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 October 31, 2001 ------------------------------------------------- OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES -------- EXCHANGE ACT OF 1934 For the transition period from to ----------------- ------------------- Commission file number 0-18370 ------- MFRI, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 36-3922969 - ----------------------------------------------------------- -------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 7720 Lehigh Avenue Niles, Illinois 60714 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (847) 966-1000 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name,former address and former fiscal year,if changed since last report) 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 X No ------- ------ On December 14, 2001, there were 4,922,364 shares of the Registrant's common stock outstanding.
PART I - FINANCIAL INFORMATION Item 1. Financial Statements The accompanying interim condensed consolidated financial statements of MFRI, Inc. and subsidiaries (the "Company") 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. Certain information and footnote disclosures have been condensed or omitted pursuant to Securities and Exchange Commission rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's annual report on Form 10-K for the year ended January 31, 2001. The results of operations for the quarter ended October 31, 2001 are not necessarily indicative of the results to be expected for the full year 2001. <TABLE> <CAPTION> MFRI, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (In thousands except per share information) Three Months Ended Nine Months Ended October 31, October 31, ----------------------------- --------------------------- 2001 2000 2001 2000 ---------- ----------- ------------ ------------ <S> <C> <C> <C> <C> Net sales $32,393 $36,943 $97,275 $112,677 Cost of sales 25,464 29,418 75,156 88,244 ---------- ----------- ------------ ------------- Gross profit 6,929 7,525 22,119 24,433 Selling expense 2,304 2,923 7,453 9,302 General and administrative expense 3,574 3,521 10,664 10,766 ---------- ----------- ------------ ------------- Income from operations 1,051 1,081 4,002 4,365 Interest expense - net 660 796 2,025 2,243 ---------- ----------- ------------ ------------- Income before income taxes 391 285 1,977 2,122 Income taxes 230 128 880 881 ---------- ----------- ------------ ------------- Net income $ 161 $ 157 $ 1,097 $ 1,241 ========== =========== ============ ============= Net income per common share - basic $0.03 $0.03 $0.22 $0.25 Net income per common share - diluted $0.03 $0.03 $0.22 $0.25 Weighted average common shares outstanding 4,922 4,922 4,922 4,922 Weighted average common shares outstanding assuming full dilution 4,922 4,922 4,922 4,923 See notes to condensed consolidated financial statements. </TABLE> 1
<TABLE> <CAPTION> MFRI, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands except per share information) October 31, January 31, Assets 2001 2001 - ---------------------------------------------------------------------------------------------- Current Assets: <S> <C> <C> Cash and cash equivalents $ 132 $ 290 Trade accounts receivable, net 22,297 26,944 Costs and estimated earnings in excess of billings on uncompleted contracts 2,855 3,208 Deferred income taxes 2,904 2,905 Inventories 20,340 21,220 Prepaid expenses and other current assets 1,478 1,404 ------------ ----------- Total current assets 50,006 55,971 Property, Plant and Equipment, At Cost 46,964 45,704 Less Accumulated Depreciation 16,455 14,353 ------------ ----------- Property, plant and equipment, net 30,509 31,351 Other Assets: Goodwill, net 12,610 12,989 Other, net 4,467 4,474 ------------ ----------- Total other assets 17,077 17,463 ------------ ----------- Total Assets $ 97,592 $ 104,785 ============ =========== Liabilities and Stockholder's Equity - -------------------------------------------------------------------------------------------- Current Liabilities: Accounts payable $ 10,202 $12,469 Commissions payable 5,239 5,492 Current maturities of long-term debt 10,699 2,745 Billings in excess of costs and estimated earnings on uncompleted contracts 979 578 Other current liabilities 3,460 5,208 ------------ ----------- Total current liabilities 30,579 26,492 Long-Term Liabilities: Long-term debt, less current maturities 23,708 36,421 Deferred income taxes 2,086 2,090 Other 1,402 983 ------------ ----------- Total long-term liabilities 27,196 39,494 Stockholder's Equity: Common stock, $.01 par value, authorized-50,000 shares; outstanding - 4,922 at October 31 and January 31 49 49 Additional paid-in capital 21,397 21,397 Retained earnings 19,196 18,099 Accumulated other comprehensive loss (825) (746) ------------ ----------- Total stockholders' equity 39,817 38,799 ------------ ----------- Total Liabilities and Stockholders' Equity $ 97,592 $ 104,785 ============ =========== See notes to condensed consolidated financial statements. </TABLE> 2
