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Perma-Pipe International Holdings, Inc. - Quarter Report: 2016 July (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2016

Commission File No. 0-18370

MFRI, Inc.
(Exact name of registrant as specified in its charter)
mfrilogo13color.jpg
Delaware
36-3922969
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
6410 W. Howard Street, Niles, Illinois
60714
(Address of principal executive offices)
(Zip Code)

(847) 966-1000
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

On September 8, 2016, there were 7,539,568 shares of the registrant's common stock outstanding.





MFRI, Inc.
FORM 10-Q
For the fiscal quarter ended July 31, 2016
TABLE OF CONTENTS

Item
 
Page
 
 
 
Part I
 
 
 
 
1.
 
 
Consolidated Statements of Operations for the Three and Six Months Ended July 31, 2016 and 2015
 
Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended July 31, 2016 and 2015
2
 
Consolidated Balance Sheets as of July 31, 2016 and January 31, 2016
 
Consolidated Statements of Stockholders' Equity as of July 31, 2016 and January 31, 2016
 
Consolidated Statements of Cash Flows for the Six Months Ended July 31, 2016 and 2015
 
 
 
 
2.
14
 
 
 
4.
19
 
 
 
Part II
 
6.
20
 
 
 
21




PART I FINANCIAL INFORMATION

Item 1.    Financial Statements

MFRI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
 
Three Months Ended July 31,
 
Six Months Ended July 31,
 
2016

2015

 
2016

2015

Net sales

$22,859


$25,147

 

$45,928


$45,424

Cost of sales
19,879

22,021

 
40,956

39,943

Gross profit
2,980

3,126

 
4,972

5,481

 
 
 
 
 
 
Operating expenses
 
 
 
 
 
General and administrative expenses
3,370

4,227

 
8,463
8,933

Selling expenses
1,450

1,429

 
2,854
2,648

Total operating expenses
4,820

5,656

 
11,317

11,581

 
 
 
 
 
 
Loss from operations
(1,840
)
(2,530
)
 
(6,345
)
(6,100
)
 
 
 
 
 
 
(Loss) income from joint venture

(49
)
 

116

Loss on consolidation of joint venture


 
(1,620
)

 
 
 
 
 
 
Interest expense, net
97

162

 
323

83

Loss from continuing operations before income taxes
(1,937
)
(2,741
)
 
(8,288
)
(6,067
)
 
 
 
 
 
 
Income tax benefit
(1,077
)
(473
)
 
(1,334
)
(447
)
 
 
 
 
 
 
Loss from continuing operations
(860
)
(2,268
)
 
(6,954
)
(5,620
)
 
 
 
 
 
 
Income (loss) from discontinued operations, net of tax
1,309

(123
)
 
1,109

(1,426
)
 
 
 
 
 
 
Net income (loss)

$449


($2,391
)
 

($5,845
)
($7,046)
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
 
 
 
Basic
7,481

7,277

 
7,416

7,264

Diluted
7,603

7,277

 
7,416

7,264

 
 
 
 
 
 
Loss per share from continuing operations
 
 
 
 
 
Basic and diluted

($0.11
)

($0.31
)
 
($0.94)
($0.77)
Earnings (loss) per share from discontinued operations
 
 
 
 
 
Basic and diluted

$0.17


($0.02
)
 

$0.15


($0.20
)
Earnings (loss) per share
 
 
 
 
 
Basic and diluted
$0.06

($0.33
)
 

($0.79
)

($0.97
)
See accompanying notes to consolidated financial statements.
Note: Earnings per share calculations could be impacted by rounding.

1


MFRI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)
(In thousands)

 
Three Months Ended July 31,
 
Six Months Ended July 31,
 
2016

2015

 
2016

2015

Net income (loss)

$449


($2,391
)
 

($5,845
)

($7,046
)
 
 
 
 
 
 
Other comprehensive income
 
 
 
 
 
Foreign currency translation adjustments, net of tax
(888
)
(184
)
 
1,034

158

Interest rate swap, net of tax

10

 

15

Unrealized gain on marketable security, net of tax
(5
)

 
(4
)

Minimum pension liability adjustment, net of tax

196

 

196

Other comprehensive (loss) income
(893
)
22

 
1,030

369

 
 
 
 
 
 
Comprehensive loss

($444
)

($2,369
)
 

($4,815
)

($6,677
)

See accompanying notes to consolidated financial statements.



2


MFRI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except per share data)
July 31, 2016

January 31, 2016

ASSETS
Unaudited

 
Current assets
 
 
Cash and cash equivalents

$11,612


$16,631

Restricted cash
943

2,324

Trade accounts receivable, less allowance for doubtful accounts of $72 at July 31, 2016 and $33 at January 31, 2016
28,341

36,090

Inventories, net
14,051

15,625

Assets of discontinued operations
2,548

15,733

Assets held for sale

3,062

Cash surrender value on life insurance policies, net
1,287

3,049

Prepaid expenses and other current assets
3,679

2,071

Costs and estimated earnings in excess of billings on uncompleted contracts
2,065

2,463

Total current assets
64,526

97,048

Property, plant and equipment, net of accumulated depreciation
37,168

25,400

Other assets
 
 
Goodwill
2,657


Note receivable from joint venture

1,905

Investment in joint venture

9,112

Other assets
5,076

4,658

Total other assets
7,733

15,675

Total assets

$109,427


$138,123

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
Current liabilities
 
 
Trade accounts payable

$7,883


$11,026

Accrued compensation and payroll taxes
3,769

4,274

Deferred compensation liability
3,207

6,167

Commissions and management incentives payable
2,144

2,874

Revolving line domestic
3,757

5,237

Current maturities of long-term debt
1,241

8,769

Customers' deposits
3,118

3,690

Outside commissions payable
1,883

1,295

Liabilities of discontinued operations
1,320

15,465

Liabilities held for sale

3,439

Billings in excess of costs and estimated earnings on uncompleted contracts
482

1,176

Other accrued liabilities
2,539

965

Income taxes payable
982

2,339

Total current liabilities
32,325

66,716

Long-term liabilities
 
 
Long-term debt, less current maturities
7,254

1,493

Deferred compensation liabilities
3,091

495

Deferred tax liabilities - long-term
1,703

160

Other long-term liabilities
395

231

Total long-term liabilities
12,443

2,379

Stockholders' equity
 
 
Common stock, $.01 par value, authorized 50,000 shares; 7,534 issued and outstanding at July 31, 2016 and 7,306 issued and outstanding at January 31, 2016
76

74

Additional paid-in capital
53,475

53,031

Treasury Stock, 45 shares at July 31, 2016 and at January 31, 2016
(290
)
(290
)
Retained earnings
14,348

20,193

Accumulated other comprehensive loss
(2,950
)
(3,980
)
Total stockholders' equity
64,659

69,028

Total liabilities and stockholders' equity

$109,427


$138,123

See accompanying notes to consolidated financial statements.

