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 October 31, 2004 -------------------------------------------------- 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 ----- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- ----- On December 14, 2004, there were 5,030,895 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/A-2 Amendment No. 2 for the year ended January 31, 2004 as filed on December 15, 2004. Reclassifications have been made in prior-year financial statements to conform to the current-year presentation. The results of operations for the quarter ended October 31, 2004 are not necessarily indicative of the results to be expected for the full year ending January 31, 2005. One of the reasons for this is that, generally, sales of the Company's piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the country. MFRI, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (In thousands except per share information) <TABLE> <CAPTION> Three Months Ended Nine Months Ended October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net sales $ 39,708 $ 32,635 $109,904 $ 93,793 Cost of sales 30,544 25,732 85,882 74,016 -------- -------- -------- -------- Gross profit 9,164 6,903 24,022 19,778 Operating expenses: Selling expense 2,583 2,418 7,690 7,582 General and administrative expense 4,098 4,242 11,500 11,571 -------- -------- -------- -------- Total operating expenses 6,681 6,660 19,190 19,153 -------- -------- -------- -------- Income from operations 2,483 243 4,832 625 Income (loss) from joint venture 189 8 178 193 Interest expense - net 456 500 1,331 1,519 -------- -------- -------- -------- Income (loss) before income taxes 2,216 (249) 3,679 (701) Income taxes (benefit) 602 (123) 1,026 (313) -------- -------- -------- -------- Net income (loss) $ 1,614 $ (126) $ 2,653 $ (388) ======== ======== ======== ======== Weighted average common shares outstanding basic 4,961 4,922 4,935 4,922 Weighted average common shares outstanding Diluted 5,304 4,922 5,109 4,922 Basic earnings per share Net income (loss) $ 0.33 $ (0.03) $ 0.54 $ (0.08) Diluted earnings per share Net income (loss) $ 0.30 $ (0.03) $ 0.52 $ (0.08) </TABLE> See notes to condensed consolidated financial statements. 1
MFRI, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands) <TABLE> <CAPTION> October 31, January 31, Assets 2004 2004 - -------------------------------------------------------------------------------- Current Assets: <S> <C> <C> Cash and cash equivalents $ 529 $ 154 Restricted cash 1,394 238 Trade accounts receivable, net 26,479 18,353 Accounts receivable - related companies 885 853 Costs and estimated earnings in excess of billings on uncompleted contracts 1,511 1,115 Income taxes receivable 572 393 Inventories 20,519 18,275 Deferred income taxes 1,651 1,639 Prepaid expenses and other current assets 586 857 -------- -------- Total current assets 54,126 41,877 Property, plant and equipment, net 25,788 28,828 Other Assets: Patents, net of accumulated amortization 581 716 Goodwill 2,591 2,549 Other assets 4,934 4,957 -------- -------- Total other assets 8,106 8,222 -------- -------- Total Assets $ 88,020 $ 78,927 ======== ======== Liabilities and Stockholders' Equity - -------------------------------------------------------------------------------- Current Liabilities: Trade accounts payable $ 12,927 $ 12,337 Accrued compensation and payroll taxes 2,477 2,673 Other accrued liabilities 3,505 2,835 Commissions payable 4,854 3,046 Current maturities of long-term debt 14,220 11,864 Billings in excess of costs and estimated earnings on uncompleted contracts 1,178 299 Income taxes payable 1,508 64 -------- -------- Total current liabilities 40,669 33,118 Long-Term Liabilities: Long-term debt, less current maturities 15,046 16,661 Other 2,372 2,275 -------- -------- Total long-term liabilities 17,418 18,936 Stockholders' Equity: Common stock, $.01 par value, authorized - 50,000 shares in October 2004 and January 2004; 4,999 issued and outstanding in October 2004 and 4,922 issued and outstanding in January 2004 50 49 Additional paid-in capital 21,622 21,397 Retained earnings 7,753 5,100 Accumulated other comprehensive income 508 327 -------- -------- Total stockholders' equity 29,933 26,873 -------- -------- Total Liabilities and Stockholders' Equity $ 88,020 $ 78,927 ======== ======== </TABLE> See notes to condensed consolidated financial statements. 2
