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Perma-Pipe International Holdings, Inc. - Annual Report: 2006 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

X

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the fiscal year ended January 31, 2006

 

 

 

 

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

 

 

 

ACT OF 1934

 

 

 

For the transition period from

 

to

 

 

 

 

 

 

Commission File No. 0-18370

 

 

 

 

MFRI, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

36-3922969

(State or other jurisdiction of

(I.R.S. Employer Identification No.)

Incorporation or organization)

 

 

 

 

 

7720 Lehigh Avenue

 

Niles, Illinois

60714

(Address of principal executive offices)

(Zip Code)

 

 

 

 

(847) 966-1000

(Registrant’s telephone number, including area code)

 

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 per share

 

 

 

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes / / No / x /

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes / / No / x /

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes / x / No / /

 

 

 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this FORM 10-K or any amendment to this FORM 10-K. / x /

 

 

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer / / Accelerated filer / / Non-accelerated filer / x /

 

 

 

 

The aggregate market value of the voting securities of the registrant beneficially owned by non-affiliates of the registrant (the exclusion of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant) was approximately $32,554,621 based on the closing sale price of $8.15 per share as reported on the NASDAQ National Market on July 29, 2005.

 

 

 

 

 

 

The number of shares of the registrant’s common stock outstanding at May 1, 2006 was 5,281,355.

DOCUMENTS INCORPORATED BY REFERENCE

 

 

Portions of the following document of the registrant are incorporated herein by reference:

 

 

 

 

 

 

Document

 

Part of FORM 10-K

 

 

 

Proxy Statement for the 2006 annual meeting of stockholders.

III

 

 

 

 



 

 

FORM 10-K CONTENTS

JANUARY 31, 2006

 

Item

 

Page

 

 

 

Part 1:

 

 

 

 

 

1.

Business

1

 

Company Profile

1

 

Filtration Products

1

 

Piping Systems

3

 

Industrial Process Cooling Equipment

5

 

Employees

7

 

Executive Officers of the Registrant

8

1A.

Risk Factors

9

1B.

Unresolved Staff Comments

10

2.

Properties

10

3.

Legal Proceedings

11

4.

Submission of Matters to a Vote of Security Holders

11

 

 

 

Part II:

 

 

 

 

 

5.

Market for Registrant’s Common Equity; Related Stockholder Matters and Issuer Purchases of Equity Securities

11

6.

Selected Financial Data

12

7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

12

7A.

Quantitative and Qualitative Disclosures About Market Risk

22

8.

Financial Statements and Supplementary Data

23

9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

23

9A.

Controls and Procedures

23

9B.

Other Information

23

 

 

 

Part III:

 

 

 

 

 

10.

Directors and Executive Officers of the Registrant

24

11.

Executive Compensation

24

12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

24

13.

Certain Relationships and Related Transactions

24

14.

Principal Accountant Fees and Services

24

 

 

 

Part IV:

 

 

 

 

 

15.

Exhibits, Financial Statement Schedules

24

 

 

 

Signatures

51

 

 



 

 

PART I

 

 

Item 1.

BUSINESS

 

Company Profile

 

MFRI, Inc. ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three distinct business segments: filtration products, piping systems and industrial process cooling equipment. As used herein, unless the context otherwise requires, the term “Company” includes MFRI and its subsidiaries, Midwesco Filter Resources, Inc., Perma-Pipe Inc., Thermal Care Inc., and their respective predecessors and subsidiaries.

 

The Filtration Products business segment manufactures and sells a wide variety of filter elements for air filtration and particulate collection systems. Air filtration systems are used in many industries in the United States and abroad to limit particulate emissions to comply with environmental regulations. The Filtration Products business segment markets air filtration-related products and accessories, and provides maintenance services, consisting primarily of dust collector inspection, filter cleaning and filter replacement.

 

The Piping System business segment engineers, designs, manufactures and sells specialty piping systems and leak detection and location systems. This segment’s specialty piping systems include (i) industrial and secondary containment piping systems for transporting chemicals, waste streams and petroleum liquids, (ii) insulated and jacketed district heating and cooling piping systems for efficient energy distribution to multiple locations from central energy plants, and (iii) oil and gas gathering flow lines and long lines for oil and mineral transportation. The Piping System business segment’s leak detection and location systems are sold as part of many of its piping systems products and on a stand-alone basis, to monitor areas where fluid intrusion may contaminate the environment, endanger personal safety, cause a fire hazard, impair essential services or damage equipment or property.

 

The Industrial Process Cooling Equipment business segment engineers, designs, manufactures and sells industrial process cooling equipment, including liquid chillers, mold temperature controllers, cooling towers, plant circulating systems, and related accessories for use in industrial process applications.

 

Additional information with respect to the Company's business segments is included in the following discussions of the separate business segments and in the financial statements and related notes thereto.

 

Filtration Products Business

 

Air Filtration and Particulate Collection Systems. Federal and state legislation and related regulations and enforcement have increased the demand for air filtration and particulate collection systems by requiring industry to meet primary and secondary ambient air quality standards for specific pollutants, including particulate. In certain manufacturing applications, particulate collection systems are an integral part of the production process. Examples of such applications include the production of cement, carbon black and industrial absorbents.

 

The principal types of industrial air filtration and particulate collection systems in use today are baghouses, cartridge collectors, electrostatic precipitators, scrubbers and mechanical collectors. This equipment is used to eliminate particulate from the air by passing particulate laden gases through fabric filters (filter bags) or pleated media filter elements, in the case of baghouses or cartridge collectors, and between electrically charged collector plates, in the case of electrostatic precipitators.

 

Products and Services. The Company manufactures and sells a wide variety of filter elements for cartridge collectors and baghouse air filtration and particulate collection systems. The Company manufactures filter elements in standard industry sizes, shapes and filtration media and to custom specifications, maintaining manufacturing standards for more than 10,000 styles of filter elements to suit substantially all industrial applications. Filter elements are manufactured from industrial yarn, fabric and papers purchased in bulk.   Most filter elements are produced from cellulose, acrylic, fiberglass, polyester, aramid or polypropylene fibers.

 

1

 



 

 The Company also manufactures filter elements from more specialized materials, sometimes using special finishes.

 

The Company markets numerous filter-related products and accessories used during the installation, operation and maintenance of cartridge collectors and baghouses, including wire cages used to support filter bags, spring assemblies for proper tensioning of filter bags and clamps and hanger assemblies for attaching filter elements. In addition, the Company markets other hardware items used in the operation and maintenance of cartridge collectors and baghouses. The Company also provides maintenance services, consisting primarily of air filtration system inspection and filter element replacement, using a network of independent contractors. The sale of filter-related products and accessories, collector inspection, maintenance services and leak detection account for approximately 11% of the net sales of the Company's filtration products and services.

 

Over the past three years, the Company's Filtration Products Business has served more than 4,000 user locations. The Company has particular expertise in supplying filter bags for use with electric arc furnaces in the steel industry. The Company believes its production capacity and quality control procedures make it a leading supplier of filter bags to large users in the electric power industry. Orders from that industry tend to be substantial in size, but are usually at lower margins than other industries. In the fiscal year ended January 31, 2006, no customer accounted for 10% or more of net sales of the Company's filtration products and services.

 

Marketing. The customer base for the Company's filtration products and services is industrially and geographically diverse. These products and services are used primarily by operators of utility and industrial coal-fired boilers, incinerators and cogeneration plants and by producers of metals, cement, chemicals and other industrial products.

 

The Company has an integrated sales program for its Filtration Products Business, which consists of field-based sales personnel, manufacturers' representatives, a telemarketing operation and computer-based customer information systems containing data on nearly 18,000 user locations. These systems enable the Company's sales force to access customer information classified by industry, equipment type, operational data and the Company's quotation and sales history. The Company believes the computer-based information systems are instrumental in increasing sales of filter-related products and accessories and maintenance services, as well as sales of filter elements. The Company’s filtration products are marketed domestically under the names, Midwesco Filter and TDC Manufacturing.

 

The Company markets its U.S. manufactured filtration products internationally using domestically based sales resources to target major users in foreign countries. Export sales, which were approximately 10% of the domestic filtration company’s product sales during the year ended January 31, 2006, were slightly higher than the previous year. Nordic Air Filtration A/S (“Nordic Air”), a wholly-owned subsidiary of the Company, manufactures in Nakskov, Denmark, and markets pleated filter elements throughout Europe and Asia, primarily to original equipment manufacturers.

 

Trademarks. The Company owns the following trademarks covering its filtration products: Seamless Tube®, Leak Seeker®, Prekote®, We Take the Dust Out of Industry®, Pleatkeeper®, Pleat Plus® and EFC®.

 

Backlog. As of January 31, 2006, the dollar amount of backlog (uncompleted firm orders) for filtration products was $20,426,000. As of January 31, 2005, the amount of backlog was $17,518,000. Certain customers have placed orders that are deliverable over multiple years. Therefore, approximately $5,552,000 of the backlog as of January 31, 2006 is not expected to be completed in 2006.

 

Raw Materials and Manufacturing. The basic raw materials used in the manufacture of the Company's filtration products are industrial fibers and media supplied by leading producers of such materials. The majority of raw materials purchased are woven fiberglass fabric, yarns for manufacturing Seamless Tube® products and other woven, felted, spun bond and cellulose media. Only a limited number of suppliers are available for some of these materials. From time to time, any of these materials could be in short supply, adversely affecting the Company's business. The Company believes that supplies of all materials are adequate to meet current demand. The Company's inventory includes substantial quantities of various types of media because lead times from

 

2

 



 

suppliers are frequently longer than the delivery times required by customers. Nevertheless, the Company employs an aggressive program to limit inventory to levels compatible with meeting customer needs.

 

Competition. The Filtration Products Business is highly competitive. In addition, new installations of cartridge collectors and baghouses are subject to competition from alternative technologies. The Company believes that, based on domestic sales, its principal competitors in this segment are: the BHA brand within GE Energy Services; the Menardi division of Beacon Industrial Group; W.L. Gore & Associates, Inc. Donaldson Company, Inc.; Farr Company; and Clarcor, Inc. There are at least 50 smaller competitors, most of which are doing business on a regional or local basis. In Europe, several companies supply filtration products, and the Company is a relatively small participant in that market. Some of the Company's competitors have greater financial resources than the Company.

 

The Company believes quality, service, and price are the most important competitive factors in its Filtration Products Business. Often, a manufacturer has a competitive advantage when its products have performed successfully for a particular customer in the past. Additional effort is required by a competitor to market products to such a customer. In certain applications, the Company's proprietary Seamless Tube® product and customer support provide the Company with a competitive advantage. Certain competitors of the Company may have a competitive advantage with respect to their own proprietary products and processes, such as specialized fabrics and fabric finishes. In addition, some competitors may have cost advantages with respect to certain products as a result of lower wage rates and/or greater vertical integration.

 

Government Regulation. The Company's Filtration Products Business is substantially dependent upon governmental regulation of air pollution at the federal and state levels. Federal clean air legislation requires compliance with national primary and secondary ambient air quality standards for specific pollutants, including particulate. The states are primarily responsible for implementing these standards and, in some cases, have adopted more stringent standards than those issued by the U.S. Environmental Protection Agency (“U.S. EPA”) under the Clean Air Act Amendments of 1990 ("Clean Air Act Amendments”).

 

Piping Systems Business

 

Products and Services. The Company engineers, designs, manufactures and sells specialty piping systems and leak detection and location systems. The Company's specialty piping systems include (i)industrial and secondary containment piping systems for transporting chemicals, hazardous fluids and petroleum products, (ii) insulated and jacketed district heating and cooling piping systems for efficient energy distribution to multiple locations from central energy plants, and (iii) oil and gas gathering flow lines and long lines for oil and mineral transportation. The Company's leak detection and location systems are sold as part of many of its piping systems, and on a stand-alone basis, to monitor areas where fluid intrusion may contaminate the environment, endanger personal safety, cause a fire hazard, impair essential services or damage equipment or property.

 

The Company's industrial and secondary containment piping systems, manufactured in a wide variety of piping materials, are generally used for the handling of chemicals, hazardous liquids and petroleum products. Industrial piping systems often feature special materials, heat tracing, leak detection and special fabrication. Secondary containment piping systems consist of service pipes housed within outer containment pipes, which are designed to contain any leaks from the service pipes. Each system is designed to provide economical and efficient secondary containment protection that will meet all governmental environmental regulations.

 

With respect to the leak detection and location system capabilities, the Company believes that its systems are superior to systems manufactured by other companies. The Company's leak detection and location systems are being used to monitor fueling systems at airports, including those located in Denver, Colorado; Atlanta, Georgia; and Frankfurt and Hamburg, Germany. They are also used in facilities used for mission-critical operations such as those operated by web hosts, application service providers, internet service providers, and in many clean rooms, including such facilities operated by IBM, Intel and Motorola. The Company believes that, in the United States, it is the only major supplier of the above-referenced types of specialty piping systems that manufactures its own leak detection and location systems.

 

 

3

 



 

 

The Company's piping systems are frequently custom-fabricated to job site dimensions and/or incorporate provisions for thermal expansion due to varying temperatures. This custom fabrication helps to minimize the amount of field labor required by the installation contractor. Most of the Company's piping systems are produced for underground installations and, therefore, require trenching, which is done by unaffiliated installation contractors. Generally, sales of the Company's piping systems tend to be lower during the winter months, due to weather constraints over much of the northern hemisphere. In the fiscal year ended January 31, 2006, no single customer accounted for more than 10% of the net sales of the Company's piping systems.

 

Marketing. The customer base for the Company's piping systems products is industrially and geographically diverse. The Company employs a national sales manager and regional sales managers who use and assist a network of approximately 80 independent manufacturers' representatives, none of whom sells products that are competitive with the Company's piping systems.

 

Recent Development. In March 2006, the Company opened a new facility (PPME), in the United Arab Emirates (“U.A.E.”). PPME will manufacture specialty pre-insulated piping systems. Initially, the plant will produce pipe that will serve the district cooling market in the U.A.E. as well as other Middle Eastern countries such as Kuwait, Qatar, and Oman. District cooling is the main air conditioning method in the Middle East. With major construction going on in Dubai and other Middle East locations, cooling needs for these buildings is expected to increase greatly. The cooling load in the Middle East is expected to grow by 4 million tons in the next 6 years, according to the International District Energy Association. PPME also intends to participate in the oil and gas markets in the region including hot oil, sulfur and liquid natural gas.

 

In September, 2005 the Company received initial orders for its new “Autotherm™”, automatically applied Glass Syntactic Polyurethane (GSPU) for oil and gas sub-sea flowlines. The Company’s Autotherm™ GSPU is a thermal insulation application process that continuously molds specially formulated compounds on the exterior of steel pipes for oil and gas flowlines to be installed on the sea floor connecting oil wells to their host platforms. The Autotherm™ system is designed to provide reliable insulation properties when subjected to the large hydrostatic pressures of deep water over long periods of time. These pipelines will be installed in water depths ranging from 2,000 to 4,500 feet. Insulating sub-sea oil flowlines is a common practice at these water depths in order to prevent paraffin or hydrate build-up on the internal pipe surfaces thus ensuring a steady flow of oil.

 

Patents, Trademarks and Approvals. The Company owns several patents covering the features of its piping and electronic leak detection systems, which expire commencing in 2006. In addition, the Company's leak detection system is listed by Underwriters Laboratories and the U.S. EPA and is approved by Factory Mutual and the Federal Communications Commission. The Company is also approved as a supplier of underground district heating systems under the federal government guide specifications for such systems. The Company owns numerous trademarks connected with its piping systems business. In addition to Perma-Pipe®, the Company owns other trademarks for its piping and leak detection systems including the following: Chil-Gard®, Double-Pipe®, Double-Quik®, Escon-A®, Ferro-Shield®, FluidWatch®, Galva-Gard®, Hi Gard®, Poly-Therm®, Pal-AT®, Ric-Wil®, Ric-Wil Dual Gard®, Stereo-Heat®, Safe-T-Gard®, Therm-O-Seal®, Uniline®, LiquidWatch®, TankWatch®, PalCom®, Xtru-therm®, Ultra-Pipe®, PEX-GARD®, and ULTRA-THERM®. The Company also owns United Kingdom trademarks for Poly-Therm®, Perma-Pipe® and Ric-Wil®, and a Canadian trademark for Ric-Wil®.

 

Backlog. As of January 31, 2006, the dollar amount of backlog (uncompleted firm orders) for piping and leak detection systems was $19,869,000, substantially all of which is expected to be completed in 2006. As of January 31, 2005, the amount of backlog was $18,125,000.

 

Raw Materials and Manufacturing. The basic raw materials used in the production of the Company's piping systems products are pipes and tubes made of carbon steel, alloy and plastics and various chemicals such as polyols, isocyanate, polyester resin, polyethylene and fiberglass, mostly purchased in bulk quantities. The Company believes that there are currently adequate supplies or sources of availability of the needed raw materials. However, there are risks and uncertainties with respect to the supply of certain of these raw materials that could impact their availability in sufficient quantities to meet the Company’s needs.

 

4

 



 

 

The sensor cables used in the Company's leak detection and location systems are manufactured to the Company's specifications by companies regularly engaged in the business of manufacturing such cables. The Company owns patents for some of the features of its sensor cables. The Company assembles the monitoring component of the leak detection and location system from standard components purchased from many sources. The Company's proprietary software is installed in the system on a read-only memory chip.

 

The Company's manufacturing processes for its piping systems include equipment and techniques to fabricate piping systems from a wide variety of materials, including carbon steel, alloy and copper piping, and engineered thermoplastics and fiberglass-reinforced polyesters and epoxies. The Company uses computer-controlled machinery for electric plasma metal cutting, filament winding, pipe coating, insulation foam and protective jacket application, pipe bending, pipe cutting and pipe welding. The Company employs skilled workers for carbon steel and alloy welding to various code requirements. The Company is authorized to apply the American Society of Mechanical Engineers code symbol stamps for unfired pressure vessels and pressure piping. The Company's inventory includes bulk resins, chemicals and various types of pipe, tube, insulation, pipe fittings and other components used in its products. The Company maintains a quality assurance program involving lead worker sign-off of each piece at each workstation, statistical process control, and nondestructive testing protocols.