3


MFRI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (unaudited)

($ in thousands, except share data)
 
Additional Paid-in Capital
Retained Earnings
Treasury Stock
Accumulated Other Comprehensive Income (Loss)
Total Stockholders' Equity
Common Stock
Total stockholders' equity at January 31, 2016
$74
$53,031
$20,193

($290
)
($3,980)
$69,028
 
 
 
 
 
 
 
Net loss
 
 

($5,845
)
 
 
(5,845
)
Stock options exercised

184

 
 
 
184

Restricted shares vested, deferred shares converted and payroll taxes paid with shares
2

123

 
 
 
125

Stock-based compensation expense
 
137

 
 
 
137

Marketable security unrealized gain/loss
 
 
 
 
(6
)
(6
)
Foreign currency translation adjustments
 
 
 
 
1,025

1,025

Tax benefit/expense on above items
 
 
 
 
11

11

Total stockholders' equity at July 31, 2016
$76
$53,475
$14,348
($290)
($2,950)
$64,659

Shares
2016

2015

 
Balances at beginning of year
7,305,925

7,290,576

 
Treasury stock purchased

(44,566
)
 
Shares issued
228,518

59,915

 
Balances at period end
7,534,443

7,305,925

 

See accompanying notes to consolidated financial statements.



4


MFRI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
Six Months Ended July 31,
 
2016

2015

Operating activities
 
 
Net loss

($5,845
)

($7,046
)
Adjustments to reconcile net loss to net cash flows provided by operating activities
 
 
Depreciation and amortization
2,830

2,903

Loss on consolidation of joint venture
1,620


Gains on disposal of subsidiaries
(867
)

Deferred tax (benefit) expense
(277
)
31

Stock-based compensation expense (benefit)
137

(26
)
Income from joint venture

(116
)
Cash surrender value on life insurance policies
(132
)
(64
)
Gain on disposal of fixed assets
(2,364
)

Provision on uncollectible accounts
400

192

Changes in operating assets and liabilities
 
 
Accounts receivable
16,277

(2,352
)
Inventories
5,004

(5,267
)
Costs and estimated earnings in excess of billings on uncompleted contracts
(296
)
2,325

Accounts payable
(4,889
)
8,250

Accrued compensation and payroll taxes
(5,884
)
4,642

Customers' deposits
(1,824
)
3,007

Income taxes receivable and payable
(1,418
)
(1,115
)
Prepaid expenses and other current assets
(1,233
)
1,178

Other assets and liabilities
(758
)
(6,469
)
Net cash provided by operating activities
481

73

Investing activities
 
 
Acquisition of interest in subsidiary, net of cash acquired
(4,672
)

Capital expenditures
(994
)
(4,997
)
Proceeds from surrender of corporate-owned life insurance policies
1,894


Receipts on loan from joint venture

1,890

Proceeds from sales of property and equipment
11,930


Net cash provided by (used in) investing activities
8,158

(3,107
)
Financing activities
 
 
Proceeds from revolving lines
21,113

48,585

Proceeds from debt
6,147

668

Proceeds from borrowing against life insurance policies

1,916

Payments of debt on revolving lines of credit
(29,835
)
(45,546
)
Payments of other debt
(10,044
)
(1,109
)
Payments of borrowing against life insurance policies

(1,916
)
(Decrease) increase in drafts payable
(248
)
359

Payments on capitalized lease obligations
(1,204
)
(434
)
Payments for repurchase of common stock

(290
)
Stock options exercised and restricted shares issued
309

(25
)
Net cash (used in) provided by financing activities
(13,762
)
2,208

Effect of exchange rate changes on cash and cash equivalents
104

326

Net decrease in cash and cash equivalents
(5,019
)
(500
)
Cash and cash equivalents - beginning of period
16,631

10,508

Cash and cash equivalents - end of period

$11,612


$10,008

Supplemental cash flow information
 
 
Interest paid

$457


$564

Income taxes paid
1,142

846

Fixed assets acquired under capital leases

732

Funds held in escrow related to the sale of Filtration assets
502


See accompanying notes to consolidated financial statements.




MFRI, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JULY 31, 2016
(Tabular amounts presented in thousands, except per share amounts)

1.
Basis of presentation. The interim consolidated financial statements of MFRI, Inc. and subsidiaries ("MFRI," "Company," or "Registrant") are unaudited, but include all adjustments which the Company's management considers necessary to present fairly the financial position and results of operations for the periods presented. These adjustments consist of normal recurring adjustments. Information and footnote disclosures have been omitted pursuant to Securities and Exchange Commission ("SEC") rules and regulations. The consolidated balance sheet as of January 31, 2016 is derived from the audited consolidated balance sheet as of that date. The results of operations for any interim period are not necessarily indicative of future or annual results. Interim financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's latest Annual Report on Form 10-K. The Company's fiscal year ends on January 31. Years and balances described as 2016 and 2015 are for the six months ended July 31, 2016 and 2015, respectively.

2.
Business segment reporting. As of January 31, 2016, MFRI is engaged in the manufacture and sale of products in one segment: Piping Systems. As described below, prior to January 29, 2016, the Company was also engaged in the manufacture and sale of products in the Filtration Products segment. Piping Systems engineers, designs, manufactures and sells specialty piping, leak detection and location systems. This segment'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 and long lines for oil and mineral transportation. Piping Systems' leak detection and location systems are sold with 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.

Prior to January 29, 2016, the Company had a Filtration Products segment. This business is reported as discontinued operations in the consolidated financial statements, and the notes to consolidated financial statements have been restated to conform to the current year reporting of this business. For further information, see "Notes to Consolidated Financial Statements Note 4 Discontinued operations".

