##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-Q (Mark One) þ Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the Quarterly Period Ended March 31, 2005 OR o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from  to Commission File Number 0-5214 PEERLESS MFG. CO.  Texas
    
    75-0724417(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)2819 Walnut Hill Lane, Dallas, Texas
    
    75229(Address of Principal Executive Offices)
    
    (Zip code)
 (214) 357-6181 
  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 þ No o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act).
Yes o No þ As of May 12, 2005, there were 3,036,434 shares of the Registrants common stock outstanding.   Page 1




---



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 TABLE OF CONTENTS PART I: FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets at March 31, 2005 (unaudited)
and June 30, 2004
    
    
    3Unaudited Condensed Consolidated Statements of Operations for the three months
and nine months ended March 31, 2005 and 2004
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for
the nine months ended March 31, 2005 and 2004
    
    
    5Notes to the Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    36PART II: OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    38Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of
Equity Securities
    
    
    38Item 3. Defaults Upon Senior Securities
    
    
    38Item 4. Submission of Matters to a Vote of Security Holders
    
    
    38Item 5. Other Information
    
    
    38Item 6. Exhibits and Reports on Form 8-K
    
    
    38SIGNATURES
    
    
    41Description of Compensation Payable to Non-Employee DirectorsEmployment AgreementRule 13a-14(a)/15d-14(a) Certification of CEORule 13a-14(a)/15d-14(a) Certification of CFOSection 1350 Certification of CEOSection 1350 Certification of CFO
  Page 2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements PEERLESS MFG. CO. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Dollars in thousands)
 March 31, 2005
    
    
    June 30, 2004(unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    9,458
    
    
    $
    4,119Accounts receivable  principally trade  net of
allowance of uncollectible accounts of $478 at
March 31, 2005 and $431 at June 30, 2004
    
    
    9,370
    
    
    
    13,604Inventories
    
    
    4,080
    
    
    
    3,106Costs and earnings in excess of billings
on uncompleted contracts
    
    
    10,395
    
    
    
    12,448Deferred income taxes
    
    
    1,165
    
    
    
    1,165Other   net
    
    
    1,304
    
    
    
    816Assets of discontinued operations
    
    
    216
    
    
    
    225Total current assets
    
    
    35,988
    
    
    
    35,483Property, plant and equipment  net
    
    
    2,913
    
    
    
    3,053Other assets
    
    
    868
    
    
    
    930Other assets of discontinued operations
    
    
    9
    
    
    
    9$
    39,778
    
    
    $
    39,475LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesAccount payable  trade
    
    
    8,946
    
    
    
    9,791Billings in excess of costs and earnings
on uncompleted contracts
    
    
    2,523
    
    
    
    399Commissions payable
    
    
    737
    
    
    
    844Income taxes payable
    
    
    
    
    
    
    557Product warranties
    
    
    1,042
    
    
    
    982Accrued liabilities and other
    
    
    1,734
    
    
    
    1,923Liabilities of discontinued operations
    
    
    224
    
    
    
    306Total current liabilities
    
    
    15,206
    
    
    
    14,802Shareholders equityCommon stock
    
    
    3,036
    
    
    
    3,014Additional paid-in capital
    
    
    2,104
    
    
    
    1,884Other
    
    
    292
    
    
    
    214Retained earnings
    
    
    19,140
    
    
    
    19,561Total shareholders equity
    
    
    24,572
    
    
    
    24,673Total liabilities and shareholders equity
    
    $
    39,778
    
    
    $
    39,475
 See accompanying notes to the condensed consolidated financial statements. Page 3




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Dollars in thousands, except per share amounts)
 Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues
    
    $
    12,999
    
    
    $
    13,491
    
    
    $
    35,061
    
    
    $
    46,727Cost of goods sold
    
    
    9,155
    
    
    
    8,679
    
    
    
    25,063
    
    
    
    32,564Gross profit
    
    
    3,844
    
    
    
    4,812
    
    
    
    9,998
    
    
    
    14,163Operating expensesSales and marketing
    
    
    1,558
    
    
    
    1,648
    
    
    
    4,440
    
    
    
    4,660Engineering and project management
    
    
    892
    
    
    
    1,041
    
    
    
    2,724
    
    
    
    3,172General and administrative
    
    
    1,200
    
    
    
    1,227
    
    
    
    3,612
    
    
    
    3,4633,650
    
    
    
    3,916
    
    
    
    10,776
    
    
    
    11,295Operating income (loss)
    
    
    194
    
    
    
    896
    
    
    
    (778
    )
    
    
    2,868Other income (expense)Foreign exchange gain (loss)
    
    
    3
    
    
    
    (68
    )
    
    
    68
    
    
    
    (20
    )Other income  net
    
    
    53
    
    
    
    14
    
    
    
    92
    
    
    
    4556
    
    
    
    (54
    )
    
    
    160
    
    
    
    25Earnings (loss) from continuing operations
before income taxes
    
    
    250
    
    
    
    842
    
    
    
    (618
    )
    
    
    2,893Income tax expense (benefit)
    
    
    45
    
    
    
    287
    
    
    
    (250
    )
    
    
    989Net earnings (loss) from continuing operations
    
    
    205
    
    
    
    555
    
    
    
    (368
    )
    
    
    1,904Discontinued operations (Note 7)Loss from discontinued operations
(including gain on disposal of $0 and $140 in
nine months ended 2005 and 2004, respectively)
    
    
    
    
    
    
    (179
    )
    
    
    (80
    )
    
    
    (297
    )Income tax benefit
    
    
    
    
    
    
    (62
    )
    
    
    (27
    )
    
    
    (103
    )Net loss from discontinued operations
    
    
    
    
    
    
    (117
    )
    
    
    (53
    )
    
    
    (194
    )Net earnings (loss)
    
    $
    205
    
    
    $
    438
    
    
    $
    (421
    )
    
    $
    1,710BASIC EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    0.07
    
    
    $
    0.18
    
    
    $
    (0.12
    )
    
    $
    0.63Loss from discontinued operations
    
    
    0.00
    
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.06
    )Basic earnings (loss) per share
    
    $
    0.07
    
    
    $
    0.15
    
    
    $
    (0.14
    )
    
    $
    0.57DILUTED EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    0.07
    
    
    $
    0.18
    
    
    $
    (0.12
    )
    
    $
    0.63Loss from discontinued operations
    
    
    0.00
    
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.06
    )Diluted earnings (loss) per share
    
    $
    0.07
    
    
    $
    0.14
    
    
    $
    (0.14
    )
    
    $
    0.56
 See accompanying notes to the condensed consolidated financial statements. Page 4




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Dollars in thousands)
  Nine months endedMarch 31,2005
    
    
    2004Cash flows from operating activities:Net earnings (loss)
    
    $
    (421
    )
    
    $
    1,710Net loss from discontinued operations
    
    
    (53
    )
    
    
    (194
    )Net earnings (loss) from continuing operations
    
    
    (368
    )
    
    
    1,904Adjustments to reconcile net earnings (loss) from
continuing operations to net cash provided by
operating activities of continuing operations:Depreciation and amortization
    
    
    487
    
    
    
    583Bad debt expense
    
    
    268
    
    
    
    (11
    )Foreign exchange (gain) loss
    
    
    (68
    )
    
    
    20Other
    
    
    70
    
    
    
    Changes in operating assets and liabilitiesAccounts receivable
    
    
    4,003
    
    
    
    1,533Inventories
    
    
    (973
    )
    
    
    (383
    )Costs and earnings in excess of billings on
uncompleted contracts
    
    
    2,094
    
    
    
    (3,768
    )Other current assets
    
    
    (488
    )
    
    
    450Other assets
    
    
    62
    
    
    
    (72
    )Accounts payable
    
    
    (795
    )
    
    
    (3
    )Billings in excess of costs and earnings on
uncompleted contracts
    
    
    2,124
    
    
    
    (1,372
    )Commissions payable
    
    
    (107
    )
    
    
    (154
    )Product warranties
    
    

    60
    
    
    
    (26
    )Income taxes payable
    
    
    (557
    )
    
    
    674Accrued liabilities and other
    
    
    (178
    )
    
    
    (748
    )6,002
    
    
    
    (3,277
    )Net cash provided by (used in) operating activities
    
    
    5,634
    
    
    
    (1,373
    )Cash flow from investing activities:Net proceeds from short-term investments
    
    
    
    
    
    
    248Net purchases of property and equipment
    
    
    (347
    )
    
    
    (301
    )Net cash used in investing activities
    
    
    (347
    )
    
    
    (53
    )Cash flows from financing activities:Proceeds from sale of common stock
    
    
    173
    
    
    
    51Net cash provided by financing activities
    
    
    173
    
    
    
    51Net cash provided by (used in) discontinued operations
    
    
    (126
    )
    
    
    1,664Effect of exchange rate changes on
cash and cash equivalents
    
    
    5
    
    
    
    (9
    )Net increase in cash and cash equivalents
    
    
    5,339
    
    
    
    280Cash and cash equivalents at beginning of period
    
    
    4,119
    
    
    
    6,680Cash and cash equivalents at end of period
    
    $
    9,458
    
    
    $
    6,960
 See accompanying notes to condensed consolidated financial statements. Page 5




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 1. Basis of Presentation The accompanying condensed consolidated financial statements of Peerless Mfg. Co. and Subsidiaries
(hereafter referred to as the Company, we, us, our) have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial
information. The condensed consolidated financial statements of the Company as of March 31, 2005,
and for the three and nine months ended March 31, 2005 and March 31, 2004 are unaudited and, in the
opinion of management, contain all adjustments necessary for the fair presentation of the financial
position and results of operations of the Company for the interim periods. These condensed
consolidated financial statements should be read in conjunction with the financial statements and
notes thereto included in the Companys Annual Report on Form 10-K for the year ended June 30,
2004. The results of operations for the three and nine months ended March 31, 2005 are not
necessarily indicative of the results to be expected for the entire year (see Item 2 
Managements Discussion and Analysis of Financial Condition and Results of Operations - Factors
That May Affect Our Operating Results and Other Risk Factors). The Companys fiscal year ends on
June 30. References herein to fiscal 2004 and fiscal 2005 refer to our fiscal years ended June 30,
2004 and 2005, respectively. In connection with the discontinuation of our Boiler operations (see Note 7  Discontinued
Operations in our Notes to Consolidated Financial Statements), the financial information has been
presented to report the discontinued operations in accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. Certain fiscal 2004 items have been reclassified to conform to the fiscal 2005 presentation.
Unless otherwise noted, all dollar and share amounts in the tables are in thousands, except per
share amounts. 2. New Accounting Standards In November 2004, the FASB issued SFAS No. 151, Inventory Costs(SFAS 151). SFAS 151 requires that
abnormal amounts of idle facility expense, freight, handling costs and spoilage be recognized as
current-period charges. Further, SFAS 151 requires the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. Unallocated overheads must be
recognized as an expense in the period in which they are incurred. SFAS 151 is effective for
inventory costs incurred beginning in the first quarter of fiscal 2006. The Company is currently
evaluating the effect of SFAS 151 on its financial statements and related disclosures. In December 2004, the Financial Accounting Standards Board (FASB) issued the revised SFAS No. 123R,
Share-Based Payment(SFAS 123R). SFAS 123R requires compensation costs related to share-based
payment transactions to be recognized in the financial statements. Generally, compensation cost
will be measured based on the grant-date fair value of the equity or liability instruments issued.
In addition, liability awards will be re-measured each reporting period. Compensation cost will be
recognized over the requisite service period, generally, as the award vests. The Company will be
required to adopt SFAS 123R in the first quarter of fiscal 2006. SFAS 123R applies to all awards
granted after June 30, 2005 and to previously granted awards unvested as of the adoption date. The
Company is currently evaluating the impact that the adoption of SFAS 123R will have on its
financial statements and related disclosures. Page 6




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 3. Accounts Receivable The Companys accounts receivable are due from companies in various industries. Credit is extended
based on evaluation of a customers financial condition and, generally collateral is not required
except on credit extension to international customers. Accounts receivable are generally due
within 30 days and are stated at amounts due from customers net of an allowance for uncollectible
accounts. Accounts outstanding longer than contractual payment terms are considered past due. The
Company records an allowance on a specific basis by considering a number of factors, including the
length of time the trade accounts receivable are past due, the Companys previous loss history, the
customers current ability to pay its obligation to the Company, and the condition of the general
economy and the industry as a whole. The Company writes-off accounts receivable when they become
uncollectible, and payments subsequently received on such receivables are credited back to bad debt
expense in the period the payment is received. Changes in the Companys allowance for uncollectible accounts are as follows: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Balance at beginning of period
    
