##### 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 September 30, 2004 OR Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the Transition Period from  to Commission File Number 0-5214 PEERLESS MFG. CO.  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
(Registrants Telephone Number, Including Area Code) 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 XNo Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X As of November 11, 2004, 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 SEPTEMBER 30, 2004 TABLE OF CONTENTS PART I:     FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets at September 30, 2004 (unaudited) and June 30, 2004
    
    
    3Unaudited Consolidated Statements of Operations for the three months ended
September 30, 2004 and 2003
    
    
    4Unaudited Consolidated Statements of Cash Flows for the three months ended
September 30, 2004 and 2003
    
    
    5Notes to the Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    28PART II:OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    29Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity
Securities
    
    
    29Item 3. Defaults Upon Senior Securities
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    29Item 5. Other Information
    
    
    29Item 6. Exhibits and Reports on Form 8-K
    
    
    30SIGNATURES
    
    
    31Rule 13a-14(a)/15d-14(a) Certification of CEORule 13a-14(a)/15d-14(a) Certification of CFOSection 1350 Certification of CEOSection 1350 Certification of CFO
  2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements 
 PEERLESS MFG. CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS(Dollars in thousands) September 30, 2004
    
    June 30, 2004(unaudited)ASSETSCurrent assetsCash and cash equivalents
    
    $
    4,033
    
    
    $
    4,119Accounts receivable  principally trade  net of
allowance of uncollectible accounts of $231 at
September 30, 2004 and $431 at June 30, 2004
    
    
    13,699
    
    
    
    13,604Inventories
    
    
    3,320
    
    
    
    3,106Costs and earnings in excess of billings
on uncompleted contracts
    
    
    11,923
    
    
    
    12,448Deferred income taxes
    
    
    1,165
    
    
    
    1,165Other   net
    
    
    956
    
    
    
    816Assets of discontinued operations
    
    
    216
    
    
    
    225Total current assets
    
    
    35,312
    
    
    
    35,483Property, plant and equipment  net
    
    
    3,001
    
    
    
    3,053Other assets
    
    
    730
    
    
    
    930Other assets of discontinued operations
    
    
    9
    
    
    
    9$
    39,052
    
    
    $
    39,475LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesAccount payable  trade
    
    
    10,205
    
    
    
    9,791Billings in excess of costs and earnings
on uncompleted contracts
    
    
    876
    
    
    
    399Commissions payable
    
    
    847
    
    
    
    844Income taxes payable
    
    
    
    
    
    
    557Product warranties
    
    
    980
    
    
    
    982Accrued liabilities and other
    
    
    1,227
    
    
    
    1,923Liabilities of discontinued operations
    
    
    215
    
    
    
    306Total current liabilities
    
    
    14,350
    
    
    
    14,802Shareholders equityCommon stock
    
    
    3,024
    
    
    
    3,014Additional paid-in capital
    
    
    2,040
    
    
    
    1,884Other
    
    
    205
    
    
    
    214Retained earnings
    
    
    19,433
    
    
    
    19,561Total shareholders equity
    
    
    24,702
    
    
    
    24,673Total liabilities and shareholders equity
    
    $
    39,052
    
    
    $
    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)
(Unaudited) Three months endedSeptember 30,2004
    
    2003Revenues
    
    $
    11,218
    
    
    $
    16,807Cost of goods sold
    
    
    8,003
    
    
    
    12,001Gross profit
    
    
    3,215
    
    
    
    4,806Operating expensesSales and marketing
    
    
    1,475
    
    
    
    1,603Engineering and project management
    
    
    951
    
    
    
    1,094General and administrative
    
    
    1,055
    
    
    
    9583,481
    
    
    
    3,655Operating income (loss)
    
    
    (266
    )
    
    
    1,151Other income (expense)Foreign exchange gain (loss)
    
    
    61
    
    
    
    (47
    )Other income  net
    
    
    40
    
    
    
    17101
    
    
    
    (30
    )Earnings (loss) from continuing operations
before income taxes
    
    
    (165
    )
    
    
    1,121Income tax expense (benefit)
    
    
    (56
    )
    
    
    381Net earnings (loss) from continuing operations
    
    
    (109
    )
    
    
    740Discontinued operations (Note 7)Earnings (loss) from discontinued operations
(including gain on disposal of $0 and $140 in
2004 and 2003, respectively)
    
    
    (30
    )
    
    
    99Income tax expense (benefit)
    
    
    (10
    )
    
    
    34Net earnings (loss) from discontinued operations
    
    
    (20
    )
    
    
    65Net earnings (loss)
    
    $
    (129
    )
    
    $
    805BASIC EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.04
    )
    
    $
    0.25Earnings (loss) from discontinued operations
    
    
    (0.01
    )
    
    
    0.02Basic earnings (loss) per share
    
    $
    (0.04
    )
    
    $
    0.27DILUTED EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.04
    )
    
    $
    0.24Earnings (loss) from discontinued operations
    
    
    (0.01
    )
    
    
    0.02Diluted earnings (loss) per share
    
    $
    (0.04
    )
    
    $
    0.26
 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)
(Unaudited) Three months endedSeptember 30,2004
    
    2003Cash flows from operating activities:Net earnings (loss)
    
    $
    (129
    )
    