 

Competition. The piping system products business is highly competitive. The Company believes its principal competition in this segment consists of Rovanco Piping Systems, Inc.; Thermacor Process, Inc.; Asahi/America; GF Plastics Systems; Bredero-Price, a subsidiary of Shaw Industries, Inc.; CRP of UK; Soctherm of Italy; Soccoreal of Argentina; Logstor Rohr of Denmark; TraceTek; Raychem, a Division of Tyco Thermal Controls LLC, a subsidiary of Tyco Industries; RLE Technologies; Tracer Technologies; Arizona Instrument Corp.; Veeder Root; and Pneumecator.

 

The Company believes that quality, service, a comprehensive product line and price are the key competitive factors in the Company's Piping Systems Business. The Company believes it has a more comprehensive line of piping systems products than any of its competitors. Certain competitors of the Company have cost advantages as a result of manufacturing a limited range of products. Some of the Company's competitors have greater financial resources than the Company.

 

Government Regulation. The demand for the Company's leak detection and location systems and secondary containment piping systems is driven by federal and state environmental regulation with respect to hazardous waste. The Federal Resource Conservation and Recovery Act requires, in some cases, that the storage, handling and transportation of certain fluids through underground pipelines feature secondary containment and leak detection. The National Emission Standard for Hydrocarbon Airborne Particulates requires reduction of airborne volatile organic compounds and fugitive emissions. Under this regulation, many major refineries are required to recover fugitive vapors and dispose of the recovered material in a process sewer system, which then becomes a hazardous secondary waste system that must be contained. Although there can be no assurances as to the ultimate effects of these governmental regulations, the Company believes they may increase the demand for its piping systems products.

 

Industrial Process Cooling Equipment Business

 

Products and Services. The Company engineers, designs, manufactures and sells coolers for industrial purposes. The Company's cooling products include: chillers (portable and central); cooling towers; plant circulating assemblies; hot water, hot oil, and negative pressure temperature controllers; water treatment equipment; specialty cooling devices for printing presses and ink management; and replacement parts and various accessories relating to the foregoing products. The Company's cooling products are used to optimize manufacturing productivity by quickly removing heat from manufacturing processes. The Company combines chillers and/or cooling towers with plant circulating systems to create plant-wide systems that account for a large portion of its business. The Company specializes in customizing cooling systems and their computerized controls according to customer specifications.

 

 

5

 



 

 

The principal markets for the Company’s cooling products are thermoplastics processing and the printing industries. The Company also sells its products to original equipment manufacturers, to other cooling manufacturers on a private branded basis and to manufacturers in the laser, metallizing, and machine tool industries.

 

The Company believes it manufactures the most complete line of chillers available in its primary markets. It incorporates a microprocessor capable of computer communications to standard industry protocols. While portable chillers are considered to be a commodity product by many customers, the Company believes that its units enable it to provide the customer with quality, features, customization and other benefits at a competitive price. The Company believes that the ability to offer central chillers that are used for plant-wide cooling provides it with a unique, total cooling approach concept sales advantage.

 

Marketing. In general, the Company sells its cooling products in the domestic and international thermoplastics and printing markets as well as to manufacturers of digital video discs (“DVDs”) and other non-plastics industries that require specialized heat transfer equipment. Domestic thermoplastics processors are the largest market served by the Company, representing the core of its business.

 

There are approximately 8,000 companies processing plastic products in the United States, primarily using injection molding, extrusion, and blow molding machinery. The Company believes the total U.S. market for water cooling equipment in the plastics industry is $100 million annually, and that the Company is one of the three largest suppliers of such equipment to the plastics industry. The Company believes that the plastics industry is a mature industry with growth generally consistent with that of the national economy. Due to the high plastics content in many major consumer items, such as cars and appliances, this industry experiences cyclical economic activity. The Company believes that it is recognized in the domestic plastics market as a quality equipment manufacturer and that it will be able to maintain current market share, with potential to increase its market share through product development. The Company's cooling products are sold through independent manufacturers' representatives on an exclusive-territory basis. Twenty representatives are responsible for covering the United States and are supported by four regional managers employed by the Company.

 

Sales of the Company's cooling products outside the United States have mainly been in Latin America. Some international sales have been obtained elsewhere as a result of the assembly of complete worldwide PET (plastic bottle) plants by multinational companies. The Company believes that it has a significant opportunity for growth due to the high quality of its equipment and the fact that it offers complete system design. Many United States competitors do not provide equipment outside the U.S. and, while European competitors sell equipment in Latin America, the Company believes that they lack system design capabilities and have a significant freight disadvantage. The Company markets its cooling products through a combination of manufacturers' representatives, distributors and consultants managed by regional managers, reporting to a National Sales and Marketing Manager.

 

The Company has increased sales to non-plastics industries that require specialized heat transfer equipment, usually sold to end users as a package by the supplier of the primary equipment, particularly in the laser industry, metallizing industry, and machine tool industry. The Company believes that the size of this market is more than $200 million annually. The original equipment manufacturer generally distributes products to the end user in these markets.

 

Trademarks. The Company has registered the trademarks Thermal Care®, AWS® and Applied Web Systems®.

 

Backlog. As of January 31, 2006, the dollar amount of backlog (uncompleted firm orders) for industrial process cooling equipment was $9,306,000, substantially all of which is expected to be completed in 2006. As of January 31, 2005, the amount of backlog was $5,321,000.

 

 

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Raw Materials and Manufacturing. The Company uses prefabricated sheet metal and subassemblies manufactured by both Thermal Care and outside vendors for temperature controller fabrication. The production line is self-contained to reduce handling required to assemble, wire, test, and crate the units for shipment.

 

Cooling towers up to 120 tons in capacity are assembled to finished goods inventory, which allows the Company to meet quick delivery requirements. The cooling towers are manufactured using fiberglass and hardware components purchased from several sources. The wet deck is cut from bulk fill material and installed inside the tower. Customer-specified options can be added at any time. The Company believes that its access to sheet metal, subassemblies, fiberglass and hardware components is adequate.

 

The Company assembles all plant circulating systems by fabricating the steel to meet the size requirements and adding purchased components to meet customers’ specifications. Portable chillers are assembled utilizing components both manufactured by the Company and supplied by outside vendors. Central chillers are manufactured to customer specifications.

 

Competition. The Company believes that there are about 15 competitors selling cooling equipment in the domestic plastics market. The Company further believes that three manufacturers, including the Company, account for approximately 50% of the domestic plastics cooling equipment market. Many international customers, with relatively small cooling needs, are able to purchase small refrigeration units (portable chillers) that are manufactured in their respective local markets at prices below that which the Company can offer due to issues such as freight cost and customs duties. However, such local manufacturers often lack the technology and products needed for plant-wide cooling systems. The Company believes that its reputation for producing quality plant-wide cooling products results in a significant portion of the Company’s business in this area.

 

The Company believes that quality, service, a comprehensive product line and price are the key competitive factors in its Industrial Process Cooling Equipment Business. The Company believes that it has a more comprehensive line of cooling products than any of its competitors. Certain competitors of the Company have cost advantages as a result of manufacturing in non-union shops and offering a limited range of products. Some of the Company's competitors may have greater financial resources than the Company.

 

Government Regulation. The Company does not expect compliance with federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment to have a material effect on capital expenditures, earnings or the Company’s competitive position. Management is not aware of the need for any material capital expenditures for environmental control facilities for the foreseeable future. Regulations, promulgated under the Federal Clean Air Act, prohibit the manufacture and sale of certain refrigerants. The Company does not use these refrigerants in its products. The Company expects that suitable refrigerants conforming to federal, state and local laws and regulations will continue to be available to the Company, although no assurances can be given as to the ultimate effect of the Federal Clean Air Act and related laws on the Company.

 

Employees

 

As of March 31, 2006, the Company had 760 full-time employees, 83 of whom were engaged in sales and marketing, 215 of whom were engaged in management, engineering and administration, and 462 were engaged in production. Hourly production employees of the Company's Filtration Products Business in Winchester, Virginia are covered by a collective bargaining agreement with the International United Automobile, Aerospace & Agricultural Implement Workers of America, which expires in October 2006. Most of the production employees of the Company's Industrial Process Cooling Equipment Business are represented by two unions, the United Association of Journeymen and Apprentices of the Plumbing and Pipefitting Industry of the United States (UAJAPPI) and the International Brotherhood of Electrical Workers Union (IBEW). The collective bargaining agreement for UAJAPPI is scheduled to expire on June 1, 2006, and the IBEW agreement expires on May 31, 2006, with both agreements thereafter continuing to be in effect for yearly periods unless amended or terminated in writing. The collective bargaining agreement of the Piping Systems Business in Lebanon, Tennessee, with the Metal Trades Division of UAJAPPI expires in March 2007.

 

 

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Executive Officers of the Registrant

The following table set forth information regarding the officers of the Company as of March 31, 2006:

 

Name

 

 

Offices and Positions, if any,

held with the Company; Age

 

 

Executive Officer of the Company

or its Predecessor since

 

David Unger

Director, Chairman of the Board, and Chief Executive Officer of the Company; Age 71

 

1972

 

 

 

 

 

 

Henry M. Mautner

Director and Vice Chairman of the Board of the Company; Age 79

 

1972

 

 

 

 

 

 

 

Bradley E. Mautner

Director, President and Chief Operating Officer of the Company; Age 50

 

1994

 

 

 

 

 

 

 

Gene K. Ogilvie

Vice President; Age 66

 

 

1969

 

 

Fati A. Elgendy

Vice President; Age 57

 

1990

 

 

 

 

 

 

Don Gruenberg

Vice President; Age 63

 

1980

 

 

 

 

 

 

Michael D. Bennett

Vice President, Chief Financial Officer,

Secretary and Treasurer; Age 62

 

1989

 

 

 

 

 

 

Thomas A. Benson

Vice President; Age 52

 

1988

 

 

 

 

 

 

Billy E. Ervin

Vice President; Age 60

 

1986

 

 

 

 

 

 

Robert A. Maffei

Vice President; Age 57

 

1987

 

 

 

 

 

 

Herbert J. Sturm

Vice President; Age 55

 

1977

 

 

All of the officers serve at the discretion of the Board of Directors.

 

David Unger has been employed by the Company and its predecessors in various executive and administrative capacities since 1958, served as President of Midwesco, Inc. (“Midwesco”) from 1972 through January 1994, and was Vice President from February 1994 through December 1996. He was also a director of Midwesco from 1972 through December 1996 and served that company in various executive and administrative capacities from 1958 until the consummation of the merger of Midwesco into the Company in December 1996 (the “Merger”). He became a director and Vice President of the company formed to succeed to the non-Thermal Care business of Midwesco (“New Midwesco”). He is the Company’s Chairman of the Board of Directors and Chief Executive Officer.

 

Henry M. Mautner has been employed by the Company and its predecessors in various executive capacities since 1972, served as Chairman of Midwesco from 1972 through December 1996, and served that company in various executive and administrative capacities from 1949 until the consummation of the Merger. Since the consummation of the Merger, he has served as the Chairman of New Midwesco. Mr. Mautner is the father of Bradley E. Mautner.

 

Bradley E. Mautner has been employed by the Company and its predecessors in various executive and administrative capacities since 1978, has served as President and Chief Operating Officer since December 2004, was Executive Vice President from December 2002 to December 2004, was Vice President of the Company from December 1996 through December 2002 and has been a director of the Company since 1995. From 1994 to the consummation of the Merger, he served as President of Midwesco and since December 30, 1996 he has

 

8

 



 

served as President of New Midwesco. In addition, since February 1996, he has served as the Chief Executive Officer of Midwesco Services, Inc. (“Midwesco Services”) which was 50% owned by New Midwesco until May 19, 2000, at which time it became a wholly-owned subsidiary of New Midwesco. On November 17, 2000, Midwesco Services was merged into New Midwesco (“Midwesco Services Merger”). From February 1988 to January 1996, he served as the President of Mid Res Inc. (predecessor to Midwesco Services). Bradley E. Mautner is the son of Henry M. Mautner.

 

Gene K. Ogilvie has been employed by the Company and its predecessors in various executive capacities since 1969. He has been general manager of Midwesco Filter or its predecessor since 1980 and President and Chief Operating Officer of Midwesco Filter since 1989. From 1982 until the consummation of the Midwesco Merger, he served as Vice President of Midwesco, Inc.

 

Fati A. Elgendy, who has been associated with the Company and its predecessors since 1978, was Vice President, Director of Sales of the Perma-Pipe Division of Midwesco, Inc. from 1990 to 1991. In 1991, he became Executive Vice President of the Perma-Pipe Division, a position he continued to hold after the acquisition by the Company to form Perma-Pipe. In March 1995, Mr. Elgendy became President and Chief Operating Officer of Perma-Pipe.

 

Don Gruenberg has been employed by the Company and its predecessors in various executive capacities since 1974, with the exception of a period in 1979-1980. He has been general manager of Thermal Care or its predecessor since 1980, and was named President and Chief Operating Officer of Thermal Care in 1988. He has been a Vice President and director of the Company since December 1996.

 

Michael D. Bennett has served as the Chief Financial Officer and Vice President of the Company and its predecessors since August 1989.

 

Thomas A. Benson has served as Vice President Sales and Marketing of Thermal Care since May 1988.

 

Billy E. Ervin has been Vice President, Director of Production of Perma-Pipe since 1986.

 

Robert A. Maffei has been Vice President, Director of Sales and Marketing of Perma-Pipe since August 1996. He had served as Vice President, Director of Engineering of Perma-Pipe since 1987 and was an employee of Midwesco, Inc. from 1986 until the acquisition of Perma-Pipe by the Company in 1994.

 

Herbert J. Sturm has served the Company since 1975 in various executive capacities including Vice President, Materials and Marketing Services of Midwesco Filter.

 

1A.

Risk Factors

 

Competition Business. The businesses in which the Company is engaged are highly competitive. Many of the competitors are larger than the Company and have more resources. Many of the Company’s products are also subject to competition from alternative technologies and alternative products. To the extent the Company relies upon a single source for key components of several of its products, the Company believes that there are alternate sources available for such components; however, there can be no assurance that the interruption of supplies of such components would not have an adverse effect on the financial condition of the Company, and that the Company, if required to do so, would be able to negotiate agreements with alternative sources on acceptable terms.

 

Government Regulation. The demand for the Company’s leak detection and location systems and secondary containment piping systems is driven primarily by government regulation with respect to hazardous waste. Laws such as the Federal Resource Conservation and Recovery Act (“RCRA”), and standards such as the National Emission Standard for Hydrocarbon Airborne Particulates (“NESHAP”), have increased the demand for the Company’s leak detection and location and secondary containment piping systems. The Company’s filtration products business to a large extent is dependent on governmental regulation of air pollution at the federal and state levels. The Company believes that continuing growth in the sale of filtration products and

 

9

 



 

services will be materially dependent on continuing enforcement of environmental laws such as the Federal Clean Air Act Amendments of 1990 (“Clean Air Act Amendments”). Although changes in such environmental regulations could significantly alter the demand for the Company’s products and services, the Company does not believe that such a change is likely to decrease demand in the foreseeable future. In addition, the Company has experienced, and may experience additional, increased costs of compliance with other government regulation, such as the Sarbanes-Oxley Act.

 

Dividends. The Company has not paid dividends in the past and does not anticipate paying cash dividends on its common stock in the foreseeable future. The Company’s line of credit agreement contains certain restrictions on payment of dividends.

 

Changes in Government Policies and Laws, Worldwide Economic Conditions. The Company anticipates that international sales will represent an increasing portion of its total sales and that continued growth and profitability may require further international expansion. The Company’s financial results could be affected by changes in trade, monetary and fiscal policies, laws and regulations, or other activities of U.S. and non-U.S. governments, agencies and similar organizations. These conditions include but are not limited to changes in a country’s or region’s economic or political conditions, trade regulations affecting production, pricing and marketing of products, local labor conditions and regulations, reduced protection of intellectual property rights in some countries, changes in the regulatory or legal environment, restrictions on currency exchange activities, burdensome taxes and tariffs and other trade barriers. International risks and uncertainties, including changing social and economic conditions as well as terrorism, political hostilities and war, could lead to reduced international sales and reduced profitability associated with such sales.

 

Economic Factors. The Company is exposed to fluctuations in currency exchange rates and commodity prices. The Company monitors and manages currency exposures that are associated with monetary asset positions, committed currency purchases and sales, and other assets and liabilities created in the normal course of business. Failure to successfully manage these risks could have an adverse impact on the Company’s financial position, results of operations and cash flows.

 

Seasonality. Sales in the Piping Systems business segment have a tendency to be lower during the winter months due to weather constraints in the northern hemisphere. Severity and duration of winter weather could have an adverse effect on the results of this segment.

 

1B.

Unresolved Staff Comments

None

 

Item 2.

PROPERTIES

 

Filtration Products Business

Illinois

Owned Production Facilities and Office Space

130,700 square feet and on 2.75 acres

Virginia

Owned Production Facilities

Leased Office Space

97,500 square feet and on 5 acres

12,000 square feet

Denmark

Owned Production Facilities and

Office Space

69,800 square feet on 3.5-acres

 

Piping Systems Business

Louisiana

Owned Production Facilities Leased land

12,000 square feet

Tennessee

Owned Production Facilities and Office Space

152,000 square feet on approximately 24 acres

United Arab Emirates

Leased Production Facilities and Office Space

80,200 square feet on 4.3 acres

 

 

10

 



 

 

Industrial Process Cooling Equipment Business

Illinois

Owned Production Facilities and Office Space

88,000 square feet on 8.1 acres

Denmark

Owned Production Facilities and

Office Space

20,000 square feet

 

The Company's principal executive offices which occupied approximately 43,000 square feet of space in Niles, Illinois is owned by the Company. The Company believes its properties and equipment are well maintained and in good operating condition and that productive capacities will generally be adequate for present and currently anticipated needs.

 

For further information regarding lease commitments, see note 7 of the notes to consolidated financial statements.

 

Item 3.

LEGAL PROCEEDINGS

 

None

 

Item 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

PART II

 

Item 5.

MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s fiscal year ends on January 31. Years described as 2005, 2004 and 2003 are the fiscal years ended January 31, 2006, 2005 and 2004, respectively. Balances described as balances as of 2005 and 2004 are balances as of January 31, 2006 and 2005, respectively.

 

The Company's Common Stock is traded on the Nasdaq National Stock Market under the symbol "MFRI." The following table sets forth, for the periods indicated, the high and low Common Stock sale prices as reported by the Nasdaq National Market for 2004 and for 2005.

 

2004

 

High

 

Low

First Quarter

 

$

2.87

 

$

2.50

Second Quarter

 

 

3.39

 

 

2.99

Third Quarter

 

 

6.67

 

 

3.28

Fourth Quarter

 

 

11.20

 

 

5.85

 

2005

 

High

 

Low

First Quarter

 

$

10.43

 

$

6.19

Second Quarter

 

 

8.37

 

 

6.40

Third Quarter

 

 

8.00

 

 

6.00

Fourth Quarter

 

 

6.30

 

 

5.09

 

As of May 10, 2006, there were approximately 100 stockholders of record.

 

The Company has never declared or paid a cash dividend and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. Management presently intends to retain all available funds for the development of the business and for use as working capital. Future dividend policy will depend upon the

 

11

 



 

 

Company's earnings, capital requirements, financial condition and other relevant factors. The Company's line of credit agreement contains certain restrictions on the payment of dividends.

 

Neither the Company nor any “affiliated purchaser” as defined in Rule 10b-18 purchased any shares of the Company’s Common Stock during the period covered by this report. The Company has not made any sale of unregistered securities during the preceding three years.

 

Item 6.

SELECTED FINANCIAL DATA

 

The following selected financial data for the Company for the years 2005, 2004, 2003, 2002, and 2001 are derived from the financial statements of the Company. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein in response to Item 7 and the consolidated financial statements and related notes included herein in response to Item 8.

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

(In thousands, except per share information)

 

Fiscal Year ended January 31,

 

 

 

2006

 

2005

 

2004

 

2003

 

 

2002

 

Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

154,587

 

$

145,096

 

$

120,889

 

 

$

122,897

 

 

$

125,534

 

Income (loss) from operations

 

 

2,679

 

 

5,177

 

 

(721

)

 

 

914

 

 

 

2,172

 

Income (loss) before extraordinary items

and cumulative effect of accounting

change

 

 

531

 

 

2,813

 

 

(1,097

)

 

 

(824

)

 

 

(374

)

Net income (loss)

 

 

531

 

 

2,813

 

 

(1,097

)

 

 

(11,528

)

 

 

(374

)

Net income (loss) per share – basic

 

 

0.10

 

 

0.56

 

 

(0.22

)

 

 

(2.34

)

 

 

(0.08

)

Net income (loss) per share – diluted

 

 

0.10

 

 

0.54

 

 

(0.22

)

 

 

(2.34

)

 

 

(0.08

)

 

(In thousands, except per share information)

 

As of January 31,

 

 

2006

 

2005

 

2004

 

2003

 

2002

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

88,635

 

$

85,516

 

$

78,927

 

$

78,976

 

$

92,529

Long-term debt (excluding capital leases),

Less current portion

 

 

29,715

 

 

26,190

 

 

16,653

 

 

18,983

 

 

20,883

Capitalized leases, less current portion

 

 

9

 

 

15

 

 

8

 

 

66

 

 

217

 

Item 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The statements contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and certain other information contained elsewhere in this annual report, which can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “continue,” “remains,” “intend,” “aim,” “should,” “prospects,” “could,” “future,” “potential,” “believes,” “plans,” “likely” and “probable” or the negative thereof or other variations thereon or comparable terminology, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbors created thereby. These statements should be considered as subject to the many risks and uncertainties that exist in the Company’s operations and business environment. Such risks and uncertainties could cause actual results to differ materially from those projected. These uncertainties include, but are not limited to, economic conditions, market demand and pricing, competitive and cost factors, raw material availability and prices, global interest rates, currency exchange rates, labor relations and other risk factors.

 

12

 



 

 

RESULTS OF OPERATIONS

 

MFRI, Inc.

 




 

MFRI, Inc. ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three distinct business segments: filtration products, piping systems and industrial process cooling equipment. Generally, sales of the Company's piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the northern hemisphere. The Company’s other businesses do not demonstrate seasonality.

 

Our analysis presented below is organized to provide instructive information for understanding the business going forward. However, this discussion should be read in conjunction with the consolidated financial statements in Item 8 of this report, including the notes thereto. An overview of the segment results is provided in Note 10 - Business Segment and Geographic Information to the consolidated financial statements in Item 8 of this report.

 

2005 Compared to 2004

 

Net sales of $154,587,000 in 2005 increased 6.5% from $145,096,000 in 2004. Sales increased in all business segments. Gross profit of $32,686,000 in 2005 increased 5.0% from $31,128,000 in 2004. Gross margin decreased to 21.1% of net sales in 2005 from 21.5% in 2004. (See discussion of each business segment below.)

 

Selling expense increased 18.2% to $12,383,000 in 2005 from $10,477,000 in 2004 due primarily to increased number of selling personnel and related commissions. (See discussion of each business segment below.)

 

General and administrative expenses increased 13.9% to $17,624,000 in 2005 from $15,474,000 in 2004. General administrative expense increases included $656,000 related to professional services expenses and use of consultants for Sarbanes-Oxley Section 404 (“SOX404”) compliance related spending. Other general administrative expense increases included $585,000 in start up costs described in the Piping Systems Business section of this report, and costs from operations interruption related to Hurricane Rita. The plant located in New Iberia, LA suffered damage of $172,000 and was not operational for most of October 2005. (See discussion of each business segment below.)

 

Net income declined to $531,000 or $0.10 per common share (basic), compared to net income of $2,813,000 or $0.56 per common share in 2004. The decrease in net income was primarily for reasons summarized above and discussed in more detail below.

 

2004 Compared to 2003

 

Net sales of $145,096,000 in 2004 increased 20.0% from $120,889,000 in 2003. Sales increased in all business segments. Gross profit of $31,128,000 in 2004 increased 26.5% from $24,598,000 in 2003. Gross margin increased to 21.5% of net sales in 2004 from 20.3% in 2003. (See discussion of each business segment below.)

 

 

13

 



 

 

Selling, general and administrative expenses increased 2.5% to $25,951,000 in 2004 from $25,319,000 in 2003. (See discussion of each business segment below.)

 

Net income rose to $2,813,000 or $0.56 per common share (basic), compared with a loss of $1,097,000 or $0.22 per common share in 2003. The increase in net income was due to increased revenue and increased gross profit.

 

Filtration Products Business

 

The Filtration Products Business sales consist primarily of a large number of small orders and a limited number of large orders. The large orders are primarily from electric utilities and original equipment manufacturers. In 2005, the average order amount was approximately $3,900. The timing of large orders can have a material effect on net sales and gross profit from period to period. Pricing on large orders was generally extremely competitive and therefore resulted in lower gross margins. In 2005, 2004 and 2003, no customer accounted for 10% or more of the net sales of the Company’s filtration products and services.

 

The Company’s Filtration Products Business is dependent on government regulation of air quality at the federal and state levels. The Company believes that growth in the sale of its filtration products and services will be materially dependent on continued enforcement of environmental laws such as the Clean Air Act Amendments. Although there can be no assurance what the ultimate effect of the Clean Air Act Amendments will be on the Company’s Filtration Products Business, the Company believes that the Clean Air Act Amendments are likely to have a positive long-term effect on demand for the Company’s filtration products and services.

 

Filtration Products Business

 

 

(In thousands)

 

% Increase

(Decrease)

 

 

2005

 

2004

 

2003

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

64,413

 

$

61,740

 

$

54,872

 

 

4.3%

 

 

12.5%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

11,758

 

 

12,320

 

 

9,782

 

 

(4.6%

)

 

25.9%

As a percentage of net sales

 

 

18.3%

 

 

20.0%

 

 

17.8%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

2,221

 

 

3,539

 

 

1,145

 

 

(37.2%

)

 

209.1%

As a percentage of net sales

 

 

3.4%

 

 

5.7%

 

 

2.1%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005 Compared to 2004

 

Net sales increased 4.3% to $64,413,000 in 2005 from $61,740,000 in 2004. This increase was primarily the result of increased sales of filter elements. This increase was offset to some extent by a decline in sales of related products. The increase in sales also resulted from better economic conditions in general and improved conditions in the domestic steel industry in particular.

 

Gross profit as a percent of net sales decreased to 18.3% in 2005 from 20.0% in 2004, primarily as a result of a decline in gross margin on filter bag sales as a result of competitive marketplace pricing and product mix.

 

Selling expense increased to $6,388,000 or 9.9% of net sales in 2005 from $5,644,000 or 9.1% of net sales in 2004. The increase was primarily due to additional selling resources and increased travel expenses.

 

General and administrative expenses decreased by 0.2% of net sales to $3,150,000 or 4.9% of net sales from $3,137,000 or 5.1% of net sales in 2004. This dollar increase was primarily the result of increased legal expense and depreciation expense. The increase in depreciation expense was related to installed computer hardware and software.

 

14

 



 

 

2004 Compared to 2003

 

Net sales increased 12.5% to $61,740,000 in 2004 from $54,872,000 in 2003. This increase was the result of increased sales of all product lines. This increase was primarily due to a better economic environment including improved conditions in the domestic steel industry.

 

Gross profit as a percent of net sales increased to 20.0% in 2004 from 17.8% in 2003, primarily as a result of improved manufacturing efficiency on higher unit volume and a favorable product mix.

 

Selling expense increased to $5,644,000 or 9.1% of net sales in 2004 from $5,531,000 or 10.1% of net sales in 2003. The increase primarily resulted from increased selling expense in pleated element product line.

 

General and administrative expenses decreased by 0.6% of sales to $3,137,000 or 5.1% of net sales in 2004 from $3,106,000 or 5.7% of net sales in 2003. This dollar increase was primarily due to increased professional services expenses.

 

Piping Systems Business

 

Generally, sales of the Company's piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the northern hemisphere.

 

The Company’s leak detection and location systems generally have higher profit margins than its District Heating and Cooling (“DHC”) piping systems and secondary containment piping systems. The Company has benefited from continuing efforts to have its leak detection and location systems included as part of the customers’ original specifications for construction projects.

 

The Company’s Piping Systems Business is characterized by a large number of small and medium orders and a small number of large orders. The average order amount for 2005 was approximately $58,000. In 2005, 2004 and 2003, no customer accounted for 10% or more of net sales of the Company’s Piping Systems Business. The timing of such orders can have a material effect on the comparison of net sales and gross profit from period to period. Most of the Company’s piping systems are produced for underground installations and, therefore, require trenching, which is performed directly for the customer by installation contractors unaffiliated with the Company.

 

Piping Systems Business

 

 

(In thousands)

 

% Increase

(Decrease)

 

 

2005

 

2004

 

2003

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

54,657

 

$

54,053

 

$

40,523

 

 

1.1%

 

 

33.4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

10,862

 

 

10,284

 

 

7,516

 

 

5.6%

 

 

36.8%

As a percentage of net sales

 

 

19.9%

 

 

19.0%

 

 

18.5%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

5,060

 

 

5,405

 

 

2,281

 

 

(6.4%

)

 

137.0%

As a percentage of net sales

 

 

9.3%

 

 

10.0%

 

 

5.6%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005 Compared to 2004

 

Net sales increased 1.1% to $54,657,000 in 2005 from $54,053,000 in 2004, primarily due to a slight increase in the oil and gas piping products.

 

 

15

 



 

 

Gross profit as a percent of net sales increased to 19.9% in 2005 from 19.0% in 2004, mainly due to product mix and an increase in the oil and gas piping products.

 

Selling expense increased to $1,442,000 or 2.6% of net sales in 2005 from $1,209,000 or 2.2% of net sales in 2004. The increase was primarily due to additional personnel early in the year.

 

General and administrative expense increased to $4,360,000 or 8.0% of net sales in 2005 from $3,670,000 or 6.8% of net sales in 2004. In March, 2006 the Company opened a new facility (PPME), in the U.A.E. The company will manufacture specialty pre-insulated piping systems for Dubai, other parts of the U.A.E., and other markets in the region. The increase in general and administrative expense was primarily due to $585,000 in start up costs related to PPME. In addition, the plant located in New Iberia, LA suffered hurricane damage of $172,000 and was not operational for most of October 2005.

 

2004 Compared to 2003

 

Net sales increased 33.4% to $54,053,000 in 2004 from $40,523,000 in 2003. This increase was primarily due to some recovery from the weak economy in both the private and public sectors and to a single large international sale.

 

Gross profit as a percent of net sales increased to 19.0% in 2004 from 18.5% in 2003, mainly due to product mix and increased volume.

 

Selling expense decreased to $1,209,000 or 2.2% of net sales in 2004 from $1,250,000 or 3.1% of net sales in 2003. The decrease was primarily due to one less sales employee.

 

General and administrative expense decreased to $3,670,000 or 6.8% of net sales in 2004 from $3,985,000 or 9.8% of net sales in 2003. The decrease was primarily due to a 2003 legal settlement of $510,000 and legal fees associated with that settlement.

 

Industrial Process Cooling Equipment Business

 

The Company’s Industrial Process Cooling Equipment Business is characterized by a large number of relatively small orders and a limited number of large orders. In 2005, the average order amount was approximately $4,900. In 2005, 2004 and in 2003, no customer accounted for 10% or more of net sales of the Cooling Equipment Business.

 

Industrial Process Cooling Equipment Business

 

 

(In thousands)

 

% Increase

(Decrease)

 

 

2005

 

2004

 

2003

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

35,517

 

$

29,303

 

$

25,494

 

 

21.2%

 

 

14.9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

10,066

 

 

8,524

 

 

7,300

 

 

18.1%

 

 

16.8%

As a percentage of net sales

 

 

28.3%

 

 

29.1%

 

 

28.6%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

1,544

 

 

1,570

 

 

738

 

 

(1.7%

)

 

112.7%

As a percentage of net sales

 

 

4.3%

 

 

5.4%

 

 

2.9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2005 Compared to 2004

 

Net sales increased 21.2% to $35,517,000 in 2005 from $29,303,000 in 2004 mainly due to improved conditions in domestic plastic molding and printing markets and continued economic recovery.

 

16

 



 

 

Gross profit as a percentage of net sales decreased to 28.3% in 2005 from 29.1% in 2004, primarily due to pricing pressure in international markets and material cost increases.

 

Selling expense increased to $4,553,000 or 12.8% of net sales in 2005 from $3,624,000 or 12.4% of net sales in 2004. The increase was primarily due to additional personnel and higher commissions associated with increased sales.

 

General and administrative expense increased to $3,969,000 or 11.2% of net sales in 2005 from $3,330,000 or 11.4% of net sales in 2004. The dollar increase was primarily due to increased professional services expenses and costs of $290,000 for the use of consultants to implement production planning systems.

 

2004 Compared to 2003

 

Net sales increased 14.9% to $29,303,000 in 2004 from $25,494,000 in 2003 mainly due to some recovery from the weak economy. Sales increased in both the domestic and international markets.

 

Gross profit as a percentage of net sales increased to 29.1% in 2004 from 28.6% in 2003, primarily due improved pricing and production efficiencies

 

As a percentage of sales, selling expense decreased 0.8% to $3,624,000 or 12.4% of net sales in 2004 from $3,361,000 or 13.2% of net sales in 2003. The dollar increase was primarily due to the higher commissions associated with increased sales.

 

General and administrative expense decreased 1.2% of sales to $3,330,000 or 11.4% of net sales in 2004 from $3,201,000 or 12.6% of net sales in 2003. The dollar increase was primarily due to higher costs for the international operation resulting from additional personnel and increased product development costs.

 

General Corporate Expense

 

General corporate expense included interest expense and general and administrative expenses that were not allocated to the business segments.

 

2005 Compared to 2004

 

General and administrative expense increased 15.1% to $6,146,000 in 2005 from $5,337,000 in 2004, and increased as a percentage of consolidated net sales to 4.0% in 2005 from 3.7% in 2004. The increase was mainly due to expenses incurred to comply with Sarbanes-Oxley including consulting fees of $656,000, additional personnel of $130,000 primarily in the accounting and control area, and increased group insurance expense of $110,000.

 

Interest expense increased 10.9% to $1,839,000 in 2005 from $1,658,000 in 2004. The increase was primarily due to the increase in interest rates and an increase of net borrowings.

 

2004 Compared to 2003

 

General and administrative expense increased 9.2% from $4,885,000 in 2003 to $5,337,000 in 2004, and decreased as a percentage of consolidated net sales from 4.0% in 2003 to 3.7% in 2004. The dollar increase was mainly due to management incentive compensation earned and building repairs and maintenance costs.

 

Interest expense decreased 17.2% to $1,658,000 in 2004 from $2,003,000 in 2003. The decrease was primarily due to lower interest expense due to the sale of a building in Winchester, Virginia in June 2004, and to lower floating interest rates in 2004. Interest income on federal tax refunds was received in 2004.

 

 

17

 



 

 

Income Taxes

 

The effective income tax expense (benefit) rates were 48.7%, 24.9%, and (50.8%) in 2005, 2004 and 2003, respectively. The differences between the effective income tax rate and the U.S. Statutory tax rate for 2005 and 2004 were:

 

 

 

2005

 

 

2004

 

Statutory tax rate

 

 

34.0%

 

 

 

34.0%

 

State taxes, net of federal benefit

 

 

5.4%

 

 

 

4.2%

 

Differences in foreign tax rate

 

 

8.0%

 

 

 

(1.6%

)

All other, net

 

 

1.3%

 

 

 

(11.7%

)

Effective tax rate

 

 

48.7%

 

 

 

24.9%

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash and cash equivalents as of January 31, 2006 were $1,114,000 as compared to $723,000 at January 31, 2005. The Company generated $2,134,000 from operations in 2005. Operating cash flows increased by $1,885,000 from 2004. There were $46,000 in proceeds from the sale of property, plant and equipment. Cash distributions of $270,000 in 2005 were received from the Company’s investment in a joint venture. These cash flows were used to support $6,315,000 in capital spending.