For the three months ended July 31, 2016, no customer accounted for 10% of the Company's consolidated net sales, and for the three months ended July 31, 2015, one customer accounted for 10.2% of the Company's consolidated net sales. For the six months ended July 31, 2016, one customer accounted for 10.7% of the Company's consolidated net sales, and for the six months ended July 31, 2015, no customer accounted for 10% of the Company's consolidated net sales.

At July 31, 2016, one customer accounted for 16% of accounts receivable. Two customers accounted for 46% of accounts receivable at January 31, 2016.

 
Three Months Ended July 31,
 
Six Months Ended July 31,
 
2016

2015

 
2016

2015

Net sales
 
 
 
 
 
Piping Systems

$22,859


$25,147

 

$45,928


$45,424

Gross profit
 
 
 
 
 
Piping Systems

$2,980


$3,126

 

$4,972


$5,481

Loss from operations
 
 
 
 
 
Piping Systems

($714
)

($825
)
 

($2,415
)

($2,251
)
Corporate

($1,126
)

($1,705
)
 
(3,930
)
(3,849
)
Total loss from operations

($1,840
)

($2,530
)
 

($6,345
)

($6,100
)


6




3.
Acquisition. MFRI entered into a purchase agreement with its joint venture partner Aegion Corporation to acquire the remaining 51% ownership of Bayou Perma-Pipe Canada, Ltd. ("BPPC"), a coating and insulation company in Camrose, Alberta, which acquisition closed on February 4, 2016. MFRI had owned a 49% interest in BPPC since 2009, when the joint venture was formed with Aegion to serve the oil and gas industry in Western Canada.

The purchase price was $13.1 million CAD ($9.6 million USD) in cash and debt at closing and is subject to certain post-closing adjustments. The initial accounting for this acquisition is not complete pending detailed analyses of the facts and circumstances that existed as of the acquisition date. The following table represents the preliminary allocation of the total consideration in the acquisition of BPPC:

Total purchase consideration:
 
 
Cash
 

$7,587

Loan payable
 
2,000

Purchase consideration to third party
 
9,587

 
 
 
Fair Value of 49% Previously Held Equity Interest
 
7,492

Total purchase consideration
 

$17,079

 
 
 
Fair value of net assets acquired:
 
 
Cash and cash equivalents
 

$2,915

Property and equipment
 
12,670

Goodwill
 
2,657

Net working capital
 
406

Other assets (liabilities) net
 
(1,569
)
Net assets acquired
 

$17,079


The acquisition has preliminarily resulted in approximately $2.7 million of goodwill. The Company incurred legal, professional and other costs related to this acquisition. These one-time costs of $0.2 million were recognized as general and administrative expenses.

In the first quarter, the Company recognized a non-cash loss of $1.6 million, which represents the difference between the pre-existing book value interest in BPPC immediately prior to the acquisition remeasured to its fair value upon the acquisition date.

Pro Forma results - The following table summarizes, on a pro forma basis, the combined results of operations of the Company and the acquired business as though the acquisition had occurred as of February 1, 2015. The pro forma amounts presented are not necessarily indicative of either the actual consolidated results had the acquisition occurred as of February 1, 2015 or of future consolidated operating results.

 
Three Months Ended July 31,
Six Months Ended July 31,
 
2016

2015

2016

2015

Revenue

$22,859


$26,935


$45,928


$56,271

Net income (loss)
449

(2,448
)
(5,845
)
(6,916
)
Earnings (loss) per share basic and diluted

$0.06


($0.34
)

($0.79
)

($0.95
)

Pro forma results presented above primarily reflect revenues that were down due to the effect of oil prices on customer demand in the U.S. and Canada and on certain market conditions in the Middle East.


7


4.
Discontinued operations. On January 29, 2016, the Company sold certain assets and liabilities of its TDC Filter business based in Bolingbrook, Illinois to the Industrial Air division of CLARCOR. On January 29, 2016, the Company also sold its Nordic Air Filtration, Denmark and Nordic Air Filtration, United Arab Emirates ("U.A.E.") businesses to Hengst Holding GmbH. The aggregated sales price of these filtration businesses was $22.0 million, including cash proceeds of $18.4 million, of which $0.5 million is held in escrow until July 2017.

In May, 2016, the Company completed the sale of its Bolingbrook Filtration manufacturing facility to a third party at a price of $7.1 million. The sale generated approximately$1.9 million in net cash after expenses and mortgage payoffs.

The Company is currently engaged in liquidating the remaining assets of the Filtration bag business in Winchester, Virginia. The Filtration business segment is reported as discontinued operations in the consolidated financial statements, and the notes to consolidated financial statements have been revised to conform to the current year reporting. There was $0.7 million of tax expense for the three and six months ended July 31, 2016. Results from discontinued operations net of tax for the three and six months ended July 31, 2016 and 2015 were as follows:
 
Three Months Ended July 31,
Six Months Ended July 31,
 
2016

2015

2016

2015

Net sales

$3,276


$14,914


$10,467


$32,311

 
 
 
 
 
Gain on disposal of discontinued operations

$1,605


$—


$2,472


$—

Income (loss) from discontinued operations

$423


($35
)
(660
)
(1,338
)
Income (loss) from discontinued operations before income taxes
2,028

(35
)
1,812

(1,338
)
Income tax expense
719

88

703

88

Income (loss) from discontinued operations, net of tax

$1,309


($123
)

$1,109


($1,426
)

Components of assets and liabilities from discontinued operations consist of the following:
 
July 31, 2016

January 31, 2016

Current assets
 
 
Cash and cash equivalents

$—


$5

Trade accounts receivable, net
597

5,720

Inventories, net

2,000

Other assets
212

1,552

Property, plant and equipment, net of accumulated depreciation
1,739

6,456

Total assets from discontinued operations

$2,548


$15,733

Current liabilities
 
 
Trade accounts payable, accrued expenses and other

$1,320


$7,514

Current maturities of long-term debt

5,322

Other liabilities

2,629

Total liabilities from discontinued operations

$1,320


$15,465



8


Cash flows from discontinued operations:
 
Six Months Ended July 31,
 
2016

2015

Net cash (used in) provided by discontinued operating activities

($208
)

$224

Net cash provided by (used in) discontinued investing activities
7,574

(1,295
)
Net cash (used in) provided by discontinued financing activities
(7,365
)
754



9



5.
Income taxes. The determination of the consolidated provision for income taxes, deferred tax assets and liabilities and related valuation allowances requires management to make judgments and estimates. As a company with subsidiaries in foreign jurisdictions, the process of calculating income taxes involves estimating current tax obligations and exposures in each jurisdiction as well as making judgments regarding the future recoverability of deferred tax assets. Income earned in the U.A.E. is not subject to local country income tax. Additionally, the relative proportion of taxable income earned domestically versus internationally can fluctuate significantly from period to period. Changes in the estimated level of annual pre-tax income, tax laws and the results of tax audits can affect the overall effective income tax rate, which impacts the level of income tax expense and net income. Judgments and estimates related to the Company's projections and assumptions are inherently uncertain; therefore, actual results could differ materially from projections.

