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
April 30, 2006
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
Commission file number
0-18370
MFRI, INC.
(Exact name of registrant as specified in its charter)
Delaware
36-3922969
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
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 o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated filer
Non-accelerated filer
x
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of
The Exchange Act) Yes o No x
On June 13, 2006, there were 5,282,155 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, 2006. Reclassifications have been made in prior year financial statements to conform to the current year presentation. The results of operations for the quarter ended April 30, 2006 are not necessarily indicative of the results to be expected for the full year ending January 31, 2007. 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 northern hemisphere.
MFRI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands except per share information)
Three Months Ended
April 30,
2006
2005
Net sales
$
46,932
36,202
Cost of sales
37,127
28,335
Gross profit
9,805
7,867
Operating expenses:
Selling expenses
3,706
2,849
General and administrative expenses
4,967
4,414
Total operating expenses
8,673
7,263
Income from operations
1,132
604
Income from joint venture
83
96
Interest expense – net
556
386
Income before income taxes
659
314
Income taxes
508
Net income
151
218
Weighted average number of common shares outstanding – basic
5,281
5,234
Weighted average number of common shares outstanding - diluted
5,662
5,623
Basic earnings per share
0.03
0.04
Diluted earnings per share
See notes to condensed consolidated financial statements.
1
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands)
January 31,
Assets
Current Assets:
Cash and cash equivalents
1,373
1,114
Restricted cash
587
369
Trade accounts receivable, net
28,390
20,377
Accounts receivable – related companies
770
1,149
Costs and estimated earnings in excess of billings on
ncompleted contracts
3,511
2,471
Income taxes receivable
178
145
Inventories
25,300
23,711
Deferred income taxes
2,005
2,131
Prepaid expenses and other current assets
1,058
1,311
Total current assets
63,172
52,778
Property, plant and equipment, net
29,620
28,320
Other Assets:
Patents, net of accumulated amortization
444
453
Goodwill
2,564
2,509
Other assets
4,471
4,575
Total other assets
7,479
7,537
Total Assets
100,271
88,635
Liabilities and Stockholders’ Equity
Current Liabilities:
Trade accounts payable
16,141
10,929
Commissions payable
5,095
5,018
Accrued compensation and payroll taxes
2,550
2,478
Other accrued liabilities
4,845
4,114
Current maturities of long-term debt
1,477
1,562
Billings in excess of costs and estimated earnings on uncompleted
ontracts
1,990
134
Total current liabilities
32,098
24,235
Long-Term Liabilities:
Long-term debt, less current maturities
32,943
29,724
Other
2,979
2,866
Total long-term liabilities
35,922
32,590
Stockholders’ Equity:
Common stock, $.01 par value, authorized – 50,000 shares in April 2006 and January 2006; 5,281 issued and outstanding in April 2006 and 5,276 issued and outstanding in January 2006
53
Additional paid-in capital
23,116
23,084
Retained earnings
8,594
8,444
Accumulated other comprehensive income
488
229
Total stockholders’ equity
32,251
31,810
Total Liabilities and Stockholders’ Equity
2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended April 30,
Cash Flows from Operating Activities:
Adjustments to reconcile net income to net cash flows from operating activities:
(Income) from joint venture
(83
)
(96
Depreciation and amortization
868
831
Provision for uncollectible accounts
47
(22
Changes in operating assets and liabilities:
Trade accounts receivable
(8,060
167
Costs and estimated earnings in excess of billings on uncompleted contracts
815
966
(1,589
(865
725
416
Current liabilities
5,360
(3,052
Other operating assets and liabilities
792
765
Net Cash Flows from Operating Activities
(974
(672
Cash Flows from Investing Activities:
Purchases of property and equipment
(2,035
(1,013
Net Cash Flows from Investing Activities
Cash Flows from Financing Activities:
Borrowings under revolving, term and mortgage loans
37,494
14,300
Repayment of debt
(34,508
(12,905
Stock options exercised
32
54
Payments on capitalized lease obligations
(2
-
Net Cash Flows from Financing Activities
3,016
1,449
Effect of Exchange Rate Changes on Cash and Cash Equivalents
252
(70
Net Increase in Cash and Cash Equivalents
259
(306
Cash and Cash Equivalents – Beginning of Period
723
Cash and Cash Equivalents – End of Period
417
Supplemental cash flow information:
Cash paid for:
Interest, net of capitalized amounts
557
339
Income taxes paid (refunded)
39
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
APRIL 30, 2006
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, 2006 audited financial statements have been omitted from these interim financial statements. 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.
