##### Table of Contents



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, 2004
Commission File No. 0-5214   PEERLESS MFG. CO.
  Texas
(State or other jurisdiction of
incorporation or organization)
    
    75-0724417
(I.R.S. employer identification no.)
 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)
Common Stock, $1.00 Par Value
    
    (Name of each exchange where registered)
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, 2003 was approximately $ 31.1 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 22, 2004 was 3,024,184. DOCUMENTS INCORPORATED
BY REFERENCE Portions of the Registrants Proxy Statement for the 2004 Annual Meeting of
Shareholders are incorporated by reference into Part III of this Form 10-K. 1




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TABLE OF CONTENTS PageNumberPART
IItem 1. Business
    
    
    3Item 2. Properties
    
    
    7Item 3. Legal Proceedings
    
    
    7Item 4. Submission of Matters to a Vote of Security Holders
    
    
    7PART
IIItem 5. Market for Registrants Common Equity, Related Shareholder Matters
and Issuer Purchases of Equity Securities
    
    
    8Item 6. Selected Financial Data
    
    
    9Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    10Item 7A. Quantitative and Qualitative Disclosures about Market Risk
    
    
    25Item 8. Consolidated Financial Statements and Supplementary Data
    
    
    26Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
    
    
    51Item 9A. Controls and Procedures
    
    
    51Item 9B. Other Information
    
    
    51PART
IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    51Item 11. Executive Compensation
    
    
    52Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Shareholder Matters
    
    
    52Item 13. Certain Relationships and Related Transactions
    
    
    52Item 14. Principal Accountant Fees and Services
    
    
    52PART
IVItem 15. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K
    
    
    53Signatures
    
    
    54Index to Exhibits
    
    
    55Employement Agreement - CornwellSubsidiariesConsent 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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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 2002, fiscal 2003, and fiscal 2004 refer to our fiscal years ended
June 30, 2002, 2003, and 2004, respectively. In connection with the discontinuation of our Boiler operations (see Note
D  Discontinued Operations in our Notes to Consolidated Financial
Statements), the fiscal 2004 financial information has been presented, and the
prior years financial information has been restated, to report the discontinued
operations in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. In addition, certain fiscal 2003 and fiscal
2002 items have been reclassified to conform to the fiscal 2004 presentation. Operating Segments and Products We operate our business through two primary business segments, the first
of which is our Environmental Systems business, which accounted for
approximately 47% of our revenues in fiscal 2004. In this segment, we design,
engineer, manufacture and sell environmental control systems, which are used
for air pollution abatement. Our main product, Selective Catalytic Reduction
Systems, referred to as 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 valves and piping. In this segment, we also offer systems to reduce
other pollutants, such as carbon monoxide (CO) and particulate matter (PM). Our other business segment is our Separation Filtration Systems business,
which accounted for approximately 53% of our revenues in fiscal 2004. In this
business segment, 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, as well as saltwater aerosols from combustion intake air of
shipboard gas turbine and diesel engines. Separators are also used in nuclear
power plants to remove water from saturated steam. Although we manufacture and stock a limited number of products 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 are designed
by us but produced by subcontractors or contract vendors under our supervision. Please
see Note O - 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 two segments, Environmental Systems and Separation Filtration
Systems. 3




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Restructuring and Organizational Realignment During fiscal 2002, the demand for electricity declined and the United
States economy weakened. As a result, a considerable slowdown in the
construction of new power plants occurred. In addition, regulatory
uncertainties caused NOx reduction initiatives relating to retrofit projects to
be delayed. In July 2002, as a response to these market and economic
indicators, we initiated a restructuring and organizational
realignment initiative. The goal of this initiative was to reduce costs,
streamline operations, and identify certain non-critical, marginally performing
operating activities, thereby positioning us with a more competitive cost
structure for our overall long-term success. In connection therewith, we
identified our Boiler business as a non-critical, marginally performing
business segment and suspended new orders during fiscal 2003. The assets of
this segment were sold during the first part of fiscal 2004, and as a result,
our financial information has been restated to present this operation as a
discontinued business unit. We
believe as a result of these initiatives, including the redirection
of our resources to focus on our two remaining segments, we are positioned to
maximize our current operational efficiencies and have the flexibility to
meet our customers current and anticipated needs. Even though our
restructuring and organizational realignment initiatives are complete, we
continue to look for ways to improve our operational efficiencies and
performance. Manufacturing and Outsourcing Our products are fabricated utilizing a combination of in-house
manufacturing, subcontractors and contract vendors. In both fiscal 2003 and
2004, manufacturing outsourced to subcontractors accounted for a significant
percentage of our costs of good sold (approximately 39% in fiscal 2003 and 41%
in fiscal 2004). We believe the 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 pricing , quality and workmanship standards and on-time delivery
performance. We maintain significant in-house manufacturing capabilities and generally
manufacture products whose complexity may preclude their production by our
subcontractors and contract vendors and where necessary, to protect our
proprietary technology. Customers Our Environmental Systems are sold to 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 NOx
emissions and ground level ozone to which NOx is a precursor. 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. We are not dependent upon any single customer or group of customers in
either of our two business segments. The custom-designed and project-specific
nature of our business can cause year-to-year 4




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variances in our major customers. During fiscal 2004, one customer
accounted for approximately 10% of our revenues, and in fiscal 2003 and 2002,
different customers accounted for approximately 16% and 15% of our total
revenues, respectively. Sales to international customers have been an integral part of our
business for more than 40 years. During fiscal 2004, foreign sales amounted to
approximately $25.1 million, or 42.0% of our revenues, compared to sales of
approximately $25.0 million, or 38.5% of our revenues during fiscal 2003, and
$20.6 million, or 21.7% of our revenues in fiscal 2002. Our global offices and
worldwide independent sales rep network allows 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, 2004, was approximately
$34 million, compared to $40 million as of June 30, 2003. Backlog has been
calculated under our customary practice of including incomplete orders for
products that are deliverable in future periods, but that may be changed or
cancelled. Approximately 70% of our backlog is scheduled to be completed
during our next fiscal year ending June 30, 2005. For further discussion on
our backlog, please see Item 7  Managements Discussion and Analysis of
Financial Condition and Results of Operations  Backlog of this Report. Competition We have several domestic and international competitors with capital and
revenues that are 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 Environmental 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 industry and filtration equipment for the marine market. Our
expenditures for new product development and improvements were approximately
$241,000 in fiscal year 2004, $316,000 in fiscal 2003, and $576,000 in fiscal
2002. To protect our intellectual property rights, we depend upon a combination
of patents, trademarks, internal controls and non-disclosure and
confidentiality agreements with our employees, subcontractors, contract
vendors, customers and others having business dealings with the Company. We
have existing patents and patent applications pending on certain products and
processes that are important to our business. These include patents on vane
designs, separator profiles, environmental controls equipment, 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. 5




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Employees At June 30, 2004, we had 181 employees (196 employees at June 30, 2003).
Our employees by location is as follows: June 30,Geographic location:
    
    2004
    
    2003United States
    
    
    156
    
    
    
    170United Kingdom
    
    
    21
    
    
    
    22Singapore
    
    
    4
    
    
    
    4Total
    
    
    181
    
    
    
    196
 None of our employees are represented by a labor union or are subject to a
collective bargaining agreement. We have not experienced any material labor
difficulties during the past year and we believe our employee relations are
good. 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 our
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 Affect Our
Operating Results and Other Risk Factors of this Report. For geographic
information see Note O  Industry Segment and Geographic Information, of our
Notes to Consolidated Financial Statements attached to this Report. Available Information Our Internet website is http://www.peerlessmfg.com. Peerless makes
available free of charge through its Internet website (under Investor
Relations) the Companys annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and Proxy Statements and all amendments to
those reports as soon as reasonable practicable after they are electronically
filed with (or furnished to) the Securities and Exchange Commission (SEC).
Reports, Proxy Statements and other information regarding the Company also are
contained on the SECs Internet website, http://www.sec.gov. Peerless has posted its Code of Conduct for Directors and Employees and
other corporate governance related policies, and charters for its Audit,
Compensation and Nomination Committees on its website,
http://www.peerlessmfg.com. This information is available in print to any
shareholder who 6




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requests it by writing to the Company at 2819 Walnut Hill Lane, Dallas, Texas
75229, attention: Ms. Susan Banner. 
 ITEM 2. PROPERTIES. Our executive offices and research and development facilities are owned,
and are located in Dallas, Texas. We own and operate manufacturing and
warehousing facilities in Abilene, Denton and Dallas, 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. ApproximateLocation
    
    Sq. Footage
    
    General UseOwned:Dallas, Texas
    
    
    48,000
    
    
    Office, warehouse and research and development.Abilene, Texas
    
    
    78,000
    
    
    Manufacturing   Environmental products and SeparationFiltration products.Denton, Texas
    
    
    22,000
    
    
    Manufacturing  Separation Filtration productsDallas, Texas
    
    
    80,000
    
    
    Manufacturing  Environmental products and SeparationFiltration products until November 2002. Currently not in use.Leased:Dallas, Texas
    
    
    3,500
    
    
    Sales and marketing officeHalstead  Essex, England
    
    
    2,900
    
    
    Sales, engineering and administration officeSingapore
    
    
    2,300
    
    
    Sales office
 During fiscal year 2003, in connection with restructuring initiatives, we
consolidated our Dallas manufacturing operations into our Abilene manufacturing
facility. While we believe our office and manufacturing facilities are adequate and
suitable for our present and future 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. Pursuant to the terms of our revolving credit facility, we have agreed not
to pledge as collateral our facilities for any obligations . 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. For further discussion on various
litigation matters, please see Note J  Contingencies, of our Notes to
Consolidated Financial Statements of this Report. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters require disclosure. 7




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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, RELATED SHAREHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
 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. Fiscal Year
    
    
    
    High
    
    Low2003
    
    First Quarter
    
    $
    17.50
    
    
    $
    7.31Second Quarter
    
    
    12.00
    
    
    
    7.75Third Quarter
    
    
    10.00
    
    
    
    8.25Fourth Quarter
    
    
    12.50
    
    
    
    8.452004
    
    First Quarter
    
    $
    11.44
    
    
    $
    9.33Second Quarter
    
    
    13.89
    
    
    
    10.91Third Quarter
    
    
    14.15
    
    
    
    10.80Fourth Quarter
    
    
    11.98
    
    
    
    10.12
 The last reported sale price of our common stock on NASDAQ on September
22, 2004 was $14.45 per share. As of that date, there were
approximately 125
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 and other
restrictive covenants of our bank credit facility, and such other factors as
the Board of Directors deems appropriate. The Company did not pay cash
dividends in either fiscal year 2004 or 2003. The Company did not repurchase
any of its common stock during fiscal 2004, nor does the Company have an
approved repurchase program. See Item 12  Security Ownership of Beneficial Owners and Management and
Related Shareholder Matters section of this Report for information relating to
our equity compensation plans. 8




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ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data regarding our
results of operations and financial position as of and for each of the years in
the five-year period ended June 30, 2004, which are derived from our audited
consolidated financial statements. Our consolidated financial statements and
notes thereto as of June 30, 2004 and 2003, and for the years ended June 30,
2004, 2003 and 2002, and the report of Grant Thornton LLP thereon, are included
in Item 8 of 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 in Item 8 of 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. Certain earnings per share amounts may not total due to rounding. For the years ended June 30,2004
    
    %
    
    2003
    
    %
    
    2002
    
    %
    
    2001
    
    %
    
    2000
    
    %(Amounts in thousands, except per share amounts)Operating
Results:Revenues
    
    $
    59,761
    
    
    
    100.0
    
    
    $
    64,854
    
    
    
    100.0
    
    
    $
    94,880
    
    
    
    100.0
    
    
    $
    75,278
    
    
    
    100.0
    
    
    $
    58,523
    
    
    
    100.0Cost of revenues
    
    
    40,959
    
    
    
    68.5
    
    
    
    47,842
    
    
    
    73.8
    
    
    
    64,908
    
    
    
    68.4
    
    
    
    51,898
    
    
    
    68.9
    
    
    
    42,766
    
    
    
    73.1Gross profit
    
    
    18,802
    
    
    
    31.5
    
    
    
    17,012
    
    
    
    26.2
    
    
    
    29,972
    
    
    
    31.6
    
    
    
    23,380
    
    
    
    31.1
    
    
    
    15,757
    
    
    
    26.9Operating expenses
    
    
    14,929
    
    
    
    25.0
    
    
    
    16,429
    
    
    
    25.3
    
    
    
    21,047
    
    
    
    22.2
    
    
    
    15,636
    
    
    
    20.8
    
    
    
    13,384
    
    
    
    22.8Operating income
    
    
    3,873
    
    
    
    6.5
    
    
    
    583
    
    
    
    0.9
    
    
    
    8,925
    
    
    
    9.4
    
    
    
    7,744
    
    
    
    10.3
    
    
    