    $
    805Net earnings (loss) from discontinued operations
    
    
    (20
    )
    
    
    65Net earnings (loss) from continuing operations
    
    
    (109
    )
    
    
    740Adjustments to reconcile net earnings (loss) from continuing operations
to net cash provided by operating activities:Depreciation and amortization
    
    
    171
    
    
    
    191Bad debt expense
    
    
    22
    
    
    
    (81
    )Foreign exchange (gain) loss
    
    
    (61
    )
    
    
    47Other
    
    
    70
    
    
    
    1Changes in operating assets and liabilitiesAccounts receivable
    
    
    (103
    )
    
    
    (576
    )Inventories
    
    
    (212
    )
    
    
    (701
    )Costs and earnings in excess of billings on uncompleted contracts
    
    
    554
    
    
    
    (653
    )Other current assets
    
    
    (139
    )
    
    
    (48
    )Other assets
    
    
    200
    
    
    
    4Accounts payable
    
    
    420
    
    
    
    1,500Billings in excess of costs and earnings on uncompleted contracts
    
    
    477
    
    
    
    Commissions payable
    
    
    3
    
    
    
    124Product warranties
    
    
    (2
    )
    
    
    (144
    )Income taxes payable
    
    
    (557
    )
    
    
    417Accrued liabilities and other
    
    
    (695
    )
    
    
    (174
    )148
    
    
    
    (93
    )Net cash provided by (used in) operating activities of continuing operations
    
    
    39
    
    
    
    647Cash flow from investing activities:Net purchases of property and equipment
    
    
    (119
    )
    
    
    (144
    )Net cash used in investing activities of continuing operations
    
    
    (119
    )
    
    
    (144
    )Cash flows from financing activities:Proceeds from sale of common stock
    
    
    97
    
    
    
    13Net cash provided by financing activities of continuing operations
    
    
    97
    
    
    
    13Net cash provided by (used in) discontinued operations
    
    
    (102
    )
    
    
    403Effect of exchange rate changes on
cash and cash equivalents
    
    
    (1
    )
    
    
    1Net increase (decrease) in cash and cash equivalents
    
    
    (86
    )
    
    
    920Cash and cash equivalents at beginning of period
    
    
    4,119
    
    
    
    6,680Cash and cash equivalents at end of period
    
    $
    4,033
    
    
    $
    7,600
 See accompanying notes to consolidated financial statements. 5




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 September 30, 2004, and
for the three months ended September 30, 2004 and 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 months ended September 30, 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 are in
thousands, except per share amounts. 2.     New Accounting Standards In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Entities. FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. It applies in the
first fiscal year or interim period ending after December 15, 2003, to variable
interest entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003 in an entity known as a special purpose
entity. FIN 46 applies to public enterprises as of the beginning of the
applicable interim or annual period after March 31, 2004, for all variable
interest entities. There is no impact upon our financial condition or results
from operations from the adoption of FIN 46. 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. 6




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3.     Accounts Receivable  Continued 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 endedSeptember 30,2004
    
    2003Balance at beginning of period
    
    $
    431
    
    
    $
    402Bad debt provision
    
    
    22
    
    
    
    (81
    )Accounts written off, net
    
    
    (222
    )
    
    
    (6
    )Balance at end of period
    
    $
    231
    
    
    $
    315
 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: September 30,
    
    June 30,2004
    
    2004Raw materials
    
    $
    2,959
    
    
    $
    2,630Work in progress
    
    
    308
    
    
    
    427Finished goods
    
    
    255
    
    
    
    2453,522
    
    
    
    3,302Reserve for obsolete and slow-moving inventory
    
    
    (202
    )
    
    
    (196
    )$
    3,320
    
    
    $
    3,106
 Changes in the Companys reserve for obsolete and slow-moving inventory are as
follows: Three months endedSeptember 30,2004
    
    2003Balance at beginning of period
    
    $
    196
    
    
    $
    122Additions
    
    
    6
    
    
    
    45Amounts written off
    
    
    
    
    
    
    Balance at end of period
    
    $
    202
    
    
    $
    167
 7




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. Product warranty activity is as follows: Three months endedSeptember 30,2004
    
    2003Balance at beginning of period
    
    $
    982
    
    
    $
    846Provision for warranty expenses
    
    
    159
    
    
    
    (13
    )Warranty charges
    
    
    (161
    )
    
    
    (131
    )Balance at end of period
    
    $
    980
    
    
    $
    702
 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. 8




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6.     Revenue
Recognition and Cost and Earnings on Uncompleted Contracts 
Continued The components of uncompleted contracts are as follows: September 30,
    
    June 30,2004
    
    2004Costs incurred on uncompleted contracts and
estimated earnings
    
    $
    47,268
    
    
    $
    44,348Less billings to date
    
    
    (36,221
    )
    
    
    (32,299
    )$
    11,047
    
    
    $
    12,049
 The components of uncompleted contracts are reflected in the balance
sheets as follows September 30,
    
    June 30,2004
    
    2004Costs and earnings in excess of billings on
uncompleted contracts
    
    $
    11,923
    
    
    $
    12,448Billings in excess of costs and earnings on
uncompleted contracts
    
    
    (876
    )
    
