<PAGE>   1
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
================================================================================

                                   FORM 10-K

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934


(Mark One)
[x]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 1997

                                     OR

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

For the transition period from ________ to ________

================================================================================
                         Commission File Number 0-5214
                               PEERLESS MFG. CO.
================================================================================
             (Exact name of registrant as specified in its charter)

        Texas                                                 75-0724417
-----------------------------------------            ---------------------------
(State or Other Jurisdiction of                              (IRS Employer    
Incorporation or Organization)                             Identification No.)
                                                           

2819 Walnut Hill Lane, Dallas, Texas                            75229
-----------------------------------------            ---------------------------
(Address of Principal Executive Offices)                      (Zip Code)

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

Securities registered pursuant to Section 12(g) of the Act:

    TITLE OF EACH CLASS               NAME OF EACH EXCHANGE ON WHICH REGISTERED
-----------------------------        -------------------------------------------
Common Stock, par value $1.00         The Nasdaq Stock Market's National Market

================================================================================

           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]

At September 19, 1997, Peerless Mfg. Co. had 1,451,992 shares of common stock,
$1.00 par value outstanding.  The Company estimates that the aggregate market
value of the common stock on September 19, 1997 (based upon the closing price
of these shares on Nasdaq) held by non-affiliates was approximately
$20,690,886.
================================================================================
<PAGE>   2
                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for Annual Meeting of Shareholders
to be held on or about November 20, 1997 (to be filed) are incorporated by
reference into Part III of this Form 10-K.
<PAGE>   3
                               TABLE OF CONTENTS

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

         1       Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   1

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

         3       Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   7

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

PART II

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

         6       Selected Financial Data  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   8

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

         8       Financial Statements and Supplementary Data  . . . . . . . . . . . . . . . . . . . . . . . . . . .  15

         9       Changes in and Disagreements with Accountants
                     on Accounting and Financial Disclosure   . . . . . . . . . . . . . . . . . . . . . . . . . . .  38

PART III

         10      Directors and Executive Officers of
                     the Registrant   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  38

         11      Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  38

         12      Security Ownership of Certain Beneficial
                     Owners and Management  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  38

         13      Certain Relationships and Related
                     Transactions   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  38

PART IV

         14      Exhibits, Financial Statement Schedule,
                     and Reports on Form 8-K  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  39
</TABLE>


                                      i

<PAGE>   4
                                     PART I


ITEM 1.  BUSINESS.

         Peerless Mfg. Co. (the "Company" or "Registrant") was organized in
1933 as a proprietorship and was incorporated as a Texas corporation in 1946.
The Company has wholly owned subsidiaries in the Netherlands, the United
Kingdom and Barbados.

Products and Operations

         The Company is engaged in the business of designing, engineering,
manufacturing and selling highly specialized products, referred to as
"separators" or "filters," which are used for a variety of purposes in cleaning
gases and liquids as they move through a piping system.  The Company also
packages these products on skids complete with instruments, controls and
related valves and piping.  These products are used, among other applications,
to remove solid and liquid contaminants from natural gas, and salt water
aerosols from the combustion intake air of ship board gas turbine and diesel
engines.

         The Company also designs, engineers, manufactures and sells
specialized products referred to as "pulsation dampeners."  These products are
used primarily to reduce or eliminate vibrations caused by acoustical
pulsations commonly found in piping connected to the reciprocating compressors
generally used to move gases and air.  Pulsation dampeners reduce noise levels,
improve efficiency and prolong the life of piping systems.

         The Company's products are also used as components in selective
catalytic reduction systems.  Selective catalytic reduction equipment is used
to separate nitrogen oxide (NOx) emissions from exhaust gases caused by burning
hydrocarbon fuels such as gasoline, natural gas and oil.  Additionally, the
Company sells gas odorization equipment, quick-opening closures, parts for its
products and other miscellaneous items.  It also renders certain engineering
services.

         While the Company manufactures and stocks a limited number of items of
equipment for immediate delivery, the vast majority of its products are
designed and constructed for specific customer requirements or specifications.
In certain cases, the Company's products and components are designed by the
Company but produced by subcontractors under Company supervision.

         The Company markets its products worldwide through manufacturers'
representatives, who sell on a commission basis under the general direction of
an officer of the Company.  Additionally, a number of the Company's employees
sell Company products directly to customers.  The Company has a sales office in
Singapore with a staff of seven engineering and administrative employees.  The
Company's United Kingdom subsidiary, Peerless Europe Ltd., began operations in
January of 1992 and currently has a staff of 13 full-time employees.  The
Company's Netherlands subsidiary has two full-time employees.





                                       2
<PAGE>   5
Customers and Export Sales

         Gas separators and filters are sold to gas producers and gas
gathering, transmission and distribution companies, and to chemical
manufacturers and oil refineries, either directly or through contractors
engaged to build plants and pipelines.  Separators and filters are also sold to
manufacturers of compressors, turbines and nuclear and conventional steam
generating equipment.  Marine separation/filtration systems are sold primarily
to ship builders.  Pulsation dampeners are purchased by customers in the same
industries as purchasers of separators and filters (except ship builders and
steam generating equipment manufacturers).  Selective catalytic reduction
equipment is sold to gas turbine operators, refineries and others who desire or
may be required to reduce nitrogen oxide (NOx) emissions.

         The Company is not dependent upon any single customer or group of
customers.  Due to the custom-designed nature of its business and the nature of
the products it sells, the Company's major customers typically vary from year
to year.  During Fiscal 1997, one of the Company's customers accounted for 
approximately 12.3% of Company revenues.  No other customer accounted for 10%
or more of Company revenues during Fiscal 1997.  During Fiscal 1996 and 1995
no single customer accounted for 10% or more of Company revenues.

         Sales to foreign customers have been a part of the Company's business
for more than forty years.  During Fiscal 1997, foreign sales amounted to
$25,605,000, or 61.7% of total consolidated revenue.  Sales in Asia were
approximately $11.0 million, or 26.6%, $5.2 million, or 15.4%, and $8.0
million, or 25.0%, of net sales in Fiscal 1997, 1996 and 1995, respectively.
Due to the custom-designed and project-specific nature of its products, the
Company's sales to any geographic region may vary from year to year.  For a
breakdown of the Company's foreign sales by geographic area during Fiscal 1997,
1996 and 1995, see Note I of the Notes to Consolidated Financial Statements.

         There are certain risks attendant to the Company's foreign sales.
These include the possibility that foreign purchasers may default in the
payment of amounts due, and that collection of such amounts may be more
difficult than for U.S.  customers, that foreign exchange rates may fluctuate
adversely, that the U.S. and foreign governments may impose regulatory burdens
upon exports and imports of the Company's products, and that the Company may be
required to perform its obligations under product warranties, which might
result in added expense due to the requirement that it perform such services in
a foreign country.  The Company has not, however, incurred substantial expenses
to date involving these risks.

         The Company believes that its credit and collection risks are reduced
to a significant extent because a substantial part of foreign sales are made
either to large, well-established foreign companies or to foreign operations of
domestic companies.  When sales are made to smaller foreign enterprises, the
Company generally requires an appropriate guarantee of payment or a letter of
credit from a banking institution.  In addition, products sold to foreign
customers are generally priced to provide a higher profit margin, designed in
part to cover the risk of potentially greater warranty costs.  In order to
minimize the risks of fluctuating currency exchange rates, the Company
generally requires payment in U.S. dollars (or in the functional





                                       3
<PAGE>   6
currency of its foreign subsidiaries) for its foreign product sales.  The
Company hedges its exposure, if substantial, to foreign currency fluctuations
on firm commitment sales under contracts that are not denominated in U.S.
dollars.

Backlog

         The Company's backlog of incomplete orders at June 30, 1997 was
approximately $20,200,000 compared to approximately $15,300,000 in 1996.
Virtually all of the June 30, 1997 backlog is presently expected to be
completed and shipped in Fiscal 1998.  Backlog has been calculated under the
Company's normal practice of including incomplete orders for products that are
deliverable over various periods and that may be changed or cancelled in the
future.

Competition and Other Market Factors

         There are a number of competitors in the manufacture and sale of
separators, filters and pulsation dampeners, some of which are larger than the
Company and have greater financial resources.  In addition, several smaller
manufacturers also produce custom-designed equipment that is competitive with
the Company's specialized products and services.  The Company believes that
performance, reliability and warranty service are the prime competitive factors
in the markets in which it competes.  The Company believes that because of its
reputation in those areas, it is a world leader in sales of custom-built
separators, filters and pulsation dampeners.

         The markets for the Company's products are highly competitive
worldwide.  In addition, competition may increase as larger and better financed
foreign companies become attracted to the market potential for products
manufactured by the Company.

Patents, Licenses and Product Development

         The Company considers itself a world leader in the technology required
to design and apply its high efficiency vapor/liquid separation and filtration
equipment.  The Company believes it is also a leader in the design, manufacture
and application of high efficiency pulsation dampeners for reciprocating
compressors, and in the production of selective catalytic reduction component
equipment.  The Company's expenditures for new product development and
improvements were approximately $554,000 in Fiscal 1997 and $515,000 in Fiscal
1996.

