,			June 30,
	Interest Rate	Maturities		2008			2008
Senior secured credit facilities:
Revolving credit facility	Prime + 1%		2011	$	—		$	—
Term loan	* Prime + 1.25%		2008-2013		38,000			40,000

Total senior secured credit facilities					38,000			40,000
Subordinated secured term loan	15%		2013		20,000			20,000

Total debt					58,000			60,000
Less current maturites					(4,000	)		(4,000	)

Total long-term debt				$	54,000		$	56,000


*		Interest rate on portion of Term loan: LIBOR + 3.50%

At December 31, 2008, there were $11,828 of letters of credit outstanding under our revolving credit facility. The amount available under our revolving credit facility, based on formula availability, at December 31, 2008 was $8,172. During the quarter, interest rates floated on our revolving credit facility and on $23,000 of the senior secured term loan ending at 4.25% and 4.5%, respectively on December 31, 2008. The senior secured credit facilities are secured by a first lien on substantially all assets of the Company. The subordinated secured term loan is secured by a second lien on substantially all assets of the Company.

As required by its Revolving Credit and Term Loan Agreement, the Company entered into a LIBOR interest rate cap transaction with respect to the senior secured 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. On the first business day of each quarter, for the applicable notional amount outstanding under the Interest Rate Cap Transaction for the prior quarter, the Company will pay the three month LIBOR rate at the beginning of the prior quarter plus the spread of 275 to 350 according to the Revolving Credit and Term Loan Agreement. Under the terms of the Interest Rate Cap Transaction, if that LIBOR rate is in excess of 3.70%, the counterparty will pay the Company 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 will amortize in the amount of (i) $5,000 on October 1, 2008, October 1, 2009 and October 1, 2010 and (ii) $4,500 on October 3, 2011. As long as the payments required under the Interest Rate Cap Transaction are made, the Company will have a maximum annual LIBOR interest rate exposure equal to the sum of 3.70% and a margin of 275 to 350 basis points based on the Company’s consolidated total leverage ratio, for the term of the Interest Rate Cap Transaction. At December 31, 2008, the Interest Rate Cap Transaction had a fair market value of $47.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

7. DEBT — Continued

The Company’s U.K. subsidiary has a £3,250 ($4,743) debenture agreement used to facilitate issuances of letters of credit and bank guarantees. At December 31, 2008, this facility was secured by substantially all of the assets of the Company’s U.K. subsidiary, and by a cash deposit of £1,822 ($2,659), which is recorded as restricted cash on the consolidated balance sheet. At December 31, 2008, there was £2,772 ($4,046) outstanding under stand-by letters of credit and bank guarantees under this debenture agreement.

As of December 31, 2008, the Company was in compliance with all covenants in its debt agreements.

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, which was a component of a fuel gas heater skid supplied by the Company to MMPP, allegedly ruptured resulting in a fire.

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 and damages as described above. We believe 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 filed with the Office of Foreign Assets Control (“OFAC”) a voluntary disclosure concerning certain activities in support of its majority-owned, separately incorporated U.K. subsidiary, Burgess-Manning Europe, Ltd. (“BMEL”), which potentially implicated the Iranian Transactions Regulations (“ITR”).

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

8. COMMITMENTS AND CONTINGENCIES — Continued

During the period 2004 to 2007, BMEL sold a number of industrial separators to Iranian customers. The industrial separators produced by BMEL and sold for Iranian customers were not of U.S. origin and had no U.S. content. During part of this period most of BMEL’s accounting work was outsourced to the U.S. headquarters office of Burgess-Manning. Burgess-Manning believes there are valid arguments to support the permissibility of the activities involved, nevertheless, out of an abundance of caution, Burgess-Manning filed a voluntary self disclosure with OFAC for its consideration. Burgess-Manning also took steps to ensure there should be no recurrence of these issues, hiring an outside accounting firm in the U.K. and giving to this firm the accounting work that Burgess-Manning did previously. Burgess-Manning has provided no accounting support to BMEL since January 2006.