    2,373
    
    
    
    4.1Other expense (income)
    
    
    24
    
    
    
    0.1
    
    
    
    (727
    )
    
    
    (1.1
    )
    
    
    (410
    )
    
    
    (0.4
    )
    
    
    989
    
    
    
    1.3
    
    
    
    122
    
    
    
    0.2Provision for taxes
    
    
    1,447
    
    
    
    2.4
    
    
    
    399
    
    
    
    0.6
    
    
    
    3,256
    
    
    
    3.4
    
    
    
    2,498
    
    
    
    3.3
    
    
    
    923
    
    
    
    1.6Net earnings from continuing operations
    
    
    2,402
    
    
    
    4.0
    
    
    
    911
    
    
    
    1.4
    
    
    
    6,079
    
    
    
    6.4
    
    
    
    4,257
    
    
    
    5.7
    
    
    
    1,328
    
    
    
    2.3Net loss from discontinued operations
    
    
    (364
    )
    
    
    (0.6
    )
    
    
    (1,290
    )
    
    
    (2.0
    )
    
    
    (1,690
    )
    
    
    (1.8
    )
    
    
    (1,185
    )
    
    
    (1.6
    )
    
    
    (397
    )
    
    
    (0.7
    )Net earnings (loss)
    
    $
    2,038
    
    
    
    3.4
    
    
    $
    (379
    )
    
    
    (0.6
    )
    
    $
    4,389
    
    
    
    4.6
    
    
    $
    3,072
    
    
    
    4.1
    
    
    $
    931
    
    
    
    1.6Basic
earnings (loss) per shareNet earnings
from continuing operations
    
    $
    0.80
    
    
    
    
    
    
    $
    0.30
    
    
    
    
    
    
    $
    2.04
    
    
    
    
    
    
    $
    1.44
    
    
    
    
    
    
    $
    0.46Net loss from discontinued operations
    
    $
    (0.12
    )
    
    
    
    
    
    $
    (0.43
    )
    
    
    
    
    
    $
    (0.57
    )
    
    
    
    
    
    $
    (0.40
    )
    
    
    
    
    
    $
    (0.14
    )Net earnings (loss)
    
    $
    0.68
    
    
    
    
    
    
    $
    (0.13
    )
    
    
    
    
    
    $
    1.47
    
    
    
    
    
    
    $
    1.04
    
    
    
    
    
    
    $
    0.32Diluted earnings (loss) per shareNet earnings
from continuing operations
    
    $
    0.79
    
    
    
    
    
    
    $
    0.30
    
    
    
    
    
    
    $
    1.97
    
    
    
    
    
    
    $
    1.42
    
    
    
    
    
    
    $
    0.45Net loss from discontinued operations
    
    $
    (0.12
    )
    
    
    
    
    
    $
    (0.43
    )
    
    
    
    
    
    $
    (0.55
    )
    
    
    
    
    
    $
    (0.39
    )
    
    
    
    
    
    $
    (0.14
    )Net earnings (loss)
    
    $
    0.67
    
    
    
    
    
    
    $
    (0.13
    )
    
    
    
    
    
    $
    1.43
    
    
    
    
    
    
    $
    1.02
    
    
    
    
    
    
    $
    0.32Cash dividends per share
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    0.13
    
    
    
    
    
    
    $
    0.25Weighted average shares outstanding:Basic earnings per share
    
    
    3,003
    
    
    
    
    
    
    
    2,996
    
    
    
    
    
    
    
    2,978
    
    
    
    
    
    
    
    2,947
    
    
    
    
    
    
    
    2,918Diluted earnings per share
    
    
    3,044
    
    
    
    
    
    
    
    3,013
    
    
    
    
    
    
    
    3,080
    
    
    
    
    
    
    
    3,002
    
    
    
    
    
    
    
    2,940
 9




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ITEM 6. SELECTED FINANCIAL DATA  CONTINUED As of the years ended June 30,2004
    
    2003
    
    2002
    
    2001
    
    2000(Amounts in thousands, except per share amounts)Financial position:Working capital
    
    $
    20,681
    
    
    $
    17,771
    
    
    $
    17,755
    
    
    $
    14,615
    
    
    $
    11,938Current assets
    
    
    35,483
    
    
    
    39,223
    
    
    
    42,129
    
    
    
    41,731
    
    
    
    27,528Total assets
    
    
    39,475
    
    
    
    43,763
    
    
    
    46,889
    
    
    
    46,156
    
    
    
    32,121Current liabilities
    
    
    14,802
    
    
    
    21,452
    
    
    
    24,374
    
    
    
    27,116
    
    
    
    15,590Long-term
debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,200
    
    
    
    1,406Total liabilities
    
    
    14,802
    
    
    
    21,452
    
    
    
    24,374
    
    
    
    28,463
    
    
    
    17,372Equity
    
    
    24,673
    
    
    
    22,311
    
    
    
    22,515
    
    
    
    17,693
    
    
    
    14,749Book value per share
    
    $
    8.19
    
    
    $
    7.44
    
    
    $
    7.53
    
    
    $
    5.99
    
    
    $
    5.02
 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. Overview We are a global company providing environmental and separation 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
2004, we discontinued the operations of our Boiler business. See Item 1 
Business  Restructuring and Organizational Realignment and Note D 
Discontinued Operations in our Notes to Consolidated Financial Statements of
this Report for additional discussion on the discontinuance of this business
unit. Environmental Systems.This business segment represented approximately
47%, 58%, and 69% of our fiscal 2004, 2003, and 2002 revenues, respectively.
The main product of the Environmental Systems segment is Selective Catalytic
Reduction Systems, referred to as SCR Systems. These environmental control
systems are used for air pollution abatement and convert NOx emissions from
exhaust gases caused by burning hydrocarbon fuels such as coal, gasoline,
natural gas and oil, into harmless nitrogen and water vapor. Along with the
SCR Systems, this segment also offers systems to reduce other pollutants such
as CO and particulate matter. These systems are totally integrated, complete
with instruments, controls and related valves and piping. Separation Filtration Systems.This business segment represented
approximately 53%, 42%, and 31% of our fiscal 2004, 2003, and 2002 revenues,
respectively. The Separation Filtration Systems segment produces 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 as well as saltwater aerosols from combustion intake air of
shipboard gas turbine and diesel engines. In addition, separators are also
used in nuclear power plants to remove water from saturated steam. Boilers.In this discontinued business segment, we designed, engineered,
manufactured and sold packaged boilers and other steam generating equipment.
This equipment is used to produce steam, which is 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 discontinuance of this business unit during
fiscal 2004. 10




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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 or by the Securities and
Exchange Commission in its rules, regulations and releases, including
statements regarding our expectations, hopes, beliefs, intentions, projections
or strategies regarding the future. We desire to avail ourselves of the safe
harbor provisions in the Private Securities Litigation Reform Act of 1996 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 SEC. 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, as set forth starting on page 21 of
this Report. All forward-looking statements included in this Report are based on
information available to us on the date hereof, and we expressly disclaim any
obligation to release publicly any updates or changes in the forward-looking
statements, whether as a result of changes in events, conditions, or
circumstances on which any forward-looking statement is based. Results of Operations  Consolidated Revenues.For fiscal 2004, revenues decreased approximately $5.1 million,
or 7.9% to $59.8 million from $64.9 million in fiscal 2003. Domestic revenues
decreased approximately $5.2 million, or 13.0%, from $39.9 million in fiscal
2003 to $34.7 million in fiscal 2004. Foreign revenues increased approximately
$100,000, or 0.4%, from $25.0 million in fiscal 2003 to $25.1 million in fiscal
2004. The decline in domestic revenues was mainly attributable to the decline
in our Environmental Systems sales, which continues to be impacted by the
slow-down in new merchant power construction and regulatory uncertainties. The
increase in our foreign revenues related primarily to the increase in our
Separation Filtration Systems sales in Europe and the Middle East through our
UK subsidiary, partially offset by a decrease in these systems sales in Latin
America. See Item 7  Results of Operations  Segments of this Report for
further discussion of revenues. For fiscal 2003, revenues decreased approximately $30.0 million, or 31.6%,
to $64.9 million from $94.9 million in fiscal 2002. Domestic revenues
decreased approximately $34.4 million, or 46.3%, from $74.3 million in fiscal
2002 to $39.9 million in fiscal 2003. Foreign revenues increased approximately
$4.4 million, or 21.4%, from $20.6 million in fiscal 2002 to $25.0 million in
fiscal 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 Separation Filtration Systems sales
through our UK subsidiary. We believe the decline in the construction of new
power plants, regulatory uncertainties, and the economic climate all
contributed to the significant decline in our domestic revenues during the
period. See Item 7  Results of Operations  Segments of this Report for
further discussion of revenues. Gross Profit Margin.Our margins, during a particular period, may be
impacted by three primary factors: (1) sales volume, (2) shifts in our
product mix and, (3) start-up and warranty costs. Certain products have
higher margins than others; as a result, shifts in the composition of our sales
can have a significant impact on our margins either at the selling margin level
or through a negative or positive impact on our manufacturing absorption. For
fiscal 2004, our gross profit margin increased $1.8 million, or 10.6%, from
$17.0 million in fiscal 2003 to $18.8 million in fiscal 2004. Gross profit
margin, as a percentage of sales, increased from 26.2% for fiscal 2003 to 31.5%
for fiscal 2004. Our margins during 11




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the fiscal 2004 were favorably impacted by a significant reduction in our
start-up and warranty costs, which decreased $2.5 million, or 71.4%, from $3.5
million in fiscal 2003 to $1.0 million in fiscal 2004, which resulted from our
project execution quality control program. This improvement was offset by a
higher unabsorbed manufacturing factor during the period due to our decreased
sales volume. In addition to the foregoing, our margins were negatively
impacted by shifts in our product mix, as our Environmental Systems revenues
declined from 58% of our total revenues in fiscal 2003 to 47% in fiscal 2004.
The negative impact associated with the decline in our Environmental Systems
revenue during fiscal 2004, was partially offset by the 103% increase in our
nuclear/marine revenues. For fiscal 2003, our gross profit margins decreased $13.0 million, or
43.3%, from $30.0 million in fiscal 2002 to $17.0 million in fiscal 2003.
Gross profit margins, as a percentage of sales, decreased from 31.6% for fiscal
2002 to 26.2% for fiscal 2003. Our reported margins during fiscal year 2003
were impacted primarily by two factors, our manufacturing absorption factor,
which was impacted by the 46.3% decrease in our domestic revenues, and a shift in our
product sales mix, as our Environmental Systems revenues, which historically
have higher gross profit margins, represented only 57.8% of our total revenues
compared to 69.1% for fiscal 2002. In addition to the two primary factors, our
margins during fiscal 2003 were also impacted by start-up costs on several SCR
system projects being higher than we initially budgeted and increased
competition in the marketplace. Operating Expenses.For fiscal 2004, operating expenses from continuing
operations decreased by approximately $1.5 million or 9.1%, from $16.4 million
for fiscal 2003 to approximately $14.9 million for fiscal 2004. Operating
expenses, as a percentage of sales, were 25.0% for fiscal 2004, compared to
25.3% for fiscal 2003. On a comparative basis, and as a percentage of
revenues, our sales and marketing expenses increased from 9.1% to 10.3%, our
engineering and project management expenses decreased from 8.0% to 6.9%, and
our general and administrative expenses (including restructuring expenses in
fiscal 2003) decreased from 8.2% to 7.8%. The increase in our sales and
marketing expenses, as a percentage of revenues, related primarily to an
increase in our commission expense during the period, which is directly related
to the increase in our Separation Filtration Systems revenues, which generally
tends to have a higher commission rate than our Environmental Systems revenues.
The decrease in engineering and project management expenses is attributed to
our restructuring and realignment initiative started last year and due to the
decline in our Environmental Systems revenues, which generally are more
engineering intensive than our Separation Filtration Systems sales. The
decrease in general and administrative expenses related primarily to the costs
in fiscal 2003 associated with our restructuring, which savings were partially
offset by the higher public company related expenses in fiscal 2004. The
higher public company related expenses are expected to continue as the Company
continues to manage the increased expense of compliance with corporate
governance requirements enacted by the SEC, as well as the Nasdaq stock market. For fiscal 2003, operational expenses decreased $4.6 million, or 21.9%,
from $21.0 million for fiscal 2002 to $16.4 million for fiscal 2003. Operating
expenses as a percentage of revenue were 25.3% for fiscal 2003 and 22.2% for
fiscal 2002. On a comparative basis, and as a percentage of revenues, our
sales and marketing expenses increased from 7.8% to 9.1%, our engineering and
project management expenses increased from 7.8% to 8.0%, and our general and
administrative expenses increased from 6.6% to 8.2%. The decrease in the
amount of total 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 the 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 in fiscal 2003 was an additional provision for doubtful
accounts of approximately $650,000, which related primarily to a customer that
had declared bankruptcy (see Item 7  Managements Discussion and Analysis of
Financial Condition and Results of Operations  Contingencies, of this Report
for further discussion). 12




