<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                 ---------------
                                    FORM 10-K

         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                     FOR THE FISCAL YEAR ENDED JUNE 30, 2003
                           COMMISSION FILE NO. 0-5214
                                 ---------------
                                PEERLESS MFG. CO.
             (Exact name of registrant as specified in its charter)

            TEXAS                                        75-0724417
(State or other jurisdiction of             (I.R.S. employer identification no.)
incorporation or organization)

                   2819 WALNUT HILL LANE, DALLAS, TEXAS 75229
                    (Address of principal executive offices)

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

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

    (Title of Class)                    (Name of each exchange where registered)
-----------------------------           ----------------------------------------
Common Stock, $1.00 Par Value                           NASDAQ

         Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]

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

         Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2 of the Act). YES [ ] NO [X]

         The aggregate value of the voting stock held by non-affiliates of the
Registrant as of December 31, 2002 was approximately $19.7 million. Shares of
voting stock held by executive officers, directors and holders of more than 10%
of the outstanding voting stock have been excluded from this calculation because
such persons may be deemed to be affiliates. Exclusion of such shares should not
be construed to indicate that any of such persons possesses the power, direct or
indirect, to control the Registrant, or that any such person is controlled by or
under common control with the Registrant.

         Number of shares outstanding of the Registrant's Common Stock, $1.00
par value, as of September 25, 2003 was 3,000,534.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the 2003 Annual Meeting of
Shareholders are incorporated by reference into Part III of this Form 10-K.

                                        1

<PAGE>

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                 PAGE
                                                                                                NUMBER
                                                                                                ------
<S>                                                                                             <C>
PART I

         Item 1.    Business..................................................................      3

         Item 2.    Properties................................................................      7

         Item 3.    Legal Proceedings.........................................................      8

         Item 4.    Submission of Matters to a Vote  of Security Holders......................      8

PART II

         Item 5.    Market for Registrant's Common Equity and Related Shareholder Matters.....      8

         Item 6.    Selected Financial Data...................................................      9

         Item 7.    Management's Discussion and Analysis of Financial Condition and Results
                    of Operations.............................................................     10

         Item 7A.   Quantitative and Qualitative Disclosures about Market Risk................     22

         Item 8.    Consolidated Financial Statements and Supplementary Data..................     23

         Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial
                    Disclosure................................................................     23

         Item 9A.   Controls and Procedures...................................................     23

PART III

         Item 10.   Directors and Executive Officers of the Registrant........................     23

         Item 11.   Executive Compensation....................................................     23

         Item 12.   Security Ownership of Certain Beneficial Owners and Management............     23

         Item 13.   Certain Relationships and Related Transactions............................     23

         Item 14.   Principal Accountant Fees and Services....................................     23

PART IV

         Item 15.   Exhibits, Financial Statement Schedules, and Reports on Form 8-K..........     24

                    Signatures................................................................     25

                    Index to Exhibits.........................................................     51
</TABLE>

                                       2

<PAGE>

                                     PART I

ITEM 1. BUSINESS

         Peerless Mfg. Co. (the "Company," "Registrant," "Peerless" or "we,"
"us" or "our") was organized in 1933 as a proprietorship and was incorporated as
a Texas corporation in 1946. We have three wholly owned subsidiaries
incorporated in Texas, the United Kingdom, and Barbados, respectively. Our
executive offices are located at 2819 Walnut Hill Lane, Dallas, TX 75229. Our
telephone number at this location is (214) 357-6181, and our website may be
accessed at www.peerlessmfg.com. Our fiscal year ends on June 30. References
herein to "fiscal 2001," "fiscal 2002," and "fiscal 2003" refer to our fiscal
years ended June 30, 2001, 2002, and 2003, respectively.

OPERATING SEGMENTS AND PRODUCTS

         We operate our business through two primary business segments, the
larger of which is our Environmental Systems business, which accounted for
approximately 54% of our revenues in fiscal 2003. In this business segment we
design, engineer, manufacture and sell highly specialized environmental control
systems for air pollution abatement. Our main product, Selective Catalytic
Reduction systems, referred to as "SCR Systems," converts nitrogen oxide (NOx)
emissions from exhaust gases caused by burning hydrocarbon fuels such as coal,
gasoline, natural gas and oil to harmless nitrogen and water vapor. These
systems are complete with instruments, controls and related valves and piping,
and are totally integrated systems. Along with the SCR Systems, we offer systems
to reduce other pollutants such as carbon monoxide (CO) and particulate matter.

         Our other primary business segment is our Separation & Filtration
Systems business, which accounted for approximately 40% of our revenues in
fiscal 2003. In this business segment we design, engineer, manufacture and sell
specialized products and systems known as "separators" or "filters" which are
used in cleaning and conditioning gases and liquids as they move through a
piping system. These products are used to remove solid and liquid contaminants
from natural gas and saltwater aerosols from the combustion intake air of
shipboard gas turbine and diesel engines. Separators are also used in nuclear
power plants to remove water from saturated steam.

         In addition to our two primary business segments, we have designed,
manufactured and sold packaged boilers and other steam generating equipment
through our Texas subsidiary, PMC Acquisition Inc., doing business as ABCO
Industries ("ABCO"). This segment accounted for approximately 6% of our revenues
in fiscal 2003. This equipment is used to produce steam, which is used in
processes to heat, dry, drive steam turbines, and a variety of other
applications. As part of our restructuring and organizational realignment
initiative, we suspended this business segment during the first quarter of
fiscal 2003, and redirected these resources to our two primary business
segments: Environmental Systems and Separation & Filtration Systems. See also
Item 1 - "Business - Restructuring and Organizational Realignment" of this
Report.

         Although we manufacture and stock a limited number of items of
equipment for immediate delivery, the majority of our products are custom
designed based on specific customer requirements or specifications, generally
pursuant to long-term fixed priced contracts. In certain cases, our products and
components are designed by us but produced by subcontractors or contract vendors
under our supervision.

         Please see Note M - "Industry Segment and Geographic Information," in
our Notes to Consolidated Financial Statements and Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations" of
this Report for further disclosure and discussion of financial information with
respect to these three segments, Environmental Systems, Separation & Filtration
Systems, and Boilers.

                                       3

<PAGE>

RESTRUCTURING AND ORGANIZATIONAL REALIGNMENT

         During the latter part of fiscal 2002, the construction of new merchant
power plants in the United States slowed considerably as a result of generating
overcapacity and lower demand for electricity, coupled with a weakness in the
United States economy. In addition, regulatory uncertainties caused NOx
reduction initiatives relating to retrofit projects to be delayed. These factors
resulted in a downturn of new SCR Systems orders during the second half of
fiscal 2002, which has had a significant impact on our backlog and reported
revenues for fiscal year 2003.

         In response to the slowdown of new merchant power plants, continued
weakness in the United States and global economies, and recent regulatory and
political uncertainties, we started our restructuring and organizational
realignment initiative in July 2002. The goals of this initiative were to reduce
costs, streamline operations, and identify and exit certain non-critical,
marginally performing operating activities, thereby positioning us with a more
competitive cost structure vital for our overall long-term success. The plan
included, among other things, the consolidation of manufacturing facilities and
processes, the scaling down of capacities at the remaining facilities to meet
anticipated market requirements and current economic conditions, suspension of
non-strategic business units, and the realignment of the organization to focus
on our two primary strategic business units: Environmental Systems and
Separation & Filtration Systems. As part of this initiative, we determined that
our Boiler segment met the criteria of a non-critical, marginally performing
business unit and thus we suspended this operation during the first quarter of
fiscal year 2003. We redirected our boiler manufacturing resources to our two
primary business units.

         We believe that as a result of this initiative, we will be positioned
to maximize our current operational and manufacturing efficiencies and still
retain the flexibility to meet our customers' current and anticipated needs,
without sacrificing our ability to expand our business to meet future demand.
While the initial phase of our restructuring and organizational realignment
initiative has been completed, and while we have seen a slight increase in our
backlog, we continue to operate in challenging times and thus continue to look
for ways to improve our operational and manufacturing efficiencies and
performance.

MANUFACTURING AND OUTSOURCING

         Our products are fabricated utilizing a combination of in-house
manufacturing, subcontractors and contract vendors. In both fiscal 2002 and
2003, we estimate manufacturing outsourced to subcontractors accounted for a
significant percentage of our costs of good sold (approximately 35% in fiscal
2002 and 39% in fiscal 2003). We believe that our use of outsourcing
relationships provides us with flexibility to rapidly expand our manufacturing
capacity without significantly increasing our capital expenditures. Our
subcontractors generally manufacture products on a fixed-price basis for each
project. We regularly review our subcontractor and contract vendor relationships
to ensure competitive costs, quality and workmanship standards and on-time
delivery.

         We maintain significant in-house manufacturing capabilities and
generally manufacture those products whose complexity may preclude their
production by our subcontractors and/or contract vendors and to protect
proprietary technology.

CUSTOMERS

         Our Environmental Systems are sold to independent power producers,
power developers, engineering and construction companies, heat recovery steam
generator manufacturers, boiler manufacturers, refineries, petrochemical plants
and others who desire or may be required by environmental regulations to reduce
nitrogen oxide (NOx) emissions and ground level zone to which NOx is a
precursor.

                                       4

<PAGE>

         Gas separators, filters and conditioning systems produced by our
Separation & Filtration Systems business are sold to gas producers and gas
gathering, transmission and distribution companies, chemical manufacturers and
oil refineries, either directly or through contractors engaged to build plants
and pipelines, and to manufacturers of compressors, turbines, and nuclear and
conventional steam generating equipment. Marine separation and filtration
systems are sold primarily to shipbuilders.

         We market our products worldwide through independent representatives
who sell on a commission basis under the general direction of an officer of
Peerless. We also sell products directly to customers through our internal sales
force. Our business activity and revenues historically have not been seasonal.

         Boilers supplied by ABCO were sold to industrial, process and utility
customers. These products were sold through a number of sales channels,
including direct to users of the equipment, consulting engineers and original
equipment manufacturers (OEM's).

         We are not dependent upon any single customer or group of customers in
either of our two primary business segments. The custom-designed and
project-specific nature of our business can cause year-to-year variance in our
major customers. During fiscal 2003, one customer accounted for approximately
15% of our consolidated revenues, and in fiscal years 2002 and 2001, different
customers accounted for approximately 13% and 17% of our total consolidated
revenues, respectively.

         Sales to international customers have been a part of our business for
more than forty years. During fiscal 2003, foreign sales amounted to
approximately $20 million, or 29% of our total consolidated revenues, compared
to sales of approximately $16 million, or 15% of our total consolidated revenues
during fiscal 2002. The custom-designed and project-specific nature of our
products enables us to sell to most geographic regions. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Factors That May Affect Our Operating Results and Other Risk
Factors" and Item 7A - "Quantitative and Qualitative Disclosures About Market
Risk" of this Report.

BACKLOG

         Our backlog of uncompleted orders as of June 30, 2003, was
approximately $40 million, compared to $36 million as of June 30, 2002. Backlog
has been calculated under our normal practice of including incomplete orders for
products that are deliverable in future periods but that may be changed or
cancelled. In excess of 80% of our backlog at June 30, 2003 is scheduled to be
completed by the end of fiscal 2004. For further discussion on our backlog and
organizational restructuring, please see Item 1 - "Business - Restructuring and
Organizational Realignment" and Item 7 - "Management's Discussion and Analysis
of Financial Condition and Results of Operations" of this Report.

COMPETITION

         There are many U.S. and international competitors with capital and
revenues both larger and smaller than ours in the manufacturing and selling of
Environmental Systems and Separation & Filtration Systems. Management believes
that experience, performance, reliability and warranty service are the prime
competitive factors in our markets. We believe that we strongly compete in all
these areas.

PATENTS, LICENSES AND PRODUCT DEVELOPMENT

         We believe that we are an industry leader in designing, engineering and
manufacturing efficient, dependable SCR Systems. We also consider ourselves to
be highly skilled in the technology required to design and manufacture high
efficiency vapor/liquid separation equipment and systems for the oil and gas
industries and filtration equipment for the marine market. Our expenditures for
new product development and improvements were approximately $316,000 in fiscal
year 2003, $576,000 in fiscal 2002, and $621,000 in fiscal 2001. See Item 1 -
"Business - Restructuring and Organizational Realignment" of this Report.

                                       5

<PAGE>

         To protect our intellectual property rights, we depend upon a
combination of patents, trademarks, non-disclosure and confidentiality
agreements with our employees, subcontractors, contract vendors, customers and
others and various internal controls. We have existing patents and patent
applications pending on some of our products and processes that are important to
our business. These include patents on vane designs, separator profiles,
marine/separator filtration systems and pressure testing capabilities. In
addition, most of our products are proprietary and are sold utilizing our proven
technology and knowledge of the applications.

EMPLOYEES

         At June 30, 2003, we had 196 employees (349 employees at June 30,
2002). Our employees by location is as follows:

<TABLE>
<CAPTION>
                               AS OF JUNE 30,
                            -------------------
GEOGRAPHIC LOCATION         2003           2002
-------------------         ----           ----
<S>                         <C>            <C>
United States               170            326
United Kingdom               22             19
Singapore                     4              4
                            ---            ---
  Total                     196            349
                            ===            ===
</TABLE>

         None of our employees are represented by a labor union or are subject
to a collective bargaining agreement. We have experienced no material labor
difficulties during the past year and we believe our employee relations are
good.

         As part of our restructuring and organizational realignment initiative,
we identified several areas for greater operational efficiencies and other areas
that could be easily and cost effectively outsourced. As a result, during fiscal
2003 we were able to significantly reduce our headcount, while still maintaining
our ability to meet our customers' needs. In connection with this restructuring,
we incurred approximately $500,000 in severance and related costs during fiscal
2003. We plan to continue to monitor our work force requirements and make
additional adjustments if appropriate. See also Item 1 - "Business -
Restructuring and Organizational Realignment" of this Report.

RAW MATERIALS

         We purchase raw materials and component parts essential to our business
from established sources and have not experienced any unusual problems in
purchasing required materials and parts. We believe that raw materials and
component parts will be available in sufficient quantities to meet anticipated
demand. However, there can be no assurance that we will continue to find our raw
materials in quantities or at prices satisfactory to us.

ENVIRONMENTAL REGULATION

         We do not believe that our compliance with federal, state or local
statutes or regulations relating to the protection of the environment has had
any material effect upon capital expenditures, earnings or our competitive
position. Our manufacturing processes do not emit substantial foreign substances
into the environment.