We cannot predict the response of the OFAC, the outcome of any related proceeding or the likelihood that future proceedings will be instituted against us. In the event that there is an adverse ruling in any proceeding, we may be required to pay fines and penalties.

Additionally, we have potential liability related to environmental matters associated with certain properties that we acquired in the Nitram acquisition. The liability related to the environmental matters has not been quantified, but is currently not expected to be material. We believe that we will be reimbursed for the cost of any remediation under our purchase agreement with Nitram’s former stockholders.

In connection with the Nitram acquisition, $10,920 of the purchase price was placed in escrow to reimburse us for breach of representation and certain other claims, including potential costs, fines or penalties related to the OFAC voluntary disclosure and environmental matters.

9. STOCKHOLDER RIGHTS PLAN

On August 15, 2008, PMFG 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.

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.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

9. STOCKHOLDER RIGHTS PLAN — Continued

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.

10. STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation arrangements in accordance with the provisions of SFAS No. 123(R),“Share-Based Payment”(“SFAS 123R”). The following information represents the Company’s grants of stock-based compensation to employees and directors during the six months ended December 31, 2008 and 2007:


	Six months ended December 31,
	2008				2007
	Number of				Number of
	Shares		Fair Value		Shares		Fair Value
Grant Type	Granted		of Grant		Granted		of Grant
Stock		24,000	$	638		—	$	—
Restricted stock		32,758	$	872		86,188	$	1,107

The company recognizes compensation expense for restricted stock awards and stock options 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. For the Company’s stock-based compensation plans, the fair value of each stock option grant is estimated at the date of grant using the Black-Scholes option pricing model.

11. SEGMENT INFORMATION

The Company has two reportable segments: Process Products (formerly Separation/Filtration systems) 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 petro-chemical processing. The main product of the Company’s Environmental Systems segment is its selective catalytic reduction systems, referred to as “SCR Systems.” These SCR systems are used for air pollution abatement and converting nitrogen oxide (NOx) emissions from exhaust gases caused by burning hydrocarbon fuels, such as coal, gasoline, natural gas and oil. Along with the SCR Systems, this segment 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 an 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 and six months ended December 31, 2008 and 2007 are presented below.

PMFG, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
(Amounts in thousands, except share and per share amounts)

11. SEGMENT INFORMATION — Continued

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,						Six months ended,
	December 31,						December 31,
	2008			2007			2008			2007
Revenues
Process Products	$	29,394		$	17,217		$	66,581		$	30,940
Environmental		9,711			19,869			16,180			36,164

Consolidated	$	39,105		$	37,086		$	82,761		$	67,104


Operating income
Process Products	$	4,045		$	2,836		$	7,472		$	5,023
Environmental		2,005			5,227			3,793			9,876
Reconciling items		(4,179	)		(2,821	)		(8,479	)		(4,873	)

Consolidated	$	1,871		$	5,242		$	2,786		$	10,026

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts 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 Form 10-K for the year ended June 30, 2008. 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 holding company reorganization and our acquisition of Nitram. This overview is followed by a discussion of our results of operations for the three and six months ended December 31, 2008 and 2007, including a discussion of significant period-to-period variances. We also include information regarding our two reportable business segments: Process Products (formerly Separation/Filtration Systems) and Environmental Systems. We then discuss our financial condition at December 31, 2008 with a comparison to June 30, 2008. 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, 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, SCR systems, and other complementary products including specialty heat exchangers, pulsation dampeners and silencers. Our primary customers include equipment manufacturers, engineering contractors and operators of power plants.

Our products and systems are marketed worldwide. In each of the last three fiscal years, more than 25% of our revenues have been generated from outside the United States. We expect our international sales to continue to be an important part of our business.

