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PMFG > SEC Filings for PMFG > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for PMFG, INC.

Form 10-Q for PMFG, INC.


8-Nov-2012

Quarterly Report


Item 2. 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 to supplement - and should be read in conjunction with - our unaudited consolidated financial statements and the accompanying notes thereto contained in "Item 1. Financial Statements" 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.

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

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

This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in this and other reports we file with the Securities and Exchange Commission (the "SEC"), including the information in "Item 1A. Risk Factors" of Part I to our Annual Report for the year ended June 30, 2012. These factors could cause our actual results for future periods to differ materially from those experienced in, or implied by, these forward-looking statements.

Our Business

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, Selective Catalytic Reduction Systems ("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. Revenue generated from outside the United States was approximately 54% in the three month period ended September 29, 2012 compared to 39% in the three month period ended October 1, 2011. 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 be a significant percentage of our consolidated revenue in the future.

We believe 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.

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 into nitrogen and water, reducing air pollution and helping our customers comply with environmental regulations.


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PMFG, Inc. and Subsidiaries

September 29, 2012

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.

Critical Accounting Policies

See the Company's critical accounting policies as described in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in Part II of our Annual Report on Form 10-K for the year ended June 30, 2012. Since the date of that report, there have been no material changes to our critical accounting policies.

Results of Operations

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



                                              Three months ended
                                       September 29,         October 1,
                                           2012                 2011
           Net revenue                          100.0 %            100.0 %
           Cost of goods sold                    65.5               70.1

           Gross profit                          34.5               29.9
           Operating expenses                    33.2               33.9

           Operating income (loss)                1.3               (4.0 )
           Other expense, net                    (1.4 )             (2.9 )

           Loss before income taxes              (0.1 )             (6.9 )
           Income tax benefit                     0.0                2.8

           Net loss                              (0.1 )%            (4.1 )%


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PMFG, Inc. and Subsidiaries

September 29, 2012

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, professional services and other administrative fees.

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 by orders originating from a country other than the United States is classified as international revenue. International revenue was approximately 54% and 39% of consolidated revenue in the three month periods ended September 29, 2012 and October 1, 2011, respectively. The following summarizes consolidated revenue (in thousands):

                                             Three months ended
                                September 29,                   October 1,
                                        % of Total                     % of Total
                            2012         Revenue           2011         Revenue
          Domestic        $ 15,260             46.3 %    $ 17,767             61.1 %
          International     17,717             53.7 %      11,321             38.9 %

          Total           $ 32,977            100.0 %    $ 29,088            100.0 %

Total revenue increased $3.9 million or 13.4% to $33.0 million in the quarter ended September 29, 2012, compared to prior year. The acquisition of Burgess Manning GmbH in November 2011 contributed $2.6 million of revenue for the quarter ended September 29, 2012. Additional increases in international revenue are attributable to growth in Asia resulting from both an increase in demand and our strategic decision to increase our sales focus on the international markets. Our international sales have traditionally been weighted toward Process Products, although there is increased quote activity related to Environmental Systems products and solutions.

Gross Profit. Our gross profit during any particular period may be impacted by several factors, primarily revenue volume, shifts in our product mix, material cost changes, warranty, start-up and commissioning costs. Shifts in the geographic composition of our revenue also can have a significant impact on our reported margins. The following summarizes revenue, cost of goods sold and gross profit (in thousands):


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                          PMFG, Inc. and Subsidiaries

                               September 29, 2012



                                                Three months ended
                                   September 29,                   October 1,
                                           % of Total                     % of Total
                               2012         Revenue           2011         Revenue
        Revenue              $ 32,977            100.0 %    $ 29,088            100.0 %
        Cost of goods sold     21,585             65.5 %      20,380             70.1 %

        Gross profit         $ 11,392             34.5 %    $  8,708             29.9 %

Gross profit in the three month period ended September 29, 2012 increased $2.7 million compared to the comparable period of the prior year, and increased as a percentage of revenue from 29.9% in the prior year to 34.5% in the current year. The increase in gross profit as a percentage of revenue during the three months ended September 29, 2012, compared to the comparable period in the prior year related to changes in product and geographic mix, as well as increased focus on manufacturing costs. Gross profit percentage in the three months ended October 1, 2011 was further dampened by cost overruns on certain projects which were not present in the current period.