         The Company has several patents on its products and processes that are
important to its business.  However, other companies are marketing competitive
products which may not infringe upon the Company's patents.

         Historically the Company's approach to its international markets was
through licensing arrangements with fabricators throughout the world.  However,
in 1992 the Company shifted its emphasis from licensing its foreign sales to a
strategy of focusing on direct international marketing through its Singapore
sales branch and its European subsidiaries, Peerless Europe B.V. and Peerless
Europe Ltd.  The Company derives royalty income from older license arrangements
in France and England and engineering fees on certain projects.  Royalty and





                                       4
<PAGE>   7
engineering fee revenues, included in net sales, are $359,038, $451,620 and
$272,673 in Fiscal 1997, 1996 and 1995, respectively.

Employees

         At June 30, 1997, the Company and its subsidiaries had approximately
164 employees.

Raw Materials

         The Company purchases the raw materials and component parts essential
to its business from established sources with which it has had commercial
relationships for many years.  During the fiscal year ended June 30, 1997, the
Company experienced no unusual problems in purchasing required materials and
parts, and the Company believes that raw materials and component parts will be
available in sufficient quantities for it to meet anticipated demand for its
products.  However, conditions may occur from time to time that could make it
difficult to obtain desired materials within timely delivery schedules.

Environmental Regulation

         The Company does not believe that its 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 the
competitive position of the Company. The Company's manufacturing processes do
not emit substantial foreign substances into the environment.  Regulations
related to nitrous oxide (NOx) emissions have in the past resulted in increased
sales of the Company's component parts for selective catalytic reduction
equipment, and further regulations in that area could increase demand for such
equipment.





                                       5
<PAGE>   8
Executive Officers of the Company

         The executive officers of the Company on September 19, 1997 are listed
below.  Each of these officers has been employed by the Company for at least
five years in the same position or a similar capacity, except as noted:

           Name and Age                 Position
           ------------                 --------
                                      
           Sherrill Stone, 60           Chairman of the Board, President and 
                                        Chief Executive Officer (1)
           Edward Perry, 59             Vice President (2)

           G. D. Cornwell, 53           Vice President (3)

           Kent J. Van Houten, 44       Chief Financial Officer and
                                        Secretary - Treasurer (4)

____________________

(1)      Mr. Stone is responsible for formulation of corporate policy,
         investment and new business opportunities.  Mr.  Stone assumed the
         duties of Chairman of the Board and Chief Executive Officer of the
         Company on March 31, 1993.

(2)      Mr. Perry is responsible for marketing, manufacturing and engineering
         of filters and separators associated with pressure applications.

(3)      Mr. Cornwall is responsible for marketing, manufacturing and
         engineering of liquid vapor separators.

(4)      Mr. Van Houten is responsible for financial and administrative
         operations, and has been employed by the Company since May 22, 1995.
         He previously was Manager of Financial Accounting at The Austin
         Company.





                                       6
<PAGE>   9
ITEM 2.  PROPERTIES.

         The principal executive offices of the Registrant are located in
Dallas, Texas, on approximately twelve acres of land owned by the Company.
These facilities include two one story buildings, one containing approximately
4,000 square feet of space used for the Company's executive and sales offices,
and the second containing 3,600 square feet used for research and development.
The Company also utilizes 20,000 square feet of a 40,000 square foot building
located on the same site, with the remaining portion leased to other companies.
Rental income from such properties is not material to the Company's results of
operations.  The Company owns approximately 21,600 additional square feet of
manufacturing facilities in Denton, Texas, and approximately 29,000 square feet
of manufacturing facilities in Carrollton, Texas.  The Company also owns a
79,800 square foot Dallas manufacturing plant which was closed in 1983, and is
now leased to other companies for periods of three years or less.

         During Fiscal 1997, the estimated average utilization of the Company's
manufacturing facilities was approximately 85% in Denton, Texas, and 90% in
Carrollton, Texas.  Because of the availability and use by the Company of
subcontractors, high utilization rates do not necessarily indicate a capacity
problem.  The Company believes that its office and manufacturing facilities are
adequate and suitable for its present requirements.  While future needs may
require additional manufacturing facilities, space at the Denton, Texas
location is available for expansion.  The Company has also determined that a
number of locations in the immediate area could be leased in the event future
needs require such action.

ITEM 3.  LEGAL PROCEEDINGS.

         From time to time the Company is involved in litigation relating to
claims arising in the ordinary course of business operations.  In addition, the
Company has been named as a defendant in one lawsuit alleging damages suffered
by former employees or independent contractors of the Company.

         In Florentino San Miguel v. Carl W. Yarbrough, and Peerless Mfg. Co.,
filed June 28, 1996 in the 211th Judicial District Court, Denton, Texas,
Plaintiff alleged that while employed by the Company he was injured and that
these injuries were caused by the negligence and gross negligence of the
Company.  The plaintiff seeks damages including exemplary damages, prejudgment
and postjudgment interest and court costs.  At this stage of the lawsuit, the
Company is unable to determine the likelihood of the Company's success.  The
Company intends to vigorously defend the case.

         In March 1997 the Company entered into a final agreement with Senior
Engineering Company ("Senior"), settling effective April 1, 1997 the action the
Company filed against Senior in Peerless Mfg. Co. v. Senior Engineering Company
on November 13, 1995, in the United States District Court for the Northern
District of Texas.  Pursuant to the settlement agreement, the Company and
Senior have established a strategic alliance to cooperate in the marketing and
sales of technology and equipment to the nuclear power generation industry.





                                       7
<PAGE>   10
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         None.

                                    PART II


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

         The Company's Common Stock is quoted on the Nasdaq Stock Market's
National Market under the symbol PMFG.  The Company's Board of Directors
reviews the financial position of the Company periodically to determine the
advisability of paying dividends.  The following table sets forth, for the
periods indicated, the range of the daily high and low closing bid prices for
the Company's Common Stock as reported by Nasdaq Stock Market's National Market
and cash dividends paid per share.


<TABLE>
<CAPTION>
        Quarter Ended:                               Closing Bid Prices            Cash Dividends
        -------------                               --------------------                        
                                                    High              Low             Per Share
                                                    ----              ---             ---------
        <S>                                         <C>              <C>              <C>
        Fiscal 1996                                                               
        -----------                                                               
        September 30, 1995                          $12-3/4          $9-7/8             $.125
        December 31, 1995                            11-5/8           9-1/4              .125
        March 31, 1996                                9-3/4           8-3/4              .125
        June 30, 1996                                11-5/8           9-5/8              .125
                                                                                      
        Fiscal 1997                                                                   
        -----------                                                                   
        September 30, 1996                          $13-3/4          $9-1/4           [$.125
        December 31, 1996                            14-7/8          11-5/8             .125
        March 31, 1997                               13-1/4           9-1/2             .125
        June 30, 1997                                11               9-1/8             .125]
</TABLE>                    

         The number of record holders of the Company's Common Stock on August
15, 1997 was 221.  The Company estimates that approximately 700 additional
shareholders own shares in broker names.

ITEM 6.  SELECTED FINANCIAL DATA

         The following table sets forth selected financial and other data
regarding the Company's results of operations and financial position.  This
information should be read in conjunction with the Company's Consolidated
Financial Statements and related Notes included elsewhere herein.





                                       8
<PAGE>   11
<TABLE>
<CAPTION>
                                                                    Year ended June 30
                                     ---------------------------------------------------------------------------------
                                         1997             1996             1995             1994             1993
                                     -------------      -----------     ------------    -------------    -------------  
        <S>                          <C>                <C>             <C>              <C>             <C>
        Net sales                    $  41,486,492      $33,643,998     $ 32,089,132    $  25,567,560    $  25,797,270
        Gross profit                    11,525,289       10,213,237       10,583,128        9,038,606        8,828,398
        Earnings before income
        taxes                              537,996        1,182,148        1,908,661        1,227,959          267,092
        Net earnings                 $     537,416      $   789,721     $  1,226,246    $     780,275    $     155,059
                                     =============      ===========     ============    =============    =============
        Earnings per
        common share:                $         .37      $       .55     $        .85    $         .54    $         .11
                                     =============      ===========     ============    =============    =============
        Total assets                 $  19,081,593      $18,191,426     $ 17,156,055    $  18,022,466    $  14,261,243
                                     =============      ===========     ============    =============    =============
        Long-term obligations                  ---              ---              ---              ---              ---
        Cash dividend per common                                         
        share                        $         .50      $      .50      $        .50    $         .50    $        .50
                                     =============      ===========     ============    =============    =============
</TABLE>





                                       9
<PAGE>   12
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS.

Liquidity And Capital Resources

         As a general policy, the Company maintains corporate liquidity at a
level it believes adequate to support existing operations and planned growth,
as well as continue operations during reasonable periods of unanticipated
adversity.  Management also intends to direct additional resources to strategic
new product development, market expansion and continuing improvement of
existing products to enhance the Company's position as a market leader and to
promote planned internal growth and profitability.