 

Trade receivables decreased $2,129,000 due to collection of Piping Systems Business aged receivables. Inventories increased $2,662,000 in 2005 due to increased make and hold orders that will ship in 2006. Prepaid expenses and other current assets increased $639,000 in 2005 partially due to an increase in deferred tax assets and prepaid insurance due to a change in funding method for workers compensation insurance. Other operating assets and liabilities decreased $1,618,000 in 2005.

 

Net cash used in 2005 investing activities was $5,999,000. Capital expenditures in 2005 increased to $6,315,000 from $1,755,000 in 2004. In March 2006, the Company opened a new facility (PPME), in the U.A.E. The company will manufacture specialty pre-insulated piping systems for Dubai, other parts of the U.A.E., and other markets in the region. Capital expenditures of $3,445,000 in equipment and other costs relate to PPME. Capital expenditures of $1,258,000 relate to the Company’s construction of a new 20,900 square foot addition to production facilities which was completed in 2005 for filtration products in Denmark. Other capital expenditures included those related to new Enterprise Resources Planning system software and to equipment purchases.

 

The Company estimates that capital expenditures for 2006 will be approximately $7,300,000. Other capital expenditures primarily will relate to machinery and equipment, building and leasehold improvements, and computer hardware and software purchases. The Company may finance capital expenditures through equipment financing loans, internally generated funds and its revolving line of credit.

 

Debt totaled $31,286,000, an increase of $3,748,000 since the beginning of 2005. Net cash inflows from financing activity were $4,203,000, primarily consisting of $4,004,000 in net borrowings on debt obligations.

 

18

 



 

 

The following table summarizes the Company’s estimated contractual obligations excluding the revolving lines of credit of $14,567,000 at January 31, 2006.

 

In Thousands

 

 

Payment Due By:

Contractual Obligations (1)

Total

 

1/31/07

 

1/31/08

 

1/31/09

 

1/31/10

 

1/31/11

 

Thereafter

Mortgages (2)

$

11,607

 

$

1,039

 

$

1,049

 

$

2,102

 

$

932

 

$

932

 

$

5,553

IRB Payable (2)

 

3,250

 

 

65

 

 

3,185

 

 

-

 

 

-

 

 

-

 

 

-

Term Loans (3)

 

5,778

 

 

1,120

 

 

3,038

 

 

240

 

 

238

 

 

222

 

 

920

Subtotals

 

20,635

 

 

2,224

 

 

7,272

 

 

2,342

 

 

1,170

 

 

1,154

 

 

6,473

Capitalized Lease Obligations

 

15

 

 

6

 

 

4

 

 

4

 

 

1

 

 

-

 

 

-

Operating Lease Obligations (4)

 

3,373

 

 

1,046

 

 

818

 

 

516

 

 

373

 

 

356

 

 

264

Projected pension contributions (5)

 

2,212

 

 

154

 

 

173

 

 

190

 

 

196

 

 

199

 

 

1,300

Deferred Compensation (6)

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

Totals

$

26,235

 

$

3,430

 

$

8,267

 

$

3,052

 

$

1,740

 

$

1,709

 

$

8,037

 

 

(1)

Interest obligations exclude floating rate interest on debt payable under revolving lines of credit. Based on the amount of such debt at January 31, 2006, and the weighted average interest rates on that debt at that date (6.99%), such interest was being incurred at an annual rate of approximately $952,000. See Note (7) below.

 

(2)

Scheduled maturities, including interest.

 

(3)

Term loan obligations exclude floating rate interest on Term Loan with a January 31 balance of $3,655,000. Based on the amount of such debt at January 31, 2006, and the weighted average interest rates on that debt at that date (7.14%), such interest was being incurred at an annual rate of approximately $261,000. See Note (7) below.

 

(4)

Minimum contractual amounts. We have assumed no changes in variable expenses.

 

(5)

Estimate future benefit payments reflecting expected future service.

 

(6)

Non-qualified deferred compensation plan – The Company has deferred compensation agreements with key employees. Vesting is based on years of service. Life insurance contracts have been purchased which may be used to fund the Company’s obligation under these agreements. No specific event to trigger a payment date has occurred.

 

(7)

To partially hedge the interest described in Notes (1) and (3) above, the Company entered into an Interest Swap Agreement for $8,000,000 fixed at 4.72% plus LIBOR margin. Based on the LIBOR margin in effect at January 31, 2006, the Company’s fixed interest obligation under the Swap Agreement was 6.97%, or $558,000 on an annual basis. The counter party to the Swap Agreement is obligated to pay the company interest on $8,000,000 each month at the one-month LIBOR interest rate in effect at the beginning of the month which effectively hedges interest rate variability on $8,000,000 of the debt described in (1) and (3) above.

 

Other long term liabilities of $2,866,000 were composed primarily of accrued pension cost and deferred compensation.

 

The Company’s working capital was approximately $28,543,000 at January 31, 2006 compared to approximately $26,332,000 at January 31, 2005. This increase was partially due to the decrease in accounts payable offset by the increase in inventories.

 

The Company’s current ratio was 2.2 to 1 and 2.0 to 1 at January 31, 2006 and January 31, 2005, respectively. Debt to total capitalization at January 31, 2006 increased to 49.6% from 46.8% at January 31, 2005.

 

Financing

 

At January 31, 2006 and October 31, 2005, the Company was not in compliance with two financial performance covenants under the Loan Agreement (see the paragraphs below that describe the Loan Agreement). The Company has received a waiver and amendment dated May 10, 2006 from the lender. The Company has made all required payments of principal and interest under the Loan Agreement to date.

 

 

19

 



 

 

On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution ("Loan Agreement"). Under the terms of the Loan Agreement, which matures on November 30, 2007, the Company can borrow up to $27,000,000, subject to borrowing base and other requirements, under a revolving line of credit. The Loan Agreement covenants restrict debt, liens, and investments, do not permit payment of dividends, and require attainment of certain levels of profitability and cash flows. Interest rates generally are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At January 31, 2006, the prime rate was 7.5%, and the margins added to the prime rate and the LIBOR rate, which are determined each quarter based on the applicable financial statement ratio, were 0.25 and 2.25 percentage points, respectively. Monthly interest payments were made. The average interest rate for the year ending January 31, 2006 was 6.02%. As of January 31, 2006, the Company had borrowed $13,612,000 and had $1,423,000 available to it under the revolving line of credit. In addition, $3,796,600 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts owed for Industrial Revenue Bond borrowings. The Loan Agreement provides that all payments by the Company's customers are deposited in a bank account from which all funds may only be used to pay the debt under the Loan Agreement. At January 31, 2006, the amount of restricted cash was $369,000. Cash required for operations is provided by draw-downs on the line of credit.

 

At September 12, 2005 the Company entered into an interest rate swap agreement through November 28, 2008 under which the interest rate on $8,000,000 is fixed at 4.72% plus LIBOR Margin. The interest rate swap was effective as a cash flow hedge and no charge to earnings was required during the year ended January 31, 2006. The fair value of the derivative financial instrument was $20,500, and $13,500, net of deferred tax benefits of $7,000, was recorded in other assets and accumulated other comprehensive income associated with the cash flow hedge at January 31, 2006.

 

On March 28, 2005, the Company's Loan Agreement was amended to (1) add a term loan of $4,300,000 ("Term Loan") and (2) amend certain covenants. The total that can be borrowed under the Loan Agreement was unchanged at $27,000,000, subject to borrowing base and other requirements. Interest rates under the Term Loan are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At March 28, 2005 the prime rate was 5.75% and the margins added to the prime rate and the LIBOR rate, which are determined each quarter based on the applicable financial statement ratio, were 1.25 and 3.5 percentage points, respectively. The Company is scheduled to pay $215,000 of principal on the first days of March, June, September, and December in each year, commencing on June 1, 2005 and ending on September 30, 2007, with the remaining unpaid principal payable on November 30, 2007.

 

On May 10, 2006, the Company’s Loan Agreement was amended to (1) increase the revolving credit line to $30,000,000 subject to borrowing base and other requirements, (2) add an equipment loan facility (“Equipment Loan Facility”) of $1,000,000 subject to certain restrictions, and (3) amend certain financial performance covenants. Interest rates under the Equipment Loan Facility are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At May 10, 2006 the prime rate was 8.00% and the margins added to the prime rate and the LIBOR rate, which are determined each quarter based on the applicable financial statement ratio, were .50 and 2.50 percentage points, respectively.

 

The proceeds of the Term Loan were used to repay the outstanding balance due under the Company's Note Purchase Agreements ($3,125,000), which have now been cancelled and to reduce the Company's revolving debt under the Loan Agreement ($1,175,000). Interest rates under the Note Purchase Agreements had been 10% per annum.

 

The Company also has short-term credit arrangements used by its European subsidiaries. These credit arrangements are generally in the form of overdraft facilities at rates competitive in the countries in which the Company operates. At January 31, 2006, borrowings under these credit arrangements totaled $955,000; an additional $691,000 remained unused.

 

 

20

 



 

 

CRITICAL ACCOUNTING POLICIES

 

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company has accounting policies which it believes are important to the Company's financial condition and results of operations, and which require the Company to make estimates about matters that are inherently uncertain. These critical accounting policies include revenue recognition, realizability of inventories, collectibility of accounts receivable, depreciation of plant and equipment, and income taxes. The Company believes that the above critical policies have resulted in past actual results approximating the estimated amounts in those areas.

 

Percentage of Completion Method Revenue Recognition: Perma-Pipe recognizes revenues on contracts under the "percentage of completion" method. The percentage of completion is determined by the relationship of costs incurred to the total estimated costs of the contract. Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements may result in revisions to costs and income. Such revisions are recognized in the period in which they are determined. Claims for additional compensation due the Company are recognized in contract revenues when realization is probable and the amount can be reliably estimated.

 

Revenue Recognition: The Company recognizes revenues when all the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the seller’s price to the buyer is fixed or determinable, and (iii) collectibility is reasonably assured. All subsidiaries of the Company except Perma-Pipe recognize revenues when product has been shipped (for FOB shipping point orders) or delivered (for FOB destination sales) or when services have been rendered.

 

Inventories: Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method for substantially all inventories.

 

Goodwill and other intangible assets with indefinite lives: The Company reviews the carrying value of goodwill in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, which requires that goodwill and other intangible assets with indefinite lives be analyzed for impairment on an annual basis or when there is reason to suspect that their values have been impaired. For the 2005 and 2004, evaluations the fair value was determined using discounted cash flows and other market-related valuation models. Certain estimates and judgments are required in the application of the fair value models. Based upon the Company’s evaluations for 2005 and 2004, no impairment of goodwill was required. Goodwill was $2,509,000 and $2,616,000 at January 31, 2006 and 2005, respectively. As of January 31, 2006 and 2005, $1,100,000 of goodwill was allocated to the Industrial Process Cooling Equipment segment. As of January 31, 2006 and 2005 $1,409,000 and $1,516,000, respectively, was allocated to the Filtration Products segment. The change in goodwill of the Filtration Products segment was due to foreign currency translation.

 

ACCOUNTING PRONOUNCEMENTS

 

In April 2005, the SEC announced the adoption of a new rule that amends the compliance dates for SFAS No. 123 (revised 2004), Share-Based Payment (Statement No. 123R). SFAS No. 123R, as amended, is applicable for all fiscal years beginning after June 15, 2005. As a result the Company is required to implement SFAS No. 123R at the beginning of its next fiscal year, and accordingly, the Company will begin to reflect the adjustment to earnings for the impact of this accounting pronouncement in the interim reporting period ending April 30, 2006. The Company does not expect the adoption of SFAS 123R to have a material effect on its financial statements.

 

 

21

 



 

 

On December 5, 2005, the Board of Directors of the Company approved the acceleration of the vesting requirements for “out-of-the-money” stock options previously granted to employees, including its officers, pursuant to the 2004 Stock Incentive Plan, and “out-of-the-money” stock options previously granted to independent directors pursuant to the 2001 Independent Directors Stock Option Plan. The primary purpose of the acceleration is to eliminate reportable compensation expense the Company would recognize in future periods in its statements of operations upon its adoption of FASB Statement No. 123R (“Share-Based Payments”) in the year beginning February 1, 2006. The Company anticipates that such acceleration of vesting will reduce its pre-tax stock option compensation expense in each of the years 2006 through 2009 by approximately $109,000, or $.02 per share. A Form 8-K was filed on December 9, 2005.

 

FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” with an effective date of December 15, 2005 provides an elective alternative transition method. The Company has one year from December 15, 2005, the initial adoption of SFAS No. 123R to evaluate the available transition alternatives and make its one-time election. The transition method prescribed by SFAS 123R will be followed until the alternative method is elected.

 

In December 2003, the FASB issued Interpretation No. 46R, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” which requires that the assets, liabilities, and the results of activities of a variable interest entity in which a business enterprise has controlling financial interest be included in consolidation with those of the business enterprise. Adoption of FIN No. 46R did not apply to the Company.

 

Item 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company is subject to market risk associated with changes in foreign currency exchange rates, interest rates and commodity prices. Foreign currency exchange rate risk is mitigated through maintenance of local production facilities in the markets served, invoicing of customers in the same currency as the source of the products and use of foreign currency denominated debt in Denmark. The Company has used foreign currency forward contracts to reduce exposure to exchange rate risks. The forward contracts are short-term in duration, generally one year or less. The major currency exposure hedged by the Company has been the Canadian dollar. The contract amounts, carrying amounts and fair values of these contracts were not significant at January 31, 2006, 2005 and 2004.

 

The Company has attempted to mitigate its interest rate risk by maintaining a balance of fixed-rate long-term debt and floating-rate debt.

 

The Company entered into an interest rate swap agreement to reduce its exposure to market risks from changing interest rates under the revolving credit agreement. Under the terms of the swap agreement, the Company agreed to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to the notional principal amount. Any differences paid or received on the interest rate swap agreements are recognized as adjustments to interest expense over the life of the swap, thereby adjusting the effective interest rate on the underlying obligation. Financial instruments are not held or issued for trading purposes.

 

At January 31, 2006 one interest rate swap agreement was in effect with a notional value of $8,000,000 maturing in 2008. The swap agreement exchanges the variable rate to fixed interest rate payments of 4.72% plus LIBOR margin. The interest rate swap was effective as a cash flow hedge and no charge to earnings was required during the year ended January 31, 2006. The fair value of the derivative financial instrument was $20,500, and $13,500, net of deferred tax benefits of $7,000, was recorded in other assets and accumulated other comprehensive income associated with the cash flow hedge at January 31, 2006.

 

A hypothetical ten percent change in market interest rates over the next year would increase interest on the Company's floating rate debt instruments by approximately $66,000.

 

Commodity price risk is the possibility of higher or lower costs due to changes in the prices of commodities, such as ferrous alloys (e.g., steel) which the Company uses in the production of piping systems. The Company attempts to mitigate such risks 

 

22

 



 

 by obtaining price commitments from its commodity suppliers and, when it appears appropriate, purchasing quantities in advance of likely price increases.

 

Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The consolidated financial statements of the Company for each of the three years in the period ended as of January 31, 2006, 2005 and 2004 and the notes thereto are set forth elsewhere herein.

 

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

Item 9A.

CONTROLS AND PROCEDURES

 

As of January 31, 2006, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended. Based solely on the material weakness described below, the Company's Chief Executive Officer and Chief Financial Officer concluded that, as of January 31, 2006, the Company's disclosure controls and procedures were not effective as of the end of the fiscal period covered by this Report on Form 10-K. The Company has restated previously reported 2005 quarterly financial results. Due to this material weakness, the Company, in preparing its consolidated financial statements as of and for the period ended January 31, 2006, performed additional procedures relating to inventory to enable it to conclude that the consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles.

 

When processing inventory transactions using an Enterprise Resources Planning system installed in December 2004 at the Company's production facility for filtration products in Winchester, VA ("Winchester Facility"), errors were made subsequent to Winchester Facility's January 31, 2005 physical inventory, and during each of the interim fiscal quarters of 2005, which were discovered by Registrant's accounting personnel only when analyzing the Winchester Facility physical inventory as of January 31, 2006. The errors did not affect the quantity of physical inventory, and no restatement for any such period affects the Registrant's sales, cash flows, or business prospects. However, the errors did result in the overstatement of inventories, current assets, total assets, income before income taxes, and net income for each of the interim fiscal quarters of 2005.

 

Changes in Internal Controls.

 

Since January 31, 2006, the Company has taken steps to correct transaction processing procedures, accounting controls and reporting controls at the Winchester Facility to prevent recurrence of such errors. The Company has also examined controls and procedures at the Registrant's other locations to detect the presence of possible weaknesses similar to those that caused the above errors, and has analyzed the inventory accounts at Registrant's other locations to detect the possible presence of errors similar to those described above. No such weaknesses or errors were detected.

 

Other than the change discussed above, there have been no significant changes in the Company's internal controls, or in other factors that could significantly affect these controls, subsequent to the date of that evaluation.

 

 

Item 9B.

OTHER INFORMATION

None.

 

 

23

 



 

 

PART III

 

Item 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

Information with respect to directors of the Company is incorporated herein by reference to the table under the caption "Nominees for Election as Directors" and the textual paragraphs following the aforesaid table and the information contained under the captions “Board of Director Meetings and Committees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company's proxy statement for the 2006 annual meeting of stockholders.

 

Information with respect to executive officers of the Company is included in Item1, Part I hereof under the caption "Executive Officers of the Registrant."

 

Item 11.

EXECUTIVE COMPENSATION

 

Information with respect to executive compensation is incorporated herein by reference to the information under the caption "Executive Compensation" in the Company's proxy statement for the 2006 annual meeting of stockholders.

 

Item 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

Information with respect to security ownership of certain beneficial owners and management of the Company and related stockholder matters is incorporated herein by reference to the information under the captions "Beneficial Ownership of Common Stock" and “Equity Compensation Plan Information” in the Company's proxy statement for the 2006 annual meeting of stockholders.

 

Item 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

Information with respect to certain relationships and transactions is incorporated herein by reference to the information under the caption "Certain Transactions" in the Company's proxy statement for the 2006 annual meeting of stockholders.