The Company's effective tax rate ("ETR") from continuing operations for the second quarter and year-to-date was 55.6% and 16.1%, respectively compared to 17.3% and 7.4% during the respective prior-year periods. The change in the ETR from the prior year-to-date to the current year-to-date is mainly due to lower activity in the U.A.E., the Canadian acquisition and the allocation of tax expense between continuing operations, other comprehensive income and discontinued operations when applying intraperiod allocation rules.

Income tax expense (or benefit) for each year is allocated to continuing operations, discontinued operations, extraordinary items, other comprehensive income, and other charges or credits recorded directly to stockholders’ equity. This allocation is commonly referred to as an intra-period tax allocation, as outlined in ASC 740, Income Taxes ("ASC 740"). When considering intra-period tax allocations, a company also should consider the accounting for income taxes in interim periods. ASC 740-20-45-7 requires that the tax effect of pretax income from continuing operations be determined without regard to the tax effects of items not included in continuing operations. This is commonly referred to as the "incremental approach", where the tax provision is generally calculated for continuing operations without regard to other items.

ASC 740 also includes an exception to the general principle of intra-period tax allocation discussed above. This exception requires that all items (e.g., extraordinary items, discontinued operations, including items charged or credited directly to other comprehensive income) be considered in determining the amount of tax benefit that results from a loss from continuing operations. That is, when a company has a current period loss from continuing operations, management must consider income recorded in other categories in determining the tax benefit that is allocated to continuing operations.

The exception in ASC 740 applies in all situations in which there is a loss from continuing operations and income from other items outside of continuing operations. This would include situations in which a company has recorded a full valuation allowance at the beginning and end of the period, and the overall tax provision for the year is zero (i.e., a benefit would be recognized in continuing operations even though the loss from continuing operations does not provide a current year incremental tax benefit). The ASC 740 exception, however, only relates to the allocation of the current year tax provision (which may be zero) and does not change a company’s overall tax provision. While intra-period tax allocation in general does not change the overall tax provision, it may result in a gross-up of the individual components, thereby changing the amount of tax provision included in each category.

The amount of unrecognized tax benefits, including interest and penalties, at July 31, 2016, recorded in other long-term liabilities was $0.1 million, all of which would impact the Company’s effective tax rate if recognized.  The Company includes accrued interest and penalties related to uncertain tax positions in income tax expense, with $1,200 included in expense for the current quarter.  The amount of accrued interest and penalties at July 31, 2016 associated with unrecognized tax benefits was $47,300.

The Company files income tax returns in U.S. federal and state jurisdictions. The IRS began an audit of the fiscal year ended January 31, 2015 in August 2016.

6.
Impairment of long-lived assets and assets held for sale. The Company evaluates long-lived assets (including intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of

10



a long-lived asset may not be recoverable. An asset is considered impaired if its carrying amount exceeds the undiscounted future net cash flow the asset is expected to generate. There was no impairment of long-lived assets as of July 31, 2016 and January 31, 2016.

Goodwill. Goodwill represents the excess of purchase price over the fair value of the net assets acquired in conjunction with the Company’s acquisition of BPPC.

7.
Other intangible assets with definite lives. The Company owns several patents, including those covering features of its piping and electronic leak detection systems. Patents are capitalized and amortized on a straight-line basis over a period not to exceed the legal lives of the patents. The Company expenses costs incurred to renew or extend the term of intangible assets. Gross patents were $2.61 million and $2.59 million as of July 31, 2016 and January 31, 2016, respectively. Accumulated amortization was approximately $2.36 million and $2.33 million as of July 31, 2016 and January 31, 2016, respectively. Future amortizations over the next five years ending January 31 will be $22,900 in 2017, $41,600 in 2018, $33,650 in 2019, $30,650 in 2020, $24,450 in 2021, and $101,200 thereafter. Patents are included in other assets in the balance sheet.
 
Three Months Ended July 31,
Six Months Ended July 31,
 
2016

2015

2016

2015

Patent amortization expense

$11


$13


$22


$26


8.
Stock-based compensation. The Company has stock-based compensation awards that can be granted to eligible employees, officers or directors.
 
Three Months Ended July 31,
Six Months Ended July 31,
 
2016

2015

2016

2015

Stock-based compensation benefit

($282
)

($96
)

($284
)

($37
)
Restricted stock based compensation expense

$390


$169


$668


$258


Stock-based compensation for 2016 was a benefit year-to-date due to cancellations. Most of these cancellations related to former employees from the Company's discontinued operations. The increase in the restricted stock based compensation expense relates to a grant in March 2016 and the conversion of performance restricted stock units to time-based restricted shares. This increase is partially offset by a decrease in management incentive compensation expense.

Stock Options. The fair value of the outstanding option awards was estimated on the grant dates using the Black-Scholes option pricing model.
 
Six Months Ended July 31,
Fair value assumptions
2016
2015
Expected volatility
40.88% - 57.02%
40.88% - 59.39%
Risk free interest rate
.74% - 1.77%
.74% - 1.77%
Dividend yield
none
none
Expected life
5.0 - 5.1 years
4.9 - 5.1 years


11



Option activity
Options
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
Outstanding at January 31, 2016
720


$11.38

5.1

$34

Granted
22

7.33

 
 
Exercised
(28
)
6.50

 
26

Expired or forfeited
(110
)
10.42

 
 
Outstanding end of period
604

11.63

4.9
259

 
 
 
 
 
Exercisable end of period
511


$12.05

4.3

$220


Unvested option activity
Options
Weighted Average Grant Date Fair Value
Aggregate Intrinsic Value
Outstanding at January 31, 2016
166


$9.51


$—

Granted
22

7.33

 
Vested
(60
)
 
 
Expired or forfeited
(35
)
8.99

 
Outstanding end of period
93


$9.33


$39


As of July 31, 2016, there was $0.3 million of total unrecognized compensation expense related to unvested stock options. The expense is expected to be recognized over a period of 2.3 years.

