##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C.
20549
   FORM 10-Q (Mark One) x Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the Quarterly Period
Ended December 31, 2004 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 x
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 x As of February 10, 2005, there were 3,032,184 shares of the Registrants common stock
outstanding.   1




---



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 TABLE OF CONTENTS PART I: FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets at December 31, 2004 (unaudited)
and June 30, 2004
    
    
    3Unaudited Consolidated Statements of Operations for the three months
and six months ended December 31, 2004 and 2003
    
    
    4Unaudited Consolidated Statements of Cash Flows for
the six months ended December 31, 2004 and 2003
    
    
    5Notes to the 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
    
    
    33Item 4. Controls and Procedures
    
    
    33PART II: OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    34Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of
Equity Securities
    
    
    35Item 3. Defaults Upon Senior Securities
    
    
    35Item 4. Submission of Matters to a Vote of Security Holders
    
    
    35Item 5. Other Information
    
    
    35Item 6. Exhibits and Reports on Form 8-K
    
    
    35SIGNATURES
    
    
    36Certification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial Officer
  2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements PEERLESS MFG. CO. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS  (Dollars in thousands)
 December 31, 2004
    
    
    June 30, 2004(unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    7,204
    
    
    $
    4,119Accounts receivable  principally trade  net of
allowance of uncollectible accounts of $427 at
December 31, 2004 and $431 at June 30, 2004
    
    
    13,179
    
    
    
    13,604Inventories
    
    
    3,337
    
    
    
    3,106Costs and earnings in excess of billings
on uncompleted contracts
    
    
    8,739
    
    
    
    12,448Deferred income taxes
    
    
    1,165
    
    
    
    1,165Other   net
    
    
    1,066
    
    
    
    816Assets of discontinued operations
    
    
    216
    
    
    
    225Total current assets
    
    
    34,906
    
    
    
    35,483Property, plant and equipment  net
    
    
    2,949
    
    
    
    3,053Other assets
    
    
    697
    
    
    
    930Other assets of discontinued operations
    
    
    9
    
    
    
    9$
    38,561
    
    
    $
    39,475LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesAccount payable  trade
    
    
    8,522
    
    
    
    9,791Billings in excess of costs and earnings
on uncompleted contracts
    
    
    1,927
    
    
    
    399Commissions payable
    
    
    803
    
    
    
    844Income taxes payable
    
    
    
    
    
    
    557Product warranties
    
    
    984
    
    
    
    982Accrued liabilities and other
    
    
    1,681
    
    
    
    1,923Liabilities of discontinued operations
    
    
    257
    
    
    
    306Total current liabilities
    
    
    14,174
    
    
    
    14,802Shareholders equity
Common stock
    
    
    3,032
    
    
    
    3,014Additional paid-in capital
    
    
    2,085
    
    
    
    1,884Other
    
    
    334
    
    
    
    214Retained earnings
    
    
    18,936
    
    
    
    19,561Total shareholders equity
    
    
    24,387
    
    
    
    24,673Total liabilities and shareholders equity
    
    $
    38,561
    
    
    $
    39,475
 See accompanying notes to the consolidated financial statements. 3




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS  (Dollars in thousands, except per share amounts)
 Three months ended
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues
    
    $
    10,844
    
    
    $
    16,429
    
    
    $
    22,062
    
    
    $
    33,236Cost of goods sold
    
    
    7,905
    
    
    
    11,884
    
    
    
    15,908
    
    
    
    23,885Gross profit
    
    
    2,939
    
    
    
    4,545
    
    
    
    6,154
    
    
    
    9,351Operating expensesSales and marketing
    
    
    1,407
    
    
    
    1,409
    
    
    
    2,882
    
    
    
    3,012Engineering and project management
    
    
    881
    
    
    
    1,037
    
    
    
    1,832
    
    
    
    2,131General and administrative
    
    
    1,357
    
    
    
    1,278
    
    
    
    2,412
    
    
    
    2,2363,645
    
    
    
    3,724
    
    
    
    7,126
    
    
    
    7,379Operating income (loss)
    
    
    (706
    )
    
    
    821
    
    
    
    (972
    )
    
    
    1,972Other incomeForeign exchange gain
    
    
    4
    
    
    
    94
    
    
    
    65
    
    
    
    47Other income
(expense) -- net
    
    
    (1
    )
    
    
    15
    
    
    
    39
    
    
    
    323
    
    
    
    109
    
    
    
    104
    
    
    
    79Earnings (loss) from continuing operations
before income taxes
    
    
    (703
    )
    
    
    930
    
    
    
    (868
    )
    
    
    2,051Income tax expense (benefit)
    
    
    (239
    )
    
    
    321
    
    
    
    (295
    )
    
    
    702Net earnings (loss) from continuing operations
    
    
    (464
    )
    
    
    609
    
    
    
    (573
    )
    
    
    1,349Discontinued operations (Note 7)Loss from discontinued operations
(including gain on disposal of $0 and $140 in
six months ended 2004 and 2003, respectively)
    
    
    (50
    )
    
    
    (217
    )
    
    
    (80
    )
    
    
    (118
    )Income tax benefit
    
    
    (17
    )
    
    
    (75
    )
    
    
    (27
    )
    
    
    (41
    )Net loss from discontinued operations
    
    
    (33
    )
    
    
    (142
    )
    
    
    (53
    )
    
    
    (77
    )Net earnings (loss)
    
    $
    (497
    )
    
    $
    467
    
    
    $
    (626
    )
    
    $
    1,272BASIC EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.15
    )
    
    $
    0.20
    
    
    $
    (0.19
    )
    
    $
    0.45Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.02
    )
    
    
    (0.03
    )Basic earnings (loss) per share
    
    $
    (0.16
    )
    
    $
    0.16
    
    
    $
    (0.21
    )
    
    $
    0.42DILUTED EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.15
    )
    
    $
    0.20
    
    
    $
    (0.19
    )
    
    $
    0.44Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.02
    )
    
    
    (0.03
    )Diluted earnings (loss) per share
    
    $
    (0.16
    )
    
    $
    0.15
    
    
    $
    (0.21
    )
    
    $
    0.42
 See accompanying notes to the consolidated financial statements. 4




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  (Dollars in thousands)
 Six months endedDecember 31,2004
    
    
    2003Cash flows from operating activities:Net earnings (loss)
    
    $
    (626
    )
    
    $
    1,272Net loss from discontinued operations
    
    
    (53
    )
    
    
    (77
    )Net earnings (loss) from continuing operations
    
    
    (573
    )
    
    
    1,349Adjustments to reconcile net earnings (loss) from
continuing operations to net cash provided by
operating activities of continuing operations:Depreciation and amortization
    
    
    335
    
    
    
    369Bad debt expense
    
    
    218
    
    
    
    (11
    )Foreign exchange gain
    
    
    (65
    )
    
    
    (47
    )Other
    
    
    70
    
    
    
    (2
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    211
    
    
    
    3,728Inventories
    
    
    (228
    )
    