 

Item 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Information with respect to the independence of the Company’s public accountants and the fees paid to such accountants is incorporated herein by reference to the information under the caption “Independent Registered Public Accounting Firm” in the Company’s proxy statement for the 2006 annual meeting of stockholders.

 

PART IV

 

Item 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 

 

a.

List of documents filed as part of this report:

 

 

(1)

Financial Statements - Consolidated Financial Statements of the Company

 

Refer to Part II, Item 8 of this report.

 

 

(2)

Financial Statement Schedules

 

 

Schedule II - Valuation and Qualifying Accounts

 

 

 

b.

Exhibits: The exhibits, as listed in the Exhibit Index included herein, are submitted as a separate section of this report.

 

 

c.

The response to this portion of Item15 is submitted under 15a (2) above.

 

 

24

 



 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 


Board of Directors and Stockholders
MFRI, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of MFRI, Inc. (a Delaware corporation) and subsidiaries as of January 31, 2006 and 2005, and the related consolidated statements of operations, stockholders equity, and cash flows for the years ended January 31, 2006 and 2005. In connection with our audits, we have also audited the financial statement schedule (the "Schedule") listed in the Index at Item 15a(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements and schedule referred to above present fairly, in all material respects, the financial position of MFRI, Inc. and subsidiaries as of January 31, 2006 and 2005, and the results of their operations and their cash flows for the years ended January 31, 2006 and 2005, in conformity with accounting principles generally accepted in the United States of America.

/s/ GRANT THORNTON LLP

Chicago, Illinois
May 10, 2006

 

 

25

 



 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

MFRI, Inc. and subsidiaries

Chicago, Illinois

 

We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows for the year ended January 31, 2004 of MFRI, Inc. and subsidiaries. Our audit also included the financial statement schedule listed in the Index at Item 15a(2) for the year ended January 31, 2004. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.

 

We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the results of MFRI, Inc. and subsidiaries’ operations and their cash flows for the year ended January 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule for the year ended January 31, 2004, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

 

DELOITTE & TOUCHE LLP

 

Chicago, Illinois

May 14, 2004

 

26

 



 

 

MFRI, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except per share information)

 

2005

2004

2003

 

 

Fiscal Year Ended January 31,

 

 

2006

2005

2004

 

Net sales

$

154,587

 

 

$

145,096

 

 

$

120,889

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

121,901

 

 

 

113,968

 

 

 

96,291

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

32,686

 

 

 

31,128

 

 

 

24,598

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Selling expense

 

12,383

 

 

 

10,477

 

 

 

10,141

 

General and administrative expense

 

17,624

 

 

 

15,474

 

 

 

15,178

 

Total operating expenses

 

30,007

 

 

 

25,951

 

 

 

25,319

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

2,679

 

 

 

5,177

 

 

 

(721

)

Income from Joint Venture

 

196

 

 

 

225

 

 

 

492

 

Interest expense, net

 

1,839

 

 

 

1,658

 

 

 

2,003

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

1,036

 

 

 

3,744

 

 

 

(2,232

)

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

505

 

 

 

931

 

 

 

(1,135

)

 

 

 

 

 

 

 

 

 

 

 

 

Net Income (Loss)

$

531

 

 

$

2,813

 

 

$

(1,097

)

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding – basic

 

5,254

 

 

 

4,986

 

 

 

4,922

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

$

0.10

 

 

$

0.56

 

 

$

(0.22

)

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding – diluted

 

5,585

 

 

 

5,223

 

 

 

4,922

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

$

0.10

 

 

$

0.54

 

 

$

(0.22

)

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

27

 



 

 

MFRI, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands except per share information)

 

 

As of January 31,

ASSETS

 

2006

 

2005

Current Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

$

1,114

 

 

$

723

 

Restricted cash

 

 

 

 

 

369

 

 

 

973

 

Trade accounts receivable, less allowance for doubtful accounts of $504 in 2005 and $482 in 2004

 

 

 

 

 

20,377

 

 

 

22,715

 

Accounts receivable – related company

 

 

 

 

 

1,149

 

 

 

887

 

Income taxes receivable

 

 

 

 

 

145

 

 

 

48

 

Costs and estimated earnings in excess of billings on uncompleted
contracts

 

 

 

 

 

2,471

 

 

 

2,472

 

Inventories, net

 

 

 

 

 

23,711

 

 

 

21,050

 

Deferred income taxes

 

 

 

 

 

2,131

 

 

 

1,842

 

Prepaid expenses and other current assets

 

 

 

 

 

1,311

 

 

 

915

 

Total current assets

 

 

 

 

 

52,778

 

 

 

51,625

 

 

 

 

 

 

 

 

 

 

 

 

 

Property, Plant and Equipment, Net

 

 

 

 

 

28,320

 

 

 

25,800

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Assets:

 

 

 

 

 

 

 

 

 

 

 

Patents, net

 

 

 

 

 

453

 

 

 

582

 

Goodwill

 

 

 

 

 

2,509

 

 

 

2,616

 

Other assets

 

 

 

 

 

4,575

 

 

 

4,893

 

Total other assets

 

 

 

 

 

7,537

 

 

 

8,091

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

 

 

 

$

88,635

 

 

$

85,516

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Trade accounts payable

 

 

 

 

$

10,929

 

 

$

13,072

 

Accrued compensation and payroll taxes

 

 

 

 

 

2,478

 

 

 

2,665

 

Commissions payable

 

 

 

 

 

5,018

 

 

 

4,192

 

Other accrued liabilities

 

 

 

 

 

4,114

 

 

 

3,172

 

Billings in excess of costs and estimated earnings on uncompleted contracts

 

 

 

 

 

134

 

 

 

790

 

Income taxes payable

 

 

 

 

 

-

 

 

 

68

 

Current maturities of long-term debt

 

 

 

 

 

1,562

 

 

 

1,334

 

Total current liabilities

 

 

 

 

 

24,235

 

 

 

25,293

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-Term Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Long-term debt, less current maturities

 

 

 

 

 

29,724

 

 

 

26,205

 

Other

 

 

 

 

 

2,866

 

 

 

2,748

 

Total long-term liabilities

 

 

 

 

 

32,590

 

 

 

28,953

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

Common stock, $0.01 par value, authorized 50,000 shares in 2005 and 2004 respectively; 5,276 and 5,226 issued and outstanding in 2005 and 2004, respectively

 

 

 

 

 

53

 

 

 

52

 

Additional paid-in capital

 

 

 

 

 

23,084

 

 

 

22,868

 

Retained earnings

 

 

 

 

 

8,444

 

 

 

7,913

 

Accumulated other comprehensive income

 

 

 

 

 

229

 

 

 

437

 

Total stockholders’ equity

 

 

 

 

 

31,810

 

 

 

31,270

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

 

 

 

$

88,635

 

 

$

85,516

 

See accompanying notes to consolidated financial statements.

 

28

 



 

 

MFRI, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

 

 

 

 

 

 

 

 

 

Additional

Paid-in

Capital

 

Retained

Earnings

 

Accumulated

Other

Comprehensive

Income (Loss)

 

Comprehensive
Income (Loss)

Common Stock

 

 

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 31, 2003

 

 

4,922

 

$

49

 

$

21,397

 

$

6,197

 

$

(1,031)

 

$

(11,375

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss)

 

 

 

 

 

 

 

 

 

 

 

(1,097

)

 

 

 

 

(1,097

)

Minimum pension liability adjustment (net of cumulative tax benefit of $217)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

715

 

 

715

 

Unrealized translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

643

 

 

643

 

Balances at January 31, 2004

 

 

4,922

 

$

49

 

$

21,397

 

$

5,100

 

$

327

 

$

261

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

2,813

 

 

 

 

 

2,813

 

Stock options exercised (including a tax benefit of $542)

 

 

304

 

 

3

 

 

1,471

 

 

 

 

 

 

 

 

 

 

Minimum pension liability adjustment (net of cumulative tax benefit of $320)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(168

)

 

(168

)

Unrealized translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

278

 

 

278

 

Balances at January 31, 2005

 

 

5,226

 

$

52

 

$

22,868

 

$

7,913

 

$

437

 

$

2,923

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

531

 

 

 

 

 

531

 

Stock options exercised (including a tax benefit of $71)

 

 

50

 

 

1

 

 

216

 

 

 

 

 

 

 

 

 

 

Minimum pension liability adjustment (net of cumulative tax benefit of $154)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

271

 

 

271

 

Interest Rate Swap (including a tax benefit of $7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13

 

 

13

 

Unrealized translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(492

)

 

(492

)

Balances at January 31, 2006

 

 

5,276

 

$

53

 

$

23,084

 

$

8,444

 

$

229

 

$

323

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

29

 



 

 

MFRI, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

2005

2004

2003

 

Fiscal Year Ended January 31,

 

2006

2005

2004

Cash Flows from Operating Activities:

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

$

531

 

 

$

2,813

 

 

$

(1,097

)

Adjustments, to reconcile net income (loss) to net cash flows from

 perating activities:

 

 

 

 

 

 

 

 

 

 

 

   Income from Joint Venture

 

(196

)

 

 

(225

)

 

 

(492

)

   Depreciation and amortization

 

3,522

 

 

 

3,779

 

 

 

4,144

 

   Provisions for uncollectible accounts

 

113

 

 

 

(75

)

 

 

147

 

   Deferred income taxes

 

(234

)

 

 

(184

)

 

 

(1,259

)

   Gain on sales of assets

 

(53

)

 

 

(10

)

 

 

(23

)

   Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

   Accounts receivable

 

2,225

 

 

 

(4,287

)

 

 

(694

)

   Income taxes receivable

 

(125

)

 

 

348

 

 

 

632

 

   Inventories

 

(2,662

)

 

 

(2,659

)

 

 

1,594

 

   Prepaid expenses and other current assets

 

(639

)

 

 

(1,594

)

 

 

1,922

 

   Accounts payable

 

(2,415

)

 

 

693

 

 

 

2,519

 

   Compensation and payroll taxes

 

640

 

 

 

(29

)

 

 

442

 

   Other assets and liabilities

 

1,427

 

 

 

1,679

 

 

 

(1,044

)

Net cash flows from operating activities

 

2,134

 

 

 

249

 

 

 

6,791

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

(6,315

)

 

 

(1,755

)

 

 

(4,102

)

Proceeds from sales of property and equipment

 

46

 

 

 

1,804

 

 

 

476

 

Distributions from joint venture

 

270

 

 

 

50

 

 

 

427

 

Net cash flows from investing activities

 

(5,999

)

 

 

99

 

 

 

(3,199

)

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

 

 

 

 

Borrowings under revolving, term and mortgage loans

 

57,005

 

 

 

15,141

 

 

 

27,396

 

Repayments of debt

 

(53,002

)

 

 

(16,271

)

 

 

(30,854

)

Net payments on capitalized lease obligations

 

(17

)

 

 

(43

)

 

 

(141

)

Tax benefit of stock options exercised

 

71

 

 

 

542

 

 

 

-

 

Stock options exercised

 

146

 

 

 

934

 

 

 

-

 

Net cash flows from financing activities

 

4,203

 

 

 

303

 

 

 

(3,599

)

 

 

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

53

 

 

 

(82

)

 

 

(185

)

 

 

 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

391

 

 

 

569

 

 

 

(192

)

Cash and cash equivalents – beginning of year

 

723

 

 

 

154

 

 

 

346

 

Cash and Cash Equivalents –end of year

$

1,114

 

 

$

723

 

 

$

154

 

 

 

 

 

 

 

 

 

 

 

 

 

Supplemental Cash Flow Information:

 

 

 

 

 

 

 

 

 

 

 

Cash paid for:

 

 

 

 

 

 

 

 

 

 

 

Interest, net of capitalized amounts

$

1,753

 

 

$

1,818

 

 

$

1,962

 

Income taxes paid (refunded)

 

719

 

 

 

(207

)

 

 

(400

)

 

See accompanying notes to consolidated financial statements.

 

30

 



 

 

MFRI, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED JANUARY 31, 2006, 2005 AND 2004

 

Note 1 - Basis of Presentation

 

MFRI, Inc. ("MFRI", the “Company”, or the “Registrant”) was incorporated on October 12, 1993. MFRI is engaged in the manufacture and sale of products in three distinct business segments: filtration products, piping systems and industrial process cooling equipment.

 

Fiscal Year: The Company’s fiscal year ends on January 31. Years described as 2005, 2004 and 2003 are the fiscal years ended January 31, 2006, 2005 and 2004, respectively. Balances described as balances as of 2005, 2004 and 2003 are balances as of January 31, 2006, 2005 and 2004, respectively.

 

Nature of Business: The Filtration Products business segment manufactures and sells a wide variety of filter elements for use in industrial air filtration systems and particulate collection systems. Air filtration systems are used in a wide variety of industries to limit particulate emissions, primarily to comply with environmental regulations. The Filtration Products business segment markets air filtration-related products and accessories, and provides maintenance services, consisting primarily of dust collector inspection, filter cleaning and filter replacement. The Piping System business segment engineers, designs, manufactures and sells specialty piping systems and leak detection and location systems. This segment’s specialty piping systems include (i) industrial and secondary containment piping systems for transporting chemicals, waste streams and petroleum liquids, (ii) insulated and jacketed district heating and cooling piping systems for efficient energy distribution to multiple locations from central energy plants, and (iii) oil and gas gathering flow lines and long lines for oil and mineral transportation. The Piping System business segment’s leak detection and location systems are sold as part of many of its piping system products, and on a stand-alone basis, to monitor areas where fluid intrusion may contaminate the environment, endanger personal safety, cause a fire hazard, impair essential services or damage equipment or property. The Industrial Cooling Equipment business segment engineers, designs, manufactures and sells industrial process cooling equipment, including chillers, cooling towers, plant circulating systems, and related accessories for use in industrial process applications. The Company’s products are sold both within the United States and internationally.

 

Note 2 - Significant Accounting Policies

 

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Revenue Recognition: The Company recognizes revenues when all the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the seller’s price to the buyer is fixed or determinable, and (iii) collectibility is reasonably assured. All business segments of the Company except the Piping System business segment recognize revenues when product has been shipped (for FOB shipping point orders) or delivered (for FOB destination sales) or when services have been rendered.

 

Percentage of Completion Revenue Recognition: The Piping System business segment recognizes revenues on contracts under the "percentage of completion" method. The percentage of completion is determined by the relationship of costs incurred to the total estimated costs of the contract. Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements may result in revisions to costs and income. Such revisions are recognized in the period in which they are determined. Claims for additional compensation due the Company are recognized in contract revenues when realization is probable and the amount can be reliably estimated.

 

 

31

 



 

 

Shipping and Handling: Shipping and handling costs are included in cost of goods sold, and the amounts invoiced to customers relating to shipping and handling are included in net sales.

 

Operating Cycle: The length of the Piping System segment’s contracts vary, but are typically less than one year. The Company includes in current assets and liabilities amounts realizable and payable in the normal course of contract completion unless completion of such contracts extends significantly beyond one year. The Company’s other businesses do not have an operating cycle beyond one year.

 

Principles of Consolidation: The consolidated financial statements include the accounts of MFRI; its principal wholly- owned subsidiaries, Midwesco Filter, Perma-Pipe and Thermal Care, Inc. (“Thermal Care”); and the majority-owned and controlled domestic and foreign subsidiaries of MFRI, Midwesco Filter, Perma-Pipe and Thermal Care (collectively referred to as the “Company”). All significant intercompany balances and transactions have been eliminated.

 

Translation of Foreign Currency: Assets and liabilities of consolidated foreign subsidiaries are translated into U.S. dollars at exchange rates in effect at year-end. Revenues and expenses are translated at average exchange rates prevailing during the year. Gains or losses on foreign currency transactions and the related tax effects are reflected in net income. The resulting translation adjustments are included in stockholders’ equity as part of accumulated comprehensive income.

 

Contingencies: The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, including those involving environmental, tax, product liability and general liability claims. The Company accrues for such liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, the Company’s estimates of the outcomes of these matters, its experience in contesting, litigating and settling other similar matters.

 

The Company does not currently anticipate the amount of any ultimate liability with respect to these matters will materially affect the Company’s financial position, liquidity or future operations.

 

Cash Equivalents: All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.

 

Restricted Cash: The Loan Agreement provides that all payments by the Company’s customers are deposited in a bank account from which all funds may only be used to pay the debt under the Loan Agreement.

 

Accounts Receivable Collection: The majority of the Company’s accounts receivable are mainly due from geographically dispersed contractors and manufacturing companies. Credit is extended based on an evaluation of a customer’s financial condition, including the availability of credit insurance, and, generally, collateral is not required. Accounts receivable are due within various time periods specified in the terms applicable to the specific customer and are stated at amounts due from customers net of an allowance for claims and doubtful accounts.

 

Concentration of Credit Risk: The Company has a broad customer base doing business in all regions of the United States as well as other areas in the world. The Company maintained foreign credit insurance covering selected foreign sales not secured by letters of credit or guarantees from parent companies in the United States. This expense is included in general and administrative expense in the Consolidated Statements of Operations.

 

32

 



 

 

Inventories: Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method for substantially all inventories. Inventories consist of the following:

 

(In thousands)

 

2005

 

2004

Raw materials

 

$

17,695

 

 

$

17,943

 

Work in process

 

 

3,045

 

 

 

2,211

 

Finished goods

 

 

4,254

 

 

 

1,854

 

Subtotal inventories

 

 

24,994

 

 

 

22,008

 

Less allowances

 

 

1,283

 

 

 

958

 

Inventories, net

 

$

23,711

 

 

$

21,050

 

 

 

 

 

 

 

 

 

 

 

Long-Lived Assets: Property, plant and equipment are stated at cost. Interest is capitalized in connection with the construction of facilities and amortized over the asset’s estimated useful life. No interest was capitalized during 2005 and 2004. Long-lived assets are reviewed for possible impairment whenever events indicate that the carrying amount of such assets may not be recoverable. If such a review indicates impairment, the carrying amount of such assets is reduced to an estimated fair value.

 

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from 3 to 30 years. Amortization of assets under capital leases is included in depreciation and amortization.

