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PMFG > SEC Filings for PMFG > Form 10-K on 6-Sep-2013All Recent SEC Filings

Show all filings for PMFG, INC.

Form 10-K for PMFG, INC.


Annual Report


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 2014, to differ materially from those disclosed 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, 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 2013. 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 represent 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.

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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
                                        2013          2012          2011
              Process Products              84 %          87 %          73 %
              Environmental Systems         16 %          13 %          27 %

                                           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 Europe 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
Estimate Description                  Uncertainty          Potential Impact if Results Differ
Revenue Recognition

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

The percentage-of-completion
methodology generally
results in the recognition
of reasonably consistent
profit margins over the life
of a contract.

Cumulative revenue
recognized may be less or
greater than cumulative
amounts 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

We maintain an allowance for   Considerable management     Bad debt expense totaled
doubtful accounts to reflect   judgment is necessary in    $1.2 million in fiscal
estimated losses resulting     determining whether a       2013 and $0.2 million in
from the inability of          receivable will be          fiscal 2012 and 2011. As
customers to make required     collectible based on a      a percentage of revenue,
payments.                      customer's potential        the bad debt expense was
                               inability to pay.           0.9%, 0.2%, and 0.2% in
On an on-going basis, we                                   fiscal 2013, 2012, and
evaluate the collectability    In making such              2011, respectively.
of accounts receivable based   determination, management
on historical collection       evaluates the age of the    The impact of a 100
trends, current economic       outstanding balance,        basis point increase or
factors, and the assessment    evaluation of the           decrease in bad debt
of collectability of           customer's current and      expense would be
specific accounts.             past financial condition    approximately $1.3
                               and related credit          million in fiscal 2013.
                               scores, recent payment
                               history, current economic
                               environment, and
                               discussions with the

Product Warranties

We provide our customers       We record an estimate of    Warranty expense totaled
with product warranties for    costs to be incurred in     $1.9 million, $1.0
specific products during a     the future for product      million and $2.4 million
defined period of time,        warranties based on both    in fiscal 2013, 2012,
generally less than 18         known claims and            and 2011, respectively.
months after shipment of the   historical experience.      As a percentage of
product. Warranties cover                                  revenue, the warranty
the failure of a product to    Such estimates also         expense was 1.4%, 0.8%,
perform after it has been      include expectations with   and 2.0% in fiscal 2013,
placed in service.             regard to applicability     2012, and 2011,
                               and enforceability of       respectively.
In general, our warranty       back-up concurrent
agreements require us to       supplier warranties in      The impact of a 100
repair or replace defective    place.                      basis point increase or
products during the warranty                               decrease in warranty
period at no cost to the                                   costs would be
customer.                                                  approximately $1.3
                                                           million in fiscal 2013.
To the extent such defects
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.

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Goodwill and Intangible

Our goodwill and intangible    Considerable management     We believe 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 our
and design guidelines with     going forward. We           assumptions may result
indefinite lives.              determine fair value        in different
                               using widely accepted       calculations of fair
Intangible assets with         valuation techniques        value that could result
indefinite lives and           including discounted cash   in a material impairment
goodwill are evaluated at      flows, market multiple      charge.
the reporting unit level for   analyses, and relief from
potential impairment at        royalty analyses.           At June 29, 2013 the
least annually, or earlier     Assumptions used in our     fair value of our
if an indicator of             valuations, such as         Process Products segment
impairment exists, to ensure   forecasted growth rates     exceeds its related
that the carrying value is     and our cost of capital,    carrying value by
recoverable.                   are consistent with our     approximately $6 million
                               internal projections and    or 5%. Increasing our
A perpetual trademark or       operating plans.            discount rate by 25
design guideline is impaired                               basis points would not
if its book value exceeds      We believe that a           have resulted in an
its estimated fair value.      trademark and/or design     impairment charge. The
Our goodwill, which relates    guideline has an            terminal revenue growth
entirely to the Process        indefinite life if it has   rate utilized in
Products segment, is           a history of strong sales   calculating the fair
evaluated for potential        and cash flow performance   value (5.0%) is
impairment if the book value   that we expect to           dependent on our ability
of its reporting unit          continue for the            to meet internal
exceeds its estimated fair     foreseeable future.         projections and
value.                         Determining the expected    operating plans, as well
                               life of a trademark         as other factors and
Amortizing intangible assets   and/or design guideline     assumptions.
are only evaluated for         requires considerable
impairment upon a              management judgment and     At June 29, 2013, the
significant change in the      is based on an ongoing      fair value of our trade
operating environment. If an   evaluation of a number of   names exceeded their
evaluation of the              factors including           carrying value by
undiscounted cash flows        competitive environment,    approximately $0.5
indicates impairment, the      trademark and product       million or 11% and the
asset is written down to its   history, and anticipated    fair value of our design
estimated fair value, which    future product demand.      guidelines exceeded
is generally based on                                      their carrying value by
discounted cash flows.                                     approximately $0.2
                                                           million or 3%. Negative
In the fourth quarter of                                   changes to the
fiscal 2013, we completed                                  assumptions related to
our annual impairment                                      royalty, growth, or
testing using the methods                                  discount rates could
described above and                                        result in impairments.
concluded there was no
impairment of our goodwill
or other intangible assets
with an indefinite life.

