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PMFG > SEC Filings for PMFG > Form 10-K on 12-Sep-2012All Recent SEC Filings

Show all filings for PMFG, INC.

Form 10-K for PMFG, INC.


12-Sep-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand PMFG, Inc., our operations and our present business environment. MD&A is provided as a supplement to - and should be read in conjunction with - our consolidated financial statements and the accompanying notes thereto contained in "Item 8. Financial Statements and Supplementary Data" of this report. This overview summarizes the MD&A, which includes the following sections:

Our Business - a general description of our business and the key drivers of product demand.

Critical Accounting Policies and Estimates - a discussion of accounting policies that require critical judgments and estimates.

Results of Operations - an analysis of our Company's consolidated and reporting segment results of operations for the three years presented in our consolidated financial statements.

Liquidity; Capital Resources and Financial Position - an analysis of cash flows; aggregate contractual obligations; foreign exchange exposure; and an overview of financial position.

This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in Part I, Item 1A of this report. These factors can cause actual results for future periods, including fiscal 2013, to differ materially from those experienced in, or implied by, these forward-looking statements.

Our Business

General

We are a leading provider of custom-engineered systems and products designed to help ensure that the delivery of energy is safe, efficient and clean. We primarily serve the markets for natural gas infrastructure, power generation and refining and petrochemical processing. We offer a broad range of separation and filtration products, SCR systems, and other complementary products including specialty heat exchangers, pulsation dampeners and silencers. Our primary customers include equipment manufacturers, engineering contractors and operators of power facilities.

Our products and systems are marketed worldwide. We classify revenue as domestic or international based upon the origination of the order. Revenue generated by orders originating from within the United States is classified as domestic revenue, regardless of where the product is shipped or where it will eventually be installed. Revenue generated by orders originating from a country other than the United States is classified as international revenue. Revenue generated from outside the United States was approximately 47% for fiscal 2012. As a result of global demand for our products and our increased sales resources outside of the United States, we expect our international sales will continue to increase as a percentage of our consolidated revenue in the future.

We believe that our success depends on our ability to understand the complex operational demands of our customers and deliver systems and products that meet or exceed the indicated design specifications. Our success further depends on our ability to provide such products in a cost-effective manner and within the time frames established with our customers. Our gross profit during any particular period may be impacted by several factors, primarily shifts in our product mix, material cost changes, and warranty costs. Shifts in the geographic composition of our sales also can have a significant impact on our reported margins.


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We have two reporting segments: Process Products and Environmental Systems. The Process Products segment produces specialized systems and products that remove contaminants from gases and liquids, improving efficiency, reducing maintenance and extending the life of energy infrastructure. The segment also includes industrial silencing equipment to control noise pollution on a wide range of industrial processes and heat transfer equipment to conserve energy in many industrial processes and in petrochemical processing. The primary product of our Environmental Systems business is SCR systems. SCR systems are integrated systems, with instruments, controls and related valves and piping. Our SCR systems convert nitrogen oxide, or NOx, into nitrogen and water, reducing air pollution and helping our customers comply with environmental regulations.

The following table sets forth the percentage of revenue related to our process products and environmental products, respectively:

                                       Fiscal        Fiscal        Fiscal
                                        2012          2011          2010
              Process products              87 %          73 %          77 %
              Environmental systems         13 %          27 %          23 %

                                           100 %         100 %         100 %

Key Drivers of Product Demand

We believe demand for our products is driven by the increasing demand for energy in both developed and emerging markets, coupled with the global trend towards increasingly restrictive environmental regulations. These trends should stimulate investment in new power generation facilities and related infrastructure, and in upgrading existing facilities.

With a shift to cleaner, more environmentally responsible power generation, power providers and industrial power consumers are building new facilities that use cleaner fuels, such as natural gas, nuclear technology, and renewable resources. In developed markets, natural gas is increasingly becoming one of the energy sources of choice. We supply product offerings throughout the entire natural gas infrastructure value chain and believe the expansion of natural gas infrastructure will drive growth of our process products and the global market for our SCR systems for natural-gas-fired power plants.

Despite existing concerns over safety and government regulations related to the construction of new nuclear power facilities and the re-commissioning of existing facilities, we believe rising nuclear capacity utilization rates and concerns about energy security and emissions will drive the increase for nuclear power generation, both domestically and internationally. China and India are expected to lead the global expansion of nuclear power generation growth. Recommissioning of existing nuclear facilities in the United States and France also will contribute to product demand.

