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UNITED STATES 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, 2006
Commission File No. 0-5214
 
 PEERLESS MFG. CO.
  Texas
(State of incorporation)
    
    75-0724417
(I.R.S. employer identification no.)
 2819 Walnut Hill Lane, Dallas, Texas 75229   (214) 357-6181
  (Title of Class)
    
    (Name of each exchange where registered)Common Stock, $1.00 Par Value
    
    The NASDAQ Stock Market LLC
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PagePART I
    
    
    
    
    3Item 1.
    
    Business
    
    
    3Item 1A.
    
    Risk Factors
    
    
    8Item 1B.
    
    Unresolved Staff Comments
    
    
    13Item 2.
    
    Properties
    
    
    13Item 3.
    
    Legal Proceedings
    
    
    14Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    14PART II
    
    
    
    
    14Item 5.
    
    Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
    
    
    14Item 6.
    
    Selected Financial Data
    
    
    15Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 8.
    
    Financial Statements and Supplementary Data
    
    
    29Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    59Item 9A.
    
    Controls and Procedures
    
    
    59Item 9B.
    
    Other Information
    
    
    59PART III
    
    
    
    
    60Item 10.
    
    Directors and Executive Officers of the Registrant
    
    
    60Item 11.
    
    Executive Compensation
    
    
    60Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
    
    
    60Item 13.
    
    Certain Relationships and Related Transactions
    
    
    60Item 14.
    
    Principal Accountant Fees and Services
    
    
    61PART IV
    
    
    
    
    61Item 15.
    
    Exhibits and Financial Statement Schedules
    
    
    61Signatures
    
    
    62Index to Exhibits
    
    
    63SubsidiariesConsent of Grant Thornton LLPRule 13a-14(a)-15d-14(a) Certification of CEORule 13a-14(a)-15d-14(a) Certification of CFOSection 1350 Certification of CEOSection 1350 Certification of CFO
  2




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Forward-Looking Statements
   
 PART I
 
 ITEM 1. BUSINESS.
 General
 www.peerlessmfg.com
  3




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Operating Segments and Products
      Patents, Licenses and Product Development
   Manufacturing and Outsourcing
  4




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Raw Materials
  Customers
       5




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Backlog
  Competition
  Environmental Regulation
  Employees
  June 30,Geographic location:
    
    2006
    
    2005United States
    
    
    144
    
    
    
    141United Kingdom
    
    
    21
    
    
    
    21Singapore
    
    
    4
    
    
    
    4Total
    
    
    169
    
    
    
    166
  6




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Executive Officers of the Registrant
  Name
    
    Age
    
    Position with the CompanyPeter J. Burlage
    
    
    42
    
    
    Chief Executive OfficerG. Darwyn Cornwell
    
    
    62
    
    
    Vice President, OperationsSean P. McMenamin
    
    
    41
    
    
    Vice President, Environmental SystemsHenry G. Schopfer, III
    
    
    60
    
    
    Chief Financial OfficerDavid Taylor
    
    
    41
    
    
    Vice President, Separation Filtration Systems
      7




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##### Table of Contents



ITEM 1A. RISK FACTORS.
  Changes in the power generation industry and/or the economy could have an adverse impact on sales
of our Environmental Systems and our operating results.
  Changes in the price, supply or demand for natural gas could have an adverse impact on our
sales of Separation Filtration Systems and our operating results.
  Changes in current environmental legislation could have an adverse impact on the sale of our
Environmental Systems and on our operating results.
  Competition could result in lower sales and decreased margins.
  8




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If actual costs for our projects with fixed-price contracts exceed our original estimates, our
profits will be reduced or we may suffer losses.
  
    
    increases in cost or shortages of components, materials or labor;
    
    unanticipated technical problems;
    
    required project modifications not initiated by the customer; and
    
    suppliers or subcontractors failure to perform.
  Customers may cancel or delay projects. As a result our backlog may not be indicative of our
future revenue.
  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.
  Our financial performance may vary significantly from period to period, making it difficult to
estimate future revenue.
  9




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Our margins are affected by shifts in our product mix.
  Our products are covered by warranties. Unanticipated warranty costs for defective products
could adversely affect our financial condition and results of operations and reputation.
  Product liability claims not covered by insurance could adversely affect our financial
condition and results of operations.
  A significant portion of our accounts receivable are related to large contracts, which
increases our exposure to credit risk.
  Changes in billing terms can increase our exposure to working capital and credit risk.
  10




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The terms and conditions of our credit facility impose restrictions on our operations,
including restrictions on our ability to raise additional capital, if needed.
   Our business is subject to risks of terrorist acts, acts of war and natural disasters.
  The inability of our engineering and/or manufacturing operations to sufficiently scale up
operations in the short term, in response to unexpected spikes in orders with short cycle times,
directly impacts our ability to optimize absorption of our manufacturing overhead expense.
  Our ability to operate effectively could be impaired if we fail to attract and retain key
personnel.
  11




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Our customers may require us to perform portions of our projects in their local countries.
  The relocation of our administrative, research & development, manufacturing and storage operations
in Dallas, Texas could result in a negative impact on the Companys financial performance.
  We will be exposed to risks relating to evaluation of our internal controls over financial
reporting required by Section 404 of the Sarbanes-Oxley Act of 2002.
   Our common stock is thinly traded, which may make it difficult to sell our common stock and
may make our stock price more volatile.
  12




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ITEM 1B. UNRESOLVED STAFF COMMENTS.
  
 ITEM 2. PROPERTIES.
   ApproximateLocation
    
    Sq. Footage
    
    General UseOwned:Abilene, Texas
    
    
    78,000
    
    
    Manufacturing   Environmental products and Separation Filtration products.Denton, Texas
    
    
    22,000
    
    
    Manufacturing  Separation Filtration products.Dallas, Texas
    
    
    48,000
    
    
    Office, warehouse, and research and development.Dallas, Texas
    
    
    80,000
    
    
    Manufacturing   Environmental products and Separation Filtration products.Leased:Halstead, U. K.
    
    
    3,995
    
    
    Sales, engineering and administration office.Singapore
    
    
    2,300
    
    
    Sales office.
  13




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ITEM 3. LEGAL PROCEEDINGS
   
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 PART II
 
 ITEM 5.
    
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
  Fiscal Year
    
    High
    
    Low2005First Quarter
    
    $
    16.00
    
    
    $
    11.85Second Quarter
    
    
    15.33
    
    
    
    13.95Third Quarter
    
    
    15.30
    
    
    
    13.07Fourth Quarter
    
    
    15.00
    
    
    
    13.752006First Quarter
    
    $
    17.99
    
    
    $
    14.15Second Quarter
    
    
    17.50
    
    
    
    15.86Third Quarter
    
    
    19.60
    
    
    
    16.97Fourth Quarter
    
    
    23.95
    
    
    
    19.20
  14




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ITEM 6. SELECTED FINANCIAL DATA
  Year ended June 30,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Amounts in thousands, except per share amounts)Operating results:Revenues
    
    $
    63,411
    
    
    $
    51,063
    
    
    $
    59,761
    
    
    $
    64,854
    
    
    $
    94,880Cost of revenues
    
    
    45,978
    
    
    
    37,356
    
    
    
    40,959
    
    
    
    47,842
    
    
    
    64,908Gross profit
    
    
    17,433
    
    
    
    13,707
    
    
    
    18,802
    
    
    
    17,012
    
    
    
    29,972Operating expenses
    
    
    16,687
    
    
    
    14,409
    
    
    
    14,929
    
    
    
    16,429
    
    
    
    21,047Operating income (loss)
    
    
    746
    
    
    
    (702
    )
    
    
    3,873
    
    
    
    583
    
    
    
    8,925Other income (expense)
    
    
    455
    
    
    
    63
    
    
    
    (24
    )
    
    
    727
    
    
    
    410Tax benefit (expense)
    
    
    (660
    )
    
    
    113
    
    
    
    (1,447
    )
    
    
    (399
    )
    