    $
    427
    
    
    $
    383
    
    
    $
    431
    
    
    $
    402Bad debt expense
    
    
    51
    
    
    
    
    
    
    
    268
    
    
    
    (11
    )Accounts written off, net
    
    
    
    
    
    
    
    
    
    
    (221
    )
    
    
    (8
    )Balance at end of period
    
    $
    478
    
    
    $
    383
    
    
    $
    478
    
    
    $
    383
 4. Inventories Inventories are valued at the lower of cost or market. Cost is determined by the first-in,
first-out (FIFO) method, including material, labor and factory overhead. The Company regularly
reviews inventory values on hand, using specific aging categories, and records a provision for
excess and potentially obsolete inventories based on historical usage and estimated future usage.
In assessing the ultimate realization of its inventory, the Company is required to make judgments
as to future demand requirements. As actual future demand or market conditions may vary from those
projected by the Company, adjustments to inventory valuations may be required. Principal components of inventories are as follows : March 31,
    
    
    June 30,2005
    
    
    2004Raw materials
    
    $
    3,447
    
    
    $
    2,630Work in progress
    
    
    567
    
    
    
    427Finished goods
    
    
    299
    
    
    
    2454,313
    
    
    
    3,302Reserve for excess and potentially
obsolete inventory
    
    
    (233
    )
    
    
    (196
    )$
    4,080
    
    
    $
    3,106
 Page 7




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 4. Inventories - Continued Changes in the Companys reserve for obsolete and slow-moving inventory are as follows: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Balance at beginning of period
    
    $
    218
    
    
    $
    184
    
    
    $
    196
    
    
    $
    122Additions/adjustments
    
    
    15
    
    
    
    (81
    )
    
    
    37
    
    
    
    (19
    )Amounts written off
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at end of period
    
    $
    233
    
    
    $
    103
    
    
    $
    233
    
    
    $
    103
 5. Product Warranties The Company warrants that its products will be free from defects in materials and workmanship and
will conform to agreed upon specifications at the time of delivery and typically for a period of 12
to 18 months from the date of customer acceptance, depending upon the specific product and terms of
the customer agreement. Typical warranties require the Company to repair or replace defective
products during the warranty period at no cost to the customer. The Company attempts to obtain
back-up concurrent warranties for major component parts from its suppliers. The Company provides
for the estimated cost of product warranties, based on historical experience by product type,
expectation of future conditions and the extent of back-up concurrent supplier warranties in place,
at the time the product revenue is recognized. Revision to the estimated product warranties is
made when necessary, based on changes in these factors. Changes in the Companys product warranty reserve are as follows: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Balance at beginning of period
    
    $
    984
    
    
    $
    771
    
    
    $
    982
    
    
    $
    846Provision for warranty expenses
    
    
    213
    
    
    
    144
    
    
    
    419
    
    
    
    499Warranty charges
    
    
    (155
    )
    
    
    (95
    )
    
    
    (359
    )
    
    
    (525
    )Balance at end of period
    
    $
    1,042
    
    
    $
    820
    
    
    $
    1,042
    
    
    $
    820
 Page 8




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 6. Revenue Recognition and Cost and Earnings on Uncompleted Contracts The Company provides products under long-term, generally fixed-priced, contracts that may extend up
to 18 months, or longer, in duration. In connection with these contracts, the Company follows the
guidance contained in AICPA Statement of Position 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts(SOP 81.1). SOP81-1 requires the use of
percentage-of-completion accounting for long-term contracts that contain enforceable rights
regarding services to be provided and received by the contracting parties, consideration to be
exchanged, and the manner and terms of settlement, assuming reasonably dependable estimates of
revenues and expenses can be made. The percentage-of-completion methodology generally results in
the recognition of reasonably consistent profit margins over the life of a contract. If it is
determined that a loss will result from the performance of a contract, the entire amount of the
loss is charged against income when it is determined. Amounts recognized in revenue are calculated
using the percentage of construction cost completed, generally on a cumulative cost to total cost
basis. Cumulative revenues recognized may be less or greater than cumulative costs and profits
billed at any point in time during a contracts term. The resulting difference is recognized as
costs and earnings in excess of billings on uncompleted contracts or billings in excess of costs
and earnings on uncompleted contracts. The completed contract method is applied to relatively short-term contracts where the financial
statement presentation does not vary materially from the presentation under the
percentage-of-completion method. Revenues under the completed contract method are recognized upon
shipment of the product. The components of uncompleted contracts are as follows: March 31,
    
    
    June 30,2005
    
    
    2004Costs incurred on uncompleted contracts and
estimated earnings
    
    $
    51,189
    
    
    $
    44,348Less billings to date
    
    
    (43,317
    )
    
    
    (32,299
    )$
    7,872
    
    
    $
    12,049
 The components of uncompleted contracts are reflected in the balance sheets as follows: March 31,
    
    
    June 30,2005
    
    
    2004Costs and earnings in excess of billings on
uncompleted contracts
    
    $
    10,395
    
    
    $
    12,448Billings in excess of costs and earnings on
uncompleted contracts
    
    
    (2,523
    )
    
    
    (399
    )$
    7,872
    
    
    $
    12,049
 Page 9




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 7. Discontinued Operations During the first quarter of fiscal 2004, the Board of Directors authorized the divestiture, and the
Company sold for $250,000 certain assets, of its Boiler business segment with a net book value of
approximately $110,000, resulting in a gain on disposal of $140,000. The following represents a summary of operating results and the gain on disposition of the boiler
segment presented as discontinued operations: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    360Cost of goods sold
    
    
    
    
    
    
    136
    
    
    
    75
    
    
    
    514Gross profit (loss)
    
    
    
    
    
    
    (136
    )
    
    
    (75
    )
    
    
    (154
    )Operating expenses
    
    
    
    
    
    
    43
    
    
    
    5
    
    
    
    283Operating loss
    
    
    
    
    
    
    (179
    )
    
    
    (80
    )
    
    
    (437
    )Income tax benefit
    
    
    
    
    
    
    (62
    )
    
    
    (27
    )
    
    
    (151
    )Net loss from operations
    
    
    
    
    
    
    (117
    )
    
    
    (53
    )
    
    
    (286
    )Gain on disposal, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    92Net loss from operations
    
    $
    
    
    
    $
    (117
    )
    
    $
    (53
    )
    
    $
    (194
    )Diluted loss per shareNet loss from operations
    
    $
    
    
    
    $
    (0.04
    )
    
    $
    (0.02
    )
    
    $
    (0.09
    )Net gain on disposal
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    0.03Net loss
    
    $
    
    
    
    $
    (0.04
    )
    
    $
    (0.02
    )
    
    $
    (0.06
    )
 The current and non-current assets and liabilities of the discontinued boiler segment are as
follows: March 31,
    
    
    June 30,2005
    
    
    2004AssetsAccounts receivable, principally trade  net of
allowance for uncollectible accounts of $10
at March 31, 2005 and June 30, 2004.
    
    $
    216
    
    
    $
    225Current assets of discontinued operations
    
    
    216
    
    
    
    225Equipment  net of accumulated depreciation of $11
at March 31, 2005 and June 30, 2004.
    
    
    9
    
    
    
    9Total assets of discontinued operations
    
    $
    225
    
    
    $
    234LiabilitiesCommissions payable
    
    
    
    
    
    
    6Product warranties and start-up reserves
    
    
    224
    
    
    
    300Total current liabilities of discontinued operations
    
    $
    224
    
    
    $
    306
 Page 10




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 8. Income Taxes On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the Act). The
Act creates a temporary incentive for U.S. corporations to repatriate foreign subsidiary earnings
by providing an elective 85% dividends received deduction for certain dividends from controlled
foreign corporations. In December 2004, the FASB issued FSP 109-2, Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of
2004.FSP 109-2 provides companies with additional time beyond the financial reporting period of
enactment to evaluate the effects of the Act on their plans for repatriation of foreign earnings
for purposes of applying SFAS 109, Accounting for Income Taxes. On January 13, 2005 the U.S.
Treasury published Notice 2005-10 providing guidance on the implementation of the repatriation
deduction. The Company is currently evaluating the repatriation provisions of the Act, which if
implemented by the Company would affect the Companys tax provision and deferred tax assets and
liabilities. However, given the preliminary stage of the Companys evaluation, it is not possible
at this time to determine the amount that may be repatriated or the related potential income tax
effects of such repatriation. 9. Contingencies On March 19, 2004, the Company received notice that an adversary proceeding was initiated by Enron
Corp. and National Energy Production Corporation in the United States Bankruptcy Court for the
Southern District of New York against PMC Acquisition, Inc., a subsidiary that operated the
discontinued Boiler business under the name ABCO Industries, alleging that certain accounts
receivable payments paid to ABCO were avoidable transfers under the Bankruptcy Code. The
plaintiffs are seeking to recover approximately $1.0 million from ABCO. The Company believes that
all or a majority of the payments fail to meet the applicable standards for avoidance under the
Bankruptcy Code and other applicable law, and that a number of defenses can be asserted that will
negate any recovery by the plaintiffs. The Company intends to vigorously defend against the
lawsuit and management believes the likelihood of loss is not probable. On April 25, 2005, the Company received notice that the Company may have received preferential
transfers amounting to approximately $900,000 in connection with the Chapter 11 filing by Erie
Power Technologies, Inc. Based on its preliminary investigation, the Company believes that all of
the payments received fail to meet the applicable standards for avoidance under the Bankruptcy Code
and other applicable law, and that a number of defenses can be asserted that will negate any
recovery by the plaintiffs. The Company intends to vigorously defend against the lawsuit and
management believes the likelihood of loss is not probable. From time to time the Company is involved in various litigation matters arising in the ordinary
course of its business. The Company does not believe the disposition of any current matter will
have a material adverse effect on its consolidated financial position or its results of operations. Page 11




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 10. Comprehensive Income (Loss) Comprehensive income (loss) is defined as all changes in equity during a period, except those
resulting from investments by owners and distributions to owners. The components of comprehensive
income (loss) were as follows: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net earnings (loss) from continuing
operations
    
    $
    205
    
    
    $
    555
    
    
    $
    (368
    )
    
    $
    1,904Net loss from discontinued operations
    
    
    
    
    
    
    (117
    )
    
    
    (53
    )
    
    
    (194
    )Foreign currency translation adjustment
    
    
    (42
    )
    
    
    60
    
    
    
    78
    
    
    
    222Comprehensive income (loss)
    
    $
    163
    
    
    $
    498
    
    
    $
    (343
    )
    
    $
    1,932
 11. Earnings (Loss) Per Share Basic earnings (loss) per share have been computed by dividing net earnings (loss) by the weighted
average number of common shares outstanding during the applicable period. Diluted earnings (loss)
per share reflect the potential dilution that could occur if options or other contracts to issue
common shares were exercised or converted into common stock. The following table sets forth the
computation for basic and diluted earnings (loss) per share for the periods indicated. Certain
earnings (loss) per share amounts may not total due to rounding. Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net earnings (loss) from continuing operations
    
    $
    205
    
    
    $
    555
    
    
    $
    (368
    )
    
    $
    1,904Loss from discontinued operations
    
    
    
    
    
    
    (117
    )
    
    
    (53
    )
    
    
    (194
    )Net earnings (loss)
    
    $
    205
    
    
    $
    438
    
    
    $
    (421
    )
    
    $
    1,710Basic weighted average common shares outstanding
    
    
    3,032
    
    
    
    3,004
    
    
    
    3,026
    
    
    
    3,001Effect of dilutive options
    
    
    43
    
    
    
    44
    
    
    
    
    
    
    
    43Diluted weighted average
common shares outstanding
    
    
    3,075
    
    
    
    3,048
    
    
    
    3,026
    
    
    
    3,044BASIC EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    0.07
    
    
    $
    0.18
    
    
    $
    (0.12
    )
    
    $
    0.63Loss from discontinued operations
    
    
    0.00
    
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.06
    )Net earnings (loss) per share
    
    $
    0.07
    
    
    $
    0.15
    
    
    $
    (0.14

    )
    