These market trends will drive the demand for both our separation/filtration products and our SCR systems, creating significant opportunities for us. We face strong competition from numerous other providers of custom-engineered systems and products. We, along with other companies that provide alternative products and solutions, are affected by a number of factors, including, but not limited to, global economic conditions, level of capital spending by companies engaged in energy production, processing, transportation, storage and distribution, as well as current and anticipated environmental regulations.


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Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates, judgments, and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. We believe that our most critical accounting policies and estimates related to the following:

                                     Judgment and/or          Potential Impact if
 Estimate Description                  Uncertainty              Results Differ
 Revenue Recognition
 We provide products under      Considerable management     A number of internal
 long-term, generally           judgment and experience     and external factors,
 fixed-priced, contracts that   is necessary to estimate    including labor rates,
 may extend up to 18 months     the aggregate amount of     plant utilization
 or longer in duration.         costs that will             factors, future
 Approximately 80% of our       ultimately be incurred      material prices,
 revenue is accounted for       related to a project.       changes in customer
 using the                      Such cost estimates         specifications,
 percentage-of-completion       include material,           manufacturing defects
 accounting method.             subcontractor, labor,       and delays, as well as
                                delivery, start-up, and     other factors can
 Under such methodology, the    warranty costs.             affect the ultimate
 contractually agreed upon                                  costs.
 revenue is recognized over     We continually update our
 the life of the contract       estimates of costs and      The impact of revisions
 based on the relationship of   the status of each          in contract estimates
 costs incurred to date in      project.                    is recognized on a
 relation to the estimated                                  cumulative basis in the
 aggregate costs to be                                      period in which the
 incurred over the contract                                 revisions are made.
 term.
                                                            Changes in cost
 The percentage-of-completion                               estimates may result in
 methodology generally                                      the recognition of
 results in the recognition                                 revenue in a period
 of reasonably consistent                                   other than which such
 profit margins over the life                               revenue is earned, as
 of a contract.                                             well as inconsistent
                                                            profit margins over the
 Cumulative revenue                                         life of a contract.
 recognized may be less or
 greater than cumulative
 costs and profits billed at
 any point 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."


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 Allowance for Doubtful
 Accounts
 We maintain an allowance for   Considerable management     Bad debt expense
 doubtful accounts to reflect   judgment is necessary in    totaled $0.2 million in
 estimated losses resulting     determining whether a       fiscal 2012 and 2011
 from the inability of          receivable will be          and $0.7 million in
 customers to make required     collectible based on a      fiscal 2010. As a
 payments.                      customer's potential        percentage of revenue,
                                inability to pay.           the bad debt expense
 On an on-going basis, we                                   was 0.2%, 0.2%, and
 evaluate the collectability    In making such              0.6% in fiscal 2012,
 of accounts receivable based   determination, management   2011, and 2010,
 on historical collection       evaluates the age of the    respectively.
 trends, current economic       outstanding balance,
 factors, and the assessment    evaluation of the           The impact of a 100
 of collectability of           customer's current and      basis point increase or
 specific accounts.             past financial condition    decrease in bad debt
                                and related credit          expense would be
                                scores, recent payment      approximately $1.4
                                history, current economic   million in fiscal 2012.
                                environment, and
                                discussions with the
                                customer.

 Product Warranties
 We provide our customers       We record an estimate of    Warranty expense
 with product warranties for    costs to be incurred in     totaled $1.0 million,
 specific products during a     the future for product      $2.4 million and $3.3
 defined period of time,        warranties based on both    million in fiscal 2012,
 generally less than 18         known claims and            2011, and 2010,
 months after shipment of the   historical experience.      respectively. As a
 product. Warranties cover                                  percentage of revenue,
 the failure of a product to    Such estimates also         the warranty expense
 perform after it has been      include expectations with   was 0.8%, 2.0%, and
 placed in service.             regard to applicability     2.8% in fiscal 2012,
                                and enforceability of       2011, and 2010,
 In general, our warranty       back-up concurrent          respectively.
 agreements require us to       supplier warranties in
 repair or replace defective    place.                      The impact of a 100
 products during the warranty                               basis point increase or
 period at no cost to the                                   decrease in warranty
 customer.                                                  costs would be
                                                            approximately $1.5
 To the extent such defects                                 million in fiscal 2012.
 arise as a result of
 subcontracted work, we may
 have the ability to recover
 a portion or all of the cost
 of repairs incurred during
 the warranty period.