On August 15, 2008, we completed a holding company reorganization. In the reorganization, Peerless Mfg. Co. became a wholly-owned subsidiary of PMFG, Inc. Shareholders of Peerless received two shares of common stock of PMFG for each outstanding share of common stock of Peerless held prior to the reorganization. As a result, the reorganization also had the effect of a two-for-one stock split. Our business, operations and management did not change as a result of the holding company reorganization.

On April 30, 2008, we completed our acquisition of Nitram for approximately $63,110 including transaction costs. This acquisition broadens our product offerings, expands our position in selected markets, increases our engineering and skilled labor resources, broadens our research and development capabilities, and furthers our strategy of providing more complete systems to our

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

customers. In addition, the acquisition of Nitram should improve our financial results by improving manufacturing and supply chain efficiencies and leveraging the cost of our corporate overhead.

As a result of the acquisition, 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. During the year ended June 30, 2008, $2,177 of the inventory cost was expensed and $2,734 of the backlog was amortized. The remaining balance was substantially amortized during the six months ended December 31, 2008, $2,196 of the inventory cost was expensed and $3,755 of the backlog was amortized. 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 in our Annual Report on Form 10-K for the year ended June 30, 2008.

The domestic and international economies are currently experiencing a significant recession and there has also been an increase in credit restrictions in the global financial markets. In the second quarter of fiscal year 2009, we have experienced a decline in our backlog from the previous quarter that we believe is a result of these current economic conditions. Management is uncertain as to the depth or length of time that the global recession and global credit restrictions will have an effect on the markets that we serve and the ability of financial institutions to provide credit. Our customers are dependent on the financial institutions to provide liquidity for capital programs and operating capital. We expect our revenues, earnings, and liquidity to be impacted to the extent that the global recession and global credit restrictions impact the markets we serve.

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, 2008. 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						Six months ended
	December 31,						December 31,
	2008			2007			2008			2007
Revenues		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold		68.6	%		66.5	%		71.5	%		66.0	%

Gross profit		31.4	%		33.5	%		28.5	%		34.0	%
Operating expenses		26.6	%		19.3	%		25.1	%		19.1	%

Operating income		4.8	%		14.2	%		3.4	%		14.9	%
Other income (expense)		(2.8	)%		0.6	%		(3.7	)%		1.0	%

Earnings (loss) before income taxes		2.0	%		14.8	%		(0.3	)%		15.9	%
Income tax benefit (expense)		(0.7	)%		(5.2)	%		0.1	%		(5.6	)%

Net earnings (loss)		1.3	%		9.6	%		(0.2	)%		10.3	%

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts 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 December 31, 2008 Compared to Three Months Ended December 31, 2007

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 December 31,
	2008		% of Total			2007		% of Total

Domestic	$	28,261		72.3	%	$	21,973		59.2	%
International		10,844		27.7	%		15,113		40.8	%

Total	$	39,105		100.0	%	$	37,086		100.0	%

Total revenues increased $2,019, or 5.4%, for the three months ended December 31, 2008 compared to the three months ended December 31, 2007 as domestic revenues increased $6,288, or 28.6%, and international revenues decreased $4,269 or 28.2%. During the three months ended December 31, 2007 two large contracts, one domestic and one international, contributed significant amounts to our revenues. The decreased revenue in the current year due to the completion of these two large contracts was partially offset by the increased revenue from the Nitram acquisition.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts 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 December 31,
	2008		% of Revenues			2007		% of Revenues

Revenues	$	39,105		100.0	%	$	37,086		100.0	%
Cost of goods sold		26,826		68.6	%		24,668		66.5	%

Gross profit	$	12,279		31.4	%	$	12,418		33.5	%

For the three months ended December 31, 2008, our gross profit decreased $139, or 1.1%, compared to the three months ended December 31, 2007. Our gross profit, as a percentage of revenues, decreased to 31.4% for the three months ended December 31, 2008 compared to 33.5% for the same period a year ago. The decrease in gross profit as a percentage of revenues during the three months ended December 31, 2008 primarily related to the $1,053 of amortization expense related to Nitram’s backlog and $373 of expense related to the fair value adjustment of Nitram’s inventory. See “Overview” above for additional information regarding the Nitram acquisition and these expenses.