Our goodwill and intangible
net assets totaled $46.6
million as of June 29, 2013

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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 the
or measurement criteria.       regulations, and taxing     outcome of tax audits or
                               authority rulings, as       changes to or further
A valuation allowance is       well as to the expiration   interpretation of tax
recorded against a deferred    of statutes of              laws and regulations.
tax asset if it is more        limitations in the          Our judgments and
likely than not that the       jurisdictions in which we   estimates concerning
asset will not be realized.    operate.                    realizability of
                                                           deferred tax assets
At June 29, 2013 our           Additionally, several       could change if any of
liability for uncertain tax    factors are considered in   the evaluation factors
positions, including accrued   evaluating the              change.
interest, was $1.4 million     realizability of our
and our valuation allowance    deferred tax assets,        If such changes take
was $1.3 million.              including the remaining     place, there is a risk
                               years available for         that our effective tax
                               carryforward, the tax       rate could increase or
                               laws for the applicable     decrease in any period,
                               jurisdictions, the future   impacting our net
                               profitability of the        earnings.
                               specific business units,
                               and tax planning

Recent Accounting Pronouncements

In July 2012 the Financial Accounting Standards Board ("FASB") issued an Accounting Standards Update related to "Testing Indefinite-Lived Intangibles for Impairment." The purpose of the update is to simplify the guidance for testing indefinite-lived intangible assets for impairment and the update permits entities to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. Unless an entity determines, through its qualitative assessment, that it is more likely than not that an indefinite-lived intangible asset is impaired, it would not be required to calculate the fair value of the asset. This standard is effective for annual and interim impairment tests of indefinite-lived intangible assets performed in fiscal years beginning after September 15, 2012, and early adoption is permitted. This standard did not have an impact on our annual indefinite-lived asset impairment testing process in fiscal 2013 as we did not elect to perform a qualitative assessment.

Results of Operations-Consolidated

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

                                                        Fiscal        Fiscal         Fiscal
                                                         2013          2012           2011
Net revenue                                               100.0 %       100.0 %        100.0 %
Cost of goods sold                                         65.0          69.5           68.5

Gross profit                                               35.0          30.5           31.5
Operating expenses                                         34.3          30.1           33.4

Operating income (loss)                                     0.7           0.4           (1.9 )
Other income (expense)                                     (0.7 )        (1.9 )          4.1

Earnings (loss) before income taxes                         0.0          (1.5 )          2.2
Income tax benefit                                         -1.1           0.7            2.5

Net earnings (loss)                                        -1.1 %        (0.8 )%         4.7 %

Less net earnings (loss) attributable to
noncontrolling interest                                     0.4          (0.1 )          0.1

Net earnings (loss) attributable to PMFG, Inc.             -1.5          (0.7 )          4.6
Dividends on preferred stock                                0.0            -            (0.6 )

Earnings (loss) applicable to PMFG, Inc. common
stockholders                                               -1.5 %        (0.7 )%         4.0 %

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.

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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.

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. The following summarizes consolidated revenue (in thousands):

                      Fiscal        % of         Fiscal        % of         Fiscal        % of
                       2013         Total         2012         Total         2011         Total
     Domestic        $  70,986        53.0 %    $  71,479        52.8 %    $  75,223        61.8 %
     International      62,906        47.0 %       63,839        47.2 %       46,571        38.2 %

     Total           $ 133,892       100.0 %    $ 135,318       100.0 %    $ 121,794       100.0 %

For fiscal 2013, total revenue decreased $1.4 million or 1.1%, compared to fiscal 2012. Domestically, lower revenue in our Process Products segment was partially offset by growth in our Environmental Systems segment. The net decrease in domestic revenue is $0.5 million in fiscal 2013 when compared to the prior fiscal year. International revenue decreased $0.9 million as increases in Asia and, to a lesser extent, in Europe, were offset by year over year decreases in revenue from Latin America and Canada.

For fiscal 2012, total revenue increased $13.5 million or 11.1%, compared to fiscal 2011. Domestically, Environmental Systems revenue was down as the primary purchasers of our SCR systems await finalization of Cross-State Air Pollution Rules. That decline was offset in part by a year over year increase in Process Products led by our pressure products offerings. These two offsetting forces combined for a net decrease in domestic revenue of $3.7 million in fiscal 2012 when compared to the prior fiscal year. International revenue increased $17.3 million or 37.1%, in fiscal 2012 compared to fiscal 2011. The acquisition of Burgess Manning GmbH contributed $8.3 million of revenue in fiscal 2012. Additional increases in international revenue were a combination of growth in Latin America, the Middle East and Asia. This growth is resulting from both an increase in demand and our strategic decision to increase our sales focus on the international markets.

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Gross Profit. Our gross profit during any particular period may be impacted by several factors, primarily sales 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):

                       Fiscal         % of         Fiscal         % of         Fiscal         % of
                        2013        Revenue         2012        Revenue         2011        Revenue
. . .
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