Operating Expenses. The following summarizes operating expenses (in thousands):

                                                       Three months ended
                                           September 29,                  October 1,
                                                   % of Total                   % of Total
                                        2012         Revenue         2011         Revenue
 Sales and marketing                  $  3,067             9.3 %    $ 2,895            10.0 %
 Engineering and project management      2,324             7.0 %      1,985             6.8 %
 General and administrative              5,541            16.9 %      4,975            17.1 %

 Total                                $ 10,932            33.2 %    $ 9,855            33.9 %

Operating expenses increased $1.1 million or 10.9% for the three months ended September 29, 2012 compared to prior year. As a percentage of revenue, these expenses decreased to 33.2% during the three months ended September 29, 2012 from 33.9% during the three months ended October 1, 2011.

Our sales and marketing expenses increased $0.2 million primarily due to increased selling related expenses associated with higher revenue. Our engineering and project management expenses increased $0.3 million for the three months ended September 29, 2012 compared to the three months ended October 2, 2011 in line with the increased revenue. General and administrative expenses increased $0.6 million during the three months ended September 29, 2012 compared to the same period a year ago primarily due to a write off of a customer receivable that was identified to be uncollectible in the current period, and increased costs of maintaining foreign offices partially offset by lower stock-based compensation expense.


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PMFG, Inc. and Subsidiaries

September 29, 2012

Other Income and Expense. The following summarizes other income and expense (in thousands):

                                                  Three months ended
                                           September 29,         October 1,
                                               2012                 2011
         Interest income                  $            10        $        10
         Interest expense                            (105 )             (427 )
         Loss on extinguishment of debt              (291 )               -
         Foreign exchange gain (loss)                 (82 )             (458 )
         Other income (expense), net                    1                 21

         Total other income (expense)     $          (467 )      $      (854 )

For the three months ended September 29, 2012, total other income and expense was a net expense of $0.5 million compared to $0.9 million in the prior year. Interest expense decreased $0.3 million from the prior year due to lower average debt balances outstanding. A $0.3 million write off of deferred financing charges associated with the refinancing of our senior secured credit agreement was recognized in the three months ended September 29, 2012. A loss on foreign exchange of $0.1 million was recognized in the quarter ended September 29, 2012 compared to $0.5 million in the prior year, primarily as a result of changes in the exchange rates of the Canadian dollar relative to the U.S. dollar and the euro relative to the British pound.

Income Taxes. Our effective income tax rates were 20.7% and 41.5% for the three months ended September 29, 2012 and October 1, 2011, respectively. For the quarter ended September 29, 2012, the effective tax rate was impacted by increased profits of our foreign subsidiaries which have a lower tax rate than the United States. For the quarter ended October 1, 2011 the effective tax rate varied from statutory rates because of income tax credits for our research and development expenditures.

Results of Operations - Segments

We have two reporting segments: Process Products and Environmental Systems.

Process Products

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. Process Products represented 87% and 83% of our revenue in the three months ended September 29, 2012 and October 1, 2011, respectively.

The following summarizes Process Products revenue and operating income (in thousands):

                                                  Three months ended
                                            September 29,        October 1,
                                                2012                2011
        Revenue                            $        28,715      $     24,235
        Operating income                             5,380             3,352
        Operating income as % of revenue              18.7 %            13.8 %

Process Products revenue increased $4.5 million or 18.5% to $28.7 million in the three months ended September 29, 2012, compared to prior year. The acquisition of Burgess Manning GmbH in November 2011 contributed $2.6 million of revenue in the


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PMFG, Inc. and Subsidiaries

September 29, 2012

three months ended September 29, 2012. Additional revenue growth for the current year resulted from increased pressure product and nuclear revenue in Asia driven by our continued focused sales efforts in that region.

Process Products operating income for the three months ended September 29, 2012 increased $2.0 million, or 60.5%, compared to prior year. The increase in operating income in the three months ended September 29, 2012 was primarily a result of increased revenue in the segment. As a percentage of revenue, operating income was 18.7% and 13.8% for the three months ended September 29, 2012 and October 1, 2011, respectively. The increase in operating income as a percentage of revenue during the current year is attributed to a change in product mix as well as an increased focus on manufacturing costs.

Environmental Systems

The primary product of our Environmental Systems business is selective catalytic reduction systems, which we refer to as 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. Environmental Systems represented 13.0% and 17.0% of our revenue in the three months ended September 29, 2012 and October 1, 2011, respectively.