Operating Expenses.The following summarizes operating expenses:


	Three months ended December 31,
			% of					% of
	2008		Revenues			2007		Revenues

Sales and marketing	$	4,160		10.6	%	$	3,036		8.2	%
Engineering and project management		2,069		5.3	%		1,319		3.6	%
General and administrative		4,179		10.7	%		2,821		7.5	%

Total	$	10,408		26.6	%	$	7,176		19.3	%

Operating expenses increased $3,232 or 45%, for the three months ended December 31, 2008 compared to the same period a year ago. As a percentage of revenues, these expenses increased from 19.3 % to 26.6% during the three months ended December 31, 2008. Our sales and marketing expenses increased $1,124 during the three months ended December 31, 2008 compared to the same period in the previous year primarily due to commissions and other selling related expenses associated with the Nitram acquisition and the higher revenues in the current quarter. Our engineering and project management expenses increased $750 for the three months ended December 31, 2008 compared to the three months ended December 31, 2007 primarily due to the Nitram acquisition and support activities associated with increased revenues in the current quarter. General and administrative expenses increased $1,358 during the three months ended December 31, 2008 compared to the same period a year ago primarily due to increased professional fees, amortization of intangibles associated with the prior fiscal year’s business acquisition, and increased expenses related to Nitram’s operations.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

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


	Three months ended December 31,
	2008			% of Revenues			2007			% of Revenues

Interest income	$	45			0.1	%	$	315			0.9	%
Interest expense		(1,597	)		(4.1	)%		—			—	%
Foreign exchange gain (loss)		575			1.5	%		(102	)		(0.3	)%
Other expense, net		(134	)		(0.3	)%		—			—	%

Total other income (expense)	$	(1,111	)		(2.8	)%	$	213			0.6	%

For the three months ended December 31, 2008, total other income (expense) items decreased by $1,324 compared to the three months ended December 31, 2007 primarily due to increased interest expense on debt incurred in connection with the Nitram acquisition. We expect interest expense will continue to be higher for the year ending June 30, 2009 compared to the previous year.

Income Taxes.Our effective income tax rate was 35% for the three months ended December 31, 2008 and 2007.

Net Earnings (Loss).Net earnings decreased by $3,056 to a net earnings of $494 during the three months ended December 31, 2008, from net earnings of $3,550 during the same period in the previous year. Basic earnings per share decreased from $0.28 per share and diluted earnings per share decreased from $0.27 per share for the three months ended December 31, 2007 to basic and diluted earnings of $0.04 per share for the three months ended December 31, 2008.

Results of Operations – Segments

We have two lines of business: Process Products (formerly Separation/Filtration Systems) and Environmental Systems. Revenues and Operating Income in this section are presented on a GAAP basis. Certain corporate level expenses have been excluded from our segment operating results and are analyzed separately.

Process Products (formerly Separation/Filtration 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 petro-chemical processing. Process Products represented 75.2% and 46.4% of our revenues for the three months ended December 31, 2008 and 2007, respectively.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

The following summarizes Process Products revenues and operating income:


	Three months ended December 31,
	2008			2007
Revenues	$	29,394		$	17,217
Operating income	$	4,045		$	2,836

Operating income as % of revenues		13.8	%		16.5	%

Process Products revenues increased by $12,177 or 70.7%, during the three months ended December 31, 2008 compared to the three months ended December 31, 2007. Domestic and international revenues increased compared to the prior year period primarily as a result of the acquisition of Nitram.

Process Products operating income for the three months ended December 31, 2008 increased $1,209 compared to the same period a year ago. The decrease in operating income as a percentage of revenues during the three months ended December 31, 2008 is primarily related to amortization expenses of backlog and fair value adjustment of inventory related to the Nitram acquisition.

