| PEERLESS MANUFACTURING CO ITEM 1A RISK FACTORS In evaluating the Company, the factors described below should be considered carefully |
| The occurrence of one or more of these events could significantly and adversely affect our business, prospects, financial condition, results of operations and cash flows |
| Changes in the power generation industry and/or the economy could have an adverse impact on sales of our Environmental Systems and our operating results |
| The demand for our Environmental Systems depends in part on the continued construction of power generation plants and the upgrade of existing power and process plants |
| The power generation industry has experienced cyclical periods of slow growth or decline |
| Any change in the power plant industry that results in a decrease in power plant construction or a decline in the refurbishing of existing power plants could have a materially adverse impact on our Environmental Systems revenues and our results of operations |
| Changes in the price, supply or demand for natural gas could have an adverse impact on our sales of Separation Filtration Systems and our operating results |
| A large portion of our Separation Filtration Systems business is driven by the construction of natural gas production and transportation infrastructure |
| Increasing demand for natural gas may result in the construction of natural gas production facilities and facilities to transport the gas to its end destination, for example pipelines and liquefied natural gas (“LNG”) processing plants |
| Increasing prices of natural gas, while beneficial to exploration activities and the financing of new projects, can adversely impact demand |
| Excess supply could also negatively impact the price of natural gas, which could discourage spending on related capital projects |
| Changes in current environmental legislation could have an adverse impact on the sale of our Environmental Systems and on our operating results |
| Our Environmental Systems business is primarily driven by capital spending by our customers to comply with environmental regulations |
| Laws and regulations governing the discharge of pollutants into the environment or otherwise relating to the protection of the environment or human health have played a significant part in the increased use of Environmental Systems in the United States |
| These laws include US federal statutes such as the Resource Conservation and Recovery Act of 1976, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA), the Clean Water Act, the Clean Air Act, the Clean Air Interstate Rule (CAIR), and the regulations implementing these statutes, as well as similar laws and regulations at state and local levels and in other countries |
| These laws and regulations may change or other jurisdictions may not adopt similar laws and regulations |
| This business will be adversely impacted to the extent that current regulations requiring the reduction of NOx emissions are repealed, amended or implementation dates delayed or to the extent that regulatory authorities reduce enforcement |
| Competition could result in lower sales and decreased margins |
| We operate in highly competitive markets worldwide |
| Competition could result in not only a reduction in our sales, but also a reduction in the prices we can charge for our products |
| To remain competitive we must be able to anticipate and respond quickly to our customers’ needs and enhance and upgrade our existing products and services to meet those needs |
| We must also be able to continue to price our products competitively |
| Our competitors may develop cheaper, more efficient products or may be willing to charge lower prices for strategic marketing or to increase market share |
| Some of our competitors have more capital and resources than we do and may be better able to take advantage of acquisition opportunities or adapt more quickly to changes in customer requirements |
| 8 _________________________________________________________________ [60]Table of Contents If actual costs for our projects with fixed-price contracts exceed our original estimates, our profits will be reduced or we may suffer losses |
| Although we benefit from cost savings, we have limited ability to recover cost overruns |
| Because of the large scale and long-term nature of our contracts, unanticipated cost increases may occur as a result of several factors, including: • increases in cost or shortages of components, materials or labor; • unanticipated technical problems; • required project modifications not initiated by the customer; and • suppliers’ or subcontractors’ failure to perform |
| Our contracts often provide for liquidated damages in the case of late delivery |
| Unanticipated costs that we cannot pass on to our customers, for example the increases in steel prices or the payment of liquidated damages under fixed contracts, would negatively impact our profits |
| Customers may cancel or delay projects |
| As a result our backlog may not be indicative of our future revenue |
| Customers may cancel or delay projects for reasons beyond our control |
| Our orders normally contain cancellation provisions which permit us to recover our costs, and, for most contracts, a portion of our anticipated profit in the event a customer cancels an order |
| If projects are delayed, the timing of our revenues could be affected and projects may remain in our backlog for extended periods of time |
| Revenue recognition occurs over long periods of time and is subject to unanticipated delays |
| If we receive relatively large orders in any given quarter, fluctuations in the levels of our quarterly backlog can result because the backlog in that quarter may reach levels that may not be sustained in subsequent quarters |
| As a result, our backlog may not be indicative of our future revenues |
| Our ability to conduct business outside the United States may be adversely affected by factors outside of our control and our revenues and profits from international sales could be adversely impacted |
| Revenue outside the United States represented 48dtta7prca, 40dtta7prca and 32dtta6prca of our consolidated revenues during fiscal 2006, 2005 and 2004, respectively |
| Our operations and earnings throughout the world have been, and may in the future be, affected from time to time in varying degrees by war, political developments and foreign laws and regulations, such as regional economic uncertainty, political instability, restrictions, customs and tariffs, government sanctions, changing regulatory environments, fluctuations in foreign currency exchange rates and adverse tax consequences |
| The likelihood of these types of occurrences and their overall effect upon us vary greatly from country to country and are not predictable |