    
    (399
    )$
    11,047
    
    
    $
    12,049
 7.     Discontinued Operations During the first quarter of fiscal 2004, the Board of Directors authorized the
divestiture, and the Company sold certain assets of its Boiler business segment
with a net book value of approximately $110, for $250, resulting in a gain on
disposal of $140. The following represents a summary of operating results and the gain on
disposition of the boiler segment presented as discontinued operations: Three months endedSeptember 30,2004
    
    2003Revenues
    
    $
    
    
    
    $
    360Cost of goods sold
    
    
    25
    
    
    
    172Gross profit (loss)
    
    
    (25
    )
    
    
    188Operating expenses
    
    
    5
    
    
    
    229Operating loss
    
    
    (30
    )
    
    
    (41
    )Income tax benefit
    
    
    (10
    )
    
    
    (14
    )Net loss from operations
    
    
    (20
    )
    
    
    (27
    )Gain on disposal, net of taxes
    
    
    
    
    
    
    92Net earnings (loss)
    
    $
    (20
    )
    
    $
    65Diluted earnings (loss) per shareNet loss from operations
    
    $
    (0.01
    )
    
    $
    (0.01
    )Net gain on disposal
    
    $
    0.00
    
    
    $
    0.03Net earnings (loss)
    
    $
    (0.01
    )
    
    $
    0.02
 9




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7.     Discontinued Operations   Continued The current and non-current assets and liabilities of the discontinued boiler
segment are as follows: September 30,
    
    June 30,2004
    
    2004AssetsAccounts receivable, principally trade  net of
allowance for uncollectible accounts of $10
at September 30, 2004 and June 30, 2004.
    
    $
    216
    
    
    $
    225Current assets of discontinued operations
    
    
    216
    
    
    
    225Equipment  net of accumulated depreciation of $11
at September 30, 2004 and June 30, 2004
    
    
    9
    
    
    
    9Total assets of discontinued operations
    
    $
    225
    
    
    $
    234LiabilitiesCommissions payable
    
    
    
    
    
    
    6Product warranties and start-up reserves
    
    
    215
    
    
    
    300Total current liabilities of discontinued operations
    
    $
    215
    
    
    $
    306
 8.     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. 9.     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 endedSeptember 30,2004
    
    2003Net earnings (loss) from continuing operations
    
    $
    (109
    )
    
    $
    740Net earnings (loss) from discontinued operations
    
    
    (20
    )
    
    
    65Foreign currency translation adjustment
    
    
    (9
    )
    
    
    17Comprehensive income (loss)
    
    $
    (138
    )
    
    $
    822
 10




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10.     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 endedSeptember 30,2004
    
    2003Net earnings (loss) from continuing operations
    
    $
    (109
    )
    
    $
    740Earnings (loss) from discontinued operations
    
    
    (20
    )
    
    
    65Net earnings (loss)
    
    $
    (129
    )
    
    $
    805Basic weighted average common shares outstanding
    
    
    3,015
    
    
    
    2,999Effect of dilutive options
    
    
    
    
    
    
    38Diluted weighted average common shares outstanding
    
    
    3,015
    
    
    
    3,037BASIC EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.04
    )
    
    $
    0.25Earnings (loss) from discontinued operations
    
    
    (0.01
    )
    
    
    0.02Net earnings (loss) per share
    
    $
    (0.04
    )
    
    $
    0.27DILUTED EARNINGS (LOSS) PER SHAREEarnings (loss) from continuing operations
    
    $
    (0.04
    )
    
    $
    0.24Earnings (loss) from discontinued operations
    
    
    (0.01
    )
    
    
    0.02Net earnings (loss) per share
    
    $
    (0.04
    )
    
    $
    0.26
 Diluted weighted average common shares outstanding excluded 212 and 65
outstanding stock options for the three months ended September 30, 2004 and
2003, respectively, because their impact would be anti-dilutive. 11.     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 Euros rate plus or minus
an applicable margin (Euros plus 1.75% at September 30, 2004), and is secured
by substantially all of the Companys assets. As of September 30, 2004, the
Company had no outstanding balances under the credit line, and $3.5 million
outstanding under stand-by letters of credit, leaving $9.0 million of
availability under the facility. The facility contains financial covenants,
restrictions on capital expenditures, acquisitions, asset dispositions, and
additional debt, as well as other customary covenants. As of September 30,
2004, the Company was in compliance with all financial and other covenants of
the loan agreement. 11




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11.     Lines of Credit  Continued In addition, our subsidiary located in the United Kingdom (our UK subsidiary)
has a £2.0 million (approximately $3.6 million) debenture agreement used to
facilitate the issuances of bank guarantees. This facility is secured by
substantially all of the UK subsidiarys assets, and is backed by a Peerless
stand-by letter of credit of £1.3 million (approximately $2.3 million, which is
included in the $3.5 million outstanding under stand-by letters of credit as
described above) and expires on October 31, 2004. At September 30, 2004, there
was approximately £1.6 million outstanding under this facility, leaving
availability of approximately £400 thousand (approximately $725 thousand). On
October 31, 2004, our UK subsidiary debenture agreement was renewed for an
additional year. In connection with this renewal, the related Peerless
stand-by letter of credit was reduced to £1.0 million (approximately $1.8
million). 12.     Stock-Based Compensation In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure (SFAS 148) which amends
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123). SFAS 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation and requires disclosures in annual and
interim financial statements of the effects of stock-based compensation as
reflected below. The Company continues to account for its stock options under the recognition
and measurement principles of Accounting Principles Board Opinion No. 25
Accounting for Stock Issued to Employees, and related interpretations. No
stock-based employee compensation expense related to the Companys stock
options is reflected in the net earnings (loss), as all options granted under
the plan had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the effect
on net earnings (loss) and earnings (loss) per share if the Company had applied
the fair value recognition provisions of SFAS 123 to stock-based compensation. Three months endedSeptember 30,2004
    