    
    (3,256
    )Net earnings (loss) from continuing
operations
    
    
    541
    
    
    
    (526
    )
    
    
    2,402
    
    
    
    911
    
    
    
    6,079Net loss from discontinued operations
    
    
    (115
    )
    
    
    (66
    )
    
    
    (364
    )
    
    
    (1,290
    )
    
    
    (1,690
    )Net earnings (loss)
    
    $
    426
    
    
    $
    (592
    )
    
    $
    2,038
    
    
    $
    (379
    )
    
    $
    4,389Diluted earnings (loss) per shareNet earnings (loss) from continuing
operations
    
    $
    0.17
    
    
    $
    (0.17
    )
    
    $
    0.79
    
    
    $
    0.30
    
    
    $
    1.97Net loss from discontinued operations
    
    $
    (0.04
    )
    
    $
    (0.02
    )
    
    $
    (0.12
    )
    
    $
    (0.43
    )
    
    $
    (0.55
    )Net earnings (loss)
    
    $
    0.14
    
    
    $
    (0.20
    )
    
    $
    0.67
    
    
    $
    (0.13
    )
    
    $
    1.43Weighted average shares outstanding:Basic
    
    
    3,067
    
    
    
    3,028
    
    
    
    3,003
    
    
    
    2,996
    
    
    
    2,978Diluted
    
    
    3,135
    
    
    
    3,028
    
    
    
    3,044
    
    
    
    3,013
    
    
    
    3,080
 (Certain earnings per share amounts may not total due to rounding.)
 As of June 30,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Amounts in thousands)Financial position:Working capital
    
    $
    22,930
    
    
    $
    20,272
    
    
    $
    20,529
    
    
    $
    17,771
    
    
    $
    17,755Current assets
    
    
    45,172
    
    
    $
    35,696
    
    
    
    35,331
    
    
    
    39,223
    
    
    
    42,129Total assets
    
    
    48,159
    
    
    
    39,804
    
    
    
    39,475
    
    
    
    43,763
    
    
    
    46,889Current liabilities
    
    
    22,242
    
    
    
    15,424
    
    
    
    14,802
    
    
    
    21,452
    
    
    
    24,374Total liabilities
    
    
    22,242
    
    
    
    15,514
    
    
    
    14,802
    
    
    
    21,452
    
    
    
    24,374Shareholders
equity
    
    
    25,917
    
    
    
    24,290
    
    
    
    24,673
    
    
    
    22,311
    
    
    
    22,515
 15




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 Results of Operations
  Year ended June 30,2006
    
    2005
    
    2004Net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    72.5
    
    
    
    73.2
    
    
    
    68.5Gross profit
    
    
    27.5
    
    
    
    26.8
    
    
    
    31.5Operating expenses
    
    
    26.3
    
    
    
    28.2
    
    
    
    25.0Operating earnings (loss)
    
    
    1.2
    
    
    
    (1.4
    )
    
    
    6.5Other income (expense)
    
    
    0.7
    
    
    
    0.1
    
    
    
    (0.1
    )Net earnings (loss) from continuing
operations before income taxes
    
    
    1.9
    
    
    
    (1.3
    )
    
    
    6.4Income tax benefit (expense)
    
    
    (1.0
    )
    
    
    0.2
    
    
    
    (2.4
    )Net earnings (loss) from continuing operations
    
    
    0.9
    
    
    
    (1.1
    )
    
    
    4.0Loss from discontinued operations, net of tax
    
    
    (0.2
    )
    
    
    (0.1
    )
    
    
    (0.6
    )Net earnings (loss)
    
    
    0.7
    %
    
    
    (1.2
    )%
    
    
    3.4
    %
      16




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Results of Operations  Consolidated
 Revenues . (dollars in thousands)
 Year ended June 30,2006
    
    
    % of Total
    
    
    2005
    
    
    % of Total
    
    
    2004
    
    
    % of TotalDomestic
    
    $
    32,513
    
    
    
    51.3
    %
    
    $
    30,248
    
    
    
    59.3
    %
    
    $
    40,231
    
    
    
    67.4
    %International
    
    
    30,898
    
    
    
    48.7
    %
    
    
    20,815
    
    
    
    40.7
    %
    
    
    19,530
    
    
    
    32.6
    %Total
    
    $
    63,411
    
    
    
    100.0
    %
    
    $
    51,063
    
    
    
    100.0
    %
    
    $
    59,761
    
    
    
    100.0
    %
    Gross Profit . (dollars in thousands)
 Year ended June 30,% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    2004
    
    
    RevenuesRevenues
    
    $
    63,411
    
    
    
    100.0
    %
    
    $
    51,063
    
    
    
    100.0
    %
    
    $
    59,761
    
    
    
    100.0
    %Cost of goods sold
    
    $
    45,978
    
    
    
    72.5
    %
    
    $
    37,356
    
    
    
    73.2
    %
    
    $
    40,959
    
    
    
    68.5
    %Gross profit
    
    $
    17,433
    
    
    
    27.5
    %
    
    $
    13,707
    
    
    
    26.8
    %
    
    $
    18,802
    
    
    
    31.5
    %
   17




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Operating Expenses. (dollars in
thousands)
 Year ended June 30,% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    % of2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    2004
    
    
    RevenuesSales and marketing
    
    $
    6,645
    
    
    
    10.5
    %
    
    $
    6,031
    
    
    
    11.8
    %
    
    $
    6,158
    
    
    
    10.4
    %Engineering and project management
    
    
    3,480
    
    
    
    5.5
    %
    
    
    3,608
    
    
    
    7.1
    %
    
    
    4,140
    
    
    
    6.9
    %General and administrative
    
    
    6,562
    
    
    
    10.3
    %
    
    
    4,770
    
    
    
    9.3
    %
    
    
    4,631
    
    
    
    7.7
    %Total operating expenses
    
    $
    16,687
    
    
    
    26.3
    %
    
    $
    14,409
    
    
    
    28.2
    %
    
    $
    14,929
    
    
    
    25.0
    %
   18




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Other Income and Expense (dollars in thousands)
   Income Taxes (dollars in thousands)
  Net Earnings (Loss) from Continuing Operations (dollars in thousands, except per share
amounts)
   Discontinued Operations (dollars in thousands, except per share amounts)
   19




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Net Earnings (Loss) (dollars in thousands, except per share amounts)
   Results of Operations  Segments
  Environmental Systems
  (dollars in
thousands)
 Year ended June 30,2006
    
    2005
    
    2004Revenue
    
    $
    19,767
    
    
    $
    20,591
    
    
    $
    28,096Operating income
    
    $
    2,055
    
    
    $
    2,309
    
    
    $
    4,133Operating income as % of revenue
    
    
    10.4
    %
    
    
    11.2
    %
    
    
    14.7
    %
   20




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1)
    
    Material price increases: Due to heavy worldwide demand, steel prices
(most notably stainless steel prices) have increased considerably over the past year. Most
of the contracts governing the sale of our products are long-term, fixed-priced contracts
which, in a volatile environment, increases our risk of margin deterioration. We attempt
to stabilize our costs by ordering materials at the time an order is received. However, on
long-term deliverable contracts, this may not always be possible. To mitigate our risk
under these contracts, we attempt to negotiate escalation provisions. However, such
provisions do not always cover our full exposure.2)
    
    Start-up and warranty expenses, as a percentage of sales: Actual
start-up and warranty expenses were $940, $1,755, and $1,059 in 2004, 2005, and
2006 respectively. Start-up and warranty expenses as a percentage of sales were
3.3%, 8.5% and 5.4% in fiscal 2004, 2005, and 2006, respectively. The increase in
expense during fiscal 2005 related predominately to two projects. These projects were high temperature, ultra-low NOx
applications that required extensive modifications to accommodate the customers
operating conditions and meet their expectations. The decrease in fiscal 2006
expenses reflects the improvement of our project execution.3)
    