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Other Income and Expense.For fiscal 2004, other income and expense items
changed by approximately $751,000, from income of approximately $727,000 for
the fiscal 2003 to expense of $24,000 for fiscal 2004. During fiscal 2003, we
recognized a gain of approximately $473,000 on the sale of our Wylie, Texas
real property and other assets. We also realized foreign currency exchange
losses associated with our UK operations of approximately $101,000 during
fiscal 2004 compared to exchange gains of approximately $146,000 in fiscal
2003. For fiscal 2003, other income and expense items changed by approximately
$317,000 from an addition to income of approximately $410,000 for fiscal
2002 to an addition to income of $727,000 for fiscal 2003. During fiscal 2003,
we recognized a gain of approximately $473,000 on the sale of our Wylie, Texas
real property and other assets and recognized a gain of approximately $267,000
in fiscal 2002 on the sale of our Carrollton, Texas real property and other
assets. We also realized foreign currency exchange gains of approximately
$146,000 during fiscal 2003 compared to exchange gains of approximately $84,000
in fiscal 2002. Income Taxes.The Companys effective income tax rate for continuing
operations was approximately 37.6%, 30.5% and 34.9% in fiscal 2004, 2003 and
2002, respectively. The increased rate in fiscal 2004 is due primarily to our
increased state income tax expense during the year and reduced foreign tax
related benefits. The decrease in our expense during fiscal 2003 related
primarily to our lower effective foreign tax rate. The increased foreign tax
related benefits during fiscal 2002, were offset by a higher state income tax
burden during that year. For further discussion related to our income taxes,
please see Note M  Income Taxes, to our Notes to Consolidated Financial
Statements attached to this Report. Net Earnings from Continuing Operations.As a result of the above
factors, our net earnings from continuing operations increased by approximately
$1.5 million, or 166.7%, from approximately $911,000, or 1.4% of sales, for
fiscal 2003, to approximately $2.4 million, or 4.0% of sales, for fiscal 2004.
Basic earnings per share increased from $0.30 per share for fiscal 2003, to
$0.80 per share for fiscal 2004. Diluted earnings per share increased from
$0.30 per share for fiscal 2003, to $0.79 per share for fiscal 2004. For fiscal year 2003, net earnings from continuing operations decreased
$5.2 million, or 85.2%, from $6.1 million for fiscal year 2002 to $911,000 in
fiscal 2003. Basic earnings per share decreased from $2.04 per share for
fiscal 2002, to $.30 per share for fiscal 2003. Diluted earnings per share
decreased from $1.97 per share for fiscal 2002, to $.30 per share for fiscal
2003. Discontinued Operations. Our net loss from discontinued operations for
the year ended June 30, 2004 was approximately $364,000 compared to a net loss
of $1.3 million for the year ended June 30, 2003. The expense in the 2004
fiscal year related primarily to costs associated with the start-up and
commissioning of projects that were not commissioned by June 30, 2003. The
Company has established a reserve (approximately $300,000 at June 30, 2004),
based on its estimate of these costs given the most current information
available and historical experience. While we believe our reserve is adequate
and the judgment applied is appropriate, due to a number of factors, our
estimated liability could differ from our actual costs incurred (see Critical
Accounting Policies  Product Warranties of this Report). Also included in
our net loss for the year ended June 30, 2004 was a net gain related to the
disposal of our Boiler operation of approximately $92,000 ($140,000 gain less
taxes of $48,000). Basic and diluted loss per share from discontinued
operations was ($0.12) per share for fiscal 2004, compared to a loss of
($0.43) per share for fiscal 2003. Our net loss from discontinued operations for fiscal 2002 was
approximately $1.7 million. Our basic loss per share from discontinued
operation in fiscal 2002 was ($0.57) per share. Our diluted loss per share
from discontinued operations in fiscal 2002 was ($0.55) per share. See also
Note D  Discontinued Operations to our Notes to Consolidated Financial
Statements of this Report for further discussion of discontinued operations. 13




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Net Earnings (Loss).As a result of the above factors, our net earnings
increased approximately $2.4 million from a net loss of $379,000, or (0.6)% of
sales, for fiscal 2003, to approximately $2.0 million, or 3.4% of sales, for
fiscal 2004. Basic earnings per share increased from a loss of ($0.13) per
share for fiscal 2003, to earnings of $0.68 per share for fiscal 2004. Diluted
earnings per share increased from a loss of ($0.13) per share for fiscal 2003,
to earnings of $0.67 per share for fiscal 2004. Our net loss was approximately $379,000, or (0.6)% of sales, for fiscal
2003, compared to net earnings of approximately $4.4 million, or 4.6% of sales
for fiscal 2002. Basic earnings per share decreased from $1.47 per share for
fiscal 2002, to a loss of ($0.13) per share for fiscal 2003. Diluted earnings
per share decreased from $1.43 per share for fiscal 2002, to a loss of ($0.13)
per share for fiscal 2003. Results of Operations  Segments Currently we are organized along two lines of business: Environmental
Systems, and Separation Filtration Systems. The Company had three reportable
segments  Environmental Systems, Separation Filtration Systems, and Boilers in
fiscal 2003 and 2002. The Boiler segment was discontinued and its assets sold
during the first quarter of fiscal 2004. See Note D  Discontinued
Operations in the Notes to our Consolidated Financial Statements for further
discussion on the Boiler segment. Segment information for fiscal 2002 has been
restated on a comparable basis with fiscal 2003 and 2004. Revenues.The following table displays revenues by reportable segment
(dollars in thousands). Fiscal Year Ended June 30,2004
    
    %
    
    2003
    
    %
    
    2002
    
    %RevenuesEnvironmental Systems
    
    
    
    
    
    $
    28,096
    
    
    
    47.0
    %
    
    $
    37,511
    
    
    
    57.8
    %
    
    $
    65,539
    
    
    
    69.1
    %Separation Filtration Systems
    
    
    
    
    
    
    31,665
    
    
    
    53.0
    %
    
    
    27,343
    
    
    
    42.2
    %
    
    
    29,341
    
    
    
    30.9
    %Total
    
    
    
    $
    59,761
    
    
    
    100.0
    
    
    $
    64,854
    
    
    
    100.0
    
    
    $
    94,880
    
    
    
    100.0
 Revenues from our Environmental Systems decreased $9.4 million, or 25.1%,
in fiscal 2004, and decreased $28.0 million, or 42.7%, in fiscal 2003. Our
Environmental Systems segment continues to be impacted by the slow-down in new
power plant construction and regulatory uncertainties. We expect
that spending for NOx reduction systems will increase in 2005  2008 as
regulatory compliance deadlines come into effect over the next 5 years. We have
experienced and continue to expect an increase in request for proposals, as
users begin to implement their compliance plans. In addition, while the
construction of new power plants has significantly declined over the past
several years, we believe this portion of the Environmental Systems
business will show improvement in 2006  2007, as older plants are retired/or
modified and new plants are built to meet the growing demand for electricity
both domestically and internationally. Separation Filtration Systems revenues increased by approximately $4.3
million, or 15.8% in fiscal 2004 and decreased by approximately $2.0 million,
or 6.8% in fiscal 2003. We saw our domestic Separation Filtration Systems
revenues increase by approximately $4.2 million, or 84.5% in fiscal 2004,
compared to a decrease of $6.7 million, or 57.7% for fiscal 2003. The increase
in our domestic revenues during fiscal 2004 can be attributed primarily to an
increase in our nuclear/marine sales, which increased by $3.6 million, or
102.9%. The increase related primarily to life extension projects at several
nuclear power plants and increased military spending. The decline in our
domestic sales during fiscal 2003 related primarily to the economic weakness in
the US economy. Our international revenues increased $100,000, or 0.6% in
fiscal 2004, compared to an increase of $4.7 million, or 26.8% in fiscal 2003.
The 14




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increase in our international revenues during fiscal 2004 can be attributed to
an increase in our UK sales of approximately $2.5 million, which was offset by
a decline in our Latin American sales of approximately $2.4 million, due to the
economic and political uncertainties surrounding this area. The increase in
international revenues during fiscal 2003, related primarily to the increase in
sales through our UK subsidiary of $1.4 million, and an increase in
international sales through our domestic operation of approximately
$3.3 million. Segment Profit.The following table displays segment profit by
reportable segment (dollars in thousands): Fiscal Year Ended June 30,2004
    
    2003
    
    2002Segment profitEnvironmental Systems
    
    $
    4,133
    
    
    $
    3,191
    
    
    $
    13,556Separation Filtration Systems
    
    
    4,371
    
    
    
    2,708
    
    
    
    1,654Total
    
    
    8,504
    
    
    
    5,899
    
    
    
    15,210Unallocated general and administrative
expenses
    
    
    (4,631
    )
    
    
    (5,316
    )
    
    
    (6,285
    )Operating income
    
    $
    3,873
    
    
    $
    583
    
    
    $
    8,925
 To measure segment profit, management uses segment revenues, less segment
costs and expenses, before allocation of general and administrative costs. In
the past, the Company did not allocate its manufacturing costs that were not
fully absorbed to each individual segment. Starting in fiscal 2003, the
Company began 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 individual segments. Fiscal 2002
segment profit information has been restated to conform to the
fiscal 2004 and 2003 presentation. Environmental Systems profit in fiscal 2004 increased $942,000, or 29.5%
over fiscal 2003. Profit in fiscal 2003 decreased $10.4 million, or 76.5% over
fiscal 2002. As a percentage of Environmental Systems revenue, profit in
Environmental Systems was 14.7%, 8.5% and 20.7%, in fiscal 2004, 2003 and 2002,
respectively. The increase in our Environmental Systems profit margin during
the fiscal 2004 related primarily to the decrease in start-up and commissioning
costs of SCR projects, resulting from the Companys project execution quality
control program, and a reduction of operational expenses in connection with our
organizational realignment and restructuring. The decline in our Environmental
System profit margin during fiscal 2003 related primarily to the 42.7% drop in
this segments revenues and the resulting impact on its operational overhead as
a percentage of sales. 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). Separation Filtration Systems profit in fiscal 2004 increased $1.7
million, or 61.4% over fiscal 2003. Profit in fiscal 2003 increased $1.1
million, or 63.7% over fiscal 2002. As a percentage of Separation Filtration
Systems revenue, profit in Separation Filtration Systems was 13.8%, 9.9%, and
5.6%, in fiscal 2004, 2003 and 2002, respectively. The increase in the
Separation Filtration Systems profit margins relates primarily to the changes
in our sales mix during these periods. Market Outlook Environmental Systems.We expect that the spending for NOx
reduction systems will increase in 2005  2008 as users implement their
compliance plans as regulatory compliance deadlines come in to effect over the
next 5 years. In addition, while the construction of new power plants has
significantly declined over the last several years, we expect this
market to improve in 2006  2007, as older plants are retired/or modified and
new plants are built to meet the growing demand for electricity both
domestically and internationally. 15




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Separation Filtration Systems.The market for nuclear/marine products remains
strong, and is expected to continue at such levels for at least the next 5
years, as nuclear power plants continue to invest in life extension projects
and increased military spending occurs. The Nuclear Regulatory Commission
estimates that by 2010, nearly 80% of nuclear power plants in the United States
will be in the license renewal process. In addition, the increased demand for
natural gas, both domestically and internationally, should also create new
opportunities for our separator and filter products. One such opportunity is
Liquified Natural Gas (LNG) and its associated gas processing facilities, which
are currently being proposed in a number of areas to facilitate the
transportation of LNG to the United States and other markets. Contingencies The Company previously disclosed that a $2.2 million receivable (before
allowance for doubtful accounts) due from a customer that had filed a plan of
reorganization under Chapter 11 of the United States Bankruptcy Code was
included in its discontinued operations. The Company obtained outside counsel
to assist with the collection of this receivable and filed a statutory lien on
the refinery where its equipment was installed. During the 2004 fiscal year,
the Company and the project owner reached a settlement agreement whereby the
parties agreed to release each other from any outstanding claims, the Company
agreed to release its lien, and the project owner paid the outstanding
unreserved balance due on the receivable. On March 19, 2004, the Company received notice that an adversary
proceeding was initiated by Enron Corp. and National Energy Production
Corporation in the United States Bankruptcy Court for the Southern District of
New York against PMC Acquisition, Inc., a subsidiary that operated the
discontinued Boiler business of the Company under the name ABCO Industries.
The plaintiffs allege that certain accounts receivable payments paid to ABCO
were avoidable transfers under the Bankruptcy Code and are seeking to recover
approximately $1 million from ABCO. The Company has engaged outside counsel
and believes that all, or a majority of the payments, fail to meet the
applicable standards for avoidance under the Bankruptcy Code and otherwise
applicable law, and that a number of defenses can be asserted that will negate
any recovery by the plaintiffs. The Company intends to vigorously defend
against the lawsuit and management believes the likelihood of loss in not
probable. From time to time the Company is involved in various litigation matters
arising in the ordinary course of its business. The Company does not believe
the disposition of any current matter will have a material adverse effect on
its consolidated financial position or its results of operations. Backlog The Companys backlog of unfilled orders was approximately $34 million at
June 30, 2004, compared to $40 million at June 30, 2003. Our backlog at June
30, 2004, when compared to our backlog at June 30, 2003, has been impacted by
the completion of a substantial contract of approximately $6 million (original
value of contract - $14 million), during the first part of fiscal 2004. Our
Environmental Systems segment continues to be impacted by the effects of the
slow down in new power plant construction. We expect that spending for NOx
reduction systems will increase in 2005  2008 as users implement their
compliance plans as regulatory deadlines approach, and we are continuing to see
an increase request for proposals relating to such initiatives. In addition,
while the construction of new power plants has seen a decline over the past
several years, we believe this portion of the Environmental Systems business
will improve in 2006  2007. The market for Peerless nuclear and marine
products remains strong as nuclear power plants continue to invest in life
extension projects and increased military spending occurs. The shortage of
natural gas supplies is creating new opportunities for Peerless separators and
filters, such as the production of LNG and the associated gas processing
facilities. 16