    $
    0.57DILUTED EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    0.07
    
    
    $
    0.18
    
    
    $
    (0.12
    )
    
    $
    0.63Loss from discontinued operations
    
    
    0.00
    
    
    
    (0.04
    )
    
    
    (0.02
    )
    
    
    (0.06
    )Net earnings (loss) per share
    
    $
    0.07
    
    
    $
    0.14
    
    
    $
    (0.14
    )
    
    $
    0.56
 Diluted weighted average common shares outstanding excluded 80,800 and 166,967 outstanding stock
options for the three and nine months ended March 31, 2005 because their impact would be
anti-dilutive. Likewise, diluted weighted average common shares outstanding excluded 96,700 and
87,467 outstanding stock options for the three and nine months ended March 31, 2004, respectively,
because their impact would be anti-dilutive. Page 12




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 12. Stock-Based Compensation In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure
(SFAS 148) which amends Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123). SFAS 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based employee compensation
and requires disclosures in annual and interim financial statements of the effects of stock-based
compensation as reflected below. The Company continues to account for its stock options under the recognition and measurement
principles of Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to
Employees, and related interpretations. No stock-based employee compensation expense related to
the Companys stock options is reflected in the net earnings (loss), as all options granted under
the plan had an exercise price equal to the market value of the underlying common stock on the date
of grant. The following table illustrates the effect on net earnings (loss) and earnings (loss)
per share if the Company had applied the fair value recognition provisions of SFAS 123 to
stock-based compensation. Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net earnings (loss), as reported
    
    $
    205
    
    
    $
    438
    
    
    $
    (421
    )
    
    $
    1,710Deduct: Total stock-based employee compensation
expense determined using
the fair value based
method
for all awards, net of tax
    
    
    (48
    )
    
    
    (23
    )
    
    
    (118
    )
    
    
    (146
    )Pro forma net earnings (loss)
    
    $
    157
    
    
    $
    415
    
    
    $
    (539
    )
    
    $
    1,564Earnings (loss) per share:Basic  as reported
    
    $
    0.07
    
    
    $
    0.15
    
    
    $
    (0.14
    )
    
    $
    0.57Basic  pro forma
    
    $
    0.05
    
    
    $
    0.14
    
    
    $
    (0.18
    )
    
    $
    0.52Diluted  as reported
    
    $
    0.07
    
    
    $
    0.14
    
    
    $
    (0.14
    )
    
    $
    0.56Diluted  pro forma
    
    $
    0.05
    
    
    $
    0.14
    
    
    $
    (0.18
    )
    
    $
    0.51
 13. Segment Information The Company identifies reportable segments based on management responsibility within the corporate
structure. The Company has two reportable industry segments: Environmental Systems and Separation
Filtration Systems. The main product of its Environmental Systems segment is its Selective
Catalytic Reduction Systems, referred to as SCR Systems. These environmental control systems are
used for air pollution abatement and convert nitrogen oxide (NOx) emissions from exhaust gases
caused by burning hydrocarbon fuels such as coal, gasoline, natural gas and oil, into harmless
nitrogen and water vapor. Along with the SCR Systems, this segment also offers systems to reduce
other pollutants such as carbon monoxide (CO) and particulate matter. The Company combines these
systems with other components, such as instruments, controls and related valves and piping to offer
customers a totally integrated system. The Separation Filtration Page 13




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 13. Segment Information - Continued Systems segment produces various types of separators and filters used for removing liquids and
solids from air and other gases. This segment also provides engineering design and services,
pulsation dampeners, natural gas odorizers, quick-opening closures and parts for its products. Segment profit and loss is based on revenue less direct expenses of the segment before allocation
of general, administrative, research and development costs. All inter-company transfers between
segments have been eliminated. The Company allocates all costs associated with the design,
manufacture, and sale of its products to the appropriate segment. Segment information and
reconciliation to operating profit for the three and nine months ended March 31, 2005 and March 31,
2004 are presented below. The Company does not allocate general and administrative expenses
(unallocated overhead), assets, expenditures for assets or depreciation expense on a segment
basis for internal management reporting, and therefore such information is not presented. SeparationEnvironmental
    
    
    Filtration
    
    
    UnallocatedSystems
    
    
    Systems
    
    
    Overhead
    
    
    ConsolidatedThree months ended March 31, 2005Net sales from customers
    
    $
    6,549
    
    
    $
    6,450
    
    
    $
    
    
    
    $
    12,999Segment profit (loss)
    
    
    645
    
    
    
    749
    
    
    
    (1,200
    )
    
    
    194Three months ended March 31, 2004Net sales from customers
    
    $
    4,937
    
    
    $
    8,554
    
    
    $
    
    
    
    $
    13,491Segment profit
    
    
    694
    
    
    
    1,429
    
    
    
    (1,227
    )
    
    
    896Nine months ended March 31, 2005Net sales from customers
    
    $
    15,526
    
    
    $
    19,535
    
    
    $
    
    
    
    $
    35,061Segment profit (loss)
    
    
    1,919
    
    
    
    915
    
    
    
    (3,612
    )
    
    
    (778
    )Nine months ended March 31, 2004Net sales from customers
    
    $
    23,946
    
    
    $
    22,781
    
    
    $
    
    
    
    $
    46,727Segment profit
    
    
    3,923
    
    
    
    2,408
    
    
    
    (3,463
    )
    
    
    2,868
 Page 14




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 14. Industry Segment and Geographic Information The Company attributes revenues from external customers to individual geographic areas based on the
country where the sale originated. Information about the Companys operations in different
geographic areas as of and for the three and nine months ended March 31, 2005 and March 31, 2004 is
as follows: UnitedStates
    
    
    Europe
    
    
    Eliminations
    
    
    ConsolidatedThree months ended March 31, 2005Net sales to unaffiliated
customers
    
    $
    10,242
    
    
    $
    2,757
    
    
    $
    
    
    
    $
    12,999Transfers between geographic areas
    
    
    1,128
    
    
    
    
    
    
    
    (1,128
    )
    
    
    Total
    
    $
    11,370
    
    
    $
    2,757
    
    
    $
    (1,128
    )
    
    $
    12,999Identifiable long-lived assets
    
    $
    2,829
    
    
    $
    84
    
    
    $
    
    
    
    $
    2,913Three months ended March 31, 2004Net sales to unaffiliated
customers
    
    $
    10,788
    
    
    $
    2,703
    
    
    $
    
    
    
    $
    13,491Transfers between geographic areas
    
    
    1,191
    
    
    
    
    
    
    
    (1,191
    )
    
    
    Total
    
    $
    11,979
    
    
    $
    2,703
    
    
    $
    (1,191
    )
    
    $
    13,491Identifiable long-lived assets
    
    $
    3,017
    
    
    $
    101
    
    
    $
    
    
    
    $
    3,118Nine months ended March 31, 2005Net sales to unaffiliated
customers
    
    $
    28,842
    
    
    $
    6,219
    
    
    $
    
    
    
    $
    35,061Transfers between geographic areas
    
    
    1,809
    
    
    
    
    
    
    
    (1,809
    )
    
    
    Total
    
    $
    30,651
    
    
    $
    6,219
    
    
    $
    (1,809
    )
    
    $
    35,061Identifiable long-lived assets
    
    $
    2,829
    
    
    $
    84
    
    
    $
    
    
    
    $
    2,913Nine months ended March 31, 2004Net sales to unaffiliated
customers
    
    $
    38,163
    
    
    $
    8,564
    
    
    
    
    
    
    $
    46,727Transfers between geographic areas
    
    
    1,431
    
    
    
    
    
    
    
    (1,431
    )
    
    
    Total
    
    $
    39,594
    
    
    $
    8,564
    
    
    $

    (1,431
    )
    
    $
    46,727Identifiable long-lived assets
    
    $
    3,017
    
    
    $
    101
    
    
    $
    
    
    
    $
    3,118
 Transfers between the geographic areas primarily represent inter-company export sales and are
accounted for based on established sales prices between the related companies. Identifiable long-lived assets of geographic areas are those assets related to the Companys
operations in each area. Page 15




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 15. Lines of Credit The Company maintains a $12.5 million revolving line of credit facility for working capital
requirements that expires on October 31, 2006. The credit line carries a floating interest rate
based on the prime or Euro rate plus or minus an applicable margin (Euro plus 1.75% at March 31,
2005), and is secured by substantially all of the Companys assets. As of March 31, 2005, the
Company had no outstanding balances under the credit line, and $3.2 million outstanding under
stand-by letters of credit, leaving $9.3 million of availability under the facility. The facility
contains financial covenants, restrictions on capital expenditures, acquisitions, asset
dispositions, and additional debt, as well as other customary covenants. As of March 31, 2005, the
Company was in compliance with all financial and other covenants of the loan agreement. In addition, our subsidiary located in the United Kingdom (our UK subsidiary) has a £2.4 million
(approximately $4.5 million) debenture agreement used to facilitate the issuances of bank
guarantees. This facility is secured by substantially all of the UK subsidiarys assets, and is
backed by a Peerless stand-by letter of credit of £1.0 million (approximately $1.9 million, which
is included in the $3.2 million outstanding under stand-by letters of credit as described above)
and expires on October 31, 2005. At March 31, 2005, there was approximately £2.2 million
outstanding under this facility, leaving availability of approximately £200,000 (approximately
$375,000). 16. Supplemental Cash Flow Information Net cash flows from operating activities reflects cash payments for income taxes as follows: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Income taxes paid
    
    $
    
    
    
    $
    
    
    
    $
    660
    
    
    $
    251
 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements From time to time, we make oral and written statements that may constitute forward-looking
statements (rather than historical facts) as defined in the Private Securities Litigation Reform
Act of 1996 or by the Securities and Exchange Commission in its rules, regulations and releases,
including statements regarding our expectations, hopes, beliefs, intentions, projections or
strategies regarding the future. We desire to avail ourselves of the safe harbor provisions in
the Private Securities Litigation Reform Act of 1996 for forward-looking statements made from time
to time, including, but not limited to, the forward-looking statements made in this Report, as well
as those made in our other filings with the SEC. Forward-looking statements contained in this
Report are based on managements current plans and expectations and are subject to a number of
risks and uncertainties that could cause actual results to differ materially from those described
in the forward-looking statements. In the preparation of this Report, where such Page 16




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 forward-looking statements appear, we have sought to accompany such statements with meaningful
cautionary statements identifying important factors that could cause actual results to differ
materially from those described in the forward-looking statements. Such factors include, but are
not limited to, the Factors That May Affect Our Operating Results and Other Risk Factors, as set
forth starting on page 31 of this Report. All forward-looking statements included in this Report are based on information available to
us on the date hereof, and we expressly disclaim any obligation to release publicly any updates or
changes in the forward-looking statements, whether as a result of changes in events, conditions, or
circumstances on which any forward-looking statement is based. Overview We are a global company providing environmental and separation filtration products for the
abatement of air pollution and the removal of contaminants from gases and liquids through our two
principal business segments  Environmental Systems and Separation Filtration Systems. During
fiscal year 2004, we discontinued the operations of our Boiler business. See Note 7 
Discontinued Operations in our Notes to Condensed Consolidated Financial Statements of this
Report for additional discussion on the discontinuance of this business unit. Environmental Systems.This business segment represented approximately 44% and 51% of our
revenues for the nine months ended March 31, 2005 and 2004, respectively. The main product of the
Environmental Systems segment is Selective Catalytic Reduction Systems, referred to as SCR
Systems. These environmental control systems are used for air pollution abatement and convert NOx
emissions from exhaust gases caused by burning hydrocarbon fuels such as coal, gasoline, natural
gas and oil, into harmless nitrogen and water vapor. Along with the SCR Systems, this segment also
offers systems to reduce other pollutants such as CO and particulate matter. These systems are
totally integrated, complete with instruments, controls and related valves and piping. Separation Filtration Systems.This business segment represented approximately 56% and 49% of
our revenues for the nine months ended March 31, 2005 and 2004, respectively. The Separation
Filtration Systems segment produces specialized products known as separators or filters which
are used for a variety of purposes in cleaning gases and liquids as they move through piping
systems. These products are used primarily to remove solid and liquid contaminants from natural
gas as well as saltwater aerosols from combustion intake air of shipboard gas turbine and diesel
engines. In addition, separators are also used in nuclear power plants to remove water from
saturated steam. Boilers.In this discontinued business segment, we designed, engineered, manufactured and
sold packaged boilers and other steam generating equipment. This equipment is used to produce
steam, which is used for heating, drying, driving steam engines and a variety of other
applications. See also Note 7  Discontinued Operations in the Notes to the Consolidated
Financial Statements of this Report for additional information regarding the Boiler segment. Page 17