    2003Net earnings (loss), as reported
    
    $
    (129
    )
    
    $
    805Deduct: Total stock-based employee compensation expense determined
using the fair value based method for all awards, net of tax
    
    
    (24
    )
    
    
    (21
    )Pro forma net earnings (loss)
    
    $
    (153
    )
    
    $
    784Earnings (loss) per share:Basic  as reported
    
    $
    (0.04
    )
    
    $
    0.27Basic  pro forma
    
    $
    (0.05
    )
    
    $
    0.26Diluted  as reported
    
    $
    (0.04
    )
    
    $
    0.26Diluted  pro forma
    
    $
    (0.05
    )
    
    $
    0.26
 12




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13.     Supplemental Cash Flow Information Net cash flows from operating activities reflects cash payments for income
taxes as follows: Three months endedSeptember 30.2004
    
    2003Income taxes paid
    
    $
    510
    
    
    $
    40
 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 months ended September 30, 2004 and 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. SeparationEnvironmental
    
    Filtration
    
    UnallocatedSystems
    
    Systems
    
    Overhead
    
    ConsolidatedThree months ended September 30, 2004Net sales from customers
    
    $
    3,990
    
    
    $
    7,228
    
    
    $
    
    
    
    $
    11,218Segment profit (loss)
    
    
    64
    
    
    
    725
    
    
    
    (1,055
    )
    
    
    (266
    )Three months ended September 30, 2003Net sales from customers
    
    $
    10,079
    
    
    $
    6,728
    
    
    $
    
    
    
    $
    16,807Segment profit (loss)
    
    
    1,735
    
    
    
    374
    
    
    
    (958
    )
    
    
    1,151
 13




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 months ended September 30, 2004 and September 30, 2003 is as follows: UnitedStates
    
    Europe
    
    Eliminations
    
    ConsolidatedThree months ended September 30, 2004Net sales to unaffiliated
customers
    
    $
    8,981
    
    
    $
    2,237
    
    
    $
    
    
    
    $
    11,218Transfers between
geographic areas
    
    
    760
    
    
    
    
    
    
    
    (760
    )
    
    
    Total
    
    $
    9,741
    
    
    $
    2,237
    
    
    $
    (760
    )
    
    $
    11,218Identifiable long-lived assets
    
    $
    2,922
    
    
    $
    79
    
    
    $
    
    
    
    $
    3,001Three months ended September 30, 2003Net sales to unaffiliated
customers
    
    $
    13,821
    
    
    $
    2,986
    
    
    $
    
    
    
    $
    16,807Transfers between
geographic areas
    
    
    142
    
    
    
    
    
    
    
    (142
    )
    
    
    Total
    
    $
    13,963
    
    
    $
    2,986
    
    
    $
    (142
    )
    
    $
    16,807Identifiable long-lived assets
    
    $
    2,976
    
    
    $
    77
    
    
    $
    
    
    
    $
    3,053
 Transfers between geographic
areas primarily represent inter-company export sales and are
accounted for based on established sales prices between related
companies. Identifiable long-lived
assets of geographic areas are those assets related to the Companys
operations in each area. 14




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 
 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 24 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
36% and 60% of our first quarter fiscal 2005 and 2004 revenues, respectively.
The main product of the Environmental Systems segment is Selective Catalytic
Reduction Systems, referred to as SCR Systems. These environmental control
systems are used for air pollution abatement and convert NOx emissions from
exhaust gases caused by burning hydrocarbon fuels such as coal, gasoline,
natural gas and oil, into harmless nitrogen and water vapor. Along with the
SCR Systems, this segment also offers systems to reduce other pollutants such
as CO and particulate matter. These systems are totally integrated, complete
with instruments, controls and related valves and piping. Separation Filtration Systems.This business segment represented
approximately 64% and 40% of our first quarter fiscal 2005 and 2004 revenues,
respectively. The Separation Filtration Systems segment produces specialized
products known as separators or filters which are used for a variety of
purposes in cleaning gases and liquids as they move through piping systems.
These products are used primarily to remove solid and liquid contaminants from
natural gas as well as saltwater aerosols from combustion intake air of
shipboard gas turbine and diesel engines. In addition, separators are also
used in nuclear power plants to remove water from saturated steam. 15




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 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. 16




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 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 EndedSeptember 30,2004
    
    2003Net revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    71.3
    
    
    
    71.4Gross profit
    
    
    28.7
    
    
    
    28.6Operating expenses
    
    
    31.0
    
    
    
    21.7Operating income (loss)
    
    
    (2.3
    )
    
    
    6.9Other income (expense)
    
    
    0.9
    
    
    