    
    321Costs and earnings in excess of billings on
uncompleted contracts
    
    
    3,802
    
    
    
    (3,144
    )Other current assets
    
    
    (249
    )
    
    
    567Other assets
    
    
    233
    
    
    
    (20
    )Accounts payable
    
    
    (1,202
    )
    
    
    (1,094
    )Billings in excess of costs and earnings on
uncompleted contracts
    
    
    1,528
    
    
    
    (943
    )Commissions payable
    
    
    (41
    )
    
    
    (66
    )Product warranties
    
    
    2
    
    
    
    (75
    )Income taxes payable
    
    
    (557
    )
    
    
    699Accrued liabilities and other
    
    
    (230
    )
    
    
    (593
    )3,827
    
    
    
    (311
    )Net cash provided by operating activities
    
    
    3,254
    
    
    
    1,038Cash flow from investing activities:Net purchases of property and equipment
    
    
    (231
    )
    
    
    (222
    )Net cash used in investing activities
    
    
    (231
    )
    
    
    (222
    )Cash flows from financing activities:Proceeds from sale of common stock
    
    
    150
    
    
    
    35Net cash provided by financing activities
    
    
    150
    
    
    
    35Net cash provided by (used in) discontinued operations
    
    
    (93
    )
    
    
    398Effect of exchange rate changes on
cash and cash equivalents
    
    
    5
    
    
    
    31Net increase in cash and cash equivalents
    
    
    3,085
    
    
    
    1,280Cash and cash equivalents at beginning of period
    
    
    4,119
    
    
    
    6,680Cash and cash equivalents at end of period
    
    $
    7,204
    
    
    $
    7,960
 See accompanying notes to consolidated financial statements. 5




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 1. Basis of Presentation The accompanying 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 consolidated financial statements of the Company as of December 31, 2004, and for the three and
six months ended December 31, 2004 and December 31, 2003 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 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 six months ended December 31, 2004 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 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 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 126R will have on its
financial statements and related disclosures. 6




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Balance at beginning of period
    
    $
    231
    
    
    $
    315
    
    
    $
    431
    
    
    $
    402Bad debt expense
    
    
    196
    
    
    
    70
    
    
    
    218
    
    
    
    (11
    )Accounts written off, net
    
    
    
    
    
    
    (2
    )
    
    
    (222
    )
    
    
    (8
    )Balance at end of period
    
    $
    427
    
    
    $
    383
    
    
    $
    427
    
    
    $
    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
obsolete and slow-moving inventory based on historical usage and estimated future usage. In
assessing the ultimate realization of its inventory, the Company is required to make judgments as
to future demand requirements. As actual future demand or market conditions may vary from those
projected by the Company, adjustments to inventory valuations may be required. Principal components of inventories are as follows : December 31,
    
    
    June 30,2004
    
    
    2004Raw materials
    
    $
    2,964
    
    
    $
    2,630Work in progress
    
    
    305
    
    
    
    427Finished goods
    
    
    286
    
    
    
    2453,555
    
    
    
    3,302Reserve for obsolete and slow-moving inventory
    
    
    (218
    )
    
    
    (196
    )$
    3,337
    
    
    $
    3,106
 7




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 4. Inventories  Continued Changes in the Companys reserve for obsolete and slow-moving inventory are as follows: Three months ended
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Balance at beginning of period
    
    $
    202
    
    
    $
    167
    
    
    $
    196
    
    
    $
    122Additions
    
    
    16
    
    
    
    17
    
    
    
    22
    
    
    
    62Amounts written off
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at end of period
    
    $
    218
    
    
    $
    184
    
    
    $
    218
    
    
    $
    184
 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Balance at beginning of period
    
    $
    980
    
    
    $
    702
    
    
    $
    982
    
    
    $
    846Provision for warranty expenses
    
    
    47
    
    
    
    368
    
    
    
    206
    
    
    
    355Warranty charges
    
    
    (43
    )
    
    
    (299
    )
    
    
    (204
    )
    
    
    (430
    )Balance at end of period
    
    $
    984
    
    
    $
    771
    
    
    $
    984
    
    
    $
    771
 8




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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 (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. 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: December 31,
    
    
    June 30,2004
    
    
    2004Costs incurred on uncompleted contracts and
estimated earnings
    
    $
    48,048
    
    
    $
    44,348Less billings to date
    
    
    (41,236
    )
    
    
    (32,299
    )$
    6,812
    
    
    $
    12,049
 The components of uncompleted contracts are reflected in the balance sheets as follows December 31,
    
    
    June 30,2004
    
    
    2004Costs and earnings in excess of billings on
uncompleted contracts
    
    $
    8,739
    
    
    $
    12,448Billings in excess of costs and earnings on
uncompleted contracts
    
    
    (1,927
    )
    
    
    (399
    )$
    6,812
    
    
    $
    12,049
 9




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    360Cost of goods sold
    
    
    50
    
    
    
    206
    
    
    
    75
    
    
    
    378Gross profit (loss)
    
    
    (50
    )
    
    
    (206
    )
    
    
    (75
    )
    
    
    (18
    )Operating expenses
    
    
    
    
    
    
    11
    
    
    
    5
    
    
    
    240Operating loss
    
    
    (50
    )
    
    
    (217
    )
    
    
    (80
    )
    
    
    (258
    )Income tax benefit
    
    
    (17
    )
    
    
    (75
    )
    
    
    (27
    )
    
    
    (89
    )Net loss from operations
    
    
    (33
    )
    
    
    (142
    )
    
    
    (53
    )
    
    
    (169
    )Gain on disposal, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    92Net loss
    
    $
    (33
    )
    
    $
    (142
    )
    
    $
    (53
    )
    
    $
    (77
    )Diluted loss per shareNet loss from operations
    
    $
    (0.01
    )
    
    $
    (0.05
    )
    
    $
    (0.02
    )
    
    $
    (0.06
    )Net gain on disposal
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    0.03Net loss
    
    $
    (0.01
    )
    
    $
    (0.05
    )
    
    $
    (0.02
    )
    
    $
    (0.03
    )
 The current and non-current assets and liabilities of the discontinued boiler segment are as
follows: December 31,
    
    
    June 30,2004
    
    
    2004AssetsAccounts receivable, principally trade  net of
allowance for uncollectible accounts of $10
at December 31, 2004 and June 30, 2004.
    