MFRI, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Nine Months Ended (In thousands) October 31, --------------------- 2004 2003 -------- -------- Cash Flows from Operating Activities: <S> <C> <C> Net income (loss) $ 2,653 $ (388) Adjustments to reconcile net income (loss) to net cash flows from operating activities: (Income) from joint venture (178) (193) Depreciation and amortization 2,779 3,082 Provision for uncollectible accounts (1) (74) (Gain) loss on sale of property, plant and equipment 17 (27) Change in operating assets and liabilities: Trade accounts receivable (8,125) (5,272) Costs and estimated earnings in excess of billings on uncompleted contracts 483 899 Inventories (2,186) 1,228 Prepaid expenses and other current assets 314 701 Current liabilities 345 1,413 Other operating assets and liabilities 2,521 54 -------- -------- Net Cash Flows from Operating Activities (1,378) 1,423 -------- -------- Cash Flows from Investing Activities: Proceeds from sale of property and equipment 1,786 475 Purchases of property and equipment (987) (3,789) Investment in joint venture 50 160 -------- -------- Net Cash Flows from Investing Activities 849 (3,154) -------- -------- Cash Flows from Financing Activities: Payments on capitalized lease obligations (51) (101) Borrowings under revolving, term and mortgage loans 10,616 15,875 Repayment of debt (9,940) (14,467) Proceeds from stock options exercised 228 - -------- -------- Net Cash Flows from Financing Activities 853 1,307 -------- -------- Effect of Exchange Rate Changes on Cash and Cash Equivalents 51 261 -------- -------- Net Increase (Decrease) in Cash and Cash Equivalents 375 (163) Cash and Cash Equivalents - Beginning of Period 154 346 -------- -------- Cash and Cash Equivalents - End of Period $ 529 $ 183 ======== ======== Supplemental cash flow information: Cash paid for: Interest, net of capitalized amounts $ 1,306 $ 1,518 Income taxes paid (refunded) (196) 5 </TABLE> See notes to condensed consolidated financial statements. 3
MFRI, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OCTOBER 31, 2004 1. The unaudited financial statements herein have been prepared by the Company in accordance with generally accepted accounting principals and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the January 31, 2004 audited financial statements have been omitted from these interim financial statements. Reclassifications have been made in prior-year financial statements to conform to the current-year presentation. 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/A-2 Amendment No. 2. 2. The Company's stock option plans are accounted for using the intrinsic value method and accordingly, no compensation cost has been recognized. Had compensation cost been determined using the fair value method in 2004 and 2003, the Company's pro forma net income (loss) and earnings (loss) per share would have been as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Net income (loss) - as reported (in <S> <C> <C> <C> <C> thousands) $ 1,614 $ (126) $ 2,653 $ (388) Compensation cost under fair-market value-based accounting method, net of tax (in thousands) (54) (42) (159) (121) Net income (loss) - pro forma (in thousands) $ 1,560 $ (168) $ 2,494 $ (509) Net income (loss) per common share - basic, as reported $ 0.33 $ (0.03) $ 0.54 $ (0.08) Net income (loss) per common share - basic, pro forma $ 0.31 $ (0.03) $ 0.51 $ (0.10) Net income (loss) per common share - diluted, as reported $ 0.30 $ (0.03) $ 0.52 $ (0.08) Net income (loss) per common share - diluted, pro forma $ 0.29 $ (0.03) $ 0.49 $ (0.10) </TABLE> 3. Inventories consisted of the following: <TABLE> <CAPTION> October 31, January 31, (In thousands) 2004 2004 -------- -------- <S> <C> <C> Raw materials $ 16,239 $ 13,593 Work in process 2,001 1,905 Finished goods 2,279 2,777 -------- -------- Total $ 20,519 $ 18,275 ======== ======== </TABLE> 4. Goodwill: Goodwill represents the excess cost over fair value of the net assets of purchased businesses. The Company does not amortize goodwill. The Company performs an annual impairment assessment of goodwill in the first quarter of each year, based on the fair value of the related reporting unit. When performing its annual impairment assessment, the Company compares the fair value of the related reporting unit to its carrying value. Fair values are determined by discounting estimated future cash flows. If the fair value of an operating unit is less than its carrying value, an impairment loss is recorded. The Company's annual impairment test at February 1, 2004 did not result in an impairment. Goodwill was $2,591,000 and $2,549,000 at October 31, 2004 and January 31, 2004, respectively. The change in Goodwill was due to foreign currency translation. 4
5. Other intangible assets with definite lives: Patents are capitalized and amortized on a straight-line basis over a period not to exceed the legal lives of the patents. Patents, net of accumulated amortization, were $581,000 and $716,000 at October 31, 2004 and January 31, 2004, respectively. Accumulated amortization was $1,588,000 and $1,453,000 at October 31, 2004 and January 31, 2004, respectively. Future amortization over the next five years ending January 31, will be 2005 - $45,100, 2006 - $180,500, 2007 - $173,800, 2008 - $29,400, 2009 - $26,400 and 2010 - $22,100. 