<TABLE> <CAPTION> MFRI, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended (In thousands) October 31, ------------------------------- 2001 2000 ------------- ------------- Cash Flows from Operating Activities: <S> <C> <C> Net income $ 1,097 $ 1,241 Adjustments to reconcile net income to net cash flows from operating activities: Provision for depreciation and amortization 3,042 3,342 Change in operating assets and liabilities: Trade accounts receivable 4,598 (1,357) Costs and estimated earnings in excess of billings on uncompleted contracts 351 (2,504) Inventories 842 (2,909) Prepaid expenses and other current assets (95) 596 Current liabilities (3,805) 1,317 Other operating assets and liabilities 106 (302) ------------- ------------- Net Cash Flows from Operating Activities 6,136 (576) ------------- ------------- Cash Flows from Investing Activities: Proceeds from sale of property and equipment 1,366 - Purchases of property and equipment (2,955) (4,682) ------------- ------------- Net Cash Flows from Investing Activities (1,589) (4,682) ------------- ------------- Cash Flows from Financing Activities: Payments on capitalized lease obligations (103) (157) Borrowings under revolving, term and mortgage loans 987,169 103,354 Repayment of debt (991,779) (98,076) ------------- ------------- Net Cash Flows from Financing Activities (4,713) 5,121 ------------- ------------- Effect of Exchange Rate Changes on Cash and Cash Equivalents 8 15 ------------- ------------- Net Decrease in Cash and Cash Equivalents (158) (122) Cash and Cash Equivalents - Beginning of Period 290 665 ------------- ------------- Cash and Cash Equivalents - End of Period $ 132 $ 543 ============= ============= See notes to condensed consolidated financial statements. </TABLE> 3
MFRI, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OCTOBER 31, 2001 1. The unaudited financial statements herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying interim financial statements have been prepared under the presumption that users of the interim financial information have either read or have access to the audited financial statements for the latest fiscal year ended January 31, 2001. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the January 31, 2001 audited financial statements have been omitted from these interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Although the Company believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these interim financial statements be read in conjunction with the financial statements and the notes thereto included in the Company's latest Annual Report on Form 10-K. <TABLE> <CAPTION> 2. Inventories consisted of the following: October 31, January 31, (In thousands) 2001 2001 ----------- ----------- <S> <C> <C> Raw materials $ 15,379 $ 15,926 Work in process 1,511 1,971 Finished goods 3,450 3,323 ----------- ----------- Total $ 20,340 $ 21,220 =========== =========== 3. Supplemental cash flow information: Nine Months Ended (In thousands) October 31, ---------------------------- 2001 2000 ----------- ----------- Cash paid for: Interest, net of capitalized amounts $ 2,275 $ 2,132 Income taxes, net of refunds received 938 226 Purchase of building: Purchase price $ - $ 4,438 Cash paid - 1,767 ----------- ----------- Net liabilities assumed $ - $ 2,671 =========== =========== </TABLE> 4
<TABLE> <CAPTION> 4. The basic weighted average shares reconcile to diluted weighted average shares as follows: Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------------- --------------------------- 2001 2000 2001 2000 ------------ ------------ ----------- ------------ <S> <C> <C> <C> <C> Net Income $161 $157 $1,097 $1,241 ============ ============ =========== ============ Basic weighted average common shares outstanding 4,922 4,922 4,922 4,922 Dilutive effect of stock options - - - 1 ------------ ------------ ----------- ------------ Weighted average common shares outstanding assuming full dilution 4,922 4,922 4,922 4,923 ============ ============ =========== ============ Net income per common share - basic $0.03 $0.03 $0.22 $0.25 Net income per common share - diluted $0.03 $0.03 $0.22 $0.25 </TABLE> The weighted average number of stock options not included in the computation of diluted earnings per share of common stock because the option exercise price exceeded the average market price of the common shares was 124,000 and 911,000 for the three months ended October 31, 2001 and 2000, respectively, and 500,000 and 876,000 for the nine months ended October 31, 2001 and 2000, respectively. Options for 729,000 shares were surrendered in June 2001 in exchange for the