    $
    216
    
    
    $
    225Current assets of discontinued operations
    
    
    216
    
    
    
    225Equipment  net of accumulated depreciation of $11
at December 31, 2004 and June 30, 2004
    
    
    9
    
    
    
    9Total assets of discontinued operations
    
    $
    225
    
    
    $
    234LiabilitiesCommissions payable
    
    
    
    
    
    
    6Product warranties and start-up reserves
    
    
    257
    
    
    
    300Total current liabilities of discontinued operations
    
    $
    257
    
    
    $
    306
 10




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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 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. 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. 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net earnings (loss) from continuing operations
    
    $
    (464
    )
    
    $
    609
    
    
    $
    (573
    )
    
    $
    1,349Net loss from discontinued operations
    
    
    (33
    )
    
    
    (142
    )
    
    
    (53
    )
    
    
    (77
    )Foreign currency translation adjustment
    
    
    129
    
    
    
    145
    
    
    
    120
    
    
    
    162Comprehensive income (loss)
    
    $
    (368
    )
    
    $
    612
    
    
    $
    (506
    )
    
    $
    1,434
 11




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net earnings (loss) from continuing operations
    
    $
    (464
    )
    
    $
    609
    
    
    $
    (573
    )
    
    $
    1,349Net loss from discontinued operations
    
    
    (33
    )
    
    
    (142
    )
    
    
    (53
    )
    
    
    (77
    )Net earnings (loss)
    
    $
    (497
    )
    
    $
    467
    
    
    $
    (626
    )
    
    $
    1,272Basic weighted average common shares outstanding
    
    
    3,030
    
    
    
    3,002
    
    
    
    3,022
    
    
    
    3,000Effect of dilutive options
    
    
    
    
    
    
    45
    
    
    
    
    
    
    
    42Diluted weighted average common shares outstanding
    
    
    3,030
    
    
    
    3,047
    
    
    
    3,022
    
    
    
    3,042BASIC EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.15
    )
    
    $
    0.20
    
    
    $
    (0.19
    )
    
    $
    0.45Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.02
    )
    
    
    (0.03
    )Net earnings (loss) per share
    
    $
    (0.16
    )
    
    $
    0.16
    
    
    $
    (0.21
    )
    
    $
    0.42DILUTED EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.15
    )
    
    $
    0.20
    
    
    $
    (0.19
    )
    
    $
    0.44Loss from discontinued operations
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.02
    )
    
    
    (0.03
    )Net earnings (loss) per share
    
    $
    (0.16
    )
    
    $
    0.15
    
    
    $
    (0.21
    )
    
    $
    0.42
 Diluted weighted average
common shares outstanding excluded 208,000 and 210,000 outstanding stock options
for the three and six months ended December 31, 2004 because their impact would be anti-dilutive.
Likewise, diluted weighted average common shares outstanding excluded
101,000 outstanding stock options
for the three and six months ended December 31, 2003, respectively, because their impact would be
anti-dilutive. 12. 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 December 31,
2004), and is secured by substantially all of the Companys assets. As of December 31, 2004, the
Company had no outstanding balances under the credit line, and $3.1 million outstanding under
stand-by letters of credit, leaving $9.4 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 December 31, 2004,
the Company was in compliance with all financial and other covenants of the loan agreement. 12




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 12. Lines of Credit - Continued In addition, our subsidiary located in the United Kingdom (our UK subsidiary) has a £2.0 million
(approximately $3.8 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 $3.1 million outstanding under stand-by letters of credit as described above)
and expires on October 31, 2005. At December 31, 2004, there was approximately £1.6 million
outstanding under this facility, leaving availability of approximately £400,000 (approximately
$760,000). 13. 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net earnings (loss), as reported
    
    $
    (497
    )
    
    $
    467
    
    
    $
    (626
    )
    
    $
    1,272Deduct: Total stock-based employee compensation expense
determined using the fair
value based method for all
awards,
net of tax
    
    
    (46
    )
    
    
    (102
    )
    
    
    (70
    )
    
    
    (123
    )Pro forma net earnings (loss)
    
    $
    (543
    )
    
    $
    365
    
    
    $
    (696
    )
    
    $
    1,149Earnings (loss) per share:Basic - as reported
    
    $
    (0.16
    )
    
    $
    0.16
    
    
    $
    (0.21
    )
    
    $
    0.42Basic - pro forma
    
    $
    (0.18
    )
    
    $
    0.12
    
    
    $
    (0.23
    )
    
    $
    0.38Diluted - as reported
    
    $
    (0.16
    )
    
    $
    0.15
    
    
    $
    (0.21
    )
    
    $
    0.42Diluted - pro forma
    
    $
    (0.18
    )
    
    $
    0.12
    
    
    $
    (0.23
    )
    
    $
    0.38
 13




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 14. 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. 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 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 six months ended December 31, 2004 and
December 31, 2003 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.
During the quarter, in connection with certain control deficiencies, as more fully described under
Part I  Item 4 Controls and Procedures of this Report, the Company recorded certain correcting
adjustments. The impact of these adjustments increased the profit of the Environmental Systems
segment by approximately $349,000 and increased the loss of the Separation Filtration Systems
segment by approximately $452,000, resulting in an immaterial net pre-tax impact to the Companys
consolidated loss for the period of approximately $103,000. SeparationEnvironmental
    
    
    Filtration
    
    
    UnallocatedThree months ended December 31, 2004
    
    Systems
    
    
    Systems
    
    
    Overhead
    
    
    ConsolidatedNet sales from customers
    
    $
    4,987
    
    
    $
    5,857
    
    
    $
    
    
    
    $
    10,844Segment profit (loss)
    
    
    1,210
    
    
    
    (559
    )
    
    
    (1,357
    )
    
    
    (706
    )Three months ended December 31, 2003Net sales from customers
    
    $
    8,930
    
    
    $
    7,499
    
    
    $
    
    
    
    $
    16,429Segment profit
    
    
    1,494
    
    
    
    605
    
    
    
    (1,278
    )
    
    
    821Six months ended December 31, 2004Net sales from customers
    
    $
    8,977
    
    
    $
    13,085
    
    
    $
    
    
    
    $
    22,062Segment profit (loss)
    
    
    1,274
    
    
    
    166
    
    
    
    (2,412
    )
    
    
    (972
    )Six months ended December 31, 2003Net sales from customers
    
    $
    19,009
    
    
    $
    14,227
    
    
    $
    
    
    
    $
    33,236Segment profit
    
    
    3,229
    
    
    
    979
    
    
    
    (2,236
    )
    
    
    1,972
 14




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 15. 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 six months ended December 31, 2004 and December 31,
2003 is as follows: UnitedStates
    
    
    Europe
    
    
    Eliminations
    
    
    ConsolidatedThree months ended December 31, 2004Net sales to unaffiliated
customers
    
    $
    9,619
    
    
    $
    1,225
    
    
    $
    
    
    
    $
    10,844Transfers between
geographic areas
    
    
    (79
    )
    
    
    
    
    
    
    79
    
    
    
    Total
    
    $
    9,540
    
    
    $
    1,225
    
    
    $
    79
    
    
    $
    10,844Identifiable long-lived assets
    
    $
    2,866
    
    
    $
    83
    
    
    $
    
    
    
    $
    2,949Three months ended December 31, 2003Net sales to unaffiliated
customers
    
    $
    13,554
    
    
    $
    2,875
    
    
    $
    
    
    
    $
    16,429Transfers between
geographic areas
    
    
    98
    
    
    
    
    
    
    
    (98
    )
    
    
    Total
    
    $
    13,652
    
    
    $
    2,875
    
    
    $
    (98
    )
    