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##### Table of Contents



Financial Position Assets.Total assets decreased by approximately $4.3 million, or 9.8%,
from $43.8 million at June 30, 2003 to $39.5 million at June 30, 2004. The
decrease in our assets during the fiscal year resulted primarily from the
downturn in our business. At June 30, 2004, we held cash and cash equivalents
of $4.1 million, had working capital of $20.7 million, and a current ratio of
2.4-to-1.0 This compares with cash and cash equivalents of $6.7 million,
$17.8 million in working capital, and a current ratio of 1.8 to-1.0 at June 30,
2003. Liabilities and Shareholders Equity.Total liabilities decreased by
approximately $6.7 million, or 31.2%, from $21.5 million at June 30, 2003 to
$14.8 million at June 30, 2004. The decrease in liabilities related primarily
to a decrease in our accounts payable of approximately $4.0 million and a
decrease in our billings in excess of costs and earnings on uncompleted
contracts of approximately $1.6 million see Liquidity and Capital Resources
of Item 7). The increase in our equity of approximately $2.4 million, or
10.8%, from $22.3 million at June 30, 2003 to $24.7 million at June 30, 2004
resulted primarily from our earnings during the period. Our debt (total
liabilities)-to-equity ratio improved from .96-to-1.0 at June 30, 2003 to .60-to-1.0 at June 30, 2004, reflecting the 31.2% reduction in our liabilities
and the 10.8% increase in our equity during the period. Liquidity and Capital Resources Our cash and cash equivalents were $4.1 million as of June 30, 2004,
compared to $6.7 million at June 30, 2003. Cash used in operating activities
during fiscal year 2004 was $4.3 million, compared to $5.7 million and $4.6
million being provided by operations during fiscal 2003 and fiscal 2002,
respectively. 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, 2004, the
balance of these working capital accounts was $15.9 million compared to $7.9
million at June 30, 2003, reflecting an increase of our investment in these
working capital items of $8.0 million. Generally, a contract will either
allow for amounts to be billed upon shipment or on a progress basis based on
the attainment of certain milestones. During the 2004 fiscal year, a greater
percentage of the Companys contracts in progress called for billings upon
project shipment versus the attainment of certain milestones, which resulted in
the increase in our investment in these working capital accounts. In addition,
during fiscal year 2004, funds were provided by our operating profit and used
to reduce our accrued expenses. Cash used in investing activities was approximately $98,000 for fiscal
year 2004, compared to cash provided by investing activities of approximately
$423,000 for fiscal 2003, and cash used of approximately $1.2 million in fiscal
2002. The use of cash during fiscal 2004 related primarily to capital
refurbishments of our Denton and Abilene, Texas manufacturing facilities,
offset by the redemption of a short-term investment. The cash provided during
the 2003 fiscal year related primarily to the sale of 32 acres of undeveloped
land in Wylie, Texas. The use of cash during fiscal 2002 related primarily to
the refurbishment of our Abilene, Texas manufacturing 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 was approximately $130,000 and
$64,000 during fiscal 2004 and 2003, respectively, and related to the proceeds
from the issuance of common stock, pursuant to employee stock options. Cash
used during fiscal 2002 was approximately $1.4 million, and related to the 17




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payment of a $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. Cash provided from our discontinued operations during the current period
was approximately $1.8 million, compared to a use of cash from discontinued
operations of approximately $900,000 and $3.1 million for fiscal 2003 and 2002,
respectively. The cash provided during the current period can be attributed to
the collection of a significant receivable due from a customer that had filed
for a plan of reorganization under Chapter 11 of the United States Bankruptcy
Code (see Item 7  Managements Discussion and Analysis of Financial Condition
and Results of Operations  Contingencies, of this Report). As a result of the above factors, during fiscal year 2004, our cash and
cash equivalents decreased by approximately $2.6 million, compared to an
increase of approximately $5.3 million and a decrease of $1.2 million during
fiscal 2003 and 2002, respectively. On October 31, 2003, we entered into a $12.5 million revolving credit
facility for working capital requirements that expires on October 31, 2006.
The facility carries a floating interest rate based on the prime or Euro rate
plus or minus an applicable margin (Euro plus 1.75% at June 30, 2004), and is
secured by substantially all our domestic assets. At June 30, 2004, we had
$3.5 million outstanding under stand-by letters of credit and no loans
outstanding, leaving us availability under our credit facility of $9.0 million.
The facility contains financial covenants, certain restrictions on capital
expenditures, acquisitions, asset dispositions, dividends and additional debt,
as well as other customary covenants. As of June 30, 2004, the Company was in
compliance with all financial and other covenants under the credit facility. In addition, our UK subsidiary has a £2.0 million (approximately $3.6
million) debenture agreement used to facilitate the issuances of bank
guarantees. This facility is secured by substantially all of the UK subsidiary
assets, and is backed by a Peerless stand-by letter of credit of £1.3 million
(approximately $2.3 million, which is included in the $3.5 million outstanding
above) and expires on October 31, 2004. At June 30, 2004, there was
approximately £1.44 million outstanding under this facility, leaving
availability of approximately £560,000 (approximately $1 million). 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. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations The following table summarizes the indicated contractual obligations and
other commitments of the Company as of June 30, 2004. The Company has no
off-balance-sheet arrangements in place as of June 30, 2004. Payments Due by PeriodLess Than
    
    1 to 3
    
    3 to 5
    
    After 5Contractual Obligations
    
    Total
    
    1 Year
    
    Years
    
    Years
    
    YearsOperating lease obligations
    
    $
    304
    
    
    $
    114
    
    
    $
    144
    
    
    $
    11
    
    
    $
    35Purchase obligations (1)
    
    
    7,503
    
    
    
    7,503
    
    
    
    
    
    
    
    
    
    
    
    Stand-by letters of credit (2)
    
    
    6,105
    
    
    
    3,058
    
    
    
    2,059
    
    
    
    988
    
    
    
    Total contractual obligations
    
    $
    13,912
    
    
    $
    10,675
    
    
    $
    2,203
    
    
    $
    999
    
    
    $
    35
  (1)
    
    Purchase obligations in the table above represent the value of open
purchase orders as of June 30, 2004. 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 18




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under such terms is difficult to quantify. In addition, the Company
generally has contracts with its customers that minimize its exposure to
losses for materials purchased within lead-times necessary to meet
customer forecasts.(2)
    
    Included in the amount of stand-by letters of credit is an
approximately $2.3 million stand-by letter of credit issued on the
behalf of Peerless to guarantee the debenture agreement of its
subsidiary, Peerless Europe Limited. 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
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. 19




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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 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 actual warranty costs
incurred in the future. Allowance for Doubtful Accounts.We maintain an allowance for doubtful
accounts to reflect estimated losses resulting from the inability of customers
to make required payments. On an on-going basis, we evaluate the
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. Reserve for Obsolete and Slow-Moving Inventory.Inventories are valued at
the lower of cost or market and are reduced by a reserve for excess and
potentially obsolete inventories. The Company regularly reviews inventory
values on hand, using specific aging categories, and records a provision for
obsolete and slow-moving inventory based on historical usage and estimated
future usage. As actual future demand or market conditions may vary from those
projected by management, adjustments to inventory valuations may be required. New Accounting Standards In November 2002, Financial Accounting Standards Board (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
was 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 process for revenue recognition purposes. The adoption of
this pronouncement did not have a material impact on our financial condition or
results of our operations. In April 2003, FASB issued Statement No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. 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 was effective for contracts entered into or
modified after June 30, 2003. The adoption of this pronouncement did not have
a material impact on our financial condition or results of our operations. In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity.
Statement 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.
Statement 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 20




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contracts that require or may require the issuer to buy back some of its shares
in exchange for cash or other assets; and 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. This Statement does not apply to features
embedded in a financial instrument that is not a derivative in its entirety.
Statement No. 150 was effective for financial instruments entered into or
modified after May 31, 2003, and otherwise was effective at the beginning of
the first interim period beginning after June 15, 2003. The adoption of this
pronouncement did not have a material impact on our financial statements. In December 2003, the FASB revised FIN No. 46 (FIN 46R), Consolidation of Variable Interest Entities. FIN 46R clarifies the
application of Accounting Research Bulletin No. 51 for certain entities for
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. The Company would currently be required to adopt FIN 46R for
any variable interest entities it had and would be required to meet the
disclosure requirements of this pronouncement. However, the Company has
determined that it does not have an interest in such entities based on its analysis
and assessment. 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, and results of operations or prospects, financial or
otherwise. Reference to these factors in the context of a forward-looking
statement or statements will 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 sales of our 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 2004, approximately 47% of our consolidated revenues
were derived from sales of Environmental Systems for new and refurbished power
plants compared to approximately 58% for fiscal 2003. 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 new power plants or a decline in the refurbishing 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 the price, supply or demand for natural gas could have an
adverse impact on our sales of Separation Systems and our operating results. A large portion of our separation filtration business is driven by the
construction of natural gas production and transportation infrastructure.
Increasing demand for natural gas may result in the construction of natural gas
production facilities and facilities to transport the gas to its end
destination (i.e., pipelines and LNG processing plants). Increasing prices of
natural gas, while beneficial to exploration activities and the financing of
new projects, can adversely impact demand. Excessive supply could also
negatively impact the price of natural gas, which could discourage spending on
new projects. 21




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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 increase 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 (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 segment 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 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. 22




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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 2004, revenue outside the United States represented
approximately 42% of our consolidated revenues. In fiscal 2003, approximately
39% 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. Our financial performance may vary significantly from period to period,
making it difficult to estimate future revenue. Our annual 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
annual operating results. Furthermore, as a significant portion of our
operating costs are fixed, an unanticipated decrease in our revenues, a delay
or cancellation of orders in backlog, or a decrease in the demand for our
products, may have a significant impact on our annual operating results.
Therefore, our annual operating results may be subject to significant
variations and our operating performance in one period may not be indicative of
our future performance. Our margins are affected by shifts in our product mix. Certain of our products have higher margins than others. Consequently,
changes in the composition of our sales between products from
quarter-to-quarter or from period-to-period can have a significant impact on
our reported margins. Certain of our products also have a much higher
internally manufactured cost component; and therefore, changes from
quarter-to-quarter or from period-to-period can have a significant impact on
our reported margins through a negative or positive impact on our manufacturing
absorption. See Item 7 -  Managements Discussion and Analysis of Financial
Condition and Results of Operations of this Report. 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. 23




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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 closely monitor the credit worthiness of our customers. Significant
portions of our sales are to customers who place large orders for custom
products and whose activities are related to the power and oil/gas industries.
As such, our exposure to credit risk is affected to some degree by conditions
within these industries and governmental and/or political conditions. We
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. Changes in billing terms can increase our exposure to working capital and
credit risk. Our products are generally sold under contracts that allow us to either
bill upon the completion of certain agreed upon milestones, or upon the actual
shipment of the product. The Company attempts to negotiate progress-billing
milestones on all large contracts to help the Company manage the working
capital and credit risk associated with these large contracts. Consequently,
shifts in the billing terms of the contracts in the Companys backlog from
period to period can increase the Companys requirement for working capital and
can increase the Companys exposure to credit risk. See Item 7  Managements
Discussion and Analysis and Results of Operations  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 $12.5 million revolving credit
facility impose restrictions that affect, among other things, our ability to
incur debt, make capital expenditures, merge, sell assets, make distributions,
or create or incur liens. The 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, 2004 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. 24




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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 global economic
instability. Any future terrorist activities, and 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 borrowing under our bank credit facility. 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 United Stated
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, 2004. 25