6. Employee Retirement Plans: The market-related value of plan assets at October 31, 2004 and January 31, 2004 were $2,943,579 and $2,682,942, respectively. Net cost recognized for the three and nine months ended October 31 was as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Components of net periodic benefit cost: <S> <C> <C> <C> <C> Service cost $ 25 $ 24 $ 75 $ 72 Interest cost 47 42 141 127 Expected return on plan assets (56) (42) (168) (125) Amortization of prior service cost 21 14 62 43 Recognized actuarial loss 20 24 59 73 -------- -------- -------- -------- Net periodic benefit cost $ 57 $ 62 $ 169 $ 190 </TABLE> Employer contributions for fiscal year ending January 31, 2005 are expected to be $252,191. As of October 2004, $185,953 in contributions were made. In November 2004, a $66,238 contribution was made. In February 2005, a $76,800 contribution is expected to be made. 7. The basic weighted average shares reconcile to diluted weighted average shares as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net income (loss) $ 1,614 $ (126) $ 2,653 $ (388) ======== ======== ======== ======== Basic weighted average common shares outstanding 4,961 4,922 4,935 4,922 Dilutive effect of stock options 343 - 174 - -------- -------- -------- -------- Weighted average common shares outstanding assuming full dilution 5,304 4,922 5,109 4,922 ======== ======== ======== ======== Basic earnings per share Net income (loss) $ 0.33 $ (0.03) $ 0.54 $ (0.08) Diluted earnings per share Net income (loss) $ 0.30 $ (0.03) $ 0.52 $ (0.08) </TABLE> 5
<TABLE> <CAPTION> Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Weighted average number of stock options not included in the computation of diluted earnings per share of common stock because the option exercise prices exceeded the average market prices of the <S> <C> <C> <C> <C> common shares 122,000 1,036,000 158,500 993,000 Stock options with an exercise price below the average stock price 861,704 - 848,904 - </TABLE> In September and October 2004, a total of 76,746 stock options were exercised. In November 2004, 28,098 stock options were exercised. As of December 7, 2004 3,687 stock options were exercised in December. As of December 7, 2004 a total of 108,531 stock options were exercised. 8. The components of comprehensive income (loss), net of tax, were as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net income (loss) $ 1,614 $ (126) $ 2,653 $ (388) Change in foreign currency translation adjustments 364 128 181 299 -------- -------- -------- -------- Comprehensive income (loss) $ 1,978 $ 2 $ 2,834 $ (89) ======== ======== ======== ======== </TABLE> Accumulated other comprehensive income presented on the accompanying condensed consolidated balance sheets consists of the following: <TABLE> <CAPTION> October 31, January 31, (In thousands) 2004 2004 -------- -------- <S> <C> <C> Accumulated translation adjustment $ 863 $ 682 Minimum pension liability adjustment (net of tax benefit of $217 at October 31 and January 31, 2004) (355) (355) -------- -------- Total $ 508 327 ======== ======== </TABLE> 9. The Company has three reportable segments under the criteria of Statement of Financial Accounting Standards 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, manufactures and sells specialty piping systems and leak detection and location systems. The Industrial Process Cooling Equipment Business engineers, designs, manufactures and sells chillers, cooling towers, plant circulating systems and accessories for industrial process applications. 6
<TABLE> <CAPTION> Three Months Ended Nine Months Ended (In thousands) October 31, October 31, --------------------- --------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Net Sales: <S> <C> <C> <C> <C> Filtration Products $ 14,067 $ 13,836 $ 45,733 $ 41,813 Piping Systems 18,544 12,274 42,531 33,227 Industrial Process Cooling Equipment 7,097 6,525 21,640 18,753 -------- -------- -------- -------- Total Net Sales $ 39,708 $ 32,635 $109,904 $ 93,793 ======== ======== ======== ======== Gross Profit: Filtration Products $ 3,238 $ 2,547 $ 9,363 $ 7,882 Piping Systems 3,773 2,428 8,406 6,506 Industrial Process Cooling Equipment 2,153 1,928 6,253 5,390 -------- -------- -------- -------- Total Gross Profit $ 9,164 $ 6,903 $ 24,022 $ 19,778 ======== ======== ======== ======== Income (loss) from Operations: Filtration Products $ 1,060 $ 367 $ 2,830 $ 1,326 Piping Systems 2,417 680 4,644 2,336 Industrial Process Cooling Equipment 452 325 1,238 607 Corporate (1,446) (1,129) (3,880) (3,644) -------- -------- -------- -------- Income from Operations $ 2,483 $ 243 $ 4,832 $ 625 ======== ======== ======== ======== </TABLE> 10. In December 2003, the Financial Accounting Standards Board (FASB) issued a revision to SFAS No. 132, "Employers' Disclosure about Pensions and Other Postretirement Benefits." This Statement retains the disclosures previously required by SFAS 132 but adds additional disclosure requirements about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. It also calls for the required information to be provided separately for pension plans and for other postretirement benefit plans. In addition to expanded annual disclosures, the standard improves information available to investors in interim financial statements. SFAS 132R was effective for fiscal years ending after December 15, 2003, and for quarters beginning after December 15, 2003. The adoption of SFAS 132R has not had a material impact on the Company's financial statements, however, required interim disclosures have been reflected in the current financial statements. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This Interpretation requires the recognition of certain guarantees as liabilities at fair market value and is effective for guarantees issued or modified after December 31, 2002. Adoption of the provisions of the Interpretation has not had a material effect on the financial statements of the Company, based on guarantees in effect on October 31, 2004. 11. On September 14, 1995, Midwesco Filter Resources, Inc. in Winchester, Virginia received $2,050,000 of proceeds from Industrial Revenue Bonds, which were to mature on August 1, 2007. These bonds had been fully secured by bank letters of credit. As a result of the sale of land and a building on June 17, 2004, the Company redeemed the bonds in September 2004. On July 11, 2002, the Company entered into secured note purchase agreements with certain institutional investors ("Note Purchase Agreements"). At July 31, 2004 and October 31, 2004, the Company was in compliance with covenants under the Note Purchase Agreement. At January 31, 2004 and April 30, 2004, the Company was not in compliance with one covenant under the Note Purchase Agreements. Waivers have been obtained for noncompliance of debt covenants for fiscal periods ending on or prior to April 30, 2004. 7
On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution ("Loan Agreement"). As of October 31, 2004, the Company had borrowed $12,844,000 and had $4,223,000 available to it under the revolving line of credit. In addition, $4,446,600 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts owed for an Industrial Revenue Bond borrowing. The Company has determined that borrowings outstanding under its revolving credit facility should be classified as current maturities of long-term debt in accordance with the provisions set forth in Emerging Issues Task Force 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box Arrangement". At July 31, 2004 and October 31, 2004, the Company was in compliance with covenants under the Loan Agreement. At January 31, 2004 and April 30, 2004, the Company was not in compliance with covenants under the Loan Agreement. Waivers have been obtained for noncompliance of debt covenants for fiscal periods ending on or prior to April 30, 2004. 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," "likely," and "probable," or the negative thereof or other variations thereon or comparable terminology, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbors created thereby. These statements should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment. Such risks and uncertainties could cause actual results to differ materially from those projected. These uncertainties include, but are not limited to, economic conditions, market demand and pricing, competitive and cost factors, raw material availability and prices, global interest rates, currency exchange rates, labor relations and other risk factors. RESULTS OF OPERATIONS MFRI, Inc. Generally, sales of the Company's piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the country. Three months ended October 31 Net sales of $39,708,000 for the quarter increased 21.7% from $32,635,000 for the comparable quarter in the prior year. (See discussion of each business segment below.) Gross profit of $9,164,000 increased 32.8% from $6,903,000 in the prior year quarter, and gross margin increased to 23.1% of net sales in the current year from 21.2 % of net sales in the prior year. (See discussion of each business segment below.) Net income rose to $1,614,000 in the current quarter from a loss of $126,000 in the prior year quarter. The increase in net income was due to increased revenue at level margins. (See discussion of each business segment below.) 8
Nine months ended October 31 Net sales of $109,904,000 for the nine months increased 17.2% from $93,793,000 for the comparable period in the prior year. (See discussion of each business segment below.) Gross profit of $24,022,000 increased 21.5% from $19,778,000 for the comparable period in the prior year, while gross margin increased to 21.9% of net sales in the current year from 21.1% of net sales in the prior year. (See discussion of each business segment below.) Net income rose to $2,653,000 for the nine months from a loss of $388,000 for the comparable period in the prior year. The increase in net income was due to increased revenue at level margins. (See discussion of each business segment below.) Filtration Products Business Three months ended October 31 Net sales for the quarter increased 