    (0.2
    )Net earnings (loss) from continuing
operations before income taxes
    
    
    (1.4
    )
    
    
    6.7Income tax expense (benefit)
    
    
    (0.5
    )
    
    
    2.3Net earnings (loss) from continuing operations
    
    
    (0.9
    )
    
    
    4.4Earnings (loss) from discontinued operations,
net of tax
    
    
    (0.2
    )
    
    
    0.4Net earnings (loss)
    
    
    (1.1)
    %
    
    
    4.8
    %
 17




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003 Results of Operations  Consolidated Revenues.For the first quarter of fiscal 2005, revenues decreased
approximately $5.6 million, or 33.3%, to $11.2 million from $16.8 million in
same period of fiscal 2004. Domestic revenues decreased approximately $4.4
million, or 42.5%, from $10.4 million during the first quarter of fiscal 2004
to $6.0 million in the same period fiscal 2005. International revenues
decreased approximately $1.2 million, or 18.0%, from $6.4 million during the
first quarter of fiscal 2004 to $5.2 million in the same period of fiscal 2005.
The decline in revenues in our domestic revenues was mainly attributable to
the decline in our Environmental Systems sales, which continues to be impacted
by the slow-down in new merchant power construction and regulatory
uncertainties. The 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 either at the selling margin level
or through a negative or positive impact on our manufacturing absorption. For
the first quarter fiscal 2005, our gross profit margin decreased $ 1.6
million, or 33.1%, from $4.8 million in fiscal 2004 to $3.2 million in the same
period of fiscal 2005. Gross profit margin, as a percentage of sales,
increased from 28.6% for the first quarter of fiscal 2004 to 28.7% for the same
period in fiscal 2005. Our margins during the period were impacted
by shifts in our product mix and the continued improvement in our start-up and
warranty costs, which decreased from 2.4% of sales for the first quarter of
fiscal 2004 to 2.1% of sales for the first quarter of fiscal 2005. Operating Expenses.For the first quarter of fiscal 2005, operating
expenses from continuing operations decreased by approximately $200,000, or
4.8%, from approximately $3.7 million for the first quarter of fiscal 2004 to
approximately $3.5 million for the same period in fiscal 2005. As a percentage
of sales, our operating expenses increased from 21.7% for the first quarter of
fiscal 2004 to 31.0% for the first quarter in fiscal 2005. The increase in
operating expenses, as a percentage of sales, is directly related to the
reduction in our sales during the period. On a comparative basis, our sales
and marketing expenses decreased from approximately $1.6 million to
approximately $1.5 million, our engineering and project management expenses
decreased from approximately $1.1 million to approximately $1.0 million and our
general and administrative expenses remained relatively constant at
approximately $1.0 million in both periods. The decrease in our sales and
marketing expenses related primarily to a decrease in our commission expense
during the first quarter of fiscal 2005, 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. Our general and administrative
expenses remained relatively constant during the period, as any cost
containment benefits realized during the current period were offset by our
increased expenses of compliance with corporate governance mandates enacted by
the SEC, as well as the Nasdaq Stock Market; which expenses are expected to
continue. Other Income and Expense.In the first quarter of fiscal 2005, other
income and expense items changed by approximately $131,000, from expense of
approximately $30,000 for the first quarter of fiscal 2004 to income of
$101,000 for the same period in fiscal 2005. This change related primarily to
the change in the impact associated with our foreign currency exchange. During
the first quarter of fiscal 18




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 2004, we realized foreign currency exchange losses of approximately
$47,000. However, due to the weakening of the dollar, we recognized foreign
currency exchange gains of approximately $61,000 for the first quarter of
fiscal 2005. Income Taxes.The Companys effective income tax rate for continuing
operations was approximately 34% for the first quarter of fiscal years 2004 and
2005. Net Earnings (loss) from Continuing Operations.As a result of the above
factors, our net earnings (loss) from continuing operations decreased by
approximately $849,000, or 114.7%, from earnings of approximately $740,000, or
4.4% of sales for the first quarter of fiscal 2004, to a net loss of
approximately $109,000, or .9% of sales for the first quarter of fiscal 2005.
Basic earnings (loss) per share decreased from earnings of $0.25 per share for
the first quarter of fiscal 2004, to a loss of ($0.04) per share for the first
quarter of fiscal 2005. Diluted earnings (loss) per share decreased from
earnings of $0.24 per share for the first quarter of fiscal 2004, to a loss of
($0.04) per share for the first quarter of fiscal 2005. Discontinued Operations. In the first quarter of fiscal 2005, we
recognized a net loss from discontinued operations of approximately $20,000
compared to net earnings of approximately $65,000 for the first quarter of
fiscal 2004. Included in the net loss for the current period was an expense of
approximately $25,000 relating to an additional provision for potential
warranty and start-up costs. The Company has established a reserve of
approximately $215,000 at September 30, 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 earnings for the first quarter of fiscal 2004 was
a net gain related to the disposal of our Boiler operation of approximately
$92,000 ($140,000 gain less taxes of $48,000). Basic and diluted loss per
share from discontinued operations was ($0.01) per share for the first quarter
of fiscal 2005, compared to earnings of $0.02 per share for the same period in
fiscal 2004. Net Earnings (Loss).As a result of the above factors, our earnings for
the first quarter of fiscal 2005 decreased approximately $934,000, from net
earnings of $805,000, or 4.8% of sales, to a net loss of approximately
$129,000, or (1.1%) of sales for the same period in fiscal 2005. Basic
earnings (loss) per share decreased from earnings of $0.27 per share for the
first quarter of fiscal 2004, to a loss of $(0.04) per share for the same
period in fiscal 2005. Diluted earnings per share decreased from earnings of
$0.26 per share for the first quarter of fiscal 2004, to a loss of ($0.04) per
share for the same period in fiscal 2005. Results of Operations  Segments We are organized along two lines of business: Environmental Systems, and
Separation Filtration Systems. The Companys Boiler segment was discontinued
and its assets sold during the first quarter of fiscal 2004. See Note 7 
Discontinued Operations in the Notes to our Consolidated Financial Statements
for further discussion on the Boiler segment. 19