 

The Company’s investment in property, plant and equipment as of January 31 is summarized below:

 

(In thousands)

 

2006

 

2005

Land, buildings and improvements

 

$

20,710

 

 

$

19,859

 

Machinery and equipment

 

 

25,521

 

 

 

21,996

 

Furniture, office equipment and computer software and systems

 

 

9,399

 

 

 

8,930

 

Transportation equipment

 

 

167

 

 

 

155

 

 

 

 

55,797

 

 

 

50,940

 

Less accumulated depreciation and amortization

 

 

27,477

 

 

 

25,140

 

Property, plant and equipment, net

 

$

28,320

 

 

$

25,800

 

 

Goodwill and other intangible assets with indefinite lives: The Company reviews the carrying value of goodwill in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, which requires that goodwill and other intangible assets with indefinite lives be analyzed for impairment on an annual basis or when there is reason to suspect that their values have been impaired. For the 2005 and 2004 evaluations the fair value was determined using discounted cash flows and other market-related valuation models. Certain estimates and judgments are required in the application of the fair value models. Based upon the Company’s evaluations for 2005 and 2004, no impairment of goodwill was required. Goodwill was $2,509,000 and $2,616,000 at January 31, 2006 and 2005, respectively. As of January 31, 2006 and 2005, $1,100,000 of goodwill was allocated to the Industrial Process Cooling Equipment segment. As of January 31, 2006 and 2005 $1,409,000 and $1,516,000, respectively, was allocated to the Filtration Products segment. The change in goodwill of the Filtration Products segment was due to foreign currency translation.

 

The changes in the carrying amount of goodwill for the year ended January 31, 2006, are as follows:

 

(In thousands)

 

 

 

 

 

 

 

 

Balance as of February 1, 2005

 

 

 

 

 

$

2,616

 

Foreign translation effect

 

 

 

 

 

 

(107

)

Balance as of January 31, 2006

 

 

 

 

 

$

2,509

 

 

 

 

 

 

 

 

 

 

 

 

33

 



 

 

Other intangible assets with definite lives: Patents are capitalized and amortized on a straight-line basis over a period not to exceed the legal lives of the patents. Patents, net of accumulated amortization, were $453,000 and $582,000 at January 31, 2006 and 2005, respectively. Accumulated amortization was $1,835,000 and $1,636,000 at January 31, 2006 and 2005, respectively. Future amortizations over the next five years ending January 31, will be 2007 - $174,000, 2008 - $30,000, 2009 - $27,000, 2010 - $23,000 and 2011 - $21,000.

 

Investment in Joint Venture: In April 2002, Perma-Pipe and two unrelated companies formed an equally owned joint venture to more efficiently market their complementary thermal insulation products and systems for use in undersea pipeline flow assurance projects worldwide. The Company received partner distributions from its joint venture of $270,000, $50,000 and $427,000 in 2005, 2004 and 2003 respectively. The Company accounts for its joint venture investment using the equity method. The Company's share of joint venture income was $196,000, $225,000 and $492,000 in 2005, 2004 and 2003 respectively.

 

Financial Instruments: The Company uses foreign currency forward contracts to reduce exposure to exchange rate risks primarily associated with transactions in the regular course of the Company’s export and international operations. The Company uses forward contracts which are short-term in duration, generally one year or less. The major currency exposure hedged by the Company has been the Canadian dollar. The contract amount, carrying amount and fair value of these contracts were not significant at January 31, 2006, 2005 and 2004.

 

The Company entered into an interest rate swap agreement to reduce its exposure to market risks from changing interest rates under the revolving credit agreement. Any differences paid or received on the interest rate swap agreements are recognized as adjustments to interest expense over the life of the swap, thereby adjusting the effective interest rate on the underlying obligation.

 

Income Tax Provision: Deferred income taxes have been provided for temporary differences arising from differences in basis of assets and liabilities for tax and financial reporting purposes. Deferred income taxes on temporary differences have been recorded at the current tax rate. The Company assessed its deferred tax assets for realizability at each reporting period.

 

Net Income (Loss) Per Common Share: Earnings (loss) per share are computed by dividing net income by the weighted average number of common shares outstanding (basic) plus all potentially dilutive common shares outstanding during the year (diluted).

 

The basic weighted average shares reconcile to diluted weighted average shares as follows:

 

(In thousands)

2005

 

2004

 

2003

Basic weighted average number of common shares outstanding

 

5,254

 

 

 

4,986

 

 

 

4,922

 

 

 

 

 

 

 

 

 

 

 

 

 

Dilutive effect of stock options

 

331

 

 

 

237

 

 

 

-

 

Weighted average number of common shares outstanding assuming full
   dilution

 

5,585

 

 

 

5,223

 

 

 

4,922

 

 

(In thousands)

2005

 

2004

 

2003

Weighted average number of stock options not included in the
   computation of diluted earnings per share of common stock because
   the option exercise prices exceeded the average market prices of the
   common shares

 

176

 

 

 

340

 

 

 

775

 

 

 

 

 

 

 

 

 

 

 

 

 

Expired options during the year

 

6

 

 

 

30

 

 

 

9

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options with an exercise price below the average stock price

 

558

 

 

 

611

 

 

 

225

 

 

In 2005, a total of 50,034 stock options were exercised. There were 5,200 stock options exercised from February 1, 2006 through May 10, 2006.

 

34

 



 

 

Stock Options: The Company’s stock option plans are accounted for in accordance with Accounting Principles Board Opinion No.25, Accounting for Stock Issued to Employees, using the intrinsic value method. Accordingly, no compensation cost has been recognized. The Company’s net income (loss) and income (loss) per share would have been reduced to the amounts shown below if compensation cost related to stock options had been determined based on fair value at the grant dates in accordance with Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation (“SFAS 148”). The pro forma net income effect of applying SFAS 148 was as follows:

 

(In thousands except per share information)

2005

 

2004

 

2003

Net income (loss) – as reported

$

531

 

 

$

2,813

 

 

$

(1,097

)

Compensation cost under fair-market value-based accounting method,
   net of tax

$

(343

)

 

$

(221

)

 

$

(134

)

Net income (loss) – pro forma

$

188

 

 

$

2,592

 

 

$

(1,231

)

Net income (loss) per common share – basic and diluted, as reported

$

0.10

 

 

$

0.56

 

 

$

(0.22

)

Net income (loss) per common share – basic and diluted, pro forma

$

0.04

 

 

$

0.52

 

 

$

(0.25

)

Reported diluted EPS higher than pro forma diluted EPS

$

0.06

 

 

$

0.04

 

 

$

0.02

 

 

The compensation cost includes costs related to “out-of-the-money” stock options that had accelerated vesting on December 5, 2005.

 

The weighted average fair value of options granted during 2005 (net of options surrendered), 2004 and 2003 are estimated at $4.36, $1.85 and $1.14, per share, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

2005

 

2004

 

2003

Expected volatility

 

51.95

%

 

 

49.18

%

 

 

50.01

%

Risk-free interest rate

 

3.86

%

 

 

4.31

%

 

 

2.93

%

Dividend yield

 

0.0

%

 

 

0.0

%

 

 

0.0

%

Expected life in years

 

7.0

 

 

 

7.0

 

 

 

7.0

 

 

Fair Value of Financial Instruments: The carrying values of cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair value due to their short-term nature. The carrying values of the Company’s unsecured senior notes at January 31, 2006 and 2005 are also reasonable estimates of their fair value, as evidenced by the renegotiation of interest rates and terms that occurred recently as described in Note 6.

 

Accumulated Other Comprehensive Income (Loss): Accumulated other comprehensive income (loss) consists of the following:

 

(In thousands)

 

 

Accumulated

Translation

Adjustment

 

 

Minimum

Pension

Liability

Adjustment

 

 

 

Interest

Rate

Swap

 

 

 

 

 

Total

 

Balances as of January 31, 2003

$

39

 

$

(1,070

)

$

-

 

$

(1,031

)

Unrealized translation adjustment

 

643

 

 

-

 

 

 

 

 

643

 

Minimum pension liability adjustment (net of cumulative tax benefit of $217)

 

 

-

 

 

 

715

 

 

 

 

 

 

715

 

Balances as of February 1, 2004

 

682

 

 

(355

)

 

-

 

 

327

 

Unrealized translation adjustment

 

278

 

 

-

 

 

 

 

 

278

 

Minimum pension liability adjustment (net of cumulative tax benefit of $320)

 

 

-

 

 

 

(168

 

)

 

 

 

 

 

(168

 

)

Balances as of January 31, 2005

 

960

 

 

(523

)

 

-

 

 

437

 

Unrealized translation adjustment

 

(492

)

 

 

 

 

 

 

 

(492

)

Interest Rate Swap (including a tax benefit of $7)

 

 

 

 

 

 

 

13

 

 

13

 

Minimum pension liability adjustment (net of cumulative tax benefit of $154)

 

 

 

 

271

 

 

 

 

 

 

 

271

 

Balances as of January 31, 2006

$

468

 

$

(252

)

$

13

 

$

229

 

 

 

35

 



 

 

 

 Accounting Pronouncements:

In April 2005, the SEC announced the adoption of a new rule that amends the compliance dates for SFAS No. 123 (revised 2004), Share-Based Payment (Statement No. 123R). SFAS No. 123R, as amended, is applicable for all fiscal years beginning after June 15, 2005. As a result the Company is required to implement SFAS No. 123R at the beginning of its next fiscal year, and accordingly, the Company will begin to reflect the adjustment to earnings for the impact of this accounting pronouncement in the interim reporting period ending April 30, 2006. The Company does not expect the adoption of SFAS 123R to have a material effect on its financial statements.

 

On December 5, 2005, the Board of Directors of the Company approved the acceleration of the vesting requirements for “out-of-the-money” stock options previously granted to employees, including its officers, pursuant to the 2004 Stock Incentive Plan, and “out-of-the-money” stock options previously granted to independent directors pursuant to the 2001 Independent Directors Stock Option Plan. The primary purpose of the acceleration is to eliminate reportable compensation expense the Company would recognize in future periods in its statements of operations upon its adoption of FASB Statement No. 123R (“Share-Based Payments”) in the year beginning February 1, 2006. The Company anticipates that such acceleration of vesting will reduce its pre-tax stock option compensation expense in each of the years 2006 through 2009 by approximately $109,000, or $.02 per share. A Form 8-K was filed on December 9, 2005.

 

FSP FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” with an effective date of December 15, 2005 provides an elective alternative transition method. The Company has one year from December 15, 2005, the initial adoption of SFAS No. 123R to evaluate the available transition alternatives and make its on-time election. The transition method prescribed by SFAS 123R will be followed until the alternative method FSP is elected.

 

In December 2003, the FASB issued Interpretation No. 46R, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” which requires that the assets, liabilities, and the results of activities of a variable interest entity in which a business enterprise has controlling financial interest be included in consolidation with those of the business enterprise. Adoption of FIN No. 46R did not apply to the Company.

 

Note 3 - Related Party Transactions

 

The Company provides certain services and facilities to a company (affiliate) primarily owned by two principal stockholders who are also members of management. The Company also purchases certain services from that company under a lease and management services agreement. The Company received $102,000 and paid $121,000 from the affiliate under such agreements in 2005. The Company received $140,000 and paid $147,000 from the affiliate under such agreements in 2004.

 

Related company accounts receivable of $1,149,000 and $887,000 were included in the receivable balances at January 31, 2006 and 2005, respectively.

 

The lease agreement and the management services agreement were approved by the Company’s Committee of Independent Directors.

 

Note 4 - Retention Receivable

 

Retention is the amount withheld by a customer until a contract is completed. Retentions of $91,544 and $142,800 were included in the balance of trade accounts receivable at January 31, 2006 and 2005, respectively.

 

 

36

 



 

 

Note 5 - Costs and Estimated Earnings on Uncompleted Contracts

 

Costs and estimated earnings on uncompleted contracts are as follows:

 

(In thousands)

 

2005

 

2004

Costs incurred on uncompleted contracts

 

$

11,669

 

 

$

19,186

 

Estimated earnings

 

 

2,694

 

 

 

5,664

 

Earned revenue

 

 

14,363

 

 

 

24,850

 

Less billings to date

 

 

12,026

 

 

 

23,168

 

Total

 

$

2,337

 

 

$

1,682

 

Classified as follows:

 

 

 

 

 

 

 

 

Costs and estimated earnings in excess of billings on
   uncompleted contracts

 

$

2,471

 

 

$

2,472

 

Billings in excess of costs and estimated earnings on
   uncompleted contracts

 

 

(134

)

 

 

(790

)

Total

 

$

2,337

 

 

$

1,682

 

 

Note 6 - Debt

 

Debt consists of the following:

(In thousands)

 

2005

 

2004

Secured senior notes

 

$

-

 

 

$

3,125

 

Revolving bank loan domestic

 

 

13,612

 

 

 

11,370

 

Industrial revenue bonds

 

 

3,150

 

 

 

3,150

 

Mortgage notes

 

 

8,998

 

 

 

9,163

 

Term loans

 

 

4,556

 

 

 

32

 

Short-term credit arrangements

 

 

955

 

 

 

668

 

Capitalized lease obligations (Note 7)

 

 

15

 

 

 

31

 

Total debt

 

 

31,286

 

 

 

27,539

 

Less current maturities

 

 

1,562

 

 

 

1,334

 

Total Long-Term Debt

 

$

29,724

 

 

$

26,205

 

 

The following table summarizes the Company’s scheduled maturities, excluding the revolving lines of credit of $14,567,000 at January 31, 2006:

 

( In thousands)

Total

 

1/31/07

 

1/31/08

 

1/31/09

 

1/31/10

 

1/31/11

 

Thereafter

Mortgages

$

8,998

 

$

579

 

$

598

 

$

1,726

 

$

631

 

$

671

 

$

4,793

IRB Payable

 

3,150

 

 

-

 

 

3,150

 

 

-

 

 

-

 

 

-

 

 

-

Term Loans

 

4,556

 

 

977

 

 

2,908

 

 

121

 

 

128

 

 

136

 

 

286

Capitalized Lease Obligations

 

15

 

 

6

 

 

4

 

 

4

 

 

1

 

 

 

 

 

 

Totals

$

16,719

 

$

1,562

 

$

6,660

 

$

1,851

 

$

760

 

$

807

 

$

5,079

 

Debt

 

At January 31, 2006 and October 31, 2005, the Company was not in compliance with two financial performance covenants under the Loan Agreement (see the paragraphs below that describe the Loan Agreement). The Company has received a waiver and amendment dated May 10, 2006 from the lender. The Company has made all required payments of principal and interest under the Loan Agreement to date.

 

On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution ("Loan Agreement"). Under the terms of the Loan Agreement, which matures on November 30, 2007, the Company can borrow up to $27,000,000, subject to borrowing base and other requirements, under a revolving line of credit. The Loan Agreement covenants restrict debt, liens, and investments, do not permit payment of dividends, and require attainment of certain levels of profitability and cash flows. Interest rates generally are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At January 31, 2006, the prime

 

37

 



 

 rate was 7.5%, and the margins added to the prime rate and the LIBOR rate, which are determined each quarter based on the applicable financial statement ratio, were 0.25 and 2.25 percentage points, respectively. Monthly interest payments were made. The average interest rate for the year ending January 31, 2006 was 6.02%. As of January 31, 2006, the Company had borrowed $13,612,000 and had $1,423,000 available to it under the revolving line of credit. In addition, $3,796,600 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts owed for Industrial Revenue Bond borrowings. The Loan Agreement provides that all payments by the Company's customers are deposited in a bank account from which all funds may only be used to pay the debt under the Loan Agreement. At January 31, 2006, the amount of restricted cash was $369,000. Cash required for operations is provided by draw-downs on the line of credit.

 

At September 12, 2005 the Company entered into an interest rate swap agreement through November 28, 2008 under which the interest rate on $8,000,000 is fixed at 4.72% plus LIBOR Margin. The interest rate swap was effective as a cash flow hedge and no charge to earnings was required during the year ended January 31, 2006. The fair value of the derivative financial instrument was $20,500, and $13,500, net of deferred tax benefits of $7,000, was recorded in other assets and accumulated other comprehensive income associated with the cash flow hedge at January 31, 2006.

 

On March 28, 2005, the Company's Loan Agreement was amended to (1) add a term loan of $4,300,000 ("Term Loan") and (2) amend certain covenants. The total that can be borrowed under the Loan Agreement was unchanged at $27,000,000, subject to borrowing base and other requirements. Interest rates under the Term Loan are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At March 28, 2005 the prime rate was 5.75% and the margins added to the prime rate and the LIBOR rate, which are determined each quarter based on the applicable financial statement ratio, were 1.25 and 3.5 percentage points, respectively. The Company is scheduled to pay $215,000 of principal on the first days of March, June, September, and December in each year, commencing on June 1, 2005 and ending on September 30, 2007, with the remaining unpaid principal payable on November 30, 2007.

 

On May 10, 2006, the Company’s Loan Agreement was amended to (1) increase the revolving credit line to $30,000,000 subject to borrowing base and other requirements, (2) add an equipment loan facility (“Equipment Loan Facility”) of $1,000,000 subject to certain restrictions, and (3) amend certain financial performance covenants. Interest rates under the Equipment Loan Facility are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At May 10, 2006 the prime rate was 8.00% and the margins added to the prime rate and the LIBOR rate, which are determined each quarter based on the applicable financial statement ratio, were .50 and 2.50 percentage points, respectively.

 

The proceeds of the Term Loan were used to repay the outstanding balance due under the Company's Note Purchase Agreements ($3,125,000), which have now been cancelled and to reduce the Company's revolving debt under the Loan Agreement ($1,175,000). Interest rates under the Note Purchase Agreements had been 10% per annum.

 

On December 31, 2005, the Company obtained a loan in the amount of 7,067,000 Danish Kroners (“DKK”) (approximately $1,122,000 at the prevailing exchange rate at the time of the transaction) from a Danish bank to partially finance the building addition. The loan has a term of twenty years. The loan bears interest at 4.28% with quarterly payments of $23,500 for both principal and interest.

 

On December 30, 2005 Perma-Pipe, Inc. borrowed $900,000 under an equipment loan secured by equipment. The loan bears interest at 6.23% with monthly payments of $13,400 for both principal and interest, and has a seven year term.