         Environmental regulations related to NOx and ozone emissions have a
significant impact on the demand for our Environmental Systems. See also Item 7
- "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Forward Looking Statements and Factors That May

                                       6

<PAGE>

Affect Our Operating Results and Other Risk Factors" of this Report. For
geographic information see Note M of our Notes to Consolidated Financial
Statements attached to this Report.

AVAILABLE INFORMATION

         Peerless is a reporting company under the Securities Exchange Act of
1934, as amended (the "1934 Act"), and files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission" or
"SEC"). The public may read and copy any materials we file with the Commission
at the Commission's Public Reference Room at 450 Fifth Street, NW, Washington,
DC 20549. The public may obtain information on the operation of the Public
Reference Room by calling the Commission at 1-800-SEC-0330. Because we make
filings to the SEC electronically, you may also access this information at the
SEC website: www.sec.gov.

         Our website address is www.peerlessmfg.com. We make available, free of
charge at the "Investor Relations" portion of this website, annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the 1934 Act. Reports of beneficial ownership filed pursuant to Section
16(a) of the 1934 Act are also available on our website.

ITEM 2. PROPERTIES.

         Our executive offices and main research and development facilities are
owned, and are located in Dallas, Texas. We own and operate manufacturing and
warehousing facilities in Dallas, Denton and Abilene, Texas. We also lease sales
and marketing facilities in Dallas, Texas, Halstead - Essex, England and
Singapore. See table below for additional details on our locations.

<TABLE>
<CAPTION>
                              APPROXIMATE
        LOCATION              SQ. FOOTAGE                       GENERAL USE
--------------------------    -----------      ---------------------------------------------
<S>                           <C>              <C>
Owned:

  Dallas, Texas                 48,000         Office, warehouse and research and
                                               development.

  Dallas, Texas                 80,000         Manufacturing - Environmental Systems and
                                               Separation & Filtration products until
                                               November 2002.

  Denton, Texas                 22,000         Manufacturing - internal components for
                                               Separation & Filtration products and
                                               Nuclear/ Marine products.

  Abilene, Texas                78,000         Manufacturing - Boiler products,
                                               Environmental Systems and Separation &
                                               Filtration Systems.
Leased:

  Dallas, Texas                  3,500         Sales and marketing office

  Halstead - Essex, England      2,200         Sales, engineering and administration office

  Singapore                      2,300         Sales office
</TABLE>

         During fiscal year 2003, in connection with our restructuring
initiatives, we consolidated our Dallas manufacturing operations into our
Abilene manufacturing facility. We feel that this consolidation will reduce our
manufacturing costs and will result in increased utilization of our remaining
manufacturing facilities. In addition, during fiscal 2003, we sold approximately
32 acres of raw land located in Wylie, Texas. See Item 1 - "Business -
Restructuring and Organizational Realignment" of this Report for further
discussion on our restructuring and reorganization.

                                       7

<PAGE>

         While we believe our office and manufacturing facilities are adequate
and suitable for our present requirements, we will continue to periodically
review our space requirements and consolidate and dispose, lease or sublet
facilities we no longer require and acquire new space, if our needs dictate.

         Our owned facilities are pledged as collateral to secure our
obligations under our revolving line of credit facility. Please see Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" of this Report.

ITEM 3. LEGAL PROCEEDINGS

         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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matters require disclosure.

                                     PART II

Unless otherwise indicated, the share, per share and dividend per share
information reflected in this report have been adjusted to reflect the
Registrant's two-for-one stock split in the form of a stock dividend effected on
October 18, 2001.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

         Our common stock, par value $1.00 per share, is listed on the Nasdaq
National Market under the symbol "PMFG." The following table sets forth, for the
periods indicated, the range of the daily high and low closing bid prices for
our common stock as reported by Nasdaq and cash dividends paid per share. The
share, per share and cash dividend amounts indicated have been adjusted to
reflect the two-for-one stock split effected on October 18, 2001.

<TABLE>
<CAPTION>
FISCAL YEAR                 HIGH         LOW       CASH DIVIDEND
-------------------       --------     -------     -------------
<S>                       <C>          <C>         <C>
2002  First Quarter       $ 22.80      $ 17.20         $ -
      Second Quarter        21.81        15.15           -
      Third Quarter         18.85        15.75           -
      Fourth Quarter        19.50        15.65           -

2003  First Quarter       $ 17.50      $  7.31         $ -
      Second Quarter        12.00         7.75           -
      Third Quarter         10.00         8.25           -
      Fourth Quarter        12.50         8.45           -
</TABLE>

The last reported sale price of the common stock on NASDAQ on September 25, 2003
was $10.90 per share. As of that date, there were approximately 131 record
holders of common stock. Cash dividends may be paid, from time to time, on our
common stock as our Board of Directors deems appropriate after consideration of
our continued growth rate, operating results, financial condition, cash
requirements, compliance with the financial covenants of our bank credit
facility, and such other factors as the Board of Directors deem appropriate.

                                        8

<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

         The following table sets forth selected financial data regarding our
results of operations and financial position for, and as of the end of, each of
the years in the five-year period ended June 30, 2003, which are derived from
our audited consolidated financial statements. Our consolidated financial
statements and notes thereto as of June 30, 2003 and 2002, and for the years
ended June 30, 2003, 2002 and 2001, and the report of Grant Thornton LLP thereon
are included elsewhere in this Report. The selected financial data should be
read in conjunction with Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and notes thereto included elsewhere in this Report. The share,
earnings (loss) per share, dividends per share, and book value per share amounts
have been adjusted to give effect to the two-for-one stock split effected on
October 18, 2001.

<TABLE>
<CAPTION>
                                                                  AS OF AND FOR THE YEARS ENDED JUNE 30,
                                     -----------------------------------------------------------------------------------------------
                                        2003        %        2002      %          2001     %        2000      %      1999      %
                                     -----------------------------------------------------------------------------------------------
                                                            (Dollars in thousands, except share and per share amounts)
<S>                                  <C>          <C>     <C>        <C>       <C>        <C>     <C>       <C>    <C>        <C>
OPERATING RESULTS:

Revenues                             $  69,170    100.0   $ 109,456  100.0     $ 78,159   100.0   $ 58,561  100.0  $ 40,568   100.0
Cost of revenues                        52,514     75.9      78,531   71.8       54,649    69.9     42,903   73.3    26,296    64.8
Gross margin                            16,656     24.1      30,925   28.2       23,510    30.1     15,658   26.7    14,272    35.2
Operating expenses                      18,148     26.2      24,657   22.5       17,608    22.5     13,882   23.7    11,293    27.8
Operating income                        (1,492)    (2.1)      6,268    5.7        5,902     7.6      1,776    3.0     2,979     7.4
Other income (expenses)                    774      1.1         472    0.4       (1,027)   (1.3)      (198)  (0.3)     (133)   (0.3)
Provision for taxes                       (339)    (0.5)      2,351    2.1        1,803     2.3        647    1.1       996     2.5
Net income                           $    (379)    (0.5)  $   4,389    4.0     $  3,072     3.9   $    931    1.6  $  1,850     4.6

PER SHARE DATA:

Basic earnings per share             $   (0.13)           $    1.47            $   1.04           $   0.32         $   0.63
Diluted earnings per share           $   (0.13)           $    1.43            $   1.02           $   0.32         $   0.63
Cash dividends per share             $       -            $       -            $   0.13           $   0.25         $   0.25

WEIGHTED AVERAGE SHARES OUTSTANDING:

Basic earnings per share                 2,996                2,978               2,947              2,918            2,910
Diluted earnings per share               2,996                3,080               3,002              2,940            2,920

FINANCIAL POSITION:

Working capital                      $  17,771            $  17,755            $ 14,615           $ 11,938         $ 11,469
Current assets                          38,012               41,746              41,731             27,528           20,456
Total assets                            42,552               46,506              46,156             32,121           23,479
Current liabilities                     20,241               23,991              27,116             15,590            8,987
Total liabilities                       20,241               23,991              28,463             17,372            8,987
Equity                                  22,311               22,515              17,693             14,749           14,492
Book value per share                 $    7.44            $    7.53            $   5.99           $   5.02         $   4.99
</TABLE>

                                       9

<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

OVERVIEW

         We are a global company providing environmental and separation and
filtration products for the abatement of air pollution and the removal of
contaminants from gases and liquids through our two principal business segments
- Environmental Systems and Separation & Filtration Systems. During fiscal year
2003, we suspended the operations of our Boiler business. See Item 1 - "Business
- Restructuring and Organizational Realignment" of this Report for additional
discussion on the suspension of this business unit.

         Environmental Systems. In this business segment, which represented 54%
of our fiscal 2003 revenues, we design, engineer, manufacture and sell highly
specialized environmental control systems, which are used for air pollution
abatement. Our main product, SCR Systems, is used to convert nitrogen oxide
(NOx) emissions from exhaust gases, caused by burning hydrocarbon fuels, such as
coal, gasoline, natural gas and oil, into harmless nitrogen and water vapor.
These systems are totally integrated, complete with instruments, controls and
related values and piping. In this segment, we also offer systems to reduce
other pollutants, such as carbon monoxide (CO) and particulate matter.

         Separation & Filtration. In this business segment, which represented
40% of our fiscal 2003 revenues, we design, engineer, manufacture and sell
specialized products known as "separators" or "filters" which are used for a
variety of purposes in cleaning gases and liquids as they move through piping
systems. These products are used primarily to remove solid and liquid
contaminants from natural gas and saltwater aerosols from combustion intake air
of shipboard gas turbine and diesel engines.

         Boilers. In this suspended business segment, which represented 6% of
our fiscal 2003 revenues, we designed, engineered, manufactured and sold
packaged boilers and other steam generating equipment. This equipment is used to
produce steam, used for heating, drying, driving steam engines and a variety of
other applications. See also Item 1 - "Business - Restructuring and
Organizational Realignment" of this Report for additional discussion on the
suspension of this business unit during fiscal 2003.

FORWARD-LOOKING STATEMENTS

         From time to time, we make oral and written statements that may
constitute "forward-looking statements" (rather than historical facts) as
defined in the Private Securities Litigation Reform Act of 1996 (the "Act") or
by the Commission in its rules, regulations and releases. We desire to take
advantage of the "safe harbor" provisions in the Act for forward-looking
statements made from time to time, including, but not limited to, the
forward-looking statements made in this Report, as well as those made in our
other filings with the Commission. Forward-looking statements contained in this
Report are based on management's current plans and expectations and are subject
to a number of risks and uncertainties that could cause actual results to differ
materially from those described in the forward-looking statements. In the
preparation of this Report, where such forward-looking statements appear, we
have sought to accompany such statements with meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those described in the forward-looking statements. Such factors
include, but are not limited to, the "Factors That May Affect Our Operating
Results and Other Risk Factors" starting on page 19 of this Report.

         We do not have, and expressly disclaim, any obligation to release
publicly any updates or changes in our expectations or changes in events,
conditions, or circumstances on which any forward-looking statement is based.

                                       10

<PAGE>

RESULTS OF OPERATIONS - CONSOLIDATED

         Revenues. For fiscal 2003, net revenues decreased approximately $40.3
million, or 36.8%, to $69.2 million from $109.5 million in fiscal 2002. Domestic
revenues decreased approximately $44.4 million, or 47.3%, from $93.9 million in
fiscal 2002 to $49.5 million in fiscal 2003. Foreign revenues increased
approximately $4.1 million, or 26.3%, from $15.6 million in fiscal 2002 to $19.7
million in fiscal year 2003. The decline in domestic revenues was mainly
attributable to the decline in our Environmental Systems sales. The increase in
foreign revenues related primarily to the increase in our U.K. operations sales
of our Separation & Filtration Systems. We feel that the decline in the
construction of new power plants, regulatory uncertainties, and the current
economic climate have all contributed to the decline in our domestic revenues
during this fiscal year.

         For fiscal 2002, net revenues increased approximately $31.3 million, or
40.0%, to $109.5 million from $78.2 million in fiscal 2001. Domestic revenues
increased approximately $25.1 million, or 36.5%, from $68.8 million in fiscal
2001 to $93.9 million in fiscal 2002. Foreign revenues increased approximately
$6.2 million, or 66.0%, from $9.4 million in fiscal 2001 to $15.6 million in
fiscal year 2002. The increase in domestic revenues was mainly attributable to
the continued demand for our Environmental Systems. The increase in our foreign
revenues related primarily to increased demand for our Separation & Filtration
Systems overseas.

         The Company's backlog of unfilled orders was approximately $40 million
at June 30, 2003, compared to $36 million at June 30, 2002 and $68 million at
June 30, 2001. While our backlog has increased since June 30, 2002, we feel that
the reduction in the construction of new power plants, environmental regulatory
uncertainties, and the current economic climate have all played a contributing
factor in the overall decline in our backlog since June 30, 2001. All of these
factors have contributed to planned projects being placed on hold or production
rescheduled, and new environmental and gas treatment projects being canceled or
delayed. These factors played a contributing role in the decline in our
Environmental Systems orders during the second half of fiscal 2002, which has
directly impacted our reported revenues and backlog during fiscal 2003. In
addition, our backlog at June 30, 2003 has been impacted by our decision to
suspend our Boiler business during fiscal 2003. We had approximately $400,000 in
Boiler orders in our backlog at June 30, 2003 compared to $2.8 million at June
30, 2002. The adoption of regulations related to NOx emissions have in the past
resulted in increased sales of our Environmental Systems, either through
new-source or retrofit applications, and we would anticipate that this trend
will continue in the future as compliance dates approach and regulatory
uncertainties are resolved. In addition, while the construction of new power
plants has seen a significant decline over the past 12 months, there is expected
to be a continued demand for our Environmental Systems as new power plants are
built to replace older, less efficient plants, and as regulatory compliance
projects are commenced. We feel these factors, to some degree, have attributed
to the improvement in our backlog since our prior fiscal year end.

