Perma-Pipe International Holdings, Inc. - Annual Report: 2008 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FORM 10-K CONTENTS

JANUARY 31, 2008

PART I

Forward Looking Statements

Statements in this Form 10-K that are not historical facts, so-called "forward-looking statements," are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including those detailed in MFRI’s filings with the Securities and Exchange Commission. See "Risk Factors" in Item 1A.

Company Profile

MFRI, Inc. collectively with its subsidiaries ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three distinct business segments: piping systems, filtration products and industrial process cooling equipment.

The Piping System business 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’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 Filtration Products business 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 markets air filtration-related products and accessories, and provides maintenance services, consisting primarily of dust collector inspection, filter cleaning and filter replacement.

The Industrial Process Cooling Equipment business 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.

During the fourth quarter 2006, the Company created a new subsidiary which engages in the installation of heating, ventilation and air conditioning (“HVAC”) systems. The activity for the HVAC systems is included in Corporate and Other activity.

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.

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Operating Units

Available Information

The Company’s internet address is www.mfri.com. The Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge as soon as possible after they are electronically file with, or furnish to, the SEC. The SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The public can also read and copy any document that the Company files, including this Annual Report on Form 10-K, at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Call the SEC at 1-800-SEC-0330 for information on the operation of the Public Reference Room.

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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 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 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 which manufactures its own leak detection and location systems.

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 North America. In the fiscal year ended January 31, 2008, no customer accounted for 10% or more of 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 independent manufacturers' representatives, none of whom sells products that are competitive with the Company's piping systems.

Recent Development. In January 2008, the Company received an order to perform the factory insulating and jacketing services for a 600 KM long 24 inch diameter heavy crude oil pipeline. This project will be the longest underground pre-insulated heat traced pipeline ever constructed The pre-insulation services will be performed at a new facility to be located in Mundra, India on the premises of Jindal Saw Ltd. Jindal, one of India’s largest steel pipe producers, will manufacture and fabricate the pipe for the project. The value of Jindal’s contract is in excess of $200,000,000 USD. The insulation and jacketing work, included in Jindal’s contract, has a total value of approximately $60,000,000, which includes the value of the insulation materials to be procured by Jindal as well as other services to be provided by the Piping Systems business. This project gives Perma-Pipe the opportunity to serve the oil and gas market in India, one of the fastest growing economies in the world.

Patents, Trademarks and Approvals. The Company owns several patents covering the features of its piping and electronic leak detection systems. 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 

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 connected with its Piping and Leak Detection Systems business including the following:  Perma-Pipe®, Chil-Gard®, Double-Quik®, Escon-A®, FluidWatch®, Galva-Gard®, Poly-Therm®, Pal-AT®, Stereo-Heat®, LiquidWatch®, PalCom®, Xtru-therm®, Auto-Therm®, Pex-Gard™, and Ultra-Therm®.  The Company also owns United Kingdom trademarks for Poly-Therm®, Perma-Pipe® and Ric-Wil®, Denmark trademark for Ric-Wil®, France trademark for Perma-Pipe®, Germany trademark for Perma-Pipe® and a Canadian trademark for Ric-Wil®.

Backlog. As of January 31, 2008, the amount of backlog (uncompleted firm orders) for piping and leak detection systems was $65,810,000, substantially all of which is expected to be completed in 2008. As of January 31, 2007, the amount of backlog was $46,385,000.

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, copper and plastics and various chemicals such as polyols, isocyanate, urethane resin, polyethylene and fiberglass, mostly purchased in bulk quantities. The Company believes 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 raw materials that could impact their availability in sufficient quantities to meet the Company’s needs.

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, using 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.; Bredero-Price, a subsidiary of Shaw Industries, Inc.; CRP of UK; Soctherm of Italy; Soccoreal of Argentina; Logstor Rohr of Denmark; EPPI of United Arab Emirates; TraceTek; Raychem,; RLE Technologies; Tracer Technologies; Arizona Instrument Corp.; Veeder Root; and Pneumecator.

The Company believes 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.

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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 particulates. 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. 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 17% 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 the electric power industry tend to be substantial in size, but are usually at lower margins than from other industries. In the fiscal year ended January 31, 2008, 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. 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 Filter 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 were approximately 8.5% of the domestic filtration business’ product sales during the year ended January 31, 2008 as compared to 11.7% in the previous year. The Denmark filtration facility markets pleated filter elements throughout Europe and Asia, primarily to original equipment manufacturers.

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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, 2008, the amount of backlog (uncompleted firm orders) for filtration products was $38,160,800. As of January 31, 2007, the amount of backlog was $36,603,000. Certain customers have placed orders that are deliverable over multiple years. Therefore, approximately $4,764,000 of the backlog as of January 31, 2008 is not expected to be completed in 2008.

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 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 suppliers are frequently longer than the delivery times required by customers. Nevertheless, the Company employs a 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, 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”).

Industrial Process Cooling Equipment Business

Products and Services. The Company engineers, designs, manufactures and sells cooling and temperature control equipment for industrial applications. The Company's 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 products are used to optimize manufacturing productivity by quickly removing heat from manufacturing processes and providing accurate temperature control. 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.

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The principal markets for the Company’s cooling and temperature control 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, machine tool industries, and various other industries.

The Company believes it manufactures the most complete line of chillers available in its primary markets. While portable chillers and temperature controllers are considered to be a commodity product by many customers, the Company believes its units enable it to provide the customer with quality, features, customization and other benefits at a competitive price. The Company believes the ability to offer central chillers used for plant-wide cooling provides it with a unique, total cooling approach concept sales advantage. In the fiscal year ended January 31, 2008, no customer accounted for 10% or more of net sales of the Company's industrial process cooling equipment business.