1.7% to $14,067,000 from $13,836,000 for the comparable quarter in the prior year. This increase was primarily due to a better economic environment including improved conditions in the domestic steel industry. Gross profit as a percent of net sales increased from 18.4% in the prior year to 23.0% in the current year, primarily as a result of improved manufacturing efficiency on slightly higher unit volume and a favorable product mix. Selling expense decreased to $1,377,000 or 9.8% of net sales from $1,380,000 or 10.0% of net sales for the comparable quarter last year. General and administrative expenses remained relatively level at $801,000 or 5.7% of net sales in the current-year quarter compared to $800,000 or 5.8% of net sales in the prior-year quarter. Nine months ended October 31 Net sales for the nine months increased 9.4% to $45,733,000 from $41,813,000 for the comparable period in the prior year. This increase was primarily due to a better economic environment including improved conditions in the domestic steel industry. Gross profit as a percent of net sales increased from 18.8% in the prior year to 20.5% in the current year, primarily as a result of improved manufacturing efficiency on higher unit volume and a favorable product mix. Selling expense for the nine months decreased to $4,171,000 or 9.1% of net sales from $4,232,000 or 10.1% of net sales for the comparable period in the prior year. The decrease was primarily due to less commission expense and lower travel costs. General and administrative expenses increased from $2,323,000 or 5.6% of net sales in the prior-year period to $2,361,000 or 5.2% of net sales in the current year period. This increase was primarily due to increased professional services expenses. Piping Systems Business Generally, sales of the Company's piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the country. 9
Three months ended October 31 Net sales increased 51.1% from $12,274,000 in the prior-year quarter to $18,544,000 for the current quarter. This increase was primarily due to some recovery from the weak economy in both the private and public sectors. Gross profit as a percent of net sales increased from 19.8% to 20.3% due to product mix. Selling expense increased from $228,000 or 1.9% of net sales for the prior year quarter to $333,000 or 1.8% of net sales in the current year quarter. The increase was primarily due to higher commissions. General and administrative expense decreased from $1,520,000 in the prior year quarter to $1,024,000 in the current year quarter, and decreased as a percent of net sales from 12.4% to 5.5%. The decrease was primarily due to the prior-year quarter legal settlement of $510,000 and $284,000 in legal fees associated with that settlement. Nine months ended October 31 Net sales of $42,531,000 for the nine months increased 28.0% from $33,227,000 for the comparable period in the prior year. This increase was primarily due to some recovery from the weak economy in both the private and public sectors. Gross profit as a percent of net sales increased from 19.6% to 19.8%, mainly due to product mix. Selling expense increased from $915,000 or 2.8% of net sales in the prior year period to $932,000 or 2.2% of net sales in the current year period. The dollar increase was primarily due to increased commissions. General and administrative expense decreased to $2,829,000, compared with $3,255,000 in the prior year period, and decreased as a percent of net sales from 9.8% to 6.7%. The decrease was primarily due to a legal settlement of $510,000 and legal fees associated with that settlement incurred in the nine months ended October 31, 2003. Industrial Process Cooling Equipment Business Three months ended October 31 Net sales of $7,097,000 for the quarter increased 8.8% from $6,525,000 for the comparable quarter in the prior year. The increase was due primarily to some recovery from the weak economy. Sales increased in both the domestic and international markets. Gross profit increased to 30.3% of net sales from 29.6% of net sales in the prior-year quarter, primarily due to improved pricing and production efficiencies. Selling expense increased to $874,000 or 12.3% of net sales in the current-year quarter from $809,000 or 12.4% of net sales in the prior-year quarter. The dollar increase was due to the higher commissions associated with increased sales and greater distributor sales. General and administrative expense increased to $828,000 or 11.7% of net sales from $794,000 or 12.2% of net sales in the prior-year quarter. This dollar increase was primarily due to higher costs for the international operation resulting from additional headcount and some additional engineering product development expenses. 10