         Gross Profit Margin. For fiscal 2003, our gross profit margin decreased
$14.2 million, or 46.0%, from $30.9 million in fiscal 2002 to $16.7 million in
fiscal 2003. Gross profit margin, as a percentage of sales, decreased from 28.2%
for the year ended June 30, 2002 to 24.1% for the year ended June 30, 2003. Our
reported margins during fiscal 2003 were impacted largely by two primary
factors: lower sales volume and shifts in product mix. As we manufacture a
significant portion of our products, fluctuations in revenues, from quarter to
quarter or year to year, will impact our manufacturing absorption factors, which
will directly impact our reported margins. Certain of our products historically
have higher margins than others; as a result, shifts in the composition of our
sales can have a significant impact on our reported margins. This was a factor
in fiscal 2003 where our Environmental Systems revenues, which historically have
higher gross profit margins, represented 54.2% of our total revenues compared
with 59.9% for fiscal 2002. In addition to the two primary factors, our margins
during the fiscal 2003 were also impacted by start-up costs on several SCR
System projects being higher than we initially budgeted and increased

                                       11

<PAGE>

competition in the marketplace. See also Item 1 - "Business - Restructuring and
Organizational Realignment" and Item 7 - "Results of Operations - Segments" of
this Report.

         For fiscal 2002, our gross profit margins increased $7.4 million, or
31.5%, from $23.5 million in fiscal 2001 to $30.9 million in fiscal 2002. Gross
profit margins, as a percentage of sales, decreased from 30.1% for the year
ended June 30, 2001 to 28.2% for year ended June 30, 2002. The reduced gross
profit percentage was primarily attributable to the increased percentage of our
boiler revenues as a percentage of our total revenues. In fiscal year 2001,
boiler revenues represented 3.7% of our total revenues. In fiscal year 2002,
this percentage had increased to 13.3%. Traditionally, we have recognized a
lower margin on our boiler products in relation to our other business segments.
Therefore, any shifts in our sales mix in any particular period could have an
impact on our reported margins for that period. As discussed in Item 1 -
"Business - Restructuring and Organizational Realignment" due to the limited
margins that the market is currently allowing for packaged boilers, and the drop
in demand for all boiler products, we suspended this operation during the first
quarter of fiscal 2003.

         Operating Expenses. For fiscal 2003, operating expenses decreased by
$6.6 million, or 26.7%, to $18.1 million, compared to $24.7 million for fiscal
year 2002. Although, operating expenses, as a percentage of sales, were 26.2%
for fiscal 2003 up from 22.5% for fiscal 2002. The decrease in the amount of
operating expenses during fiscal 2003 was due to the implementation of our
restructuring and organizational realignment initiative. As the steps in this
initiative were phased-in over the year, we did not realize the full benefit of
this initiative until the second half of our fiscal year. In connection with
this initiative, we incurred approximately $500,000 in severance payments and
related costs. In addition, included in our operating expenses this year is an
additional provision for doubtful accounts of approximately $650,000. Given the
current economic environment and uncertainties surrounding certain receivables,
we deemed an increase in our allowance for doubtful accounts was appropriate.
Excluding these charges, our operating expenses as a percentage of sales would
have been 24.4% for fiscal 2003. See also Item 1 - "Business - Restructuring and
Organizational Realignment" and Item 7 - "Management's Discussion and Analysis
of Financial Condition and Results of Operation - Liquidity and Capital
Resources" of this Report.

         For fiscal 2002, operational expenses increased $7.1 million, or 40.3%,
from $17.6 million for fiscal year 2001 to $24.7 million for fiscal year 2002.
Operating expenses as a percentage of revenue were 22.5% for both fiscal years
2002 and 2001. The increase in the amount of operating expenses during fiscal
2002 related to the additional engineering and project management personnel
required for the increased level and complexity of our Environmental Systems
sales.

         Other Income and Expense. For fiscal 2003, other income and expense
items changed by approximately $302,000 from an addition to income of
approximately $472,000 for the fiscal year 2002 to addition to income of
$774,000 for fiscal year 2003. During fiscal 2003, we recognized a gain of
approximately $473,000 on the sale of our Wylie, Texas property and other assets
and recognized a gain of approximately $267,000 in fiscal 2002 on the sale of
our Carrollton, Texas property and other assets. We also realized foreign
currency exchange gains of approximately $146,000 during fiscal 2003 compared to
approximately $84,000 in fiscal 2002.

         During fiscal year 2002, other income and expense items changed by
approximately $1.5 million from a charge to earnings of approximately $1.0
million for fiscal 2001 to an addition of income of approximately $472,000 for
fiscal 2002. During fiscal 2002, we incurred approximately $625,000 less in
interest expense, as we had less debt outstanding during the period, and
realized a gain of approximately $267,000 from the sale of our Carrollton, Texas
facility and other assets. In addition, we realized foreign currency exchange
gains of approximately $84,000 in fiscal 2002 versus currency exchange losses of
approximately $155,000 in fiscal 2001.

Income Taxes. The Company's effective income tax rate was approximately 47.2%,
34.9% and 37.0% in fiscal 2003, 2002 and 2001, respectively. The increase in the
effective rate in fiscal 2003 is a result of

                                       12

<PAGE>

benefits from the lower foreign tax rate and foreign sales income exclusions
increasing the tax benefit (and effective rate) in fiscal 2003, as opposed to
decreasing the tax expense (and effective rate) in fiscal 2002 and 2001.
Additionally, the credits in fiscal 2003 represented a larger percentage of the
tax expense (benefit) in fiscal 2003 compared with fiscal 2002 or 2001. For
further discussion related to our income taxes, please see Note K to our Notes
to Consolidated Financial Statements attached to this Report.

         Net Earnings (loss). As a result of the above factors, we incurred a
net loss of approximately $380,000, or .5% of sales, for fiscal 2003 compared to
net earnings of approximately $4.4 million, or 4.0% sales, for fiscal 2002.
Basic earnings per share decreased from $1.47 per share for 2002, to a loss of
$0.13 per share for 2003. Diluted earnings per share decreased from $1.43 per
share for 2002, to a loss of $0.13 per share for 2003. For fiscal year 2002, net
earnings increased $1.3 million, or 41.9%, from $3.1 million for fiscal year
2001. Basic earnings per share increased from $1.04 per share for fiscal 2001,
to $1.47 per share for 2002, or 41.3%. Diluted earnings per share increased from
$1.02 per share for 2001, to $1.43 per share for 2002, or 40.2%.

RESULTS OF OPERATIONS - SEGMENTS

         Currently we are organized on a global basis along two lines of
business: Environmental Systems, and Separation & Filtration Systems. The
Company had three reportable segments - Environmental Systems, Separation &
Filtration Systems and Boilers for fiscal 2003 and 2002. Segment information for
fiscal year 2001 has been restated on a comparable basis with fiscal years 2002
and 2003.

         Revenues. The following table displays revenues by reportable segment
(dollars in thousands).

<TABLE>
<CAPTION>
                                                      FISCAL YEAR ENDED JUNE 30,
                                      ---------------------------------------------------------
                                        2003       %         2002       %        2001       %
                                      ---------------------------------------------------------
<S>                                   <C>        <C>      <C>         <C>      <C>        <C>
REVENUES
  Environmental Systems               $ 37,511    54.2    $  65,539    59.9    $ 53,329    68.2
  Separation & Filtration Systems       27,343    39.5       29,341    26.8      21,949    28.1
  Boilers                                4,316     6.3       14,576    13.3       2,881     3.7
                                      --------   -----    ---------   -----    --------   -----
    Total                             $ 69,170   100.0    $ 109,456   100.0    $ 78,159   100.0
                                      ========   =====    =========   =====    ========   =====
</TABLE>

         Revenues from our Environmental Systems decreased $28.0 million, or
42.8%, in fiscal 2003, and increased $12.2 million, or 22.9%, in fiscal 2002.
This segment is impacted by the demand for new power plants and compliance with
various NOx reduction regulations. The increase in Environmental Systems revenue
during fiscal 2002 related primarily to the increase in the construction of new
merchant power plants in this country to meet the anticipated demand for
electricity. During the later part of fiscal 2002, the construction of new
merchant power plants in this country slowed considerably as generating
overcapacity occurred, coupled with the continued weakness in the U.S. economy.
In addition, recent regulatory uncertainties have caused NOx reduction
initiatives relating to retrofit projects to be delayed. These factors resulted
in the downturn of new orders during the second half of fiscal 2002, which
impacted our backlog entering fiscal 2003. As a result, revenues from this
segment were significantly lower for fiscal year 2003. However, the Company
feels that the market for its Environmental Systems products will improve once
the demand, regulatory, and economic issues are resolved.

         Separation & Filtration Systems revenues decreased by approximately
$2.0 million, or 6.8% in fiscal 2003 and increased by approximately $7.4
million, or 33.8% in fiscal 2002. The continued weakness in the U.S. economy
affected this segment as well during fiscal 2003. We saw our domestic Separation
& Filtration Systems revenues decrease by approximately $4.8 million or 35.1% in
fiscal 2003, compared to an increase of $1.2 million, or 9.6% for fiscal 2002.
During fiscal 2003, we were able to mitigate this decline, to some extent, by
the continued strength of our international sales, where revenues increased
approximately $2.8 million, or 18.2% in fiscal 2003 and $6.2 million, or 65.8%
in fiscal 2002.

                                       13

<PAGE>

         Boiler revenues during fiscal year 2003 decreased $10.3 million over
fiscal year 2002. Fiscal year 2002 Boiler revenues increased $11.7 million over
fiscal 2001. We entered into the Boiler market in the later part of fiscal year
2001. The reduction in our Boiler revenues, during fiscal 2003, relates directly
to our decision to suspend this operation. As part of our restructuring and
reorganization, we suspended this business in August 2002. As a result, no new
Boiler orders were accepted during fiscal 2003. See Item 1 - "Business -
Restructuring and Organizational Realignment" of this Report.

         Segment Profit (Loss). Management uses segment profit (loss), which
consists of segment revenues less segment costs and expenses before allocation
of general and administrative costs to measure segment profit or loss. In the
past, the Company did not allocate its unabsorbed manufacturing costs to each
individual segment. Starting in fiscal year 2002, the Company started allocating
all costs associated with the manufacture, sale and design of its products to
each segment. The Company does not allocate its general and administrative
expenses to its individual segments. Therefore, fiscal 2001 segment profit and
loss information has been restated to conform to the fiscal 2003 and 2002
presentation. The following table displays segment profit (loss) by reportable
segment (dollars in thousands).

<TABLE>
<CAPTION>
                                                      FISCAL YEAR ENDED JUNE 30,
                                                ------------------------------------
                                                  2003          2002           2001
                                                ------------------------------------
<S>                                             <C>           <C>           <C>
SEGMENT PROFIT (LOSS)
  Environmental Systems                         $  2,543      $ 12,653      $ 12,385
  Separation & Filtration Systems                  3,439         2,592         1,741
  Boilers                                         (1,069)       (1,189)       (2,327)
                                                --------      --------      --------
    Total                                          4,913        14,056        11,799
  Unallocated general and administrative
    expenses                                      (6,405)       (7,788)       (5,897)
                                                --------      --------      --------
  Operating income (loss)                       $ (1,492)     $  6,268      $  5,902
                                                ========      ========      ========
</TABLE>

         Environmental Systems profit in fiscal 2003 decreased $10.1 million, or
79.9% over fiscal 2002. Profit in fiscal 2002 increased $268,000, or 2.2% over
fiscal 2001. As a percentage of Environmental Systems revenue, profit in
Environmental Systems was 6.8%, 19.3% and 23.2%, in fiscal years 2003, 2002 and
2001, respectively. The decline in our Environmental Systems profit margin
during the current fiscal year related primarily to the 42.8% drop in this
segment's revenues during the period, and the resulting impact on our
manufacturing operations. In addition, start-up costs on several jobs were
higher than initially budgeted which impacted this segment's reported profits by
approximately 4% (as a percentage of sales). The decline in the operating
margins in fiscal 2002 related primarily to the addition of engineering and
project management personnel to support the increased level of Environmental
Systems revenues and the increased complexity associated with these projects,
and lower overall margins due to increased competition in the marketplace. See
Item 1 - "Business - Restructuring and Organizational Realignment" of this
Report.

         Separation & Filtration Systems profit in fiscal year 2003 increased
$847,000, or 32.7% over fiscal 2002. Profit in fiscal year 2002 increased
$851,000, or 48.9% over fiscal year 2001. As a percentage of Separation &
Filtration Systems revenue, profit in Separation & Filtration Systems was 12.6%,
8.8%, and 7.9%, in fiscal years 2003, 2002 and 2001, respectively. The increase
in the Separation & Filtration Systems profit margins during these periods
relates to the increase in our component of international sales, where we tend
to have a higher margin than domestically, and to a general improvement in
domestic margins.

         The Boiler business recorded a loss of approximately $1.1 million for
fiscal 2003 compared to a loss of approximately $1.2 million and $2.3 million
for fiscal 2002 and 2001, respectively. During the first quarter of fiscal 2003,
we decided as part of our restructuring and organizational realignment to
suspend this operation. See Item 1 - "Business - Restructuring and
Organizational Realignment" of this Report for further discussion on the
suspension of the Boiler business.

                                       14

<PAGE>

FINANCIAL POSITION

         Assets. Total assets decreased by approximately $3.9 million, or 8.4%,
from $46.5 million at June 30, 2002 to $42.6 million at June 30, 2003. The
decrease in our assets during this period resulted primarily from the downturn
in our business and the resultant restructuring and reorganization strategies
employed by us during fiscal 2003. At June 30, 2003, we held cash and short-term
investments of $7.0 million, had working capital of $17.8 million, and a current
ratio of 1.9-to-1.0. This compares with cash and short-term investments of $1.7
million, $17.7 million in working capital, and a current ratio of 1.7-to-1.0 at
June 30, 2002.

         Liabilities and Shareholders' Equity. Total liabilities decreased by
approximately $3.8 million, or 15.8%, from $24.0 million at June 30, 2002 to
$20.2 million at June 30, 2003. This related primarily to a reduction in our
billings in excess of costs and earnings on uncompleted contracts of
approximately $2.2 million and an overall decrease in our payables and other
liabilities of $1.6 million. The decrease in our equity of approximately
$200,000, or .9%, from $22.5 million at June 30, 2002 to $22.3 million at June
30, 2003 resulted primarily from our loss for the period. Our debt-to-equity
ratio has improved from 1.1-to-1.0 at June 30, 2002, to .9-to-1.0 at June 30,
2003, reflecting the 15.8% reduction in our liabilities and the .9% reduction in
our equity during the period.

LIQUIDITY AND CAPITAL RESOURCES

         Our cash and cash equivalents were $6.7 million as of June 30, 2003,
compared to $1.4 million at June 30, 2002. Our current cash position as of
September 17, 2003 was approximately $9.0 million. Cash provided by operating
activities during fiscal year 2003 was $4.9 million compared to $1.4 million for
fiscal year 2002.