Marketing. In general, the Company sells its products in the domestic and international thermoplastics and printing markets as well as to other industrial applications 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 over $100 million annually, and that the Company is one of the three largest suppliers of such equipment to the plastics industry. The Company believes 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 it is recognized in the domestic plastics market as a quality equipment manufacturer and 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. Regional managers employed by the Company supported representatives responsible for covering the United States, Canada, Mexico and Puerto Rico.

Sales of the Company's cooling products outside the United States have mainly been in Canada, Latin America and Northern Europe. Some international sales of cooling products have been obtained elsewhere as a result of multinational companies selecting the Company’s cooling products for use at international locations. Temperature control products are sold globally through a network of independent dealers/distributors in major industrial markets. The Company believes it has a significant opportunity for growth due to the high quality of its equipment and the fact that it offers complete cooling system design.

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 industries. The Company believes 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, 2008, the amount of backlog (uncompleted firm orders) for industrial process cooling equipment was $6,315,000, substantially all of which is expected to be completed in 2008. As of January 31, 2007, the amount of backlog was $6,805,000.

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 240 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 its access to sheet metal, subassemblies, fiberglass and hardware components is adequate.

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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 there are about 15 competitors selling cooling equipment in the domestic plastics market. The Company further believes three manufacturers, including the Company, account for approximately 50% of the domestic plastics cooling equipment market. The Company believes its principal competition in this segment is the AEC and Sterling subsidiaries of ACS Group and Advantage Engineering, Inc. Many international customers, with relatively small cooling needs, are able to purchase small refrigeration units (portable chillers), which 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 its reputation for producing quality plant-wide cooling products results in a significant portion of the Company’s business in the cooling product area. Temperature control units, which are sold globally, compete with both local and European manufacturers. The quality, reliability, features and range of temperature control applications addressed by the Company’s products provide a competitive advantage.

The Company believes quality, service, a comprehensive product line and price are the key competitive factors in its Industrial Process Cooling Equipment business. The Company believes 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.

Other Business

During the fourth quarter 2006, the Company created a new subsidiary that is not sufficiently large to constitute a reportable segment which engages in the installation of heating, ventilation and air conditioning (HVAC) systems. During 2007, this subsidiary’s net sales were $1,463,000 and 0.6% of consolidated net sales.

Backlog. As of January 31, 2008, the amount of backlog (uncompleted firm orders) for other business was $33,179,000. As of January 31, 2007, the amount of backlog was $8,350,000. Certain customers have placed orders that are deliverable over multiple years. Therefore, approximately $15,000,000 of the backlog as of January 31, 2008 is not expected to be completed in 2008.

Employees

As of March 31, 2008, the Company had 1,263 full-time employees, 100 of whom were engaged in sales and marketing, 282 of whom were engaged in management, engineering and administration, and 881 were engaged in production. Of the total employees, 41% worked outside the United States.

The Piping Systems business production employees in Tennessee are covered by a collective bargaining agreement which is scheduled to expire in 2010. The Filtration Products business hourly production employees in Virginia, Denmark and South Africa are covered by three collective bargaining agreements. The agreement in Virginia is scheduled to expire in 2009, the agreement in Denmark expires in 2011, and the agreement in South Africa is renegotiated every May. Most of the Industrial Process Cooling Equipment business and the Other

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business production employees in Illinois and Denmark are covered by three collective bargaining agreements. The hourly office workers in Denmark and the productions workers are covered by an evergreen collective agreement which remains in effect unless amended or terminated in writing. The two agreements in Illinois renew annually unless amended or terminated in writing.

International

The Company’s international operations as of January 31, 2008 include subsidiaries in three foreign countries on three continents. The Company’s international operations contributed approximately 20.6% of revenues in 2007 and 12.5% of revenues in 2006.

Refer to the Business Segment descriptions on pages 1 through 7 above and Note 10 - Business Segment and Geographic Information in Notes to Consolidated Financial Statements elsewhere herein for additional information on international activities. International operations are subject to certain risks inherent in conducting business in foreign countries, including price controls, exchange controls, limitations on participation in local enterprises, nationalization, expropriation and other governmental action, and changes in currency exchange rates.

Executive Officers of the Registrant

The following table set forth information regarding the officers of the Company as of March 31, 2008:

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

David Unger, Chairman of the Board of Directors and Chief Executive Officer of the Company since 1989; President of the Company from 1994 until 2004.

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Henry M. Mautner, Vice Chairman of the Company since 1989. Mr. Mautner is the father of Bradley E. Mautner.

Bradley E. Mautner, President and Chief Operating Officer since December 2004; Executive Vice President from December 2002 to December 2004;Vice President of the Company from December 1996 through December 2002; director of the Company since 1995. Bradley E. Mautner is the son of Henry M. Mautner.

Michael D. Bennett, Chief Financial Officer and Vice President of the Company since August 1989.

Fati A. Elgendy, President and Chief Operating Officer of Perma-Pipe since March 1995.

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

Robert A. Maffei, Vice President, Director of Sales and Marketing of Perma-Pipe since August 1996.

Gene K. Ogilvie, President and Chief Operating Officer of Midwesco Filter since 1989.

Stephen C. Buck, President of Thermal Care since 2007. Mr. Buck comes to Thermal Care after a 22 year career most recently as President - Safety Products Group with Federal Signal Corporation (NYSE: FSS), which manufactures and markets products to industrial and municipal customers worldwide.  Prior to his employment with Federal Signal Corporation, Mr. Buck held various positions in marketing and management for companies in computer hardware/software, oil field services and telecommunications.

Thomas A. Benson, Vice President Sales and Marketing of Thermal Care since May 1988.

Edward A. Crylen, President and Chief Operating Officer of Midwesco Mechanical and Energy since its formation in December 2006. President of the Midwesco Mechanical and Energy a division of Midwesco, Inc. (affiliate) that was primarily owned by two principal stockholders who are also members of management, since 1989.