    Operational expenses, as a percentage of sales: As part of our
continued cost control measures and product standardization activities, our
operational expenses have continued to decline from $4,362 in fiscal 2004, to
$3,792 in fiscal 2005 and $3,005 in fiscal 2006. However, the expenses have, as a
percentage of sales, increased from 15.5% in fiscal 2004, to 18.4% in fiscal 2005,
and decreased to 15.2% in fiscal 2006.
 Separation Filtration Systems
  (dollars
in thousands)
 Year ended June 30,2006
    
    2005
    
    2004Revenues
    
    $
    43,644
    
    
    $
    30,472
    
    
    $
    31,665Operating income
    
    $
    5,253
    
    
    $
    1,759
    
    
    $
    4,371Operating income as % of revenue
    
    
    12.0
    %
    
    
    5.8
    %
    
    
    13.8
    %
  21




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1)
    
    Shifts in our product mix and increased demand: Due to the increased
demand for natural gas, both domestically and internationally, we have experienced a shift
in our product mix, with a significant increase in revenues from our separation and
filtration products. As a result of this increase in demand, many orders require expedited
delivery and our customers have been willing to pay a premium for the expedited delivery. Additionally, our operating income has
benefited from the competitive advantages of new products we have recently introduced to the
market.2)
    
    Material price increases: Due to heavy worldwide demand, steel prices
(most notably stainless steel prices) have increased considerably over the past several
years. Most of the contracts governing the sale of our products are long-term,
fixed-priced contracts which, in a volatile environment, increase our risk of margin
deterioration. We attempt to stabilize our costs by ordering materials at the time an
order is received. However, on long-term deliverable contracts, this may not always be
possible. To mitigate our risk under these contracts, we attempt to negotiate escalation
provisions. However, such provisions do not always cover our full exposure.3)
    
    Operational expenses, as a percentage of sales: Our operational
expenses were $5,936 in fiscal 2004, $5,847 in fiscal 2005 and $7,120, in fiscal
2006. The expenses as a percentage of revenue were 18.7% in fiscal 2004, 19.2% in
fiscal 2005, and 16.3% in fiscal 2006. The change in the expense is primarily
attributed to changes in the commission expense associated with changes in
revenues.
 Corporate Level Expenses
 (dollars in thousands)
 Year ended June 30,2006
    
    2005
    
    2004Corporate level expenses
    
    $
    6,562
    
    
    $
    4,770
    
    
    $
    4,631
  22




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Market Outlook
 Environmental Systems
 Separation Filtration Systems
 Contingencies (dollars in thousands)
    23




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Backlog
  Financial Position (dollars in thousands)
 Assets
 Liabilities and Shareholders Equity
 Liquidity and Capital Resources (dollars in thousands)
    24




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Off-Balance Sheet Arrangements
  Aggregate Contractual Obligations (dollars in thousands)
  Payments Due by PeriodLess Than
    
    
    1 to 3
    
    
    3 to 5
    
    
    After 5Contractual Obligations
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    YearsOperating lease obligations (1)
    
    $
    206
    
    
    $
    154
    
    
    $
    52
    
    
    $
    
    
    
    $
    Purchase obligations (2)
    
    
    15,481
    
    
    
    15,481
    
    
    
    
    
    
    
    
    
    
    
    Stand-by letters of credit (3)
    
    
    8,817
    
    
    
    6,750
    
    
    
    2,067
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    24,504
    
    
    $
    22,385
    
    
    $
    2,119
    
    
    $
    
    
    
    $
    
 
 (1)
    
    The Company anticipates that it will be required to relocate its headquarters facility during the quarter
ending March 31, 2007. The relocation of the headquarters facility is expected to result in
additional operating leases not reflected in the above table. For further discussion, see
Note F  Assets Held for Sale in our Notes to Consolidated Financial Statements contained in
this Report.(2)
    
    Purchase obligations in the table above represent the value of open purchase orders as of
June 30, 2006. We believe that some of these obligations could be canceled for payment of a
nominal penalty, or no penalty. However, the amount of open purchase orders that could be
canceled in this manner is difficult to quantify. In addition, we generally have contracts
with our customers that minimize our exposure to losses for materials purchased within
lead-times necessary to meet customer forecasts.(3)
    
    The stand-by letters of credit includes $5,157 issued under the Peerless $12,500 revolving
credit facility and $3,660 issued by the UK subsidiary under its facility. Critical Accounting Policies
   Revenue Recognition
 26




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Product Warranties
 Allowance for Doubtful Accounts
 Reserve for Obsolete and Slow-Moving Inventory
 Deferred Tax Asset  Valuation Allowance
 27




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##### Table of Contents



New Accounting Standards
   
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
  28




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##### Table of Contents



ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 Report of Independent Registered Public Accounting Firm
 
    Share-Based Payments
 /s/ Grant Thornton LLPDallas, TexasSeptember 22, 2006
 29




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Consolidated Balance Sheets  (Amounts in thousands)
 ASSETS
 June 30,2006
    
    
    2005Current assets:Cash and cash equivalents
    
    $
    6,411
    
    
    $
    8,277Accounts receivable-principally trade  net of
allowance for doubtful accounts of $462 at
June 30, 2006 and $352 at June 30, 2005
    
    
    16,463
    
    
    
    11,613Inventories
    
    
    4,871
    
    
    
    3,297Costs and earnings in excess of billings
on uncompleted contracts
    
    
    13,891
    
    
    
    10,140Assets held for sale
    
    
    767
    
    
    
    Deferred income taxes
    
    
    1,338
    
    
    
    1,163Other current assets
    
    
    1,431
    
    
    
    1,206Total current assets
    
    
    45,172
    
    
    
    35,696Property, plant and equipment  net
    
    
    2,140
    
    
    
    3,315Other assets
    
    
    845
    
    
    
    784Deferred income taxes
    
    
    2
    
    
    
    Other assets of discontinued operations
    
    
    
    
    
    
    9Total assets
    
    $
    48,159
    
    
    $
    39,804
 See accompanying notes to consolidated financial statements.
 30




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Peerless Mfg. Co. and Subsidiaries
Consolidated Balance Sheets  (Amounts in thousands, except share data)
 LIABILITIES AND SHAREHOLDERS EQUITY
 June 30,2006
    
    
    2005Current liabilities:Accounts payable
    
    $
    13,860
    
    
    $
    8,572Billings in excess of costs and earnings
on uncompleted contracts
    
    
    2,601
    
    
    
    2,081Commissions payable
    
    
    1,238
    
    
    
    762Income taxes payable
    
    
    75
    
    
    
    Product warranties
    
    
    851
    
    
    
    845Accrued liabilities and other
    
    
    3,617
    
    
    
    3,058Current liabilities of discontinued operations
    
    
    
    
    
    
    106Total current liabilities
    
    
    22,242
    
    
    
    15,424Deferred income taxes
    
    
    
    
    
    
    90Commitments
and contingenciesShareholders equity:Common stock  authorized, 10,000,000
shares of $1 par value; issued and
outstanding, 3,133,809 and 3,036,434
shares at June 30, 2006 and 2005, respectively
    
    
    3,134
    
    
    
    3,036Additional paid-in capital
    
    
    3,143
    
    
    
    2,114Accumulated other comprehensive income
    
    
    245
    
    
    
    171Retained earnings
    
    
    19,395
    
    
    
    18,969Total shareholders equity
    
    
    25,917
    
    
    
    24,290Total liabilities and shareholders equity
    
    $
    48,159
    
    
    $
    39,804
 See accompanying notes to consolidated financial statements.
 31




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Consolidated Statements of Operations  (Amounts in thousands, except per share amounts)
 Year ended June 30,2006
    
    
    2005
    
    
    2004Revenues
    
    $
    63,411
    
    
    $
    51,063
    
    
    $
    59,761Cost of goods sold
    
    
    45,978
    
    
    
    37,356
    
    
    
    40,959Gross profit
    
    
    17,433
    
    
    
    13,707
    
    
    
    18,802Operating expensesSales and marketing
    
    
    6,645
    
    
    