---



##### Table of Contents



PEERLESS MFG. CO.
AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 Revenues.The following table displays revenues by reportable segment
(dollars in thousands). Three months endedSeptember 30,2004
    
    %
    
    2003
    
    %RevenuesEnvironmental Systems
    
    $
    3,990
    
    
    
    35.6
    %
    
    $
    10,079
    
    
    
    60.0
    %Separation Filtration Systems
    
    
    7,228
    
    
    
    64.4
    %
    
    
    6,728
    
    
    
    40.0
    %Total
    
    $
    11,218
    
    
    
    100.0
    %
    
    $
    16,807
    
    
    
    100.0
    %
 Revenues from our Environmental Systems decreased $6.1 million, or 60.4%,
in the first quarter of fiscal 2005. The reduction in the revenue for the
quarter ended September 30, 2004 related primarily to the completion of a major
$15 million contract during the first quarter of fiscal 2004, which impact was
not replicated in the first quarter of fiscal 2005. In addition, our
Environmental Systems segment continues to be impacted by the slow-down in new
power plant construction and the delay in compliance expenditures associated
with regulatory uncertainties. We expect that spending for NOx reduction
systems will increase in 2005  2008 as regulatory compliance deadlines come
into effect over the next 5 years. We have experienced and continue to expect
an increase in request for proposals, as users begin to implement their
compliance plans. In addition, while the construction of new power plants has
significantly declined over the past several years, we believe this portion of
the Environmental Systems business will show improvement in 2006  2007, as
older plants are retired or modified and new plants are built to meet the
growing demand for electricity both domestically and internationally. Separation Filtration Systems revenues increased by approximately
$500,000, or 7.4% in the first quarter of fiscal 2005. Revenues originated by
our domestic operations increased by approximately $1.3 million, or 33.4% in
fiscal 2005, while revenues through our UK operation decreased by approximately
$800,000, or 25.1%. The increase in revenues through our domestic operations
can be attributed primarily to an increase in our nuclear/marine sales, which
increased by approximately $1.5 million, or 233.3%, and related primarily to
life extension projects at several nuclear power plants and increased military
spending. The decline in the sales through our UK operation during the period
related primarily to the completion of two major projects during the first
quarter of fiscal 2004, which impact was not replicated during the first
quarter of fiscal 2005. Segment Profit.The following table displays segment profit by reportable
segment (dollars in thousands): Three months endedSeptember 30,2004
    
    2003Segment profitEnvironmental Systems
    
    $
    64
    
    
    $
    1,735Separation Filtration Systems
    
    
    725
    
    
    
    374Total
    
    
    789
    
    
    
    2,109Unallocated general and administrative
expenses
    
    
    (1,055
    )
    
    
    (958
    )Operating income (loss)
    
    $
    (266
    )
    
    $
    1,151
 20




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 profit in the first quarter of fiscal 2005 decreased
by approximately $1.7 million, or 96.3% over the first quarter of fiscal 2004.
As a percentage of Environmental Systems revenue, profit in Environmental
Systems was 1.6% and 17.2%, in the first quarter of fiscal 2005 and 2004,
respectively. The decrease in our Environmental Systems profit during the
first quarter of fiscal 2005 related primarily to this segments decreased
revenue during the quarter, as operational expenses increased from 11.6% of
revenue for the quarter ended September 30, 2004, to 22.2% for the quarter
ended September 30, 2005. In addition to the operational expense impact, our
Environmental Systems profit during the period was impacted by changes in our
product mix, and increased competitive pressures, both of which impacted our
reported margins during the current period. Separation Filtration Systems profit in the first quarter of fiscal 2005
increased by $351,000 or 93.9% over the same period of fiscal 2004. As a
percentage of Separation Filtration Systems revenue, profit in Separation
Filtration Systems was 10.0% and 5.6% for the first quarter of fiscal 2005 and
2004, respectively. The increase in the Separation Filtration Systems profit
during the current period relates primarily to improvements in our gross profit
margins, which directly related to changes in our sales mix, and the impact of
the increased revenue on our operational expenses. As a percentage of sales,
our operational expenses decreased from 22.7% of sales for the quarter ended
September 30, 2004, to 21.3% of sales for the quarter ended September 30, 2005. Market Outlook Environmental Systems.We expect that the spending for NOx reduction
systems will increase in 2005  2008 as users implement their compliance plans
as regulatory compliance deadlines come in to effect over the next 5 years. In
addition, while the construction of new power plants has significantly declined
over the last several years, we expect this market to improve in 2006
 2007,
as older plants are retired or modified and new plants are built to meet the
growing demand for electricity both domestically and internationally. Separation Filtration Systems.The market for nuclear/marine products
remains strong, and is expected to continue at such levels for at least the
next 5 years, as nuclear power plants continue to invest in life extension
projects and as military spending occurs. The Nuclear Regulatory Commission
estimates that by 2010, nearly 80% of nuclear power plants in the United States
will be in the license renewal process. In addition, the increased demand for
natural gas, both domestically and internationally, should also create new
opportunities for our separator and 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 21