 Goodwill and Intangible
 Assets
 Our goodwill and intangible    Considerable management     We believe that the
 assets result primarily from   judgment is necessary to    assumptions used in
 acquisitions. Intangible       initially value             valuing our intangible
 assets include licensing       intangible assets upon      assets and in our
 agreements and customer        acquisition and to          impairment analysis are
 relationships with finite      evaluate those assets and   reasonable, but
 lives, as well as trademarks   goodwill for impairment     variations in any of
 and design guidelines with     going forward. We           our assumptions may
 indefinite lives.              determine fair value        result in different
                                using widely accepted       calculations of fair
                                valuation techniques        value that could result
                                including discounted cash   in a material
                                flows, market multiple      impairment charge.
                                analyses, and relief from
                                royalty analyses.
                                Assumptions used in our
                                valuations, such as
                                forecasted growth rates
                                and our cost of capital,
                                are consistent with our
                                internal projections and
                                operating plans.


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 Intangible assets with                                     At June 30, 2012, the
 indefinite lives and           We believe that a           fair value of our
 goodwill are evaluated at      trademark and/or design     Process Products
 the reporting unit level for   guideline has an            segment exceeds its
 potential impairment at        indefinite life if it has   related carrying value
 least annually, or earlier     a history of strong sales   by approximately $15
 if an indicator of             and cash flow performance   million or 14%.
 impairment exists, to ensure   that we expect to           Increasing our discount
 that the carrying value is     continue for the            rate by 25 basis points
 recoverable.                   foreseeable future.         would not have resulted
                                Determining the expected    in an impairment
 A perpetual trademark or       life of a trademark         charge. The terminal
 design guideline is impaired   and/or design guideline     revenue growth rate
 if its book value exceeds      requires considerable       utilized in calculating
 its estimated fair value.      management judgment and     the fair value (5.0%)
 Our goodwill, which relates    is based on an evaluation   is dependent on our
 entirely to the Process        of a number of factors      ability to meet
 Products segment, is           including competitive       internal projections
 evaluated for potential        environment, trademark      and operating plans, as
 impairment if the book value   and product history, and    well as other factors
 of its reporting unit          anticipated future          and assumptions.
 exceeds its estimated fair     product demand.
 value.                                                     At June 30, 2012, the
                                                            fair value of our trade
 Amortizing intangible assets                               names exceeded their
 are only evaluated for                                     carrying value by
 impairment upon a                                          approximately $0.8
 significant change in the                                  million or 17% and the
 operating environment. If an                               fair value of our
 evaluation of the                                          design guidelines
 undiscounted cash flows                                    exceeded their carrying
 indicates impairment, the                                  value by approximately
 asset is written down to its                               $0.8 million or 11%.
 estimated fair value, which                                Negative changes to the
 is generally based on                                      assumptions related to
 discounted cash flows.                                     royalty, growth, or
                                                            discount rates could
 In the fourth quarter of                                   result in impairments.
 fiscal 2012, we completed
 our annual impairment
 testing using the methods
 described above and
 concluded there was no
 impairment of our goodwill
 or other intangible assets
 with an indefinite life.

 Our goodwill and intangible
 net assets totaled $51
 million as of June 30, 2012.


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 Other Intangibles
 In July 2010, the Company      The fair value of the       To the extent no
 entered into a manufacturing   license agreement and       commercially viable
 license agreement with CEFCO   amounts ultimately          product results from
 Global Clean Energy, LLC       payable to CEFCO are        the development of the
 ("CEFCO"), granting the        largely dependent on the    CEFCO technology,
 Company exclusive              commercial viability of     extended delays in
 manufacturing rights in the    the CEFCO technology and    product introduction,
 continental United States to   the demand for such         or product demand is
 manufacture equipment and      technology in the market    less than expected, the
 process units incorporating    place.                      Company may be unable
 the CEFCO technology. In                                   to recover all or some
 addition, the Company          While further testing of    of the costs deferred
 entered into a lab test        the CEFCO technology        as of June 30, 2012.
 agreement under which the      remains to be completed,
 Company built a test unit to   management believes that
 support the commercial         the CEFCO technology may
 viability of the CEFCO         result in a commercially
 technology.                    viable product with
                                sufficient demand to
 The Company has deferred a     recover the costs
 total of $3.5 million of       incurred to date.
 funds advanced to CEFCO or
 incurred under the lab test
 agreement. Such amounts,
 will reduce the aggregate
 obligations owed to CEFCO
 under the license agreement,
 and will be recognized as
 expense over the exclusive
 license period.