    $
    16,429Identifiable long-lived assets
    
    $
    3,149
    
    
    $
    105
    
    
    $
    
    
    
    $
    3,254Six months ended December 31, 2004Net sales to unaffiliated
customers
    
    $
    18,600
    
    
    $
    3,462
    
    
    $
    
    
    
    $
    22,062Transfers between
geographic areas
    
    
    681
    
    
    
    
    
    
    
    (681
    )
    
    
    Total
    
    $
    19,281
    
    
    $
    3,462
    
    
    $
    (681
    )
    
    $
    22,062Identifiable long-lived assets
    
    $
    2,866
    
    
    $
    83
    
    
    $
    
    
    
    $
    2,949Six months ended December 31, 2003Net sales to unaffiliated
customers
    
    $
    27,375
    
    
    $
    5,861
    
    
    $
    
    
    
    $
    33,236Transfers between
geographic areas
    
    
    240
    
    
    
    
    
    
    
    (240
    )
    
    
    Total
    
    $
    27,615
    
    
    $
    5,861
    
    
    $
    (240
    )
    
    $
    33,236Identifiable long-lived assets
    
    $
    3,149
    
    
    $
    105
    
    
    $
    
    
    
    $
    3,254
 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. 15




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 16. Supplemental Cash Flow Information Net cash flows from operating activities reflects cash payments for income taxes as follows: Three months ended
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Income taxes paid
    
    $
    150
    
    
    $
    
    
    
    $
    660
    
    
    $
    
 
 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 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 28 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 Consolidated Financial Statements of this Report for
additional discussion on the discontinuance of this business unit. Environmental Systems.This business segment represented approximately 41% and 57% of our
revenues for the six months ended December 31, 2004 and 2003, 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. 16




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 Separation Filtration Systems.This business segment represented approximately 59% and 43% of
our revenues for the six months ended December 31, 2004 and 2003, 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. 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-price arrangements, thereby reducing the risk of significant cost
overruns on any given project. However, a number of internal and 17




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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. 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 collectibility of accounts receivable based upon historical
collection trends, current economic factors, and the assessment of the collectibility of specific
accounts. We evaluate the collectibility of specific accounts using a combination of factors,
including the age of the outstanding balances, evaluation of customers current and past financial
condition and credit scores, recent payment history, current economic environment, 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    72.9
    
    
    
    72.3
    
    
    
    72.1
    
    
    
    71.9Gross profit
    
    
    27.1
    
    
    
    27.7
    
    
    
    27.9
    
    
    
    28.1Operating expenses
    
    
    33.6
    
    
    
    22.7
    
    
    
    32.3
    
    
    
    22.2Operating income (loss)
    
    
    (6.5
    )
    
    
    5.0
    
    
    
    (4.4
    )
    
    
    5.9Other income
    
    
    
    
    
    
    0.7
    
    
    
    0.5
    
    
    
    0.2Net earnings (loss) from continuing
operations before income taxes
    
    
    (6.5
    )
    
    
    5.7
    
    
    
    (3.9
    )
    
    
    6.1Income tax expense (benefit)
    
    
    (2.2
    )
    
    
    2.0
    
    
    
    (1.3
    )
    
    
    2.1Net earnings (loss) from continuing operations
    
    
    (4.3
    )
    
    
    3.7
    
    
    
    (2.6
    )
    
    
    4.0Loss from discontinued operations,
net of tax
    
    
    (0.3
    )
    
    
    (0.9
    )
    
    
    (0.2
    )
    
    
    (0.2
    )Net earnings (loss)
    
    
    (4.6
    )%
    
    
    2.8
    %
    
    
    (2.8
    )%
    
    
    3.8
    %
 18




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 Three Months Ended December 31, 2004 Compared to Three Months Ended December 31, 2003 Results of Operations  Consolidated Revenues.For the three months ended December 31, 2004, revenues decreased approximately $5.6
million, or 34.0%, to $10.8 million from $16.4 million for the three months ended December 31,
2003. Domestic revenues decreased approximately $5.8 million, or 45.0%, from $12.9 million for the
three months ended December 31, 2003 to $7.1 million for the three months ended December 31, 2004.
International revenues increased approximately $200,000, or 5.6%, from $3.6 million for the three
months ended December 31, 2003 to $3.8 million for the three months ended December 31, 2004. The
decline in our domestic revenues was mainly attributable to the decline in our Environmental
Systems sales, which continues to be impacted by the slow pace of new power plant construction and
regulatory uncertainties. The increase in our international revenues related primarily to an
increase in our international sales originated by our domestic operations, which was partially
offset by a decrease in our Separation Filtration System sales through our European subsidiary.
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 three
primary factors: (1) sales volume, (2) shifts in our product mix and, (3) start-up and warranty
costs. Certain products have higher margins than others; and as a result, shifts in the
composition of our sales can have a significant impact on our margins. For the three months ended
December 31, 2004, our gross profit margin decreased by approximately $ 1.6 million, or 35.3%, from
$4.5 million for the three months ended December 31, 2003 to $2.9 million for the three months
ended December 31, 2004. Gross profit margin, as a percentage of sales, decreased from 27.7% for
the three months ended December 31, 2003 to 27.1% for the three months ended December 31, 2004.
While our margins were favorably impacted by shifts in our product mix during the period, they were
negatively impacted by: 1) our warranty and start-up costs, which increased as a percentage of
sales from 2.1% for the second quarter of fiscal 2004 to 2.9% for the second quarter of fiscal year
2005, and 2) our unabsorbed manufacturing costs, which increased as a percentage of sales from 3.9%
for the second quarter of fiscal 2004 to 4.3% for the second quarter of fiscal year 2005. Both of
these were volume related, as our actual warranty and start-up costs decreased from approximately
$347,000 to $312,000, or 10.1%, and our unabsorbed manufacturing costs decreased from $646,000 to
$468,000, or 27.6%, for the three months ended December 31, 2003 and 2004, respectively. Operating Expenses.For the three months ended December 31, 2004, operating expenses from
continuing operations decreased by approximately $100,000, or 2.7%, from approximately $3.7 million
for the three months ended December 31, 2003 to approximately $3.6 million for the three months
ended December 31, 2004. However, due to the decline in our volume during the period, our
operating expenses, as a percentage of our sales, increased from 22.7% for the three months ended
December 31, 2003 to 33.6% for the three months ended December 31, 2004. On a comparative basis,
our sales and marketing expenses remained relatively constant at approximately $1.4 million in both
periods, our engineering and project management expenses decreased from approximately $1.0 million
to approximately $881,000, and our general and administrative expenses increased slightly, from
$1.3 million for the three months ended December 31, 2003 to $1.4 million for the three months
ended December 31, 2004. The decrease in engineering and project management expenses during this
period can be attributed to our continued emphasis on cost controls and improved project execution.
The increase in our general and administrative expenses during the period is attributed to the
increased 19