Company's agreement to issue new options in December 2001 at the then fair market value. <TABLE> <CAPTION> 5. The components of comprehensive income, net of tax, were as follows: Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------------- --------------------------- 2001 2000 2001 2000 ------------ ------------ ----------- ------------ <S> <C> <C> <C> <C> Net Income $161 $ 157 $ 1,097 $1,241 Change in foreign currency translation adjustments 74 (213) (79) (369) ------------ ------------ ----------- ------------ Comprehensive income $235 $ (56) $ 1,018 $ 872 ============ ============ =========== ============ Accumulated other comprehensive loss presented on the accompanying condensed consolidated balance sheets consists of the following: October 31, January 31, (In thousands) 2001 2001 ------------ ------------ Accumulated translation adjustment $(559) $(480) Minimum pension liability adjustment (net of tax benefit of $164) (266) (266) ------------ ------------ Total $(825) $(746) ============ ============ </TABLE> 5
6. The Company has three reportable segments under the criteria of Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Filtration Products Business manufactures and sells a wide variety of filter elements for air filtration and particulate collection systems. The Piping Systems Business engineers, designs and manufactures specialty piping systems and leak detection and location systems. The Industrial Process Cooling Equipment Business engineers, designs and manufactures chillers, mold temperature controllers, cooling towers, plant circulating systems and coolers for industrial process applications. <TABLE> <CAPTION> (In thousands) Three Months Ended Nine Months Ended October 31, October 31, ----------------------------- ---------------------------- 2001 2000 2001 2000 ------------ ------------ ----------- ---------- Net Sales: <S> <C> <C> <C> <C> Filtration Products $15,041 $14,632 $40,995 $45,395 Piping Systems 12,345 15,078 39,597 44,691 Industrial Process Cooling Equipment 5,007 7,233 16,683 22,591 ------------ ------------ ----------- ---------- Total Net Sales $32,393 $36,943 $97,275 $112,677 ============ ============ =========== ========== Gross Profit: Filtration Products $ 3,065 $ 2,513 $ 8,047 $ 9,170 Piping Systems 2,464 2,653 9,324 8,014 Industrial Process Cooling Equipment 1,400 2,359 4,748 7,249 ------------ ------------ ----------- ---------- Total Gross Profit $ 6,929 $ 7,525 $22,119 $24,433 ============ ============ =========== ========== Income from Operations: Filtration Products $ 1,233 $ 502 $ 2,439 $ 2,571 Piping Systems 748 792 3,989 2,555 Industrial Process Cooling Equipment 116 857 674 2,434 Corporate (1,046) (1,070) (3,100) (3,195) ------------ ------------ ----------- ---------- Total Income from Operations $ 1,051 $ 1,081 $ 4,002 $ 4,365 ============ ============ =========== ========== </TABLE> 7. On February 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. This statement standardizes the accounting for derivative instruments by requiring that an entity recognize all derivatives as assets and liabilities in the statement of financial position and measure them at fair value. When certain criteria are met, it also provides for matching of gain or loss recognition on the derivative hedging instrument with the recognition of (a) the changes in the fair value or cash flows of the hedged asset or liability attributable to the hedged risk or (b) the earnings effect of the hedged forecasted transaction. The Company has a small number of derivative instruments. Application of SFAS 133 was not material to the results of operations, financial condition or cash flows of the Company. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." This SAB provides guidance on the recognition, presentation and disclosure of revenue in the financial statements of public companies. The adoption of SAB No. 101 has not had a material effect on the reported results of operations, financial condition or cash flows of the Company. 6
In September 2000, the Financial Accounting Standards Board issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" which the Company adopted for all applicable transactions occurring after March 31, 2001. The adoption of SFAS No. 140 has not had a material effect on the reported results of operations, financial condition or cash flows of the Company. The Company is currently evaluating the impact of adopting SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." The Company plans to adopt these statements for the Company's fiscal year beginning February 1, 2002. The Company is therefore unable to disclose the impact that adopting SFAS No. 141 and SFAS No. 142 will have on its financial position and results of operations when such statements are adopted. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The statements contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and certain other information contained elsewhere in this 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" and "likely" 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. RESULTS OF OPERATIONS - --------------------- MFRI, Inc. Three months ended October 31 Net sales of $32,393,000 for the quarter ended October 31, 2001 decreased 12.3 percent from $36,943,000 for the comparable quarter last year. Gross profit of $6,929,000 decreased 7.9 percent from $7,525,000 in the prior year quarter. Sales and gross profit declined in all business units except the filtration products business. Gross margin increased to 21.4 percent of net sales in the current year from 20.4 percent of net sales in the prior year. Improved margins in the piping systems business and the filtration products business, mainly due to improved plant efficiencies and a more favorable product mix of sales in those business units, was partially offset by lower gross margin in the industrial process cooling equipment business related to reduced sales volume. (See discussion of each business unit's results of operations below). Net income of $161,000 and net income per common share (diluted) of $0.03 in the current year quarter were essentially flat compared with the net income of $157,000 and net income per common share (diluted) of $0.03 in the prior year quarter. Nine months ended October 31 Net sales of $97,275,000 for the nine months ended October 31, 2001 decreased 13.7 percent from $112,677,000 for the comparable period last year. Sales declined in all business units. Gross profit of $22,119,000 decreased 9.5 percent from $24,433,000 in the prior year, while gross margin increased to 22.7 percent of net sales in the current year from 21.7 percent of net sales in the prior year. Gross profit and gross margin declined in the filtration products business and the industrial process cooling equipment business primarily due to lower sales volume. Gross profit and gross margin increased in the piping systems business in spite of the decline in sales volume, primarily due to improved plant efficiency and a more favorable product mix of sales. (See discussion of each business unit's results of operations below). 8
Net income decreased 11.6 percent to $1,097,000 or $0.22 per common share (diluted) in the current year from $1,241,000 or $0.25 per common share (diluted) in the prior year. The reduction in gross profit discussed above was partially offset by reduced selling, general, administrative and interest expense in the current year. Filtration Products Business Three months ended October 31 Net sales for the quarter ended October 31, 2001 increased 2.8 percent to $15,041,000 from $14,632,000 in the comparable quarter one year ago. This increase is the result of higher sales of pleated filter elements and non-filtration products and services, partially offset by lower sales of fabric filter elements. Gross profit as a percent of net sales increased from 17.2 percent in the prior year to 20.4 percent in the current year, primarily as a result of increased manufacturing efficiencies. Selling expense for the quarter ended October 31, 2001 decreased to $1,073,000 or 7.1 percent of net sales from $1,287,000 or 8.8 percent of net sales for the comparable quarter last year due to reduced sales staff and lower sales commissions. General and administrative expense increased slightly to $759,000 in the current year quarter from $724,000 for the comparable period one year ago and remained relatively flat as a percentage of net sales at 5.0 percent compared to 4.9 percent in the comparable period last year. Nine months ended October 31 Net sales for the nine months ended October 31, 2001 decreased 9.7 percent to $40,995,000 from $45,395,000 in the comparable period one year ago. This decrease is the result of lower sales of fabric filter elements. Gross profit as a percent of net sales decreased from 20.2 percent in the prior year to 19.6 percent in the current year, primarily as a result of lower sales volume and competitive pricing pressures in the marketplace. Selling expense for the nine months ended October 31, 2001 decreased to $3,507,000 or 8.6 percent of net sales from $4,171,000 or 9.2 percent of net sales for the comparable period last year. The decrease is attributable to reduced sales staff and lower sales commissions. General and administrative expense decreased to $2,101,000 or 5.1 percent of net sales in the current year from $2,428,000 or 5.3 percent of net sales for the comparable period one year ago, primarily due to staff reductions and lower profit-related incentive compensation. 9