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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors
Peerless Mfg. Co. We have audited the accompanying consolidated balance sheets of Peerless Mfg.
Co. and subsidiaries as of June 30, 2004 and 2003, 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, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2004 and 2003, and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended June 30, 2004, in conformity with accounting principles
generally accepted in the United States of America. /s/ GRANT THORNTON LLP
Grant Thornton LLP Dallas, Texas
September 15, 2004 26




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PEERLESS MFG. CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS(Dollars in thousands) ASSETS June 30,2004
    
    2003Current assets:Cash and cash equivalents
    
    $
    4,119
    
    
    $
    6,680Short-term investments
    
    
    
    
    
    
    309Accounts receivable-principally trade - net of
allowance for doubtful accounts of $431 at
June 30, 2004 and $402 at June 30, 2003
    
    
    13,604
    
    
    
    14,995Inventories
    
    
    3,106
    
    
    
    3,215Costs and earnings in excess of billings
on uncompleted contracts
    
    
    12,448
    
    
    
    8,721Deferred income taxes
    
    
    1,165
    
    
    
    1,445Other
    
    
    816
    
    
    
    1,098Current assets of discontinued operations
    
    
    225
    
    
    
    2,760Total current assets
    
    
    35,483
    
    
    
    39,223Property, plant and equipment - net
    
    
    3,053
    
    
    
    3,400Other assets
    
    
    930
    
    
    
    989Other assets of discontinued operations
    
    
    9
    
    
    
    151Total assets
    
    $
    39,475
    
    
    $
    43,763
 See accompanying notes to consolidated financial statements. 27




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PEERLESS MFG. CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
 LIABILITIES AND SHAREHOLDERS EQUITY June 30,2004
    
    2003Current liabilities:Accounts payable
    
    $
    9,791
    
    
    $
    13,793Billings in excess of costs and earnings
on uncompleted contracts
    
    
    399
    
    
    
    2,027Commissions payable
    
    
    844
    
    
    
    1,041Income taxes payable
    
    
    557
    
    
    
    53Product warranties
    
    
    982
    
    
    
    846Accrued liabilities and other
    
    
    1,923
    
    
    
    2,828Current liabilities of discontinued operations
    
    
    306
    
    
    
    864Total current liabilities
    
    
    14,802
    
    
    
    21,452Commitments and contingencies
    
    
    
    
    
    
    Shareholders equity:Common stock - authorized, 10,000,000
shares of $1 par value; issued and
outstanding, 3,013,684 and 2,998,534
shares at June 30, 2004 and 2003, respectively
    
    
    3,014
    
    
    
    2,999Additional paid-in capital
    
    
    1,884
    
    
    
    1,771Other, principally other comprehensive income
    
    
    214
    
    
    
    18Retained earnings
    
    
    19,561
    
    
    
    17,523Total shareholders equity
    
    
    24,673
    
    
    
    22,311Total liabilities and shareholders equity
    
    $
    39,475
    
    
    $
    43,763
 See accompanying notes to consolidated financial statements. 28




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##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share amounts)
 Year ended June 30,2004
    
    2003
    
    2002Revenues
    
    $
    59,761
    
    
    $
    64,854
    
    
    $
    94,880Cost of goods sold
    
    
    40,959
    
    
    
    47,842
    
    
    
    64,908Gross profit
    
    
    18,802
    
    
    
    17,012
    
    
    
    29,972Operating expensesSales and marketing
    
    
    6,158
    
    
    
    5,926
    
    
    
    7,411Engineering and project
management
    
    
    4,140
    
    
    
    5,187
    
    
    
    7,351General and administrative
    
    
    4,631
    
    
    
    4,833
    
    
    
    6,285Restructuring expense
    
    
    
    
    
    
    483
    
    
    
    14,929
    
    
    
    16,429
    
    
    
    21,047Operating income
    
    
    3,873
    
    
    
    583
    
    
    
    8,925Other expense (income)Foreign exchange loss (gain)
    
    
    101
    
    
    
    (146
    )
    
    
    (84
    )Other income, net
    
    
    (77
    )
    
    
    (581
    )
    
    
    (326
    )24
    
    
    
    (727
    )
    
    
    (410
    )Earnings from continuing operations
before income taxes
    
    
    3,849
    
    
    
    1,310
    
    
    
    9,335Income tax expense
    
    
    1,447
    
    
    
    399
    
    
    
    3,256Net earnings from continuing operations
    
    
    2,402
    
    
    
    911
    
    
    
    6,079Discontinued operations (Note D)Loss from discontinued operations,
(including gain on disposal of $140
for the
year ended June 30, 2004)
    
    
    (622
    )
    
    
    (2,028
    )
    
    
    (2,595
    )Income tax benefit
    
    
    (258
    )
    
    
    (738
    )
    
    
    (905
    )Net loss from discontinued operations
    
    
    (364
    )
    
    
    (1,290
    )
    
    
    (1,690
    )Net earnings (loss)
    
    $
    2,038
    
    
    $
    (379
    )
    
    $
    4,389BASIC EARNINGS (LOSS) PER SHAREEarnings from continuing operations
    
    $
    0.80
    
    
    $
    0.30
    
    
    $
    2.04Loss from discontinued operations
    
    
    (0.12
    )
    
    
    (0.43
    )
    
    
    (0.57
    )Basic earnings (loss) per share
    
    $
    0.68
    
    
    $
    (0.13
    )
    
    $
    1.47DILUTED EARNINGS (LOSS) PER SHAREEarnings from continuing operations
    
    $
    0.79
    
    
    $
    0.30
    
    
    $
    1.97Loss from discontinued operations
    
    
    (0.12
    )
    
    
    (0.43
    )
    
    
    (0.55
    )Diluted earnings (loss) per share
    
    $
    0.67
    
    
    $
    (0.13
    )
    
    $
    1.43
 See accompanying notes to consolidated financial statements 29




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##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (Dollars in
thousands)
 Accumulated$ 1 Par
    
    
    
    
    
    Unamortized Value
    
    Other
    
    
    
    
    
    TotalCommon
    
    Paid-in
    
    of Restricted
    
    Comprehensive
    
    Retained
    
    ShareholderStock
    
    Capital
    
    Stock Grants
    
    Income (loss)
    
    Earnings
    
    EquityBalances at July 1, 2001
    
    $
    1,477
    
    
    $
    2,804
    
    
    $
    (35
    )
    
    $
    (66
    )
    
    $
    13,513
    
    
    $
    17,693Net earnings from continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,079
    
    
    
    6,079Net loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,690
    )
    
    
    (1,690
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16
    )
    
    
    
    
    
    
    (16
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,373Stock split (2-for-1)
    
    
    1,477
    
    
    
    (1,477
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock options exercised
    
    
    37
    
    
    
    180
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    217Amortization of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    19Income tax benefit related to restricted
stock plan
    
    
    
    
    
    
    213
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    213Balance at June 30, 2002
    
    
    2,991
    
    
    
    1,720
    
    
    
    (16
    )
    
    
    (82
    )
    
    
    17,902
    
    
    
    22,515Net earnings from continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    911
    
    
    
    911Net loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,290
    )
    
    
    (1,290
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    103
    
    
    
    
    
    
    
    103Total comprehensive income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (276
    )Stock options exercised
    
    
    11
    
    
    
    53
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64Stock grant forfeiture
    
    
    (3
    )
    
    
    (16
    )
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    (11
    )Amortization of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    5Income tax benefit related to restricted
stock plan
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14Balance at June 30, 2003
    
    
    2,999
    
    
    
    1,771
    
    
    
    (3
    )
    
    
    21
    
    
    
    17,523
    
    
    
    22,311Net earnings from continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,402
    
    
    
    2,402Net loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (364
    )
    
    
    (364
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    193
    
    
    
    
    
    
    
    193Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,231Stock options exercised
    
    
    15
    
    
    
    83
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98Amortization of restricted stock grants
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    3Income tax benefit related to restricted
stock plan
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30Balance at June 30, 2004
    
    $
    3,014
    
    
    $
    1,884
    
    
    $
    
    
    
    $
    214
    
    
    $
    19,561
    
    
    $
    24,673
 See accompanying notes to consolidated financial statements 30




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##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
 Year ended June 30,2004
    
    2003
    
    2002Cash flows from operating activities:Net earnings (loss)
    
    $
    2,038
    
    
    $
    (379
    )
    
    $
    4,389Net loss from discontinued operations
    
    
    364
    
    
    
    1,290
    
    
    
    1,690Net earnings from continuing operations
    
    
    2,402
    
    
    
    911
    
    
    
    6,079Adjustments to reconcile net earnings from continuing operations
to net cash provided by operating activities:Depreciation and amortization
    
    
    754
    
    
    
    759
    
    
    
    683Deferred income taxes
    
    
    280
    
    
    
    (503
    )
    
    
    (393
    )Bad debt expense
    
    
    39
    
    
    
    124
    
    
    
    133Foreign exchange (gain) loss
    
    
    101
    
    
    
    (146
    )
    
    
    (84
    )Gain on sales on property and equipment
    
    
    
    
    
    
    (473
    )
    
    
    (267
    )Other
    
    
    
    
    
    
    7
    
    
    
    213Changes in operating assets and liabilitiesAccounts receivable
    
    
    1,393
    
    
    
    6,747
    
    
    
    981Inventories
    
    
    110
    
    
    
    63
    
    
    
    (1,360
    )Costs and earnings in excess of billings on uncompleted contracts
    
    
    (3,705
    )
    
    
    798
    
    
    
    (3,191
    )Other current assets
    
    
    284
    
    
    
    (357
    )
    
    
    12Other assets
    
    
    59
    
    
    
    (581
    )
    
    
    405Accounts payable
    
    
    (3,971
    )
    
    
    2,578
    
    
    
    1,793Billings in excess of costs and earnings uncompleted contracts
    
    
    (1,628
    )
    
    
    (1,895
    )
    
    
    (775
    )Commissions payable
    
    
    (197
    )
    
    
    (395
    )
    
    
    2Product warranties
    
    
    136
    
    
    
    218
    
    
    
    235Income taxes payable
    
    
    504
    
    
    
    (713
    )
    
    
    (988
    )Accrued liabilities and other
    
    
    (889
    )
    
    
    (1,395
    )
    
    
    1,103(6,730
    )
    
    
    4,836
    
    
    
    (1,498
    )Net cash provided by (used in) operating activities of continuing
operations
    
    
    (4,328
    )
    
    
    5,747
    
    
    
    4,581Cash flow from investing activities:Net proceeds from short-term investments
    
    
    309
    
    
    
    (2
    )
    
    
    (7
    )Net purchases of property and equipment
    
    
    (407
    )
    
    
    425
    
    
    
    (1,213
    )Net cash provided by (used in) investing activities of continuing
operations
    
    
    (98
    )
    
    
    423
    
    
    
    (1,220
    )Cash flows from financing activities:Proceeds from sale of common stock
    
    
    130
    
    
    
    64
    
    
    
    236Payments on long-term borrowings
    
    
    
    
    
    
    
    
    
    
    (1,600
    )Net cash provided by (used in) financing activities of continuing
operations
    
    
    130
    
    
    
    64
    
    
    
    (1,364
    )Net cash provided by (used in) discontinued operations
    
    
    1,755
    
    
    
    (893
    )
    
    
    (3,146
    )Effect of exchange rate changes on
cash and cash equivalents
    
    
    (20
    )
    
    
    (47
    )
    
    
    (42
    )Net increase (decrease) in cash and cash equivalents
    
    
    (2,561
    )
    
    
    5,294
    
    
    
    (1,191
    )Cash and cash equivalents at beginning of period
    
    
    6,680
    
    
    
    1,386
    
    
    
    2,577Cash and cash equivalents at end of period
    
    $
    4,119
    
    
    $
    6,680
    
    
    $
    1,386Supplemental information on cash flow:Interest paid
    
    $
    
    
    
    $
    
    
    
    $
    123Income taxes paid
    
    $
    128
    
    
    $
    834
    
    
    $
    3,402
 See accompanying notes to consolidated financial statements. 31




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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 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 are as follows: Year Ended June 30,2004
    
    2003
    
    2002Balance at beginning of year
    
    $
    402
    
    
    $
    354
    
    
    $
    297Bad debt expense
    
    
    39
    
    
    
    124
    
    
    
    133Accounts written off, net
    
    
    (10
    )
    
    
    (76
    )
    
    
    (76
    )Balance at end of year
    
    $
    431
    
    
    $
    402
    
    
    $
    354
 32




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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 A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Inventories Inventories are valued at the lower of cost or market. Cost is determined by
the first-in, first-out (FIFO) method, including material, labor and factory
overhead. The Company regularly reviews inventory values on hand, using
specific aging categories, and records a provision for obsolete and slow-moving
inventory based on historical usage and estimated future usage. In assessing
the ultimate realization of its inventory, the Company is required to make
judgments as to future demand requirements. As actual future demand or market
conditions may vary from those projected by the Company, adjustments to
inventory valuations may be required. Depreciable Assets Depreciation is provided for in amounts sufficient to relate the cost of
depreciable assets to operations over their estimated service lives (generally
3 to 7 years), principally by the straight-line method. Routine maintenance
costs are expensed as incurred. Major improvements that extend the life,
increase the capacity or improve the safety or the efficiency of property owned
are capitalized. Major improvements to leased buildings are capitalized as
leasehold improvements and amortized over the shorter of the estimated life or
the lease term. 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. 33




