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PMFG > SEC Filings for PMFG > Form 10-Q on 7-Feb-2013All Recent SEC Filings

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Form 10-Q for PMFG, INC.


7-Feb-2013

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 and six 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 53% in the six months ended December 29, 2012 compared to 45% in the six months ended December 31, 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.


Table of Contents

PMFG, Inc. and Subsidiaries

December 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 is 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.

We believe 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.


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PMFG, Inc. and Subsidiaries

December 29, 2012

Results of Operations

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



                                            Three months ended                             Six months ended
                                    December 29,           December 31,           December 29,           December 31,
                                        2012                   2011                   2012                   2011
Net revenue                                 100.0 %                100.0 %                 100.0 %               100.0 %
Cost of goods sold                           63.3                   66.9                    64.4                  68.3

Gross profit                                 36.7                   33.1                    35.6                  31.7
Operating expenses                           33.9                   30.5                    33.5                  32.0

Operating income (loss)                       2.8                    2.6                     2.1                  (0.3 )
Other expense, net                           (0.2 )                 (1.7 )                  (0.8 )                (2.2 )

Income (loss) before income
taxes                                         2.6                    0.9                     1.3                  (2.5 )
Income tax benefit (expense)                 (0.7 )                 (0.7 )                  (0.3 )                 0.8

Net income (loss)                             1.9 %                  0.2 %                   1.0 %                (1.7 )%

Net income (loss)
attributable to
noncontrolling interest                       0.4                     -                      0.7                  (0.1 )

Net income (loss)
attributable to PMFG, Inc.                    1.5                    0.2 %                   0.3                  (1.6 )%

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.

Quarter Ended December 29, 2012 Compared to Quarter Ended December 31, 2011

Results of Operations - Consolidated

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 53% and 49% of consolidated revenue in the quarters ended December 29, 2012 and December 31, 2011, respectively. The following summarizes consolidated revenue (in thousands):


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                          PMFG, Inc. and Subsidiaries

                               December 29, 2012



                                             Three months ended
                     December 29,       % of Total        December 31,       % of Total
                         2012            Revenue              2011            Revenue
    Domestic        $       14,883             47.3 %    $       19,272             51.1 %
    International           16,569             52.7 %            18,449             48.9 %

    Total           $       31,452            100.0 %    $       37,721            100.0 %

Total revenue decreased $6.2 million, or 16.6%, to $31.5 million in the second quarter of fiscal 2013 compared to the same period in fiscal 2012. Reduced activity in both our Environmental Systems and Process Products segments contributed to the decrease in revenue in the second quarter of fiscal 2013 compared to fiscal 2012.

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):

                                                Three months ended
                        December 29,       % of Total        December 31,       % of Total
                            2012            Revenue              2011            Revenue
  Revenue              $       31,452            100.0 %    $       37,721            100.0 %
  Cost of goods sold           19,923             63.3 %            25,245             66.9 %

  Gross profit         $       11,529             36.7 %    $       12,476             33.1 %

Gross profit in the second quarter of fiscal 2013 decreased $1.0 million compared to the same period in fiscal 2012 attributed to the decreased revenue in the period. The increase in gross profit, as a percentage of revenue, during the second quarter of fiscal 2013 compared to the same period last year resulted from lower than previously estimated costs on certain projects, improved manufacturing efficiencies, and changes in product mix.

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

                                                                  Three months ended
                                        December 29,        % of Total          December 31,        % of Total
                                            2012              Revenue               2011              Revenue
Sales and marketing                    $        3,936              12.5 %      $        3,582               9.5 %
Engineering and project management              2,377               7.6 %               2,471               6.6 %
General and administrative                      4,356              13.8 %               5,445              14.4 %

Total                                  $       10,669              33.9 %      $       11,498              30.5 %

Operating expenses decreased $0.8 million, or 7.2%, for the second quarter of fiscal 2013 compared to the same period in fiscal 2012. As a percentage of revenue, these expenses increased to 33.9% during the second quarter of fiscal 2013, from 30.5% during the same period last year.