 

On May 11, 2005, the Company obtained a loan in the amount of 3,241,500 DKK (approximately $536,000 at the prevailing exchange rate at the time of the transaction) from a Danish bank to partially finance the building

 

38

 



 

addition. The loan has a term of twenty years. The loan bears interest at 4.89% with quarterly payments of $10,700 for both principal and interest.

 

On April 8, 2003, the Company obtained a loan from a Danish bank to purchase equipment and office furniture for the new building, in the amount of 700,000 Euro, approximately $754,600 at the exchange rate prevailing at the time of the transaction. The loan has a term of ten years. The loan bears interest at 6.1% with quarterly payments of $9,400 for both principal and interest.

 

On January 29, 2003, the Company obtained a loan from a Danish bank to construct a building, in the amount of 1,050,000 Euro, approximately $1,136,000 at the exchange rate prevailing at the time of the transaction. The loan has a term of twenty years. The loan bears interest at 4.0% with quarterly payments of $19,000 for both principal and interest.

 

On April 26, 2002, Midwesco Filter borrowed $2,025,000 under a mortgage note secured by its manufacturing facility in Winchester, Virginia. Proceeds from the mortgage, net of a prior mortgage loan were used to make principal payments to the lenders under the Prior Term Loans and the bank which was the lender under the Company’s revolving line of credit at that time. The loan bears interest at 7.10% with a monthly payment of $23,616 for both principal and interest, and has a ten year term.

 

On July 31, 2002 Perma-Pipe, Inc. borrowed $1,750,000 under a mortgage note secured by its manufacturing facility in Lebanon, Tennessee. From the proceeds, $1,000,000 was used for a payment of amounts borrowed under the Note Purchase Agreements with the remaining proceeds used to repay amounts borrowed under the Loan Agreement. The loan bears interest at 7.75% with monthly payments of $21,001 for both principal and interest, and has a ten year term.

 

On September 20, 2000, the Company purchased an 8.1-acre parcel of land with a 131,000-square foot building in Niles, Illinois, from two principal stockholders, who are also members of management, for approximately $4,438,000. This amount included the assumption of a $2,500,000 mortgage note with a remaining balance of $2,405,000. The loan bears interest at 7.52% with monthly payments of $18,507 for both principal and interest based on an amortization schedule of 25 years with a balloon payment at the end of the ten-year term. At the date of purchase, the remaining term of the loan was 7.25 years.

 

On June 30, 1998, the Company borrowed $1,400,000 under a mortgage note secured by the manufacturing facility in Cicero, Illinois. The loan bears interest at 6.76% with monthly payments of $9,682 for both principal and interest based on an amortization schedule of 25 years with a balloon payment at the end of the ten-year term.

 

On June 1, 1998, the Company obtained a loan in the amount of 4,500,000 DKK (approximately $650,000 at the prevailing exchange rate at the time of the transaction) from a Danish bank to partially finance the acquisition of Boe-Therm A/S (“Boe-Therm”). It is secured by the land and building of Boe-Therm, bears interest at 6.48% and has a term of twenty years. Another loan in the amount of 850,000 DKK (approximately $134,000 at the prevailing exchange rate at the time of the transaction) was obtained on January 1, 1999 to acquire land and a building, bears interest at 6.1% and has a term of twenty years. The interest rates on both the twenty-year loans are guaranteed for the first ten years, after which they will be renegotiated based on prevailing market conditions.

 

On October 18, 1995, Perma-Pipe in Lebanon, Tennessee received $3,150,000 of proceeds of Industrial Revenue Bonds, which mature on September 1, 2007. The bonds are fully secured by bank letters of credit, which the Company expects to renew, reissue, extend or replace prior to each expiration date during the term of the bonds. The bonds bear interest at a variable rate, which approximates 4.5% per annum, including letter of credit and re-marketing fees. The bond proceeds were available for capital expenditures related to manufacturing capacity expansions and efficiency improvements during a three-year period which commenced in the fourth quarter of 1995 and ended during the Company’s fiscal quarter ended October 31, 1998. On November 1, 1999, the Company used $1,100,000 of unspent bond proceeds to redeem bonds outstanding as provided in the indenture.

 

39

 



 

 

The Company also has short-term credit arrangements used by its European subsidiaries. These credit arrangements are generally in the form of overdraft facilities at rates competitive in the countries in which the Company operates. At January 31, 2006, borrowings under these credit arrangements totaled $955,000; an additional $691,000 remained unused.

Note 7 - Lease Information

 

The following is an analysis of property under capitalized leases:

 

(In thousands)

 

2005

 

2004

Machinery and equipment

 

$

164

 

 

$

164

 

Furniture and office equipment

 

 

698

 

 

 

698

 

Transportation equipment

 

 

38

 

 

 

245

 

 

 

 

900

 

 

 

1,107

 

Less accumulated amortization

 

 

890

 

 

 

1,084

 

 

 

$

10

 

 

$

23

 

 

The Piping Systems Business leases manufacturing and warehouse facilities, land, transportation equipment and office space under non-cancelable operating leases, which expire beginning 2007 through 2017. The Filtration Products Business leases approximately 12,000 square feet of office space under an operating lease which began in June 2004 and expires in June 2007. Management expects that these leases will be renewed or replaced by other leases in the normal course of business.

 

At January 31, 2006, future minimum annual rental commitments under non-cancelable lease obligations were as follows:

 

(In thousands)

 

Operating

Leases

 

Capital

Leases

2007

 

$

1,046

 

 

$

6

 

2008

 

 

818

 

 

 

4

 

2009

 

 

516

 

 

 

4

 

2010

 

 

373

 

 

 

1

 

2011

 

 

356

 

 

 

 

 

Thereafter

 

 

264

 

 

 

 

 

Present value of future minimum lease payments (Note 6)

 

$

3,373

 

 

$

15

 

 

Rental expense for operating leases was $1,341,600, $752,300 and $807,000 in 2005, 2004 and 2003, respectively.

 

Note 8 - Income Taxes

 

The following is a summary of domestic and foreign income (loss) before income taxes:

(In thousands)

2005

 

2004

 

2003

Domestic

$

(210

)

 

$

2,172

 

 

$

(2,995

)

Foreign

 

1,246

 

 

 

1,572

 

 

 

763

 

Total

$

1,036

 

 

$

3,744

 

 

$

(2,232

)

 

 

40

 



 

 

Components of income tax expense (benefit) are as follows:

(In thousands)

2005

 

2004

 

2003

Current:

 

 

 

 

 

 

 

 

 

 

 

Federal

$

(109

)

 

$

467

 

 

$

41

 

Foreign

 

566

 

 

 

475

 

 

 

158

 

State and other

 

140

 

 

 

173

 

 

 

78

 

 

 

597

 

 

 

1,115

 

 

 

277

 

Accrued (Deferred)

 

(92

)

 

 

(184

)

 

 

(1,412

)

Totals

$

505

 

 

$

931

 

 

$

(1,135

)

 

The tax benefit related to stock options recorded through equity was $71,000 and $542,000 in 2005 and 2004 which did not affect net income in 2005 and 2004.

 

The difference between the provision (benefit) for income taxes and the amount computed by applying the federal statutory rate is as follows:

 

(In thousands)

2005

 

2004

 

2003

Tax (benefit) at federal statutory rate

$

352

 

 

$

1,273

 

 

$

(759

)

Foreign rate tax differential

 

83

 

 

 

(59

)

 

 

(171

)

State (benefit) taxes, net of federal benefit

 

56

 

 

 

157

 

 

 

(120

)

Research & development credit

 

(68

)

 

 

(401

)

 

 

-

 

Other – net

 

82

 

 

 

(39

)

 

 

(85

)

Totals

$

505

 

 

$

931

 

 

$

(1,135

)

 

Components of the current deferred income tax asset (liability) balances are as follows:

 

(In thousands)

 

2005

 

2004

Accrued commissions and bonuses

 

$

969

 

 

$

788

 

Other accruals not yet deducted

 

 

590

 

 

 

507

 

Inventory valuation allowance

 

 

489

 

 

 

373

 

Allowance for doubtful accounts

 

 

170

 

 

 

140

 

Inventory uniform capitalization

 

 

(20

)

 

 

(15

)

Other

 

 

(22

)

 

 

49

 

Totals

 

$

2,176

 

 

$

1,842

 

 

Components of the long-term deferred income tax asset (liability) balances are as follows:

 

(In thousands)

 

2005

 

2004

Capital loss carry forward from sale of foreign subsidiary

 

$

114

 

 

$

307

 

Depreciation

 

 

(1,124

)

 

 

(1,291

)

Goodwill

 

 

338

 

 

 

424

 

Non-qualified deferred compensation

 

 

642

 

 

 

434

 

Minimum pension liability

 

 

(230

)

 

 

(91

)

Net operating loss

 

 

744

 

 

 

536

 

Research & development credit

 

 

426

 

 

 

358

 

Alternative minimum tax credit

 

 

-

 

 

 

55

 

Foreign deferred liability

 

 

(230

)

 

 

(145

)

Other

 

 

237

 

 

 

524

 

Totals

 

$

917

 

 

$

1,111

 

 

At January 31, 2006 the Company had a net operating loss carryforward of $2,235,000 available to offset future taxable income in the United States and certain foreign jurisdictions, which expires in 2024.

 

 

41

 



 

 

Note 9 - Employee Retirement Plans

 

Pension Plan

 

The Winchester facility has a defined benefit plan covering its hourly rated employees. The benefits are based on fixed amounts multiplied by years of service of retired participants. The Company engages outside actuaries to calculate its obligations and costs. The funding policy is to contribute such amounts as are necessary to provide for benefits attributed to service to date and those expected to be earned in the future. The amounts contributed to the plan are sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974. The Company may contribute additional amounts at its discretion.

 

The market related value of plan assets at January 31, 2006 was $3,419,846. The plans hold no securities of MFRI, Inc. 100% of the assets are held for benefits under the plan. The target asset allocation was 95% to 100% mutual funds. The investment policy is to invest all funds in the Vanguard Balanced Index Fund except for cash needed to pay benefits and investment expenses for the year. At January 31, 2006, 98.5% of plan assets were held in a mutual fund and the remaining 1.5% was in a money market fund. The expected long-term rate-of-return-on-assets is based on historical long-term rates of equity and fixed income investments and the asset mix objective of the fund.

 

 

42

 



 

 

The following provides a reconciliation of benefit obligations, plan assets and funded status of the plan:

 

(In thousands)

 

 

2005

 

2004

Accumulated benefit obligations:

 

 

 

 

 

 

 

 

 

 

 

Vested benefits

 

 

 

 

$

3,456

 

 

$

3,413

 

Accumulated benefits

 

 

 

 

 

3,466

 

 

 

3,422

 

Total accumulated benefit obligations

 

 

 

 

 

6,922

 

 

 

6,835

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in benefit obligation:

 

 

 

 

 

 

 

 

 

 

 

Benefit obligation – beginning of year

 

 

 

 

$

4,647

 

 

$

3,312

 

Service cost

 

 

 

 

 

114

 

 

 

99

 

Interest cost

 

 

 

 

 

248

 

 

 

187

 

Amendments

 

 

 

 

 

-

 

 

 

-

 

Actuarial loss

 

 

 

 

 

(1,319

)

 

 

1,134

 

Benefits paid

 

 

 

 

 

(90

)

 

 

(85

)

Benefit obligation – end of year

 

 

 

 

 

3,600

 

 

 

4,647

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in plan assets:

 

 

 

 

 

 

 

 

 

 

 

Fair value of plan assets – beginning of year

 

 

 

 

$

3,091

 

 

$

2,683

 

Actual return on plan assets

 

 

 

 

 

260

 

 

 

163

 

Company contributions

 

 

 

 

 

159

 

 

 

330

 

Benefits paid

 

 

 

 

 

(90

)

 

 

(85

)

Fair value of plan assets – end of year

 

 

 

 

 

3,420

 

 

 

3,091

 

 

 

 

 

 

 

 

 

 

 

 

 

Funded status

 

 

 

 

$

(179

)

 

$

(1,556

)

Unrecognized prior service cost

 

 

 

 

 

489

 

 

 

571

 

Unrecognized actuarial loss

 

 

 

 

 

539

 

 

 

2,067

 

Prepaid benefit cost recognized in the consolidated balance sheet

 

 

 

 

$

849

 

 

$

1,082

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts recognized in the consolidated balance sheet:

 

 

 

 

 

 

 

 

 

 

 

Prepaid benefit cost

 

 

 

 

$

849

 

 

$

1,082

 

Accrued benefit liability

 

 

 

 

 

(895

)

 

 

(1,413

)

Intangible asset

 

 

 

 

 

489

 

 

 

571

 

Accumulated other comprehensive income

 

 

 

 

 

406

 

 

 

842

 

Net amount recognized

 

 

 

 

$

849

 

 

$

1,082

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average assumptions used to determine net cost and benefit

 

 

 

 

 

 

 

 

 

 

 

Obligations for years ended January 31:

 

 

 

 

 

 

 

 

 

 

 

End of year benefit obligation

 

 

 

 

 

5.620%

 

 

 

5.735%

 

Service cost discount rate

 

 

 

 

 

5.388%

 

 

 

5.388%

 

Expected return on plan assets

 

 

 

 

 

8.000%

 

 

 

8.000%

 

Rate of compensation increase

 

 

 

 

 

N/A

 

 

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

 

 

 

$

114

 

 

$

99

 

Interest cost

 

 

 

 

 

248

 

 

 

187

 

Expected return on plan assets

 

 

 

 

 

(252

)

 

 

(223

)

Amortization of prior service cost

 

 

 

 

82

 

 

 

82

 

Recognized actuarial loss

 

 

 

 

 

201

 

 

 

78

 

Net periodic benefit cost

 

 

 

 

$

393

 

 

$

223

 

 

 

43

 



 

 

Cash Flows:

 

(In thousands)

 

 

 

 

Expected employer contributions for fiscal year ending 1/31/2007

 

$

0

 

Expected employee contributions for fiscal year ending 1/31/2007

 

 

$

0

 

Estimated future benefit payments reflecting expected future service for the fiscal year(s) ending:

 

 

 

 

 

1/31/2007

 

 

$

154

 

1/31/2008

 

 

 

173

 

1/31/2009

 

 

 

190

 

1/31/2010

 

 

 

196

 

1/31/2011

 

 

 

199

 

1/31/2012-1/31/2016

 

 

$

1,300

 

 

 

 

 

 

 

 

401(k) Plan

 

The domestic employees of the Company participate in the MFRI, Inc. Employee Savings and Protection Plan, which is applicable to all employees except certain employees covered by collective bargaining agreement benefits. The plan allows employee pretax payroll contributions of up to 16% of total compensation. The Company matches 50% of each participant's contribution, up to a maximum of 2% of each participant’s salary.

 

Contributions to the 401(k) Plan and its predecessors were $346,400, $329,300 and $347,000 for the years ended January 31, 2006, 2005 and 2004, respectively. The Company estimates that it will contribute $347,000 for the year ending January 31, 2007.

 

Deferred Compensation Plans

 

The Company also has deferred compensation agreements with key employees. Vesting is based on years of service. Life insurance contracts have been purchased which may be used to fund the Company’s obligation under these agreements. The cash surrender value of the life insurance contracts was included in other assets and the deferred compensation liability was included in other long-term liabilities in the consolidated balance sheet. The charges to expense were $225,900, $288,200 and $209,000 in 2005, 2004 and 2003, respectively.

 

Note 10 - Business Segment and Geographic Information

 

Business Segment Information

 

The Company has three reportable segments: the Filtration Products Business, the Piping Systems Business and the Industrial Process Cooling Equipment Business. The Filtration Products Business manufactures and sells a wide variety of filter elements for air filtration and particulate collection systems. The Piping Systems Business engineers, designs, manufactures, and sells specialty piping systems and leak detection and location systems. The Industrial Process Cooling Equipment Business engineers, designs, manufactures and sells chillers, mold temperature controllers, cooling towers, plant circulating systems and coolers for industrial process applications.

 

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. (See Note 2.) The Company evaluates performance based on gross profit and income or loss from operations.

 

MFRI’s reportable segments are strategic businesses that offer different products and services. Each is managed separately based on fundamental differences in their operations. Each strategic business was acquired as a unit and management at the time of acquisition was retained.

 

 

44

 



 

 

The following is information relevant to the Company's business segments:

 

(In thousands)

2005

 

2004

 

2003

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

64,413

 

 

$

61,740

 

 

$

54,872

 

Piping Systems

 

54,657

 

 

 

54,053

 

 

 

40,523

 

Industrial Process Cooling Equipment

 

35,517

 

 

 

29,303

 

 

 

25,494

 

Total Net Sales

$

154,587

 

 

$

145,096

 

 

$

120,889

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Profit:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

11,758

 

 

$

12,320

 

 

$

9,782

 

Piping Systems

 

10,862

 

 

 

10,284

 

 

 

7,516

 

Industrial Process Cooling Equipment

 

10,066

 

 

 

8,524

 

 

 

7,300

 

Total Gross Profit

$

32,686

 

 

$

31,128

 

 

$

24,598

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from Operations:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

2,221

 

 

$

3,539

 

 

$

1,145

 

Piping Systems

 

5,060

 

 

 

5,405

 

 

 

2,281

 

Industrial Process Cooling Equipment

 

1,544

 

 

 

1,570

 

 

 

738

 

Corporate

 

(6,146

)

 

 

(5,337

)

 

 

(4,885

)

Total Income (loss) from Operations

$

2,679

 

 

$

5,177

 

 

$

(721

)

 

 

 

 

 

 

 

 

 

 

 

 

Income before Income Taxes:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

2,221

 

 

$

3,539

 

 

$

1,145

 

Piping Systems

 

5,256

 

 

 

5,630

 

 

 

2,773

 

Industrial Process Cooling Equipment

 

1,544

 

 

 

1,570

 

 

 

738

 

Corporate

 

(7,985

)

 

 

(6,995

)

 

 

(6,888

)

Total Income (loss) before Income Taxes

$

1,036

 

 

$

3,744

 

 

$

(2,232

)

 

 

 

 

 

 

 

 

 

 

 

 

Segment Assets:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

36,179

 

 

$

33,511

 

 

$

35,621

 

Piping Systems

 

30,333

 

 

 

29,696

 

 

 

22,852

 

Industrial Process Cooling Equipment

 

12,545

 

 

 

12,101

 

 

 

11,228

 

Corporate

 

9,578

 

 

 

10,208

 

 

 

9,226

 

Total Segment Assets

$

88,635

 

 

$

85,516

 

 

$

78,927

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital Expenditures:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

1,654

 

 

$

623

 

 

$

2,236

 

Piping Systems

 

4,043

 

 

 

762

 

 

 

1,605

 

Industrial Process Cooling Equipment

 

230

 

 

 

139

 

 

 

87

 

Corporate

 

388

 

 

 

226

 

 

 

174

 

Total Capital Expenditures

$

6,315

 

 

$

1,750

 

 

$

4,102

 

 

Depreciation and Amortization:

 

 

 

 

 

 

 

 

 

 

 

Filtration Products

$

1,194

 

 

$

1,214

 

 

$

1,262

 

Piping Systems

 

1,416

 

 

 

1,385

 

 

 

1,577

 

Industrial Process Cooling Equipment

 

357

 

 

 

357

 

 

 

385

 

Corporate

 

555

 

 

 

823

 

 

 

920

 

Total Depreciation and Amortization

$

3,522

 

 

$

3,779

 

 

$

4,144

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

45

 



 

 

Geographic Information

 

Net sales are attributed to a geographic area based on the destination of the product shipment. Long-lived assets are based on the physical location of the assets and consist of property, plant and equipment used in the generation of revenues in the geographic area.