| These factors may result in a decline in revenues or profitability and could adversely affect our ability to expand our business outside of the United States and from time-to-time may impact our ability to ship our products and collect our receivables |
| Our financial performance may vary significantly from period to period, making it difficult to estimate future revenue |
| Our annual revenues and earnings have varied in the past and are likely to vary in the future |
| Our contracts generally stipulate customer specific delivery terms and may have contract cycles of a year or more, which subjects these contracts to many factors beyond our control |
| In addition, contracts that are significantly larger in size than our typical contracts tend to intensify their impact on our annual operating results |
| Furthermore, as a significant portion of our operating costs are fixed, an unanticipated decrease in our revenues, a delay or cancellation of orders in backlog, or a decrease in the demand for our products, 9 _________________________________________________________________ [61]Table of Contents may have a significant impact on our annual operating results |
| Therefore, our annual operating results may be subject to significant variations and our operating performance in one period may not be indicative of our future performance |
| Our margins are affected by shifts in our product mix |
| Certain of our products have higher profit margins than others |
| Consequently, changes in the product mix of our sales from quarter-to-quarter or from year-to-year can have a significant impact on our reported profit margins |
| Certain of our products also have a much higher internally manufactured cost component |
| Therefore, changes from quarter-to-quarter or from year-to-year can have a significant impact on our reported margins through a negative or positive impact on our manufacturing absorption |
| Our products are covered by warranties |
| Unanticipated warranty costs for defective products could adversely affect our financial condition and results of operations and reputation |
| We offer warranty periods of various lengths to our customers depending upon the specific product and terms of the customer agreement |
| While we continually monitor our warranty claims and provide a reserve for estimated warranty issues on an on-going basis, an unanticipated claim could have a material adverse impact on our results of operations |
| In some cases, we may be able to recover a portion of our warranty cost from a subcontractor, if the subcontractor supplied the defective product or performed the service |
| The need to repair or replace products with design or manufacturing defects could temporarily delay the sale of new products, reduce our profits, cause us to suffer a loss and could adversely affect our reputation |
| Product liability claims not covered by insurance could adversely affect our financial condition and results of operations |
| We may be subject to product liability claims for personal injury or property damage |
| While we maintain product liability insurance coverage to protect us in the event of a claim, our coverage may not be adequate to cover the cost of defense and the potential award in the event of a claim |
| Also, industry awareness of actual or perceived problems with our products could adversely affect our reputation and reduce sales |
| A significant portion of our accounts receivable are related to large contracts, which increases our exposure to credit risk |
| We closely monitor the credit worthiness of our customers |
| Significant portions of our sales are to customers who place large orders for custom products and whose activities are related to the power and oil/gas industries |
| As a result, our exposure to credit risk is affected to some degree by conditions within these industries and governmental and/or political conditions |
| We frequently attempt to reduce our exposure to credit risk by requiring progress payments and letters of credit |
| However unanticipated events that affect our customers could have a materially adverse impact on our operating results |
| Our products are generally sold under contracts that allow us to either bill upon the completion of certain agreed upon milestones, or upon actual shipment of the product |
| We attempt to negotiate progress-billing milestones on all large contracts to help us manage the working capital and credit risk associated with these large contracts |
| Consequently, shifts in the billing terms of the contracts in our backlog from period to period can increase our requirement for working capital and can increase our exposure to credit risk |
| 10 _________________________________________________________________ [62]Table of Contents The terms and conditions of our credit facility impose restrictions on our operations, including restrictions on our ability to raise additional capital, if needed |
| The terms and conditions of our revolving credit facility impose restrictions that affect, among other things, our ability to incur debt, make capital expenditures, merge, sell assets, make distributions, and create or incur liens |
| Our ability to borrow under our credit facility is also subject to our compliance with certain financial covenants |
| Our ability to comply with these covenants may be affected by events beyond our control and we cannot assure that we will achieve operating results that will allow us to meet the requirements of the credit agreement |
| A breach of any of these covenants could result in a default under our credit facility |
| In the event of a default, the lender could elect to declare all amounts outstanding under our credit facility to be immediately due and payable |
| As of June 30, 2006, we were in compliance with all financial and other covenants of our credit facility |
| Our ability to satisfy any debt obligations will depend upon our future operating performance, which will be affected by prevailing economic, financial and business conditions and other factors, some of which are beyond our control |
| We anticipate that borrowings from our existing revolving credit facility, or the refinancing of our revolving credit facility, and cash provided by operating activities, should provide sufficient funds to finance capital expenditures, working capital and otherwise meet our operating expenses and service our debt requirements as they become due |
| However, in the event that we require additional capital, there can be no assurance that we will be able to raise the necessary capital when needed or on satisfactory terms |