    6,031
    
    
    
    6,158Engineering and project management
    
    
    3,480
    
    
    
    3,608
    
    
    
    4,140General and administrative
    
    
    6,562
    
    
    
    4,770
    
    
    
    4,63116,687
    
    
    
    14,409
    
    
    
    14,929Operating income (loss)
    
    
    746
    
    
    
    (702
    )
    
    
    3,873Other income (expense)Interest income
    
    
    248
    
    
    
    158
    
    
    
    80Foreign exchange gain (loss)
    
    
    101
    
    
    
    (22
    )
    
    
    (101
    )Other income (expense)  net
    
    
    106
    
    
    
    (73
    )
    
    
    (3
    )455
    
    
    
    63
    
    
    
    (24
    )Earnings (loss) from continuing operations before income taxes
    
    
    1,201
    
    
    
    (639
    )
    
    
    3,849Income tax benefit (expense)
    
    
    (660
    )
    
    
    113
    
    
    
    (1,447
    )Net earnings (loss) from continuing operations
    
    
    541
    
    
    
    (526
    )
    
    
    2,402Discontinued operationsLoss from discontinued operations
    
    
    (183
    )
    
    
    (80
    )
    
    
    (622
    )Income tax benefit
    
    
    68
    
    
    
    14
    
    
    
    258Net loss from discontinued operations
    
    
    (115
    )
    
    
    (66
    )
    
    
    (364
    )Net earnings (loss)
    
    $
    426
    
    
    $
    (592
    )
    
    $
    2,038BASIC EARNINGS (LOSS) PER SHARE *Earnings (loss) from continuing operations
    
    $
    0.18
    
    
    $
    (0.17
    )
    
    $
    0.80Loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.12
    )Basic earnings (loss) per share
    
    $
    0.14
    
    
    $
    (0.20
    )
    
    $
    0.68DILUTED EARNINGS (LOSS) PER SHARE *Earnings (loss) from continuing operations
    
    $
    0.17
    
    
    $
    (0.17
    )
    
    $
    0.79Loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.12
    )Diluted earnings (loss) per share
    
    $
    0.14
    
    
    $
    (0.20
    )
    
    $
    0.67
 
 *
    
    Certain earnings (loss) per share amounts may not total due to rounding See accompanying notes to the consolidated financial statements.
 32




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Consolidated Statements of Shareholders Equity and
Comprehensive Income (Loss)  (Amounts in thousands)
 AccumulatedAdditional
    
    
    Other
    
    
    
    
    
    
    TotalNo. of
    
    Common
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Retained
    
    
    ShareholdersShares
    
    Stock
    
    
    Capital
    
    
    Income
    
    
    Earnings
    
    
    EquityBalance at July 1, 2003
    
    
    2,999
    
    $
    2,999
    
    
    $
    1,768
    
    
    $
    21
    
    
    $
    17,523
    
    
    $
    22,311Comprehensive incomeNet earnings from continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,402
    
    
    
    2,402Net loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (364
    )
    
    
    (364
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    193
    
    
    
    
    
    
    
    193Total
comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,231Restricted stock grants
    
    
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    3Stock options exercised
    
    
    15
    
    
    15
    
    
    
    83
    
    
    
    
    
    
    
    
    
    
    
    98Income tax benefit related to stock
options exercised
    
    
    
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    30Balance at June 30, 2004
    
    
    3,014
    
    
    3,014
    
    
    
    1,884
    
    
    
    214
    
    
    
    19,561
    
    
    
    24,673Comprehensive lossNet loss from continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (526
    )
    
    
    (526
    )Net loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (66
    )
    
    
    (66
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    (43
    )
    
    
    
    
    
    
    (43
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (635
    )Stock options expense
    
    
    
    
    
    
    
    
    
    69
    
    
    
    
    
    
    
    
    
    
    
    69Stock options exercised
    
    
    22
    
    
    22
    
    
    
    118
    
    
    
    
    
    
    
    
    
    
    
    140Income tax benefit related to stock
options exercised
    
    
    
    
    
    
    
    
    
    43
    
    
    
    
    
    
    
    
    
    
    
    43Balance at June 30, 2005
    
    
    3,036
    
    
    3,036
    
    
    
    2,114
    
    
    
    171
    
    
    
    18,969
    
    
    
    24,290Comprehensive incomeNet earnings from continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    541
    
    
    
    541Net loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (115
    )
    
    
    (115
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    74
    
    
    
    
    
    
    
    74Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    500Restricted stock grants
    
    
    10
    
    
    10
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    29Stock options expense
    
    
    
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    
    
    
    
    118Stock options exercised
    
    
    88
    
    
    88
    
    
    
    586
    
    
    
    
    
    
    
    
    
    
    
    674Income tax benefit related to stock
options exercised
    
    
    
    
    
    
    
    
    
    306
    
    
    
    
    
    
    
    
    
    
    
    306Balance at June 30, 2006
    
    
    3,134
    
    $
    3,134
    
    
    $
    3,143
    
    
    $
    245
    
    
    $
    19,395
    
    
    $
    25,917
 See accompanying notes to consolidated financial statements
 33




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Peerless Mfg. Co. and Subsidiaries
Consolidated Statements of Cash Flows  (Amounts in thousands)
 Year ended June 30,2006
    
    
    2005
    
    
    2004Cash flows from operating activities:Net earnings (loss)
    
    $
    426
    
    
    $
    (592
    )
    
    $
    2,038Adjustments to reconcile net earnings (loss) from operations to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    688
    
    
    
    636
    
    
    
    754Deferred income taxes
    
    
    (267
    )
    
    
    100
    
    
    
    280Provision for bad debts
    
    
    427
    
    
    
    318
    
    
    
    39Provision for warranty expense
    
    
    590
    
    
    
    541
    
    
    
    880Inventory valuation reserve
    
    
    271
    
    
    
    161
    
    
    
    74Foreign exchange (gain) loss
    
    
    (101
    )
    
    
    22
    
    
    
    101Gain on sale of equipment
    
    
    (22
    )
    
    
    
    
    
    
    Stock based compensation
    
    
    118
    
    
    
    
    
    
    
    Restricted stock amortization
    
    
    29
    
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    69
    
    
    
    Changes in operating assets and liabilities of continuing operations:Accounts receivable
    
    
    (5,227
    )
    
    
    1,661
    
    
    
    1,393Inventories
    
    
    (1,833
    )
    
    
    (359
    )
    
    
    36Costs and earnings in excess of billings on uncompleted contracts
    
    
    (3,653
    )
    
    
    2,288
    
    
    
    (3,705
    )Other current assets
    
    
    (221
    )
    
    
    (348
    )
    
    
    284Other assets
    
    
    (61
    )
    
    
    138
    
    
    
    59Accounts payable
    
    
    5,300
    
    
    
    (1,236
    )
    
    
    (3,971
    )Billings in excess of costs and earnings on uncompleted contracts
    
    
    520
    
    
    
    1,682
    
    
    
    (1,628
    )Commissions payable
    
    
    476
    
    
    
    (82
    )
    
    
    (197
    )Product warranties
    
    
    (584
    )
    
    
    (678
    )
    
    
    (744
    )Excess tax benefits from stock-based payment arrangements
    
    
    (306
    )
    
    
    
    
    
    
    Income taxes payable
    
    
    381
    
    
    
    (557
    )
    
    
    534Accrued liabilities and other
    
    
    561
    
    
    
    1,123
    
    
    
    (887
    )Net cash provided by (used in) operating activities of continuing operations:
    
    
    (2,488
    )
    
    
    4,887
    
    
    
    (4,660
    )Cash flow from investing activities of continuing operations:Proceeds from short term investments
    
    
    
    
    
    
    
    
    
    
    309Purchases of property and equipment
    
    
    (315
    )
    
    
    (897
    )
    
    
    (407
    )Proceeds from the sale of equipment
    
    
    57
    
    
    
    
    
    
    