Restricted stock. The following table summarizes restricted stock activity for the year:
Restricted stock activity
Restricted Shares
Weighted Average Grant Price Per Share
Aggregate Intrinsic Value
Outstanding at January 31, 2016
163


$8.60


$1,040

Granted
241

7.26

 
Issued
(94
)
 
 
Forfeited
(1
)
6.38

 
Outstanding end of period
309


$7.91


$2,157


As of July 31, 2016, there was $0.8 million of unrecognized compensation expense related to unvested restricted stock granted under the plans. The cost is expected to be recognized over the weighted-average period of 2.9 years.


12



9.    Earnings per share.
 
Three Months Ended July 31,
Six Months Ended July 31,
 
2016

2015

2016

2015

Basic weighted average common shares outstanding
7,481

7,277

7,416

7,264

Dilutive effect of equity compensation plans
122




Weighted average common shares outstanding assuming full dilution
7,603

7,277

7,416

7,264

 
 
 
 
 
Stock options not included in the computation of diluted earnings per share of common stock because the option exercise prices exceeded the average market prices of the common shares
356

740

378

672

 
 
 
 
 
Stock options with an exercise price below the average market price
248

16

226

84


10.    Interest expense, net.
 
Three Months Ended July 31,
Six Months Ended July 31,
 
2016

2015

2016

2015

Interest expense

$139


$172


$392


$367

Interest income
(42
)
(10
)
(69
)
(284
)
Interest expense, net

$97


$162


$323


$83


11.    Debt. Debt totaled $12.3 million at July 31, 2016, a net decrease of $3.2 million since January 31, 2016.

Revolving lines domestic. On September 24, 2014, the Company entered into a Credit and Security Agreement with a financial institution (as amended, "Credit Agreement"). Under the terms of the Credit Agreement, which matures on September 24, 2019, the Company can borrow up to $15.0 million, subject to borrowing base availability from secured domestic assets, such as accounts receivable and inventory, and other requirements, under a revolving line of credit. The Credit Agreement covenants restrict debt, liens, and investments, and require attainment of specific levels of profitability and cash flows. At July 31, 2016, the Company was in compliance with loan covenants. The domestic revolving line balance as of July 31, 2016 and January 31, 2016 was included as a current liability in the consolidated balance sheets.

Interest rates vary based on the average availability in the preceding fiscal quarter and are: (a) a margin in effect plus a base rate, if below certain availability limits; or (b) a margin in effect plus the Eurodollar rate for the corresponding interest period. As of July 31, 2016, the Company had borrowed $3.8 million at 3.5% and 2.22% and had $7.0 million available to it under the revolving line of credit. In addition, $0.3 million of availability was used under the Credit Agreement primarily to support letters of credit to guarantee amounts committed for inventory purchases. Cash required for operations, as needed, is provided by draw downs on the line of credit.

Revolving lines foreign. The Company also had credit arrangements used by its Middle Eastern subsidiaries. These credit arrangements are in the form of overdraft facilities and project financing at rates competitive in the countries in which the Company operates. The lines of credit are secured by certain equipment, certain assets, such as accounts receivable and inventory, and a guarantee by the Company. The Company's credit arrangement covenants require a minimum tangible net worth to be maintained. At July 31, 2016, the Company was in compliance with the covenants under the credit arrangements. At July 31, 2016, interest rates were 4.0% per annum below National Bank of Fujairah Base Rate, minimum 3.5% per annum, and Emirates Inter Bank Offered Rate (EIBOR) plus 3.5% per annum. At July 31 2016, the Company's interest rates range from 3.5% to 6.0%. At July 31, 2016, the Company had available borrowing capacity of $29.1 million under these credit arrangements. In addition, $7.7 million of availability was used to support letters of credit to guarantee amounts committed for inventory purchases

13



and project completion guarantees. At July 31, 2016, borrowings under these credit arrangements totaled $0.8 million; an additional $20.6 million remained unused. The foreign revolving lines balances as of July 31, 2016 and January 31, 2016 were included as current maturities of long-term debt in the consolidated balance sheets.

On February 1, 2016, the Company executed a promissory note in favor of United Pipeline Systems Limited, an affiliate of Aegion, Inc. for $2.0 million. The promissory note was paid on July 28, 2016. In addition, the Company on July 28, 2016 paid off the balance of $2.2 million in previously affiliated debt to Aegion in its Canadian subsidiary which was acquired in the purchase of BPPC.

On July 28, 2016, the Company borrowed $8.0 million CAD (approximately $6.1 million USD at the prevailing exchange rate on the transaction date) from a bank in Canada under a mortgage note secured by the manufacturing facility located in Alberta, Canada that matures on December 23, 2042. The interest rate is variable, currently at 4.7% with monthly payments of $31 thousand CAD (approximately $24 thousand USD) for interest; principal payments begin January 2017.

12.    Fair Value. In relation to the acquisition of BPPC, the Company estimated the fair value of the assets acquired and liabilities assumed at acquisition date. See "Notes to Consolidated Financial Statements Note 3 Acquisition", for a further discussion of this purchase. The carrying values of cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair value due to their short-term nature. The carrying amount of the Company's short-term debt, revolving line of credit and long-term debt approximate fair value, because the majority of the amounts outstanding accrue interest at variable rates.

The Company held a marketable equity security of approximately $0.1 million at July 31, 2016, which it classified as available-for-sale and recorded in other non-current assets on the Consolidated Balance Sheet. This security is carried at estimated fair value with unrealized gains and losses reflected in Accumulated Other Comprehensive Income and classified as Level 1 in the fair value hierarchy. The assessment for impairment of marketable equity securities as available-for sale is based on established financial methodologies, including quoted market prices for publicly traded securities. If the Company determines that a loss in the value of the investment is other than temporary, any such losses are recorded in other expense (income), net.