         The Company has historically financed and continues to finance working
capital requirements and any expansion, equipment purchases or acquisitions
primarily through the retention of earnings, which is reflected by the absence
of long-term debt on the Company's consolidated balance sheet.  In addition to
retained earnings, the Company has infrequently used short term bank credit
lines of $7,500,000 to supplement working capital.  During Fiscal 1996 and
Fiscal 1997, it was necessary for the Company to use its short-term bank credit
lines in order to finance a temporary shortfall in working capital.  At June
30, 1997, the Company had no amounts outstanding against its credit lines. The
Company pays an annual commitment fee of 0.25% of the unused balance under the
credit lines.  The Company has no material commitments for capital expenditures
other than replacing equipment and maintaining its existing plants and
equipment.  During Fiscal 1997 the Company purchased fixed assets totaling
$596,395, consisting primarily of replacement manufacturing equipment, computer
hardware and software, office equipment and building improvements.  This is
compared to purchases of $273,593 during Fiscal 1996.  The Company believes
that these sources will be sufficient to satisfy its needs in the foreseeable
future.

         Working capital was $8,584,400 at June 30, 1997, down from $9,350,600
at June 30, 1996, a decline of 8.2%.  This decline was due primarily to the
adverse effects of a third-quarter cost overrun related to a major
international project in the Company's environmental equipment division and to
the early declaration of dividends in Fiscal 1997 rather than in Fiscal 1998,
which resulted in a charge against working capital in Fiscal 1997.





                                       10
<PAGE>   13
         The following table sets forth certain information related to working
capital for the Company's last three fiscal years:

<TABLE>
<CAPTION>
                                           1997          1996           1995  
                                           ----          ----           ----
         <S>                               <C>           <C>            <C>
         Average working capital as     
         a percentage of net sales         20.8%         25.6%          27.5%

         Annual accounts receivable     
             turnover(1)                    4.3           3.8            6.0

         Annual inventory turnover(2)       6.6           5.7            6.7
</TABLE>

(1)      Annual accounts receivable turnover is computed by dividing annual net
         sales by the average monthly accounts receivable.

(2)      Annual inventory turnover is computed by dividing the cost of goods
         sold by the average monthly inventory and contract costs.

         The average working capital decrease as a percentage of net sales is
related to increased sales volume of approximately $7,842,000 reported in Fiscal
1997 over Fiscal 1996. The increase in annual accounts receivable turnover
reflects improved collection methods by the Company in Fiscal 1997. The increase
in average inventory turnover is due primarily to increased efforts to manage
inventory in Fiscal 1997. Peerless continues to monitor and streamline the
Company's receivable collection and inventory purchasing procedures to enhance
and maximize cash flow.

Results of Operations

         The following table sets forth various measures of performance
expressed as percentages of net sales for the Company's last three fiscal
years, as well as the Company's effective income tax rate for the same periods:

<TABLE>
<CAPTION>
                                           1997            1996         1995  
                                           ----            ----         ----
<S>                                        <C>             <C>          <C>
Gross profit margin                        27.8%           30.4%        33.0%
Operating expenses                         26.8%           26.8%        27.3%
Earnings before income taxes                1.3%            3.5%         6.0%
Effective income tax rate                   0.1%           33.2%        35.8%
</TABLE>                                 

         Inflation did not have a material impact on the Company's operating
results during the last three fiscal years.





                                       11
<PAGE>   14
Comparison of Fiscal 1997 to Fiscal 1996

Net Sales

         The Company's net sales increased approximately $7,842,000, or 23.3%,
to $41,486,000 in Fiscal 1997 from $33,644,000 in Fiscal 1996.  Compared to
Fiscal 1996, Fiscal 1997 domestic sales increased by 11.5% from $14,244,000 to
$15,886,000.  Foreign sales increased from $19,400,000 in Fiscal 1996 to
$25,600,000 in Fiscal 1997, an increase of 32.0%.  The increase resulted
primarily from additional sales realized in Asia.

         The Company's backlog of unfilled orders increased from $15,300,000 at
June 30, 1996 to $20,200,000 at June 30, 1997.

         Sales increased from $2,562,000 in Fiscal 1996 to $3,326,000 in Fiscal
1997 at the Company's Singapore sales office.  The backlog of unfilled orders
at June 30, 1997 includes approximately $2,000,000 of orders generated through
the Singapore office.  The Company continues to believe that its sales in Asia
are enhanced by its maintenance of a Singapore office.

         During Fiscal 1997, Peerless Europe Ltd., the Company's UK subsidiary,
contributed Fiscal 1997 sales revenue of $4,605,000, representing a decrease of
$789,000, or 14.6% below Fiscal 1996 revenue of $5,394,000.  This subsidiary
continued to operate solidly during Fiscal 1997, with a year-end backlog of
approximately $2,515,000 as compared with $1,000,000 in Fiscal 1996.
Approximately $800,000 of this increase is attributable to Peerless Europe Ltd.
assuming certain sales of Peerless Europe B.V. in Fiscal 1997. 

         Peerless Europe B.V., the Company's Dutch subsidiary, continued its
efforts during Fiscal 1997 to implement the Company's direct marketing strategy
in Europe.  Sales revenue decreased from $2,105,000 in Fiscal 1996 to
$1,332,000 in Fiscal 1997. Peerless Europe B.V. is winding down its operations,
which will be continued by Peerless Europe Ltd., the Company's U.K. subsidiary.

         Sales by the Company's SCR (Selective Catalytic Reduction) division
improved from $6,013,000 in Fiscal 1996 to $9,632,000 in Fiscal 1997.  During
Fiscal 1997, the SCR division, which designs and manufactures equipment used to
remove nitrogen oxide (NOx) emissions caused by boilers, gas burners, turbines
and internal combustion engines, ended the year with a backlog of unfilled
orders of approximately $2,123,000, a decrease from the Fiscal 1996 backlog of
$4,838,000.

Gross Profit Margin

         The Company's gross profit margin decreased from 30.4% of net sales in
Fiscal 1996 to 27.8% of net sales in Fiscal 1997. The decrease resulted from a
change in product mix of orders completed in Fiscal 1997 and adverse effects of
a cost overrun related to a major international project in the Company's
environmental equipment division in the third quarter.

Operating Expenses

         Operating expenses increased from $9,009,000 in Fiscal 1996 to
$11,118,000 in Fiscal 1997.  However, operating expenses as a percent of sales
held steady at 26.8% in Fiscal 1996





                                       12



<PAGE>   15
and 26.8% in Fiscal 1997.  This increase in operating expenses was primarily due
to increased sales and additional personnel hired to support the increased
level of sales anticipated by the Company.

Income Tax

         The Company's effective income tax rate decreased from 33.2% in Fiscal
1996 to 0.1% in Fiscal 1997.  This decrease resulted from foreign deferred tax
benefits offsetting domestic tax expenses.  The Company anticipates that it
will not be able to continue utilizing these deferred tax benefits to the same
extent and expects that the Company's effective income tax rates will return to
historical levels in Fiscal 1998. For a further discussion of the Company's
federal income taxes, see Note H to the Company's Consolidated Financial
Statements.

Comparison of Fiscal 1996 to Fiscal 1995

Net Sales

         The Company's net sales increased approximately $1,555,000, or 4.8%,
to $33,644,000 in Fiscal 1996 as compared to $32,089,000 in Fiscal 1995.
Compared to Fiscal 1995, Fiscal 1996 domestic sales decreased by 1.0% from
$14,389,000 to $14,244,000.  Foreign sales increased from $17,700,000 in Fiscal
1995 to $19,400,000 in Fiscal 1996, an increase of 9.6%.  The increase was
primarily the result of additional sales realized in Europe.

         The Company's backlog of unfilled orders decreased slightly from
$15,875,000 at June 30, 1995 to $15,300,000 at June 30, 1996.

         Sales decreased from $3,346,000 in Fiscal 1995 to $2,562,000 in Fiscal
1996 at the Company's Singapore sales office.  The backlog of unfilled orders
at June 30, 1996 includes approximately $510,000 of orders generated through
the Singapore office.  The Company continues to believe that its sales in Asia
are enhanced by its maintenance of a Singapore office.

         During Fiscal 1996, Peerless Europe Ltd., the Company's UK subsidiary,
contributed Fiscal 1996 sales revenue of $5,394,000, representing an increase
of $1,760,000, or 48.4% over Fiscal 1995 revenue of $3,634,000.  This
subsidiary continued to operate solidly during Fiscal 1996, with a year-end
backlog of approximately $1,000,000.

         Peerless Europe B.V., the Company's Dutch subsidiary which became
operational as a trading company late in Fiscal 1993, continued its efforts
during Fiscal 1996 to implement the Company's direct marketing strategy in
Europe.  Sales revenue increased from $1,155,000 in Fiscal 1995 to $2,105,000
in Fiscal 1996.

         Sales by the Company's SCR (Selective Catalytic Reduction) division
improved from $3,696,000 in Fiscal 1995 to $6,013,000 in Fiscal 1996.  During
Fiscal 1996, the SCR division, which designs and manufactures equipment used to
remove nitrogen oxide (NOx) emissions caused by boilers, gas burners, turbines
and internal combustion engines, experienced an





                                       13
<PAGE>   16
improvement in its order intake activity and ended the year with a backlog of
unfilled orders of approximately $4,838,000.

Gross Profit Margin

         The Company's gross profit margin decreased from 33.0% of net sales in
Fiscal 1995 to 30.4% of net sales in Fiscal 1996. The decrease resulted from a
change in product mix of orders completed in Fiscal 1996.