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Critical Accounting Policies The preparation of our financial statements in conformity with accounting principles generally
accepted in the United States of America requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
as of the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Our estimates, judgments and assumptions are continually evaluated based on
available information and experience. Because of the use of estimates inherent in the financial
reporting process, actual results could differ from those estimates. Certain of our accounting policies require a higher degree of judgment than others in their
application. These include revenue recognition on long-term contracts, accrual for estimated
warranty costs, allowance for doubtful accounts, and reserve for obsolete and slow moving
inventory. Our policies and related procedures for these items are summarized below. Revenue Recognition. We provide products under long-term, generally fixed-priced, contracts
that may extend up to 18 months, or longer, in duration. In connection with these contracts, we
follow the guidance contained in AICPA Statement of Position (SOP) 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts. SOP 81-1 requires the use
of percentage-of-completion accounting for long-term contracts that contain enforceable rights
regarding services to be provided and received by the contracting parties, consideration to be
exchanged, and the manner and terms of settlement, assuming reasonably dependable estimates of
revenues and expenses can be made. The percentage-of-completion methodology generally results in
the recognition of reasonably consistent profit margins over the life of a contract. Amounts
recognized in revenue are calculated using the percentage of construction cost completed, generally
on a cumulative cost to total cost basis. Cumulative revenues recognized may be less or greater
than cumulative costs and profits billed at any point in time during a contracts term. The
resulting difference is recognized as costs and earnings in excess of billings on uncompleted
contracts or billings in excess of costs and earnings on uncompleted contracts. When using the percentage-of-completion method, we must be able to accurately estimate the
total costs we expect to incur on a project in order to record the proper amount of revenues for
that period. We continually update our estimates of costs and status of each project with our
subcontractors and our manufacturing plants. If it is determined that a loss will result from the
performance of a contract, the entire amount of the loss is charged against income when it is
determined. The impact of revisions in contract estimates are recognized on a cumulative basis in
the period in which the revisions are made. In addition, significant portions of our costs are
subcontracted under fixed-priced arrangements, thereby reducing the risk of significant cost
overruns on any given project. However, a number of internal and external factors, including labor
rates, plant utilization factors, future material prices, changes in customer specifications, and
other factors can affect our cost estimates. While we attempt to reduce the risk relating to
revenue and cost estimates in percentage-of-completion models through corporate policy and approval
and monitoring processes, any estimation process, including that used in preparing contract
accounting models, involves inherent risk. Page 18




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Product Warranties. We offer warranty periods of various lengths to our customers
depending upon the specific product and terms of the customer agreement. We typically negotiate
varying terms regarding warranty coverage and length of warranty depending upon the product
involved and customary practices. In general, our warranties require us to repair or replace
defective products during the warranty period at no cost to the customer. We attempt to obtain
back-up concurrent warranties for major component parts from our suppliers. As of each balance
sheet date, we record an estimate for warranty related costs for products sold based on historical
experience, expectation of future conditions and the extent of back-up concurrent supplier
warranties in place. While we believe that our estimated warranty reserve is adequate and the
judgment applied is appropriate, due to a number of factors our estimated liability for product
warranties could differ from actual warranty costs incurred in the future. Allowance for Doubtful Accounts.We maintain an allowance for doubtful accounts to reflect
estimated losses resulting from the inability of customers to make required payments. On an
on-going basis, we evaluate the collectability of accounts receivable based upon historical
collection trends, current economic factors, and the assessment of the collectability of specific
accounts. We evaluate the collectability of specific accounts using a combination of factors,
including the age of the outstanding balances, evaluation of customers current and past financial
condition and credit scores, recent payment history, current economic environment, discussions with
our project managers, and discussions with the customers directly. Reserve for Obsolete and Slow-Moving Inventory.Inventories are valued at the lower of cost
or market and are reduced by a reserve for excess and potentially obsolete inventories. The
Company regularly reviews inventory values on hand, using specific aging categories, and records a
provision for obsolete and slow-moving inventory based on historical usage and estimated future
usage. As actual future demand or market conditions may vary from those projected by management,
adjustments to inventory valuations may be required. Results of Operations The following table displays our statements of operations as a percentage of net revenues: Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    70.4
    
    
    
    64.4
    
    
    
    71.5
    
    
    
    69.7Gross profit
    
    
    29.6
    
    
    
    35.6
    
    
    
    28.5
    
    
    
    30.3Operating expenses
    
    
    28.1
    
    
    
    29.0
    
    
    
    30.7
    
    
    
    24.2Operating income (loss)
    
    
    1.5
    
    
    
    6.6
    
    
    
    (2.2
    )
    
    
    6.1Other income (expense)
    
    
    0.4
    
    
    
    (0.4
    )
    
    
    0.5
    
    
    
    0.1Net earnings (loss) from continuing
operations before income taxes
    
    
    1.9
    
    
    
    6.2
    
    
    
    (1.7
    )
    
    
    6.2Income tax expense (benefit)
    
    
    0.3
    
    
    
    2.1
    
    
    
    (0.7
    )
    
    
    2.1Net earnings (loss) from continuing operations
    
    
    1.6
    
    
    
    4.1
    
    
    
    (1.0
    )
    
    
    4.1Loss from discontinued operations,
net of tax
    
    
    
    
    
    
    (0.9
    )
    
    
    (0.2
    )
    
    
    (0.4
    )Net earnings (loss)
    
    
    1.6
    %
    
    
    3.2
    %
    
    
    (1.2
    )%
    
    
    3.7
    %
 Page 19




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 Results of Operations  Consolidated Revenues.For the three months ended March 31, 2005, revenues decreased approximately
$500,000, or 3.7%, to $13.0 million from $13.5 million for the three months ended March 31, 2004.
Revenues originated by our domestic operations decreased by approximately $600,000, or 5.6%, from
$10.8 million for the three months ended March 31, 2004 to $10.2 million for the three months ended
March 31, 2005. Revenues originated by our international operations increased by approximately
$100,000, or 3.7%, from $2.7 million for the three months ended March 31, 2004 to $2.8 million for
the three months ended March 31, 2005. The decrease in our domestically originated revenues was
mainly attributable to the decrease in our Separation Filtration System sales, which decreased by
approximately $2.2 million, or 36.9%. This was partially offset by an increase in our
Environmental Systems sales, which increased by approximately $1.6 million, or 32.7%. The increase
in our international originated revenues related primarily to an increase in our pressure vessel
sales originated by our United Kingdom operations, which increased by approximately $100,000, or
3.7%. See Item 2  Results of Operations  Segments of this Report for further discussion on
revenues. Gross Profit Margin.Our margins, during a particular period, may be impacted by the
following factors: (1) sales volume, (2) shifts in our product mix, (3) unanticipated increase in
our component costs, and (4) start-up and warranty costs. Shifts in our product mix can impact
our margin performance two ways: (1) certain of our products have higher margins than others; and
as a result, shifts in the composition of our sales from quarter to quarter can have a significant
impact on our reported margins, and (2) certain of our products have a higher internal
manufacturing cost component associated with them, thus changes in our sales mix from quarter to
quarter can have a significant impact on the utilization of our manufacturing facilities, and thus
impact our reported margin through our absorption factors. For the three months ended March 31, 2005, our gross profit margin decreased by approximately $1.0
million, or 20.8%, from $4.8 million for the three months ended March 31, 2004 to $3.8 million for
the three months ended March 31, 2005. Gross profit margin, as a percentage of sales, decreased
from 35.6% for the three months ended March 31, 2004 to 29.6% for the three months ended March 31,
2005. Our margins during the quarter were impacted by all of the factors noted above. Our sales
volume was down for the quarter and our domestic Separation Filtration System sales, which tend to
have a much higher internal manufacturing cost component associated with them, decreased as a
percentage of our sales during the quarter from 43.3% to 28.4% for the three months ended March 31,
2004 and 2005, respectively. The result was that our plant utilization factors decreased during
the quarter and as such, our unabsorbed manufacturing costs increased from approximately $500,000,
or 3.6% of sales for the three months ended March 31, 2004 to approximately $600,000, or 4.8% of
sales for the three months ended March 31, 2005. In addition, our warranty and start-up costs
increased as a percentage of sales from 0.8% for the third quarter of fiscal 2004 to 4.3% for the
third quarter of fiscal year 2005. The increase in our warranty and start-up costs related
primarily to one Environmental System project, for which the Company has provided a specific
reserve of approximately $450,000 ($250,000 during the current period) to cover certain
contractually imposed process related issues and a potential liquidated damages claim. The Company
feels it potentially has mitigating factors with respect to the liquidated damages claim and
intends to assert such factors Page 20




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 against such claim if made. With respect to the process issues, while the equipment meets
operating permit standards, it is not meeting all contractually obligated process requirements. As
such, the Company has agreed with the owner, at the Companys expense, to install additional
catalyst to comply with all contractually obligated process requirements. Operating Expenses.For the three months ended March 31, 2005, operating expenses from
continuing operations decreased by approximately $200,000, or 5.1%, from approximately $3.9 million
for the three months ended March 31, 2004 to approximately $3.7 million for the three months ended
March 31, 2005. As a percentage of sales, our operating expenses decreased from 29.0% for the
three months ended March 31, 2004 to 28.1% for the three months ended March 31, 2005. On a
comparative basis, our sales and marketing expenses decreased approximately $100,000 and our
engineering and project management expenses decreased approximately $100,000. Our general and
administrative expenses remained relatively constant during both periods, as any cost control
benefits achieved during the current quarter were offset by the increased costs of compliance with
corporate governance mandates enacted by the SEC and the Nasdaq Stock Market, which are expenses
that are expected to continue. Other Income and Expense.For the three months ended March 31, 2005, other income and expense
items changed by approximately $110,000 from expense of approximately $54,000 for the three months
ended March 31, 2004 to income of approximately $56,000 for the three months ended March 31, 2005.
This change related primarily to the impact associated with our foreign currency exchange. During
the three months ended March 31, 2004, we realized foreign currency exchange losses of
approximately $68,000 compared to foreign currency exchange gains of approximately $3,000 for the
three months ended March 31, 2005. In addition to the foreign currency impact during the current
period, we recognized net rental income of approximately $33,000 associated with the lease of a
portion of our Dallas, Texas warehouse space. Income Taxes.The Companys provision for incomes taxes is based upon the estimated
effective tax rates in the tax jurisdictions in which the Company operates and includes federal,
state and foreign taxes. The effective tax rate for the three months ended March 31, 2005 and 2004
was approximately 18% and 34%, respectively. During the current period, our effective tax rate was
impacted by a change in our estimated effective annual tax rate from 34% to 40%. This adjustment
resulted in a reduction of our current period tax expense of approximately $40,000. The increase
in our effective tax rate is due primarily to a shift in the composition of our foreign and
domestic pre-tax earnings (loss). Net Earnings (Loss) from Continuing Operations.As a result of the above factors, our net
earnings from continuing operations decreased by approximately $350,000, from earnings of
approximately $555,000 or 4.1% of sales for the three months ended March 31, 2004, to earnings of
approximately $205,000, or 1.6% of sales for the three months ended March 31, 2005. Basic earnings
per share decreased from earnings of $0.18 per share for the three months ended March 31, 2004, to
earnings per share of $0.07 per share for the three months ended March 31, 2005. Diluted earnings
per share decreased from earnings of $0.18 per share for the three months ended March 31, 2004, to
earnings of $0.07 per share for the three months ended March 31, 2005. Discontinued Operations. For the three months ended March 31, 2005, there were no charges or
income recognized from discontinued operations compared to a net loss of approximately $117,000 for
the three months ended March 31, 2004. The Company has a reserve of approximately $224,000 at
March 31, 2005, based on its estimate of potential start-up and warranty costs associated with
certain non-commissioned boiler projects. The Company has Page 21