         Because we are engaged in the business of manufacturing custom systems,
our progress billing practices are event-oriented rather than date-oriented, and
vary from contract to contract. We customarily bill our customers after the
occurrence of project milestones. Billings to customers affect the balance of
billings in excess of costs and earnings or the balance of cost and earnings in
excess of billings, 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 June 30, 2003, the balance of
these working capital accounts was $10.2 million compared to $18.0 million at
June 30, 2002, reflecting a decrease of our investment in these working capital
items of $7.8 million. We used cash during the fiscal year to reduce our accrued
liabilities and fund our operating loss.

         Cash provided by investing activities was approximately $423,000 for
fiscal year 2003, compared to a use of cash of approximately $1.2 million for
fiscal 2002. The cash provided during the 2003 fiscal year related primarily to
the sale of 32 acres of raw land in Wylie, Texas. The use of cash during fiscal
2002 related primarily to the refurbishment of our Abilene, Texas facility and
new technology equipment purchased during the year, offset by the proceeds from
the sale of our Carrollton, Texas facility.

         Cash provided by financing activities during fiscal 2003 related to the
proceeds from the issuance of common stock during the period, pursuant to
employee stock options. The use of cash during fiscal 2002 related primarily to
the payoff of the $1.6 million note on our Abilene, Texas facility, offset by
the proceeds from the issuance of common stock, pursuant to employee stock
options, of approximately $236,000.

         We maintain a $10 million revolving line of credit facility that
expires on October 31, 2003. The credit line carries a floating interest rate
based on the prime or Euros rate plus or minus an applicable margin (currently -
prime less .25% or Euros plus 2.00%), and is secured by substantially all of our
assets.

                                       15

<PAGE>

The margin factor is subject to adjustment based on our obtainment of threshold
financial performance criteria. As of June 30, 2003, we had no outstanding
balances under our credit line, and $3.5 million outstanding under letters of
credit, leaving $6.5 million of availability under the facility. The facility
contains financial covenants, restrictions on capital expenditures,
acquisitions, asset dispositions, and additional debt, as well as other
customary covenants. As of June 30, 2003 we were in compliance with all
financial and other covenants of our loan agreement. We are currently in the
process of renewing our credit facility and have received commitments from
several financial institutions to provide a credit facility under terms and
conditions that are at least as favorable as our current facility.

         Included in our financial statements is a $2.2 million receivable due
from a customer that during the current fiscal year filed a plan of
reorganization under Chapter 11 of the United States Bankruptcy Code (original
amount of the contract was approximately $6.2 million). We have been classified
as an unsecured creditor under such filing. We hired legal counsel to help with
the collection of this receivable and have filed a statutory lien on the
refinery where our equipment was installed. In addition, we have filed a lawsuit
to perfect our lien interest against the owner of the refinery. While we believe
our lien is valid, no assurances can be given. We have had, and continue to have
meetings with the refinery owner to resolve this issue. We will vigorously
pursue the collection of this receivable and believe that it will be collected.
However, in the event that our lien is invalidated, or if the receivable or a
significant portion thereof is deemed to be not collectible, we will be required
to write down the receivable to its net realizable value. To the extent that our
existing allowance for doubtful accounts is not adequate to cover a write down,
the additional reserve required will be a charge against our operating results.
Such an event could have a material adverse impact on our financial condition
and reported results of our operations, and in addition, could potentially
result in a violation of our loan covenants. While we would attempt, and have
reason to believe that we would be able, to obtain a waiver for such a
violation, no assurances can be given that we would be successful in such
endeavor.

         We believe we maintain adequate liquidity to support existing
operations and planned growth, as well as to continue operations during
reasonable periods of unanticipated adversity. See also Item 1 - "Business -
Restructuring and Organizational Realignment" of this Report.

CRITICAL ACCOUNTING POLICIES

         The preparation of our financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities as
of the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Our estimates, judgments and assumptions
are continually evaluated based on available information and experience. Because
of the use of estimates inherent in the financial reporting process, actual
results could differ from those estimates.

         Certain of our accounting policies require a higher degree of judgment
than others in their application. These include revenue recognition on long-term
contracts, accrual for estimated warranty costs and allowance for doubtful
accounts. Our policies and related procedures for revenue recognition on
long-term contracts, accrual of warranty costs and allowance for doubtful
accounts are summarized below.

         Revenue Recognition. We provide products under long-term, generally
fixed-priced, contracts that may extend up to 18 months, or longer, in duration.
In connection with these contracts, we follow the guidance contained in AICPA
Statement of Position ("SOP") 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts." 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, 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

                                       16

<PAGE>

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 in time 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."

         When using the percentage-of-completion method, we must be able to
accurately estimate the total costs we expect to incur on a project in order to
record the proper amount of revenues for that period. We continually update our
estimates of costs and status of each project with our subcontractors and our
manufacturing plants. If it is determined that a loss will result from the
performance of a contract, the entire amount of the loss is charged against
income when it is determined. The impact of revisions in contract estimates are
recognized on a cumulative basis in the period in which the revisions are made.
In addition, significant portions of the our costs are subcontracted under
fixed-price arrangements, thereby reducing the risk of significant cost overruns
on any given project. However, a number of internal and external factors,
including labor rates, plant utilization factors, future material prices,
customer change specifications, and other factors can affect our cost estimates.
While we attempt to reduce the risk relating to revenue and cost estimates in
percentage-of-completion models through corporate policy and approval and
monitoring processes, any estimation process, including that used in preparing
contract accounting models, involves inherent risk.

         Product Warranties. We offer warranty periods of various lengths to our
customers depending upon the specific product and terms of the customer
agreement. We typically negotiate varying terms regarding warranty coverage and
length of warranty dependent upon the product involved and customary practices.
In general our warranties require us to repair or replace defective products
during the warranty period at no cost to the customer. We attempt to obtain
back-up concurrent warranties for major component parts from our suppliers. As
of each balance sheet date, we record an estimate for warranty related costs for
products sold based on historical experience, expectation of future conditions
and the extent of back-up concurrent supplier warranties in place. While we
believe that our estimated warranty reserve is adequate and the judgment applied
is appropriate, due to a number of factors our estimated liability for product
warranties could differ from future actual warranty costs incurred.

         Allowance for Doubtful Accounts. We maintain an allowance for doubtful
accounts to reflect estimated losses resulting from the inability of customers
to make required payments. On an ongoing basis, we evaluate the collectibility
of accounts receivable based upon historical collection trends, current economic
factors, and the assessment of the collectibility of specific accounts. We
evaluate the collectibility of specific accounts using a combination of factors,
including the age of the outstanding balances, evaluation of customers' current
and past financial condition and credit scores, recent payment history, current
economic environment, and discussions with our project managers and with the
customers directly. See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources"
of this Report.

NEW ACCOUNTING STANDARDS

         In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." The Statement requires companies to recognize costs associated with
exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. FASB Statement No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
We do not expect the adoption of this pronouncement to have a material impact on
our financial condition or results of our operations.

         In November 2002, FASB reached a consensus on Emerging Issues Task
Force ("EITF") Issue 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." The guidance in this Issue is effective for revenue arrangements
entered into in fiscal years beginning after June 15, 2003. The Issue addresses
certain aspects of the accounting by a vendor for arrangements under which it
will perform multiple revenue-generating activities and whether, as a result,
there is embedded more than one earnings

                                       17

<PAGE>

process for revenue recognition purposes. We do not expect the adoption of this
pronouncement to have a material impact on our financial condition or results of
our operations.

         In November 2002, FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees of
Indebtedness of Others." This Interpretation clarifies the requirements of SFAS
No. 5, "Accounting for Contingencies," relating to the guarantor's accounting
for, and disclosure of, the issuance of certain types of guarantees. The
Interpretation's provision for initial recognition and measurement are required
on a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements are required for financial statements of interim or
annual reports that end after December 15, 2002. We have adopted FIN No. 45 and
have included the new disclosure requirements in Note H - "Product Warranties"
to the Notes to the Consolidated Financial Statements.

         In December 2002, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," which amends SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. SFAS No. 148 also requires that
disclosures of the pro forma effect of using the fair value method of accounting
for stock-based employee compensation be displayed more prominently and in a
tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma
effect in interim financial statements. See "Stock-Based Compensation" in Note
A, "Nature of Operations and Summary of Significant Accounting Policies" for the
additional annual disclosures made to comply with SFAS No. 148. The interim
disclosure provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. As we do not
intend to adopt the provisions of SFAS No. 123, we do not expect the transition
provisions of SFAS No. 148 to have a material effect on our results of
operations or our financial condition.

         In January 2003, FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." This Interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," addresses consolidation by business
enterprises of variable interest entities that possess certain characteristics.
The Interpretation requires that if a business enterprise has a controlling
financial interest in a variable interest entity, the assets, liabilities, and
results of the activities of the variable interest entity must be included in
the consolidated financial statements with those of the business enterprise.
This Interpretation applies immediately to variable interest entities created
after January 31, 2003 and to variable interest entities in which an enterprise
obtains an interest after that date. We did not have any ownership interest in
any variable interest entities as of June 30, 2003.

         In April 2003, FASB issued Statement No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities." FASB Statement No. 149
requires that contracts with comparable characteristics be accounted for
similarly. The Statement clarifies the circumstances in which a contract with an
initial net investment meets the characteristics of a derivative, and when a
derivative contains a financing component and amends certain other existing
pronouncements. This Statement is effective for contracts entered into or
modified after June 30, 2003. We do not expect the adoption of this
pronouncement to have a material impact on our financial condition or results of
our operations.

         In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. Many
of these instruments were previously classified as equity. SFAS No. 150 requires
that an issuer classify a financial instrument that is within its scope as a
liability, or as an asset in some circumstances. This Statement applies to three
types of freestanding financial instruments, other than outstanding shares. One
type is mandatory redeemable shares, which the issuing company is obligated to
buy back in exchange for cash or assets; a second type includes put options and
forward purchase contracts that require or may require the issuer to buy back
some of its shares in exchange for cash or other assets; and

                                       18

<PAGE>

the third type is obligations that can be settled with shares, the monetary
value of which is fixed, ties solely or predominantly to a variable such as a
market index, or varies inversely with the value of the issuer's shares. SFAS
No. 150 does not apply to features embedded in a financial instrument that is
not a derivative in its entirety.

         SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. We will implement SFAS No.
150 in our first quarter of fiscal year 2004. We have not, nor do we expect to
enter into any transactions that would be covered by SFAS No. 150 and therefore
the adoption of the Statement is not expected to have a material impact on our
financial statements.

FACTORS THAT MAY AFFECT OUR OPERATING RESULTS AND OTHER RISK FACTORS

         Investing in our common stock involves a high degree of risk. Any of
the following risks could have a material adverse effect on our financial
condition, liquidity, results of operations or prospects, financial or
otherwise. Reference to these factors in the context of a forward-looking
statement or statements shall be deemed to be a statement that any one or more
of the following factors may cause actual results to differ materially from
those in such forward-looking statement or statements. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Forward-Looking Statements" of this Report.

         CHANGES IN THE POWER GENERATION INDUSTRY AND/OR THE ECONOMY COULD HAVE
AN ADVERSE IMPACT ON OUR SALES OF ENVIRONMENTAL SYSTEMS AND OUR OPERATING
RESULTS.

         The demand for our Environmental Systems depends to an extent on the
continued construction of power generation plants and the upgrade of existing
power plants. In fiscal 2003, approximately 54% of our consolidated revenues
were derived from sales of Environmental Systems for new and refurbished power
plants compared to approximately 60% for fiscal 2002. The power generation
industry has experienced cyclical periods of slow growth or decline. Any change
in the power plant industry that results in a decline in the construction of
power plants or a decline in the upgrading of existing power plants could have a
materially adverse impact on our Environmental Systems revenues and our results
of operations. See Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations" of this Report.

         CHANGES IN CURRENT ENVIRONMENTAL LEGISLATION COULD HAVE AN ADVERSE
IMPACT ON THE SALE OF OUR ENVIRONMENTAL SYSTEMS AND ON OUR OPERATING RESULTS.

         Our Environmental Systems business is primarily regulatory driven. Laws
and regulations governing the discharge of pollutants into the environment or
otherwise relating to the protection of the environment or human health have
played a significant part in the increased use of Environmental Systems in the
United States. These laws include U.S. federal statutes such as the Resource
Conservation and Recovery Act of 1976, the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980, or CERCLA, the Clean Water Act and the
Clean Air Act, and the regulations implementing them, as well as similar laws
and regulations at state and local levels and in other countries. These laws and
regulations may change or other jurisdictions may not adopt similar laws and
regulations. This business will be adversely impacted to the extent that current
regulations requiring the reduction of NOx emissions are repealed, amended or
implementation dates delayed or to the extent that regulatory authorities
minimize enforcement. See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations" of this Report.

         COMPETITION COULD RESULT IN LOWER SALES AND DECREASED MARGINS.

         We operate in highly competitive markets worldwide. Competition could
result in not only a reduction in our sales, but also a reduction in the prices
we charge for our products. To remain

                                       19

<PAGE>

competitive we must be able to not only anticipate or respond quickly to our
customers' needs and enhance and upgrade our existing products and services to
meet those needs, but also continue to price our products competitively. Our
competitors may develop cheaper, more efficient products or may be willing to
charge lower prices for strategic marketing or to increase market share. Some of
our competitors have more capital and resources than we do and may be better
able to take advantage of acquisition opportunities or adapt more quickly to
changes in customer requirements. See Item 7 - "Management's Discussion and
Analysis of Financial Condition and Results of Operations" of this Report.

         WE ENTER INTO FIXED-PRICED CONTRACTS. IF OUR ACTUAL COSTS EXCEED OUR
ORIGINAL ESTIMATES, OUR PROFITS WILL BE REDUCED.

         The majority of our contracts are on a fixed-price basis. Although we
benefit from cost savings, we have limited ability to recover cost overruns.
Because of the large scale and long duration of our contracts, unanticipated
cost increases may occur as a result of several factors, including, but not
limited to, (1) increases in the cost, or shortages of components, materials or
labor; (2) unanticipated technical problems; (3) required project modifications
not initiated by the customer; and (4) suppliers' or subcontractors' failure to
perform. These factors could delay delivery of our products and our contracts
often provide for liquidated damages for late delivery. Unanticipated costs that
we cannot pass on to our customers or the payment of liquidated damages under
fixed contracts would negatively impact our profits.