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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 three months ended December 31, 2004, other income and
expense items changed by approximately $106,000, from income of approximately $109,000 for the
three months ended December 31, 2003 to income of approximately $3,000 for the three months ended
December 31, 2004. This change related primarily to the impact associated with our foreign
currency exchange. During the three months ended December 31, 2003, we realized foreign currency
exchange gains of approximately $94,000 compared to foreign currency exchange gains of
approximately $4,000 for the three months ended December 31, 2004. In addition, during the current
fiscal quarter, we received net rental income of approximately $11,000 associated with our lease of
some inactive warehouse space. Income Taxes.The Companys effective income tax rate for continuing operations was
approximately 34% for the three months ended December 31, 2003 and 2004. Net Earnings (Loss) from Continuing Operations.As a result of the above factors, our net
earnings (loss) from continuing operations decreased by approximately $1.1 million, from earnings
of approximately $609,000, or 3.7% of sales for the three months ended December 31, 2003, to a net
loss of approximately $464,000, or (4.3%) of sales for the three months ended December 31, 2004.
Basic and diluted earnings (loss) per share decreased from earnings of $0.20 per share for the
three months ended December 31, 2003, to a loss of ($0.15) per share for the three months ended
December 31, 2004. Discontinued Operations. For the three months ended December 31, 2004, we recognized a net
loss from discontinued operations of approximately $33,000 compared to a net loss of approximately
$142,000 for the three months ended December 31, 2003. Included in the net loss for the current
period was an expense of approximately $50,000 relating to an additional provision for potential
warranty and start-up costs. The Company has established a reserve of approximately $257,000 at
December 31, 2004, 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). Basic and diluted loss per share from discontinued operations
was ($0.01) per share for the three months ended December 31, 2004, compared to a loss of ($0.05)
per share for the three months ended December 31, 2003. Net Earnings (Loss).As a result of the above factors, our earnings for the three months ended
December 31, 2004 decreased approximately $964,000, from net earnings of $467,000, or 2.8% of sales
for the three months ended December 31, 2003, to a net loss of approximately $497,000, or (4.6%) of
sales for the three months ended December 31, 2004. Basic earnings (loss) per share decreased from
earnings of $0.16 per share for the three months ended December 31, 2003, to a loss of $(0.16) per
share for the three months ended December 31, 2004. Diluted earnings (loss) per share decreased
from earnings of $0.15 per share for the three months ended December 31, 2003, to a loss of $(0.16)
per share for the three months ended December 31, 2004. 20




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 Six Months Ended December 31, 2004 Compared to Six Months Ended December 31, 2003 Results of Operations  Consolidated Revenues.For the six months ended December 31, 2004, revenues decreased approximately $11.1
million, or 33.4%, to $22.1 million from $33.2 million for the six months ended December 31, 2003.
Domestic revenues decreased approximately $10.2 million, or 43.8%, from $23.3 million for the six
months ended December 31, 2003 to $13.1 million for the six months ended December 31, 2004.
International revenues decreased approximately $900,000, or 9.1%, from $9.9 million for the six
months ended December 31, 2003 to $9.0 million for the six months ended December 31, 2004. The
decline in our domestic revenues was mainly attributable to the decline in our Environmental
Systems sales, which continues to be impacted by the slow pace of new power plant construction and
regulatory uncertainties. The decrease in our international revenues related primarily to the
decrease in our Separation Filtration System sales through our European operations. 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 three
primary factors: (1) sales volume, (2) shifts in our product mix and, (3) start-up and warranty
costs. Certain products have higher margins than others; as a result, shifts in the composition of
our sales can have a significant impact on our margins. For the six months ended December 31,
2004, our gross profit margin decreased approximately $ 3.2 million, or 34.0%, from $9.4 million in
fiscal 2004 to $6.2 million in the six months ended December 31, 2004. Our gross profit margin, as
a percentage of sales, decreased from 28.1% for the six months ended December 31, 2003 to 27.9% for
the six months ended December 31, 2004. The slight variation from our prior year gross profit
margin is due to the increase, as a percentage of sales, in our warranty and start-up costs which
increased from 2.3% of sales for the six months ended December 31, 2003 to 2.5% of sales for the
six months ended December 31, 2004. However, on a dollar basis our actual warranty and start-up
costs decreased from approximately $758,000 for the six months ended December 31, 2003 to $552,000
for the six months ended December 31, 2004. Operating Expenses.For the six months ended December 31, 2004, operating expenses from
continuing operations decreased by approximately $300,000, or 4.1%, from approximately $7.4 million
for the six months ended December 31, 2003 to approximately $7.1 million for the six months ended
December 31, 2004. As a percentage of sales, our operating expenses increased from 22.2% for the
six months ended December 31, 2003 to 32.3% for the six months ended December 31, 2004. 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 $3.0 million to approximately $2.9 million, our engineering and project
management expenses decreased from approximately $2.1 million to approximately $1.8 million and our
general and administrative expenses increased from approximately $2.2 million to approximately $2.4
million. The decrease in our sales and marketing expenses related primarily to a decrease in our
commission expense during the six months ended December 31, 2004, which is directly related to the
decrease in our revenues. The decrease in engineering and project management expenses during this
period can be attributed to our continued emphasis on cost controls and improved project execution.
The increase in our general and administrative expenses during the current year 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. 21




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 Other Income and Expense.In the six months ended December 31, 2004, other income and
expense items changed by approximately $25,000, from income of approximately $79,000 for the six
months ended December 31, 2003 to income of approximately $104,000 for the six months ended
December 31, 2004. This change related primarily to the impact associated with our foreign
currency exchange. During the six months ended December 31, 2003, we realized foreign currency
exchange gains of approximately $47,000. However, due to the weakening of the dollar, we
recognized foreign currency exchange gains of approximately $65,000 for the six months ended
December 31, 2004. Additionally, we recognized net rental income of approximately $11,000
associated with our lease of some inactive warehouse space. Income Taxes.The Companys effective income tax rate for continuing operations was
approximately 34% for the six months ended December 31, 2003 and
2004. Net Earnings (Loss) from Continuing Operations.As a result of the above factors, our net
earnings (loss) from continuing operations decreased by approximately $1.9 million, from earnings
of approximately $1.3 million, or 4.0% of sales for the six months ended December 31, 2003, to a
net loss of approximately $573,000, or (2.6%) of sales for the six months ended December 31, 2004.
Basic earnings (loss) per share decreased from earnings of $0.45 per share for the six months ended
December 31, 2003, to a loss of ($0.19) per share for the six months ended December 31, 2004.
Diluted earnings (loss) per share decreased from earnings of $0.44 per share for the six months
ended December 31, 2003, to a loss of ($0.19) per share for the six months ended December 31, 2004. Discontinued Operations.For the six months ended December 31, 2004, we recognized a net loss
from discontinued operations of approximately $53,000 compared to a net loss of approximately
$77,000 for the six months ended December 31, 2003. Included in the net loss for the current
period was an expense of approximately $75,000 relating to an additional provision for potential
warranty and start-up costs. The Company has established a reserve of approximately $257,000 at
December 31, 2004, 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 six months ended
December 31, 2003 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 six months ended December 31, 2004, compared to a loss of
($0.03) per share for the six months ended December 31, 2003. Net Earnings (Loss).As a result of the above factors, our earnings for the six months ended
December 31, 2004 decreased approximately $1.9 million, from net earnings of approximately $1.3
million, or 3.8% of sales, to a net loss of approximately $626,000, or (2.8%) of sales for the six
months ended December 31, 2004. Basic and Diluted earnings (loss) per share decreased from
earnings of $0.42 per share for the six months ended December 31, 2003, to a loss of $(0.21) per
share for the six months ended December 31, 2004. 22