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 established this reserve based on the most current information available and historical
experience, and while the Company believes the reserve to be adequate and the judgment applied
appropriate, due to a number of factors, our estimated liability could differ from our actual cost
incurred (see Critical Accounting Policies  Product Warranties of this Report). Basic and
diluted loss per share from discontinued operations was $0.00 per share for the three months ended
March 31, 2005, compared to a loss of ($0.04) per share for the three months ended March 31, 2004. Net Earnings.As a result of the above factors, our earnings for the three months ended March
31, 2005 decreased approximately $233,000 from net earnings of $438,000, or 3.2% of sales for the
three months ended March 31, 2004, to net earnings of approximately $205,000, or 1.6% of sales for
the three months ended March 31, 2005. Basic earnings per share decreased from earnings of $0.15
per share for the three months ended March 31, 2004, to earnings per share of $0.07 for the three
months ended March 31, 2005. Diluted earnings per share decreased from earnings of $0.14 per share
for the three months ended March 31, 2004, to earnings per share of $0.07 for the three months
ended March 31, 2005. Nine months ended March 31, 2005 Compared to Nine months ended March 31, 2004 Results of Operations  Consolidated Revenues.For the nine months ended March 31, 2005, revenues decreased approximately $11.6
million, or 24.8% from $46.7 million for the nine months ended March 31, 2004 to $35.1 million for
the nine months ended March 31, 2005. Revenues originated by our domestic operations decreased by
approximately $9.3 million, or 24.3%, from $38.2 million for the nine months ended March 31, 2004
to $28.9 million for the nine months ended March 31, 2005. Revenues originated by our
international operations decreased by approximately $2.3 million, or 27.1% from $8.5 million for
the nine months ended March 31, 2004 to $6.2 million for the nine months ended March 31, 2005. The
decline in our domestically originated revenues was mainly attributable to the decline in our
Environmental Systems sales, which has been impacted by the slow pace of new power plant
construction and regulatory uncertainties. The decrease in our internationally originated revenues
related primarily to the decrease in our Separation Filtration System sales through our United
Kingdom operations. See Item 2  Results of Operations  Segments of this Report for further
discussion on revenues. Gross Profit Margin.For the nine months ended March 31, 2005, our gross profit margin decreased
by approximately $4.2 million, or 29.6% from $14.2 million for the nine months ended March 31, 2004
to $10.0 million for the nine months ended March 31, 2005. Our gross profit margin, as a
percentage of sales, decreased from 30.3% for the nine months ended March 31, 2004 to 28.5% for the
nine months ended March 31, 2005. As noted previously, our margins during any particular period
may be impacted by any of, or combination of, the following factors: (1) sales volume, (2) shifts
in our product mix, (3) unanticipated increase in our component costs, and (4) start-up and
warranty costs. During the current period our margins were negatively impacted by unanticipated
increases in our material costs. Due to worldwide demand, the cost associated with steel, and
particularly stainless steel, increased dramatically over the last 18 months. As most of our
contracts are long-term fixed-priced contracts, unanticipated changes in our material costs can
have a significant impact on our reported margins (see also Item 2  Results of Operations -
Segment Profit - Separation Filtration Systems for further discussion on the impact of material
cost increases). Additionally, during the period our margins were marginally impacted by: 1) our
warranty and start-up costs, which increased as a percentage of Page 22




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 sales from 1.8% for the nine months ended March 31, 2004 to 2.1% for the nine months ended
March 31, 2005, and 2) our unabsorbed manufacturing costs, which increased as a percentage of sales
from 3.7% for the nine months ended March 31, 2004 to 4.1% for the nine months ended March 31,
2005. While these costs increased as a percentage of sales, they actually decreased on a dollar
basis. Our actual warranty and start-up costs decreased from approximately $900,000 for the nine
months ended March 31, 2004 to $800,000 for the nine months ended March 31, 2005, and our actual
unabsorbed manufacturing costs decreased from $1.7 million for the nine months ended March 31, 2004
to $1.4 million for the nine months ended March 31, 2005. Operating Expenses.For the nine months ended March 31, 2005, operating expenses from
continuing operations decreased by approximately $500,000, or 4.6% from approximately $11.3
million for the nine months ended March 31, 2004 to approximately $10.8 million for the nine months
ended March 31, 2005. As a percentage of sales, our operating expenses increased from 24.2% for
the nine months ended March 31, 2004 to 30.7% for the nine months ended March 31, 2005. The
increase in operating expenses, as a percentage of sales, is directly related to the reduction in
our sales during the period. On a comparative basis, our sales and marketing expenses decreased
from approximately $4.6 million to approximately $4.4 million, our engineering and project
management expenses decreased from approximately $3.2 million to approximately $2.7 million and our
general and administrative expenses increased from approximately $3.5 million to approximately $3.6
million. The decrease in our sales and marketing expenses related primarily to a decrease in our
commission expense during the nine months ended March 31, 2005, which is directly related to the
decrease in our revenues. The decrease in engineering and project management expenses can be
attributed to our continued emphasis on cost controls and improved project execution. The increase
in our general and administrative expenses is attributed to the increased expense of compliance
with corporate governance mandates enacted by the SEC and the Nasdaq Stock Market, which are
expenses that are expected to continue. Other Income and Expense.For the nine months ended March 31, 2005, other income and expense
items changed by approximately $135,000, from income of approximately $25,000 for the nine months
ended March 31, 2004 to income of approximately $160,000 for the nine months ended March 31, 2005.
This change related primarily to the impact associated with our foreign currency exchange. During
the nine months ended March 31, 2004, we realized foreign currency exchange losses of approximately
$20,000, compared to foreign currency exchange gains of approximately $68,000 for the nine months
ended March 31, 2005. Additionally, we recognized net rental income of approximately $55,000
associated with the lease of some of our warehouse space. Income Taxes.The Companys effective tax rate for continuing operations was approximately
40% for the nine months ended March 31, 2005 and 34% for the nine months ended March 31, 2004. The
increase in our effective tax rate for the current period is due primarily to a shift in the
composition of our foreign and domestic pre-tax earnings (loss). Net Earnings (Loss) from Continuing Operations.As a result of the above factors, our net
earnings (loss) from continuing operations decreased by approximately $2.3 million from earnings of
approximately $1.9 million, or 4.1% of sales for the nine months ended March 31, 2004, to a loss of
approximately $368,000, or 1.0% of sales for the nine months ended March 31, 2005. Basic earnings
(loss) per share decreased from earnings of $0.63 per share for the nine months ended March 31,
2004, to a loss of ($0.12) per share for the nine months ended March 31, Page 23




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 2005. Diluted earnings per share decreased from earnings of $0.63 per share for the nine
months ended March 31, 2004, to a loss of ($0.12) per share for the nine months ended March 31,
2005. Discontinued Operations. For the nine months ended March 31, 2005, we recognized a net loss
from discontinued operations of approximately $53,000 compared to a net loss of approximately
$194,000 for the nine months ended March 31, 2004. The Company has a reserve of approximately
$224,000 at March 31, 2005, based on its estimate of potential start-up and warranty costs
associated with certain non-commissioned boiler projects. The Company has established this reserve
based on the most current information available and historical experience, and while the Company
believes the reserve to be adequate and the judgment applied appropriate, due to a number of
factors, our estimated liability could differ from our actual cost incurred (see Critical
Accounting Policies  Product Warranties of this Report). Included in our net loss for the nine
months ended March 31, 2004 was a net gain related to the disposal of our Boiler operation of
approximately $92,000 ($140,000 gain less taxes of $48,000). Basic and diluted loss per share from
discontinued operations was ($0.02) per share for the nine months ended March 31, 2005, compared to
a loss of ($0.06) per share for the nine months ended March 31, 2004. Net Earnings (Loss).As a result of the above factors, our earnings for the nine months ended
March 31, 2005 decreased approximately $2.1 million, from net earnings of approximately $1.7
million, or 3.7% of sales, to a net loss of approximately $421,000, or 1.2% of sales for the nine
months ended March 31, 2005. Basic earnings (loss) per share decreased from earnings of $0.57 per
share for the nine months ended March 31, 2004, to a loss of ($0.14) per share for the nine months
ended March 31, 2005. Diluted earnings (loss) per share decreased from earnings of $0.56 per share
for the nine months ended March 31, 2004, to a loss of ($0.14) per share for the nine months ended
March 31, 2005. Results of Operations  Segments We are organized along two lines of business: Environmental Systems, and Separation
Filtration Systems. The Companys Boiler segment was discontinued and its assets sold during the
first quarter of fiscal 2004. See Note 7  Discontinued Operations in the Notes to our
Consolidated Financial Statements for further discussion on the Boiler segment. Revenues.The following table displays revenues by reportable segment (dollars in thousands). Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    %
    
    
    2004
    
    
    %
    
    
    2005
    
    
    %
    
    
    2004
    
    
    %RevenuesEnvironmental Systems
    
    $
    6,549
    
    
    
    50.4
    %
    
    $
    4,937
    
    
    
    36.6
    %
    
    $
    15,526
    
    
    
    44.3
    %
    
    $
    23,946
    
    
    
    51.2
    %Separation Filtration Systems
    
    
    6,450
    
    
    
    49.6
    %
    
    
    8,554
    
    
    
    63.4
    %
    
    
    19,535
    
    
    
    55.7
    %
    
    
    22,781
    
    
    
    48.8
    %Total
    
    $
    12,999
    
    
    
    100.0
    %
    
    $
    13,491
    
    
    
    100.0
    %
    
    $
    35,061
    
    
    
    100.0
    %
    
    $
    46,727
    
    
    
    100.0
    %
 Environmental Systems.Revenues from our Environmental Systems for the three months ended
March 31, 2005, when compared to the same period last year, increased by approximately $1.6
million, or 32.7%. For the nine months ended March 31, 2005, revenues from Environmental Systems,
when compared to the same period last year, decreased by approximately $8.4 million, or 35.2%. The
increase in the revenues for the three months ended Page 24




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 March 31, 2005 is due to the completion of two projects, and specifically one short cycle
project for which revenue was recognized predominately during this period. The reduction in
revenues during the nine month period ended March 31, 2005 is due primarily to the completion of a
$15 million, NOx compliance project during the first half of fiscal 2004, which impact has not been
replicated this fiscal year. We are currently beginning to see compliance projects in regions of
the United States that previously have not had requirements for NOx control equipment. We also
expect that spending for NOx reduction systems will increase in future periods as users execute
their compliance plan to meet State Implementation Plans (SIP). In addition, while the
construction of new power plants has experienced a significant decline compared to previous years,
we believe this portion of the Environmental Systems business will begin to improve beginning in
2006  2007. On March 10, 2005, the United States Environmental Protection Agency (EPA)
announced the most comprehensive air quality regulations for power plants since the Clean Air Acts
Acid Rain Program, which began in 1995. Among other provisions, the regulations require power
plants in 28 eastern states and the District of Columbia to reduce NOx emissions by 53% of 2003
levels by 2009. We expect this mandate to positively impact our future Environmental Systems
business. Separation Filtration Systems.When compared to the same periods last fiscal year, our
Separation Filtration Systems revenues decreased approximately $2.1 million, or 24.6% and $3.2
million, or 14.2% for the three and nine months ended March 31, 2005, respectively. Revenues
originated by our domestic operations, when compared to the same periods last year, decreased
approximately $2.2 million, or 36.9%, and approximately $900,000, or 6.3%, for the three and nine
months ended March 31, 2005, respectively. Revenues originated by our international operations,
when compared to the same periods last year, increased by approximately $100,000, or 3.7% for the
three months ended March 31, 2005 and decreased by approximately $2.3 million, or 27.4% for the
nine months ended March 31, 2005. The decrease in revenue through our domestic operations can be
attributed primarily to a decrease in our domestic pressure product sales, which decreased by
approximately $2.2 million, or 51.7% for the three months ended March 31, 2005 and $3.8 million, or
35.0 % for the nine months ended March 31, 2005 and related principally to a decrease in domestic
pipeline projects. The decrease in our pressure product sales has been partially offset by an
increase in our nuclear marine product sales, which for the nine months ended March 31, 2005 has
increased by approximately $3.0 million, or 90.2% and related principally to life extension
projects at several nuclear power plants. The decrease in revenues originated through our
international operations relates to the completion by our United Kingdom subsidiary of two major
projects during the first part of fiscal 2004, which impact has not been replicated during the
current year. Segment Profit.The following table displays segment profit by reportable segment (dollars in
thousands): Three months ended
    