13.
Other accrued liabilities. In the second quarter, the Company recorded a legal settlement accrual of $0.8 million, which is included in other accrued liabilities.

14.
Recent accounting pronouncements. In August 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The new standard provides guidance on eight targeted areas and how they are presented and classified in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017. The Company is currently evaluating the effect that this standard will have on the consolidated financial statements.

In March 2016, the FASB issued guidance relating to the accounting for share-based payment transactions. This guidance involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classifications of awards as either equity or liabilities and classification on the statement of cash flows. The standard is effective for the Company beginning in its fiscal year 2017, including interim periods within those fiscal years, and early adoption is permitted. The Company is currently evaluating the effect that this standard will have on the consolidated financial statements and related disclosures.


14



In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires entities to recognize assets and liabilities for most leases on their balance sheets. It also requires additional qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU No. 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted.  The Company is currently evaluating the effect that this standard will have on the consolidated financial statements and related disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40) - Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. The adoption of ASU 2014-15 is not expected to have an impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This new standard provides for a single comprehensive model and supersedes most current revenue recognition guidance, including industry specific guidance, and provides for enhanced disclosure requirements. The objective of the new guidance is to improve the consistency, comparability and usefulness to users of financial statements. On April 1, 2015, FASB decided to defer the effective date of the new revenue standard by one year. As a result, public entities would apply the new revenue standard for fiscal years, and interim periods within those years, beginning after December 15, 2017. ASU 2014-09 provides for two implementation methods (1) full retrospective application to each prior period or (2) modified retrospective application with the cumulative effect as of the date of adoption. The Company is evaluating the financial statement impacts of the guidance in this ASU and determining which transition method will be utilized.

15.    Reclassifications. Reclassifications were made to the prior-year balance sheet to conform to the current-year presentations.

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")

The statements contained under the caption MD&A and other information contained elsewhere in this quarterly 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 as a result of many factors, including, but not limited to, those under the heading Item 1A. Risk Factors included in the Company's latest Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Consolidated MFRI, Inc.

MFRI, Inc. is engaged in the manufacture and sale of products in one reportable segment: Piping Systems. The Company's website is www.mfri.com. Since the Piping Systems segment is based on large discrete projects, operating results could be negatively impacted in the future as a result of large variations in the level of market demand in both geographies and reporting periods.

This discussion should be read in conjunction with the consolidated financial statements, including the notes thereto, contained elsewhere in this report. An overview of the segment results is provided in "Notes to Consolidated Financial Statements, Note 2 Business segment reporting" contained in Item 1 of this report.

For the three months ended July 31, 2016, no customer accounted for 10% of the Company's consolidated net sales, and for the three months ended July 31, 2015, one customer accounted for 10.2% of the Company's consolidated net sales. For the six months ended July 31, 2016, one customer accounted for 11% of the Company's consolidated net sales, and for the six months ended July 31, 2015, no customer accounted for 10% of the Company's consolidated net sales.

15




At July 31, 2016, one customer accounted for 16% of accounts receivable. Two customers accounted for 46% of accounts receivable at January 31, 2016.

Prior to January 29, 2016, the Company was also engaged in the manufacture and sale of products in the Filtration Products segment.  On January 29, 2016, the Company sold certain assets and liabilities of its TDC Filter business based in Bolingbrook, Illinois and its Nordic Air Filtration, Denmark and Nordic Air Filtration, U.A.E. businesses. The Company is currently engaged in liquidating the remaining assets of the Filtration bag business in Winchester, Virginia. The Filtration business segment is reported as discontinued operations in the consolidated financial statements, and the notes to consolidated financial statements have been revised to conform to the current year reporting. There was $0.7 million of tax expense for the three and six months ended July 31, 2016. For further information, see "Notes to Consolidated Financial Statements, Note 4 Discontinued operations".

Piping Systems
 
Three Months Ended July 31,
Six Months Ended July 31,
($ in thousands)
2016

%
2015

%
% Increase (decrease)
2016

%

2015

%

% Increase (decrease)
Net sales
$22,859
 
$25,147
 
(9
)%
$45,928
 
$45,424
 
1
 %
Gross profit
2,980

13
 %
3,126

12
 %
(5
)%
4,972
11
 %
5,481
12
 %
(9
)%
General and administrative expenses
2,244

10
 %
2,522

10
 %
(11
)%
4,533

10
 %
5,084
11
 %
(11
)%
Selling expenses
1,450

6
 %
1,429

6
 %
1
 %
2,854

6
 %
2,648
6
 %
8
 %
Loss from operations
(714
)
(3
)%
(825
)
(3
)%
(13
)%
(2,415
)
(5
)%
(2,251
)
(5
)%
7
 %
Loss on consolidation of joint venture

 

 
 
(1,620
)
 

 
 

Three months ended July 31, 2016 ("current quarter") vs. Three months ended July 31, 2015 ("prior-year quarter")

On December 31, 2015, MFRI entered into a purchase agreement with its joint venture partner Aegion Corporation to acquire the remaining 51% ownership of BPPC, a coating and insulation company in Camrose, Alberta, which acquisition closed on February 4, 2016.

The purchase price was $13.1 million CAD ($9.6 million USD) in cash and debt at closing and is subject to certain post-closing adjustments. The initial accounting for this acquisition is not complete pending detailed analysis of the facts and circumstances that existed as of the acquisition date.

The acquisition has preliminarily resulted in approximately $2.7 million of goodwill. In the first quarter, the Company recorded a one-time non-cash loss of $1.6 million from the consolidation of the joint venture. The Company incurred legal, professional and other costs related to this acquisition. These one-time costs of $0.2 million were recognized as general and administrative expenses.

Current quarter vs. prior-year quarter

Net sales decreased 9% to $22.9 million in the current quarter from $25.1 million in the prior-year quarter. The decrease was driven by weak demand in the Middle East due to the economic downturn in the region affected by low oil prices.

Gross margin increased to 13% of net sales in the current quarter from 12% of net sales in the prior-year quarter due to favorable margins in domestic oil and gas and projects completed in India. Gross profit decreased due to pricing pressure in the Middle East.


16



General and administrative expenses decreased to $2.2 million from $2.5 million, despite a one-time legal settlement accrual of $0.8 million partially offset by $0.5 million gain in foreign currency exchange.

Selling expenses increased to $1.5 million from $1.4 million due to the addition of the Canadian entity now included.