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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 A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED 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. 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 In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure (SFAS 148) which amends
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123). SFAS 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation and requires disclosures in annual and
interim financial statements of the effects of stock-based compensation as
reflected below. At June 30, 2004, the Company has two stock-based employee compensation plans,
which are described more fully in Note K. The Company accounts for these 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. Year ended June 30,2004
    
    2003
    
    2002Net earnings (loss), as reported
    
    $
    2,038
    
    
    $
    (379
    )
    
    $
    4,389Deduct: Total stock-based employee
compensation expense determined
using the fair value based method for
all awards, net of related tax effects
    
    
    (161
    )
    
    
    (117
    )
    
    
    (115
    )Pro forma net earnings (loss)
    
    $
    1,877
    
    
    $
    (496
    )
    
    $
    4,274Earnings (loss) per share:Basic - as reported
    
    $
    0.68
    
    
    $
    (0.13
    )
    
    $
    1.47Basic - pro forma
    
    $
    0.63
    
    
    $
    (0.17
    )
    
    $
    1.44Diluted - as reported
    
    $
    0.67
    
    
    $
    (0.13
    )
    
    $
    1.43Diluted - pro forma
    
    $
    0.62
    
    
    $
    (0.16
    )
    
    $
    1.39
 34




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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 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
translations 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, short-term investments,
accounts receivable, accounts payable and accrued expenses approximate fair
value because of the short-term nature of these items. Long-Lived Assets In accordance with statement on Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, the Company
reviews it long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable and exceeds its fair value. If conditions indicate an asset might
be impaired, the Company estimates the future cash flows expected to result
from the use of the asset and its eventual disposition. The impairment would
be measured by the amount by which the asset exceeds its fair value typically
represented by the discounted cash flows associated with the asset. 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. 35




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED Reclassification Certain reclassifications of prior year amounts have been made to conform to
the current year presentation. NOTE B. NEW ACCOUNTING PRONOUNCEMENTS In November 2002, Financial Accounting Standards Board (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
was 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 process for revenue recognition purposes. The adoption of
this pronouncement did not have a material impact on our financial condition or
results of our operations. In April 2003, FASB issued Statement No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. 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 was effective for contracts entered into or
modified after June 30, 2003. The adoption of this pronouncement did not have
a material impact on our financial condition or results of our operations. In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity.
Statement 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.
Statement 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 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. This Statement does not apply to features
embedded in a financial instrument that is not a derivative in its entirety.
Statement No. 150 was effective for financial instruments entered into or
modified after May 31, 2003, and otherwise was effective at the beginning of
the first interim period beginning after June 15, 2003. The adoption of this
pronouncement did not have a material impact on our financial statements. 36




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE B. NEW ACCOUNTING PRONOUNCEMENTS - CONTINUED In December 2003, the FASB revised FIN No. 46 (FIN 46R), Consolidation of
Variable Interest Entities. FIN 46R clarifies the application of Accounting
Research Bulletin No. 51 for certain entities for which equity investors do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The Company
would currently be required to adopt FIN 46R for any variable interest entities
it had and would be required to meet the disclosure requirements of this
pronouncement. However, the Company has determined that it does not have an
interest in such entities based on its analysis and assessment. NOTE C. CONCENTRATIONS OF CREDIT RISK The Company closely monitors the creditworthiness of its customers.
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
financial 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 2004, one customer accounted for approximately
10% of its consolidated revenues, and in fiscal years 2003 and 2002, different
customers accounted for approximately 16% and 15% of its total consolidated
revenues, respectively. 37




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE D. DISCONTINUED OPERATIONS During the first quarter of fiscal 2004, the Board of Directors authorized the
divestiture, and the Company sold certain assets of its Boiler business segment
with a net book value of approximately $110, for $250, resulting in a gain on
disposal of $140. The following represents a summary of operating results and the gain on
disposition of the Boiler segment presented as discontinued operations: For the years ended June 30,2004
    
    2003
    
    2002Revenues
    
    $
    360
    
    
    $
    4,316
    
    
    $
    14,576Cost of goods sold
    
    
    833
    
    
    
    4,711
    
    
    
    13,623Gross margin (loss)
    
    
    (473
    )
    
    
    (395
    )
    
    
    953Operating expenses
    
    
    289
    
    
    
    1,680
    
    
    
    3,610Operating loss
    
    
    (762
    )
    
    
    (2,075
    )
    
    
    (2,657
    )Other income
    
    
    
    
    
    
    47
    
    
    
    62Income tax benefit
    
    
    (306
    )
    
    
    (738
    )
    
    
    (905
    )Net loss from operations
    
    
    (456
    )
    
    
    (1,290
    )
    
    
    (1,690
    )Gain on disposal, net of taxes
    
    
    92
    
    
    
    
    
    
    
    Net loss
    
    $
    (364
    )
    
    $
    (1,290
    )
    
    $
    (1,690
    )Diluted loss per shareNet loss from operations
    
    $
    (0.15
    )
    
    $
    (0.43
    )
    
    $
    (0.55
    )Net gain on disposal
    
    $
    0.03
    
    
    $
    
    
    
    $
    Net loss
    
    $
    (0.12
    )
    
    $
    (0.43
    )
    
    $
    (0.55
    )
 The current and non-current assets and liabilities of the discontinued
boiler segment are as follows: June 30,
    
    June 30,2004
    
    2003Accounts receivable, principally trade - net of
allowance for uncollectible accounts of $10
at June 30, 2004 and $650 at June 30, 2003
    
    $
    225
    
    
    $
    2,631Costs and earnings in excess of billings
on uncompleted contracts
    
    
    
    
    
    
    129Current assets of discontinued operations
    
    
    225
    
    
    
    2,760Equipment, net
    
    
    9
    
    
    
    30Other
    
    
    
    
    
    
    121Total assets of discontinued operations
    
    $
    234
    
    
    $
    2,911Accounts payable
    
    $
    
    
    
    $
    336Commissions payable
    
    
    6
    
    
    
    78Product warranties and start-up reserves
    
    
    300
    
    
    
    450Total current liabilities of discontinued operations
    
    $
    306
    
    
    $
    864
 38




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE E. INVENTORIES Principal components of inventories are as follows: June 30,2004
    
    2003Raw materials
    
    $
    2,630
    
    
    $
    2,444Work in progress
    
    
    427
    
    
    
    581Finished goods
    
    
    245
    
    
    
    3123,302
    
    
    
    3,337Reserve for obsolete and slow-moving inventory
    
    
    (196
    )
    
    
    (122
    )$
    3,106
    
    
    $
    3,215
 Changes in the Companys reserve for obsolete and slow-moving inventory
are as follows: Year Ended June 30,2004
    
    2003
    
    2002Balance at beginning of year
    
    $
    122
    
    
    $
    45
    
    
    $
    Additions
    
    
    74
    
    
    
    77
    
    
    
    45Amounts written off
    
    
    
    
    
    
    
    
    
    
    Balance at end of year
    
    $
    196
    
    
    $
    122
    
    
    $
    45
 NOTE F. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is summarized as follows: June 30,2004
    
    2003Buildings & improvements
    
    $
    3,969
    
    
    $
    3,827Equipment
    
    
    4,137
    
    
    
    4,019Furniture and fixtures
    
    
    3,097
    
    
    
    2,94411,203
    
    
    
    10,790Less accumulated depreciation
    
    
    (8,893
    )
    
    
    (8,133
    )2,310
    
    
    
    2,657Land
    
    
    743
    
    
    
    743$
    3,053
    
    
    $
    3,400
 Depreciation expense for the years ended June 30, 2004, 2003 and 2002 totaled
$754, $759, and $683, respectively. 39




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE G. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS The components of uncompleted contracts are as follows: June 30,2004
    
    2003Costs incurred on uncompleted contracts and
estimated earnings
    
    $
    44,348
    
    
    $
    29,339Less billings to date
    
    
    (32,299
    )
    
    
    (22,645
    )$
    12,049
    
    
    $
    6,694
 The components of uncompleted contracts are reflected in the balance sheets
are as follows: June 30,2004
    
    2003Costs and earnings in excess billings on
uncompleted contracts
    
    $
    12,448
    
    
    $
    8,721Billings in excess of costs and earnings on
uncompleted contracts
    
    
    (399
    )
    
    
    (2,027
    )$
    12,049
    
    
    $
    6,694
 NOTE H. LINE OF CREDIT The Company maintains a $12.5 million revolving line of credit facility for
working capital requirements that expires in October 31, 2006. The credit line
carries a floating interest rate based on the prime or Euros rate plus or minus
an applicable margin (Euros plus 1.75% at June 30, 2004), and is secured by
substantially all of the Companys assets. As of June 30, 2004, the Company
had no outstanding balances under the credit line, and $3.5 million outstanding
under stand-by letters of credit, leaving $9.0 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, 2004, the Company was in
compliance with all financial and other covenants of the loan agreement. In addition, our UK subsidiary has a £2.0 million (approximately $3.6 million)
debenture agreement used to facilitate the issuances of bank guarantees. This
facility is secured by substantially all of the UK subsidiary assets, and is
backed by a Peerless stand-by letter of credit of £1.3 million (approximately
$2.3 million, which is included in the $3.5 million outstanding above) and
expires on October 31, 2004. At June 30, 2004, there was approximately £1.44
million outstanding under this facility, leaving availability of approximately
£560,000 (approximately $1 million). 40




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE I. 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 12 to 18 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 revenue is recognized.
Revision to the estimated product warranties is made when necessary, based on
changes in these factors. Product warranty activity is as follows: Year Ended June 30,2004
    
    2003
    
    2002Balance at beginning of period
    
    $
    846
    
    
    $
    627
    
    
    $
    392Provision for warranty expenses
    
    
    880
    
    
    
    1,157
    
    
    
    980Warranty charges
    
    
    (744
    )
    
    
    (938
    )
    
    
    (745
    )Balance at end of period
    
    $
    982
    
    
    $
    846
    
    
    $
    627
 NOTE J. CONTINGENCIES On March 19, 2004, the Company received notice that an adversary proceeding was
initiated by Enron Corp. and National Energy Production Corporation in the
United States Bankruptcy Court for the Southern District of New York against
PMC Acquisition, Inc., a subsidiary that operated the discontinued Boiler
business under the name ABCO Industries. The plaintiffs allege that certain
accounts receivable payments paid to ABCO were avoidable transfers under the
Bankruptcy Code. The plaintiffs are seeking to recover approximately $1
million from ABCO. The Company believes that all or a majority of the payments
fail to meet the applicable standards for avoidance under the Bankruptcy Code
and otherwise applicable law, and that a number of defenses can be asserted
that will negate any recovery by the plaintiffs. The Company intends to
vigorously defend against the lawsuit and management believes the likelihood of
loss in not probable. From time to time the Company is involved in various litigation matters arising
in the ordinary course of its business. The Company does not believe the
disposition of any current matter will have a material adverse effect on its
consolidated financial position or its results of operations. NOTE K. 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 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 K. SHAREHOLDERS EQUITY - CONTINUED for stock grants is charged to earnings over the restriction period and
amounted to $3, $5 and $19 in fiscal 2004, 2003, and 2002, 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, 2004,
21,900 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,
2004, 137,300 shares of common stock were available for issuance under the 2001
Plan. Additional information with respect to options outstanding under the plans is
as follows: Number of
    
    Weightedshares
    
    averageunderlying
    
    exerciseOptions
    
    PriceOutstanding at July 1, 2001
    
    
    182,600
    
    
    $
    5.79Granted
    
    
    68,500
    
    
    
    19.17Exercised
    
    
    (36,150
    )
    
    
    5.96Canceled
    
    
    (3,000
    )
    
    
    19.50Outstanding at June 30, 2002
    
    
    211,950
    
    
    
    9.89Granted
    
    
    4,000
    
    
    
    9.85Exercised
    
    
    (10,400
    )
    
    
    6.17Canceled
    
    
    (18,800
    )
    
    
    14.91Outstanding at June 30, 2003
    
    
    186,750
    
    
    
    9.59Granted
    
    
    67,300
    
    
    
    12.32Exercised
    
    
    (15,150
    )
    
    
    6.38Canceled
    
    
    (16,300
    )
    
    
    15.52Outstanding at June 30, 2004
    
    
    222,600
    
    
    