Nine months ended October 31 Net sales of $21,640,000 for the nine months increased 15.4% from $18,753,000 for the comparable period in the prior year, mainly due to some recovery from the weak economy. Sales increased in both the domestic and international markets. Gross margin increased from 28.7% of net sales in the prior year to 28.9% of net sales in the current year, primarily due to improved pricing and production efficiencies. Selling expense increased to $2,586,000 or 12.0% of net sales in the current year period from $2,434,000 or 13.0% of net sales in the prior year. The dollar increase was primarily due to the higher commissions associated with increased sales and greater distributor sales. General and administrative expense increased to $2,431,000 or 11.2% of net sales in the current year period from $2,349,000 or 12.5% of net sales in the prior year. This increase was primarily due to higher costs for the international operation resulting from additional headcount and increased product development costs. General Corporate Expense General corporate expense included interest expense and general and administrative expenses that were not allocated to the business segments. Three months ended October 31 General and administrative expense increased from $1,129,000 in the prior year quarter to $1,446,000 in the current year quarter, and increased as a percentage of net sales from 3.5% in the prior year quarter to 3.6% in the current year quarter. The increase was mainly due to management incentive compensation and building repairs and maintenance costs. Interest expense decreased to $456,000 for the current year quarter from $500,000 in the prior year quarter. The decrease was primarily due to lower interest expense due to the sale of a building in Winchester, Virginia in June 2004, and redemption of the Industrial Revenue Bonds in September 2004. Nine months ended October 31 General and administrative expense increased from $3,644,000 in the prior year period to $3,879,000 in the current-year nine-month period, and decreased as a percentage of net sales from 3.9% in the prior year period to 3.5% in the current year period. The increase was mainly due to management incentive compensation and building repairs and maintenance costs. Interest expense decreased to $1,331,000 for the current year period from $1,519,000 for the comparable period in the prior year. The decrease was primarily due to lower interest expense due to the sale of a building in Winchester, Virginia in June 2004, and redemption of the Industrial Revenue Bonds in September 2004. Interest income on federal tax refunds was received in the current year. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents as of October 31, 2004 were $529,000 as compared to $154,000 at January 31, 2004. The Company used $1,378,000 from operations during the first nine months. Operating cash flows decreased by $2,801,000 from the same period in the prior year. The cash from investing activities of $849,000 mainly resulted from the sale of a building and land to a third party in June 2004. A cash distribution of $50,000 was received from the Company's investment in a joint venture. These cash flows, plus borrowings of $676,000 from the Company's credit facility, were used to support $987,000 in capital spending. Exercise of stock options resulted in $228,000 of cash inflow. 11
Trade receivables increased $8,125,000 and inventories increased $2,186,000 from January 31, 2004 due to increased sales. Prepaid expenses and other current assets decreased $314,000 due to insurance premiums that will be renewed in November and utilization of sales tax credits. Other operating assets and liabilities increased $2,519,000 from January 31, 2004 due to increased commission liability and increased accrued liabilities. Net cash flow from investing activities for the nine months ended October 31, 2004 was $849,000. Net cash used for investing activities for the nine months ended October 31, 2003 was $3,154,000. Proceeds from the sale of property and equipment increased $1,311,000 from the prior year. On June 17, 2004, the Company sold one of its buildings located in Winchester, Virginia. The building sold consisted of 66,998 square feet on 10 acres. The Company is leasing from the Buyer approximately 12,000 square feet of the building. This transaction did not materially affect the earnings of the Company. Capital expenditures decreased $2,802,000 from the prior year. The prior year's capital additions of $3,789,000 mainly related to the Company's construction of a new building for one of its foreign subsidiaries. Current year capital expenditures related to new ERP business applications software and equipment purchases. Debt totaled $29,266,000, an increase of $741,000 since the beginning of the year. Net cash inflows from financing activities were $852,000, primarily as a result of borrowings of $10,616,000 and payments of $9,940,000 as well as $51,000 used for payments on capitalized lease obligations. Exercise of stock options resulted in $228,000 of cash inflow. The following table summarizes the Company's estimated contractual obligations, excluding the revolving lines of credit at October 