Piping Systems Business Three months ended October 31 Net sales decreased 18.1 percent from $15,078,000 in the prior year quarter to $12,345,000 for the quarter ended October 31, 2001. This decrease was primarily due to lower domestic sales, particularly a sale of $1,962,000 for an airport distribution system in the prior year quarter. Gross profit as a percent of net sales increased from 17.6 percent in the prior year quarter to 20.0 percent in the current year quarter, mainly as a result of a more favorable product mix of sales and improved plant operating efficiency. Selling expense decreased from $770,000 or 5.1 percent of net sales in the prior year quarter to $484,000 or 3.9 percent of net sales in the current year quarter. The dollar decrease was primarily due to cost savings from the December 2000 sale of the German subsidiary, SZE Hagenuk GmbH ("SZE Hagenuk"), which had selling expense of $201,000 in the prior year quarter. General and administrative expense increased from $1,091,000 or 7.2 percent of net sales in the prior year quarter to $1,232,000 or 10.0 percent of net sales in the current year quarter. The increase is primarily due to increases in engineering expense and profit-related incentive compensation, partially offset by the sale of SZE Hagenuk. Nine months ended October 31 Net sales decreased 11.4 percent to $39,597,000 for the nine months ended October 31, 2001 from $44,691,000 in the comparable prior year period, mainly due to a $4,708,000 sale of a mineral transportation line and a $1,962,000 sale of an airport distribution system in the third quarter of the prior year. This was partially offset by a $2,159,000 sale of a high temperature oil recovery project in Canada and a $1,045,000 sale of a military base distribution system in the current year period. Gross profit as a percent of net sales increased from 17.9 percent to 23.5 percent, mainly resulting from a more favorable product mix of sales including the Canadian project and improved plant operating efficiency. Selling expense decreased from $2,240,000 or 5.0 percent of net sales last year to $1,569,000 or 4.0 percent of net sales in the current year period. The dollar decrease was primarily due to cost savings from the December 2000 sale SZE Hagenuk, which had selling expense of $607,000 in the prior year period. General and administrative expense increased from $3,219,000 or 7.2 percent of net sales in the prior year period to $3,766,000 or 9.5 percent of net sales in the current year period. The increase is primarily due to increases in engineering expense and profit-related incentive compensation, partially offset by the sale of SZE Hagenuk. 10
Industrial Process Cooling Equipment Business Three months ended October 31 Net sales of $5,007,000 for the quarter ended October 31, 2001 decreased 30.8 percent from $7,233,000 for the comparable quarter in the prior year. Sales decreased in the primary target markets of the plastics industry and original equipment manufacturers (OEM). Sales to the plastics industry decreased 9% from the prior year, mainly due to the general economic slowdown. OEM sales decreased 57% from the prior year, mainly due to a slowdown in the semiconductor sector and unusually high demand in the prior year. These two markets account for over 80% of total sales. Gross margins as a percentage of net sales decreased from 32.6 percent for the prior year to 28.0 percent for the current year. The decrease is due primarily to a less favorable product mix of sales and reduced sales volume. Selling expense decreased from $867,000 in the prior year to $747,000 in the current year, but increased as a percentage of net sales from 12.0 percent to 14.9 percent. The dollar decrease is attributable to a decline in commission expense due to lower sales volume. General and administrative expense decreased from $635,000 in the prior year to $537,000 in the current year, but increased as a percentage of net sales from 8.8 percent in the prior year to 10.7 percent in the current year. The dollar decrease is primarily due to staff reductions and lower variable expense resulting from the lower sales volume. Nine months ended October 31 Net sales of $16,683,000 for the nine months ended October 31, 2001 decreased 26.2 percent from $22,591,000 for the comparable period in the prior year. Sales decreased in our primary target markets of the plastics industry and OEM. Sales to the plastics industry decreased 25% from the prior year period, mainly due to the general economic slowdown. OEM sales decreased 42% from the prior year period, mainly due to a slowdown in the semiconductor sector. These two markets account for over 80% of total sales. Gross margins as a percentage of net sales decreased from 32.1 percent for the prior year to 28.5 percent for the current year. The decrease is due primarily to product mix of sales and reduced sales volume. Selling expense decreased from $2,891,000 in the prior year period to $2,377,000 in the current year period, but increased as a percentage of net sales from 12.8 percent to 14.2 percent. The dollar decrease is attributable to a decline in commission expense due to lower sales volume and reduced spending for advertising. General and administrative expense decreased from $1,924,000 in the prior year to $1,697,000 in the current year, but increased as a percentage of net sales from 8.5 percent in the prior year to 10.2 percent in the current year. The dollar decrease is primarily due to staff reductions and lower variable expense resulting from the lower sales volume. 11