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 $33.4 million
at September 30, 2004, compared to $34.0 million at June 30, 2004 and $37.8
million at September 30, 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 $400,000, or 1.1%, from
approximately $39.5 million at June 30, 2004 to approximately $39.1 million at
September 30, 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. 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 $20.7 million, and a
current ratio of 2.4 to 1.0 This compares with cash and cash equivalents of
$4.0 million, $21.0 million in working capital, and a current ratio of 2.5 to
1.0 at September 30, 2004. Liabilities
and Shareholders Equity.Total liabilities decreased by
approximately $400,000, or 3.1%, from approximately $14.8 million at June 30,
2004 to approximately $14.4 million at September 30, 2004. The decrease in
liabilities related primarily to a decrease in our accrued and other
liabilities, offset by an increase in our trade payables. Liquidity and Capital Resources Our cash and cash equivalents were $4.0 million as of September 30, 2004,
compared to $4.1 million at June 30, 2004. Cash provided by operating
activities during the current quarter of fiscal 2005 was $39,000 compared to
cash of $647,000 provided by our operating activities during the same period of
fiscal 2004. Because we are engaged in the business of manufacturing custom systems,
our progress billing practices are event-oriented rather than date-oriented,
and vary from contract to contract. We customarily bill our customers after
the occurrence of project milestones. Billings to customers affect the balance
of 22




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 $14.5
million at September 30, 2004, reflecting a decrease of our investment in these
working capital items of $1.4 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 three months ended September 30, 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 $119,000 for the
current quarter of fiscal 2005, compared to cash used in investing activities
of approximately $144,000 for same period in fiscal 2004. The use of cash
during the first quarter of fiscal 2005 and 2004 related primarily to capital
expenditures during the periods. Cash provided by financing activities was approximately $97,000 and
$13,000 during fiscal 2005 and 2004, respectively, and related to the proceeds
from the issuance of common stock, pursuant to employee stock options. Cash used in our discontinued operations was $102,000 during the first
quarter of fiscal 2005, compared to $403,000 provided from discontinued
operations during the same period in fiscal 2004. As a result of the above factors, during the current quarter of fiscal
year 2005, our cash and cash equivalents decreased by approximately $86,000,
compared to an increase of approximately $920,000 during the same period of
fiscal 2004. On October 31, 2003, we entered into a $12.5 million revolving credit
facility for working capital requirements that expires on October 31, 2006.
The facility carries a floating interest rate based on the prime or Euro rate
plus or minus an applicable margin (Euro plus 1.75% at September 30, 2004), and
is secured by substantially all our domestic assets. At September 30, 2004, we
had $3.5 million outstanding under stand-by letters of credit and no loans
outstanding, leaving us availability under our credit facility of $9.0 million.
The facility contains financial covenants, certain restrictions on capital
expenditures, acquisitions, asset dispositions, dividends and additional debt,
as well as other customary covenants. As of September 30, 2004, the Company
was in compliance with all financial and other covenants under the credit
facility. In addition, our UK subsidiary has a £2.0 million (approximately $3.6
million) debenture agreement used to facilitate the issuances of bank
guarantees. This facility is secured by substantially all of the UK subsidiary
assets, and is backed by a Peerless stand-by letter of credit of £1.3 million
(approximately $2.3 million, which is included in the $3.5 million outstanding
above) and expires on October 31, 2004. At September 30, 2004, there was
approximately £1.6 million outstanding under this facility, leaving
availability of approximately £400,000 (approximately $725,000). This facility
was renewed on October 31, 2004 for an additional year, and in connection
therewith the outstanding Peerless stand-by letter of credit securing this
facility was reduced to £1.0 million, or approximately $1.8 million. We believe we maintain adequate liquidity to support existing operations
and planned growth, as well as to continue operations during reasonable periods
of unanticipated adversity. 23




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Entities. FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. It applies in the
first fiscal year or interim period ending after December 15, 2003, to variable
interest entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003 in an entity known as a special purpose
entity. FIN 46 applies to public enterprises as of the beginning of the
applicable interim or annual period after March 31, 2004, for all variable
interest entities. There is no impact upon our financial condition or results
from operations from the adoption of FIN 46. Factors That May Affect Our Operating Results and Other Risk Factors Investing in our common stock involves a high degree of risk. Any of the
following risks could have a material adverse effect on our financial
condition, liquidity, and results of operations or prospects, financial or
otherwise. Reference to these factors in the context of a forward-looking
statement or statements will be deemed to be a statement that any one or more
of the following factors may cause actual results to differ materially from
those in such forward-looking statement or statements. See Item 2 -
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Forward-Looking Statements of this Report. Changes in the power generation industry and/or the economy could have an
adverse impact on sales of our Environmental Systems and our operating results. The demand for our Environmental Systems depends to an extent on the
continued construction of power generation plants and the upgrade of existing
power plants. In the first quarter of fiscal 2005, approximately 36% of our
consolidated revenues were derived from sales of Environmental Systems for new
and refurbished power plants compared to approximately 60% 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 24