 Income Taxes
 A liability for uncertain      Considerable management     Our judgments and
 tax positions is recorded to   judgment is necessary to    estimates concerning
 the extent a tax position      assess the inherent         uncertain tax positions
 taken or expected to be        uncertainties related to    may change as a result
 taken in a tax return does     the interpretations of      of evaluation of new
 not meet certain recognition   complex tax laws,           information, such as
 or measurement criteria.       regulations, and taxing     the outcome of tax
                                authority rulings, as       audits or changes to or
 A valuation allowance is       well as to the expiration   further interpretation
 recorded against a deferred    of statutes of              of tax laws and
 tax asset if it is more        limitations in the          regulations. Our
 likely than not that the       jurisdictions in which we   judgments and estimates
 asset will not be realized.    operate.                    concerning
                                                            realizability of
 At June 30, 2012, our          Additionally, several       deferred tax assets
 liability for uncertain tax    factors are considered in   could change if any of
 positions, including accrued   evaluating the              the evaluation factors
 interest, was $0.7 million     realizability of our        change.
 and our valuation allowance    deferred tax assets,
 was $0.                        including the remaining     If such changes take
                                years available for         place, there is a risk
                                carryforward, the tax       that our effective tax
                                laws for the applicable     rate could increase or
                                jurisdictions, the future   decrease in any period,
                                profitability of the        impacting our net
                                specific business units,    earnings.
                                and tax planning
                                strategies.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (the "FASB") amended its guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. The provisions of this new guidance are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We expect that a new statement of comprehensive income will be presented in future consolidated financial statements instead of the current reporting of comprehensive income in the Consolidated Statement of Stockholders' Equity.


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Results of Operations-Consolidated

The following summarizes our Consolidated Statements of Operations as a percentage of net revenue:

                                                       Fiscal          Fiscal         Fiscal
                                                        2012            2011           2010
Net revenue                                              100.0 %         100.0 %        100.0 %
Cost of goods sold                                        69.5            68.5           63.7

Gross profit                                              30.5            31.5           36.3
Operating expenses                                        30.1            33.4           29.2

Operating income (loss)                                    0.4            (1.9 )          7.1
Other income (expense)                                    (1.9 )           4.1           (9.7 )

Earnings (loss) before income taxes                       (1.5 )           2.2           (2.6 )
Income tax benefit (expense)                               0.7             2.5           (1.0 )

Net earnings (loss)                                       (0.8 )%          4.7 %         (3.6 )%

Less net earnings (loss) attributable to
noncontrolling interest                                   (0.1 )           0.1             -

Net earnings (loss) attributable to PMFG, Inc.            (0.7 )           4.6           (3.6 )
Dividends on preferred stock                                -             (0.6 )         (0.9 )

Earnings (loss) applicable to PMFG, Inc. common
stockholders                                              (0.7 )%          4.0 %         (4.5 )%

Cost of goods sold includes manufacturing and distribution costs for products sold. The manufacturing and distribution costs include material, direct and indirect labor, manufacturing overhead, depreciation, sub-contract work, inbound and outbound freight, purchasing, receiving, inspection, warehousing, internal transfer costs and other costs of our manufacturing and distribution processes. Cost of goods sold also includes the costs of commissioning the equipment and warranty related costs. Operating expenses include sales and marketing expenses, engineering and project management expenses and general and administrative expenses which are further described below.

Sales and marketing expenses-include payroll, employee benefits, stock-based compensation and other employee-related costs associated with sales and marketing personnel. Sales and marketing expenses also include travel and entertainment, advertising, promotions, trade shows, seminars and other programs and sales commissions paid to independent sales representatives.

Engineering and project management expenses-include payroll, employee benefits, stock-based compensation and other employee-related costs associated with engineering, project management and field service personnel. Additionally, engineering and project management expenses include the cost of sub-contracted engineering services.

General and administrative expenses-include payroll, employee benefits, stock-based compensation and other employee-related costs and costs associated with executive management, finance, human resources, information systems and other administrative employees. General and administrative costs also include board of director compensation and expenses, facility costs, insurance, audit fees, legal fees, reporting expense, professional services and other administrative fees.


Table of Contents

Revenue. We classify revenue as domestic or international based upon the origination of the order. Revenue generated by orders originating from within the United States is classified as domestic revenue, regardless of where the product is shipped or where it will eventually be installed. Revenue generated . . .

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