General Corporate Expense General corporate expense includes general and administrative expense not allocated to business segments and interest expense. Three months ended October 31 General and administrative expense decreased from $1,070,000 in the prior year quarter to $1,046,000 in the current year quarter, but increased as a percentage of net sales from 2.9 percent in the prior year quarter to 3.2 percent in the current year quarter. The dollar decrease is mainly due to reductions in data processing expense and occupancy costs, offset partially by an increase in franchise tax expense and medical claims expense. Interest expense decreased to $660,000 for the quarter ending October 31, 2001 from $796,000 in the prior year quarter. The decrease is due to lower borrowing levels in the current year. Nine months ended October 31 General and administrative expense decreased from $3,195,000 in the prior year period to $3,100,000 in the current year period, but increased as a percentage of net sales from 2.8 percent in the prior year period to 3.2 percent in the current year period. The dollar decrease is mainly due to reductions in medical claims expense and occupancy costs, offset partially by increases in salary expense and franchise tax expense. Interest expense decreased to $2,025,000 for the nine months ending October 31, 2001 from $2,243,000 for the comparable period in the prior year. The decrease is due to lower borrowing levels in the current year. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Liquidity and Operating Cash Flow Cash and cash equivalents as of October 31, 2001 were $132,000 as compared to $543,000 at October 31, 2000. Net cash provided from operating activities of $6,136,000 and proceeds from the sale of property and equipment of $1,366,000 were used to fund net payments on long-term debt of $4,610,000, purchases of property and equipment of $2,955,000, and payments on capitalized lease obligations of $103,000. Net cash provided by operating activities was $6,136,000 for the nine months ended October 31, 2001, compared with net cash outflows from operating activities of $576,000 for the nine months ended October 31, 2000. The reduction in trade accounts receivable of $4,598,000 was partially offset by decreases in accounts payable and other current liabilities in the current year. Net cash used for investing activities for the nine months ended October 31, 2001 and 2000 were $1,589,000 and $4,682,000, respectively. Capital expenditures decreased from $4,682,000 in the prior year to $2,955,000 in the current year. Proceeds from the sale of property and equipment in the current year were $1,366,000, consisting primarily of the transaction described in the next paragraph. No property or equipment was sold in the prior year period. 12
On June 11, 2001, the Company sold equipment for $1,359,000. The equipment was leased back from the purchaser under a master lease agreement for a period of seven years. No gain or loss was recognized on this transaction and the lease is being accounted for as an operating lease. The lease requires the Company to pay customary operating and repair expenses. The lease also contains a renewal option and a purchase option at fair market value at lease termination. For the nine months ended October 31, 2001, $4,610,000 was used for net payments on long-term debt and $103,000 was used for payments on capitalized lease obligations. In the comparable prior year period, the Company obtained $5,278,000 from net proceeds of long-term debt and utilized $157,000 to repay capitalized lease obligations. The Company's current ratio was 1.6 to 1 at October 31, 2001 and 2.1 to 1 at January 31, 2001. Debt to total capitalization decreased to 46.4 percent from 50.2 percent at January 31, 2001. Financing On December 15, 1996, the Company entered into a private placement with institutional investors of $15,000,000 of 7.21 percent unsecured senior notes due January 31, 2007 (the "Notes due 2007"). The Notes due 2007 were amended on April 30, 2001, modifying certain covenants, increasing the interest rate to 8.46 percent, and changing the schedule of principal payments. At October 31, 2001, the Company was not in compliance with one