    10.20Options exercisable at June 30, 2002
    
    
    129,700
    
    
    $
    7.07Options exercisable at June 30, 2003
    
    
    142,850
    
    
    $
    8.13Options exercisable at June 30, 2004
    
    
    153,500
    
    
    $
    8.95
 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 K. SHAREHOLDERS
EQUITY - CONTINUED Weighted average fair value per share of options granted: Year ended June 30, 2002
    
    $
    9.00Year ended June 30, 2003
    
    $
    5.46Year ended June 30, 2004
    
    $
    6.44
 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 54% for fiscal 2004, 69% for fiscal 2003,
and 48% to 49% for fiscal 2002; risk-free interest rates of 4.0% for fiscal
2004, 4.0% for fiscal 2003 and 4.0% to 4.2% for fiscal 2002; dividend yield of
0% in fiscal years 2004, 2003 and 2002; and expected lives of five to seven
years. The following table summarizes information about stock options at June 30,
2004: Outstanding WeightedRange of
    
    Number
    
    Weighted average remaining
    
    averageExercise Prices
    
    outstanding
    
    contractual life (in years)
    
    exercise price$
    4.625 - $4.6250
    
    
    
    32,000
    
    
    
    1.6
    
    
    
    4.63$
    5.313 - $5.9380
    
    
    
    18,500
    
    
    
    3.8
    
    
    
    5.36$
    6.000 - $6.6880
    
    
    
    60,400
    
    
    
    6.2
    
    
    
    6.18$
    9.850 - $10.750
    
    
    
    15,000
    
    
    
    8.9
    
    
    
    10.57$
    12.64 - $12.900
    
    
    
    54,500
    
    
    
    9.4
    
    
    
    12.66$
    16.94 - $19.500
    
    
    
    42,200
    
    
    
    7.4
    
    
    
    18.98222,600
 Exercisable WeightedRange of
    
    Number
    
    Weighted average remaining
    
    averageExercise Prices
    
    outstanding
    
    contractual life (in years)
    
    exercise price$
    4.625 - $4.6250
    
    
    
    32,000
    
    
    
    1.6
    
    
    
    4.63$
    5.313 - $5.9380
    
    
    
    18,500
    
    
    
    3.8
    
    
    
    5.36$
    6.000 - $6.6880
    
    
    
    54,900
    
    
    
    6.2
    
    
    
    6.17$
    9.850 - $10.750
    
    
    
    3,000
    
    
    
    8.9
    
    
    
    9.85$
    12.64 - $12.900
    
    
    
    16,000
    
    
    
    9.4
    
    
    
    12.71$
    16.94 - $19.500
    
    
    
    29,100
    
    
    
    7.4
    
    
    
    19.09153,500
 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 43




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE K. SHAREHOLDERS
EQUITY - CONTINUED Acquiring Party owning 20% or more of the Companys common stock, and such
transaction has not been approved by the 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. NOTE L. 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, 2004, 2003 and 2002 was approximately
$229, $249, and $282, respectively. NOTE M. 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: June 30,2004
    
    2003Deferred tax assetsInventories
    
    $
    136
    
    
    $
    70Net operating loss carryforwards
    
    
    212
    
    
    
    228Accrued expenses
    
    
    712
    
    
    
    1,027Accounts receivable
    
    
    162
    
    
    
    386Other
    
    
    3
    
    
    
    491,225
    
    
    
    1,760Deferred tax liabilitiesProperty, plant and equipment
    
    
    (48
    )
    
    
    (303
    )Other
    
    
    (4
    )
    
    
    (4
    )(52
    )
    
    
    (307
    )Net deferred tax asset
    
    $
    1,173
    
    
    $
    1,453
 44




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE M. INCOME TAXES - CONTINUED At June 30, 2004 the Company had State net operating loss carry-forwards of
approximately $8.0 million. 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. The
operating loss carry-forwards by expiry date and related deferred assets are as
follows: Expiration
    
    
    
    
    
    DeferredDate/
    
    Carry-
    
    TaxFiscal Year
    
    Forward
    
    Asset2006
    
    
    $
    662
    
    
    $
    172007
    
    
    
    3,299
    
    
    
    872008
    
    
    
    2,107
    
    
    
    552009
    
    
    
    1,910
    
    
    
    50$
    7,978
    
    
    $
    209
 Deferred tax assets and liabilities included in the balance sheet are as
follows: June 30,2004
    
    2003Current deferred tax asset
    
    $
    1,165
    
    
    $
    1,445Non-current deferred tax asset
    
    
    8
    
    
    
    8$
    1,173
    
    
    $
    1,453
 The provision (benefit) for income taxes consists of the following: Year ended June 30,2004
    
    2003
    
    2002Federal tax expenseCurrent
    
    $
    698
    
    
    $
    (117
    )
    
    $
    2,136Deferred
    
    
    266
    
    
    
    (503
    )
    
    
    (399
    )State tax expense
    
    
    96
    
    
    
    51
    
    
    
    523Foreign tax expenseCurrent
    
    
    115
    
    
    
    230
    
    
    
    85Deferred
    
    
    14
    
    
    
    
    
    
    
    6$
    1,189
    
    
    $
    (339
    )
    
    $
    2,351Income tax
expense - continuing operations
    
    $
    1,447
    
    
    $
    399
    
    
    $
    3,256Income tax
benefit - discontinued operations
    
    
    (258
    )
    
    
    (738
    )
    
    
    (905
    )Income tax expense (benefit)
    
    $
    1,189
    
    
    $
    (339
    )
    
    $
    2,351
 45




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE M. INCOME TAXES - CONTINUED The income tax expense (benefit) varies from the federal statutory rate due to
the following: Year ended June 30,2004
    
    2003
    
    2002Income tax expense (benefit) at federal statutory rate
    
    $
    1,097
    
    
    $
    (244
    )
    
    $
    2,292Increase (decrease) in income tax expense
resulting fromState tax, net of federal effect
    
    
    96
    
    
    
    (21
    )
    
    
    200Foreign sales income exclusions
    
    
    (26
    )
    
    
    (22
    )
    
    
    (83
    )Effect of lower foreign tax rate
    
    
    (36
    )
    
    
    (43
    )
    
    
    (78
    )Other
    
    
    58
    
    
    
    (9
    )
    
    
    20Income tax expense (benefit)
    
    $
    1,189
    
    
    $
    (339
    )
    
    $
    2,351
 NOTE N. EARNINGS PER SHARE Basic earnings (loss) per share have been computed by dividing net earnings
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share reflect the potential dilution that
could occur if options or other contracts to issue common shares were exercised
or converted into common stock. The following table sets forth the computation
for basic and diluted earnings (loss) per share for the periods indicated.
Certain earnings per share amounts may not total due to rounding. Year ended June 30,2004
    
    2003
    
    2002Net earnings from continuing operations
    
    $
    2,402
    
    
    $
    911
    
    
    $
    6,079Loss from discontinued operations
    
    
    (364
    )
    
    
    (1,290
    )
    
    
    (1,690
    )Net earnings (loss)
    
    $
    2,038
    
    
    $
    (379
    )
    
    $
    4,389Basic weighted average common shares outstanding
    
    
    3,003
    
    
    
    2,996
    
    
    
    2,978Effect of dilutive options
    
    
    41
    
    
    
    17
    
    
    
    102Diluted weighted average common shares outstanding
    
    
    3,044
    
    
    
    3,013
    
    
    
    3,080Net earnings
(loss) per share - basic:Earnings from continuing operations
    
    $
    0.80
    
    
    $
    0.30
    
    
    $
    2.04Loss from discontinued operations
    
    
    (0.12
    )
    
    
    (0.43
    )
    
    
    (0.57
    )Net earnings (loss) per share
    
    $
    0.68
    
    
    $
    (0.13
    )
    
    $
    1.47Net earnings
(loss) per share - diluted:Earnings from continuing operations
    
    $
    0.79
    
    
    $
    0.30
    
    
    $
    1.97Loss from discontinued operations
    
    
    (0.12
    )
    
    
    (0.43
    )
    
    
    (0.55
    )Net earnings (loss) per share
    
    $
    0.67
    
    
    $
    (0.13
    )
    
    $
    1.43
 For fiscal 2004, 2003 and 2002, stock options covering approximately 90, 27 and
30 shares, respectively were excluded in the computations of diluted earnings
per share because their effect was antidilutive. 46




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE O. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION The Company identifies reportable segments based on management responsibility
within the corporate structure. The Company has two reportable industry
segments: Environmental Systems and Separation Filtration Systems. 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 carbon monoxide (CO) and
particulate matter. The Company combines these systems with other components,
such as instruments, controls and related valves and piping to offer its
customers a totally integrated system. 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. 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 2003, the Company started
allocating all costs associated with the manufacture, sale and design of its
products to each segment. Fiscal year 2002 information has been restated to
conform to fiscal years 2003 and 2004 presentation. Segment information and
reconciliation to operating profit for the years ended June 30, 2004, 2003, and
2002 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. SeparationEnvironmental
    
    Filtration
    
    UnallocatedSystems
    
    Systems
    
    Overhead
    
    Consolidated2004Net sales from customers
    
    $
    28,096
    
    
    $
    31,665
    
    
    $
    
    
    
    $
    59,761Segment profit (loss)
    
    
    4,133
    
    
    
    4,371
    
    
    
    (4,631
    )
    
    
    3,8732003Net sales from customers
    
    $
    37,511
    
    
    $
    27,343
    
    
    $
    
    
    
    $
    64,854Segment profit (loss)
    
    
    3,191
    
    
    
    2,708
    
    
    
    (5,316
    )
    
    
    5832002Net sales from customers
    
    $
    65,539
    
    
    $
    29,341
    
    
    $
    
    
    
    $
    94,880Segment profit (loss)
    
    
    13,556
    
    
    
    1,654
    
    
    
    (6,285
    )
    
    
    8,925
 47




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE O. 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, 2004, 2003 and 2002 is as follows: UnitedStates
    
    Europe
    
    Eliminations
    
    Consolidated2004Net 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
    
    
    $
    
    
    
    $
    3,0532003Net sales to unaffiliated
customers
    
    $
    55,823
    
    
    $
    9,031
    
    
    $
    
    
    
    $
    64,854Transfers between
geographic areas
    
    
    809
    
    
    
    
    
    
    
    (809
    )
    
    
    Total
    
    $
    56,632
    
    
    $
    9,031
    
    
    $
    (809
    )
    
    $
    64,854Identifiable long-lived assets
    
    $
    3,329
    
    
    $
    71
    
    
    $
    
    
    
    $
    3,4002002Net sales to unaffiliated
customers
    
    $
    87,210
    
    
    $
    7,670
    
    
    $
    
    
    
    $
    94,880Transfers between
geographic areas
    
    
    962
    
    
    
    
    
    
    
    (962
    )
    
    
    Total
    
    $
    88,172
    
    
    $
    7,670
    
    
    $
    (962
    )
    
    $
    94,880Identifiable long-lived assets
    
    $
    4,058
    
    
    $
    54
    
    
    $
    
    
    
    $
    4,112
 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. 48




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE P. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION  UNAUDITED The following tables represent the unaudited quarterly financial data of the
Company for fiscal years 2004 and 2003. Year ended June 30, 2004First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth Quarter
    
    TotalRevenues
    
    
    16,807
    
    
    
    16,429
    
    
    
    13,491
    
    
    
    13,034
    
    
    
    59,761Gross profit
    
    
    4,806
    
    
    
    4,545
    
    
    
    4,812
    
    
    
    4,639
    
    
    
    18,802% of revenues
    
    
    28.6
    %
    
    
    27.7
    %
    
    
    35.7
    %
    
    
    35.6
    %
    
    
    31.5
    %Operating income
    
    
    1,151
    
    
    
    821
    
    
    
    896
    
    
    
    1,005
    
    
    
    3,873% of revenues
    
    
    6.8
    %
    
    
    5.0
    %
    
    
    6.6
    %
    
    
    7.7
    %
    
    
    6.5
    %Net earnings
from continuing operations
    
    
    740
    
    
    
    609
    
    
    
    555
    
    
    
    498
    
    
    
    2,402% of revenues
    
    
    4.4
    %
    
    
    3.7
    %
    
    
    4.1
    %
    
    
    3.8
    %
    
    
    4.0
    %Net earnings (loss)
from discontinued
operations
    
    
    65
    
    
    
    (142
    )
    
    
    (117
    )
    
    
    (170
    )
    
    
    (364
    )% of revenues
    
    
    0.4
    %
    
    
    -0.9
    %
    
    
    -0.9
    %
    
    
    -1.3
    %
    
    
    -0.6
    %Net earnings
    
    
    805
    
    
    
    467
    
    
    
    438
    
    
    
    328
    
    
    