2.
At April 30, 2006 the Company has equity-based compensation plans from which stock-based compensation awards can be granted to eligible employees, officers or directors.
Prior to February 1, 2006, the Company accounted for its equity-based awards in accordance with the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). The Company did not recognize stock-based compensation cost in its Consolidated Statement of Operations prior to February 1, 2006, since the options granted had an exercise price equal to the market value of the common stock on the grant date.
Effective February 1, 2006, the Company adopted the fair value recognition provision of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the modified-prospective-transition method. Under this transition method, compensation cost recognized includes compensation costs for all share-based payments granted prior to, but not vested as of February 1, 2006 based on the fair value at grant date estimated in accordance with SFAS 123. The Company has not awarded stock-based compensation to employees, officers or directors during the three-month period ended April 30, 2006. No stock options vested in the first quarter and the stock-based compensation expense for the 2006’s first quarter was $15,000 (net of tax). Results for prior periods have not been restated.
The fair values of the option awards granted prior to but not vested as of April 2006 and 2005 respectively, were estimated on the grant date using the Black-Scholes option pricing model and the assumptions shown in the following table:
April 30, 2005
Expected volatility
46.81%-51.95%
44.85%-50.01%
Risk-free interest rate
2.93%-4.51%
2.93%-4.95%
Dividend yield
0%
Expected life in years
7
Had compensation cost been determined using the fair value method at April 30, 2005, the Company’s pro forma net income (loss) and earnings (loss) per share would have been as follows:
Net income – as reported
Compensation cost using fair market value-based accounting method net
of tax
(21
Net income – pro forma
197
Net income per common share – basic, as reported
Net income per common share – basic, pro forma
Net income per common share – diluted, as reported
Net income per common share – diluted, pro forma
4
3.
Inventories consisted of the following:
Raw materials
19,099
17,695
Work in progress
3,197
3,045
Finished goods
4,267
4,254
Sub total
26,563
24,994
Less: Inventory allowance
1,263
1,283
Inventory, net
4.
Goodwill: The Company reviews the carrying value of goodwill in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, which requires that goodwill and other intangible assets with indefinite lives be analyzed for impairment on an annual basis or when there is reason to suspect that their values have been impaired. For the 2006 and 2005 evaluations, the fair value was determined using discounted cash flows and other market-related valuation models. Certain estimates and judgments are required in the application of the fair value models. Based upon the Company’s evaluations for 2006 and 2005, no impairment of goodwill was required. Goodwill was $2,564,000 and $2,509,000 at April 30, 2006 and January 31, 2006, respectively. As of April 30, 2006 and January 31, 2006, $1,100,000 of goodwill was allocated to the Industrial Process Cooling Equipment segment. As of April 30, 2006 and January 31, 2006, $1,464,000 and $1,409,000, respectively, was allocated to the Filtration Products segment. The change in goodwill was due to foreign currency translation.
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 $444,000 and $453,000 at April 30, 2006 and January 31, 2006, respectively. Accumulated amortization was $1,879,000 and $1,835,000 at April 30, 2006 and January 31, 2006, respectively. Future amortization over the next five years ending January 31, will be 2007 - $130,500, 2008 - $30,000, 2009 - $27,000 2010 - $23,000, 2011 - $21,000.
6.
Pension Plan for Hourly Rated Employees of Midwesco Filter Resources, Inc., Winchester, Virginia: The market-related value of plan assets at April 30, 2006 and January 31, 2006 were $3,467,007 and $3,419,846, respectively. Net cost recognized was as follows:
Components of net periodic benefit cost:
Service cost
24
29
Interest cost
49
62
Expected return on plan assets
(67
(63
Amortization of prior service cost
21
20
Recognized actuarial loss
6
50
Net periodic benefit cost
33
98
Employer contributions remaining for fiscal year ending January 31, 2007 are expected to be $292,509. In February 2006 a $23,693 contribution was made.
5
7.
The basic weighted average shares reconcile to diluted weighted average shares as follows:
Basic weighted average number of common shares outstanding
Dilutive effect of stock options
381
389
Weighted average number of common shares outstanding assuming full dilution
Basic earnings per share net income
Diluted earnings per share net income
Stock options not included in the computation of diluted earnings per share of common stock because the option exercise prices exceeded the average market prices of the common shares
75,000
Stock options with an exercise price below the average stock price
652,521
595,568
As of June 13, 2006 a total of 6,000 stock options were exercised since February 1, 2006.