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    %
    
    
    2003
    
    
    %
    
    
    2004
    
    
    %
    
    
    2003
    
    
    %RevenuesEnvironmental Systems
    
    $
    4,987
    
    
    
    46.0
    %
    
    $
    8,930
    
    
    
    54.4
    %
    
    $
    8,977
    
    
    
    40.7
    %
    
    $
    19,009
    
    
    
    57.2
    %Separation Filtration Systems
    
    
    5,857
    
    
    
    54.0
    %
    
    
    7,499
    
    
    
    45.6
    %
    
    
    13,085
    
    
    
    59.3
    %
    
    
    14,227
    
    
    
    42.8
    %Total
    
    $
    10,844
    
    
    
    100.0
    %
    
    $
    16,429
    
    
    
    100.0
    %
    
    $
    22,062
    
    
    
    100.0
    %
    
    $
    33,236
    
    
    
    100.0
    %
 Environmental Systems.Revenues from our Environmental Systems, when compared to the
same periods last fiscal year, decreased approximately $4.0 million, or 44.2% and $10.0 million,
or 52.8% for the three and six months ended December 31, 2004, respectively. The reduction in
revenues during the current year related 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. Although our bookings for this quarter and for the six months ended December 31, 2004
are consistent with our bookings rate over the previous twelve months when the aforementioned NOx
compliance project is excluded, our Environmental Systems segment continues to experience the
impact of the slow pace of new power plant construction. However, 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. Lastly, when either the Clean Air Interstate Regulation or the
Clean Skies initiative is promulgated, a significant reduction in current NOx emission levels is
expected to be required. Separation Filtration Systems.When compared to the same periods last fiscal year, our
Separation Filtration Systems revenues decreased approximately $1.6 million, or 21.9% and $1.1
million, or 8.0% for the three and six months ended December 31, 2004, respectively. Revenues
originated by our domestic operations were relatively flat during the second quarter of fiscal 2005
when compared to the same period in fiscal 2004. For the six months ended December 31, 2004, our
revenues originated by our domestic operations increased by approximately $1.3 million, or 15.0%,
when compared to the same period last year. Our UK revenues decreased approximately $1.7 million,
or 57.4% for the three months ended December 31, 2004 and $2.4 million, or 40.9% for the six months
ended December 31, 2004, when compared to the same periods last year. The increase in revenue
through our domestic operations can be attributed primarily to an increase in our nuclear/marine
sales, which increased by approximately $1.5 million, or 157.3% for the three months ended December
31, 2004 and $2.9 million, or 187.5% for the six
months ended December 31, 2004, and related principally to life extension projects at several
nuclear power plants and increased military spending. This was offset by a decrease in our
domestic pressure product sales, which decreased by approximately $1.4 million and $1.6 million for
the three and six months ended December 31, 2004. The decrease in revenues through our U.K.
operation is primarily due 23




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 the completion 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
    
    
    Six months endedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Segment profitEnvironmental Systems
    
    $
    1,210
    
    
    $
    1,494
    
    
    $
    1,274
    
    
    $
    3,229Separation Filtration Systems
    
    
    (559
    )
    
    
    605
    
    
    
    166
    
    
    
    979Total
    
    
    651
    
    
    
    2,099
    
    
    
    1,440
    
    
    
    4,208Unallocated general and administrative
expenses
    
    
    (1,357
    )
    
    
    (1,278
    )
    
    
    (2,412
    )
    
    
    (2,236
    )Operating income (loss)
    
    $
    (706
    )
    
    $
    821
    
    
    $
    (972
    )
    
    $
    1,972
 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 in the second quarter of fiscal 2005
decreased by $284,000, or 19.0% compared to the second quarter of fiscal 2004. As a percentage of
Environmental Systems revenue, profit in Environmental Systems was 16.7% and 24.3% for the three
months ended December 31, 2003 and 2004, respectively. As discussed under Part I  Item 4
Controls and Procedures, of this Report, Company management discovered certain control
deficiencies during the second quarter of fiscal 2005. In connection therewith, management
determined that the Companys previously reported financial information was inaccurate by
immaterial amounts. Necessary correcting adjustments have been recorded in this quarter and while
the effects of these corrections were immaterial with respect to the Companys previously reported
financial information and to the current quarters consolidated results, they did have a
significant effect on each segments reported profit (loss) for this quarter. Specifically,
absent this correction, the Environmental Systems segment profit would have been 17.3% for the
quarter ended December 31, 2004, which is more in line with the 16.7% achieved during
the second quarter of fiscal 2003. For the six months ended December 31, 2004, our
Environmental Systems profits decreased by approximately $1.9 million, or 60.5% over the same
period last year. As a percentage of Environmental Systems revenue, our operational performance
decreased from a segment profit of 17.0% for the six months ended December 31, 2003 to segment
profit of 14.2% for the same period this year. The decrease in our Environmental Systems profit
during the six months ended December 31, 2004, relates primarily to this segments volume related
decrease in revenues during this period. Operational expenses, as a percentage of revenues,
increased from 11.7% for the six months ended December 31, 2003 to 20.1% for the six months ended
December 31, 2004. This increase was offset by the effect of the adjustment discussed above. Separation Filtration Systems.Separation Filtration Systems profits decreased in the second
quarter of fiscal 2005 by approximately $1.2 million, from a profit of approximately $605,000 for
the second quarter of fiscal 2004, to a loss of $559,000 for the same quarter this fiscal year. As
a percentage of Separation Filtration Systems revenue, our operational performance decreased from a
segment profit of 24