         OUR BACKLOG MAY NOT BE INDICATIVE OF OUR FUTURE REVENUE.

         Customers may cancel or delay projects for reasons beyond our control.
Our orders normally contain cancellation provisions, which permit us to recover
only our costs and a portion of our anticipated profit in the event a customer
cancels an order. If a customer elects to cancel, we may not realize the full
amount of revenues included in our backlog. If projects are delayed, the timing
of our revenues could be affected and projects may remain in our backlog for
extended periods of time. Revenue recognition occurs over long periods of time
and is subject to unanticipated delays. If we receive relatively large orders in
any given quarter, fluctuations in the levels of our quarterly backlog can
result because the backlog in that quarter may reach levels that may not be
sustained in subsequent quarters. Our backlog may not be indicative of our
future revenues. See Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations" of this Report.

         OUR ABILITY TO CONDUCT BUSINESS OUTSIDE THE UNITED STATES MAY BE
ADVERSELY AFFECTED BY FACTORS OUTSIDE OF OUR CONTROL AND OUR REVENUES AND
PROFITS FROM INTERNATIONAL SALES COULD BE ADVERSELY IMPACTED.

         For fiscal 2003, revenue outside the United States represented
approximately 29% of our consolidated revenues. In fiscal 2002, approximately
15% of our revenue was derived from sales outside the United States. Our
operations and earnings throughout the world have been, and may in the future
be, affected from time to time in varying degrees by war, political developments
and foreign laws and regulations, such as regional economic uncertainty,
political instability, restrictions, customs and tariffs, changing regulatory
environments, fluctuations in foreign currency exchange rates and adverse tax
consequences. The likelihood of such occurrences and their overall effect upon
us vary greatly from country to country and are not predictable. These factors
may result in a decline in revenues or profitability and could adversely affect
our ability to expand our business outside of the United States.

                                       20

<PAGE>

         OUR FINANCIAL PERFORMANCE MAY VARY SIGNIFICANTLY FROM QUARTER TO
QUARTER, MAKING IT DIFFICULT TO ESTIMATE FUTURE REVENUE.

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

         OUR PRODUCTS ARE COVERED BY WARRANTIES. UNANTICIPATED WARRANTY COSTS
FOR DEFECTIVE PRODUCTS COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND REPUTATION.

         We provide warranties on our products generally for terms of three
years or less. These warranties require us to repair or replace faulty products
and meet certain performance standards, among other customary warranty
provisions. While we continually monitor our warranty claims and provide a
reserve for estimated warranty issues on an on-going basis, an unanticipated
claim could have a material adverse impact on our operations. In some cases, we
may be able to subrogate a claim back to a subcontractor, if the subcontractor
supplied the defective product or performed the service, but this may not always
be possible. The need to repair or replace products with design or manufacturing
defects could temporarily delay the sale of new products, reduce our profits and
could adversely affect our reputation. See Item 7 - "Management's Discussion and
Analysis of Financial Condition and Results of Operation" of this Report.

         PRODUCT LIABILITY CLAIMS NOT COVERED BY INSURANCE COULD ADVERSELY
AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

         We may be subject to product liability claims involving claims of
personal injury or property damage. While we maintain product liability
insurance coverage to protect us in the event of such a claim, our coverage may
not be adequate to cover the cost of defense and the potential award in the
event of a claim. Also, a well-publicized actual or perceived problem could
adversely affect our reputation and reduce the demand for our products.

         LARGE CONTRACTS REPRESENT A SIGNIFICANT PORTION OF OUR ACCOUNTS
RECEIVABLE, WHICH INCREASES OUR EXPOSURE TO CREDIT RISK.

         We continue to closely monitor the credit worthiness of our customers
and have not, to date, experienced any significant credit losses. Significant
portions of our sales are to customers who place large orders for custom
products and whose activities are related to the power industry. As such, our
exposure to credit risk is affected to some degree by conditions within the
power industry and governmental and/or political conditions. We try to mitigate
our exposure to credit risk, to some extent, by requiring progress payments and
letters of credit. However, as some of our exposure is outside of our control,
unanticipated events could have a materially adverse impact on our operating
results. See Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operation - Liquidity and Capital Resources" of this
Report.

         THE TERMS AND CONDITIONS OF OUR CREDIT FACILITY IMPOSE RESTRICTIONS ON
OUR OPERATIONS. WE MAY NOT BE ABLE TO RAISE ADDITIONAL CAPITAL, IF NEEDED.

         The terms and conditions of our current $10 million revolving credit
facility impose restrictions that affect, among other things, our ability to
incur debt, make capital expenditures, merge, sell assets, make

                                       21

<PAGE>

distributions, or create or incur liens. Availability of our credit facility is
also subject to certain financial covenants, including a prohibition against
consecutive quarterly losses. Our ability to comply with the covenants may be
affected by events beyond our control and we cannot assure that we will achieve
operating results meeting the requirements of the credit agreement. A breach of
any of these covenants could result in a default under our credit facility. In
the event of a default, the bank could elect to declare the outstanding
principal amount of our credit facility, all interest thereon, and all other
amounts payable under our credit facility to be immediately due and payable. As
of June 30, 2003 we were in compliance with all financial and other covenants of
our credit facility.

         Our ability to satisfy any debt obligations will depend upon our future
operating performance, which will be affected by prevailing economic, financial
and business conditions and other factors, some of which are beyond our control.
We anticipate that borrowings from our existing revolving credit facility, or
the refinancing of our revolving credit facility, and cash provided by operating
activities, should provide sufficient funds to finance capital expenditures,
working capital and otherwise meet our operating expenses and service our debt
requirements as they become due. However, in the event that we require
additional capital, there can be no assurance that we will be able to raise such
capital when needed or on satisfactory terms, if at all. See Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Liquidity and Capital Resources" of this Report.

         OUR BUSINESS IS SUBJECT TO RISKS OF TERRORIST ACTS AND ACTS OF WAR.

         Terrorist acts and acts of war may disrupt our operations, as well as
our customers operations. Such acts have created, and continue to create,
economic and political uncertainties and have contributed to the global economic
instability that we are currently facing. Any future terrorist activities, or
any continued military or security operations could further weaken the global
economy and create additional uncertainties forcing our customers to further
reduce their capital spending, or cancel or delay already planned construction
projects, which could have a material adverse impact on our business, operating
results and financial condition.

         OUR COMMON STOCK IS THINLY TRADED, WHICH MAY RESULT IN LOW LIQUIDITY.

         The daily trading volume of our common stock is relatively low and
therefore the liquidity and appreciation in our stock may not meet our
shareholders' expectations. The market price of our common stock could be
adversely impacted as a result of sales by our existing shareholders of a large
number of shares of our common stock in the market, or the perception that such
sales could occur.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         Our primary market risk exposures are in the areas of interest rate
risk and foreign currency exchange rate risk. We feel our risk to interest rate
fluctuations is nominal, as our investments are short-term in nature and we are
currently not in a borrowing position. Our exposure to currency exchange rate
fluctuations has been, and is expected to continue to be, modest as foreign
contracts payable in currencies other than US dollars are performed, for the
most part, in the local currency and therefore provide a "natural hedge" against
currency fluctuations. We, on occasion, will purchase derivative transactions
with respect to foreign contracts that do not contain a "natural hedge," but the
impact of any fluctuation in the exchange rates in these hedged currencies,
would be expected to have an immaterial impact on our financial operations. The
impact of currency exchange rate movements on inter-company transactions has
been, and is expected to continue to be, immaterial. We did not have any
derivative transactions outstanding as of June 30, 2003.

                                       22

<PAGE>

ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         The information required by this Item begins on page 26 of this Report.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE.

         No matter requires disclosure.

ITEM 9A. CONTROLS AND PROCEDURES.

         The Company, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of the design and operation
of the Company's disclosure controls and procedures. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures were effective as of June 30, 2003
to ensure that information required to be disclosed by the Company in reports
that it files or submits under the 1934 Act is recorded, processed, summarized
and reported within the time periods specified in SEC rules and forms.

         There were no changes in the Company's internal control over financial
reporting during the Company's fiscal fourth quarter ended June 30, 2003 that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

ITEM 11. EXECUTIVE COMPENSATION.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

         All information required by Items 10, 11, 12, 13, and 14, is
incorporated by reference to the definitive proxy statement for our 2003 Annual
Meeting of Shareholders.

                                       23

<PAGE>

                                     PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K.

 (a)(1)  FINANCIAL STATEMENTS

         See Index to Consolidated Financial Statements of Peerless Mfg. Co. and
         Subsidiaries on page 26 of this Report.

 (a)(2)  FINANCIAL STATEMENT SCHEDULES

         The following financial statement schedule of Peerless Mfg. Co. and
         subsidiaries is included.

         Schedule II - Valuation and Qualifying Accounts - see page 50 of this
         Report.

         All other schedules for which provision is made in the applicable
         accounting regulation of the Securities and Exchange Commission have
         been omitted because of the absence of the conditions under which they
         would be required or because the information required is included in
         the consolidated financial statements or notes thereto.

 (a)(3)  EXHIBITS

         See the exhibit index, which is included in this Report beginning on
         page 51.

 (b)     REPORTS ON FORM 8-K

         On May 14, 2003, the Registrant filed a Report on Form 8-K to file a
         press release announcing its financial results for the third quarter
         ended March 31, 2003, which information was "furnished" and not "filed"
         with the Commission.

         On September 19, 2003, the Registrant filed a Report on Form 8-K to
         file a press release announcing its financial results for the fourth
         quarter and for the year ended June 30, 2003, which information was
         "furnished" and not "filed" with the Commission.

                                       24

<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

                         PEERLESS MFG. CO.

                         By: /s/ Sherrill Stone
                             -------------------------------
                         Sherrill Stone
                         Chairman  of the Board  and Chief  Executive Officer
                         Date:  September 25, 2003

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on September 25, 2003, except for Mr. Mulford who
signed this Report on September 26, 2003.

/s/ Sherrill Stone                  Chairman of the Board and
---------------------------         Chief Executive Officer
Sherrill Stone

/s/ Richard L. Travis, Jr.          Vice President and Chief Financial Officer
---------------------------         (Principal Financial and Accounting Officer)
Richard L. Travis, Jr.

/s/ Donald A. Sillers, Jr.          Director
---------------------------
Donald A. Sillers, Jr.

/s/ J. V. Mariner, Jr.              Director
---------------------------
J. V. Mariner, Jr.

/s/ Bernard S. Lee                  Director
---------------------------
Bernard S. Lee

/s/ R. Clayton Mulford              Director
---------------------------
R. Clayton Mulford

                                       25
<PAGE>

                       PEERLESS MFG. CO AND SUBSIDIARIES
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                        AND FINANCIAL STATEMENT SCHEDULE

<TABLE>
<CAPTION>
                                                                                                            PAGE
                                                                                                           NUMBER
                                                                                                           ------
<S>                                                                                                        <C>
Report of Independent Certified Public Accountants.......................................................    27

Consolidated Balance Sheets at June 30, 2003 and 2002....................................................    28

Consolidated Statements of Operations for the years ended June 30, 2003, 2002 and 2001...................    30

Consolidated Statements of Changes in Shareholders' Equity
  for the years ended June 30, 2003, 2002 and 2001.......................................................    31

Consolidated Statements of Cash Flows for the years ended June 30, 2003, 2002 and 2001...................    32

Notes to Consolidated Financial Statements...............................................................    34

Report of Independent Certified Public Accountants on Financial Schedule.................................    49

Financial Statement Schedule.............................................................................    50
</TABLE>

                                       26

<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors
Peerless Mfg. Co.

We have audited the accompanying consolidated balance sheets of Peerless Mfg.
Co. and subsidiaries as of June 30, 2003 and 2002, and the related consolidated
statements of operations, changes in shareholders' equity, and cash flows for
each of the three years in the period ended June 30, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.

In our opinion, the financial statements referred to above, present fairly, in
all material respects, the consolidated financial position of Peerless Mfg. Co.
and subsidiaries as of June 30, 2003 and 2002, and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended June 30, 2003, in conformity with accounting principles
generally accepted in the United States of America.