Environmental Systems

The primary product of our Environmental Systems segment 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 24.8% and 53.6% of our revenues for the three months ended December 31, 2008 and 2007, respectively.

The following summarizes Environmental Systems revenues and operating income:


	Three months ended December 31,
	2008			2007
Revenues	$	9,711		$	19,869
Operating income	$	2,005		$	5,227

Operating income as % of revenues		20.6	%		26.3	%

Revenues from Environmental Systems decreased $10,158 or 51.1%, during the three months ended December 31, 2008 compared to the same period in the previous year. Environmental Systems revenues for the three months ended December 31, 2007 included a large project related to a power plant expansion that was not replicated in the current year.

Environmental Systems operating income for the three months ended December 31, 2008 decreased $3,222 compared to the three months ended December 31, 2007. As a percentage of Environmental Systems revenues, operating income decreased to 20.6% during the three months ended December 31, 2008 from 26.3% for the same period in the prior year. The decrease in the Environmental System operating income is primarily related to lower revenues in the current fiscal year.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

Corporate Level Expenses

Corporate level general and administrative expenses were $4,179 and $2,821 for the three months ended December 31, 2008 and 2007, respectively. These expenses are excluded from our segment operating results. See “Operating Expenses” above for additional discussion.

Six Months Ended December 31, 2008 Compared to Six Months Ended December 31, 2007

Results of Operations – Consolidated

Revenues.The following table summarizes consolidated revenues:


	Six months ended December 31,
	2008		% of Total			2007		% of Total

Domestic	$	56,593		68.4	%	$	43,025		64.1	%
International		26,168		31.6	%		24,079		35.9	%

Total revenues	$	82,761		100.0	%	$	67,104		100.0	%

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. Revenue generated by orders originating from a country other than the United States is classified as international revenue.

For the first six months of fiscal 2009, total revenues increased $15,657, or 23.3%, compared to the first six months of fiscal 2008. Domestic revenues increased $13,568, or 31.5%, in the first six months of fiscal 2009 when compared to the first half of fiscal 2008. International revenues increased $2,089, or 8.7%, in the first six months of fiscal 2008 when compared to the first six months of fiscal 2007. The net increase in domestic and international revenue is primarily a result of the Nitram acquisition partially offset by decreased revenue from two large projects in the comparative six months last year.

Gross Profit.The following table summarizes revenues, cost of goods sold, and gross profit:


	Six months ended December 31,
	2008		% of Revenues			2007		% of Revenues

Revenues	$	82,761		100.0	%	$	67,104		100.0	%
Cost of goods sold		59,205		71.5	%		44,301		66.0	%

Gross profit	$	23,556		28.5	%	$	22,803		34.0	%

For the first six months of fiscal 2009, our gross profit increased $753, or 3.3%, compared to the first six months of fiscal 2008. Our gross profit, as a percentage of revenues, decreased to 28.5% for the first six months of fiscal 2009 compared to 34.0% for the first six months of fiscal 2008. The decrease in gross profit as a percentage of revenues during the six months ended December 31, 2008 primarily related to the $3,755 of amortization expense related to Nitram’s backlog and $2,196 of expense related to the fair value adjustment of Nitram’s inventory.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

Operating Expenses.The following table summarizes operating expenses:


	Six months ended December 31,
			% of					% of
	2008		Revenues			2007		Revenues
Sales and marketing	$	8,246		10.0	%	$	5,453		8.1	%
Engineering and project management		4,045		4.9	%		2,451		3.7	%
General and administrative		8,479		10.2	%		4,873		7.2	%