Our sales and marketing expenses increased $0.4 million in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012, primarily due to higher commissions' expense and increased costs associated with additional sales resources located in China. Our engineering and project management expenses decreased $0.1 million in the second quarter of fiscal 2013 compared to the same period in fiscal 2012. General and administrative expenses decreased $1.0 million during the second quarter of fiscal 2013 compared to the same period last year, primarily due to the expense of $2.1 million for accelerated vesting of restricted stock in the second quarter of fiscal 2012 that was not replicated in the same period in fiscal 2013, partially offset by increased costs of maintaining foreign offices, and increased professional services' fees.


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PMFG, Inc. and Subsidiaries

December 29, 2012

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

                                                Three months ended
                                        December 29,          December 31,
                                            2012                  2011
         Interest income                $           7        $            7
         Interest expense                        (210 )                (443 )
         Foreign exchange gain (loss)             117                  (211 )
         Other income (expense), net               32                     3

         Total other income (expense)   $         (54 )      $         (644 )

For the second quarter of fiscal 2013, total other income and expense was a net expense of $0.1 million compared to $0.6 million in the second quarter of fiscal 2012. Interest expense decreased $0.2 million in the second quarter of fiscal 2013 from the same period last year due to lower average debt balances outstanding. A gain on foreign exchange of $0.1 million was recognized in the second quarter of fiscal 2013, driven largely by positive movements in the euro relative to the British pound, compared to a loss of $0.2 million in the same period last year, primarily as a result from changes in the exchange rates of the Canadian dollar and the euro relative to the U.S. dollar.

Income Taxes. Our effective income tax rates were 26.4% and 87.4% for the quarters ended December 29, 2012 and December 31, 2011, respectively. For the second quarter of fiscal 2013, the effective tax rate was impacted by increased profits of our foreign subsidiaries that have a lower relative effective tax rate.

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 91% and 87% of our revenue in the quarters ended December 29, 2012 and December 31, 2011, respectively.

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

                                                   Three months ended
                                            December 29,        December 31,
                                                2012                2011
        Revenue                            $       28,480      $       32,665
        Operating income                            4,710               5,527

        Operating income as % of revenue             16.5 %              16.9 %

Process Products revenue decreased $4.2 million, or 12.8%, to $28.5 million in the second quarter of fiscal 2013, compared to the second quarter of fiscal 2012. In the current quarter, we saw lengthening cycles in the quotation approval process on our active quotes and we have experienced customer-driven delays in the required completion date on some of the orders in our backlog, both of which have combined to result in lower revenue this quarter than in the comparable period last fiscal year.


Table of Contents

PMFG, Inc. and Subsidiaries

December 29, 2012

Process Products operating income for the second quarter of fiscal 2013 decreased $0.8 million, or 14.8%, compared to the second quarter of fiscal 2012. The decrease in operating income in the second quarter of fiscal 2013 was primarily a result of decreased revenue in the period. As a percentage of revenue, operating income remained relatively flat at 16.5% and 16.9% for the quarters ended December 29, 2012 and December 31, 2011, respectively.

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 9.0% and 13.0% of our revenue in the quarters ended December 29, 2012 and December 31, 2011, respectively.

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

                                                  Three months ended
                                           December 29,        December 31,
                                               2012                2011
        Revenue                            $       2,972      $        5,056
        Operating income                             506                 896

        Operating income as % of revenue            17.0 %              17.7 %

Environmental Systems revenue decreased $2.1 million, or 41.2%, to $3.0 million in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012. The lower revenue reflects dampened demand for SCR Systems brought about by continued delays in the implementation of published environmental regulations.

Environmental Systems operating income for the second quarter of fiscal 2013 decreased $0.4 million compared to the second quarter of fiscal 2012. As a percentage of revenue, operating income remained relatively flat at 17.0% in the second quarter of fiscal 2013, compared to 17.7% in the second quarter of fiscal 2012.

Six Months Ended December 29, 2012 Compared to Six Months Ended December 31, 2011

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