Six months ended July 31, 2016 ("year-to-date") vs. Six months ended July 31, 2015 ("prior-year year-to-date")

Net sales increased 1% to $45.9 million year-to-date from $45.4 million in the prior-year-to-date. The Canadian operations contributed $4.5 million, which was offset by decreases in year-over-year revenue in the Middle East for the reasons previously discussed.

Gross margin decreased to 11% of net sales year-to-date from 12% of net sales in the prior-year-to-date. Gross margin and gross profit decreased due to competitive pricing pressure in the Middle East and operations of the newly acquired Canadian facility, which had relatively low capacity utilization in the first half of the year.

General and administrative expenses decreased to $4.5 million from $5.1 million despite a one-time legal settlement of $0.8 million and the addition of the Canadian general and administrative expenses in the period. There was a decrease of $0.6 million in comparable general and administrative expenses year-over-year.

Selling expenses increased to $2.9 million from $2.6 million mainly due to the addition of the Canadian activity.

Corporate
Current quarter vs. prior-year quarter

Corporate operating expenses include general and administrative expenses that are not allocated to the segment. General and administrative expenses decreased to $1.1 million in the current quarter from $1.7 million in the prior-year quarter. This decrease was due to $0.4 million lower stock compensation expense and reduced staffing.

Net interest expense decreased to $97 thousand in the current quarter from $162 thousand in the prior-year quarter due to lower borrowings both domestic and foreign.

Year-to-date vs. prior-year year-to-date

General and administrative expenses increased to $3.9 million year-to-date from $3.8 million in the prior-year-to-date. In the first quarter, the Company had a reduction of its workforce and incurred severance expense of $0.3 million.

Net interest expense increased to $0.3 million year-to-date from $0.1 million in the prior-year period. Interest income decreased in India because of a dividend payment made in January 2016 to support the acquisition of BPPC.

Pretax loss from continuing operations was $1.9 million in the current quarter versus $2.7 million in the prior-year quarter due to:
reduced volume in North American oil and gas operations affected by low oil prices
competitive pricing pressure and uncertain market conditions in the Middle East
a one-time $0.8 million lawsuit settlement
$0.4 million related to the Canadian facility now included in the consolidated financial statements
increased professional services associated with the changes in the Company's business structure to concentrate on a single line of business.

Pretax loss from continuing operations was $8.3 million year-to-date versus $6.1 million in the prior-year-to-date. The factors contributing to the 2016 results were:

17



reduced volume in North American oil and gas operations affected by low oil prices
competitive pricing pressure and uncertain market conditions in the Middle East
a non-cash loss of $1.6 million from the consolidation of the joint venture
a one-time $0.8 million lawsuit settlement
$1.1 million related to the Canadian facility now included in the consolidated financial statements
$0.3 million in severance costs
increased professional services associated with the changes in the Company's business structure to concentrate on a single line of business.

INCOME TAXES

The Company's effective tax rate ("ETR") from continuing operations for the quarter and year-to-date was 55.6% and 16.1%, respectively, compared to 17.3% and 7.4% during the respective prior-year periods. The change in the ETR from the prior year-to-date to the current year-to-date is mainly due to lower activity in the U.A.E., the Canadian acquisition and the allocation of tax expense between continuing operations, other comprehensive income and discontinued operations when applying intraperiod allocation rules. The Company remains in a domestic NOL carryforward position. For additional information, see "Notes to Consolidated Financial Statements, Note 5 Income taxes".

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents as of July 31, 2016 were $11.6 million compared to $16.6 million at January 31, 2016. At July 31, 2016, $0.2 million was held in the U.S., and $11.4 million was held at the foreign subsidiaries. The Company's working capital was $32.2 million on July 31, 2016 compared to $30.3 million on January 31, 2016. Of the working capital components, accounts receivable decreased $7.7 million, inventory decreased $1.6 million and accounts payable decreased $3.1 million. Net cash provided by operating activities during the first six months of 2016 was $0.5 million compared to $0.1 million during the first six months of 2015.

During the quarter, the Company paid out $0.7 million under its terminated deferred compensation plans. The Company has paid $3.2 million year-to-date under its terminated deferred compensation plans. $1.9 million of these payments were funded by the liquidation of life insurance contracts previously purchased by the Company.

The Company has not provided for Federal tax on unremitted earnings of its Middle East subsidiaries. The Company does not believe that it will be necessary to repatriate investments from these subsidiaries.

Net cash provided by investing activities for the six months ended July 31, 2016 was $8.2 million of which $11.9 million was from the proceeds of several sales discussed below, partially offset by $4.7 million related to the acquisition of BPPC.

In May 2016, the Company completed the sale of its former corporate headquarters, land and building, to a third party at a purchase price of $4.4 million. The sale generated approximately $0.4 million in net cash after expenses and mortgage payoff.

In May 2016, the Company also completed the sale of its Bolingbrook Filtration facility to a third party at a purchase price of $7.1 million. The sale generated approximately $1.9 million in net cash after expenses and mortgage payoff.

Debt totaled $12.3 million at July 31, 2016, a net decrease of $3.2 million compared to the beginning of the current fiscal year. For additional information, see "Notes to Consolidated Financial Statements, Note 11 Debt". Net cash used in financing activities was $13.8 million for the six months ended July 31, 2016.

On September 24, 2014, the Company entered into a Credit and Security Agreement with a financial institution (as amended, "Credit Agreement"). Under the terms of the Credit Agreement, which matures on September 24, 2019,

18



the Company can borrow up to $15.0 million, subject to borrowing base availability from secured domestic assets, such as accounts receivable and inventory, and other requirements, under a revolving line of credit. The Credit Agreement covenants restrict debt, liens, and investments, and require attainment of specific levels of profitability and cash flows. At July 31, 2016, the Company was in compliance with loan covenants. The domestic revolving line balance as of July 31, 2016 and January 31, 2016 was included as a current liability in the consolidated balance sheets.

Interest rates vary based on the average availability in the preceding fiscal quarter and are: (a) a margin in effect plus a base rate, if below certain availability limits; or (b) a margin in effect plus the Eurodollar rate for the corresponding interest period. As of July 31, 2016, the Company had borrowed $3.8 million at 3.5% and 2.22% and had $7.0 million available to it under the revolving line of credit. In addition, $0.3 million of availability was used under the Credit Agreement primarily to support letters of credit to guarantee amounts committed for inventory purchases. Cash required for operations, as needed, is provided by draw downs on the line of credit.