Total	$	20,770		25.1	%	$	12,777		19.0	%

For the first six months of fiscal 2009, our operating expenses increased by $7,993 compared to the first six months of fiscal 2008. As a percentage of revenue, these expenses increased to 25.1% in the first six months of fiscal 2009 from 19.0% in the first six months of fiscal 2008. Our sales and marketing expenses increased $2,793 in the first six months of fiscal 2009 compared to the first six months of fiscal 2008 primarily due to the addition of Nitram personnel, increased commissions and other selling related expenses associated with the greater revenue in the current period. Our engineering and project management expense increased $1,594 in the first six months of fiscal 2009 compared to the first six months of fiscal 2008 primarily due to the addition of Nitram personnel and the support activities associated with the increased revenue in the current period. Our general and administrative expenses increased $3,606 in the first six months of fiscal 2009 compared to the first six months of fiscal 2008. The increase in general and administrative expenses was primarily due to increased legal and professional fees, amortization of intangibles associated with the prior fiscal year’s business acquisition, and increased expenses related to Nitram’s operations.

Other Income and Expense.The following table summarizes other income and expenses:


	Six months ended December 31,
	2008			% of Revenues			2007			% of Revenues
Interest income	$	123			0.1	%	$	682			1.0	%
Interest expense		(3,193	)		(3.9	)%		—			—	%
Foreign exchange gain (loss)		(75	)		(0.1	)%		(33	)		—	%
Other income (expense), net		94			0.2	%		(9	)		—	%

Total other income (expense)	$	(3,051	)		(3.7	)%	$	640			1.0	%

For the first six months of fiscal 2009, other expenses increased by $3,691, from net income of $640 for the first six months of fiscal 2008. The primary reason for the increased expense is the interest on the long term debt associated with the Nitram acquisition.

Income Taxes.Our effective income tax rate was 35% for the first six months of fiscal years 2009 and 2008.

Net Earnings.Our net earnings decreased by $7,108 from a net income of $6,936, in the first six months of fiscal 2008, to net loss of $172 for the first six months of fiscal 2009. The primary reason for loss is due to inclusion of $5,951 of amortization expenses relating to the fair value

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

adjustment of inventory and backlog associated with the Nitram acquisition, partially offset by increased revenue. Additionally, interest expense of $3,187 for long term debt contributed to the decreased earnings in the current period

Basic earnings per share decreased from earnings of $0.54 per share for the first six months of fiscal 2008, to a loss of $(0.01) per share for the first six months of fiscal 2009. Diluted earnings per share decreased from earnings of $0.53 per share for the first six months of fiscal 2008, to a loss of $(0.01) per share for the first six months of fiscal 2009.

Results of Operations – Segments

Process Products (formerly Separation/Filtration)

This reporting segment represented 80.4% and 46.1% of our revenues for the first six months of fiscal 2009 and fiscal 2008, respectively.

The following table summarizes Process Products revenues and operating income:


	Six months ended December 31,
	2008			2007
Revenues	$	66,581		$	30,940
Operating income	$	7,472		$	5,023

Operating income as % of revenues		11.2	%		16.2	%

Process Products revenues increased by $35,641, or 115.2%, in the first six months of fiscal 2009 when compared to the first six months of fiscal 2008. The increase in Process Products revenue is primarily attributable to the Nitram acquisition.

Process Products operating income in the first six months of fiscal 2009 increased by $2,449 compared to the first six months of fiscal 2008. As a percentage of Process Products revenues, operating income was 11.2% in the first six months of fiscal 2009 compared to 16.2% in the first six months of fiscal 2008. The decrease in operating income was primarily due to $3,755 of amortization expenses related to Nitram backlog and $2,196 of amortization expense related to the fair value adjustment of Nitram’s inventory.

Environmental Systems

This reporting segment represented 19.6% and 53.9% of our revenues for the first six months of fiscal 2009 and fiscal 2008, respectively.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

The following table summarizes Environmental Systems revenues and operating income:


	Six months ended December 31,
	2008			2007
Revenues	$	16,180		$	36,164
Operating income	$	3,793		$	9,876

Operating income as % of revenues		23.4	%		27.3	%

Revenues from Environmental Systems decreased $19,984, or 55.3% in the first six months of fiscal 2009 when compared to the first six months of fiscal 2008. The decrease was primarily due to the inclusion of a large project relating to a power plant expansion during the six months ended December 31, 2007.