| Our business is subject to risks of terrorist acts, acts of war and natural disasters |
| Terrorist acts, acts of war, or national disasters may disrupt our operations, as well as those of our customers |
| These types of acts have created, and continue to create, economic and political uncertainties and have contributed to global economic instability |
| Future terrorist activities, military or security operations, or natural disasters could weaken the domestic/global economies and create additional uncertainties, thus forcing our customers to reduce their capital spending, or cancel or delay already planned construction projects, which could have a material adverse impact on our business, operating results and financial condition |
| The inability of our engineering and/or manufacturing operations to sufficiently scale up operations in the short term, in response to unexpected spikes in orders with short cycle times, directly impacts our ability to optimize absorption of our manufacturing overhead expense |
| Our engineering and manufacturing operations require a highly skilled workforce for which there is increasing demand and short supply in a very competitive environment |
| Consequently, unexpected spikes in demand to produce sales orders that require tight delivery and short order cycle times may require us to outsource the engineering and/or manufacturing of these orders |
| While our ability to do so is one of our perceived strengths, this practice could negatively affect our profit margins, through higher unabsorbed manufacturing costs |
| Our ability to operate effectively could be impaired if we fail to attract and retain key personnel |
| Our ability to operate our businesses and implement our strategies depends, in part, on the efforts of our executive officers and other key employees |
| In addition, our future success will depend on, among other factors, our ability to attract and retain qualified personnel |
| The loss of the services of one or more key employees or the failure to attract or retain other qualified personnel could have a material adverse effect on our business or business prospects |
| 11 _________________________________________________________________ [63]Table of Contents Our customers may require us to perform portions of our projects in their local countries |
| Certain countries have regulations, or in some cases, customer preferences, requiring that a certain degree of local content be included in projects destined for installation in their country |
| These requirements may negatively impact our profit margins and present project management issues |
| The relocation of our administrative, research & development, manufacturing and storage operations in Dallas, Texas could result in a negative impact on the Company’s financial performance |
| Our headquarters facility in Dallas, Texas is expected to be acquired by the Dallas Area Rapid Transit Authority in either a negotiated transaction or condemnation proceeding under eminent domain laws |
| We estimate that the fair value of this facility is between dlra4dtta0 million and dlra4dtta4 million |
| At June 30, 2006, the book value of the facility was dlra0dtta8 million |
| The Company will be required to relocate all of its administrative offices, research & development laboratory, manufacturing and storage operations that are currently being performed at this facility |
| The relocation(s) are expected to be completed in the quarter ending March 31, 2007 |
| The Company is currently making plans to vacate this facility |
| The disruption on the Company’s administrative function, our research & development activities and its manufacturing and storage operations during the relocation, and additional incurred expenses may have an adverse impact on our business and results of operations |
| We will be exposed to risks relating to evaluation of our internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002 |
| Section 404 of the Sarbanes-Oxley Act requires us to furnish a management certification and auditor attestation regarding the effectiveness of our internal control systems over financial reporting |
| We will be required to comply with Section 404 for either the fiscal year ending June 30, 2007 or June 30, 2008 |
| In the event the aggregate market value of our common stock held by non-affiliates exceeds dlra75 million as of December 29, 2006, we will be subject to Section 404 beginning with our annual report due in September 2007 |
| Otherwise, we will be subject to Section 404 beginning with our annual report due in September 2008 |
| We have begun the evaluation process necessary for us to comply with Section 404 |
| During this evaluation process, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight Board rules and regulations that remain unremediated |
| As a public company, we are required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that materially affect, or are reasonably likely to materially affect, internal controls over financial reporting |
| A “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| To comply with Section 404 within the prescribed period will be time consuming and costly, which could directly impact our results of operations |
| If we fail to implement the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory agencies such as the SEC In addition, failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose confidence in our financial statements and the trading price of our common stock may decline |
| If we fail to remedy any material weakness, our financial statements may be inaccurate, our access to the capital markets may be restricted and the trading price of our common stock may decline |
| Our common stock is thinly traded, which may make it difficult to sell our common stock and may make our stock price more volatile |
| The daily trading volume of our common stock is relatively low |
| The market price of thinly traded stock can be more volatile than a stock that has greater trading volume |
| Our financial results, large sales of our common stock by our existing shareholders, the perception that large sales of our common 12 _________________________________________________________________ [64]Table of Contents stock may occur and various factors affecting the industry in which we operate may have a significant impact on the market price of our common stock |
| In recent years, the stock market has experienced a high level of price and volume volatility, and market prices for the stocks of many companies have experienced wide price fluctuations that have not necessarily been related to their operating performance |
| As a result, our shareholders may not be able to sell their shares at the volumes, prices or times that they desire |