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 (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. We enter into fixed-priced contracts. If our actual costs exceed our
original estimates, our profits will be reduced. The majority of our contracts are on a fixed-price basis. Although we
benefit from cost savings, we have limited ability to recover cost overruns.
Because of the large scale and long duration of our contracts, unanticipated
cost increases may occur as a result of several factors, including, but not
limited to, (1) increases in the cost, or shortages of components, materials or
labor; (2) unanticipated technical problems; (3) required project modifications
not initiated by the customer; and (4) suppliers or subcontractors failure to
perform. These factors could delay delivery of our products and our contracts
often provide for liquidated damages for late delivery. Unanticipated costs
that we cannot pass on to our customers, for example, the volatile nature of
steel prices, or the payment of liquidated damages under fixed contracts would
negatively impact our profits. Our backlog may not be indicative of our future revenue. Customers may cancel or delay projects for reasons beyond our control.
Our orders normally contain cancellation provisions, which permit us to recover
only our costs and a portion of our anticipated profit in the event a customer
cancels an order. If a customer elects to cancel, we may not realize the full
amount of revenues included in our backlog. If projects are delayed, the
timing of our revenues could be affected and projects may remain in our backlog
for extended periods of time. Revenue recognition 25




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 quarter of fiscal 2005, revenue outside the United States
represented approximately 46% of our consolidated revenues. In the first
quarter of fiscal 2004, approximately 38% of our revenue was derived from sales
outside the United States. Our operations and earnings throughout the world
have been, and may in the future be, affected from time to time in varying
degrees by war, political developments and foreign laws and regulations, such
as regional economic uncertainty, political instability, restrictions, customs
and tariffs, changing regulatory environments, fluctuations in foreign currency
exchange rates and adverse tax consequences. The likelihood of such
occurrences and their overall effect upon us vary greatly from country to
country and are not predictable. These factors may result in a decline in
revenues or profitability and could adversely affect our ability to expand our
business outside of the United States. Our financial performance may vary significantly from period to period,
making it difficult to estimate future revenue. Our annual revenues and earnings have varied in the past and are likely to
vary in the future. Our Environmental Systems contracts generally stipulate
customer specific delivery terms and may have contract cycles of a year or
more, which subjects them to many factors beyond our control. In addition,
these contracts are significantly larger in size than our typical Separation
Filtration Systems contracts, which tend to intensify their impact on our
annual operating results. Furthermore, as a significant portion of our
operating costs are fixed, an unanticipated decrease in our revenues, a delay
or cancellation of orders in backlog, or a decrease in the demand for our
products, may have a significant impact on our annual operating results.
Therefore, our annual operating results may be subject to significant
variations and our operating performance in one period may not be indicative of
our future performance. 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 26




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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. 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 September 30, 2004 we were in compliance with all financial and other
covenants of our credit facility. Our ability to satisfy any debt obligations will depend upon our future
operating performance, which will be affected by prevailing economic, financial
and business conditions and other factors, some of which are beyond our
control. We anticipate that borrowings from our existing revolving credit 27




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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. 
 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 Stated
dollars are performed, for the most part, in the local currency and therefore
provide a natural hedge against currency fluctuations. We, on occasion, will
purchase derivative transactions with respect to foreign contracts that do not
contain a natural hedge, but the impact of any fluctuation in the exchange
rates in these hedged currencies, would be expected to have an immaterial
impact on our financial operations. The impact of currency exchange rate
movements on inter-company transactions has been, and is expected to continue
to be, immaterial. As of September 30, 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 September 30,
2004, the Companys disclosure controls and procedures were effective in
ensuring that all material information 28




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 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 September 30, 2004, there was no change in the
Companys internal controls over financial reporting, or in other factors, that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting. Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404) requires the
Registrant 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 Registrant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 Registrants independent auditors regarding that assessment.
Accordingly, the Registrant 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 8  Contingencies in
our Notes to the Consolidated Financial Statements of this Report). Items 2, 3, 4, and 5 are not applicable and have been omitted 29




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits The following exhibits are filed as part of this report. ExhibitNumber
    
    Exhibit3(a)
    
    Articles of Incorporation, as amended to date (filed as
Exhibit 3(a) to our Quarterly Report on Form 10-Q 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. 0-05214), 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. *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 September 17, 2004, the Company filed a Report on Form 8-K
to file a press release announcing its financial results for the
fiscal year ending June 30, 2004, which information was furnished
and not filed with the Commission. 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. 30




---



##### Table of Contents



PEERLESS MFG. CO. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004 
 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:
    
    November 15, 2004
    
    /s/ Sherrill StoneSherrill Stone
Chairman and Chief Executive OfficerDate:
    
    November 15, 2004
    
    /s/ Richard L. Travis, Jr.Richard L. Travis, Jr., Chief Financial Officer(Principal Financial and Accounting Officer)
 31