    
    Nine months endedMarch 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Segment profitEnvironmental Systems
    
    $
    645
    
    
    $
    694
    
    
    $
    1,919
    
    
    $
    3,923Separation Filtration Systems
    
    
    749
    
    
    

    1,429
    
    
    
    915
    
    
    
    2,408Total
    
    
    1,394
    
    
    
    2,123
    
    
    
    2,834
    
    
    
    6,331Unallocated general and
administrative
expenses
    
    
    (1,200
    )
    
    
    (1,227
    )
    
    
    (3,612
    )
    
    
    (3,463
    )Operating income (loss)
    
    $
    194
    
    
    $
    896
    
    
    $
    (778
    )
    
    $
    2,868
 Page 25




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Segment profit and loss is based on revenue less direct expenses of the segment before
allocation of general, administrative, research and development costs. All inter-company transfers
between segments have been eliminated. The Company allocates all costs associated with the design,
manufacture, and sale of its products to each segment. The Company does not allocate general and
administrative expenses (unallocated overhead), assets, expenditures for assets or depreciation
expense on a segment basis for internal management reporting, and therefore such information is not
presented. Environmental Systems.Environmental Systems profits for the three months ended March 31,
2005 decreased by approximately $49,000, or 7.1% compared to the same period of fiscal 2004. As a
percentage of Environmental Systems revenue, profit in Environmental Systems was 9.8% and 14.1% for
the three months ended March 31, 2005 and 2004, respectively. The decrease in profit, as a
percentage of sales, during the three months ended March 31, 2005 is primarily related to an
increase in start-up and warranty costs during the current period when compared to the prior year.
During the current period, our start-up and warranty costs were $542,000, or 8.3% of revenues,
compared to $103,000, or 2.1% of revenues for the three months ended March 31, 2004. The increase
in start-up and warranty costs during the current period related primarily to one project. For
further discussion please refer to Item 2  Results of Operations  Three Months Ended March 31,
2005 Compared to Three Months Ended March 31, 2004  Gross Profit Margin section of this Report.
For the nine months ended March 31, 2005, our Environmental Systems profits decreased by
approximately $2.0 million, or 51.1% over the same period last year. As a percentage of
Environmental Systems revenue, our operational performance decreased from a segment profit of 16.4%
for the nine months ended March 31, 2004 to segment profit of 12.4% for the same period this year.
The decrease in our Environmental Systems profit during the nine months ended March 31, 2005,
relates primarily to the following:  1.
    Increase in operational expenses, as a percentage of sales. While
our actual operational expenses were down from approximately $3.4 million to $2.8
million for the nine months ended March 31, 2004 and 2005, respectively, as a
percentage of sales, these expenses increased from 14.1% of sales for the nine months
ended March 31, 2004 to 18.3% of sales for the three months ended March 31, 2005.2.
    Increase in start-up and warranty expenses, as a percentage of
sales. Although our actual start-up and warranty expenses have declined on a
dollar-basis, from approximately $816,000 for the nine months ended March 31, 2004 to
$688,000 for the nine months ended March 31, 2005, as a percentage of sales, these
expenses increased from 3.4% for the nine months ended March 31, 2004 to 4.4% for the
nine months ended March 31, 2005.3.
    Corrections associated with control deficiencies. As discussed under Part I  Item 4
Controls and Procedures of this Report and as more fully described under that same section in our
Quarterly Report on Form 10-Q filed with the commission on February 14, 2005, the Companys
management discovered certain control deficiencies during the second quarter of fiscal 2005. In
connection therewith, certain correcting adjustments were recorded in the second quarter to the
Companys previously reported financial results. These adjustments, while immaterial in aggregate
to both the Companys previously reported financial results and to the quarter, did have a
significant impact on the Companys reported segment profit for the period. Page 26




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005  Specifically, this correction increased the Companys Environmental
Systems reported segment profits for the nine months ended March 31, 2005 by
approximately $348,000, or 2.2%. Separation Filtration Systems. Separation Filtration Systems profits decreased in the three
months ended March 31, 2005 by approximately $700,000, from a profit of approximately $1.4 million
for the three months ended March 31, 2004, to $700,000 for the three months ended March 31, 2005.
As a percentage of Separation Filtration Systems revenue, our operational performance decreased
from a segment profit of 16.7% for the three months ended March 31, 2004 to 11.6% for the three
months ended March 31, 2005. The decrease in our Separation Filtration Systems profit during the
current quarter was primarily volume related, as our operational expenses as a percentage of sales
increased from 18.0% for the three months ended March 31, 2004 to 21.9% for the three months ended
March 31, 2005. Our Separation Filtration Systems profits decreased for the nine months ended March 31, 2005
by approximately $1.5 million, from a profit of approximately $2.4 million for nine months ended
March 31, 2004, to a profit of $900,000 for the same period this fiscal year. As a percentage of
Separation Filtration Systems revenue, our operational performance decreased from a segment profit
of 10.6%, to a segment profit of 4.7%, for the nine months ended March 31, 2004 and 2005,
respectively. The decrease in our Separation Filtration Systems operational performance during the
nine months ended March 31, 2005 can be attributed to the following items:  1.
    Increase in operational expenses, as a percentage of sales. While
our actual operational expenses were down from approximately $4.5 million to $4.3
million for the nine months ended March 31, 2004 and 2005, respectively, as a
percentage of sales, these expenses increased from 19.6% for the nine months ended
March 31, 2004 to 22.1% for the nine months ended March 31, 2005.2.
    Significant material price increases. Due to worldwide consumption,
steel prices, most notably stainless steel prices, have increased considerably over
the past year (over 55% in the past 18 months). Stainless steel is a very significant
material cost to the production of our nuclear steam dryer products and our marine
separation products. Most of the contracts governing the sale of these products are
long-term, fixed-priced contracts, which in a volatile environment, increases the
Companys risks to margin deterioration. The Company attempts to stabilize its costs
by ordering materials at the time an order is received. However, on long-term
deliverable contracts (i.e., over 3 years), this may not always be possible. To
mitigate its risk under these contracts the Company attempts to negotiate escalation
provisions. See Factors That May Affect Our Operating Results and Other Risk Factors
 We enter into fixed-priced contracts. If our actual costs exceed our original
estimates, our profits will be reduced page 32 of this Report.3.
    Corrections associated with control deficiencies. As noted under Environmental Systems,
during the three months ended December 31, 2004, correcting adjustments were made to the Companys
financial statements as the result of certain management identified control deficiencies. These
adjustments, while immaterial in aggregate to both the Companys previously reported financial
results and to the quarter, did have a significant impact on the Companys reported segment profit
for the period. Specifically, this correction decreased the Companys Separation Page 27




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005  Filtration Systems reported segment profits for the nine months ended March 31, 2005
by approximately $452,000, or 2.3%. Market Outlook Environmental Systems.We expect that the spending for NOx reduction systems will increase in
late 2005 through 2009 as users implement their compliance plans to adhere to regulatory compliance
deadlines that come into effect over the next 3 to 5 years. In addition, while the construction of
new power plants has significantly declined over the last several years, we expect this market to
improve beginning in 2006 or 2007. Separation Filtration Systems.The market for nuclear/marine products remains strong, and is
expected to continue at such levels for at least the next 5 years, as nuclear power plants continue
to invest in life extension projects. The Nuclear Regulatory Commission estimates that by 2010,
nearly 80% of nuclear power plants in the United States will be in the license renewal process. In
addition, the increased demand for natural gas, both domestically and internationally, should also
create new opportunities for our separation and filtration products. One such opportunity is
Liquified Natural Gas (LNG) and its associated gas processing facilities, which are currently being
proposed in a number of areas to facilitate the transportation of LNG to the United States and
other markets. Contingencies On March 19, 2004, the Company received notice that an adversary proceeding was initiated by
Enron Corp. and National Energy Production Corporation in the United States Bankruptcy Court for
the Southern District of New York against PMC Acquisition, Inc., a subsidiary that operated the
discontinued Boiler business of the Company under the name ABCO Industries. The plaintiffs allege
that certain accounts receivable payments paid to ABCO were avoidable transfers under the
Bankruptcy Code and are seeking to recover approximately $1 million from ABCO. The Company has
engaged outside counsel and believes that all, or a majority of the payments, fail to meet the
applicable standards for avoidance under the Bankruptcy Code and other applicable law, and that a
number of defenses can be asserted that will negate any recovery by the plaintiffs. The Company
intends to vigorously defend against the lawsuit and management believes the likelihood of loss is
not probable. On April 25, 2005, the Company received notice that the Company may have received preferential
transfers amounting to approximately $900,000 in connection with the Chapter 11 filing by Erie
Power Technologies, Inc. Based on its preliminary investigation, the Company believes that all of
the payments received fail to meet the applicable standards for avoidance under the Bankruptcy Code
and other applicable law, and that a number of defenses can be asserted that may negate any
recovery by the plaintiffs. The Company intends to vigorously defend against the lawsuit and
management believes the likelihood of loss is not probable. From time to time the Company is involved in various litigation matters arising in the
ordinary course of its business. The Company does not believe the disposition of any current
matter will have a material adverse effect on its consolidated financial position or its results of
operations. Page 28




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Backlog The Companys backlog of unfilled orders was approximately $36.0 million at March 31, 2005,
compared to $34.0 million at June 30, 2004 and $34.0 million at March 31, 2004. Our Environmental
Systems segment continues to be impacted by the effects of the slow down in new power plant
construction. We expect that spending for NOx reduction systems will increase in 2005  2009 as
users implement their compliance plans and as regulatory deadlines approach, and we continue to see
an increase in requests for proposals relating to such initiatives. In addition, while the
construction of new power plants has seen a decline over the past several years, we believe this
portion of the Environmental Systems business will improve in 2006  2007. The market for Peerless
nuclear and marine products remains strong as nuclear power plants continue to invest in life
extension projects. The shortage of natural gas supplies is creating new opportunities for
Peerless separators and filters, such as the production of LNG and the associated gas processing
facilities. Financial Position Assets.Total assets increased by approximately $300,000, or 0.8% from approximately $39.5
million at June 30, 2004 to approximately $39.8 million at March 31, 2005. The increase in our
assets during the fiscal year resulted primarily from an increase in our cash and cash equivalents
balances of approximately $5.4 million and an increase in our inventories of approximately $1.0
million, which was offset by a decrease in costs and earnings in excess of billings on uncompleted
contracts of approximately $2.0 million and a decrease in our accounts receivable of approximately
$4.2 million. See Item 2  Liquidity and Capital Resources of this Report for further
discussion. At March 31, 2005, we held cash and cash equivalents of $9.5 million, had working
capital of approximately $20.8 million, and a current ratio of 2.4 to 1.0. This compares with cash
and cash equivalents of $4.1 million, approximately $20.7 million in working capital, and a current
ratio of 2.4 to 1.0 at June 30, 2004. Liabilities and Shareholders EquityTotal liabilities increased by approximately $400,000
or 2.7%, from approximately $14.8 million at June 30, 2004 to approximately $15.2 million at March
31, 2005. The increase in liabilities related primarily to an increase in our billings in excess
of costs and earnings on uncompleted contracts, offset by a decrease in our trade payables and
other accrued liabilities. Our debt (total liabilities) to equity ratio increased slightly to .62-to-1.0 at March 31, 2005, compared to .60-to-1.0 at June 30, 2004. See Item 2  Liquidity and
Capital Resources of this Report for further discussion. Liquidity and Capital Resources Our cash and cash equivalents were $9.5 million as of March 31, 2005, compared to $4.1 million
at June 30, 2004. Cash provided by operating activities during the nine months ended March 31,
2005 was approximately $5.6 million compared to cash of approximately $1.4 million used by our
operating activities during the nine months ended March 31, 2004. Because we are engaged in the business of manufacturing custom systems, our progress billing
practices are event-oriented rather than date-oriented, and vary from contract to contract. We
customarily bill our customers after the occurrence of project milestones. Billings to customers
affect the balance of billings in excess of costs and earnings or the balance of cost and Page 29