    Net cash used in investing activities of continuing operations
    
    
    (258
    )
    
    
    (897
    )
    
    
    (98
    )Cash flows from financing activities of continuing operations:Proceeds from exercise of stock options
    
    
    674
    
    
    
    140
    
    
    
    98Excess tax benefits from stock-based payment arrangements
    
    
    306
    
    
    
    
    
    
    
    Net cash provided by financing activities of continuing operations
    
    
    980
    
    
    
    140
    
    
    
    98Cash flow from discontinued operations  revised:Cash provided by (used in) operating activities
    
    
    (106
    )
    
    
    25
    
    
    
    1,977Cash provided by investing activities
    
    
    9
    
    
    
    
    
    
    
    142Cash provided by financing activities
    
    
    
    
    
    
    
    
    
    
    Net cash provided by (used in) discontinued operations
    
    
    (97
    )
    
    
    25
    
    
    
    2,119Effect of exchange rate changes on cash and cash equivalents
    
    
    (3
    )
    
    
    3
    
    
    
    (20
    )Net increase (decrease) in cash and cash equivalents
    
    
    (1,866
    )
    
    
    4,158
    
    
    
    (2,561
    )Cash and cash equivalents at beginning of period
    
    
    8,277
    
    
    
    4,119
    
    
    
    6,680Cash and cash equivalents at end of period
    
    $
    6,411
    
    
    $
    8,277
    
    
    $
    4,119Supplemental information on cash flow:Income taxes paid
    
    $
    45
    
    
    $
    730
    
    
    $
    177Income taxes refunded
    
    $
    (237
    )
    
    $
    (14
    )
    
    $
    (49
    )
 See accompanying notes to consolidated financial statements
 34




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Nature of Operations
   Consolidation
  Cash Equivalents
   Accounts Receivable
   35




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED
  Year ended June 30,2006
    
    
    2005
    
    
    2004Balance at beginning of year
    
    $
    352
    
    
    $
    431
    
    
    $
    402Bad debt expense
    
    
    427
    
    
    
    318
    
    
    
    39Accounts written off, net
    
    
    (317
    )
    
    
    (397
    )
    
    
    (10
    )Balance at end of year
    
    $
    462
    
    
    $
    352
    
    
    $
    431
 Inventories
  Depreciable Assets
  Long-Lived Assets
  36




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED
 Revenue Recognition
   Warranty Costs
  Share-Based Compensation
  Shipping and Handling Policy
  37




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED
 Income Taxes
  Earnings (Loss) Per Share
  Foreign Currency
  Financial Instruments
  Use of Estimates
  Reclassification
  38




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE B. NEW ACCOUNTING PRONOUNCEMENTS
   NOTE C. CONCENTRATIONS OF CREDIT RISK
   39




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE D. DISCONTINUED OPERATIONS
   Year ended June 30,2006
    
    
    2005
    
    
    2004Revenues
    
    $
    
    
    
    $
    
    
    
    $
    360Cost of goods sold
    
    
    
    
    
    
    75
    
    
    
    833Gross margin (loss)
    
    
    
    
    
    
    (75
    )
    
    
    (473
    )Operating expenses
    
    
    183
    
    
    
    5
    
    
    
    289Operating loss
    
    
    (183
    )
    
    
    (80
    )
    
    
    (762
    )Other income
    
    
    
    
    
    
    
    
    
    
    Income tax benefit
    
    
    68
    
    
    
    14
    
    
    
    306Net loss from operations
    
    
    (115
    )
    
    
    (66
    )
    
    
    (456
    )Gain on disposal, net of taxes
    
    
    
    
    
    
    
    
    
    
    92Net loss
    
    $
    (115
    )
    
    $
    (66
    )
    
    $
    (364
    )Diluted loss per shareNet loss from operations
    
    $
    (0.04
    )
    
    $
    (0.02
    )
    
    $
    (0.15
    )Net gain on disposal
    
    $
    
    
    
    $
    
    
    
    $
    0.03Net loss
    
    $
    (0.04
    )
    
    $
    (0.02
    )
    
    $
    (0.12
    )
  June 30,2006
    
    
    2005AssetsEquipment  net of accumulated depreciation of $11 at June 30, 2005
    
    $
    
    
    
    $
    9Total assets of discontinued operations
    
    $
    
    
    
    $
    9LiabilitiesProduct warranties and other reserves
    
    $
    
    
    
    $
    106Total current liabilities of discontinued operations
    
    $
    
    
    
    $
    106
 40




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE E. INVENTORIES
  June 30,2006
    
    2005Raw materials
    
    $
    4,417
    
    
    $
    3,027Work in progress
    
    
    626
    
    
    
    232Finished goods
    
    
    262
    
    
    
    3565,305
    
    
    
    3,615Reserve for obsolete and slow-moving inventory
    
    
    (434
    )
    
    
    (318
    )$
    4,871
    
    
    $
    3,297
  Year ended June 30,2006
    
    2005
    
    2004Balance at beginning of year
    
    $
    318
    
    
    $
    196
    
    
    $
    122Additions
    
    
    271
    
    
    
    161
    
    
    
    74Amounts written off
    
    
    (155
    )
    
    
    (39
    )
    
    
    Balance at end of year
    
    $
    434
    
    
    $
    318
    
    
    $
    196
 NOTE F. ASSETS HELD FOR SALE
   June 30, 2006Buildings & improvements
    
    $
    2,768Equipment
    
    
    152Furniture and fixtures
    
    
    132,933Less accumulated depreciation
    
    
    (2,794
    )139Land
    
    
    628$
    767
 41




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE G. PROPERTY, PLANT AND EQUIPMENT
  June 30,2006
    
    2005Buildings & improvements
    
    $
    1,329
    
    
    $
    3,965Equipment
    
    
    4,642
    
    
    
    4,577Furniture and fixtures
    
    
    3,356
    
    
    
    3,5129,327
    
    
    
    12,054Less accumulated depreciation
    
    
    (7,302
    )
    
    
    (9,482
    )2,025
    
    
    
    2,572Land
    
    
    115
    
    
    
    743$
    2,140
    
    
    $
    3,315
  NOTE H. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
  June 30,2006
    
    2005Costs incurred on uncompleted contracts and
estimated earnings
    
    $
    43,448
    
    
    $
    34,978Less billings to date
    
    
    (32,158
    )
    
    
    (26,919
    )$
    11,290
    
    
    $
    8,059
  June 30,2006
    
    2005Costs and earnings in excess of billings on
uncompleted contracts
    
    $
    13,891
    
    
    $
    10,140Billings in excess of costs and earnings on
uncompleted contracts
    
    
    (2,601
    )
    
    
    (2,081
    )$
    11,290
    
    
    $
    8,059
 42




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE I. LINE OF CREDIT
    43




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE J. PRODUCT WARRANTIES
  Year ended June 30,2006
    
    2005
    
    2004Balance at beginning of period
    
    $
    845
    
    
    $
    982
    
    
    $
    846Provision for warranty expenses
    
    
    590
    
    
    
    541
    
    
    
    880Warranty charges
    
    
    (584
    )
    
    
    (678
    )
    
    
    (744
    )Balance at end of period
    
    $
    851
    
    
    $
    845
    
    
    $
    982
 NOTE K. COMMITMENTS AND CONTINGENCIES
   Fiscal Year
    
    Amount2007
    
    $
    1542008
    
    
    52Thereafter
    
    
    $
    206
 44




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE K. COMMITMENTS AND CONTINGENCIES  CONTINUED
     45




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE L. STOCK BASED COMPENSATION
      46




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE L. STOCK BASED COMPENSATION  CONTINUED
  Year ended June 30,2005
    
    
    2004Net earnings (loss), as reported
    
    $
    (592
    )
    
    $
    2,038Deduct: Total stock-based employee compensation
expense determined using
the fair value based
method
for all awards, net of tax
    
    
    (161
    )
    
    
    (161
    )Pro forma net earnings (loss)
    
    $
    (753
    )
    