Environmental Systems operating income in the first six months of fiscal 2009 decreased $6,083 or 61.6% compared to the first six months of fiscal 2008. The decrease was primarily attributable to the decreased revenue in fiscal 2008 partially offset by improved margin associated with reduced start-up (commissioning) expenses.

Corporate Level Expenses

Corporate level expenses were $8,479 and $4,873 for the six months ended December 31, 2008 and 2007, respectively. Corporate level general and administrative expenses are excluded from our segment operating results. See “Operating Expenses” above for additional discussion on these expenses.

Contingencies

A description of our contractual obligations and contingent commitments are described in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual report on Form 10-K for the fiscal year ended June 30, 2008 and there have been no significant changes in our commitments or contingencies as previously disclosed. Our significant legal proceedings are described in Note 8 to our Consolidated Financial Statements and in Part II item 1. “Legal Proceedings” in this Report. Also, 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. We have no off-balance sheet financing arrangements and there have been no significant changes to our off-balance sheet arrangements as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008.

Backlog

Our backlog of uncompleted orders was $92,000 at December 31, 2008, compared to $107,000 at June 30, 2008. 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. The timing of our larger contracts can have a notable impact upon our backlog from period to period.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

Financial Position

Assets.Total assets decreased by $14,886, or 8.9%, from $166,736 at June 30, 2008, to $151,850 at December 31, 2008. On December 31, 2008, we held cash and cash equivalents of $6,710 had working capital of $44,255 and a current liquidity ratio of 2.0-to-1.0. This compares with cash and cash equivalents of $11,444, working capital of $42,334, and a current liquidity ratio of 1.8-to-1.0 at June 30, 2008.

Liabilities and Stockholders’ Equity.Total liabilities decreased by $13,785, or 11.1%, from $123,805 at June 30, 2008 to $110,020 at December 31, 2008. The decrease can be attributed to lower trade payables and a decrease of customer deposits associated with orders that were completed and shipped. Additionally, the long-term debt decreased as result of scheduled payments of senior term-loan.

The decrease in our equity of $1,101 or 2.6%, from $42,931 at June 30, 2008 to $41,830 at December 31, 2008 is primarily attributable to our net decrease in accumulated other comprehensive income, partially offset by the increase in additional paid-in capital related to stock awards. Our ratio of debt (total liabilities)-to-equity improved from 2.9-to-1.0 at June 30, 2008 to 2.6-to-1.0 at December 31, 2008.

Liquidity and Capital Resources

Our cash and cash equivalents were $6,710 as of December 31, 2008 compared to $11,444 at June 30, 2008. Cash used in operating activities for the six months ended December 31, 2008 was $3,801 compared to cash provided by operating activities of $10,264 for the six months ended December 31, 2007.

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 December 31, 2008, the balance of these working capital accounts was $38,181 compared to $31,872 at June 30, 2008, reflecting an increase of our investment in these working capital items of $6,309. 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. During the six months ended December 31, 2008, cash used in operating activities increased as a result of an overall increase in our accounts receivable due to several large projects reaching milestones that allowed us to invoice our customers.

Cash used in investing activities was $797 for the six months ended December 31, 2008, compared to cash used in investing activities of $569 for the six months ended December 31, 2007. Cash provided during the six months ended December 31, 2008 primarily related to the capitalization of acquisition cost offset by purchases of property and equipment.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

Cash used in financing activities during the three months ended December 31, 2008 was $2,196 compared to $42 provided during the same period in the previous year. The cash used in financing activities for the six months ended December 31, 2008 primarily related to $2,000 in principal payments on the senior term loan.

As a result of the events described above, our cash and cash equivalents during the six months ended December 31, 2008 decreased by $4,734 compared to an increase of $9,805 during the six months ended December 31, 2007.