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 earnings in excess of billings, as well as the balance of accounts receivable. Consequently,
we focus on the net amount of these accounts along with accounts payable, to determine our
management of working capital. At June 30, 2004, the balance of these working capital accounts was
$15.9 million, compared to $8.3 million at March 31, 2005, reflecting a decrease of our investment
in these working capital items of $7.6 million. Generally, a contract will either allow for
amounts to be billed upon shipment or on a progress basis, based on the attainment of certain
milestones. Therefore, changes in the composition of contract mix, from quarter-to-quarter, can
tend to either increase or decrease our net investment in these accounts during any given quarter
or period. In addition, during the nine months ended March 31, 2005, funds were used by our
operating loss and used to reduce our accrued expenses and pay our prior year tax liability. Cash used in investing activities was approximately $347,000 for the nine months ended March
31, 2005, compared to cash used in investing activities of approximately $53,000 for the same
period in fiscal 2004. The use of cash during the nine months ended March 31, 2005 and 2004
related primarily to capital expenditures during the periods. Fiscal year 2004 capital
expenditures were offset by proceeds of approximately $248,000 relating to the sale of certain
short-term investments. Cash provided by financing activities was approximately $173,000 and $51,000 for the nine
months ended March 31, 2005 and 2004, respectively, and related to the proceeds from the issuance
of common stock, pursuant to employee stock options. Cash used in our discontinued operations was $126,000 during the nine months ended March 31,
2005, compared to $1.7 million provided by our discontinued operations during the same period in
fiscal 2004. As a result of the above factors, during the first nine months of fiscal year 2005, our cash
and cash equivalents increased by approximately $5.3 million, compared to an increase of
approximately $280,000 during the same period of fiscal 2004. On October 31, 2003, we entered into a $12.5 million revolving credit facility for working
capital requirements that expires on October 31, 2006. The facility carries a floating interest
rate based on the prime or Euro rate plus or minus an applicable margin (Euro plus 1.75% at March
31, 2005), and is secured by substantially all our domestic assets. At March 31, 2005, we had $3.2
million outstanding under stand-by letters of credit and no loans outstanding, leaving us
availability under our credit facility of $9.3 million. The facility contains financial covenants,
certain restrictions on capital expenditures, acquisitions, asset dispositions, dividends and
additional debt, as well as other customary covenants. As of March 31, 2005, the Company was in
compliance with all financial and other covenants under the credit facility. In addition, our UK subsidiary has a £2.4 million (approximately $4.5 million) debenture
agreement used to facilitate the issuances of bank guarantees. This facility is secured by
substantially all of the UK subsidiary assets, and is backed by a Peerless stand-by letter of
credit of £1.0 million (approximately $1.9 million, which is included in the $3.2 million
outstanding above) and expires on October 31, 2005. At March 31, 2005, there was approximately
£2.2 million outstanding under this facility, leaving availability of approximately £200,000
(approximately $375,000). We believe we maintain adequate liquidity to support existing operations and planned growth,
as well as to continue operations during reasonable periods of unanticipated adversity. Page 30




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Off-Balance Sheet Arrangements and Aggregate Contractual Obligations The Company has no off-balance-sheet arrangements that have, or are reasonably likely to have,
a current or future effect on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures, or capital resources that are
material to investors. New Accounting Standards In November 2004, the FASB issued SFAS No. 151, Inventory Costs(SFAS 151). SFAS 151 requires
that abnormal amounts of idle facility expense, freight, handling costs and spoilage be recognized
as current-period charges. Further, SFAS 151 requires the allocation of fixed production overheads
to inventory based on the normal capacity of the production facilities. Unallocated overheads must
be recognized as an expense in the period in which they are incurred. SFAS 151 is effective for
inventory costs incurred beginning in the first quarter of fiscal 2006. We are is currently
evaluating the effect of SFAS 151 on our financial statements and related disclosures. In December 2004, the Financial Accounting Standards Board (FASB) issued the revised SFAS No.
123R, Share-Based Payment(SFAS 123R). SFAS 123R requires compensation costs related to
share-based payment transactions to be recognized in the financial statements. Generally,
compensation cost will be measured based on the grant-date fair value of the equity or liability
instruments issued. In addition, liability awards will be re-measured each reporting period.
Compensation cost will be recognized over the requisite service period, generally, as the award
vests. We will be required to adopt SFAS 123R in the first quarter of fiscal 2006. SFAS 123R
applies to all awards granted after June 30, 2005 and to previously granted awards unvested as of
the adoption date. We are currently evaluating the impact that the adoption of SFAS 123R will have
on our financial statements and our related disclosures. Factors That May Affect Our Operating Results and Other Risk Factors Investing in our common stock involves a high degree of risk. Any of the following risks could
have a material adverse effect on our financial condition, liquidity, and results of operations or
prospects, financial or otherwise. Reference to these factors in the context of a forward-looking
statement or statements will be deemed to be a statement that any one or more of the following
factors may cause actual results to differ materially from those in such forward-looking statement
or statements. See Item 2 - Managements Discussion and Analysis of Financial Condition and
Results of Operations - Forward-Looking Statements of this Report. Changes in the power generation industry and/or the economy could have an adverse impact on
sales of our Environmental Systems and our operating results. The demand for our Environmental Systems depends to an extent on the continued construction of
power generation plants and the upgrade of existing power plants. In the first nine months of
fiscal 2005, approximately 44% of our consolidated revenues were derived from sales of
Environmental Systems for new and refurbished power plants compared to approximately 51 % for the
same period in fiscal 2004. The power generation industry has experienced cyclical periods of slow
growth or decline. Any change in the power plant industry that results in a decline in the
construction of new power plants or a decline in the refurbishing of existing power Page 31




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 plants could have a materially adverse impact on our Environmental Systems revenues and our
results of operations. See Item 2 -  Managements Discussion and Analysis of Financial Condition
and Results of Operations of this Report. Changes in the price, supply or demand for natural gas could have an adverse impact on our
sales of Separation Systems and our operating results. A large portion of our separation filtration business is driven by the construction of natural
gas production and transportation infrastructure. Increasing demand for natural gas may result in
the construction of natural gas production facilities and facilities to transport the gas to its
end destination (i.e., pipelines and LNG processing plants). Increasing prices of natural gas,
while beneficial to exploration activities and the financing of new projects, can adversely impact
demand. Excessive supply could also negatively impact the price of natural gas, which could
discourage spending on new projects. Changes in current environmental legislation could have an adverse impact on the sale of our
Environmental Systems and on our operating results. Our Environmental Systems business is primarily regulatory driven. Laws and regulations
governing the discharge of pollutants into the environment or otherwise relating to the protection
of the environment or human health have played a significant part in the increased use of
Environmental Systems in the United States. These laws include U.S. federal statutes such as the
Resource Conservation and Recovery Act of 1976, the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980 (CERCLA), the Clean Water Act and the Clean Air Act, and
the regulations implementing them, as well as similar laws and regulations at state and local
levels and in other countries. These laws and regulations may change or other jurisdictions may
not adopt similar laws and regulations. This business segment will be adversely impacted to the
extent that current regulations requiring the reduction of NOx emissions are repealed, amended or
implementation dates delayed or to the extent that regulatory authorities minimize enforcement.
See Item 2 - Managements Discussion and Analysis of Financial Condition and Results of
Operations of this Report. Competition could result in lower sales and decreased margins. We operate in highly competitive markets worldwide. Competition could result in not only a
reduction in our sales, but also a reduction in the prices we charge for our products. To remain
competitive we must be able to not only anticipate or respond quickly to our customers needs and
enhance and upgrade our existing products and services to meet those needs, but also continue to
price our products competitively. Our competitors may develop cheaper, more efficient products or
may be willing to charge lower prices for strategic marketing or to increase market share. Some of
our competitors have more capital and resources than we do and may be better able to take advantage
of acquisition opportunities or adapt more quickly to changes in customer requirements. See Item 2
- Managements Discussion and Analysis of Financial Condition and Results of Operations of this
Report. We enter into fixed-priced contracts. If our actual costs exceed our original estimates, our
profits will be reduced. The majority of our contracts are on a fixed-priced basis. Although we benefit from cost
savings, we have limited ability to recover cost overruns. Because of the large scale and long
duration of our contracts, unanticipated cost increases may occur as a result of several factors,
including, but not limited to, (1) increases in the cost, or shortages of components, materials or Page 32




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 labor; (2) unanticipated technical problems; (3) required project modifications not
initiated by the customer; and (4) suppliers or subcontractors failure to perform. These factors
could delay delivery of our products and our contracts often provide for liquidated damages for
late delivery. Unanticipated costs that we cannot pass on to our customers, for example, the
volatile nature of steel prices, or the payment of liquidated damages under fixed contracts would
negatively impact our profits. See Item 2 -  Managements Discussion and Analysis of Financial
Condition and Results of Operations of this Report. Our backlog may not be indicative of our future revenue. Customers may cancel or delay projects for reasons beyond our control. Our orders normally
contain cancellation provisions, which permit us to recover only our costs and a portion of our
anticipated profit in the event a customer cancels an order. If a customer elects to cancel, we
may not realize the full amount of revenues included in our backlog. If projects are delayed, the
timing of our revenues could be affected and projects may remain in our backlog for extended
periods of time. Revenue recognition occurs over long periods of time and is subject to
unanticipated delays. If we receive relatively large orders in any given quarter, fluctuations in
the levels of our quarterly backlog can result because the backlog in that quarter may reach levels
that may not be sustained in subsequent quarters. Our backlog may not be indicative of our future
revenues. See Item 2 -  Managements Discussion and Analysis of Financial Condition and Results
of Operations of this Report. Our ability to conduct business outside the United States may be adversely affected by factors
outside of our control and our revenues and profits from international sales could be adversely
impacted. For the first nine months of fiscal 2005 and fiscal 2004, revenue outside the United States
represented approximately 18% of our consolidated revenues. Our operations and earnings throughout
the world have been, and may in the future be, affected from time to time in varying degrees by
war, political developments and foreign laws and regulations, such as regional economic
uncertainty, political instability, restrictions, customs and tariffs, changing regulatory
environments, fluctuations in foreign currency exchange rates and adverse tax consequences. The
likelihood of such occurrences and their overall effect upon us vary greatly from country to
country and are not predictable. These factors may result in a decline in revenues or
profitability and could adversely affect our ability to expand our business outside of the United
States. Our financial performance may vary significantly from period to period, making it difficult to
estimate future revenue. Our annual revenues and earnings have varied in the past and are likely to vary in the future.
Our Environmental Systems contracts generally stipulate customer specific delivery terms and may
have contract cycles of a year or more, which subjects them to many factors beyond our control. In
addition, these contracts are significantly larger in size than our typical Separation Filtration
Systems contracts, which tend to intensify their impact on our annual operating results.
Furthermore, as a significant portion of our operating costs are fixed, an unanticipated decrease
in our revenues, a delay or cancellation of orders in backlog, or a decrease in the demand for our
products, may have a significant impact on our annual operating results. Therefore, our annual
operating results may be subject to significant variations and our operating performance in one
period may not be indicative of our future performance. See Item 2 -  Managements
Discussion and Analysis of Financial Condition and Results of Operations of this Report. Page 33




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Our margins are affected by shifts in our product mix. Certain of our products have higher margins than others. Consequently, changes in the
composition of our sales between products from quarter-to-quarter or from period-to-period can have
a significant impact on our reported margins. Certain of our products also have a much higher
internally manufactured cost component; and therefore, changes from quarter-to-quarter or from
period-to-period can have a significant impact on our reported margins through a negative or
positive impact on our manufacturing absorption. See Item 2 -  Managements Discussion and
Analysis of Financial Condition and Results of Operations of this Report. Our products are covered by warranties. Unanticipated warranty costs for defective products
could adversely affect our financial condition and results of operations and reputation. We provide warranties on our products generally for terms of three years or less. These
warranties require us to repair or replace faulty products and meet certain performance standards,
among other customary warranty provisions. While we continually monitor our warranty claims and
provide a reserve for estimated warranty issues on an on-going basis, an unanticipated claim could
have a material adverse impact on our operations. In some cases, we may be able to subrogate a
claim back to a subcontractor, if the subcontractor supplied the defective product or performed the
service, but this may not always be possible. The need to repair or replace products with design
or manufacturing defects could temporarily delay the sale of new products, reduce our profits and
could adversely affect our reputation. See Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operation of this Report. Product liability claims not covered by insurance could adversely affect our financial
condition and results of operations. We may be subject to product liability claims involving claims of personal injury or property
damage. While we maintain product liability insurance coverage to protect us in the event of such
a claim, our coverage may not be adequate to cover the cost of defense and the potential award in
the event of a claim. Also, a well-publicized actual or perceived problem could adversely affect
our reputation and reduce the demand for our products. Large contracts represent a significant portion of our accounts receivable, which increases
our exposure to credit risk. We closely monitor the credit worthiness of our customers. Significant portions of our sales
are to customers who place large orders for custom products and whose activities are related to the
power and oil/gas industries. As such, our exposure to credit risk is affected to some degree by
conditions within these industries and governmental and/or political conditions. We mitigate our
exposure to credit risk, to some extent, by requiring progress payments and letters of credit.
However, as some of our exposure is outside of our control, unanticipated events could have a
materially adverse impact on our operating results. See Item 2  Managements Discussion and
Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources of this
Report. Page 34