Competition. 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 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 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 such a change is likely to decrease demand in the foreseeable future.

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.

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Changes in Government Policies and Laws, Worldwide Economic Conditions. International sales represent an increasing portion of the Company’s total sales and continued growth and profitability may involve 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.

Percentage-of-completion method of accounting.  The Company measures and recognizes a portion of revenue and profits under the percentage-of-completion accounting methodology. This methodology allows revenue and profits to be recognized ratably over the life of a contract by comparing the amount of the cost incurred to date against the total amount of cost expected to be incurred. The effect of revisions to revenue and total estimated cost is recorded when the amounts are known and can be reasonably estimated, and these revisions can occur at any time and could be material. On a historical basis, management believes that reasonably reliable estimates of the progress towards completion on long term contracts have been made. However, given the uncertainties associated with these types of contracts, it is possible for actual cost to vary from estimates previously made, which may result in reductions or reversals of previously recorded revenue and profits.

Manufacturer’s warranties. The Company may be subject to warranty claims in the future relating to workmanship and materials. These types of warranty claims could result in costly product recalls, repair costs and damage to our reputation, which could materially adversely affect our business, financial condition and results of operations.

Financing. If there were an event of default under our revolving credit facility, as amended, the holders of the defaulted debt could cause all amounts outstanding with respect to that debt to be due and payable immediately

Seasonality. Due to the seasonality of the Company's domestic Piping Systems business, sales and earnings are typically lower during the late fall, winter and early spring (fourth and first quarters), due to unfavorable weather for construction over much of North America and are correspondingly higher during the late spring, summer and early fall months (second and third quarters).

Internal Controls. As a public company, the Company is required to comply with the reporting obligations of the Exchange Act and is required to comply with Section 404 of the Sarbanes-Oxley Act (“SOX 404”). Failure to comply with the reporting obligations of the Exchange Act or failure to maintain adequate internal controls over financial reporting as required in SOX 404 could result in a material weakness and the financial statements will be restated, as well as reduce investors’ confidence in the Company. If the Company fails to achieve and maintain the adequacy of internal controls, management may not be able to conclude on an ongoing basis that there are effective internal controls over financial reporting in accordance with SOX 404. In addition, the Company has experienced, and may experience additional, increased costs of compliance with SOX 404.

International rapid growth. Potential future rapid growth could place a significant strain on management, operations and financial systems as well as on the Company’s ability to attract and retain competent employees. Future operating results will depend in part on the Company’s ability to continue to implement and improve operating and financial controls and management information systems. Failure to effectively manage growth could materially adversely impact the business, financial conditions and results of operations.

11

None

Piping Systems Business

Filtration Products Business

Industrial Process Cooling Equipment Business

The Company's principal executive offices, which occupied approximately 43,000 square feet of space in Niles, Illinois are 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.

The terms of the two significant lease agreements are as follows:

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

On March 4, 2008 the Filtration Products business purchased a new production facility and office space in Illinois which consists of 101,200 square feet to which it intends to relocate operations from its Cicero, Illinois facility in the summer of 2008.

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The Company had no pending litigation material to its business.

None.

PART II

The Company’s fiscal year ends on January 31. Years described as 2007, 2006, 2005, 2004 and 2003 are the fiscal years ended January 31, 2008, 2007, 2006, 2005 and 2004, respectively. Balances described as balances as of 2007 and 2006 are balances as of January 31, 2008, and 2007 respectively.

The Company's Common Stock is traded on the Nasdaq Global 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 Global Market for 2007 and for 2006.

As of April 1, 2008, there were approximately 75 stockholders of record.

STOCK PRICE PERFORMANCE GRAPH

The Stock Price Performance Graph compares the yearly dollar change in the Company’s cumulative total stockholder return on its Common Stock with the cumulative total returns of the Nasdaq Market Index (the “Nasdaq Index”), the Russell 2000 Index and the S & P 600 Small Cap index. The Company has selected these indices because they include companies with similar market capitalizations to the Company, as the most appropriate comparisons because the Company has three distinctly different businesses and no industry “peer” group is comparable to the Company. The comparison assumes $100.00 investments on January 31, 2003 in the Company’s Common Stock, the Nasdaq Index, the Russell 2000 Index, and the S & P 600 Small Cap index and further assumes reinvestment of dividends.

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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 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.

The Transfer Agent and Registrar for the Common Shares is Continental Stock Transfer & Trust Company, 17 Battery Place, New York, New York 10004, (212) 509-4000.

In February 2007, the Company sold 1,003,000 shares of common stock at a price of $18.50 per share pursuant to the Company’s existing shelf registration statement previously filed and declared effective by the U.S. Securities and Exchange Commission. The net proceeds of $18,332,000 from this sale were utilized to pay down the revolving line of credit. As a result, increased revolving line of credit borrowing capacity was available to finance general business needs.

14

Equity Compensation Plan Information

The following table provides certain information regarding the number of shares of Common Stock to be issued upon exercise of outstanding options, warrants and rights under the Company’s equity compensation plans and the weighted average exercise price and number of shares of Common Stock remaining available for issuance under those plans as of January 31, 2008.

The following selected financial data for the Company for the years 2007, 2006, 2005, 2004, and 2003 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.

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.

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RESULTS OF OPERATIONS

Consolidated

MFRI, Inc. ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three distinct business segments: piping systems, filtration products and industrial process cooling equipment. Due to the seasonality of the Company's domestic Piping Systems business, sales and earnings are typically lower during the late fall, winter and early spring (fourth and first quarters), due to unfavorable weather for construction over much of North America and are correspondingly higher during the late spring, summer and early fall months (second and third quarters). The Company’s other businesses do not demonstrate seasonality.

Our analysis presented below was 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.