                                                  /s/ Grant Thornton, LLP
                                                  -----------------------
                                                  Grant Thornton, LLP

Dallas, Texas
September 2, 2003

                                       27

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                             (Dollars in thousands)

ASSETS

<TABLE>
<CAPTION>
                                                             JUNE 30,
                                                      -----------------------
                                                         2003         2002
                                                      -----------------------
<S>                                                   <C>          <C>
Current assets:
     Cash and cash equivalents                        $     6,680  $    1,386
     Short-term investments                                   309         307
     Accounts receivable-principally trade                 17,547      25,506
     Inventories                                            3,218       3,671
     Costs and earnings in excess of billings
           on uncompleted contracts                         7,715       9,218
     Deferred income taxes                                  1,445         933
     Other current assets                                   1,098         725
                                                      -----------  ----------
              Total current assets                         38,012      41,746
     Property, plant and equipment - net                    3,430       4,152
     Deferred income taxes                                      8          17
     Other assets                                           1,102         591
                                                      -----------  ----------
              Total assets                            $    42,552  $   46,506
                                                      ===========  ==========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       28

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                             (Dollars in thousands)

LIABILITIES AND SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                        JUNE 30,
                                                                                 ----------------------
                                                                                    2003        2002
                                                                                 ----------------------
<S>                                                                              <C>         <C>
Current liabilities:
       Accounts payable                                                          $   12,997  $   12,545
       Billings in excess of costs and earnings
              on uncompleted contracts                                                2,027       4,231
       Commissions payable                                                            1,119       1,556
       Income taxes payable                                                              53         766
       Product warranties                                                               994         750
       Accrued liabilities and other payables                                         3,051       4,143
                                                                                 ----------  ----------
              Total current liabilities                                              20,241      23,991

Shareholders' equity:
       Common stock - authorized, 10,000,000
              shares of $1 par value; issued and
              outstanding, 2,998,534 and 2,991,134
              shares at June 30, 2003 and 2002, respectively                          2,999       2,991
       Additional paid-in capital                                                     1,771       1,720
       Other                                                                             18         (98)
       Retained earnings                                                             17,523      17,902
                                                                                 ----------  ----------
              Total shareholders' equity                                             22,311      22,515
                                                                                 ----------  ----------
              Total liabilities and shareholders' equity                         $   42,552  $   46,506
                                                                                 ==========  ==========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       29

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                (Dollars in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                   YEAR ENDED JUNE 30,
                                           ----------------------------------
                                              2003        2002        2001
                                           ----------------------------------
<S>                                        <C>         <C>         <C>
Revenues                                   $   69,170  $  109,456  $   78,159
Cost of goods sold                             52,514      78,531      54,649
                                           ----------  ----------  ----------
Gross profit                                   16,656      30,925      23,510
Operating expenses
       Sales and marketing                      6,130       8,636       6,613
       Engineering and project management       5,613       8,233       5,098
       General and administrative               5,922       7,788       5,897
       Restructuring expense                      483           -           -
                                           ----------  ----------  ----------
                                               18,148      24,657      17,608
                                           ----------  ----------  ----------
Operating income (loss)                        (1,492)      6,268       5,902

Other income (expense)
       Interest expense                             -        (123)       (744)
       Foreign exchange gain (loss)               146          84        (155)
       Gain on sale of assets                     473         267           -
       Other, net                                 155         244        (128)
                                           ----------  ----------  ----------
                                                  774         472      (1,027)
                                           ----------  ----------  ----------
Earnings (loss) before income taxes              (718)      6,740       4,875

Income tax expense (benefit)
       Current                                    164       2,744       2,265
       Deferred                                  (503)       (393)       (462)
                                           ----------  ----------  ----------
                                                 (339)      2,351       1,803
                                           ----------  ----------  ----------
Net earnings (loss)                        $     (379) $    4,389  $    3,072
                                           ==========  ==========  ==========

Basic earnings (loss) per share            $    (0.13) $     1.47  $     1.04
                                           ==========  ==========  ==========

Diluted earnings (loss) per share          $    (0.13) $     1.43  $     1.02
                                           ==========  ==========  ==========
</TABLE>

           See accompanying notes to consolidated financial statements

                                       30
<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                 ACCUMULATED
                                           $1 PAR            UNAMORTIZED VALUE      OTHER                  TOTAL
                                           COMMON   PAID-IN    OF RESTRICTED    COMPREHENSIVE  RETAINED  SHAREHOLDER
                                           STOCK    CAPITAL     STOCK GRANTS    INCOME (LOSS)  EARNINGS    EQUITY
                                          -------   -------  -----------------  -------------  --------  -----------
<S>                                       <C>       <C>      <C>                <C>            <C>       <C>
Balances at July 1, 2000                  $ 1,468   $ 2,692      $     (71)        $  (149)    $ 10,809   $  14,749

Net earnings                                    -         -              -               -        3,072       3,072
Foreign currency translation adjustment         -         -              -              83            -          83
                                                                                                          ---------
              Total comprehensive income                                                                      3,155

Dividends ($.50 per share)                      -         -              -               -         (368)       (368)
Forfeiture of restricted stock grants          (1)       (9)             -               -            -         (10)
Stock options exercised                        10       111              -               -            -         121
Amortization of restricted stock grants         -         -             36               -            -          36
Income tax benefit related to restricted
      stock plan                                -        10              -               -            -          10

                                          -------   -------      ---------         -------     --------   ---------
Balance at June 30, 2001                    1,477     2,804            (35)            (66)      13,513      17,693

Net earnings                                    -         -              -               -        4,389       4,389
Foreign currency translation adjustment         -         -              -             (16)           -         (16)
                                                                                                          ---------
              Total comprehensive income                                                                      4,373

Stock split (2-for-1)                       1,477    (1,477)             -               -            -           -
Stock options exercised                        37       180              -               -            -         217
Amortization of restricted stock grants         -         -             19               -            -          19
Income tax benefit related to restricted
      stock plan                                -       213              -               -            -         213

                                          -------   -------      ---------         -------     --------   ---------
Balance at June 30, 2002                    2,991     1,720            (16)            (82)      17,902      22,515

Net (loss)                                      -         -              -               -         (379)       (379)
Foreign currency translation adjustment         -         -              -             103            -         103
                                                                                                          ---------
              Total comprehensive (loss)                                                                       (276)

Stock options exercised                        11        53              -               -            -          64
Stock grant forfeiture                         (3)      (16)             8               -            -         (11)
Amortization of restricted stock grants         -         -              5               -            -           5
Income tax benefit related to restricted
      stock plan                                -        14              -               -            -          14

                                          -------   -------      ---------         -------     --------   ---------
Balance at June 30, 2003                  $ 2,999   $ 1,771      $      (3)        $    21     $ 17,523   $  22,311
                                          =======   =======      =========         =======     ========   =========
</TABLE>

           See accompanying notes to consolidated financial statements

                                       31
<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                         YEAR ENDED JUNE 30,
                                                              ------------------------------------------
                                                                 2003            2002            2001
                                                              ----------      ----------      ----------
<S>                                                           <C>             <C>             <C>
Cash flows from operating activities:
     Net earnings (loss)                                      $     (379)     $    4,389      $    3,072
     Adjustments to reconcile net earnings (loss)
       to net cash provided by
       operating activities:
          Depreciation and amortization                              769             682             566
          Deferred income taxes                                     (503)           (393)           (462)
          Foreign exchange (gain) loss                              (146)            (84)            155
          Gain on sales of property and equipment                   (473)           (267)              -
          Bad debt expense                                           774             133              54
          Other                                                        7             213              73
     Changes in operating assets and liabilities
          Accounts receivable                                      7,319           3,372         (16,823)
          Inventories                                                456          (1,586)          1,236
          Cost and earnings in excess of
             billings on uncompleted contracts                     1,504          (2,890)          3,392
          Other current assets                                      (357)             12             (47)
          Other assets                                              (511)            476             (45)
          Accounts payable                                           596           2,408           3,703
          Billings in excess of costs and earnings
             on uncompleted contracts                             (2,204)         (5,387)          9,254
          Commissions payable                                       (437)            113             458
          Accrued expenses and other                              (1,561)            187           3,917
                                                              ----------      ----------      ----------
                                                                   5,233          (3,011)          5,431
                                                              ----------      ----------      ----------
Net cash provided by operating activities                          4,854           1,378           8,503

Cash flows from investing activities:
     Net purchases of short-term investments                          (2)             (7)            (27)
     Purchase of property and equipment                             (137)         (1,561)           (316)
     Proceeds from sale of property and equipment                    562             405               -
                                                              ----------      ----------      ----------
Net cash provided by (used in) investing activities                  423          (1,163)           (343)

Cash flows from financing activities:
     Sale of common stock                                             64             236             121
     Net changes in lines of credit                                    -               -          (5,800)
     Payments on long-term borrowings                                  -          (1,600)           (227)
     Dividends paid                                                    -               -            (368)
                                                              ----------      ----------      ----------
Net cash provided by (used in)
     financing activities                                             64          (1,364)         (6,274)
</TABLE>

           See accompanying notes to consolidated financial statements.

                                       32

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                          YEAR ENDED JUNE 30,
                                                              ------------------------------------------
                                                                 2003            2002            2001
                                                              ----------      ----------      ----------
<S>                                                           <C>             <C>             <C>
Effect of exchange rate changes on
     cash and cash equivalents                                       (47)            (42)            130
                                                              ----------      ----------      ----------
Net increase (decrease) in cash and
     cash equivalents                                              5,294          (1,191)          2,016

Cash and cash equivalents at
     beginning of year                                             1,386           2,577             561
                                                              ----------      ----------      ----------

Cash and cash equivalents at
     end of year                                              $    6,680      $    1,386      $    2,577
                                                              ==========      ==========      ==========

Supplemental information on cash flow:

     Interest paid                                            $        -      $      123      $      744
     Income taxes paid                                        $      834      $    3,402      $      105
</TABLE>

           See accompanying notes to consolidated financial statements.

                                       33

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS

Peerless Mfg. Co. designs, engineers, and manufactures specialized products for
the removal of contaminants from gases and liquids and for air pollution
abatement. The Company's products are manufactured principally at plants located
in Texas and are sold worldwide with the principal markets located in North
America and Europe. Primary customers are equipment manufacturers, engineering
contractors and operators of power plants.

A summary of the significant accounting policies consistently applied in the
preparation of the accompanying consolidated financial statements follows.

CONSOLIDATION

The Company consolidates the accounts of its subsidiaries, all of which are
wholly owned. All significant inter-company accounts and transactions have been
eliminated in consolidation.

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 evaluation of the customer's financial condition
and, generally collateral is not required except on credit extension to
international customers. Accounts receivable are generally due within 30 days
and are stated at amounts due from customers net of an allowance for
uncollectible 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 trade
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 general economy and the industry as a whole. The Company
writes-off accounts receivable when they become uncollectible, and payments
subsequently received on such receivables are credited back to bad debt expense
in the period the payment is received.

Changes in the Company's allowance for uncollectible accounts for the years
ended June 30, 2003 and 2002 are as follows.

<TABLE>
<CAPTION>
                                                    Year ended June 30,
                                                 ------------------------
                                                   2003           2002
                                                 ---------      ---------
<S>                                              <C>            <C>
Beginning balance                                $     354      $     297
Bad Debt expense, net of recoveries                    774            133
Accounts written off                                   (76)           (76)
                                                 ---------      ---------
Ending balance                                   $   1,052      $     354
                                                 =========      =========
</TABLE>

                                       34

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
        CONTINUED

INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out) or market.

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. The cost of maintenance
and repairs is expensed as incurred and significant renewals and betterments are
capitalized.

WARRANTY COSTS

The Company provides product warranties for specific product lines and accrues
for estimated future warranty costs in the period in which the revenue is
recognized based on historical experience, expectation of future conditions, and
the extent of backup concurrent supplier warranties in place.

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 ("SOP") 81-1, "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts." 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, 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 revenues recognized may be less or greater than cumulative costs and
profits billed at any point in time 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.

SHIPPING AND HANDLING POLICY

Shipping and handling fees charged to customers are reported as revenue.
Shipping and handling costs that are incurred that related to products sold are
reported as cost of goods sold.

                                       35

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
        CONTINUED

EARNINGS (LOSS) PER COMMON SHARE

Basic earnings (loss) per common share are computed by dividing net earnings
(loss) by the weighted average number of common shares outstanding during each
year presented. Diluted earnings (loss) per common share give effect to the
assumed issuance of shares pursuant to outstanding stock option plans, when
dilutive.

STOCK BASED COMPENSATION

At June 30, 2003, the Company has two stock-based employee compensation plans,
which are described more fully in Note I. The Company accounts for those plans
under the recognition and measurement principles of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market price of the underlying common stock on the date of grant. The
following table illustrates the effect on net earnings (loss) and earnings
(loss) per share if the Company had applied the fair value recognition
provisions of Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.

<TABLE>
<CAPTION>
                                                               Year ended June 30,
                                                    ----------------------------------------
                                                      2003            2002            2001
                                                    ----------------------------------------
<S>                                                 <C>             <C>             <C>
Net earnings (loss), as reported                    $   (379)       $  4,389        $  3,072
Deduct: Total stock-based employee
  compensation expense determined
  using the fair value based method for
  all awards, net of related tax effects                (117)           (115)             (6)
                                                    --------        --------        --------
Pro forma net earnings (loss)                       $   (496)       $  4,274        $  3,066
                                                    ========        ========        ========

Earnings (loss) per share:
     Basic - as reported                            $  (0.13)       $   1.47        $   1.04
                                                    ========        ========        ========

     Basic - pro forma                              $  (0.17)       $   1.44        $   1.02
                                                    ========        ========        ========

     Diluted - as reported                          $  (0.13)       $   1.43        $   1.02
                                                    ========        ========        ========

     Diluted - pro forma                            $  (0.17)       $   1.39        $   1.00
                                                    ========        ========        ========
</TABLE>

                                       36

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
        CONTINUED

FOREIGN CURRENCY

All balance sheet accounts of foreign operations are translated into U.S.
dollars at the year-end rate of exchange and statements of operations items are
translated at the weighted average exchange rates for the year. The resulting
translation adjustments are made directly to a separate component of
stockholders' equity. Gains and losses from foreign currency transactions, such
as those resulting from the settlement of foreign receivables or payables, are
included in the consolidated statements of operations.

FINANCIAL INSTRUMENTS

The carrying amounts of cash and cash equivalents and short-term investments
approximate fair value because of the short-term nature of these items.

STOCK SPLIT

In September 2001 the board of directors approved a two-for-one stock split of
the Company's common stock effected in the form of a 100% stock dividend, which
was distributed on October 18, 2001, to shareholders of record on October 8,
2001. All share and per share amounts have been restated to give retroactive
effect to the stock split. In addition, all references in the Consolidated
Financial Statements and Notes to Consolidated Financial Statements, to weighted
average number of shares, per share amounts, cash dividends, and market prices
of the Company's common stock have been restated to give retroactive recognition
to the stock split.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

RECLASSIFICATION

Certain reclassifications of prior year amounts have been made to conform to the
current year presentation.

                                       37

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE B. NEW ACCOUNTING PRONOUNCEMENTS

In July 2002, the Financial Accounting Standards Board ("FASB") issued Statement
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The
Statement requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. FASB Statement No. 146 is to be applied prospectively to
exit or disposal activities initiated after December 31, 2002. The Company does
not expect the adoption of this pronouncement to have a material impact on its
financial condition or results of its operations.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. SFAS No. 148 also requires
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more prominently
and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the
pro forma effect in interim financial statements. See "Stock-Based Compensation"
within Note A, "Nature of Operations and Summary of Significant Accounting
Policies" for the additional annual disclosures made to comply with SFAS No.
148. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after December 15,
2002.

NOTE C. CONCENTRATIONS OF CREDIT RISK

The Company continues to closely monitor the creditworthiness of its customers
and has not experienced significant credit losses to date. Significant portions
of the Company's sales are to customers who place large orders for custom
systems and customers whose activities are related to the electrical generation
and oil and gas industries, including some who are located in other countries.
The Company generally requires progress payments, but may extend credit to some
of its customers. The Company's exposure to credit risk is also affected to some
degree by conditions within the electrical generation and oil and gas
industries. When sales are made to smaller international enterprises, the
Company generally requires progress payments or an appropriate guarantee of
payment, such as a letter of credit from a banking institution.