Operating Expenses

         Operating expenses increased from $8,770,000 in Fiscal 1995 to
$9,009,000 in Fiscal 1996.  However, operating expenses as a percent of sales
decreased slightly from 27.3% in Fiscal 1995 to 26.8% in Fiscal 1996, due
primarily to the increase in net sales.

Income Tax

         The Company's effective income tax rate decreased from 35.8% in Fiscal
1995 to 33.2% in Fiscal 1996. For a further discussion of the Company's federal
income taxes, see Note H to the Company's Consolidated Financial Statements.

Outlooks and Uncertainties

         This Annual Report on Form 10-K contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Such statements refer to events that could occur in the future or may be
identified by the use of words such as "expect," "intend," "plan," "believe," 
correlative words, and other expressions indicating that future events are
contemplated. Such statements are subject to inherent risks and uncertainties,
and actual results could differ materially from those projected in the
forward-looking statements as a result of certain of the risk factors set forth
below and elsewhere in this Annual Report on Form 10-K.  In addition to the
other information contained in this Annual Report on Form 10-K, investors should
carefully consider the following risk factors.

Competition.  The Company operates in highly competitive markets worldwide.
The Company competes with manufacturers and sellers of separators, filters and
pulsation dampeners, some of which are larger than the Company and have greater
financial resources.  In addition, several smaller manufacturers also produce
custom-designed equipment that is competitive with the Company's specialized
products and services.  Competition may also increase as larger and better
financed foreign companies become attracted to the market potential for products
manufactured by the Company.  There can be no assurance that the Company will be
able to compete successfully with current or future competitors.

Foreign Operations.   The Company derives a significant portion of its
revenues from foreign sales, particularly in Asia.  The Company is subject to
risks of doing business abroad, including





                                       14
<PAGE>   17
the possibility that foreign purchasers may default in the payment of amounts
due, and that collection of such amounts may be more difficult than for U.S.
customers, adverse fluctuations in currency exchange rates, that the U.S. and
foreign governments may impose regulatory burdens upon exports and imports of
the Company's products, and that the Company may be required to perform its
obligations under product warranties, which might result in added expense due
to the requirement that it perform such services in a foreign country.  The
occurrence of any one or more of the foregoing could adversely affect the
Company's operations.

Concentrations of Credit Risk.  The Company continues to closely monitor the
creditworthiness of its customers and has never experienced significant credit
losses; however, a significant portion of the Company's sales are to customers
whose activities are related to the oil and gas industry, including some who
are located in foreign countries.  The Company generally extends credit to
these customers.  Its exposure to credit risk is affected by conditions within
the oil and gas industry, and with respect to foreign sales, collection may be
more difficult in the event of a default.  However, substantially all foreign
sales are made to large, well-established companies and the Company generally
requires collateral or guarantees on foreign sales to smaller companies.





                                       15
<PAGE>   18
ITEM 8.          FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

                         Index to Financial Statements

<TABLE>
<CAPTION>
                                                                                                                     Page
                                                                                                                     ----
<S>                                                                                                                  <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC
         ACCOUNTANTS  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   17

CONSOLIDATED BALANCE SHEETS AT JUNE 30, 1997 AND 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   18

CONSOLIDATED STATEMENTS OF EARNINGS FOR THE YEARS
         ENDED JUNE 30, 1997, 1996 AND 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   20 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS'
         EQUITY FOR THE YEARS ENDED JUNE 30, 1997,
         1996 AND 1995  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   21

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS
         ENDED JUNE 30, 1997, 1996 AND 1995   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   22  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE
         YEARS ENDED JUNE 30, 1997, 1996 AND 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   24

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
         ON SCHEDULE  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   36

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNT  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   37
</TABLE>





                                       16
<PAGE>   19
                                        





               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS




Board of Directors
Peerless Mfg. Co.


We have audited the accompanying consolidated balance sheets of Peerless Mfg.
Co. and Subsidiaries as of June 30, 1997 and 1996, and the related consolidated
statements of earnings, changes in stockholders' equity, and cash flows for
each of the three years in the period ended June 30, 1997.  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 generally accepted auditing
standards.  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, 1997 and 1996, and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended June 30, 1997, in conformity with generally accepted
accounting principles.




GRANT THORNTON LLP

Dallas, Texas
September 2, 1997





                                       17
<PAGE>   20
                       PEERLESS MFG. CO. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

                                    June 30,




<TABLE>
<CAPTION>
                    ASSETS                                                         1997                          1996      
                                                                                   ----                          ----       
<S>                                                                             <C>                           <C>
CURRENT ASSETS
    Cash and cash equivalents                                                 $    772,553                   $  2,082,329
    Short-term investments                                                         259,007                        246,659
    Accounts receivable - principally trade - net of allowance for
        doubtful accounts of $312,450 and $100,000 in 1997
        and 1996, respectively                                                   9,671,067                      8,404,331
    Inventories                                                                  2,993,855                      2,972,456
    Costs and earnings in excess of billings on uncompleted contracts            1,871,817                      1,403,199
    Deferred income taxes                                                          269,721                        226,214
    Other                                                                          298,605                        240,214
                                                                               -----------                    -----------

              TOTAL CURRENT ASSETS                                             16,136,625                      15,575,402

PROPERTY, PLANT AND EQUIPMENT - AT COST, less
    accumulated depreciation                                                     1,527,856                      1,213,859

PROPERTY HELD FOR INVESTMENT - AT COST, less
    accumulated depreciation                                                       888,383                        948,775

OTHER ASSETS                                                                       528,729                        453,390
                                                                               -----------                    -----------

                                                                              $ 19,081,593                   $ 18,191,426
                                                                               ===========                    ===========
</TABLE>





                                       18
<PAGE>   21
                       PEERLESS MFG. CO. AND SUBSIDIARIES

                    CONSOLIDATED BALANCE SHEETS - CONTINUED

                                    June 30,




<TABLE>
<CAPTION>
   LIABILITIES AND STOCKHOLDERS' EQUITY                                         1997                            1996     
                                                                                ----                            ----
<S>                                                                           <C>                            <C>
CURRENT LIABILITIES
    Accounts payable - trade                                                  $  5,054,532                   $  4,325,595
     Billings in excess of costs and earnings on uncompleted
         contracts                                                                 363,257                            -
    Commissions payable                                                            779,474                        566,766
    Accrued expenses
        Compensation                                                               656,082                        549,210
        Warranty reserve                                                           406,903                        286,384
        Other                                                                      291,953                        496,847
                                                                               -----------                    -----------

              TOTAL CURRENT LIABILITIES                                          7,552,201                      6,224,802

DEFERRED INCOME TAXES                                                               99,962                         86,768

COMMITMENTS                                                                            -                              -

STOCKHOLDERS' EQUITY
    Common stock - authorized, 4,000,000 shares of $1 par value;
       issued and outstanding, 1,451,992 and 1,446,742 shares in
    1997 and 1996, respectively                                                  1,451,992                      1,446,742
    Additional paid-in capital                                                   2,535,221                      2,489,879
    Unamortized value of restricted stock grants                                   (44,625)                       (33,750)
    Cumulative foreign currency translation adjustment                             (93,944)                        23,842
    Retained earnings                                                            7,580,786                      7,953,143
                                                                               -----------                    -----------
                                                                                11,429,430                     11,879,856
                                                                               -----------                    -----------

                                                                              $ 19,081,593                   $ 18,191,426
                                                                               ===========                     ==========
</TABLE>



       The accompanying notes are an integral part of these statements.



                                       19
<PAGE>   22
                       PEERLESS MFG. CO. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF EARNINGS

                              Year ended June 30,




<TABLE>
<CAPTION>
                                                             1997               1996               1995     
                                                             ----               ----               ----
<S>                                                      <C>                <C>                  <C>
NET SALES                                                  $41,486,492        $33,643,998        $32,089,132

COST OF GOODS SOLD                                          29,961,203         23,430,761         21,506,004
                                                          ------------       ------------         ----------

          GROSS PROFIT                                      11,525,289         10,213,237         10,583,128

OPERATING EXPENSES
   Marketing and engineering                                 9,129,347          7,524,363          7,011,380
   General and administrative                                1,988,618          1,485,113          1,758,432 
                                                          ------------       ------------         ----------
                                                            11,117,965          9,009,476          8,769,812 
                                                          ------------       ------------         ----------

          OPERATING PROFIT                                     407,324          1,203,761          1,813,316

OTHER INCOME (EXPENSE)
   Interest income                                              24,687             45,559             93,974
   Interest expense                                            (55,475)           (16,858)            (8,040)
   Foreign exchange gains (losses)                             103,583            (28,628)           (56,368)
   Other, net                                                   57,877            (21,686)            65,779
                                                          ------------       ------------         ----------
                                                               130,672            (21,613)            95,345
                                                          ------------       ------------         ----------

          EARNINGS BEFORE INCOME TAXES                         537,996          1,182,148          1,908,661

INCOME TAX EXPENSE (BENEFIT)
   Current                                                      65,766            397,023            661,046
   Deferred                                                    (65,186)            (4,596)            21,369
                                                          ------------       ------------         ----------
                                                                   580            392,427            682,415
                                                          ------------       ------------         ----------

          NET EARNINGS                                   $     537,416      $     789,721        $ 1,226,246
                                                          ============       ============         ==========

Earnings per common share                                         $.37               $.55               $.85
                                                                   ===                ===                ===

Weighted average number of common shares outstanding         1,454,045          1,446,742          1,442,039
                                                             =========          =========          =========
</TABLE>


       The accompanying notes are an integral part of these statements.