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Changes in billing terms can increase our exposure to working capital and credit risk. Our products are generally sold under contracts that allow us to either bill upon the
completion of certain agreed upon milestones, or upon the actual shipment of the product. The
Company attempts to negotiate progress-billing milestones on all large contracts to help the
Company manage the working capital and credit risk associated with these large contracts.
Consequently, shifts in the billing terms of the contracts in the Companys backlog from period to
period can increase the Companys requirement for working capital and can increase the Companys
exposure to credit risk. See Item 2  Managements Discussion and Analysis and Results of
Operations  Liquidity and Capital Resources of this Report. The terms and conditions of our credit facility impose restrictions on our operations. We may
not be able to raise additional capital, if needed. The terms and conditions of our current $12.5 million revolving credit facility impose
restrictions that affect, among other things, our ability to incur debt, make capital expenditures,
merge, sell assets, make distributions, or create or incur liens. The availability of our credit
facility is also subject to certain financial covenants, including a prohibition against
consecutive quarterly losses. Our ability to comply with the covenants may be affected by events
beyond our control and we cannot assure that we will achieve operating results meeting the
requirements of the credit agreement. A breach of any of these covenants could result in a default
under our credit facility. In the event of a default, the bank could elect to declare the
outstanding principal amount of our credit facility, all interest thereon, and all other amounts
payable under our credit facility to be immediately due and payable. As of March 31, 2005 we were
in compliance with all financial and other covenants of our credit facility. Our ability to satisfy any debt obligations will depend upon our future operating performance,
which will be affected by prevailing economic, financial and business conditions and other factors,
some of which are beyond our control. We anticipate that borrowings from our existing revolving
credit facility, or the refinancing of our revolving credit facility, and cash provided by
operating activities, should provide sufficient funds to finance capital expenditures, working
capital and otherwise meet our operating expenses and service our debt requirements as they become
due. However, in the event that we require additional capital, there can be no assurance that we
will be able to raise such capital when needed or on satisfactory terms, if at all. Our business is subject to risks of terrorist acts and acts of war. Terrorist acts and acts of war may disrupt our operations, as well as our customers
operations. Such acts have created, and continue to create, economic and political uncertainties
and have contributed to global economic instability. Any future terrorist activities, and any
continued military or security operations could further weaken the global economy and create
additional uncertainties forcing our customers to further reduce their capital spending, or cancel
or delay already planned construction projects, which could have a material adverse impact on our
business, operating results and financial condition. Page 35




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Our common stock is thinly traded, which may result in low liquidity. The daily trading volume of our common stock is relatively low and therefore the liquidity and
appreciation in our stock may not meet our shareholders expectations. The market price of our
common stock could be adversely impacted as a result of sales by our existing shareholders of a
large number of shares of our common stock in the market, or the perception that such sales could
occur. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk. Our primary market risk exposures are in the areas of interest rate risk and foreign currency
exchange rate risk. We feel our risk to interest rate fluctuations is nominal, as our investments
are short-term in nature and we are currently not borrowing under our bank credit facility. Our
exposure to currency exchange rate fluctuations has been, and is expected to continue to be, modest
as foreign contracts payable in currencies other than United States dollars are performed, for the
most part, in the local currency and therefore provide a natural hedge against currency
fluctuations. On occasion, we will purchase derivative transactions with respect to foreign
contracts that do not contain a natural hedge, but the impact of any fluctuation in the exchange
rates in these hedged currencies, would be expected to have an immaterial impact on our financial
operations. The impact of currency exchange rate movements on inter-company transactions has been,
and is expected to continue to be, immaterial. As of March 31, 2005, we did not hold or issue
derivative instruments for trading purposes and are not a party to any instruments with leverage or
prepayment features. We have no affiliation with partnerships, trusts or other entities (sometimes
referred to a special-purpose or variable-interest entities) whose purpose is to facilitate
off-balance-sheet financial transactions or similar arrangements. 
 Item 4. Controls and Procedures The Company maintains disclosure controls and procedures that are designed to ensure that
information related to the Company (including its consolidated subsidiaries) that is required to be
disclosed in the reports it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the Securities and
Exchange Commissions rules and forms. The Companys management has evaluated, with the participation of the Companys Chief
Executive Officer and Chief Financial Officer, the effectiveness of these disclosure controls and
procedures as of the end of the period covered by this Report. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2005, the
Companys disclosure controls and procedures were effective in ensuring that all material
information required to be filed in this Report has been made known to them in a timely fashion.
Due to the inherent limitations of control systems, not all misstatements may be detected. These
inherent limitations include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake. Additionally, controls could be
circumvented by the individual acts of some persons or by collusion of two or more people. The
Registrants controls and procedures can only provide reasonable, not absolute, assurance that the
above objectives have been met. Page 36




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 During the quarter ended March 31, 2005, there have been no changes in the Companys
internal control over financial reporting, or in other factors, except as noted below, that have
materially affected or are reasonably likely to materially affect our internal controls over
financial reporting. During the previous quarter, the Companys principal executive officer and principal financial
officer identified certain deficiencies in the Companys internal controls over financial reporting
as they relate to the Companys administration of contracts. For further discussion on the control
deficiencies noted, reference is made to our Quarterly Report on Form 10-Q for the period ended
December 31, 2004, filed with the Commission on March 14, 2005. Management concluded, after a
thorough review, that while a material weakness, as defined by the Public Company Accounting
Oversight Board (PCAOB), existed with respect to its administration of contracts, such weakness
did not result in a material misstatement of the Companys previously reported financial results,
nor is it expected to have a material impact on the Companys projected results for fiscal year
2005. The correction of the control deficiencies did however have a significant impact on the
reported segment results (but not the Companys consolidated results) for the quarter ended
December 31, 2004 and the nine months ended March 31, 2005. Management presented the Audit
Committee with a plan of remediation to correct the control issues noted. In connection therewith,
the following steps have been taken:  1.
    We have developed and implemented new written sales order entry procedures
designed to ensure that the essential elements of all contracts are in place prior to
entering sales orders into the Companys Enterprise Resource Planning System (ERP).2.
    We have developed and implemented written contract filing and maintenance
procedures designed to ensure that all contracts meet Company, customer and
3rd party requirements.3.
    We have developed and implemented new written change order procedures
designed to ensure: a) proper management approval prior to implementation, b) timely
entry of contract changes, and c) the Companys ERP system reflects the most current
contract sales order value and data.4.
    We have improved the status review process for on-going projects to assure
that potential project cost overruns are timely identified and the Companys ERP
system is timely updated.5.
    We have realigned the departments and reporting responsibilities associated
with the Contracts Administration and Project Management departments. Our management and Audit Committee is dedicating significant resources to assessing the issues
underlying the weakness identified with the Companys administration of contracts and to ensuring
that proper steps have been and are being taken to improve our control environment. We have
prioritized the correction of these deficiencies and have taken and will continue to take action to
correct them. Management is committed to instilling strong control policies and procedures and
will ensure that the tone at the top is committed to accuracy and completeness in all financial
reporting. Page 37




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404) requires the Company to
include a report regarding the effectiveness of its internal control over financial reporting,
beginning with its Annual Report on Form 10-K for the year ending June 30, 2007. That report is to
include an assessment by the Companys management of the effectiveness of its internal control over
financial reporting as of the end of the fiscal year along with an attestation report from the
Companys independent auditors regarding that assessment. Accordingly, the Company will undertake a
comprehensive effort to assess its system of internal controls over financial reporting. Using
internal resources and external consulting assistance, the Company will review its internal
controls over financial reporting to assess their adequacy and, as necessary, to address identified
issues or inadequacies. 
 PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings From time to time we are involved in various litigation matters arising in the ordinary course
of our business. We do not believe the disposition of any current matter will have a material
adverse effect on our consolidated financial position or results of operations (see Note 9 
Contingencies in our Notes to the Condensed Consolidated Financial Statements of this Report). 
 Items 2, 3, and 5 are not applicable and have been omitted 
 Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to security holders for a vote during this quarter. 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    Exhibits The following exhibits are filed as part of this report. ExhibitNumber
    
    Exhibit3(a)
    
    Articles of Incorporation, as amended to date (filed as Exhibit 3(a) to our Quarterly Report on Form 10-Q
(file No. 0-5214) for the fiscal quarter ended December 31, 1997, and incorporated herein by reference).3(b)
    
    Bylaws, as amended to date (filed as Exhibit 3(b) to our Quarterly Report on Form 10-Q for the fiscal
quarter ended March 31, 2004, and incorporated herein by reference).4(a)
    
    Rights Agreement dated May 22, 1997 between Peerless Mfg. Co. and Mellon Investor Services, LLC (formerly ChaseMellon
Shareholder Services, L.L.C.), as Rights Agent (filed as Exhibit 1 to our Registration Statement on Form 8-A (file No. 0-5214), dated
May 22, 1997, and incorporated herein by reference).
 Page 38




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 ExhibitNumber
    
    Exhibit4
    (b)
    
    Amendment to Rights Agreement dated August 23, 2001, between Peerless Mfg. Co. and Mellon Investor
Services, LLC, as Rights Agent (filed as Exhibit 2 to our Registration Statement on Form 8-A dated August
30, 2001, and incorporated herein by reference).10
    (a)
    
    Key Employee Bonus Plan effective as of January 4, 2005 (filed as Exhibit 10.4 to our Current Report on
Form 8-K dated February 9, 2005, and incorporated herein by reference).10
    (b)
    
    Description of Compensation Payable to Non-Employee Directors. *10
    (c)
    
    Form of Non-Employee Director Stock Option Agreement (filed as Exhibit 10.1 to our Current Report of Form
8-K on February 9, 2005, and incorporated herein by reference).10
    (d)
    
    Form of Chief Executive Officer Stock Option Agreement (filed as Exhibit 10.2 to our Current Report of
Form 8-K on February 9, 2005, and incorporated herein by reference).10
    (e)
    
    Form of Executive Stock Option Agreement (filed as Exhibit 10.3 to our Current Report of Form 8-K on
February 9, 2005, and incorporated herein by reference).10
    (f)
    
    Employment Agreement dated February 11, 2005, by and between Peerless Mfg. Co. and Richard L. Travis, Jr. *31
    (a)
    
    Rule 13a  14(a)/15d  14(a) Certification of Chief Executive
Officer. *31
    (b)
    
    Rule 13a  14(a)/15d  14(a) Certification of Chief Financial
Officer. *32
    (a)
    
    Section 1350 Certification of Chief Executive Officer. **32
    (b)
    
    Section 1350 Certification of Chief Financial Officer. **
   *
    
    Filed herewith**
    
    Furnished herewith Page 39




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 Item 6. Exhibits and Reports on Form 8-K - continued  (b)
    Reports on Form 8-K. On February 9, 2005, the Company filed a Report on Form 8-K describing
Non-Employee Director Compensation, announcing the grant of stock options to
employees, and describing the Companys Key Employee Bonus Plan. On February 11, 2005, the Company filed a Report on Form 8-K to file a press
release announcing its financial results for the second quarter of the fiscal year
ending June 30, 2005, which information was furnished and not filed with the
Commission. On February 16, 2005, the Company filed a Report on Form 8-K describing an
employment agreement with its existing Chief Financial Officer and Vice President
of Administration, Mr. Richard L. Travis, Jr. Page 40




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2005 
 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. PEERLESS MFG. CO.Date: May 16, 2005
    
    /s/ Sherrill StoneSherrill StoneChairman and Chief Executive OfficerDate: May 16, 2005
    
    /s/ Richard L. Travis, Jr.Richard L. Travis, Jr., Chief Financial Officer(Principal Financial and Accounting Officer)
 Page 41