We have filed a shelf registration statement with the SEC that will allow us to sell up to 3 million shares of our common stock in one or more offerings. The shelf registration statement gives us greater flexibility to raise funds from the offering of our common stock, subject to market conditions and our capital needs. Under the terms of our debt agreements, part of the proceeds from any offering would be required to be used to repay a portion of the indebtedness we incurred in connection with our acquisition of Nitram.

We believe we maintain adequate liquidity to support our current level of operations. The domestic and international economies are currently experiencing a significant recession and there has also been an increase in credit restrictions in the global financial markets. In the second quarter of fiscal year 2009, we have experienced a decline in our backlog from the previous quarter that we believe is a result of these current economic conditions. Management is uncertain as to the depth or length of time that the global recession and global credit restrictions will have an effect on the markets that we serve and the ability of financial institutions to provide credit. Our customers are dependent on the financial institutions to provide liquidity for capital programs and operating capital. We expect our revenues, earnings, and liquidity to be impacted to the extent that the global recession and global credit restrictions impact the markets we serve.

New Accounting Standards

Information regarding new accounting pronouncements is included in Note 2 to the Consolidated Financial Statements in this Report.

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 and six months ended December 31, 2008, there were no material changes in our primary market risk.

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,

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective in ensuring that all information required to be disclosed in this Report has been recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Additionally, based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures were effective in ensuring that all material information required to be filed in this Report has been accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, in a timely fashion to allow decisions regarding required disclosures.

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

During the six months ended December 31, 2008, 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.

The Company’s litigation matters are described in Note 8 to the Consolidated Financial Statements in this Report and in Part I, Item 3. “Legal Proceedings” included in our annual Report on Form 10-K for the fiscal year ended June 30, 2008.We are, from time to time, involved in various litigation matters. We do not believe that the outcome of any litigation matters in which we are involved will have a material adverse effect on our consolidated financial condition. However, we cannot predict with certainty any eventual loss or range of possible loss related to such matters.

Item 1A. Risk Factors

Current economic uncertainty in domestic and global market

The domestic and international economies are currently experiencing a significant recession and there has also been an increase in credit restrictions in the global financial markets. In the second quarter of fiscal year 2009, we have experienced a decline in our backlog from the previous quarter that we believe is a result of these current economic conditions. Management is uncertain as to the depth or length of time that the global recession and global credit restrictions will have an effect on the markets that we serve and the ability of financial institutions to provide credit. Our customers are dependent on the financial institutions to provide liquidity for capital programs and operating capital. We expect our revenues, earnings and liquidity to be impacted to the extent that the global recession and global credit restrictions impact the markets we serve.

There have been no other 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, 2008 and discussed above.

PMFG, Inc. and Subsidiaries
December 31, 2008
(Amounts in thousands, except share and per share amounts)

Item 4. Submission of Matters to a Vote of Security Holders

Our 2008 Annual Meeting of Shareholders was held on November 19, 2008. A total of 12,554,326 shares of our common stock, or approximately 95.9% of all shares of our common stock entitled to vote at the meeting, were represented by proxy or ballot.

At the Annual Meeting, two Directors were elected to the Board of Directors, each to serve a three year term. The vote with respect to the election of these Directors was as follows:

Total Vote

Annual

Total Vote

Withheld

Meeting

for Each

from Each

when Term

Director

Expires

Robert McCashin

10,990,927

1,563,399

2011

Howard G. Westerman, Jr.

10,984,524

1,569,802

2011

Peter J. Burlage, Sherrill Stone, Kenneth R. Hanks, and R. Clayton Mulford will continue to serve as Directors.

Item 6. Exhibits

The following exhibits are filed as part of this Report:


Exhibit
Number		Exhibit

10.1		Employment Agreement, dated December 8, 2008, between Peerless Mfg. Co. and Melissa G. Beare.

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
December 31, 2008
(Amounts 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: February 9, 2009	/s/ Peter J. Burlage
	Peter J. Burlage
	President and Chief Executive Officer (Principal Executive Officer)

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

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	7th grade Avg

Pmfg Inactive 10-Q2009 Q2 Quarterly report

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