The following summarizes Environmental Systems revenue and operating income (in thousands):

                                                   Three months ended
                                            September 29,         October 1,
                                                2012                 2011
        Revenue                            $         4,262       $      4,853
        Operating income                               621                476

        Operating income as % of revenue              14.6 %              9.8 %

Environmental Systems revenue decreased $0.6 million or 12.2% to $4.3 million in the three months ended September 29, 2012, compared to prior year. The lower revenue reflects a decline in bookings in late fiscal 2011 and early fiscal 2012. Demand for SCR Systems has been dampened by continued delays in the implementation of published environmental regulations.

Environmental Systems operating income for the three months ended September 29, 2012 increased $0.1 million in comparison to the prior year. As a percentage of revenue, operating income increased to 14.6% during the three months ended September 29, 2012, from 9.8% for the three months ended October 1, 2011 as a result of lower selling and engineering costs relative to revenue.

General and Administrative Expenses

General and administrative expenses include those related to the corporate office, as well as general and administrative costs of international subsidiaries. General and administrative expenses increased $0.6 million or 11.4% in the quarter ended September 29, 2012 in comparison to the prior year. The increase was primarily due to the write off of a customer receivable that was identified to be uncollectible in the current period, and increased costs of maintaining foreign offices partially offset by lower stock-based compensation expense.


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PMFG, Inc. and Subsidiaries

September 29, 2012

Contingencies

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 in the Notes to the Consolidated Financial Statements.

Net Bookings and Backlog

The following table shows the activity and balances related to our backlog for
the three months ended and as of September 29, 2012 and October 1, 2011 (in
millions):



                                                  Three Months Ended
                                           September 29,         October 1,
                                               2012                 2011
         Backlog at beginning of period   $          99.9       $       89.0
         Net bookings                                24.7               26.1
         Revenue recognized                         (33.0 )            (29.1 )

         Backlog at end of period         $          91.6       $       86.0

Our backlog was approximately $91.6 million at September 29, 2012, compared to $99.9 million at June 30, 2012. At September 29, 2012, approximately 85% of our backlog related to Process Products sales orders with the balance pertaining to Environmental Systems sales orders. Backlog includes contractual purchase orders for products that are deliverable in future periods less revenue recognized on such orders to date. Of our backlog at September 29, 2012, we estimate approximately 80% of the revenue related to our existing backlog will be recognized in the next 12 months. Orders in backlog are subject to change, delays or cancellation by our customers.

Financial Position

Assets. Total assets increased by $3.4 million, or 1.9%, from $183.3 million at June 30, 2012, to $186.7 million at September 29, 2012. On September 29, 2012, we held cash, including restricted cash, and cash equivalents of $68.2 million, had working capital of $77.5 million and a current liquidity ratio of 2.6-to-1.0. This compares with cash, including restricted cash, and cash equivalents of $60.2 million, working capital of $77.3 million, and a current liquidity ratio of 2.7-to-1.0 at June 30, 2012.

Liabilities and Equity. Total liabilities increased by $2.6 million, or 5.0%, from $52.4 million at June 30, 2012 to $55.0 million at September 29, 2012. The increase in our total liabilities is primarily attributed to an increase in accounts payable.

The increase in our stockholder's equity of $0.8 million, or 0.6%, from $130.9 million at June 30, 2012 to $131.7 million at September 29, 2012 is attributable to stock awards and an increase in Other Comprehensive Income partially offset by our net loss for the three months ended September 29, 2012. Our ratio of debt (total liabilities)-to-equity was 0.4-to-1.0 at September 29, 2012 and June 30, 2012.

Liquidity and Capital Resources

Because we are engaged in the business of manufacturing systems, our progress billing practices are event-oriented rather than date-oriented and vary from contract to contract. 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. We typically bill our customers upon the occurrence of project milestones. Billings to customers affect the balance of billings in excess of costs and earnings on uncompleted contracts or the balance of costs and earnings in excess of billings on uncompleted contracts, as well as the balance of accounts receivable. Consequently, we focus on the net


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PMFG, Inc. and Subsidiaries

September 29, 2012

amount of these accounts, along with accounts payable, to determine our management of working capital. At September 29, 2012, the balance of these working capital accounts was $8.8 million compared to $16.7 million at June 30, 2012, reflecting a decrease of our investment in these working capital items of $7.9 million.

Many of our customers require bank letters of credit or other forms of financial guarantees to secure progress payments and performance. Such letters of credit and guarantees are issued under various bank and financial institution arrangements (see Note 7 of Item 1 in the Notes to the Consolidated Financial Statements). As of September 29, 2012 and June 30, 2012, we had outstanding letters of credit and bank guarantees of $23.0 million and $22.1 million, . . .

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