31, 2004: <TABLE> <CAPTION> Total 1/31/05 1/31/06 1/31/07 1/31/08 1/31/09 Thereafter - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- <S> <C> <C> <C> <C> <C> <C> <C> Mortgages $ 9,252,400 $125,400 $502,800 $ 533,900 $ 567,700 $603,600 $6,919,000 - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Senior Debt 3,312,500 187,500 750,000 750,000 1,625,000 - - - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- IRB Payable 3,150,000 - - - 3,150,000 - - - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Term Loans 125,400 125,400 - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Capitalized Lease 23,900 15,900 6,000 2,000 - - - Obligations - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Sub Total (1) $15,864,200 $ 454,200 $1,258,800 1,285,900 5,342,700 $603,600 $6,919,000 - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Operating lease Obligations 2,070,800 $ 340,000 $ 520,000 $426,800 $366,500 $ 53,000 $ 364,500 - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Purchase Committments (2) 8,300,900 7,085,400 1,022,000 139,700 40,000 13,800 - - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- Total 26,235,900 $ 7,879,600 $2,800,800 $1,852,400 $5,749,200 $670,400 $7,283,500 - ----------------------- -------------- -------------- ------------- ------------- -------------- ------------- --------------- </TABLE> (1) Scheduled maturities, excluding the revolving line of credits (2) Purchase commitments were for purchases made in the normal course of business to meet operational and capital expenditure requirements. Other long term liability of $2,372,000 was composed of accrued pension cost and deferred compensation. The Company's working capital was approximately $13,458,000 at October 31, 2004 compared to approximately $8,759,000 at January 31, 2004. The change was primarily due to the increased accounts receivable. The Company's current ratio remained at 1.3 to 1 for October 31, 2004 and January 31, 2004, respectively. Debt to total capitalization at October 31, 2004 decreased to 49.4% from 51.5% at January 31, 2004. On September 14, 1995, Midwesco Filter Resources, Inc. in Winchester, Virginia received $2,050,000 of proceeds from Industrial Revenue Bonds, which were to mature on August 1, 2007. These bonds had been fully secured by bank letters of credit. As a result of the sale of land and a building on June 17, 2004, the Company redeemed the bonds in September 2004. 12
On July 11, 2002, the Company entered into secured note purchase agreements with certain institutional investors ("Note Purchase Agreements"). At July 31, 2004 and October 31, 2004, the Company was in compliance with covenants under the Note Purchase Agreement. At January 31, 2004 and April 30, 2004, the Company was not in compliance with one covenant under the Note Purchase Agreements. Waivers were previously obtained for noncompliance of debt covenants for fiscal periods ending on or prior to April 30, 2004. On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution ("Loan Agreement"). As of October 31, 2004, the Company had borrowed $12,844,000 and had $4,223,000 available to it under the revolving line of credit. In addition, $4,446,600 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts owed for an Industrial Revenue Bond borrowing. The Company has determined that borrowings outstanding under its revolving credit facility should be classified as current maturities of long-term debt in accordance with the provisions set forth in Emerging Issues Task Force 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box Arrangement." At July 31, 2004 and October 31, 2004, the Company was in compliance with covenants under the Loan Agreement. At January 31, 2004 and April 30, 2004, the Company was not in compliance with covenants under the Loan Agreement. Waivers were previously obtained for noncompliance of debt covenants for fiscal periods ending on or prior to April 30, 2004. ACCOUNTING PRONOUNCEMENTS In December 2003, the Financial Accounting Standards Board (FASB) issued a revision to SFAS No. 132, "Employers' Disclosure about Pensions and Other Postretirement Benefits." This Statement retains the disclosures previously required by SFAS 132 but adds additional disclosure requirements about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. It also calls for the required information to be provided separately for pension plans and for other postretirement benefit plans. In addition to expanded annual disclosures, the standard improves information available to investors in interim financial statements. SFAS 132R was effective for fiscal years ending after December 15, 2003, and for quarters beginning after December 15, 2003. The adoption of SFAS 132R has not had a material impact on the Company's financial statements, however, required interim disclosures have been reflected in the current financial statements. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This Interpretation requires the recognition of certain guarantees as liabilities at fair market value and is effective for guarantees issued or modified after December 31, 2002. Adoption of the provisions of the Interpretation has not had a material effect on the financial statements of the Company, based on guarantees in effect on October 31, 2004. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company was subject to market risk associated with changes in foreign currency exchange rates and interest rates. Foreign currency exchange rate risk was mitigated through maintenance of local production facilities in the markets served, invoicing of customers in the same currency as the source of the products and use of foreign currency denominated debt in Denmark. The Company also utilized foreign currency forward contracts to reduce exposure to exchange rate risks. The forward contracts were short-term in duration, generally one year or less. The major currency exposure hedged by the Company was the Canadian dollar. The contract amounts, carrying amounts and fair values of these contracts were not significant at October 31, 2004 or January 31, 2004. 13
The changeover from national currencies to the Euro began on January 1, 2002 and has not materially affected, 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 by maintaining a balance of fixed-rate long-term debt with floating rate debt. Commodity price risk is the possibility of higher or lower costs due to changes in the prices of commodities, such as ferrous alloys (e.g., steel) which are used in the production of the piping systems. The Company attempted to mitigate such risks by obtaining price commitments from its commodity suppliers and, when it appeared appropriate, purchasing quantities in advance of likely price increases. Item 4. Controls and Procedures As of October 31, 2004, the Company carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed in the Company's periodic SEC filings. There have been no changes in the Company's internal controls over financial reporting during the fiscal quarter to which this report relates that have materially effected or are reasonably likely to effect the Company's internal controls over financial reporting. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. 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 (1) Chief Executive Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2) Chief Financial Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 14
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: December 15, 2004 /s/ David Unger -------------------------------------------- David Unger Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer) Date: December 15, 2004 /s/ Michael D. Bennett -------------------------------------------- Michael D. Bennett Vice President, Secretary and Treasurer (Principal Financial and Accounting Officer) 15
Exhibit 31.1 I, David Unger, certify that: 1. I have reviewed this quarterly report on Form 10-Q of MFRI, Inc. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 15, 2004 /s/ David Unger - --------------------------- Director and Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)
Exhibit 31.2 I, Michael D. Bennett, certify that: 1. I have reviewed this quarterly report on Form 10-Q of MFRI, Inc. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 15, 2004 /s/ Michael D. Bennett - --------------------------- Michael D. Bennett Vice President, Secretary and Treasurer (Principal Financial and Accounting Officer)
Exhibit 32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) I, David Unger, Chief Executive Officer (principal executive officer) of MFRI, Inc. (the "Registrant"), certify that, to the best of my knowledge, based upon a review of the Quarterly Report on Form 10-Q for the period ended October 31, 2004 of the Registrant (the "Report"): (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. /s/ David Unger - ------------------------------ David Unger Director and Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer) December 15, 2004 A signed original of this written statement required by Section 906 has been provided to MFRI, Inc. and will be retained by MFRI, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
Exhibit 32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) I, Michael D. Bennett, Chief Financial Officer (principal financial officer) of MFRI, Inc. (the "Registrant"), certify that, to the best of my knowledge, based upon a review of the Quarterly Report on Form 10-Q for the period ended October 31, 2004 of the Registrant (the "Report"): (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. /s/ Michael D. Bennett - ------------------------------ Michael D. Bennett Vice President, Secretary and Treasurer (Principal Financial and Accounting Officer) December 15, 2004 A signed original of this written statement required by Section 906 has been provided to MFRI, Inc. and will be retained by MFRI, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.