                                       20
<PAGE>   23
                      PEERLESS MFG. CO. AND SUBSIDIARIES

          CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY



<TABLE>
<CAPTION>
                                                                                                          Cumulative      
                                                                                        Unamortized        foreign        
                                                                        Additional        value of         currency       
                                                        Common           paid-in         restricted       translation     
                                                         stock           capital        stock grants       adjustment     
                                                      ----------        ----------      ------------       ----------     
<S>                                                    <C>              <C>              <C>              <C>             
Balances as of July 1995                               1,436,742        $2,383,870       $   (49,841)     $   (76,063)     
                                                                                                                          
Net earnings                                                 -                 -                 -                -       
Issuance of 12,000 shares of common stock                 12,000           123,000          (135,000)             -       
Forfeiture of 2,000 shares of common stock                (2,000)          (18,500)           20,500              -       
Translation adjustment                                       -                 -                 -            132,173     
Cash dividends paid ($.50 per share)                         -                 -                 -                -       
Amortization of restricted stock grants                      -                 -              67,234              -       
Income tax benefit related to restricted stock plans         -               5,058               -                -       
                                                       ---------         ---------        ----------       ----------     
                                                                                                                          
Balances as of June 30, 1995                           1,446,742         2,493,428           (97,107)          56,110     
                                                                                                                          
Net earnings                                                 -                 -                 -                -       
Translation adjustment                                       -                 -                 -            (32,268)     
Cash dividends paid ($.50 per share)                         -                 -                 -                -       
Amortization of restricted stock grants                      -                 -              63,357              -       
Income tax expense related to restricted stock plans         -              (3,549)              -                -       
                                                       ---------         ---------        ----------       ----------     
                                                                                                                          
Balances as of June 30, 1996                           1,446,742         2,489,879           (33,750)          23,842     
Net earnings                                                 -                 -                 -                -       
Issuance of 8,000 shares of common stock                   8,000            72,250           (80,250)             -       
Forfeiture of 4,000 shares of common stock                (4,000)          (38,750)           42,750              -       
Stock options exercised                                    1,250            10,312               -                -       
Translation adjustment                                       -                 -                 -           (117,786)     
Cash dividends paid ($.50 per share)                         -                 -                 -                -       
Cash dividends declared ($.125 per share)                    -                 -                 -                -       
Amortization of restricted stock grants                      -                 -              26,625              -       
Income tax benefit related to restricted stock plans         -               1,530               -                -       
                                                       ---------         ---------        ----------       ----------     
                                                                                                                          
Balances as of June 30, 1997                          $1,451,992        $2,535,221       $   (44,625)     $   (93,944)     
                                                       =========         =========        ==========       ==========      
</TABLE>

<TABLE>
<CAPTION>
                                                                  Retained                     
                                                                  earnings           Total        
                                                                  --------           -----
<S>                                                               <C>              <C>         
Balances as of July 1995                                          $7,381,682       $11,076,390 
                                                                                               
Net earnings                                                       1,226,246         1,226,246 
Issuance of 12,000 shares of common stock                                -                 -   
Forfeiture of 2,000 shares of common stock                               -                 -   
Translation adjustment                                                   -             132,173 
Cash dividends paid ($.50 per share)                                (721,122)         (721,122) 
Amortization of restricted stock grants                                  -              67,234 
Income tax benefit related to restricted stock plans                     -               5,058 
                                                                   ---------        ---------- 
                                                                                               
Balances as of June 30, 1995                                       7,886,806        11,785,979 
                                                                                               
Net earnings                                                         789,721           789,721 
Translation adjustment                                                   -             (32,268) 
Cash dividends paid ($.50 per share)                                (723,384)         (723,384) 
Amortization of restricted stock grants                                  -              63,357 
Income tax expense related to restricted stock plans                     -              (3,549) 
                                                                   ---------        ---------- 
                                                                                               
Balances as of June 30, 1996                                       7,953,143        11,879,856 
Net earnings                                                         537,416           537,416 
Issuance of 8,000 shares of common stock                                 -                 -   
Forfeiture of 4,000 shares of common stock                               -                 -   
Stock options exercised                                                  -              11,562 
Translation adjustment                                                   -            (117,786) 
Cash dividends paid ($.50 per share)                                (727,149)         (727,149) 
Cash dividends declared ($.125 per share)                           (182,624)         (182,624) 
Amortization of restricted stock grants                                  -              26,625 
Income tax benefit related to restricted stock plans                     -               1,530 
                                                                   ---------        ---------- 

Balances as of June 30, 1997                                      $7,580,786       $11,429,430 
                                                                   =========        ========== 

</TABLE>

                                                          
       The accompanying notes are an integral part of these statements.

                                      21


<PAGE>   24


                      PEERLESS MFG. CO. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                              Year ended June 30,



<TABLE>
<CAPTION>
                                                              1997               1996                 1995     
                                                          -------------      -------------        -----------
<S>                                                       <C>                <C>                  <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Net earnings                                           $     537,416      $     789,721        $ 1,226,246
   Adjustments to reconcile net earnings to net cash
      provided by (used in) operating activities
         Depreciation and amortization                          370,525            416,207            386,364
         Deferred income taxes                                  (65,185)            (4,596)            21,369
         Foreign exchange loss (gain)                          (103,583)            28,628             56,368
         Other                                                    1,530             (2,342)             5,058
         Changes in operating assets and liabilities
            Accounts receivable                              (1,586,991)           508,764           (323,226)
            Inventories                                         (11,463)          (154,231)         1,695,052
            Cost and profit in excess of billings
               on uncompleted contracts                        (468,618)        (1,287,644)           115,555
            Other current assets                                (59,501)          (285,196)           108,174
            Other assets                                        (40,466)           156,025           (195,985)
            Accounts payable                                    791,364          1,240,661            464,022
            Billings in excess of costs and earnings
               on uncompleted contracts                         363,257           (197,010)        (1,624,268)
            Commissions payable                                 212,708             57,254              6,981
            Accrued expenses                                     22,497            266,563           (133,144)
                                                          -------------      -------------        -----------
                                                               (573,926)           743,083            582,320
                                                          -------------      -------------        -----------

                   NET CASH PROVIDED BY (USED IN)
                       OPERATING ACTIVITIES                     (36,510)         1,532,804          1,808,566

CASH FLOWS FROM INVESTING ACTIVITIES
   Net sales (purchases) of short-term investments              (12,348)           (24,691)           415,017
   Purchase of property and equipment                          (596,395)          (273,593)          (339,199)
                                                          -------------      -------------        -----------

                   NET CASH PROVIDED BY (USED IN)
                        INVESTING ACTIVITIES                   (608,743)          (298,284)            75,818
</TABLE>





                                       22
<PAGE>   25
                       PEERLESS MFG. CO. AND SUBSIDIARIES

               CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

                              Year ended June 30,



<TABLE>
<CAPTION>
                                                              1997               1996                 1995     
                                                           ------------        -----------        -----------
<S>                                                       <C>                <C>                  <C>
CASH FLOWS FROM FINANCING ACTIVITIES
   Sale of common stock                                  $       11,562       $        -         $        -
   Net changes in short-term borrowings                             -                  -             (260,400)
   Dividends paid                                              (727,149)          (723,384)          (721,122)
                                                           ------------        -----------        -----------

               NET CASH USED IN FINANCING ACTIVITIES           (715,587)          (723,384)          (981,522)

EFFECT OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS             51,064              9,446             25,691
                                                           ------------        -----------        -----------

               NET INCREASE (DECREASE) IN CASH 
                 AND CASH EQUIVALENTS                        (1,309,776)           520,582            928,553

Cash and cash equivalents at beginning of year                2,082,329          1,561,747            633,194
                                                           ------------        -----------        -----------

Cash and cash equivalents at end of year                  $     772,553       $  2,082,329       $  1,561,747
                                                           ============        ===========        ===========


Supplemental information on cash flows:
-------------------------------------- 

Interest paid                                               $    55,475        $    16,858       $      9,597
Income taxes paid                                           $   379,347        $   138,018       $  1,059,500
</TABLE>


       The accompanying notes are an integral part of these statements.


                                       23
<PAGE>   26
                       PEERLESS MFG. CO. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                          June 30, 1997, 1996 and 1995


NOTE A - NATURE OF OPERATIONS AND SUMMARY OF 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 Dallas, Texas and are sold worldwide with the principal markets
   located in the United States and Europe.  Primary customers are equipment
   manufacturers, engineering contractors and operators of power plants.

   Consolidation

   The Company consolidates the accounts of its wholly-owned foreign
   subsidiaries, Peerless Europe Limited (Europe Limited), Peerless
   International N.V. (International) and Peerless Europe B.V. (Europe B.V.).
   All significant intercompany 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.