2007 Compared to 2006

Net sales were a new record at $239,487,000 in 2007, an increase of 12.2% from $213,471,000 in 2006, with increased sales in the Piping Systems business and the Filtration Products business while the Industrial Process Cooling business decreased.

Net income for 2007 was sharply down primarily due to the following factors:

Piping Systems:

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Filtration Products:

Industrial Process Cooling:  

Other significant incremental expenses in 2007 not incurred in 2006:

Because of the above factors and other occurrences, gross profit of $41,249,000 in 2007 decreased 7.1% from $44,405,000 in 2006. Gross margin for 2007 declined to 17.2% from 20.8% in 2006. (See discussion of each business segment below.)

Tax rate for 2007 was 158.3% mainly due to the valuation allowance for state and foreign net operating losses as described in Income Taxes below.

2006 Compared to 2005

Net sales of $213,471,000 in 2006 increased 38.1% from $154,587,000 in 2005, with increased sales in all business segments. Gross profit of $44,405,000 in 2006 increased 35.9% from $32,686,000 in 2005. Gross margin decreased to 20.8% of net sales in 2006 from 21.1% in 2005. (See discussion of each business segment below.)

Selling expense increased 17.3% to $14,530,000 in 2006 from $12,383,000 in 2005 primarily due to increased number of selling personnel and related commissions. (See discussion of each business segment below.)

General and administrative expenses increased 18.8% to $20,933,000 in 2006 from $17,624,000 in 2005. General administrative expense increases included an increase in management incentive compensation earned as a result of improved profitability, and higher travel and administrative costs associated with the U.A.E. facility. (See discussion of each business segment below.)

Net income increased to $4,593,000 or $0.86 per common share (basic), compared to net income of $531,000 or $0.10 per common share in 2005 primarily for reasons summarized above and discussed in more detail below.

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Piping Systems Business

Due to the seasonality of the Company's domestic Piping Systems business, sales and earnings are typically lower during the late fall, winter and early spring (fourth and first quarters), due to unfavorable weather for construction over much of North America and are correspondingly higher during the late spring, summer and early fall months (second and third quarters).

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 timing of smaller orders can have a material effect on the comparison of net sales and gross profit from period to period. In 2007 and 2005, no customer accounted for 10% or more of net sales of the Company’s Piping Systems business. In 2006 only one customer, BHP Billiton Petroleum (Americas) Inc. ("BHP Billiton"), accounted for more than 10% of the net sales of the Company's piping systems. As of April 6, 2007, the Company does not have an outstanding receivable from BHP Billiton.

2007 Compared to 2006

Net sales increased 26.9% to $104,273,000 in 2007 from $82,166,000 in 2006. This increase was primarily due to $22,339,000 in 2007 sales at the U.A.E. facility compared to $2,792,000 in sales from the U.A.E. in the prior year, partially offset by decreased sales to oil and gas customers. At the New Iberia facility, half the 2007 third quarter was devoted to research and develop a new product for a major customer application. While progress was made, the effort was not successful. In the middle of October 2007, the New Iberia facility resumed work on production of customer orders.

Gross profit as a percent of net sales decreased to 18.2% in 2007 from 20.4% in 2006, primarily due to lower sales to oil and gas customers, which tend to have a higher margin over other customers and the additional product development work for oil and gas in the third quarter. Gross margin at the U.A.E. facility was lower than the Piping Systems business’s average, during its first year of rapid growth and production of a particularly challenging order for an oil and gas customer.

Total selling expense increased to $2,297,000 or 2.2% of net sales in 2007 from $1,560,000 or 1.9% of net sales in 2006. Selling expense in the U.A.E. increased to $750,000 in 2007 from $177,000 in 2006. The increased expense was mainly due to additional staffing primarily in the U.A.E., and the addition of an international sales manager based in the United States.

General and administrative expense increased to $6,032,000 or 5.8% of net sales in 2007 from $5,653,000 or 6.9% of net sales in 2006. The dollar increase in general and administrative expenses was primarily due to increased staffing in the U.A.E. to support the location’s growth and increased staffing in the U.S.

2006 Compared to 2005

Net sales increased 50.3% to $82,166,000 in 2006 from $54,657,000 in 2005. This increase was primarily due to increased demand from the oil and gas industry as well as a strong year for the DHC business.

Gross profit as a percent of net sales increased to 20.4% in 2006 from 19.9% in 2005, mainly from higher margins in the oil and gas industry.

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Selling expense increased to $1,560,000 or 1.9% of net sales in 2006 from $1,442,000 or 2.6% of net sales in 2005. This dollar increase was primarily due to higher commissions, travel and marketing expenses.

General and administrative expense increased to $5,653,000 or 6.9% of net sales in 2006 from $4,360,000 or 8.0% of net sales in 2005. The dollar increase in general and administrative expenses was primarily due to an increase in management incentive compensation earned as a result of improved profitability, and higher travel and administrative costs associated with the U.A.E. facility, which opened in March 2006.

Filtration Products Business

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 2007, 2006 and 2005, 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 the Clean Air Act Amendments are likely to have a positive long-term effect on demand for the Company’s filtration products and services.

2007 Compared to 2006

Net sales increased 12.5% to $97,120,000 in 2007 from $86,362,000 in 2006. This increase was the result of increased sales in all product lines and geographic areas, primarily the result of a growing electric power generation customer base.

Gross profit as a percent of net sales decreased to 14.2% in 2007 from 18.8% in 2006, primarily due to the highly competitive marketplace, increasing cost of raw materials, customer mix and additional post-sale customer support costs, including rework and replacement of a sizeable customer order produced in the South African facility. The cost of production labor at the Denmark facility was higher than in prior years.

Selling expense increased to $6,873,000 or 7.1% of net sales in 2007 from $6,541,000 or 7.6% of net sales in 2006. The dollar increase in selling expense was primarily due to increased commission expense related to higher sales and increased advertising expense.