    $
    1,877Earnings (loss) per share:Basic  as reported
    
    $
    (0.20
    )
    
    $
    0.68Basic  pro forma
    
    $
    (0.25
    )
    
    $
    0.63Diluted  as reported
    
    $
    (0.20
    )
    
    $
    0.67Diluted  pro forma
    
    $
    (0.25
    )
    
    $
    0.62
    47




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE L. STOCK BASED COMPENSATION  CONTINUED
  Twelve monthsended June 30, 2006Income from continuing operations before income taxes
    
    $
    118Income from continuing operations
    
    
    75Net income
    
    
    75Basic and diluted net earning per common share
    
    $
    0.02
   WeightedWeighted
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicExercise
    
    
    Term
    
    
    ValueNo. of Options
    
    
    Price
    
    
    (in years)
    
    
    (in thousands)Balance at July 1, 2005
    
    
    237,950
    
    
    $
    11.22Granted
    
    
    22,000
    
    
    $
    18.13Exercised
    
    
    (87,375
    )
    
    $
    7.71Forfeited before vesting
    
    
    (28,425
    )
    
    $
    13.06Forfeited after vesting
    
    
    (500
    )
    
    $
    19.50Balance at June 30, 2006
    
    
    143,650
    
    
    $
    14.02
    
    
    
    5.1
    
    
    $
    1,427Exercisable at June 30, 2006
    
    
    98,364
    
    
    $
    13.31
    
    
    
    3.5
    
    
    $
    1,047
 48




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE L. STOCK BASED COMPENSATION  CONTINUED
  Year ended June 30,2006
    
    2005
    
    2004Expected volatility
    
    
    47.7 % - 52.6
    %
    
    
    36.8% - 46.4
    %
    
    
    54.0
    %Expected term (years)
    
    
    4.05 - 5.66
    
    
    
    5.00
    
    
    
    5.00Risk free interest rate
    
    
    4.12% - 4.63
    %
    
    
    4.00
    %
    
    
    4.00
    %Dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Weighted average grant
date fair value
    
    $
    8.08
    
    
    $
    5.76
    
    
    $
    6.44
  Year ended June 30,2006
    
    2005
    
    2004Total cash received
    
    $
    674
    
    
    $
    140
    
    
    $
    98Income tax benefits
    
    $
    306
    
    
    $
    43
    
    
    $
    30Total intrinsic value of options exercised
    
    $
    899
    
    
    $
    195
    
    
    $
    81
  Twelve months ended June 30, 2006WeightedAverageGrant DateNo. of Options
    
    Fair ValueUnvested at beginning of period
    
    
    70,100
    
    
    $
    5.98New Grants
    
    
    18,000
    
    
    $
    7.88Vested
    
    
    (14,389
    )
    
    $
    6.00Forfeited
    
    
    (28,425
    )
    
    $
    5.94Unvested at end of period
    
    
    45,286
    
    
    $
    6.75
  49




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE L. STOCK BASED COMPENSATION  CONTINUED
   WeightedAverageGrant DateNo. of Shares
    
    Fair ValueBalance at July 1, 2005
    
    
    
    
    
    $
    Granted
    
    
    10,000
    
    
    $
    17.06Vested
    
    
    
    
    
    $
    Forfeited
    
    
    
    
    
    $
    Balance at June 30, 2006
    
    
    10,000
    
    
    $
    17.06
  NOTE M. SHAREHOLDER RIGHTS PLAN
   50




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE N. EMPLOYEE BENEFIT PLANS
  NOTE O. INCOME TAXES
  June 30,2006
    
    2005Deferred tax assetsInventories
    
    $
    203
    
    
    $
    150Net operating loss carry-forwards
    
    
    195
    
    
    
    202Accrued expenses
    
    
    937
    
    
    
    825Accounts receivable
    
    
    170
    
    
    
    130Stock based compensation
    
    
    46
    
    
    
    Other
    
    
    18
    
    
    
    581,569
    
    
    
    1,365Less valuation allowance
    
    
    (149
    )
    
    
    (149
    )1,420
    
    
    
    1,216Deferred tax liabilitiesProperty, plant and equipment
    
    
    (76
    )
    
    
    (139
    )Other
    
    
    (4
    )
    
    
    (4
    )(80
    )
    
    
    (143
    )Net deferred tax asset
    
    $
    1,340
    
    
    $
    1,073
  June 30,2006
    
    2005Current deferred tax asset
    
    $
    1,338
    
    
    $
    1,163Non-current deferred tax asset, net
    
    
    2
    
    
    
    Non-current deferred tax liability, net
    
    
    
    
    
    
    (90
    )$
    1,340
    
    
    $
    1,073
 51




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE O. INCOME TAXES  CONTINUED
   Year ended June 30,2006
    
    2005
    
    2004Current tax benefit (expense)Federal
    
    $
    (746
    )
    
    $
    332
    
    
    $
    (698
    )State
    
    
    (180
    )
    
    
    (33
    )
    
    
    (96
    )Foreign
    
    
    66
    
    
    
    (72
    )
    
    
    (115
    )(860
    )
    
    
    227
    
    
    
    (909
    )Deferred tax benefit (expense)
    
    
    268
    
    
    
    (100
    )
    
    
    (280
    )$
    (592
    )
    
    $
    127
    
    
    $
    (1,189
    )Income tax benefit (expense)  continuing operations
    
    $
    (660
    )
    
    $
    113
    
    
    $
    (1,447
    )Income tax benefit  discontinued operations
    
    
    68
    
    
    
    14
    
    
    
    258Income tax benefit (expense)
    
    $
    (592
    )
    
    $
    127
    
    
    $
    (1,189
    )
  Year ended June 30,2006
    
    2005
    
    2004Income tax benefit (expense) at federal statutory rate
    
    $
    (346
    )
    
    $
    244
    
    
    $
    (1,097
    )Decrease (increase) in income tax expense
resulting fromState tax, net of federal benefit
    
    
    (218
    )
    
    
    (38
    )
    
    
    (96
    )Foreign sales income exclusions
    
    
    13
    
    
    
    67
    
    
    
    26Effect of lower tax rate on foreign income
    
    
    6
    
    
    
    15
    
    
    
    36Net operating loss valuation allowance
    
    
    
    
    
    
    (149
    )
    
    
    Other
    
    
    (47
    )
    
    
    (12
    )
    
    
    (58
    )Income tax benefit (expense)
    
    $
    (592
    )
    
    $
    127
    
    
    $
    (1,189
    )
 52




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except per share amounts.)
 NOTE
O. INCOME TAXES  CONTINUED
   NOTE P. EARNINGS (LOSS) PER SHARE
 Certain
earnings per share amounts may not total due to rounding.
 Year ended June 30,2006
    
    2005
    
    2004Net earnings (loss) from continuing operations
    
    $
    541
    
    
    $
    (526
    )
    
    $
    2,402Loss from discontinued operations
    
    
    (115
    )
    
    
    (66
    )
    
    
    (364
    )Net earnings (loss)
    
    $
    426
    
    
    $
    (592
    )
    
    $
    2,038Basic weighted average common shares outstanding
    
    
    3,067
    
    
    
    3,028
    
    
    
    3,003Effect of
dilutive options and restricted stock
    
    
    68
    
    
    
    
    
    
    
    41Diluted weighted average common shares outstanding
    
    
    3,135
    
    
    
    3,028
    
    
    
    3,044Net earnings (loss) per share  basic:Earnings (loss) from continuing operations
    
    $
    0.18
    
    
    $
    (0.17
    )
    
    $
    0.80Loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.12
    )Net earnings (loss) per share
    
    $
    0.14
    
    
    $
    (0.20
    )
    
    $
    0.68Net earnings (loss) per share  diluted:Earnings (loss) from continuing operations
    
    $
    0.17
    
    
    $
    (0.17
    )
    
    $
    0.79Loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.12
    )Net earnings (loss) per share
    
    $
    0.14
    
    
    $
    (0.20
    )
    