The Company is not dependent upon any single customer or group of customers in
either of our two primary business segments. The custom-designed and
project-specific nature of its business can cause year-to-year variance in its
major customers. During fiscal 2003, one customer accounted for approximately
15% of its consolidated revenues, and in fiscal years 2002 and 2001, different
customers accounted for approximately 13% and 17% of its total consolidated
revenues, respectively.

                                       38
<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE D. INVENTORIES

    Principal components of inventories are as follows:

<TABLE>
<CAPTION>
                           JUNE 30,
                     ------------------
                       2003       2002
                     ------------------
<S>                  <C>        <C>
Raw materials        $ 2,325    $ 2,201
Work in progress         581      1,085
Finished goods           312        385
                     -------    -------
                     $ 3,218    $ 3,671
                     =======    =======
</TABLE>

NOTE E. PROPERTY, PLANT AND EQUIPMENT

    Property, plant and equipment is summarized as follows:

<TABLE>
<CAPTION>
                                            JUNE 30,
                                      ------------------
                                        2003       2002
                                      ------------------
<S>                                   <C>        <C>
Buildings & improvements              $ 3,827    $ 3,806
Equipment                               4,079      4,058
Furniture and fixtures                  2,944      2,879
                                      -------    -------
                                       10,850     10,743
     Less accumulated depreciation     (8,163)    (7,403)
                                      -------    -------
                                        2,687      3,340
Land                                      743        812
                                      -------    -------
                                      $ 3,430    $ 4,152
                                      =======    =======
</TABLE>

Depreciation expense for the years ended June 30, 2003, 2002 and 2001 totaled
$769, $682 and $566, respectively.

                                       39

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE F. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

     The components of uncompleted contracts are as follows:

<TABLE>
<CAPTION>
                                                      JUNE 30,
                                              ------------------------
                                                 2003          2002
                                              ------------------------
<S>                                           <C>           <C>
Costs incured on uncompleted contracts and
   estimated earnings                         $  28,333     $   42,371
Less billings to date                           (22,645)       (37,384)
                                              ---------     ----------
                                              $   5,688     $    4,987
                                              =========     ==========
</TABLE>

The components of uncompleted contracts are reflected in the balance sheets at
June 30, 2003 and 2002 as follows:

<TABLE>
<CAPTION>
                                                      JUNE 30,
                                               ---------------------
                                                 2003         2002
                                               ---------------------
<S>                                            <C>          <C>
Costs and earnings in excess billings on
  uncompleted contracts                        $  7,715     $  9,218
Billings in excess of costs and earnings on
  uncompleted contracts                          (2,027)      (4,231)
                                               --------     --------
                                               $  5,688     $  4,987
                                               ========     ========
</TABLE>

NOTE G. LINE OF CREDIT

The Company maintains a $10 million revolving line of credit facility that
expires in October 2003. The credit line carries a floating interest rate based
on the prime or Euros rate plus or minus an applicable margin (Euros plus 2.00%
at June 30, 2003), and is secured by substantially all of the Company's assets.
The margin factor is subject to adjustment based on the Company's obtainment of
certain financial performance criteria. As of June 30, 2003, the Company had no
outstanding balances under the credit line, and $3.5 million outstanding under
letters of credit, leaving $6.5 million of availability under the facility. The
facility contains financial covenants, restrictions on capital expenditures,
acquisitions, asset dispositions, and additional debt, as well as other
customary covenants. As of June 30, 2003, the Company was in compliance with all
financial and other covenants of the loan agreement.

NOTE H. PRODUCT WARRANTIES

The Company warrants that its products will be free from defects in materials
and workmanship and will conform to agreed upon specifications at the time of
delivery and typically for a period of 18 to 36 months from the date of customer
acceptance, depending upon the specific product and terms of the customer
agreement. Typical warranties require the Company to repair or replace defective
products during the warranty period at no cost to the customer. The Company
attempts to obtain back-up concurrent warranties for major component parts from
its suppliers. The Company provides for the estimated cost of product
warranties, based on historical experience by product type, expectation of
future conditions and the extent of back-up concurrent supplier warranties in
place, at the time the product

                                       40

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE H. PRODUCT WARRANTIES - CONTINUED

revenue is recognized. Revision to the estimated product warranties is made when
necessary, based on changes in these factors. Product warranty activity for the
fiscal years ended June 30, 2003, 2002, and 2001 are as follows:

<TABLE>
<CAPTION>
                                          YEAR ENDED JUNE 30,
                                    ------------------------------
                                     2003       2002         2001
                                    ------------------------------
<S>                                 <C>        <C>         <C>
Balance at beginning of period      $   750    $   446     $   219

Provision for warranty expenses       1,197      1,181         512

Warranty charges                       (953)      (877)       (285)

                                    -------    -------     -------
Balance at end of period            $   994    $   750     $   446
                                    =======    =======     =======
</TABLE>

NOTE I. SHAREHOLDERS' EQUITY

The Company had a 1985 restricted stock plan (the 1985 Plan), which expired in
December 2000, under which 150,000 shares of common stock were reserved for
awards to employees. Restricted stock grants made under the 1985 Plan generally
vest ratably over a three to five-year period. Compensation expense for stock
grants is charged to earnings over the restriction period and amounted to $5,
$19 and $36 in fiscal 2003, 2002, and 2001, respectively. The tax effect of
differences between compensation expense for financial statement and income tax
purposes is charged or credited to additional paid-in capital.

In December 1995, the Company adopted a stock option and restricted stock plan
(the 1995 Plan), which provides for a maximum of 240,000 shares of common stock
to be issued. Stock options are granted at market value, generally vest ratably
over four years, and expire ten years from date of grant. At June 30, 2003,
17,400 shares of common stock were available for issuance under the 1995 Plan.

In January 2002, the Company adopted a stock option and restricted stock plan
(the 2001 Plan), which provides for a maximum of 250,000 shares of common stock
to be issued. Stock options are granted at market value, generally vest ratably
over four years, and expire ten years from date of grant. At June 30, 2003,
192,800 shares of common stock were available for issuance under the 2001 Plan.

                                       41

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE I.   SHAREHOLDERS' EQUITY - CONTINUED

Additional information with respect to options outstanding under the plan is as
follows:


<TABLE>
<CAPTION>
                                          Number of     Weighted
                                           shares        average
                                         underlying     exercise
        Stock Options                     options        price
        -------------                    ----------     --------
<S>                                      <C>            <C>
Outstanding at July 1, 2000               159,600           5.59

Granted                                    61,000           6.35
Exercised                                 (21,000)          5.80
Canceled                                  (17,000)          5.89
                                          -------
Outstanding at June 30, 2001              182,600           5.79

Granted                                    68,500          19.17
Exercised                                 (36,150)          5.96
Canceled                                   (3,000)         19.50
                                          -------
Outstanding at June 30, 2002              211,950           9.89

Granted                                     4,000           9.85
Exercised                                 (10,400)          6.17
Canceled                                  (18,800)         14.91
                                          -------
Outstanding at June 30, 2003              186,750           9.59
                                          =======       ========

Options exercisable at June 30, 2001      135,350       $   5.65
                                          =======       ========

Options exercisable at June 30, 2002      129,700       $   7.07
                                          =======       ========

Options exercisable at June 30, 2003      142,850       $   8.13
                                          =======       ========
</TABLE>

Weighted average fair value per share of options granted:

<TABLE>
<S>                            <C>
Year ended June 30, 2001       $3.99
Year ended June 30, 2002       $9.00
Year ended June 30, 2003       $5.46
</TABLE>

The fair value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: expected volatility of 69% for fiscal 2003, 48% to 49% for fiscal
2002, and 62% to 74% for fiscal 2001; risk-free interest rates of 4.0% for
fiscal 2003, 4.2% to 4.4% for fiscal 2002 and 5.0% to 5.8% for fiscal 2001;
dividend yield of 0%, 0% and 4.2% in fiscal 2003, 2002 and 2001, respectively;
and expected lives of five to seven years.

                                       42

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE I. SHAREHOLDERS' EQUITY - CONTINUED

The following table summarizes information about stock options at June 30, 2003:

Outstanding

<TABLE>
<CAPTION>
                                                                    Weighted
    Range of          Number       Weighted average remaining        average
Exercise Prices    outstanding     contractual life (in years)    exercise price
---------------    -----------     ---------------------------    --------------
<S>                <C>             <C>                            <C>
$4.625                32,000                   2.6                      4.63
$5.313 - $5.938       21,500                   4.7                      5.40
$6.000 - $6.668       75,550                   6.8                      6.20
$9.85                  4,000                   9.4                      9.85
$16.94 - $19.50       53,700                   8.4                     19.09
                     -------
                     186,750
                     =======
</TABLE>

Exercisable

<TABLE>
<CAPTION>
                                                                    Weighted
    Range of          Number       Weighted average remaining        average
 Exercise Prices   outstanding     contractual life (in years)    exercise price
----------------   -----------     ---------------------------    -------------
<S>                <C>              <C>                           <C>
$4.625                32,000                 2.6                        4.63
$5.313 - $5.938       21,500                 4.7                        5.40
$6.000 - $6.668       60,050                 6.6                        6.17
$9.85                  4,000                 9.4                        9.85
$16.94 - $19.50       25,300                 8.4                       19.23
                     -------
                     142,850
                     =======
</TABLE>

On May 21, 1997, the Company adopted a Rights Agreement (the "Agreement")
pursuant to which each outstanding share of the Company's common stock received,
as a dividend, one purchase right (a "Right"). The Rights become exercisable
only in the event that a person or group of affiliated persons (an "Acquiring
Party") acquires, or obtains the right to acquire, beneficial ownership of 20%
or more of the Company's common stock, or commences a tender offer or exchange
offer that would result in an Acquiring Party owning 20% or more of the
Company's common stock, and such transaction has not been approved by Company's
Board of Directors (a "Triggering Event"). The Agreement was amended on August
23, 2001 to, among other things, set the purchase price of a Right at $200.00,
which subsequently was adjusted to $100.00 to give effect to a two-for-one stock
split on October 18, 2001 (the "Purchase Price").

In general, when a Triggering Event has occurred, the holders of the Rights can
purchase from the Company, for the Purchase Price, a certain number of shares
of Common Stock having a market value of two times the Purchase Price, in
other words, at a 50% discount, or in the event the Company's common stock
would be cancelled, the holders may purchase stock of the acquiring entity at a
50% discount. Alternatively, the Board may distribute the net economic impact
of the Rights. In addition, after a Triggering Event, and at the Board's
discretion, the Rights may be redeemed for $.01 per Right. The Rights expire in
May 2007.

                                       43

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE J. EMPLOYEE BENEFIT PLANS

The Company has a 401(k) Plan to provide eligible employees with a retirement
savings plan. All employees are eligible to participate in the plan upon
completing 90 days of service. Company contributions are voluntary and at the
discretion of the Board of Directors of the Company. The Company's contribution
expense for the years ended June 30, 2003, 2002 and 2001 was approximately $249,
$282, and $191, respectively.

NOTE K.   INCOME TAXES

Deferred taxes are provided for the temporary differences between the financial
reporting bases and the tax bases of the Company's assets and liabilities. The
temporary differences that give rise to the deferred tax assets or liabilities
are as follows:

<TABLE>
<CAPTION>
                                             JUNE 30,
                                         ----------------
                                          2003      2002
                                         ----------------
<S>                                      <C>       <C>
Deferred tax assets
     Restricted stock grants             $    5    $   10
     Inventories                             70        71
     Net operating loss carryforwards       228       177
     Accrued expenses                     1,027       706
     Accounts receivable                    386       118
     Other                                   44        28
                                         ------    ------
                                          1,760     1,110
Deferred tax liabilities
     Property, plant and equipment         (303)     (156)
     Other                                   (4)       (4)
                                         ------    ------
                                           (307)     (160)
                                         ------    ------
           Net deferred tax asset        $1,453    $  950
                                         ======    ======
</TABLE>


At June 30, 2003 the Company has State net operating loss carry-forwards of
approximately $7.0 million, which can be carried forward indefinitely. The
Company has determined that no valuation allowance is required on the net
operating loss carry-forwards as it is more likely than not that sufficient
taxable income will be generated by the subsidiary in the applicable state to
realize the deferred tax asset.

Deferred tax assets and liabilities included in the balance sheet are as
follows:

<TABLE>
<CAPTION>
                                                   JUNE 30,
                                              ----------------
                                               2003      2002
                                              ----------------
<S>                                           <C>        <C>
Current deferred tax asset                    $ 1,445    $ 933
Non-current deferred tax asset (liability)          8       17
                                              -------    -----
                                              $ 1,453    $ 950
                                              =======    =====
</TABLE>

                                       44

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE K. INCOME TAXES - CONTINUED

The provision for income taxes consists of the following:

<TABLE>
<CAPTION>
                                   YEAR ENDED JUNE 30,
                        -----------------------------------
                          2003         2002         2001
                        -----------------------------------
<S>                     <C>          <C>          <C>
Federal
  Current               $    (117)   $   2,136    $   1,962
  Deferred                   (503)        (399)        (536)
State                          51          523          303
Foreign
  Current                     230           85            -
  Deferred                      -            6           74
                        ---------    ---------    ---------
                        $    (339)   $   2,351    $   1,803
                        =========    =========    =========
</TABLE>

The income tax expense (benefit) varies from the federal statutory rate due to
the following:

<TABLE>
<CAPTION>
                                                             YEAR ENDED JUNE 30,
                                                         ---------------------------
                                                          2003     2002       2001
                                                         ---------------------------
<S>                                                      <C>      <C>        <C>
Income tax expense (benefit) at federal statutory rate   $(244)   $ 2,292    $ 1,657
Increase (decrease) in income tax expense
   resulting from
      State tax, net of federal effect                     (21)       200        145
      Foreign sales income exclusions                      (22)       (83)       (28)
      Effect of lower foreign tax rate                     (43)       (78)       (47)
      Other                                                 (9)        20         76
                                                         -----    -------    -------
   Income tax expense (benefit)                          $(339)   $ 2,351    $ 1,803
                                                         =====    =======    =======
</TABLE>

NOTE L. EARNINGS (LOSS) PER SHARE

Summarized basic and diluted earnings (loss) per common share for each of the
three years ended June 30, 2003, 2002 and 2001 is as follows: Earnings(loss) and
share amounts are in thousands.