of these covenants. The Company has negotiated a waiver for such non-compliance and an amendment of that covenant and expects documents to be signed by no later than December 21, 2001. The amendment requires previously unscheduled principal payments of $1,000,000 no later than March 31, 2002 and $2,196,000 on June 30, 2002, in addition to the previously scheduled level monthly principal payments of $179,000 beginning May 31, 2001 and continuing monthly thereafter as required by the April 30, 2001 amendment. Based on the amended schedule of principal repayments, the Notes due 2007 will be paid in full in September 2004. On September 17, 1998, the Company entered into a private placement with institutional investors of $10,000,000 of 6.97 percent unsecured senior notes due September 17, 2008 (the "Notes due 2008"). The Notes due 2008 were amended on April 30, 2001, modifying certain covenants, increasing the interest rate to 7.97 percent, and changing the schedule of principal payments. At October 31, 2001, the Company was not in compliance with one of these covenants. The Company has negotiated a waiver for such non-compliance and an amendment of that covenant and expects documents to be signed by no later than December 21, 2001. The amendment requires previously unscheduled principal payments of $1,000,000 no later than March 31, 2002 and $2,196,000 on June 30, 2002, in addition to the previously scheduled level monthly principal payments of $119,000 beginning October 17, 2002 and continuing monthly thereafter as required by the April 30, 2001 amendment. Based on the amended schedule of principal repayments, the Notes due 2008 will be paid in full in July 2006. 13
On August 8, 2000, the Company entered into an unsecured credit agreement with a bank (the "Bank"). Under the terms of this agreement, the Company can borrow up to $10,000,000 under a revolving line of credit, which matures on July 31, 2003. On April 30, 2001 and September 14, 2001, the agreement was amended, modifying certain covenants and increasing the interest rate. Interest rates are based on one of three options selected by the Company at the time of each borrowing, as follows: (1) the higher of the prime rate or the federal funds rate plus 0.50 percent, (2) the LIBOR rate plus a margin for the term of the loan, or (3) a rate quoted by the Bank for the term of the loan. At October 31, 2001, the prime rate was 5.5 percent and the margin added to the LIBOR rate, which is determined each quarter based on a financial statement ratio, was 2.25 percent. The Company had borrowed $4,000,000 under the revolving line of credit at October 31, 2001. The Company's policy is to classify borrowings under the revolving line of credit as long-term debt since the Company has the ability and the intent to maintain this obligation for longer than one year. In addition, $433,000 was drawn under the agreement as letters of credit. These letters of credit principally guarantee performance to third parties as a result of various trade activities; guarantee performance under the mortgage note secured by the manufacturing facility located in Cicero, Illinois with respect to the making of certain repairs and the payment of property taxes and insurance premiums; and guarantee repayment of a foreign subsidiary's borrowings under an overdraft facility. At October 31, 2001, the Company was not in compliance with one of these covenants. The Company has obtained a waiver for such non-compliance, which permits prepayment of up to $1,000,000 of the Notes due 2007 and $1,000,000 of the Notes due 2008 no earlier than March 31, 2002. The Company is negotiating amendments to the credit agreement, which the Company and the bank expect to finalize during the fourth quarter. During the quarter ended October 31, 2001, the Company pledged substantially all of its assets that were not previously pledged as security for the Notes due 2007, the Notes due 2008 and the Bank credit agreement. In 1995, the Company received an aggregate of $6,300,000 of proceeds of Industrial Revenue Bonds which were utilized by the Filtration Products Business in Winchester, Virginia and the Piping Systems Business in Lebanon, Tennessee, and which mature in August and September 2007, respectively. These bonds are fully secured by bank letters of credit, which the Company expects to renew, reissue or extend prior to each expiration date during the term of the bonds. The bonds bear interest at a variable rate, which approximates five percent per annum, including letter of credit and re-marketing fees. On November 1, 1999, the Company utilized $1,100,000 of unspent bond proceeds to redeem bonds outstanding as provided in the indenture. On May 8, 1996, the Company purchased a 10.3-acre parcel of land with a 67,000-square foot building adjacent to its Midwesco