    $
    0.67
  53




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE Q. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
   Year ended June 30,2006
    
    2005
    
    2004RevenuesEnvironmental
    
    $
    19,767
    
    
    $
    20,591
    
    
    $
    28,096Separation Filtration
    
    
    43,644
    
    
    
    30,472
    
    
    
    31,665Consolidated
    
    $
    63,411
    
    
    $
    51,063
    
    
    $
    59,761Operating income (loss)Environmental
    
    $
    2,055
    
    
    $
    2,309
    
    
    $
    4,133Separation Filtration
    
    
    5,253
    
    
    
    1,759
    
    
    
    4,371Reconciling items
    
    
    (6,562
    )
    
    
    (4,770
    )
    
    
    (4,631
    )Consolidated
    
    $
    746
    
    
    $
    (702
    )
    
    $
    3,873
 54




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE
Q. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION  CONTINUED
  United
    
    
    UnitedStates
    
    
    Kingdom
    
    
    Eliminations
    
    
    Consolidated2006Net sales to unaffiliated customers
    
    $
    53,281
    
    
    $
    10,130
    
    
    $
    
    
    
    $
    63,411Transfers between geographic areas
    
    
    503
    
    
    
    
    
    
    
    (503
    )
    
    
    Total
    
    $
    53,784
    
    
    $
    10,130
    
    
    $
    (503
    )
    
    $
    63,411Identifiable long-lived assets
    
    $
    2,088
    
    
    $
    52
    
    
    $
    
    
    
    $
    2,1402005Net sales to unaffiliated customers
    
    $
    40,261
    
    
    $
    10,802
    
    
    $
    
    
    
    $
    51,063Transfers between geographic areas
    
    
    2,230
    
    
    
    
    
    
    
    (2,230
    )
    
    
    Total
    
    $
    42,491
    
    
    $
    10,802
    
    
    $
    (2,230
    )
    
    $
    51,063Identifiable long-lived assets
    
    $
    3,247
    
    
    $
    68
    
    
    $
    
    
    
    $
    3,3152004Net sales to unaffiliated customers
    
    $
    48,589
    
    
    $
    11,172
    
    
    $
    
    
    
    $
    59,761Transfers between geographic areas
    
    
    2,369
    
    
    
    
    
    
    
    (2,369
    )
    
    
    Total
    
    $
    50,958
    
    
    $
    11,172
    
    
    $
    (2,369
    )
    
    $
    59,761Identifiable long-lived assets
    
    $
    2,964
    
    
    $
    89
    
    
    $
    
    
    
    $
    3,053
    Fiscal Year
    
    United States
    
    International
    
    Consolidated2006
    
    $32,513
    
    $30,898
    
    $63,4112005
    
    $30,248
    
    $20,815
    
    $51,0632004
    
    $40,231
    
    $19,530
    
    $59,761
  55




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE
R. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION  UNAUDITED
  Year ended June 30, 2006First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth Quarter
    
    TotalRevenues
    
    $
    11,642
    
    
    $
    11,534
    
    
    $
    18,121
    
    
    $
    22,114
    
    
    $
    63,411Gross profit
    
    
    2,353
    
    
    
    3,146
    
    
    
    5,343
    
    
    
    6,591
    
    
    
    17,433Operating expenses
    
    
    3,506
    
    
    
    4,472
    
    
    
    3,890
    
    
    
    4,819
    
    
    
    16,687Operating income (loss)
    
    
    (1,153
    )
    
    
    (1,326
    )
    
    
    1,453
    
    
    
    1,772
    
    
    
    746Net earnings (loss)
from continuing
operations
    
    
    (689
    )
    
    
    (792
    )
    
    
    1,003
    
    
    
    1,019
    
    
    
    541Net earnings (loss)
from discontinued
operations
    
    
    
    
    
    
    (33
    )
    
    
    (88
    )
    
    
    6
    
    
    
    (115
    )Net earnings (loss)
    
    
    (689
    )
    
    
    (825
    )
    
    
    915
    
    
    
    1,025
    
    
    
    426Basic earnings (loss) per share *Earnings (loss) from
continuing operations
    
    ($
    0.23
    )
    
    ($
    0.26
    )
    
    $
    0.32
    
    
    $
    0.33
    
    
    $
    0.18Net earnings (loss)
from discontinued
operations
    
    $
    0.00
    
    
    ($
    0.01
    )
    
    ($
    0.03
    )
    
    $
    0.00
    
    
    ($
    0.04
    )Net earnings (loss)
    
    ($
    0.23
    )
    
    ($
    0.27
    )
    
    $
    0.30
    
    
    $
    0.33
    
    
    $
    0.14Diluted earnings (loss) per share *Earnings (loss) from
continuing operations
    
    ($
    0.23
    )
    
    ($
    0.26
    )
    
    $
    0.32
    
    
    $
    0.32
    
    
    $
    0.17Net earnings (loss)
from discontinued
operations
    
    $
    0.00
    
    
    ($
    0.01
    )
    
    ($
    0.03
    )
    
    $
    0.00
    
    
    ($
    0.04
    )Net earnings (loss)
    
    ($
    0.23
    )
    
    ($
    0.27
    )
    
    $
    0.29
    
    
    $
    0.32
    
    
    $
    0.14
 
 *
    
    Certain earnings per share amounts may not total due to rounding. 56




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Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE
R. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION  UNAUDITED
 Year ended June 30, 2005First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth Quarter
    
    TotalRevenues
    
    $
    11,218
    
    
    $
    10,844
    
    
    $
    12,999
    
    
    $
    16,002
    
    
    $
    51,063Gross profit
    
    
    3,215
    
    
    
    2,939
    
    
    
    3,844
    
    
    
    3,709
    
    
    
    13,707Operating expenses
    
    
    3,481
    
    
    
    3,645
    
    
    
    3,650
    
    
    
    3,633
    
    
    
    14,409Operating income (loss)
    
    
    (266
    )
    
    
    (706
    )
    
    
    194
    
    
    
    76
    
    
    
    (702
    )Net earnings (loss)
from continuing
operations
    
    
    (109
    )
    
    
    (464
    )
    
    
    205
    
    
    
    (158
    )
    
    
    (526
    )Net earnings (loss)
from discontinued
operations
    
    
    (20
    )
    
    
    (33
    )
    
    
    
    
    
    
    (13
    )
    
    
    (66
    )Net earnings (loss)
    
    
    (129
    )
    
    
    (497
    )
    
    
    205
    
    
    
    (171
    )
    
    
    (592
    )Basic earnings (loss) per share *Earnings (loss) from
continuing operations
    
    ($
    0.04
    )
    
    ($
    0.15
    )
    
    $
    0.07
    
    
    ($
    0.05
    )
    
    ($
    0.17
    )Net earnings (loss)
from discontinued
operations
    
    ($
    0.01
    )
    
    ($
    0.01
    )
    
    $
    0.00
    
    
    $
    0.00
    
    
    ($
    0.02
    )Net earnings (loss)
    
    ($
    0.04
    )
    
    ($
    0.16
    )
    
    $
    0.07
    
    
    ($
    0.06
    )
    
    ($
    0.20
    )Diluted earnings (loss) per share *Earnings (loss) from
continuing operations
    
    ($
    0.04
    )
    
    ($
    0.15
    )
    
    $
    0.07
    
    
    ($
    0.05
    )
    
    ($
    0.17
    )Net earnings (loss)
from discontinued
operations
    
    ($
    0.01
    )
    
    ($
    0.01
    )
    
    $
    0.00
    
    
    $
    0.00
    
    
    ($
    0.02
    )Net earnings (loss)
    
    ($
    0.04
    )
    
    ($
    0.16
    )
    
    $
    0.07
    
    
    ($
    0.06
    )
    
    ($
    0.20
    )
 
 *
    
    Certain earnings per share amounts may not total due to rounding. 57




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##### Table of Contents



Peerless Mfg. Co. and Subsidiaries
Notes to Consolidated Financial Statements  (Amounts in thousands, except share and per share amounts.)
 NOTE S. OTHER INFORMATION
  June 30,2006
    
    2005Accrued start-up expense
    
    $
    1,492
    
    
    $
    974Accrued compensation
    
    
    1,094
    
    
    
    691Accrued professional, legal and other expenses
    
    
    531
    
    
    
    270Sales and use tax payable
    
    
    3
    
    
    
    491Other
    
    
    497
    
    
    
    632$
    3,617
    
    
    $
    3,058
  Year ended June 30,2006
    
    2005
    
    2004Continuing operationsUnited States
    
    $
    1,404
    
    
    $
    (886
    )
    
    $
    3,366United Kingdom
    
    
    (203
    )
    
    
    247
    
    
    
    4831,201
    
    
    
    (639
    )
    
    
    3,849Discontinued operations  U. S.
    