(In thousands)

2005

 

2004

 

2003

Net Sales:

 

 

 

 

 

 

 

 

 

 

 

United States

$

129,556

 

 

$

117,511

 

 

$

100,017

 

Europe

 

9,830

 

 

 

12,994

 

 

 

10,219

 

Asia

 

8,860

 

 

 

8,200

 

 

 

3,588

 

Canada

 

2,471

 

 

 

3,415

 

 

 

3,711

 

Mexico, South America, Central America and the Caribbean

 

3,719

 

 

 

2,686

 

 

 

3,201

 

Other

 

151

 

 

 

290

 

 

 

153

 

$

154,587

 

 

$

145,096

 

 

$

120,889

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-Lived Assets:

 

 

 

 

 

 

 

 

 

 

 

United States

$

20,340

 

 

$

21,882

 

 

$

25,054

 

Europe

 

4,535

 

 

 

3,918

 

 

 

3,774

 

United Arab Emirates

 

3,445

 

 

 

-

 

 

 

-

 

Total Long-Lived Assets

$

28,320

 

 

$

25,800

 

 

$

28,828

 

 

Note 11 - Supplemental Cash Flow Information

 

A summary of annual supplemental cash flow information follows:

 

(In thousands)

2005

 

2004

 

2003

Cash Paid For:

 

 

 

 

 

 

 

 

 

 

 

Income taxes, net of (refunds) received

$

719

 

 

$

(207

)

 

$

(400

)

Interest paid, net of amounts capitalized

$

1,753

 

 

$

1,818

 

 

$

1,962

 

 

 

 

 

 

 

 

 

 

 

 

 

Noncash Financing and Investing Activities:

 

 

 

 

 

 

 

 

 

 

 

Fixed assets acquired under capital leases

$

-

 

 

$

-

 

 

$

18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note 12 - Stock Options

 

Under the 2004 Stock Option Plan (“Option Plans”), 250,000 shares of common stock are reserved for issuance to key employees of the Company and its affiliates as well as certain advisors and consultants to the Company. In addition, under the 2004 Option Plan, an additional two percent of shares of the Company’s common stock outstanding have been added to the shares reserved for issuance each February 1, beginning February 1, 2006. Option exercise prices will be no less than fair market value for the common stock on the date of grant. The options granted under the Option Plan may be either non-qualified options or incentive options. Such options vest ratably over four years and are exercisable for up to ten years from the date of grant.

 

Pursuant to the 2001 Independent Directors’ Stock Option Plan (the “Directors’ Plan”), an option to purchase 10,000 shares of common stock is granted automatically to each director who is not an employee of the Company (an “Independent Director”) on the date the individual is first elected as an Independent Director, an option to purchase 1,000 shares was granted to each Independent Director acting on December 31, 2001, and options to purchase 1,000 shares are granted to each Independent Director upon each date such Independent Director is re-elected as an Independent Director, commencing with the Company’s annual meeting for the year 2002.

 

 

46

 



 

 

In connection with the purchase agreement relating to the acquisition of TDC Filter Manufacturing, Inc., (acquired in December 1997 as part of the Filtration Products business), the Company issued stock options to purchase 75,000 shares of common stock at $9.60. These options may be exercised through November 2008.

 

The following summarizes the changes in options under the plans:

 

 

 

2005

 

2004

 

2003

 

 

Shares

 

Weighted

Average

Exercise Price

 

Shares

 

Weighted

Average

Exercise Price

 

Shares

 

Weighted

Average

Exercise Price

Outstanding at beginning of year

 

 

688,380

 

 

$

3.62

 

 

1,017,950

 

 

$

3.44

 

 

946,400

 

$

3.57

Granted

 

 

101,600

 

 

 

7.61

 

 

4,000

 

 

 

3.31

 

 

103,250

 

 

2.16

Exercised

 

 

(50,034

)

 

 

2.90

 

 

(303,757

)

 

 

3.08

 

 

-

 

 

-

Cancelled

 

 

(6,350

)

 

 

3.49

 

 

(29,813

)

 

 

2.91

 

 

(31,700

)

 

3.41

Outstanding at end of year

 

 

733,596

 

 

$

4.22

 

 

688,380

 

 

$

3.62

 

 

1,017,950

 

$

3.44

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at year-end

 

 

655,496

 

 

 

 

 

 

385,025

 

 

 

 

 

 

486,374

 

 

 

 

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of

Exercise

Prices

 

Number

Outstanding at

January 31, 2006

 

Weighted Average Remaining

Contractual Life

 

Weighted

Average

Exercise Price

 

Number

Outstanding at

January 31, 2006

 

Weighted

Average

Exercise Price

$2.00-$2.99

 

 

154,933

 

 

6.9

 

$

2.16

 

 

79,833

 

$

2.16

$3.00-$3.99

 

 

390,163

 

 

5.9

 

 

3.12

 

 

387,163

 

 

3.12

$4.00-$4.99

 

 

11,200

 

 

3.9

 

 

4.14

 

 

11,200

 

 

4.14

$5.00-$5.99

 

 

1,500

 

 

0.9

 

 

6.92

 

 

1,500

 

 

6.92

$6.00-$6.99

 

 

100,300

 

 

9.4

 

 

7.61

 

 

100,300

 

 

7.61

$8.00-$8.99

 

 

500

 

 

2.2

 

 

8.10

 

 

500

 

 

8.10

$9.00-$9.99

 

 

75,000

 

 

1.8

 

 

9.60

 

 

75,000

 

 

9.60

 

 

 

733,596

 

 

6.2

 

$

4.22

 

 

655,496

 

$

4.46

 

The Company’s stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, using the intrinsic value method and, accordingly, no compensation cost has been recognized. The Company’s net income (loss) and income (loss) per share would have been reduced to the amounts shown below if compensation cost related to stock options had been determined based on fair value at the grant dates in accordance with Statement of Financial Accounting

Standards No. 148, Accounting for Stock-Based Compensation (“SFAS 148”). The pro forma net income effect of applying SFAS 148 was as follows:

 

(In thousands except per share information)

2005

 

2004

 

2003

Net income (loss) – as reported

$

531

 

 

$

2,813

 

 

$

(1,097

)

Compensation cost under fair-market value-based accounting method,
   net of tax

$

(343

)

 

$

(221

)

 

$

(134

)

Net income (loss) – pro forma

$

188

 

 

$

2,592

 

 

$

(1,231

)

Net income (loss) per common share – basic and diluted, as reported

$

0.10

 

 

$

0.56

 

 

$

(0.22

)

Net income (loss) per common share – basic and diluted, pro forma

$

0.04

 

 

$

0.52

 

 

$

(0.25

)

Reported diluted EPS higher than pro forma diluted EPS

$

0.06

 

 

$

0.04

 

 

$

0.02

 

 

 

47

 



 

 

The weighted average fair value of options granted during 2005 (net of options surrendered), 2004 and 2003 are estimated at $4.36, $1.85 and $1.14, per share, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

2005

 

2004

 

2003

Expected volatility

 

51.95

%

 

 

49.18

%

 

 

50.01

%

Risk-free interest rate

 

3.86

%

 

 

4.31

%

 

 

2.93

%

Dividend yield

 

0.0

%

 

 

0.0

%

 

 

0.0

%

Expected life in years

 

7.0

 

 

 

7.0

 

 

 

7.0

 

 

Note 13 - Stock Rights

 

On September 15, 1999, the Company’s Board of Directors declared a dividend of one common stock purchase right (a “Right”) for each share of MFRI’s common stock outstanding at the close of business on September 22, 1999. The stock issued after September 22, 1999 and before the redemption or expiration of the Rights is also entitled to one Right for each such additional share. Each Right entitles the registered holders, under certain circumstances, to purchase from the Company one share of MFRI’s common stock at $25.00, subject to adjustment. At no time will the Rights have any voting power.

 

The Rights may not be exercised until 10 days after a person or group acquires 15% or more of the Company’s common stock, or announces a tender offer that, if consummated, would result in 15% or more ownership of the Company’s common stock. Separate Rights certificates will not be issued and the Rights will not be traded separately from the stock until then.

 

Should an acquirer become the beneficial owner of 15% or more of the Company’s common stock, Rights holders other than the acquirer would have the right to buy common stock in MFRI, or in the surviving enterprise if MFRI is acquired, having a value of two times the exercise price then in effect. Also, MFRI’s Board of Directors may exchange the Rights (other than those of the acquirer which will have become void), in whole or in part, at an exchange ratio of one share of MFRI common stock (and/or other securities, cash or other assets having equal value) per Right subject to adjustment. The Rights described in this paragraph and the preceding paragraph shall not apply to an acquisition, merger or consolidation approved by the Company’s Board of Directors.

 

The Rights will expire on September 15, 2009, unless exchanged or redeemed prior to that date. The redemption price is $0.01 per Right. MFRI’s Board of Directors may redeem the Rights by a majority vote at any time prior to the 20th day following public announcement that a person or group has acquired 15% of MFRI’s common stock. Under certain circumstances, the decision to redeem requires the concurrence of a majority of the independent directors.

 

 

48

 



 

 

Note 14 - Quarterly Financial Data (Unaudited)

 

The following is a summary of the unaudited quarterly results of operations for the years 2005 and 2004:

 

 

2005

(In thousands except per share information)

First

Quarter

 

Second

Quarter

 

Third

Quarter

 

Fourth

Quarter

Net Sales

$

36,202

 

 

$

40,691

 

 

$

39,384

 

 

$

38,310

 

Gross Profit

 

7,867

 

 

 

9,074

 

 

 

9,163

 

 

 

6,582

 

Net income (loss)

 

218

 

 

 

619

 

 

 

788

 

 

 

(1,094

)

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding – basic

 

5,234

 

 

 

5,252

 

 

 

5,262

 

 

 

5,267

 

Outstanding – diluted

 

5,623

 

 

 

5,606

 

 

 

5,596

 

 

 

5,541

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) – basic

$

0.04

 

 

 

0.12

 

 

 

0.15

 

 

$

(0.21

)

Net income (loss) - diluted

$

0.04

 

 

 

0.11

 

 

 

0.14

 

 

$

(0.19

)

 

 

 

2004

(In thousands except per share information)

First

Quarter

 

Second

Quarter

 

Third

Quarter

 

Fourth

Quarter

Net Sales

$

32,128

 

 

$

38,068

 

 

$

39,708

 

 

$

35,192

 

Gross Profit

 

5,906

 

 

 

8,952

 

 

 

9,164

 

 

 

7,106

 

Net income (loss)

 

(329

)

 

 

1,369

 

 

 

1,614

 

 

 

160

 

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding – basic

 

4,922

 

 

 

4,922

 

 

 

4,961

 

 

 

5,138

 

Outstanding – diluted

 

4,922

 

 

 

4,997

 

 

 

5,304

 

 

 

5,527

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) – basic

$

(0.07

)

 

$

0.27

 

 

$

0.33

 

 

$

0.03

 

Net income (loss) - diluted

$

(0.07

)

 

$

0.27

 

 

$

0.31

 

 

$

0.03

 

 

Note 15 - Product Warranties

 

The Company issues a standard warranty with the sale of its products and sells extended warranty contracts to customers. The Company’s recognition of warranty liability is based, generally, on analyses of warranty claims experiences in the operating units in the preceding years. Changes in the warranty liability in 2005 and 2004 are summarized below:

 

 (In thousands)

2005

 

2004

 

2003

Aggregate product warranty liability at beginning of year

$

738

 

 

 

630

 

 

$

553

 

Aggregate accruals related to product warranties

 

907

 

 

 

451

 

 

 

535

 

Aggregate reductions for payments

 

(802

)

 

 

(387

)

 

 

(567

)

Aggregate changes for pre-existing warranties

 

(16

)

 

 

44

 

 

 

109

Aggregate product warranty liability at end of year

$

827

 

 

$

738

 

 

$

630

 

 

 

49

 



 

 

Schedule II

MFRI, INC. AND SUBSIDIARIES

 

VALUATION AND QUALIFYING ACCOUNTS

For the Years Ended January 31, 2006, 2005 and 2004

 

In Thousands

 

Description

 

Balance at Beginning

of Period

 

Charged to Costs and Expenses

 

Deductions from Reserves (1)

 

Recoveries from previous accounts charged off (2)

 

 

Balance at End

of Period

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended January 31, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for possible losses in collection of trade receivables

 

$

482

 

$

91

 

$

142

 

$

73

 

$

504

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended January 31, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for possible losses in collection of trade receivables

 

$

557

 

$

189

 

$

264

 

$

-

 

$

482

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended January 31, 2004:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for possible losses

in collection of trade receivables

 

$

410

 

$

308

 

$

161

 

$

-

 

$

557

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Uncollectible accounts charged off

 

(2)

Recoveries from accounts previously charged off

 

50

 



 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

MFRI, INC.

 

Date:

May 15, 2006

/s/ David Unger

 

 

David Unger

 

 

Chairman of the Board of Directors, and

 

 

Chief Executive Officer

 

 

(Principal Executive Officer)

 

 

 

 

 

 

Date:

May 15, 2006

/s/ Michael D. Bennett

 

 

Michael D. Bennett

 

 

Vice President, Secretary and Treasurer

 

 

(Principal Financial and Accounting Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.

 

DAVID UNGER*

 

Director, Chairman of the Board of Directors, and Chief Executive Officer (Principal Executive Officer)

)

)

)

 

 

 

 

)

 

HENRY M. MAUTNER*

 

Director

)

 

 

 

 

)

 

BRADLEY E. MAUTNER*

 

Director and President

)

 

 

 

 

)

 

MICHAEL D. BENNETT*

 

Vice President, Secretary and Treasurer (Principal Financial and Accounting Officer)

)

)

 

 

 

 

)

 

ARNOLD F. BROOKSTONE*

 

Director

)

 

 

 

 

)

 

EUGENE MILLER*

 

Director

)

 

 

 

 

)

 

STEPHEN B. SCHWARTZ*

 

Director

)

 

 

 

 

)

 

DENNIS KESSLER*

 

Director

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*By:

/s/ David Unger

 

Individually and as Attorney in Fact

 

 

 

David Unger

 

 

 

 

                

 

51

 



 

 

EXHIBIT INDEX

 

Exhibit No.

 

Description

3(i)

 

Certificate of Incorporation of MFRI, Inc. [Incorporated by reference to Exhibit 3.3 to Registration Statement No. 33-70298]

 

3(ii)

 

By-Laws of MFRI, Inc. [Incorporated by reference to Exhibit 3.4 to Registration Statement No. 33-70298]

 

4

 

Specimen Common Stock Certificate [Incorporated by reference to Exhibit 4 to Registration Statement No. 33-70794]

 

10(a)

 

1993 Stock Option Plan [Incorporated by reference to Exhibit 10.4 of Registration Statement No. 33-70794]

 

10(b)

 

1994 Stock Option Plan [Incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1994 (SEC File No. 0-18370)]

 

10(c)

 

2001 Independent Directors Stock Option Plan, as amended [Incorporated by reference to Exhibit 10(d)(5) to the Company’s Schedule TO filed on May 25, 2001 (SEC File No. 0-18370)]

 

10(d)*

 

Form of Directors Indemnification Agreement

 

10(e)

 

MFRI 2004 Stock Incentive Plan [Incorporated by reference to Exhibit 10(e) to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2005 (SEC File No. 0-18370)]

 

10(f)

 

Loan and Security Agreement between the Company and Fleet Capital Corporation dated July 11, 2002 and the amendments thereto dated October 3, 2002, December 12, 2002, April 30, 2003, October 31, 2003, July 1, 2004 and March 28, 2005. [Incorporated by reference to Exhibit 10(f) to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2005 (SEC File No. 0-18370)]

 

10(g)

 

Seventh Amendment to Loan and Security Agreement between the Company and Bank of America dated May 10, 2006

 

14

 

Code of Conduct [Incorporated by reference to Exhibit 14 of the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004 (SEC File No. 0-18370)]

 

21*

 

Subsidiaries of MFRI, Inc.

 

23*

23.1*

 

Consent of Independent Registered Public Accounting Firm – Grant Thornton LLP

Consent of Independent Registered Public Accounting Firm – Deloitte & Touche LLP

 

24*

 

Power of Attorney executed by directors and officers of the Company

 

31*

 

Rule 13a – 14(a)/15d – 14(a) Certifications

(1)  Chief Executive Officer certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002

(2)  Chief Financial Officer certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002

 

32*

 

Section 1350 Certifications

(1)  Chief Executive Officer certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

(2)  Chief Financial Officer certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

 

* Filed herewith

 

52