General and administrative expenses increased to $4,682,000 or 4.8% of net sales from $4,415,000 or 5.1% of net sales in 2006. The dollar increase was the result of additional staffing in the foreign locations and the ERP software implementation expenses incurred at the Denmark facility.

2006 Compared to 2005

During the second quarter 2006, the Company finalized the purchase accounting for a filtration facility in South Africa that was acquired on April 12, 2006. This acquisition was not material to the financial statements.

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Net sales increased 34.1% to $86,362,000 in 2006 from $64,413,000 in 2005. This increase was the result of increased sales in all product lines, primarily as a result of better economic conditions in general.

Gross profit as a percent of net sales increased to 18.8% in 2006 from 18.3% in 2005, primarily as a result of improved product mix, which has been offset in part by a highly competitive marketplace.

Selling expense increased to $6,541,000 or 7.6% of net sales in 2006 from $6,388,000 or 9.9% of net sales in 2005. The dollar increase in selling expense was primarily due to additional selling personnel, related commissions and travel expenses.

General and administrative expenses increased to $4,415,000 or 5.1% of net sales from $3,150,000 or 4.9% of net sales in 2005. The dollar increase was the result of the inclusion of $234,000 of general and administrative expenses from the South African facility acquired in April 2006 and increased professional service fees.

Industrial Process Cooling Equipment Business

In 2007, 2006 and in 2005, no customer accounted for 10% or more of net sales of the Industrial Process Cooling Equipment business.

2007 Compared to 2006

Net sales decreased 11.7% to $36,327,000 in 2007 from $41,161,000 in 2006. The decrease was primarily due to lower demand for its products in major market sectors and a temporary hold on selling a new central chilling product line launched in 2005, to resolve some performance issues. The product line was re-launched in the fourth quarter of 2007.

Gross profit as a percentage of net sales decreased to 23.4% in 2007 from 27.4% in 2006, primarily due to material cost increases, which were not completely offset by selling price increases, lower sales volume over which to spread fixed manufacturing overhead expenses and field modification costs for a central chilling product line. Manufacturing staff was reduced by 12% in the fourth quarter 2007 to better balance production expenses with demand.

Selling expense decreased to $5,100,000 or 14.0% of net sales in 2007 from $5,713,000 or 13.9% of net sales in 2006.  The decrease was due to reduced commission expense from lower sales.

General and administrative expense increased to $4,635,000 or 12.8% of net sales in 2007 from $4,339,000 or 10.5% of net sales in 2006.  This increase was primarily due to increased professional costs including employment-related hiring expenses and engineering consulting fees related to new product development.

2006 Compared to 2005

Net sales increased 15.9% to $41,161,000 in 2006 from $35,517,000 in 2005 mainly due to increased demand from original equipment manufacturers in several markets and new products.

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Gross profit as a percentage of net sales decreased to 27.4% in 2006 from 28.3% in 2005, primarily due to competitive pricing pressure, material cost increases, and increasing sales to original equipment manufacturers.

Selling expense increased to $5,713,000 or 13.9% of net sales in 2006 from $4,553,000 or 12.8% of net sales in 2005. The increase was primarily due to increased customer service, advertising and trade show expenses, and the commissions associated with higher sales.

General and administrative expense increased to $4,339,000 or 10.5% of net sales in 2006 from $3,969,000 or 11.2% of net sales in 2005. This dollar increase was primarily due to increased staffing and related benefit costs.

General Corporate and Other

The 2007 year included sales of $1,767,000 related to startup stage of the heating, ventilation and air conditioning (HVAC) systems business, which had a backlog (uncompleted firm orders) of $33,179,000 as of January 31, 2008.

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

2007 Compared to 2006

General and administrative expense increased 20.6% to $8,733,000 in 2007 from $7,242,000 in 2006, and increased as a percentage of consolidated net sales to 3.6% in 2007 from 3.4% in 2006. The increase was mainly due to incremental expenses of $929,000 incurred to comply with SOX 404 (including consulting fees) that were not incurred in 2006, the inclusion of $664,000 of the general and administrative expense from the newly created subsidiary that installs HVAC systems, and additional stock compensation expense of $365,800 compared to the prior year. These expenses were offset by decreased management incentive expense and deferred compensation expense.

Interest expense decreased 10.0% to $2,408,000 in 2007 from $2,676,000 in 2006. The decrease was primarily due to reduced borrowings.

2006 Compared to 2005

General and administrative expense increased 17.8% to $7,242,000 in 2006 from $6,146,000 in 2005, and decreased as a percentage of consolidated net sales to 3.4% in 2006 from 4.0% in 2005. The dollar increase in general and administrative expenses was primarily due to an increase in management incentive compensation earned as a result of improved profitability.

Interest expense increased 45.5% to $2,676,000 in 2006 from $1,839,000 in 2005. The increase was primarily due to additional borrowings on the Company’s revolving line of credit at higher interest rates.

INCOME TAXES

In the first quarter of 2007, the Company adopted FIN 48. The total amount of unrecognized tax liability as of February 1, 2007 was approximately $573,700, all of which would impact the effective tax rate if recognized. A decrease of $504,500 was recorded to retained earnings as of February 1, 2007 upon the adoption of FIN 48 (“Accounting for Uncertainty in Income Taxes”). During 2007, the liability for income taxes associated with uncertain tax positions as described in FIN 48 increased by $130,400 for a total of $704,100 at January 31, 2008. These non-current income tax liabilities are recorded in other long-term liabilities in the consolidated balance sheet. Included in the total unrecognized tax liability were estimated accrued interest of $33,700 and penalties of $44,100. The Company’s policy is to include interest and penalties in income tax expense.