    
    (183
    )
    
    
    (80
    )
    
    
    (622
    )$
    1,018
    
    
    $
    (719
    )
    
    $
    3,227
 58




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##### Table of Contents



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
  
 ITEM 9A. CONTROLS AND PROCEDURES.
    
 ITEM 9B. OTHER INFORMATION.
  59




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##### Table of Contents



PART III
 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
    www.peerlessmfg.com
 
 ITEM 11. EXECUTIVE COMPENSATION.
  
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER
MATTERS.
  
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
  60




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##### Table of Contents



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
  
 PART IV
 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
  Financial Statements:
 
 Financial Statement Schedules:
  Exhibits:
  61




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##### Table of Contents



SIGNATURES
  Date:  September 27, 2006
    PEERLESS MFG. CO.By:
    /s/ Peter J. BurlagePeter J. BurlageChief Executive Officer  /s/ Sherrill Stone

Sherrill Stone
    
    Chairman of the Board/s/ Peter J. Burlage

Peter J. Burlage
    
    Chief Executive Officer and Director
(Principal Executive Officer)/s/ Henry G. Schopfer

Henry G. Schopfer
    
    Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)/s/ Kenneth R. Hanks

Kenneth R. Hanks
    
    Director/s/ Bernard S. Lee

Bernard S. Lee
    
    Director/s/ J. V. Mariner, Jr.

J. V. Mariner, Jr.
    
    Director/s/ R. Clayton Mulford

R. Clayton Mulford
    
    Director/s/ Howard G. Westerman, Jr.

Howard G. Westerman, Jr.
    
    Director
 62




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##### Table of Contents



Exhibit No.
    
    Exhibit Description3(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, Commission File No. 000-05214, and incorporated
herein by reference).3(b)
    
    Bylaws (filed as Exhibit 3(b) to our Quarterly Report on Form 10-Q,
for the quarter ended December 31, 2003, and incorporated herein by
reference).3(c)
    
    Amendment to the Bylaws (filed as Exhibit 3.2 to our Current Report
on Form 8-K filed with the Commission on May 23, 2006, and
incorporated herein by reference).4(a)
    
    Rights Agreement dated May 22, 1997 between Peerless Mfg. Co. and
Mellon Investor Services, LLC (formerly ChaseMellon Shareholder
Services, L.L.C.), as Rights Agent (filed as Exhibit 1 to our
Registration Statement on Form 8-A, dated May 22, 1997, Commission
File No. 000-05214, and incorporated herein by reference).4(b)
    
    Amendment to Rights Agreement dated August 23, 2001 between Peerless
Mfg. Co. and Mellon Investor Services, LLC, as Rights Agent (filed as
Exhibit 99.2 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, Commission File No.
000-05214, 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, Commission File No. 000-05214, 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 September 30, 1999,
Commission File No. 000-05214, 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)
    
    Credit Agreement dated as of October 30, 2003, by and between
Peerless Mfg. Co. and Comerica Bank (filed as Exhibit 10(a) to our
Quarterly Report on Form 10-Q, for the fiscal quarter ended December
31, 2003, and incorporated herein by reference).10(f)
    
    First Amendment to Credit Agreement, dated as of September 30, 2006,
by and between Peerless Mfg. Co. and Comerica Bank (filed as Exhibit
10.2 to our Current Report on Form 8-K filed with the Commission on
September 22, 2006, and incorporated herein by reference).10(g)
    
    Master Revolving Note dated as of October 30, 2003, by Peerless Mfg.
Co. in favor of Comerica Bank (filed as Exhibit 10(c) to our
Quarterly Report on Form 10-Q, for the fiscal quarter ended December
31, 2003, and incorporated herein by reference).10(h)
    
    Master Revolving Note dated September 30, 2006, by Peerless Mfg. Co.
in favor of Comerica Bank (filed as Exhibit 10.3 to our Current
Report on Form 8-K filed with the Commission on September 22, 2006,
and incorporated herein by reference).10(i)*
    
    Employment Agreement dated October 31, 2005, by and between Peerless
Mfg. Co. and Peter J. Burlage (filed as Exhibit 10(a) to our
Quarterly Report on Form 10-Q for the fiscal quarter ended December
31, 2005, and incorporated herein by reference).10(j)*
    
    Employment Agreement dated January 11, 2006, by and between Peerless
Mfg. Co. and Sean P. McMenamin (filed as Exhibit 10(a) to our
Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
2006, and incorporated herein by reference).10(k)*
    
    Employment Agreement dated October 10, 2003, by and between Peerless
Mfg. Co. and David Taylor (filed as Exhibit 10(f) to our Quarterly
Report on Form 10-Q for the fiscal quarter ended December 31, 2003,
and incorporated herein by reference).10(l)*
    
    Employment Agreement dated July 1, 2004, by and between Peerless Mfg.
Co. and G. Darwyn Cornwell (filed as Exhibit 10(q) to our Annual
Report on Form 10-K for the fiscal year ended June 30, 2004, and
incorporated herein by reference).




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##### Table of Contents



Exhibit No.
    
    Exhibit Description10(m)*
    
    Consulting Agreement dated June 29, 2006, by and between Peerless
Mfg. Co. and Sherrill Stone (filed as Exhibit 10.1 to our Current
Report on Form 8-K filed with the Commission on July 7, 2006, and
incorporated herein by reference).10(n)*
    
    Key Employee Bonus Plan effective as of January 4, 2005 (filed as
Exhibit 10.4 to our Current Report on Form 8-K filed with the
Commission on February 9, 2005, and incorporated herein by
reference).10(o)*
    
    Description of Compensation Payable to Non-Employee Directors (filed
as Exhibit 10(b) to our Quarterly Report on Form 10-Q for the fiscal
quarter ended March 31, 2005, and incorporated herein by reference).10(p)*
    
    Form of Non-Employee Director Stock Option Agreement (filed as
Exhibit 10.1 to our Current Report on Form 8-K filed with the
Commission on February 9, 2005, and incorporated herein by
reference).10(q)*
    
    Form of Chief Executive Officer Stock Option Agreement (filed as
Exhibit 10.2 to our Current Report on Form 8-K filed with the
Commission on February 9, 2005, and incorporated herein by
reference).10(r)*
    
    Form of Executive Stock Option Agreement (filed as Exhibit 10.3 to
our Current Report on Form 8-K filed with the Commission on February
9, 2005, and incorporated herein by reference).10(s)*
    
    Form of Restricted Stock Agreement (filed as Exhibit 10.1 to our
Current Report on Form 8-K filed with the Commission on November 4,
2005, and incorporated herein by reference).21
    
    Subsidiaries of Peerless Mfg. Co.23
    
    Consent of Grant Thornton LLP.31(a)
    
    Rule 13a  14(a)/15d  14(a) Certification of Chief Executive Officer.31(b)
    
    Rule 13a  14(a)/15d  14(a) Certification of Chief Financial Officer.32(a)
    
    Section 1350 Certification of Chief Executive Officer.32(b)
    
    Section 1350 Certification of Chief Financial Officer.
 
 *
    
    Management contract, compensatory plan or arrangement