Filter property in Winchester, Virginia for approximately $1.1 million. The purchase was financed 80 percent by a seven-year mortgage note bearing interest at 8.38 percent (the "Existing Winchester Mortgage") and 20 percent by the Industrial Revenue Bonds described above. The Company has accepted a proposal from a lender for mortgage financing of all its property in Winchester, Virginia (the "Proposed Winchester Mortgage"), which includes the refinancing of the Existing Winchester Mortgage. Proceeds from the Proposed Winchester Mortgage, net of repayment of the Existing Winchester Mortgage, are expected to be approximately $2.1 million. The Proposed Winchester Mortgage is expected to be completed prior to March 31, 2002. 14
On June 30, 1998, the Company borrowed $1,400,000 under a mortgage note secured by the manufacturing facility in Cicero, Illinois. The loan bears interest at 6.76 percent and the term of the loan is ten years with an amortization schedule of 25 years. On June 1, 1998, the Company obtained two loans from a Danish bank to partially finance the acquisition of Boe-Therm A/S. The first loan in the amount of 4,500,000 Danish krone ("DKK") (approximately $650,000) is secured by the land and building of Boe-Therm, bears interest at 6.48 percent and has a term of twenty years. The second loan in the amount of 2,750,000 DKK (approximately $400,000) is secured by the machinery and equipment of Boe-Therm, bears interest at 5.80 percent and has a term of five years. In addition, on February 16, 1999, the Company obtained a loan from a Danish bank in the amount of 850,000 DKK (approximately $125,000) to finance the purchase of a parcel of land directly adjacent to the manufacturing facility in Assens, Denmark. This loan is secured by the land and building purchased. On August 10, 1999, the Company obtained a loan from a Danish bank in the amount of 3,000,000 DKK (approximately $425,000) to complete the permanent financing of the Nordic Air A/S acquisition. The loan bears interest at 6.22 percent and has a term of five years. 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 includes the assumption of a $2,500,000 mortgage note with a remaining balance of $2,405,000. The loan bears interest at 7.52 percent and the term of the loan is ten years with an amortization schedule of 25 years. At the date of purchase the remaining term of the loan was 7.25 years. The Company also had short-term credit arrangements utilized by its European subsidiaries. These credit arrangements are generally in the form of overdraft facilities at rates competitive in the countries in which the Company operates. The Company anticipates that cash flows from operating activities will be sufficient to support scheduled principal repayments through 2002 with the exception of the $1,000,000 repayment of the Notes due 2007 and the $1,000,000 repayment of the Notes due 2008 scheduled to be paid no later than March 31, 2002. These principal payments will be funded by the proceeds of the Proposed Winchester Mortgage described above. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company is subject to market risk associated with changes in foreign currency exchange rates and interest rates. Foreign currency exchange rate risk is mitigated through maintenance of local production facilities in the markets served, invoicing of customers in the same currency as the source of the products and use of foreign currency denominated debt in Denmark and the United Kingdom. The Company also utilizes foreign currency forward contracts to reduce exposure to exchange rate risks. The forward contracts are short-term in duration, generally one year or less. The major currency exposure hedged by the Company is the Canadian dollar. The contract amounts, carrying amounts and fair values of these contracts were not significant at October 31, 2001 or January 31, 2001. 15
The next phase of the Euro implementation, the changeover from national currencies to the Euro, is scheduled to begin on January 1, 2002, and is not expected to materially affect the Company's foreign currency exchange risk profile, although some customers may require the Company to invoice or pay in Euros rather than the functional currency of the manufacturing entity. The Company has attempted to mitigate its interest rate risk through management of the proportion of fixed rate debt and variable rate debt in its total debt portfolio. PART II - OTHER INFORMATION None 16
SIGNATURE 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: December 17, 2001 /s/ David Unger ---------------------------------------------- David Unger Chairman of the Board of Directors Date: December 17, 2001 /s/ Michael D. Bennett ---------------------------------------------- Vice President, Secretary and Treasurer (Principal Financial and Accounting Officer) 17