Revolving lines foreign. The Company also had credit arrangements used by its Middle Eastern subsidiaries. These credit arrangements are in the form of overdraft facilities and project financing at rates competitive in the countries in which the Company operates. The lines of credit are secured by certain equipment, certain assets, such as accounts receivable and inventory, and a guarantee by the Company. The Company's credit arrangement covenants requires a minimum tangible net worth to be maintained. At July 31, 2016, the Company was in compliance with the covenants under the credit arrangements. At July 31, 2016, interest rates were 4.0% per annum below National Bank of Fujairah Base Rate, minimum 3.5% per annum, and Emirates Inter Bank Offered Rate (EIBOR) plus 3.5% per annum. At July 31, 2016, the Company's interest rates range from 3.5% to 6.0%. At July 31, 2016, the Company had available borrowing capacity of $29.1 million under these credit arrangements. In addition, $7.7 million of availability was used to support letters of credit to guarantee amounts committed for inventory purchases and project completion guarantees. At July 31, 2016, borrowings under these credit arrangements totaled $0.8 million; an additional $20.6 million remained unused. The foreign revolving lines balances as of July 31, 2016 and January 31, 2016 were included as current maturities of long-term debt in the consolidated balance sheets.

The Company believes its current cash and cash flow from operations, together with borrowing capacity under the revolving credit facilities, will be sufficient to fund anticipated operations, working capital and capital spending needs for at least the next 12 months.

On February 1, 2016, the Company executed a promissory note in favor of United Pipeline Systems Limited, an affiliate of Aegion, Inc. for $2.0 million. The promissory note was paid on July 28, 2016. In addition, the Company July 28, 2016 paid off the balance of $2.2 million in previously affiliated debt to Aegion in its Canadian subsidiary which was acquired in the purchase of BPPC.

On July 28, 2016, the Company borrowed $8.0 million CAD (approximately $6.1 million USD at the prevailing exchange rate on the transaction date) from a bank in Canada under a mortgage note secured by the manufacturing facility located in Alberta, Canada that matures on December 23, 2042. The interest rate is variable, currently at 4.7% with monthly payments of $31 thousand CAD (approximately $24 thousand USD) for interest; principal payments begin January 2017.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies are described in Item 7. MD&A and in the Notes to the Consolidated Financial Statements for the year ended January 31, 2016 contained in the Company's most recent Annual Report on Form 10-K. Any new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements have been discussed in the Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q. The application of critical accounting policies may require management to make assumptions, judgments and estimates about the amounts reflected in the Consolidated Financial Statements. Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.

Item 4.    Controls and Procedures

19




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 July 31, 2016. This evaluation included consideration of the controls, processes, and procedures that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Management has previously reported on a material weakness in our internal control over financial reporting in connection with calculations to determine whether the acquisition of certain assets was material to the Company, which resulted in a failure to timely file a current report on Form 8-K, leading management to conclude that disclosure controls and procedures were not effective.

As described below, the Company has adopted and implemented policies and procedures to ensure that management’s review process over estimates and calculations pertaining to the acquisition of assets properly factors in all relevant assumptions and required inputs including inputs from outside advisors as appropriate. These controls have been operating since April 30, 2016 and for the quarter ending July 31, 2016, as the Company has since filed all subsequently required reports with the SEC on a timely basis.

Notwithstanding the material weaknesses described above, our management, including our Chief Executive Officer and Chief Financial Officer, has concluded that the financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations, and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

Change in Internal Controls: A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

As reported in our assessment of the effectiveness of our internal control over financial reporting as of January 31, 2016 described in Item 9A of the Company's January 31, 2016 10-K filed on April 28, 2016, the Company's processes, procedures and controls related to the preparation, review and filing related to management’s period end review over certain calculations and estimates did not operate effectively, which resulted in a failure to timely file a current report on Form 8-K.

As reported in our assessment of the effectiveness of our internal control over financial reporting as of January 31, 2016 described in Item 9A of the Company's January 31, 2016 10-K filed on April 28, 2016, the Company reported a material weakness regarding excess and obsolete inventory reserves. Starting in the quarter ending April 30, 2016, we have implemented certain policies and procedures that now calculates excess and obsolete inventory reserve centrally and qualitative assessments are reviewed by appropriate operations management as well as the Corporate Controller on a quarterly basis. The excess and obsolete inventory reserve methodology is now calculated using the demand, the age of the inventory and specific identification determined based on extended value of excess inventory. We have tested the newly implemented controls and found them to be effective and have concluded that, as of July 31, 2016, this material weakness has been remediated.

Remediation Plan for the Material Weakness in Internal Control over Financial Reporting: To address the material weakness regarding timely filing of the current report on Form 8-K, the Company has adopted a revised policy to ensure that management’s review process over complex estimates and calculations pertaining to the acquisition of assets properly factors in all relevant assumptions and required inputs including inputs from outside advisors as appropriate. The 8-K/A filing of required disclosures including audited comparative financial statements for the acquired business and a pro-forma statement of the Company, including the acquired assets and liabilities, is expected to be completed by the end of the third quarter to bring the Company current with all required filings.

PART II OTHER INFORMATION

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Item 6.     Exhibits

31
 
Rule 13a - 14(a)/15d - 14(a) Certifications
(1) Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(2) Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32
 
Section 1350 Certifications (Chief Executive Officer and Chief Financial Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
101.INS
 
XBRL Instance
101.SCH
 
XBRL Taxonomy Extension Schema
101.CAL
 
XBRL Taxonomy Extension Calculation
101.DEF
 
XBRL Taxonomy Extension Definition
101.LAB
 
XBRL Taxonomy Extension Labels
101.PRE
 
XBRL Taxonomy Extension Presentation


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SIGNATURES


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


MFRI, INC.

Date:
September 9, 2016
/s/ Bradley E. Mautner
 
 
Bradley E. Mautner
 
 
Director, President and
 
 
Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
Date:
September 9, 2016
/s/ Karl J. Schmidt
 
 
Karl J. Schmidt
 
 
Vice President and Chief Financial Officer
 
 
(Principal Financial and Accounting Officer)



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