21

The effective income tax expense rates were 158.3%, 32.0%, and 48.7% in 2007, 2006 and 2005, respectively. The differences between the effective income tax rate and the U.S. Statutory tax rate for 2007 and 2006 were:

During the fourth quarter, management determined that all of its foreign net operating loss (“NOL”) carryovers and most of its state NOL carryovers were no longer more likely than not realizable. Additional tax expense of $583,000 was recorded to establish a valuation allowance against those deferred tax assets. Management believes that the remainder of its deferred tax assets, which primarily relate to its profitable domestic operations, are more likely than not to be realized. (See Note 8)

LIQUIDITY AND CAPITAL RESOURCES

In February 2007, the Company sold 1,003,000 shares of common stock at a price of $18.50 per share pursuant to the Company’s existing shelf registration statement previously filed and declared effective by the U.S. Securities and Exchange Commission. The net proceeds of $18,332,000 from this sale were utilized to pay down the revolving line of credit. As a result, increased revolving line of credit borrowing capacity was available to finance general business needs.

Cash and cash equivalents as of January 31, 2008 were $2,665,000 as compared to $565,000 as January 31, 2007. The Company used $7,350,000 from operations in 2007. Operating cash flows in 2007 decreased by $430,000 from 2006. Cash distributions of $286,000 in 2007 were received from the Company’s investment in a joint venture and exercise of stock options resulted in proceeds of $932,000. These cash inflows were used to support $5,763,000 in capital spending.

Net sales in 2007 increased $26,016,000 or 12.2% compared to 2006 net sales. The higher sales contributed to the increased balances in trade accounts receivable, inventories, and trade accounts payable. Compared to January 31, 2007, trade receivables increased by $3,878,000 primarily due to the piping systems business, of which $7,260,000 was in the U.A.E. offset by a decrease of $5,242,000 in the Filtration Products business. Inventories increased by $5,452,000 in 2007 primarily due to increased raw material requirements for future production. Total inventory increased in the U.A.E. by $4,684,000. Customer deposits decreased $1,482,000 from January 31, 2007 of which $1,589,000 related to the Filtration Products business and the product shipped early in 2007. At January 31, 2008, the Filtration Products business had customer deposits of $3,000,000 and product is expected to ship in the first and second quarter of 2008.

Net cash used in 2007 investing activities was $5,070,000 mainly comprised of capital expenditures. Capital expenditures in 2007 decreased to $5,763,000 from $8,269,000 in 2006. Capital expenditures in 2007 of $1,322,000 related to equipment and other costs at the U.A.E. facility. Other 2007 capital expenditures were mainly equipment purchases. Proceeds of $258,000 from sales of Marketable Securities were received in 2007.

The Company estimates that capital expenditures for 2008 will be approximately $18,200,000, of which approximately $8,000,000 is expected to be related to a new facility described below. The Filtration Products business facility in Cicero, Illinois is relocating its operations in the summer of 2008 to a building purchased for $6,400,000 in Bolingbrook, Illinois in March 2008. Improvements and modifications are underway which are expected to cost an additional $1,600,000. In the beginning of 2008, the Piping Systems business is opening a facility to be located in Mundra, India with an expected cost of $4,700,000 for the leasehold improvements and equipment. Other capital expenditures primarily related to machinery and equipment, building and leasehold improvements, and computer hardware and software purchases. The Company may finance capital

22

expenditures through real estate mortgages, equipment financing loans, internally generated funds and its revolving line of credit. Debt totaled $34,240,000, a decrease of $4,795,000 since the beginning of 2007. Net cash inflows from financing activity were $14,831,000, primarily to support higher working capital investments. Stock option activity resulted in $2,400,000 of total cash inflow, which included $1,466,000 tax benefit of stock options exercised in addition to stock option proceeds of $932,000. While the Company expects to achieve its plan, $8,582,000 of the company’s line of credit and $2,786,000 of term loan has been reflected as current to reflect uncertainties associated with the attainment of loan covenants. In management’s opinion adequate financing sources are available to refinance the amounts outstanding under the line of credit during 2008 should this become necessary.

The following table summarizes the Company’s estimated contractual obligations at January 31, 2008.

Notes to Contractual Obligations Table

Other long term liabilities of $4,520,000 were composed primarily of deferred compensation, and accrued pension cost.

The Company’s working capital was $39,544,000 at January 31, 2008 compared to $30,734,000 at January 31, 2007. This increase was due to the increase in inventories and accounts receivable offset by the increase in accounts payable.

The Company’s current ratio was 1.7 to 1 and 1.6 to 1 at January 31, 2008 and January 31, 2007, respectively. Debt to total capitalization at January 31, 2008 decreased to 36.4% from 50.1% at January 31, 2007.

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Financing

At January 31, 2007, the Company was in compliance with covenants under the Loan Agreement as defined below.   At January 31, 2008, the Company was not in compliance with an earnings covenant (the “Covenant”) under the Loan Agreement.  A waiver has been obtained for such noncompliance, and the Covenant has been amended to levels consistent with the Company’s then current business plan beginning with the period ending July 31, 2008.  There is no Covenant for periods prior to July 2008. While the Company expects to comply with the Covenant, in recognition of the uncertainty of compliance $8,582,000 of the Company’s line of credit (of which $16,585,200 was available as of January 31, 2008) and $2,786,000 of term debt have been classified as current in the accompanying consolidated financial statements.  In management’s opinion adequate financing sources are available to refinance the amounts outstanding under the line of credit during 2008 should this become necessary.