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 8.1%, to a segment loss of 9.5%, for the three months ended December 31, 2003 and
2004, respectively. Separation Filtration Systems profits decreased in the six months ended
December 31, 2004 by approximately $813,000, from a profit of approximately $979,000 for six months
ended December 31, 2003, to a profit of $166,000 for the same period this fiscal year. As a
percentage of Separation Filtration Systems revenue, our operational performance decreased from a
segment profit of 6.9%, to a segment profit of 1.3%, for the six months ended December 31, 2003 and
2004, respectively. The decrease in our Separation Filtration Systems operational performance
during the current fiscal year can be attributed to the following items:  1.
    Increase in operational expenses, as a percentage of sales. Our
increase in operational expenses, as a percentage of sales, was especially evident in
the second quarter of fiscal 2004, because our Separation Filtration Systems revenues
were down approximately 22%. While our operational expenses remained relatively
constant, when compared to the same period last year, as a percentage of sales these
expenses increased from 18.5% for the three months ended December 31, 2003 to 23.3% for
the three months ended December 31, 2004.2.
    Significant material price increases. Due to worldwide consumption, steel prices, most
notably stainless steel prices, have increased considerably over the past year (increased over 55%
in the past 12 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 30 of this
Report.3.
    Corrections associated with control deficiencies. As noted under
Environmental Systems, during the current quarter, correcting adjustments have been
made to the Companys financial statements as the result of certain control
deficiencies. Without the impact of these corrections, the operational
performance of the Separation Filtration Systems would have been (1.8%) and 4.7% for
the three and six months ended December 31, 2004, respectively. Market Outlook Environmental Systems.We expect that the spending for NOx reduction systems will increase in
late 2005 through 2008 as users implement their compliance plans as regulatory compliance deadlines
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 25




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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 in
not probable. From time to time the Company is involved in various litigation matters arising in the
ordinary course of its business. The Company does not believe the disposition of any current
matter will have a material adverse effect on its consolidated financial position or its results of
operations. Backlog The Companys backlog of unfilled orders was approximately $34 million at December 31, 2004,
compared to $34 million at June 30, 2004 and $40 million at December 31, 2003. Our Environmental
Systems segment continues to be impacted by the effects of the slow down in new power plant
construction. We expect that spending for NOx reduction systems will increase in 2005  2008 as
users implement their compliance plans as regulatory deadlines approach, and we 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 and increased military spending occurs. The shortage of natural gas supplies is creating
new opportunities for Peerless separators and filters, such as the production of LNG and the
associated gas processing facilities. Financial Position Assets. Total assets decreased by approximately $900,000, or 2.3% from approximately $39.5
million at June 30, 2004 to approximately $38.6 million at December 31, 2004. The decrease in our
assets during the fiscal year resulted primarily from a decrease in costs and earnings in excess of
billings on uncompleted contracts of approximately $3.7 million, which was offset by an increase in
our cash and cash equivalents balances of approximately $3.1 million. See Item 2  Liquidity and
Capital Resources of this Report for further discussion. At June 30, 2004, we held cash and cash
equivalents of $4.1 million, had working capital of approximately $20.7 million, and a current
ratio of 2.4 to 1.0. This compares with cash and cash equivalents of $7.2 million, approximately
$20.7 million in working capital, and a current ratio of 2.5 to 1.0 at December 31, 2004. 26




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 Liabilities and Shareholders EquityTotal liabilities decreased by approximately $600,000,
or 4.2%, from approximately $14.8 million at June 30, 2004 to approximately $14.2 million at
December 31, 2004. The decrease in liabilities related primarily to a decrease in our trade
payables and other accrued liabilities, offset by an increase in our billings in excess of costs
and earnings on uncompleted contracts. See Item 2  Liquidity and Capital Resources of this
Report for further discussion. Liquidity and Capital Resources Our cash and cash equivalents were $7.2 million as of December 31, 2004, compared to $4.1
million at June 30, 2004. Cash provided by operating activities during the six months ended
December 31, 2004 was approximately $3.3 million compared to cash of approximately $1.0 million
provided by our operating activities during the six months ended December 31, 2003. Because we are engaged in the business of manufacturing custom systems, our progress billing
practices are event-oriented rather than date-oriented, and vary from contract to contract. We
customarily bill our customers after the occurrence of project milestones. Billings to customers
affect the balance of billings in excess of costs and earnings or the balance of cost and earnings
in excess of billings, as well as the balance of accounts receivable. Consequently, we focus on the
net amount of these accounts along with accounts payable, to determine our management of working
capital. At June 30, 2004, the balance of these working capital accounts was $15.9 million,
compared to $11.5 million at December 31, 2004, reflecting a decrease of our investment in these
working capital items of $4.4 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 six months ended December 31, 2004, funds were used by our operating loss and
used to reduce our accrued expenses and pay our income tax liability. Cash used in investing activities was approximately $231,000 for the six months ended December
31, 2004, compared to cash used in investing activities of approximately $222,000 for same period
in fiscal 2004. The use of cash during the six months ended December 31, 2004 and 2003 related
primarily to capital expenditures during the periods. Cash provided by financing activities was approximately $150,000 and $35,000 for the six
months ended December 31, 2004 and 2003, respectively, and related to the proceeds from the
issuance of common stock, pursuant to employee stock options. Cash used in our discontinued operations was $93,000 during the six months ended December 31,
2004, compared to $398,000 provided from discontinued operations during the same period in fiscal
2004. As a result of the above factors, during the first six months of fiscal year 2005, our cash
and cash equivalents increased by approximately $3.1 million, compared to an increase of
approximately $1.3 million 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
December 31, 2004), and is secured by substantially all our domestic assets. At December 31, 2004,
we had $3.1 million outstanding under stand-by letters of credit and no loans outstanding, leaving
us availability under our credit facility of $9.4 million. The facility contains financial
covenants, certain restrictions on capital expenditures, 27




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 acquisitions, asset dispositions,
dividends and additional debt, as well as other customary covenants. As of December 31, 2004, the
Company was in compliance with all financial and other covenants under the credit facility. In addition, our UK subsidiary has a £2.0 million (approximately $3.8 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 $3.1 million
outstanding above) and expires on October 31, 2005. At December 31, 2004, there was approximately
£1.6 million outstanding under this facility, leaving availability of approximately £400,000
(approximately $760,000). 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. 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 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 126R 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. 28




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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 six months of
fiscal 2005, approximately 41% of our consolidated revenues were derived from sales of
Environmental Systems for new and refurbished power plants compared to approximately 57% 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 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 increase use of
Environmental Systems in the United States. These laws include U.S. federal statutes such as the
Resource Conservation and Recovery Act of 1976, the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980 (CERCLA), the Clean Water Act and the Clean Air Act, and
the regulations implementing them, as well as similar laws and regulations at state and local levels and in
other countries. These laws and regulations may change or other jurisdictions may not adopt similar laws and regulations.
This business segment will be adversely impacted to the extent that current regulations requiring
the reduction of NOx emissions are repealed, amended or implementation dates delayed or to the
extent that regulatory authorities minimize enforcement. See Item 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. 29




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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
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 six months of fiscal 2005, revenue outside the United States represented
approximately 41% of our consolidated revenues. In the first six months of fiscal 2004,
approximately 30% of our revenue was derived from sales outside the United States. Our operations and
earnings throughout the world have been, and may in the future be, affected from time to time in
varying degrees by war, political developments and foreign laws and regulations, such as regional
economic uncertainty, political instability, restrictions, customs and tariffs, changing regulatory
environments, fluctuations in foreign currency exchange rates and adverse tax consequences. The
likelihood of such occurrences and their overall effect upon us vary greatly from country to
country and are not predictable. These factors may result in a decline in revenues or
profitability and could adversely affect our ability to expand our business outside of the United
States. Our financial performance may vary significantly from period to period, making it difficult to
estimate future revenue. Our annual revenues and earnings have varied in the past and are likely to vary in the future.
Our Environmental Systems contracts generally stipulate customer specific delivery terms and may
have contract cycles of a year or more, which subjects them to many factors beyond our control. In
addition, these contracts are significantly larger in size than our typical Separation Filtration
Systems contracts, which tend to intensify their impact on our annual operating results.
Furthermore, as a significant portion of our operating costs are fixed, an unanticipated decrease
in our revenues, a delay or cancellation of orders in backlog, or a decrease in the demand for our
products, may have a significant impact on our 30