<TABLE>
<CAPTION>
                                                             YEAR ENDED JUNE 30,
                          --------------------------------------------------------------------------------------
                                    2003                            2002                          2001
                          --------------------------------------------------------------------------------------
                                              PER                            PER                           PER
                           NET               SHARE        NET               SHARE       NET               SHARE
                           LOSS    SHARES    AMOUNT     EARNINGS   SHARES   AMOUNT    EARNINGS   SHARES   AMOUNT
                          --------------------------    ---------------------------   --------------------------
<S>                       <C>      <C>       <C>        <C>        <C>      <C>       <C>        <C>      <C>
Basic earnings (loss)
per share                 $ (379)  $ 2,996   $ (0.13)   $  4,389   2,978    $ 1.47    $  3,072    2,947   $ 1.04
  Effect of Dilutive
  Options                      -         -         -           -     102     (0.04)          -       55    (0.02)
                          --------------------------    --------------------------    --------------------------
Diluted earnings (loss)
per share                 $ (379)    2,996   $ (0.13)   $  4,389   3,080    $ 1.43    $  3,072    3,002   $ 1.02
                          ==========================    ==========================    ==========================
</TABLE>

For fiscal 2003, 2002 and 2001, stock options covering 196, 30 and 25 shares,
respectively were excluded in the computations of diluted earnings per share
because their effect was antidilutive.

                                       45

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE M. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION

The Company identifies reportable segments based on management responsibility
within the corporate structure. The Company has three reportable industry
segments: Environmental Systems, Separation & Filtration Systems and Boilers.
The main product of its Environmental Systems segment, is its Selective
Catalytic Reduction Systems, referred to as "SCR Systems". These environmental
control systems are used for air pollution abatement and convert 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 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. The Separation & Filtration Systems segment produces
various types of separators and filters used for removing liquids and solids
from gases and air. This segment also provides engineering design and services,
pulsation dampeners, natural gas odorizers, quick-opening closures and parts for
its products. The Boiler segment provides packaged boilers used to produce
steam, used for heating, drying, driving steam engines and a variety of other
applications.

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. In the past,
the Company did not allocate its unabsorbed manufacturing costs to each
individual segment. Starting in fiscal year 2002, the Company started allocating
all costs associated with the manufacture, sale and design of its products to
each segment. Fiscal year 2001 information has been restated to conform to
fiscal years 2002 and 2003 presentation. Segment information and reconciliation
to operating profit for the years ended June 30, 2003, 2002, and 2001 are
presented below. Note that the Company does not allocate general and
administrative expenses ("unallocated overhead"), assets, expenditures for
assets or depreciation expense on a segment basis for internal management
reporting, and therefore such information is not presented.

<TABLE>
<CAPTION>
                                             SEPARATION
                            ENVIRONMENTAL   & FILTRATION                 UNALLOCATED
                              SYSTEMS         SYSTEMS       BOILERS        OVERHEAD      CONSOLIDATED
                            -------------   ------------    -------      -----------     ------------
<S>                         <C>             <C>             <C>          <C>             <C>
2003

Net sales from customers      $ 37,511        $ 27,343      $  4,316     $       -        $  69,170

Segment profit (loss)            2,543           3,439        (1,069)       (6,405)          (1,492)

2002

Net sales from customers      $ 65,539        $ 29,341      $ 14,576     $       -        $ 109,456

Segment profit (loss)           12,653           2,592        (1,189)       (7,788)           6,268

2001

Net sales from customers      $ 53,329        $ 21,949      $  2,881    $        -        $  78,159

Segment profit (loss)           12,385           1,741        (2,327)       (5,897)           5,902
</TABLE>

                                       46

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (Dollars in thousands, except per share amounts)

NOTE M. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION - CONTINUED

The Company attributes revenues from external customers to individual geographic
areas based on the country where the sale originated. Information about the
Company's operations in different geographic areas as of and for the years ended
June 30, 2003, 2002 and 2001 is as follows:

<TABLE>
<CAPTION>
                                   UNITED
                                   STATES       EUROPE    ELIMINATIONS    CONSOLIDATED
                                  ---------    -------    ------------    ------------
<S>                               <C>          <C>        <C>             <C>
2003
Net sales to unaffiliated
      customers                   $  60,139    $ 9,031       $    -         $ 69,170
Transfers between
      geographic areas                  809          -         (809)               -
                                  ---------    -------       ------         --------
Total                             $  60,948    $ 9,031       $ (809)        $ 69,170
                                  ---------    -------       ------         --------
Identifiable long-lived assets    $   3,359    $    71            -         $  3,430
                                  =========    =======       ======         ========

2002
Net sales to unaffiliated
      customers                   $ 101,786    $ 7,670       $    -         $109,456
Transfers between
      geographic areas                  962          -         (962)               -
                                  ---------    -------       ------         --------
Total                             $ 102,748    $ 7,670       $ (962)        $109,456
                                  ---------    -------       ------         --------
Identifiable long-lived assets    $   4,098    $    54       $    -         $  4,152
                                  =========    =======       ======         ========

2001
Net sales to unaffiliated
      customers                   $  72,791    $ 5,368       $    -         $ 78,159
Transfers between
      geographic areas                  492          -         (492)               -
                                  ---------    -------       ------         --------
Total                             $  73,283    $ 5,368       $ (492)        $ 78,159
                                  ---------    -------       ------         --------
Identifiable long-lived assets    $   3,800    $    31       $    -         $  3,831
                                  =========    =======       ======         ========
</TABLE>

Transfers between the geographic areas primarily represent inter-company export
sales and are accounted for based on established sales prices between the
related companies.

Identifiable long-lived assets of geographic areas are those assets related to
the Company's operations in each area.

                                       47
<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
            (Dollars in thousands, except per share amounts)

NOTE N. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION - UNAUDITED

<TABLE>
<CAPTION>
                                                FISCAL 2003
                          -------------------------------------------------------
                           FIRST      SECOND       THIRD      FOURTH
                          QUARTER     QUARTER     QUARTER     QUARTER      TOTAL
                          -------------------------------------------------------
<S>                       <C>         <C>         <C>         <C>         <C>
Net sales                 $14,454     $20,742     $13,564     $20,410     $69,170
Gross profit                3,323       4,289       3,379       5,665      16,656
% of net sales               23.0%       20.7%       24.9%       27.8%       24.1%
Operating income (loss)    (2,092)       (116)       (652)      1,368      (1,492)
% of net sales              -14.5%       -0.6%       -4.8%        6.7%       -2.2%
Net earnings (loss)       $(1,343)    $   (26)    $  (375)    $ 1,365     $  (379)
% of net sales               -9.3%       -0.1%       -2.8%        6.7%       -0.5%

Net earnings (loss)
   per share
    Basic                 $ (0.45)    $ (0.01)    $ (0.13)    $  0.46     $ (0.13)
    Diluted               $ (0.45)    $ (0.01)    $ (0.13)    $  0.45     $ (0.13)
</TABLE>

<TABLE>
<CAPTION>
                                                FISCAL 2002
                          --------------------------------------------------------
                           FIRST      SECOND       THIRD      FOURTH
                          QUARTER     QUARTER     QUARTER     QUARTER      TOTAL
                          --------------------------------------------------------
<S>                       <C>         <C>         <C>         <C>         <C>
Net sales                 $24,509     $27,044     $29,087     $28,816     $109,456
Gross profit                6,903       6,961       8,007       9,054       30,925
% of net sales               28.2%       25.7%       27.5%       31.4%        28.3%
Operating income            1,223       1,283       1,811       1,951        6,268
% of net sales                5.0%        4.7%        6.2%        6.8%         5.7%
Net earnings              $   768     $   948     $ 1,187     $ 1,486     $  4,389
% of net sales                3.1%        3.5%        4.1%        5.2%         4.0%

Net earnings
   per share
    Basic                 $  0.26     $  0.32     $  0.40     $  0.49     $   1.47
    Diluted               $  0.25     $  0.31     $  0.38     $  0.48     $   1.43
</TABLE>

                                       48

<PAGE>

    REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON FINANCIAL SCHEDULE

Board of Directors
Peerless Mfg. Co.

In connection with our audit of the consolidated financial statements of
Peerless Mfg. Co. and Subsidiaries referred to in our report dated September 2,
2003, which is included in Part II of this form, we have also audited Schedule
II for each of the three years in the period ended June 30, 2003. In our
opinion, this schedule presents fairly, in all material respects, the
information required to be set forth therein.

                                             /s/ Grant Thornton, LLP
                                             -----------------------
                                             Grant Thornton, LLP

Dallas, Texas
September 2, 2003

                                       49

<PAGE>

                       PEERLESS MFG. CO. AND SUBSIDIARIES
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                         YEAR ENDED JUNE 30,
                                        ----------------------
                                         2003    2002    2001
                                        ----------------------
<S>                                     <C>      <C>     <C>
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS:

   Balance at beginning of year         $  354   $ 297   $ 778

   Additions
    Charged to expense                     774     133      54

   Amounts written off                     (76)    (76)   (535)

                                        ------   -----   -----
   Balance at end of year               $1,052   $ 354   $ 297
                                        ======   =====   =====
</TABLE>

                                       50

<PAGE>

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
  NO.                              EXHIBIT DESCRIPTION
------            --------------------------------------------------------------
<S>               <C>
 3(a)             Articles of Incorporation, as amended to date (filed as
                  Exhibit 3(a) to our Quarterly Report on Form 10-Q, for the
                  fiscal quarter ended December 31, 1997, and incorporated
                  herein by reference).

 3(b)             Bylaws, as amended to date (filed as Exhibit 3(b) to our
                  Annual Report on Form 10-K, for the fiscal year ended June 30,
                  1997, and incorporated herein by reference).

 4(a)             Rights Agreement between Peerless Mfg. Co. and ChaseMellon
                  Shareholder Services, L.L.C., adopted by the Board of
                  Directors May 21, 1997 (filed as Exhibit 1 to our Registration
                  Statement on Form 8-A (File No. 0-05214) and incorporated
                  herein by reference).

 4(b)             First Amendment to Rights Agreement between Peerless Mfg. Co.
                  and ChaseMellon Shareholder Services, L.L.C. (filed as Exhibit
                  2 to our Registration Statement on Form 8-A dated August 30,
                  2001 and incorporated herein by reference).

 10(a)            Incentive Compensation Plan effective January 1, 1981, as
                  amended January 23, 1991 (filed as Exhibit 10(b) to our Annual
                  Report on Form 10-K, for the fiscal year ended June 30, 1991,
                  and incorporated herein by reference).

 10(b)            Peerless Mfg. Co. 1995 Stock Option and Restricted Stock Plan
                  (filed as Exhibit 10(h) to our Annual Report on Form 10-K for
                  the fiscal year ended June 30, 1997 and incorporated herein by
                  reference).

 10(c)            Amendment to Peerless Mfg. Co. 1995 Stock Option and
                  Restricted Stock Plan dated November 11, 1999 (filed as
                  exhibit 10(h) to our Quarterly Report on Form 10-Q, for the
                  fiscal quarter ended December 31, 1999 and incorporated herein
                  by reference).

 10(d)            Peerless Mfg. Co. 2001 Stock Option and Restricted Stock Plan
                  (filed as Appendix B to our Proxy Statement on Schedule 14A
                  dated October 24, 2001 and incorporated herein by reference).

 10(e)            Asset Purchase Agreement dated February 25, 2000, by and
                  between PMC Acquisition, Inc. and ABCO Industries, Inc. (filed
                  as Exhibit 2.1 to our Current Report on Form 8-K dated
                  February 25, 2000 and incorporated herein by reference).

 10(f)            Loan Agreement, Revolving Note, Security Agreement and Deed of
                  Trust dated as of August 31, 2001, by and between Peerless
                  Mfg. Co. and Bank of America (filed as Exhibit 10(h) to our
                  Annual Report on Form 10-K for the fiscal year ended June 30,
                  2001, and incorporated herein by reference).
</TABLE>

<PAGE>

                          INDEX TO EXHIBITS - CONTINUED

<TABLE>
<CAPTION>
  NO.                              EXHIBIT DESCRIPTION
------            --------------------------------------------------------------
<S>               <C>
 10(g)            Employment Agreement dated July 20, 2001, by and between
                  Peerless Mfg. Co. and Sherrill Stone (filed as Exhibit 10(i)
                  to our Quarterly Report on Form 10-Q, for the fiscal quarter
                  ended September 30, 2001 and incorporated herein by
                  reference).

 10(h)            Agreement dated July 20, 2001, by and between Peerless Mfg.
                  Co. and Sherrill Stone (filed as Exhibit 10(k) to our
                  Quarterly Report on Form 10-Q, for the fiscal quarter ended
                  September 30, 2001 and incorporated herein by reference).

 10(i)            Employment Agreement dated February 4, 2002, by and between
                  Peerless Mfg. Co. and Richard L. Travis (filed as Exhibit
                  10(m) to our Quarterly Report on Form 10-Q, for the fiscal
                  quarter ended March 31, 2002 and incorporated herein by
                  reference).

 10(j)            Agreement dated February 2, 2002, by and between Peerless Mfg.
                  Co. and Richard L. Travis (filed as Exhibit 10(n) to our
                  Quarterly Report on Form 10-Q, for the fiscal quarter ended
                  March 31, 2002 and incorporated herein by reference).

 10(k)            Amendment dated August 12, 2002 to Employment Agreement dated
                  February 4, 2002, by and between Peerless Mfg. Co. and Richard
                  L. Travis, Jr. (filed as Exhibit 10 (n) to our Quarterly
                  Report on Form 10-Q, for the fiscal quarter ended September
                  30, 2002 and incorporated herein by reference).

 10(l)            Agreement dated August 12, 2002, by and between Peerless Mfg.
                  Co. and Richard L. Travis, Jr. (filed as Exhibit 10(o) to our
                  Quarterly Report on Form 10-Q, for the fiscal quarter ended
                  September 30, 2002 and incorporated herein by reference).

 21               Subsidiaries of Peerless Mfg. Co. *

 23               Consent of Grant Thornton LLP. *

 31.1             Certification of Chief Executive Officer pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002. *

 31.2             Certification of Chief Financial Officer pursuant to Section
                  302 of the Sarbanes-Oxley Act of 2002. *

 32.1             Certification of Chief Executive Officer pursuant to Section
                  906 of the Sarbanes-Oxley Act of 2002. *

 32.2             Certification of Chief Financial Officer pursuant to Section
                  906 of the Sarbanes-Oxley Act of 2002. *
</TABLE>

    -------------------------
*   Filed herewith