   Inventories

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

   Depreciable Assets

   Depreciation is provided for in amounts sufficient to relate the cost of
   depreciable assets to operations over their estimated service lives,
   principally by the straight-line method.

   Revenue Recognition

   The Company generally recognizes sales of custom-contracted products at the
   completion of the manufacturing process.  The percentage-of-completion
   method is used for significant long-term contracts.
   Percentage-of-completion is generally determined using the actual labor





                                       24
<PAGE>   27
                       PEERLESS MFG. CO. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


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

   incurred to date as compared to management's estimate of total labor to be
   incurred on each contract.

   Stock-Based Compensation

   Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting
   for Stock-Based Compensation, encourages, but does not require, companies to
   record compensation cost for stock-based employee compensation plans at fair
   value.  The Company has chosen to account for stock-based compensation using
   the intrinsic value method prescribed in Accounting Principles Board Opinion
   No. 25 (APB 25), Accounting for Stock Issued to Employees, and related
   interpretations.

   Earnings Per Common Share

   Earnings per common share are computed by dividing net earnings by the
   weighted average number of shares of common stock outstanding during the
   year.  The dilutive effect of stock options is not material.

   Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings Per
   Share, is effective for financial statements issued after December 15, 1997.
   The adoption of SFAS 128 is not expected to have a material impact on the
   disclosure of earnings per share in the financial statements.

   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 earnings items
   are translated at the weighted average exchange rates for the year.  The
   resulting translation adjustments are made directly to a separate component
   of stockholders' equity.  Gains and losses from foreign currency
   transactions, such as those resulting from the settlement of foreign
   receivables or payables, are included in the consolidated statements of
   earnings.

   From time to time, the Company enters into forward exchange contracts in
   anticipation of future movements in certain foreign exchange rates and to
   hedge against foreign currency fluctuations.  Realized and unrealized gains
   and losses on these contracts are included in net





                                       25
<PAGE>   28
                       PEERLESS MFG. CO. AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


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

   income, except that gains and losses on contracts to hedge specific foreign
   currency commitments are deferred and accounted for as part of the
   underlying transaction.

   Reclassifications

   Certain prior years' amounts have been reclassified to conform with the 1997
   presentation.

   Financial Instruments

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

   Use of Estimates

   The preparation of financial statements in conformity with generally
   accepted accounting principles 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.





                                       26
<PAGE>   29
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE B - CONCENTRATIONS OF CREDIT RISK

   A significant portion of the Company's sales are to customers whose
   activities are related to the oil and gas industry, including some who are
   located in foreign countries.  The Company generally extends credit to these
   customers.  Its exposure to credit risk is affected by conditions within the
   oil and gas industry.  Also, with respect to foreign sales, collection may
   be more difficult in the event of a default.

   However, the Company closely monitors extensions of credit and has never
   experienced significant credit losses.  Substantially all foreign sales are
   made to large, well-established companies.  The Company generally requires
   collateral or guarantees on foreign sales to smaller companies.

   Sales to one customer accounted for approximately 12.3% of revenues for the
   year ended June 30, 1997. No single customer accounted for more than 10% of
   revenues in 1996 or 1995.

NOTE C - INVENTORIES AND UNCOMPLETED CONTRACTS

   Principal components of inventories are as follows:

<TABLE>
<CAPTION>
                                                         June 30,         
                                              ------------------------------
                                                 1997                1996     
                                              ----------          ----------
      <S>                                     <C>                 <C>
      Raw materials                           $1,084,890          $1,094,774
      Work in process                          1,586,213           1,591,289
      Finished goods                             322,752             286,393
                                              ----------          ----------
                                                               
                                              $2,993,855          $2,972,456
                                               =========           =========
</TABLE>                                    

   At June 30, 1997 and 1996, progress payments of $318,043 and $296,431
   respectively, have been offset against inventories and costs of uncompleted
   contracts.





                                       27
<PAGE>   30
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE D - PROPERTY, PLANT AND EQUIPMENT AND PROPERTY HELD FOR INVESTMENT

   Property, plant and equipment is summarized as follows:

<TABLE>
<CAPTION>                                             
                                                        June 30,              
                                           --------------------------------
                                               1997                1996     
                                           ------------        ------------
      <S>                                  <C>                 <C>
      Buildings                            $  1,380,241        $  1,418,842
      Equipment                               2,432,792           2,300,777
      Furniture and fixtures                  1,585,930           1,114,583
                                            -----------         -----------
                                              5,398,963           4,834,202
        Less accumulated depreciation        (4,131,323)         (3,880,559)
                                            -----------         ----------- 
                                              1,267,640             953,643
      Land                                      260,216             260,216
                                            -----------         -----------
                                                              
                                           $  1,527,856        $  1,213,859
                                            ===========         ===========
</TABLE>                                                            

   Property held for investment is summarized as follows:

<TABLE>
<CAPTION>
                                                         June 30,              
                                           ---------------------------------
                                                 1997              1996      
                                           -------------       -------------
      <S>                                   <C>                 <C>
      Buildings                            $   1,641,769       $   1,641,776
      Equipment                                  158,171             158,171
                                            ------------        ------------
                                               1,799,940           1,799,947
        Less accumulated depreciation         (1,440,967)         (1,380,582)
                                            ------------        ------------ 
                                                 358,973             419,365
      Land                                       529,410             529,410
                                            ------------        ------------
                                                               
                                           $     888,383       $     948,775
                                            ============        ============
</TABLE>                                   





                                      28
<PAGE>   31
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE E - CREDIT ARRANGEMENT

   The Company has banking agreements for unsecured revolving lines of credit
   in the combined amount of $7,500,000 due upon demand, with interest at the
   banks' prime lending rate (8.50% at June 30, 1997), payable monthly.  The
   banks charge usage fees at an annual rate of .25% of the average daily
   unused portion of the line.  At June 30, 1997 and 1996, no amounts were
   outstanding under the lines.  The Company had letters of credit outstanding
   under separate arrangements of $3,597,646 and $3,259,533 at June 30, 1997
   and 1996, respectively.  Other assets with a cost of approximately $566,000
   were pledged against the letters of credit outstanding at June 30, 1997.


NOTE F - STOCKHOLDERS' EQUITY

   The Company has a 1985 restricted stock plan (the 1985 Plan) under which
   75,000 shares of common stock were reserved for awards to employees.
   Restricted stock grants made under the 1985 Plan vest over a five-year
   period.  The Company awarded 12,000 shares (fair value at date of grant of
   $135,000) in fiscal 1995 and 8,000 shares (fair value at date of grant of
   $80,250), of which 3,000 shares were subsequently forfeited, in fiscal 1997.
   Compensation expense for stock grants is charged to earnings over the
   five-year restriction period and amounted to $26,625, $63,357 and $67,234 in
   fiscal 1997, 1996, and 1995, 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 100,000 shares of
   common stock to be issued.  Stock options are granted at market value, vest
   generally over four years, and expire ten years from date of grant.

   At June 30, 1997, 67,250 shares of common stock were available for issuance
   under the 1995 Plan, and 4,750 shares were available under the 1985 Plan.

   The Company has adopted the disclosure provisions of SFAS 123.  It applies
   APB 25 and related interpretations in accounting for stock options issued
   and, therefore, does not recognize compensation expense for stock options
   granted at or greater than market value.  If the Company had elected to
   recognize compensation expense based upon the fair value at the grant date
   for awards under this plan consistent with the methodology prescribed by
   SFAS 123, the effect on net earnings and earnings per share would have been
   as follows:





                                       29
<PAGE>   32
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE F - STOCKHOLDERS' EQUITY - CONTINUED

<TABLE>
<CAPTION>
                                            Year ended       Year ended
                                           June 30, 1997    June 30, 1996
                                           -------------    -------------
   <S>                                         <C>              <C>
   Net earnings - as reported                  $537,416         $789,721
   Net earnings - pro forma                     527,012          784,896
   Earnings  per share - as reported                .37              .55
   Earnings per share - pro forma                   .36              .54
</TABLE>                                        

   The fair value of these options was estimated at the date of grant using the
   Black-Scholes option pricing model with the following weighted-average
   assumptions:  expected volatility of 45%; risk-free interest rates ranging
   from 4.6% to 5.3%; dividend yield of 3.7% in fiscal 1997 and 5.4% in
   fiscal 1996; and expected lives of five years.

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

<TABLE>
<CAPTION>
                                                    Number of      Weighted
                                                     shares         average
                                                    underlying     exercise
           Stock options                             options         price   
           -------------                            ---------      --------
   <S>                                                <C>          <C>
   Outstanding at June 30, 1995                           -        $     -
   Granted                                             34,000          9.25
                                                       ------              
                                                                   
   Outstanding at June 30, 1996                        34,000          9.25
   Granted                                              2,500         13.33
   Exercised                                           (1,250)         9.25
   Canceled/forfeited                                  (3,750)         9.25
                                                       ------               
                                                                   
   Outstanding at June 30, 1997                        31,500          9.57
                                                       ======              
                                                                   
   Exercisable at June 30, 1997                         9,250          9.25
                                                        =====              
                                                                   
   Exercisable at June 30, 1996                           -         
                                                       ======       
</TABLE>

  The weighted-average remaining life of options outstanding at June 30, 1997
  was 9.08 years.  The weighted average fair-value at grant date for options
  granted in 1997 was $1.82





                                       30
<PAGE>   33
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE F - STOCKHOLDERS' EQUITY - CONTINUED

  On May 21, 1997, the Board of Directors declared a dividend of one common
  share purchase right for each outstanding share of common stock to
  shareholders of record at the close of business on June 2, 1997.  Each Right
  entitles the registered holder to purchase from the Company one common share
  at a price of $30.00, subject to adjustment, as more fully set forth in a
  Rights Agreement dated May 22, 1997.