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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. 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. 31




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 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 December 31, 2004 we
were in compliance with all financial and other covenants of our credit facility. Our ability to satisfy any debt obligations will depend upon our future operating performance,
which will be affected by prevailing economic, financial and business conditions and other factors,
some of which are beyond our control. We anticipate that borrowings from our existing revolving
credit facility, or the refinancing of our revolving credit facility, and cash provided by
operating activities, should provide sufficient funds to finance capital expenditures, working
capital and otherwise meet our operating expenses and service our debt requirements as they become
due. However, in the event that we require additional capital, there can be no assurance that we will be able to raise such
capital when needed or on satisfactory terms, if at all. Our business is subject to risks of terrorist acts and acts of war. Terrorist acts and acts of war may disrupt our operations, as well as our customers
operations. Such acts have created, and continue to create, economic and political uncertainties
and have contributed to global economic instability. Any future terrorist activities, and any
continued military or security operations could further weaken the global economy and create
additional uncertainties forcing our customers to further reduce their capital spending, or cancel
or delay already planned construction projects, which could have a material adverse impact on our
business, operating results and financial condition. Our common stock is thinly traded, which may result in low liquidity. The daily trading volume of our common stock is relatively low and therefore the liquidity and
appreciation in our stock may not meet our shareholders expectations. The market price of our
common stock could be adversely impacted as a result of sales by our existing shareholders of a
large number of shares of our common stock in the market, or the perception that such sales could
occur. 32




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 
 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. We, on occasion, will purchase derivative transactions with respect to foreign
contracts that do not contain a natural hedge, but the impact of any fluctuation in the exchange
rates in these hedged currencies, would be expected to have an immaterial impact on our financial
operations. The impact of currency exchange rate movements on inter-company transactions has been,
and is expected to continue to be, immaterial. As of December 31, 2004, 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 December 31, 2004, the
Companys disclosure controls and procedures were effective in ensuring that all material
information required to be filed in this Report has been made known to them in a timely fashion.
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. During the quarter ended December 31, 2004, there has 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 current quarter, the Companys principal executive officer and principal financial
officer identified deficiencies in the Companys internal controls over financial reporting as they
relate to the Companys administration of contracts. More specifically, these deficiencies concern
1) completeness of the Companys contract file documentation, and 2) the Companys process to
timely update its accounting records to reflect contract modifications and changes in estimates to
complete. Management, including our principal executive officer and principal financial officer,
conducted additional substantive testing to evaluate these deficiencies, notified the Companys
Audit Committee and outside public accounting firm of its initial findings, and supervised and
participated in the evaluation of these deficiencies. 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 33




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 previously reported financial results, nor is it
expected to have a material impact on the Companys projected results for fiscal year 2005. The
accounting consequence of 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. The PCAOB defines a material weakness as a significant deficiency, or a
combination of significant deficiencies, that result in more than a remote likelihood that a
material misstatement of annual or interim financial statements will not be prevented or detected.
A significant deficiency is defined as a control deficiency, or combination of deficiencies, that
adversely affects the ability to initiate, authorize, record, process or report external financial
data reliably in accordance with generally accepted accounting principles such that more than a
remote likelihood that a misstatement of financial statements that is more than inconsequential
will not be prevented or detected. The Companys Audit Committee engaged the Companys outside
accounting firm to review the results the procedures executed by
management and to perform additional
procedures as deemed appropriate to validate managements conclusions. The Companys outside
accounting firm has completed its review and procedures and has issued a material weakness letter
to the Companys Audit Committee with respect to the Companys administration of contracts. Our management and Audit Committee have dedicated 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. In addition to internal resources, the Company has engaged a third party
consulting firm to assist in the development of detailed control policies and procedures with
respect to contract administration. Accordingly, management has presented to the Audit Committee a
plan to remedy the control issues noted. The Company will be implementing new contract control
procedures, to assure the completeness of customer sales files and the accuracy of sales order
information and any modifications thereto. In addition, the Company will be instituting additional
control and review procedures with respect to the status of projects in process. The Company
believes that these steps should remedy the weakness identified with the Companys administration
of contracts. 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, 2006. 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 Consolidated Financial Statements of this Report). 34




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 
 Items 2, 3, and 5 are not applicable and have been omitted 
 Item 4. Submission of Matters to a Vote of Security Holders The following matters were submitted to a vote of securities holders at the Annual
Meeting of Shareholders held on November 18, 2004. A total of 2,904,764 shares (approximately 96%
of all shares entitled to vote) were represented by proxy or ballot at the meeting. The shareholders elected Mr. R. Clayton Mulford to serve as Class I Director for a three-year
term expiring at the annual meeting of shareholders in 2007, or until his successor is elected and
qualified with 2,847,405 votes for, no votes against, and with 57,359 votes abstaining. Additional
directors, whose term of office as directors continued after the meeting, are Bernard S. Lee,
Joseph V. Mariner, Jr., Donald A. Sillers, Jr. and Sherrill Stone. In addition, the shareholders ratified the selection of Grant Thornton LLP to serve as the
Companys independent accountants for the fiscal year ending June 30, 2005 with 2,836,889 for,
61,775 against, and with 6,100 votes abstaining. 
 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The following exhibits are filed as part of this report. Exhibit
Number
    
    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 December 31, 2003, 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).4(b)
    
    Amendment to Rights Agreement dated August 23, 2001, between Peerless Mfg.
Co. and Mellon Investor Services, LLC, as Rights Agent (filed as Exhibit 2 to our
Registration Statement on Form 8-A dated August 30, 2001, and incorporated herein by
reference).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. *
 35




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004 32(a)
    
    Section 1350 Certification of Chief Executive Officer. **32(b)
    
    Section 1350 Certification of Chief Financial Officer. **
   *
    
    Filed herewith**
    
    Furnished herewith  (b)
    Reports on Form 8-K. On November 12, 2004, the Company filed a Report on Form 8-K to file a press
release announcing its financial results for the first quarter of the fiscal year
ending June 30, 2005, which information was furnished and not filed with the
Commission. 
 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: February 14, 2005
    
    /s/ Sherrill StoneSherrill StoneChairman and Chief Executive OfficerDate: February 14, 2005
    
    /s/ Richard L. Travis, Jr.Richard L. Travis, Jr., Chief Financial Officer(Principal Financial and Accounting Officer)
 36