On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution ("Loan Agreement"). The Loan Agreement was amended and restated on December 15, 2006. Under the terms of the Loan Agreement, which matures on November 13, 2010, the Company can borrow up to $38,000,000, 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, 2008, the prime rate was 6.00%, 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 0.25 and 1.75 percentage points, respectively. Monthly interest payments were made. The average interest rate for the year ending January 31, 2008 was 7.92%. As of January 31, 2008, the Company had borrowed $8,582,000 and had $16,585,200 available to it under the revolving line of credit. In addition, $4,685,000 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts committed for inventory purchases. 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, 2008, the amount of restricted cash was $565,000. Cash required for operations is provided by draw-downs on the line of credit.

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 matured in the fourth quarter of 2007 and was paid in full. On January 18, 2008, the Company borrowed $3,675,000 under a mortgage note secured by its manufacturing and office facility in Niles, Illinois. The loan bears interest at 6.26% with monthly payments of $22,652 for both principal and interest based on an amortization schedule of 30 years with a balloon payment at the end of the ten-year term.

On October 18, 1995, the Piping Systems business’ Lebanon, Tennessee location received $3,150,000 of proceeds from Industrial Revenue Bonds, which matured and were paid in full on September 1, 2007. These bonds had been fully secured by bank letters of credit.

On August 28, 2007, the Company Amended and Restated the Term Loan Note to $3,000,000 ("Term Loan"). 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 January 31, 2008, the prime rate was 6.0i%, 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 0.50 and 2.0 percentage points, respectively. The Company is scheduled to pay $107,000 of principal on the first day of March, June, September, and December in each year ending on September 30, 2010, with the remaining unpaid principal payable on November 30, 2010.

On March 9, 2007, the Filtration Products business in the Denmark location obtained a loan in the amount of 1,343,200 Euros (approximately $1,765,000 U.S. dollars at the prevailing exchange rate at the time of the transaction) from a Danish bank to finance capital expenditures and other expenses. The loan matures May 2011. The loan bears interest at a floating rate currently 5.00% per annum with monthly principal payments of $35,300.

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At January 31, 2007, one interest rate swap agreement was in effect with a notional value of $15,000,000 maturing in 2011. On February 5, 2007, the Company terminated such interest rate swap and recognized a loss of $72,500. No such agreement was in effect at January 31, 2008.

The Company also has short-term credit arrangements used by its Denmark and U.A.E. 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, 2008, borrowings under these credit arrangements totaled $8,162,000; an additional $1,178,000 remained unused.

Subsequently on March 4, 2008, the Company borrowed $5,440,000 under a mortgage note secured by the new Filtration Product’s manufacturing facility located in Bolingbrook, Illinois. The 25 year mortgage resets its interest rate every five years based on a published index. The initial interest rate is 6.54% during the first five years with monthly payments of $36,867 for both principal and interest.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

Revenue Recognition: The Company recognizes revenues including shipping and handling charges billed to customers, 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 as noted below, recognize revenues upon shipment or delivery of goods or services when title and risk of loss pass to customers.

Percentage of Completion Method Revenue Recognition: The Piping System business and Corporate and Other recognize revenues under the above stated revenue recognition policy except for sizable complex contracts that require periodic recognition of income based on the status of the uncompleted contracts and the current estimates of costs to complete and of progress toward completion. For these contracts, the Company uses "percentage of completion" method. The choice of accounting method is made at the time the contract is received based on the nature of the contract. 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.

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 2007 and 2006 evaluations, the fair value was determined using discounted cash flows. Certain estimates and judgments are required in the application of the fair value models. Based upon the Company’s evaluations for 2007 and 2006, no impairment of goodwill was required. As of January 31, 2008 and 2007, $1,100,000 of goodwill was allocated to the Industrial Process Cooling Equipment business. As of January 31, 2008 and 2007, $1,726,000 and $1,513,000, respectively, was allocated to the Filtration Products business. The change in goodwill of the Filtration Products business was due to foreign currency translation.

Stock Options: Effective February 1, 2006, the Company adopted the fair value recognition provision of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the modified-prospective-transition method. Under this transition method, compensation cost recognized for the year ended January 31, 2008 includes: (a) compensation costs for all share-based payments granted prior to, but not vested as of February 1, 2006 based on the fair value at grant date estimated in accordance with SFAS 123, and (b) compensation cost for all

25

share-based payments granted subsequent to February 1, 2007, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). In accordance with SFAS 123R, results for prior periods have not been restated.

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.

Recently Adopted Accounting Standards

Effective February 1, 2007, the Company adopted the provisions of the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”, (“FIN 48’). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return. In May 2007, the FASB issued FASB Staff Position FIN 48-1 that amends FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48-1”). FIN 48-1 provides guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits.

As required by FIN 48, which clarifies Statement 109, Accounting for Income Taxes, the Company recognizes the financial statement benefit of tax positions only after determining that the relevant tax authority would more likely than not sustain the position following an audit. The total amount of unrecognized tax liability as of February 1, 2007 was approximately $573,700, all of which would impact the effective tax rate if recognized. This was recorded as a decrease of $504,500 to retained earnings as of February 1, 2007 upon the adoption of FIN 48. During 2007, the liability for income taxes associated with uncertain tax positions increased by $130,400 for a total of $704,100 at January 31, 2008. These non-current income tax liabilities are recorded in other long-term liabilities in the consolidated balance sheet. Included in the total unrecognized tax liability were estimated accrued interest of $33,700 and penalties of $44,100. The Company’s policy is to include interest and penalties in income tax expense.

New Accounting Pronouncements

In September 2006, FASB issued Financial Accounting Standard No.157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, and accordingly, does not require any new fair value measurements. SFAS 157 is effective February 1, 2008. The Company is currently reviewing the provisions of SFAS 157, but does not expect the provisions to have a material impact on its consolidated financial statements.

In February 2007, the FASB issued Financial Accounting Standard No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 provides the option to report certain financial assets and liabilities at fair value, with the intent to mitigate volatility in financial reporting that can occur when related assets and liabilities are recorded on different bases. This statement is effective February 1, 2008. The Company does not expect SFAS 159 to have a material impact on its consolidated financial statements.