  The Rights will become exercisable only in the event that any person or group
  of affiliated persons acquires, or obtains the right to acquire, beneficial
  ownership of 20% or more of the outstanding common shares or commences a
  tender or exchange offer, the consummation of which would result in the
  beneficial ownership by a person or group of 20% or more of such outstanding
  common shares.  The rights are redeemable under certain circumstances at $.01
  each and expire in May 2007.





                                       31
<PAGE>   34
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE G - 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, 1997, 1996
   and 1995 was $119,500, $109,000 and $103,000, respectively.


NOTE H - FEDERAL INCOME TAXES

   Deferred taxes are provided for the temporary differences between the
   financial reporting bases and the tax bases of the Company's assets and
   liabilities.  The temporary differences that give rise to the deferred tax
   assets or liabilities are as follows:
<TABLE>
<CAPTION>
                                                                                              June 30,               
                                                                                   ---------------------------
                                                                                       1997            1996    
                                                                                   -----------      ----------
      <S>                                                                          <C>              <C>
      Deferred tax assets
          Restricted stock grants                                                  $    13,938      $    19,125
          Inventories                                                                   28,362           16,052
          Foreign subsidiaries' net operating loss carryforwards                       145,157           15,371
          Accrued expenses                                                             243,090          311,237
          Other                                                                         52,701           70,158
                                                                                    ----------       ----------
                                                                                       483,248          431,943
          Less valuation allowance                                                     (29,710)        (160,405)
                                                                                    ----------         -------- 
                                                                                       453,538          271,538

      Deferred tax liabilities
          Property, plant and equipment                                               (110,396)         (88,491)
          Uncompleted contracts                                                       (135,006)         (39,014)
          Other                                                                         (3,504)          (4,587)
                                                                                    ----------       ---------- 
                                                                                      (248,906)        (132,092)
                                                                                    ----------        --------- 

                Net deferred tax asset                                             $   204,632       $  139,446
                                                                                    ==========        =========
</TABLE>

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





                                       32
<PAGE>   35
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE H - FEDERAL INCOME TAXES - CONTINUED

<TABLE>
<CAPTION>
                                                            June 30,         
                                                  --------------------------
                                                    1997              1996    
                                                  ---------         --------
     <S>                                           <C>              <C>
     Current deferred tax asset                    $269,721         $226,214
     Noncurrent deferred tax asset                   34,873              -
     Noncurrent deferred tax liability              (99,962)         (86,768)
                                                   --------         -------- 
                                                 
                                                   $204,632         $139,446
                                                    =======          =======
</TABLE>

   The provision for income taxes consisted of the following:

<TABLE>
<CAPTION>
                                  1997             1996             1995    
                              ------------     ------------     ------------
      <S>                      <C>                <C>              <C>
      Federal                 
          Current              $   41,765        $ 348,830        $ 581,976
          Deferred                (65,185)          (4,596)          21,369
      State                        24,000           48,193           79,070
                                ---------         --------         --------
                              
                               $      580        $ 392,427        $ 682,415
                                =========         ========         ========
</TABLE>

   The valuation allowance relates to deferred tax assets of foreign
   subsidiaries. These assets are recoverable only from future income of the
   respective foreign subsidiaries.  Because of a recapitalization of Europe
   Limited and a reorganization of European operations, the Company concluded
   at June 30, 1997 that it was more likely than not that certain of the
   deferred tax assets are recoverable, and the valuation allowance was
   reduced.  Utilization of foreign net operating carryforwards reduced income
   tax expense by approximately $130,000, $19,000 and $55,000 for 1997, 1996
   and 1995, respectively.

   The effective income tax rate varies from the statutory rate due to the
   following:

<TABLE>
<CAPTION>
                                                                                        As a percentage
                                                                                       of pretax earnings        
                                                                                  ---------------------------
                                                                                    1997       1996     1995 
                                                                                  -------     ------   ------
    <S>                                                                            <C>         <C>      <C>
    Income tax expense at statutory rate                                            34.0%      34.0%    34.0%
    Increase (decrease) in income taxes resulting from
        State tax, net of federal benefits                                           2.9        2.8      2.9
        Foreign sales corporation exclusions                                       (10.2)      (1.5)    (3.1)
        Change in valuation allowance                                              (24.3)       3.5     (1.4)
        Other                                                                       (2.3)      (5.6)     3.4
                                                                                   -----       ----     ----

    Income tax expense at effective rate                                              .1%      33.2%    35.8%
                                                                                    ====       ====     ==== 
</TABLE>





                                       33
<PAGE>   36
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE I - INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION

   The Company's operations consist of a dominant industry segment, the
   designing and manufacturing of specialized products for the removal of
   contaminants from gases and liquids and for air pollution abatement,
   principally in the United States and the United Kingdom.

   Information about the Company's operations in different geographic areas as
   of and for the years ended June 30, 1996, 1995 and 1994 is as follows:

<TABLE>
<CAPTION>
                                      United            United
                                      States            Kingdom        Other          Eliminations    Consolidated
                                  ---------------    -----------   ---------------    ------------    ------------
   <S>                              <C>              <C>          <C>                 <C>              <C>
   1997
   ----
     Net sales to unaffiliated
     customers                        $35,553,000     $4,601,000     $1,332,000             -       $41,486,000
                                                                                                               
   Transfers between
     geographic areas                     889,000          4,000            -         (893,000)            -  
                                       ----------      ---------      ---------     ----------       ----------

   Total                              $36,442,000     $4,605,000     $1,332,000    $  (893,000)     $41,486,000
                                       ==========      =========      =========     ==========       ==========

   Operating profit (loss)            $   549,000     $ (129,000)    $  (12,000)        (1,000)     $   407,000
                                       ==========      =========      =========     ==========       ==========

   Identifiable assets                $18,129,000     $2,790,000     $1,027,000    $(2,144,000)     $19,082,000
                                       ==========      =========      =========     ==========       ==========

   1996
   ----
     Net sales to unaffiliated
     customers                        $26,775,000     $4,764,000     $2,105,000    $         -      $33,644,000
   Transfers between
     geographic areas                     984,000        630,000            -       (1,614,000)            -  
                                       ----------      ---------      ---------     ----------       ----------

   Total                              $27,759,000     $5,394,000     $2,105,000    $(1,614,000)     $33,644,000
                                       ==========      =========      =========     ===========      ==========

   Operating profit (loss)            $ 1,119,000     $  145,000     $  (39,000)   $   (21,000)     $ 1,204,000
                                       ==========      =========      =========     ==========       ==========

   Identifiable assets                $17,244,000     $2,112,000     $1,599,000    $(2,764,000)     $18,191,000
                                       ==========      =========      =========     ==========       ==========
</TABLE>





                                       34
<PAGE>   37
                       PEERLESS MFG. CO. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

                          June 30, 1997, 1996 and 1995


NOTE I - INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION - CONTINUED

<TABLE>
<CAPTION>
                                      United           United
                                      States           Kingdom        Other           Eliminations    Consolidated
                                  ---------------    -----------   ---------------    ------------    ------------
   <S>                               <C>             <C>            <C>                <C>             <C>
   1995
   ----
     Net sales to unaffiliated
     customers                        $27,673,000     $3,261,000     $1,155,000             -       $32,089,000
                                                                                                               
   Transfers between
     geographic areas                     479,000        373,000            -         (852,000)            -  
                                       ----------      ---------      ---------     ----------       ----------

   Total                              $28,152,000     $3,634,000     $1,155,000    $  (852,000)     $32,089,000
                                       ==========      =========      =========     ==========       ==========

   Operating profit (loss)            $ 1,764,000     $  (13,000)    $    9,000    $     5,000      $ 1,765,000
                                       ==========      =========      =========     ==========       ==========

   Identifiable assets                $16,048,000     $2,113,000     $1,237,000    $(2,242,000)     $17,156,000
                                       ==========      =========      =========     ==========       ==========
</TABLE>

   Transfers between the geographic areas primarily represent intercompany
   export sales and are accounted for based on established sales prices between
   the related companies.  In computing operating profit (loss), no allocations
   of general corporate expenses have been made.

   Identifiable assets of geographic areas are those assets related to the
   Company's operations in each area.  United States assets consist of all
   other operating assets of the Company.

   Export sales account for a significant portion of the Company's revenues and
   are summarized by geographic area as follows:

<TABLE>
<CAPTION>
                                                                1997               1996             1995     
                                                          ---------------    ---------------  ---------------
       <S>                                                   <C>                <C>              <C>
       North and South America (excluding U.S.A.)            $  5,899,000       $  5,864,000     $  3,817,000
       Europe                                                   5,213,000          6,627,000        5,055,000
       Asia                                                    11,023,000          5,188,000        8,008,000
       Other                                                    3,470,000          1,756,000          826,000
                                                              -----------        -----------     ------------

                                                              $25,605,000        $19,435,000      $17,706,000
                                                               ==========         ==========       ==========
</TABLE>





                                       35
<PAGE>   38




         REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULE



Board of Directors
Peerless Mfg. Co.