    2,038% of revenues
    
    
    4.8
    %
    
    
    2.8
    %
    
    
    3.2
    %
    
    
    2.5
    %
    
    
    3.4
    %Basic earnings (loss) per share*Earnings from
continuing
operations
    
    $
    0.25
    
    
    $
    0.20
    
    
    $
    0.18
    
    
    $
    0.17
    
    
    $
    0.80Net earnings (loss)
from discontinued
operations
    
    $
    0.02
    
    
    ($
    0.05
    )
    
    ($
    0.04
    )
    
    ($
    0.06
    )
    
    ($
    0.12
    )Net earnings
    
    $
    0.27
    
    
    $
    0.16
    
    
    $
    0.15
    
    
    $
    0.11
    
    
    $
    0.68Diluted earnings (loss)
per share*Earnings from
continuing
operations
    
    $
    0.24
    
    
    $
    0.20
    
    
    $
    0.18
    
    
    $
    0.16
    
    
    $
    0.79Net earnings (loss)
from discontinued
operations
    
    $
    0.02
    
    
    ($
    0.05
    )
    
    ($
    0.04
    )
    
    ($
    0.06
    )
    
    ($
    0.12
    )Net earnings
    
    $
    0.26
    
    
    $
    0.15
    
    
    $
    0.14
    
    
    $
    0.11
    
    
    $
    0.67
  *
    
    Certain earnings per share amounts may not total due to rounding. 49




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PEERLESS MFG. CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in thousands, except per share amounts) NOTE P. QUARTERLY CONSOLIDATED FINANCIAL INFORMATION  UNAUDITED Year ended June 30, 2003First Quarter
    
    Second Quarter
    
    Third Quarter
    
    Fourth Quarter
    
    TotalRevenues
    
    
    13,276
    
    
    
    20,011
    
    
    
    12,822
    
    
    
    18,745
    
    
    
    64,854Gross profit
    
    
    3,273
    
    
    
    4,476
    
    
    
    3,637
    
    
    
    5,626
    
    
    
    17,012% of revenues
    
    
    24.7
    %
    
    
    22.4
    %
    
    
    28.4
    %
    
    
    30.0
    %
    
    
    26.2
    %Operating income (loss)
    
    
    (1,653
    )
    
    
    675
    
    
    
    (151
    )
    
    
    1,712
    
    
    
    583% of revenues
    
    
    -12.5
    %
    
    
    3.4
    %
    
    
    -1.2
    %
    
    
    9.1
    %
    
    
    0.9
    %Net earnings (loss)
from continuing
operations
    
    
    (1,055
    )
    
    
    468
    
    
    
    (56
    )
    
    
    1,554
    
    
    
    911% of revenues
    
    
    -7.9
    %
    
    
    2.3
    %
    
    
    -0.4
    %
    
    
    8.3
    %
    
    
    1.4
    %Net loss from
discontinued
operations
    
    
    (288
    )
    
    $
    (494
    )
    
    $
    (319
    )
    
    $
    (189
    )
    
    
    (1,290
    )% of revenues
    
    
    -2.2
    %
    
    
    -2.5
    %
    
    
    -2.5
    %
    
    
    -1.0
    %
    
    
    -2.0
    %Net earnings (loss)
    
    
    (1,343
    )
    
    $
    (26
    )
    
    $
    (375
    )
    
    $
    1,365
    
    
    
    (379
    )% of revenues
    
    
    -10.1
    %
    
    
    -0.1
    %
    
    
    -2.9
    %
    
    
    7.3
    %
    
    
    -0.6
    %Basic earnings (loss)
per share*Earnings (loss) from
continuing operations
    
    ($
    0.35
    )
    
    $
    0.16
    
    
    ($
    0.02
    )
    
    $
    0.52
    
    
    $
    0.30Net loss from
discontinued
operations
    
    ($
    0.10
    )
    
    ($
    0.17
    )
    
    ($
    0.11
    )
    
    ($
    0.06
    )
    
    ($
    0.43
    )Net earnings (loss)
    
    ($
    0.45
    )
    
    ($
    0.01
    )
    
    ($
    0.13
    )
    
    $
    0.46
    
    
    ($
    0.13
    )Diluted earnings (loss)
per share*Earnings (loss) from
continuing operations
    
    ($
    0.35
    )
    
    $
    0.15
    
    
    ($
    0.02
    )
    
    $
    0.51
    
    
    $
    0.30Net loss from
discontinued
operations
    
    ($
    0.10
    )
    
    ($
    0.16
    )
    
    ($
    0.11
    )
    
    ($
    0.06
    )
    
    ($
    0.43
    )Net earnings (loss)
    
    ($
    0.45
    )
    
    ($
    0.01
    )
    
    ($
    0.13
    )
    
    $
    0.45
    
    
    ($
    0.13
    )
  *
    
    Certain earnings per share amounts may not total due to rounding. NOTE Q. OTHER
INFORMATION The Companys Earnings
(Loss) Before Income Taxes is As Follows: Year ended June 30,2004
    
    2003
    
    2002Continuing OperationsUnited States
    
    $
    3,366
    
    
    $
    595
    
    
    $
    8,841Europe
    
    
    483
    
    
    
    715
    
    
    
    4943,849
    
    
    
    1,310
    
    
    
    9,335Discontinued Operations  U.S.
    
    
    (622
    )
    
    
    (2,028
    )
    
    
    (2,595
    )$
    3,227
    
    
    $
    (718
    )
    
    $
    6,740
 50




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##### Table of Contents



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. No matter requires disclosure. 
 ITEM 9A. CONTROLS AND PROCEDURES. The Company maintains disclosure controls and procedures that are designed
to ensure that information the Company is required to disclose in the reports
it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commissions rules and forms. The Companys management has evaluated, with the participation of the
Companys Chief Executive Officer and Chief Financial Officer, the
effectiveness of these disclosure controls and procedures as of the end of the
period covered by this Report. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that, as of June 30, 2004,
the Companys disclosure controls and procedures were effective in ensuring
that all material information required to be filed in this Report has been made
known to them in a timely fashion. There was no change in the Companys internal controls over financial
reporting identified in connection with that evaluation that occurred during
the quarter ended June 30, 2004 that has materially affected, or is reasonably
likely to materially affect, the Companys internal controls over financial
reporting. 
 ITEM 9B. OTHER INFORMATION No matter requires disclosure. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information concerning Executive Officers of the Registrant is
incorporated by reference to the definitive Proxy Statement for our 2004 Annual
Meeting of Shareholders. Information regarding the Companys Code of Ethics and its Audit Committee
are included below. The remaining information required by Item 10, is
incorporated by reference to the definitive Proxy Statement for our 2004 Annual
Meeting of Shareholders. Code of Ethics The Company has adopted a Code of Conduct for Directors and Employees (the
Code). The Code is posted on the Companys Internet website at
http//:www.peerlessmfg.com (under Investor Relations) and applies to the
Companys principal executive officer and senior financial officer, including
the principal financial officer, the principal accounting officer and others
performing similar functions. If we make any substantive amendments to the
Code, or grant any waivers to the Code for any of our senior officers or
directors, we will disclose such amendment or waiver on our website and in a
report on Form 8-K. The Company undertakes to provide any person without charge, a copy of the
Code. Request should be submitted in writing to the attention of Ms. Susan
Banner at 2819 Walnut Hill Lane, Dallas, Texas 75229. 51




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##### Table of Contents



Information About the Audit Committee The Companys Board of Directors has a standing audit committee
established in accordance with Section 3(a)(58)(A) of the Securities Act of
1934, as amended. The current members of the audit committee are: Bernard S.
Lee, Joseph V. Mariner, Jr. and Donald A. Sillers, Jr. The Board of directors
of the Company has determined that all members of the audit committee are
financial experts as defined by Item 401(h) of SEC Regulation S-K. Each member
of the audit committee has been determined by the Board of Directors to be
independent as defined under the rules of the NASDAQ Stock Market. 
 ITEM 11. EXECUTIVE COMPENSATION. The
information required by Item 13 is hereby incorporated by reference to
the definitive Proxy Statement for our 2004 Annual Meeting of Shareholders. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS. The information required by Item 12, as to certain beneficial owners and
management, is incorporated by reference to the definitive Proxy Statement for
our 2004 Annual Meeting of Shareholders. The following table provides information about securities authorized for
issuance under the Companys equity compensation plans: Number ofsecuritiesavailable forfuture issuancesNumber of
    
    
    
    
    
    under equitysecurities to be
    
    Weighted-
    
    compensationissued upon
    
    average
    
    plans (excludingexercise of
    
    exercise price
    
    securitiesoutstanding
    
    of outstanding
    
    reflected inoptions
    
    options
    
    column (a))Plan Category
    
    (a)
    
    (b)
    
    (c)Equity compensation
plans approved by
security
holders (1)
    
    
    222,600
    
    
    $
    10.20
    
    
    
    159,200Equity compensation
plans not approved
by security holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    222,600
    
    
    $
    10.20
    
    
    
    159,200
 (1) Includes the 1995 Stock Option and Restricted Stock Plan and the 2001 Stock
Option and Restricted Stock Plan. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The
information required by Item 13 is hereby incorporated by reference to
the definitive Proxy Statement for our 2004 Annual Meeting of Shareholders. 
 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. All information required by Item 14, is hereby incorporated by reference
to the definitive Proxy Statement for our 2004 Annual Meeting of Shareholders. 52




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##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K. (a)(1)
    
    The following audited consolidated financial statements of Peerless Mfg.
Co. and Subsidiaries are included in Part II, Item 8, of this Report.
 Report of Independent Certified Public Accountants
Consolidated Balance Sheets at June 30, 2004 and 2003
Consolidated Statements of Operations for the years ended June 30, 2004,
2003 and 2002
Consolidated Statements of Changes in Shareholders Equity for the years
ended June 30, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended June 30, 2004,
2003 and 2002
Notes to Consolidated Financial Statements (a)(2)
    
    The following financial statement schedule of Peerless Mfg. Co. and
Subsidiaries is included.
 All 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 55. (b)
    
    Reports on Form 8-K
 On May 13, 2004, the Registrant filed a Report on Form 8-K to furnish a
press release announcing its financial results for the third quarter of
the fiscal year ending June 30, 2004, which information was furnished
and not filed with the SEC. On September 17, 2004, the Registrant filed a Report on Form 8-K to
furnish a press release announcing its financial results for the fiscal
year ending June 30, 2004, which information was furnished and not
filed with the SEC. 53




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##### Table of Contents



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 24, 2004 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 24, 2004. /s/
SHERRILL STONE
Sherrill Stone
    
    Chairman of the Board and
Chief Executive Officer/s/
RICHARD L. TRAVIS, JR.
Richard L. Travis, Jr.
    
    Vice President and Chief Financial Officer (Principal Financial
and Accounting Officer)/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/
DONALD A. SILLERS, JR.
Donald A. Sillers, Jr
    
    Director
 54




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##### Table of Contents



INDEX TO EXHIBITS 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, and incorporated herein by reference).3(b)
    
    Bylaws, as amended to date (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).4(a)
    
    Rights Agreement 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 (File No. 0-05214), dated May 22, 1997, and incorporated herein by
reference).4(b)
    
    Amendment to Rights Agreement between Peerless Mfg. Co. and Mellon
Investor Services, LLC, as Rights Agent (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)
    
    Credit Agreement, Guaranty Agreement, Master Revolving Note, and
Security Agreement each dated as of October 30, 2003, by and between
Peerless Mfg. Co. and Comerica Bank (filed as Exhibits 10(a) through
10(d) to our Quarterly Report on Form 10-Q, for the fiscal quarter
ended December 31, 2003, and incorporated herein by reference).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).
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##### Table of Contents



INDEX TO EXHIBITS  CONTINUED No.
    
    Exhibit Description10(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, Jr. (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, Jr. (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).10 (m)
    
    Employment Agreement dated July 16, 2003, by and between Peerless Mfg.
Co. and William T. Strohecker (filed as Exhibit 10(m) to our Quarterly
Report on Form 10-Q, for the fiscal quarter ended September 30, 2003,
and incorporated herein by reference).10 (n)
    
    Agreement dated July 16, 2003, by and between Peerless Mfg. Co. and
William T. Strohecker (filed as Exhibit 10(n) to our Quarterly Report
on Form 10-Q, for the fiscal quarter ended September 30, 2003, and
incorporated herein by reference).10 (o)
    
    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 (p)
    
    Employment Agreement dated October 10, 2003, by and between Peerless
Mfg. Co. and Peter J. Burlage (filed as Exhibit 10(e) to our Quarterly
Report on Form 10-Q, for the fiscal quarter ended December 31, 2003,
and incorporated herein by reference).10 (q)
    
    Employment Agreement dated July 1, 2004, by and between Peerless Mfg.
Co. and G. Darwyn Cornwell. *21
    
    Subsidiaries of Peerless Mfg. Co. *23
    
    Consent of Grant Thornton LLP. *
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##### Table of Contents



INDEX TO EXHIBITS  CONTINUED No.
    
    Exhibit Description31(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. **
   *
    
    Filed herewith**
    
    Furnished herewith 57