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, often though not always invoicing customers in the same currency as the source of the products and use of foreign currency denominated debt in Denmark, U.A.E. and South Africa. At times 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 had 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

26

 principal amount. Any differences paid or received on the interest rate swap agreements were recognized as adjustments to interest expense over the life of the swap, thereby adjusting the effective interest rate on the underlying obligation. Financial instruments were not held or issued for trading purposes.

At January 31, 2007, one interest rate swap agreement was in effect with a notional value of $15,000,000 maturing in 2011. On February 5, 2007, the Company terminated such interest rate swap and recognized a loss of $72,500. No such agreement was in effect at January 31, 2008.

A hypothetical ten percent change in market interest rates over the next year would increase or decrease interest on the Company's floating rate debt instruments by approximately $68,900.

Commodity price risk is the possibility of higher or lower costs due to changes in the prices of commodities, such as ferrous alloys which the Company uses in the production of piping systems. The Company attempts to mitigate such risks by obtaining price commitments from its commodity suppliers and, when it appears appropriate, purchasing quantities in advance of likely price increases.

The consolidated financial statements of the Company for each of the three years in the period ended as of January 31, 2008, 2007 and 2006 and the notes thereto are set forth elsewhere herein.

None.

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of January 31, 2008. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, due to a material weakness in internal control over financial reporting described below in Management’s Annual Report on Internal Control Over Financial Reporting, the company’s disclosure controls and procedures were not effective as of January 31, 2008.

Management’s Report on Internal Control Over Financial Reporting: The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. As required by Rule 13a-15(c) under the Exchange Act, MFRI’s management carried out an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of its internal control over financial reporting as of the end of the last fiscal year. The framework on which such evaluation was based is contained in the report entitled “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”).

The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Based on its assessment, management has concluded that the Company has not maintained effective internal control over financial reporting as of January 31, 2008, based on criteria in the COSO report.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting,

27

such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The Company’s processes, procedures and controls related to the preparation and review of the quarterly and annual income tax provision were not effective at October 31, 2007 and January 31, 2008 to ensure that amounts related to the income tax provision were accurate. This material weakness resulted in an accounting error. The error did not affect the Registrant's sales, operating expenses, or cash flow. However, the error did result in the understatement of income taxes, and overstatement of current assets, total assets, and net income for the interim fiscal period reported at October 31, 2007. Grant Thornton, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K, have also issued an attestation report on internal control over financial reporting, which is included herein.

Change in Internal Controls: Other than the material weakness noted above, there has been no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Remediation Plan for Material Weaknesses in Internal Control over Financial Reporting: Beginning in 2005, the Company engaged a national public accounting, tax and business consulting firm with affiliates worldwide (the “Tax Advisor”) to assist the Company with calculation and review of its quarterly and annual income tax provisions and with its income tax compliance. To avoid recurrence of an error such as the one described above, the Company and Tax Advisor are assessing the appropriateness of technical resources assigned to the engagement, improving income tax accounting documentation, and adjusting the timing of quarterly and annual income tax accounting work.

We anticipate the actions described above and resulting improvements in controls will strengthen our internal control over financial reporting relating to accounting for income taxes and will address the related material weakness that we identified as of January 31, 2008.

None.

PART III

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 2008 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".

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 2008 annual meeting of stockholders.

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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 caption "Beneficial Ownership of Common Stock" in the Company's proxy statement for the 2008 annual meeting of stockholders.

Information with respect to certain relationships and transactions, and director independence is incorporated herein by reference to the information under the caption "Certain Transactions" in the Company's proxy statement for the 2008 annual meeting of stockholders.

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 2008 annual meeting of stockholders.

PART IV

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Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

Board of Directors and Stockholders

MFRI, Inc. and Subsidiaries

We have audited MFRI, Inc.’s (a Delaware corporation) and Subsidiaries (the “Company”) internal control over financial reporting as of January 31, 2008 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express an opinion on the Company’s internal control over financial reporting 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment.

The Company did not maintain effective processes, procedures and controls over the preparation and review of its accounting for income taxes. This deficiency resulted in more than a remote likelihood that a material misstatement of the annual or interim financial statements would not be prevented or detected.

In our opinion, because of the effect of the material weakness identified above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of January 31, 2008, based on the criteria established in Internal Control-Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of January 31, 2008 and 2007 and the related consolidated statements of income, shareholders’ equity, and cash flows for the three years then ended. The material weakness identified above was considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements and financial statement schedule as of and for the year ended January 31, 2008, and this report does not affect our report dated April 30, 2008, which expressed an unqualified opinion on those financial statements.

/s/ Grant Thornton LLP

Chicago, Illinois

April 30, 2008

30

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholder

MFRI, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of MFRI, Inc. (a Delaware corporation) and Subsidiaries (the “Company”) as of January 31, 2008 and 2007, and the related consolidated statements of income, shareholders’ equity, and cash flows for the three years then ended. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). 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 audits.

We conducted our audits 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. 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 audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MFRI, Inc. and Subsidiaries as of January 31, 2008 and 2007 and the results of their operations and cash flows for the three years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, the Company adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes and Interpretation of FASB Statement No. 109,” on February 1, 2008. For the year ended January 31, 2007, the Company adopted Financial Accounting Standards Board Statements No. 123(R), “Share-Based Payments,” and No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” as discussed in Note 12 and Note 9, respectively, to the consolidated financial statements.

We also have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), MFRI, Inc.’s and Subsidiaries internal control over financial reporting as of January 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated April 30, 2008 expressed an adverse opinion due to the identification and disclosure of a material weakness.

/s/ Grant Thornton, LLP

Chicago, Illinois

April 30, 2008

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MFRI, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands except per share information)