In connection with our audit of the consolidated financial statements of
Peerless Mfg. Co. and Subsidiaries referred to in our report dated September 2,
1997, which is included in Part II of this form, we have also audited Schedule
II for each of the three years in the period ended June 30, 1997.  In our
opinion, this schedule presents fairly, in all material respects, the
information required to be set forth therein.




GRANT THORNTON LLP

Dallas, Texas
September 2, 1997





                                       36
<PAGE>   39
                       PEERLESS MFG. CO. AND SUBSIDIARIES

                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

                                    June 30,


<TABLE>
<CAPTION>
                                                                  Additions                    
                                     Balance at         ----------------------------------
                                    beginning of        Charged to          Charged to                               Balance at
     Description                       period            expenses         other accounts(1)      Deductions(2)      end of period
     -----------                    -------------       -----------       --------------         ----------         -------------
<S>                                   <C>           <C>                       <C>                   <C>             <C>    
1997                                                                                          
----                                                                                          
                                                                                              
Allowance for doubtful accounts        $100,000         $ 249,612            $   -               $  37,162 (2)        $ 312,450
                                        =======           =======             ======              ========             ========
                                                                                              
Deferred tax valuation allowance       $160,405         $      -             $   -               $ 130,695 (3)        $  29,710
                                        =======          ========             ======              ========             ========
1996                                                                                          
----                                                                                          
                                                                                              
Allowance for doubtful accounts        $ 99,082         $  44,307            $   852             $  44,241 (2)        $ 100,000
                                        =======          ========             ======              ========             ========
                                                                                              
Deferred tax valuation allowance       $121,091         $  39,314            $   -               $      -             $ 160,405
                                        =======          ========             ======              ========             ========
                                                                                              
1995                                                                                          
----                                                                                          
                                                                                              
Allowance for doubtful accounts        $ 85,827         $  55,401            $   -               $  42,146  (2)       $  99,082
                                        =======          ========             ======              ========             ========
                                                                                              
Deferred tax valuation allowance       $147,071         $       -            $   -               $  25,980  (3)       $ 121,091
                                        =======          ========             ======              ========             ========
</TABLE>                                                               


(1)    Collections on accounts previously written off.

(2)    Write offs.

(3)    Utilization and/or revaluation of net operating loss carryovers.





                                      37
<PAGE>   40
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
         FINANCIAL DISCLOSURE.

         None.


                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         For information concerning the Company's Directors, reference is made
to the information set forth under the caption "Election of Directors" and
"Common Stock Ownership of Management and Certain Beneficial Owners" in the
Company's Proxy Statement for the Annual Meeting of Shareholders to be held
November 20, 1997 (the "Proxy Statement"), which information is incorporated
herein by reference.

         For information concerning the Company's Executive Officers, see Item
1, "Business - Executive Officers of the Company."


ITEM 11. EXECUTIVE COMPENSATION.

         For information concerning the Company's executive compensation,
reference is made to the information set forth under the caption "Executive
Compensation" in the Proxy Statement, which information is incorporated herein
by reference.


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

         For information concerning the security ownership of certain
beneficial owners and management, reference is made to the information set
forth under the caption "Election of Directors" and "Common Stock Ownership of
Management and Certain Beneficial Owners" in the Proxy Statement, which
information is incorporated herein by reference.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         For information concerning certain relationships and related
transactions, reference is made to the information set forth under the caption
"Compensation Committee Interlocks and Insider Participation" in the Proxy
Statement, which information is incorporated herein by reference.





                                      38
<PAGE>   41
                                    PART IV

ITEM 14.         EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM
                 8-K.

(a)      1.      All Financial Statements:  see Item 8 "Financial Statements
                 and Supplementary Data" in Part II of this Report.

         2.      Financial Statement Schedule and Exhibits filed in Part IV of
                 this report are as follows:

                 SCHEDULES*:

                 II       -    Valuation and Qualifying Account - Years Ended 
                               June 30, 1997, 1996 and 1995

                 *All other schedules are omitted because the required
                 information is inapplicable or the information is presented in
                 the financial statements and the related notes.

(b)      Reports on Form 8-K: None

(c)      Exhibits: see Index to Exhibits, pages 41-42.





                                      39
<PAGE>   42
                                   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.
                                          (Registrant)


                                        By:   /s/ SHERRILL STONE
                                            ---------------------------
                                              Sherrill Stone, Chairman,
                                              President, and Chief
                                              Executive Officer
Date: September 26, 1997.

         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 and on the dates indicated.

Date:

September 26, 1997                  /s/ SHERRILL STONE
                                -------------------------------------------
                                    Sherrill Stone, Chairman of the
                                    Board,   President, Director and
                                    Chief Executive Officer
                                
September 26, 1997                  /s/ KENT J. VAN HOUTEN
                                -------------------------------------------
                                    Kent J. Van Houten, Treasurer,
                                    Principal Financial Officer and
                                    Principal Accounting Officer
                                
September 26, 1997                  /s/ DONALD A. SILLERS
                                -------------------------------------------
                                    Donald A. Sillers, Jr., Director
                                
September 26, 1997                  /s/ J. V. MARINER
                                -------------------------------------------
                                    J. V. Mariner, Director
                                
September 26, 1997                  /s/ BERNARD S. LEE
                                -------------------------------------------
                                    Bernard S. Lee, Director
                                
September 26, 1997                  /s/ D. D. BATTERSHELL
                                -------------------------------------------
                                    D. D. Battershell, Director





                                       40
<PAGE>   43
                               INDEX TO EXHIBITS
<TABLE>
<CAPTION>
<S>              <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
FINANCIAL STATEMENT SCHEDULES:
         II      Valuation and Qualifying Accounts - Years
                 Ended June 30, 1997, 1996 and 1995 (included in Item 8)

EXHIBITS:
         3(a)     The Company's Articles of Incorporation, as  amended to date (filed
                  as Exhibit 1 to  the Company's Registration Statement on  Form S-1,
                  Registration No.  2-35767) and  amended by  the Company's  December
                  12,  1990  Form 8  amending Exhibit  3(a)  to the  Company's Annual
                  Report on  Form 10-K dated  June 30, 1990,  and incorporated herein
                  by reference).
         3(b)     The Company's Bylaws, as amended to date.*
         10(a)    Incentive Compensation Plan  effective January 1, 1981,  as amended
                  January 23,  1991 (filed as  Exhibit 10(b) to  the Company's Annual
                  Report on Form 10-K,  dated June 30, 1991, and  incorporated herein
                  by reference).
         10(b)    1985  Restricted  Stock  Plan  for  Peerless  Mfg.  Co.,  effective
                  December 13, 1985 (filed  as Exhibit 10(b) to the  Company's Annual
                  Report on Form 10-K,  dated June 30, 1993, and  incorporated herein
                  by reference).
         10(c)    1991 Restricted Stock  Plan for Non-Employee Directors  of Peerless
                  Mfg.  Co., adopted  subject to  shareholder approval May  24, 1991,
                  and approved  by shareholders November  20, 1991 (filed  as Exhibit
                  10(e) to  the Company's Annual  Report on Form 10-K  dated June 30,
                  1991 and incorporated herein by reference).
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<TABLE>
         <S>      <C>
         10(d)    Employment Agreement,  dated as of  April 29, 1994,  by and between
                  the  Company  and Sherrill  Stone (filed  as  Exhibit 10(d)  to the
                  Company's Annual  Report on  Form 10-K  for the  fiscal year  ended
                  June 30, 1994 and incorporated herein by reference).

         10(e)    Agreement,  dated as of April 29,  1994, by and between the Company
                  and Sherrill  Stone (filed as Exhibit 10(e) to the Company's Annual
                  Report on  Form 10-K for  the fiscal year  ended June 30,  1994 and
                  incorporated herein by reference).

         10(f)    Fifth Amended  and Restated Loan Agreement, dated as of February 3,
                  1997, between  NationsBank of Texas, N.A. and the Company (filed as
                  Exhibit 10(f)  to the Company's  Quarterly Report on  Form 10-Q for
                  the  quarter  ended March  31,  1997  and  incorporated  herein  by
                  reference).

         10(g)    Loan Agreement,  dated as of  March 7,  1997, by and  between Texas
                  Commerce  Bank  National  Association and  the  Company  (filed  as
                  Exhibit 10(g)  to the Company's  Quarterly Report on  Form 10-Q for
                  quarter  ended   March  31,   1997  and   incorporated  herein   by
                  reference).

         10(h)    Peerless  Mfg. Co.  1995  Stock Option  and Restricted  Stock Plan,
                  adopted by  the Board of  Directors December 31,  1995 and approved
                  by the Shareholders of the Company November 21, 1996.*

         21       Subsidiaries of the Company.*

         27       Financial Data Schedule.*

</TABLE>
--------------                                              
* Filed herewith





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