8.
The components of comprehensive income, net of tax, were as follows:
Interest rate swap
45
0
Change in foreign currency translation adjustments
212
(79
Comprehensive income
408
139
Accumulated other comprehensive income presented on the accompanying condensed consolidated balance sheets consists of the following:
Accumulated translation adjustment
681
468
Interest rate swap (net of tax benefit of $30)
59
13
Minimum pension liability adjustment (net of cumulative tax benefit of $154 at April 30 and January 31, 2006)
(252
9.
Business Segment Reporting: 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.
Net sales:
Filtration Products
18,565
17,037
Piping Systems
14,246
11,306
Industrial Process Cooling Equipment
11,636
7,859
Corporate and Other
2,485
Total net sales
Gross profit:
3,302
3,129
2,906
2,424
3,517
2,314
80
Total gross profit
Income (expense) from operations:
682
835
1,092
1,038
904
367
(1,546
(1,636
Income (expense) before income taxes:
1,175
1,134
(2,102
(2,022
10.
Related Party Transactions: The Company provides certain services to a company primarily owned by two principal stockholders who are also members of management of the Company. The Company also purchases certain services, leases space and subcontracts projects with such company under management services agreement, a lease agreement or contracts, which was approved by the Company’s Committee of Independent Directors.
Related company accounts receivable of $770,000 and $1,149,000 were included in the receivable balances at April 30, 2006 and January 31, 2006 respectively. During the first quarter of 2006, the Company recorded revenue of $2,485,000 pursuant to a contract wholly subcontracted to such company.
11.
Contingencies: The Company is subject to various unresolved legal actions, which arise in the normal course of its business. None of these matters is expected to have a material adverse effect on the Company’s financial position or results of operations. However, the ultimate resolution of these matters could result in a change in the Company’s estimate of its liability for these matters.
The Company issues a standard warranty with the sale of its products and sells extended warranty contracts to customers. The Company’s recognition of warranty liability is based, generally, on analyses
of warranty claims experiences in the operating units in the preceding years. Changes in the warranty liability in 2006 are summarized below (in thousands):
Year Ended
Aggregate product warranty liability at beginning of year
827
738
Aggregate accruals related to product warranties
438
907
Aggregate reductions for payments
(802
Aggregate changes for pre-existing warranties
(16
Aggregate product warranty liability at end of year
957
12.
In April 2005, the SEC announced the adoption of a new rule that amends the compliance dates for Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (Statement No. 123R). Under Statement No. 123R, the Company is required to implement 123R for the first interim period ending April 30, 2006. The impact on the Company in the future is not expected to be material.
FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” with an effective date of December 15, 2005 provides an elective alternative transition method. The Company has one year from December 15, 2005, the initial adoption of SFAS No. 123R to evaluate the available transition alternatives and make its one-time election. The transition method prescribed by SFAS 123R will be followed until the alternative method is elected.
In December 2003, the FASB issued Interpretation No. 46R, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” which requires that the assets, liabilities, and the results of activities of a variable interest entity in which a business enterprise has controlling financial interest be included in consolidation with those of the business enterprise. Adoption of FIN No. 46R does not apply to the Company.
13.
At April 30, 2006, the Company was in compliance with covenants under the Loan Agreement as defined below.
On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution (“Loan Agreement”). Under the terms of the Loan Agreement as amended through May 10, 2006, which matures on November 30, 2007, the Company can borrow under a revolving line of credit $30,000,000, subject to borrowing base and other requirements. Interest rates generally are based on options selected by the Company as follows: (a) a margin in effect plus a prime rate; or (b) a margin in effect plus the LIBOR rate (“LIBOR Margin”) for the corresponding interest period. At April 30, 2006, the prime rate was 7.75%, and the margin added to the LIBOR rate, which is determined each quarter based on the applicable financial statement ratio, was 2.25 percentage points. Monthly interest payments were made. As of April 30, 2006, the Company had borrowed $15,290,000 and had $2,800,000 available to it under the revolving line of credit. In addition, $4,521,400 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 Loan Agreement provides that all payments by the Company’s customers are deposited in a bank account from which all funds may only be used to pay the debt under the Loan Agreement. At April 30, 2006, the amount of restricted cash was $587,000. Cash required for operations is provided by draw-downs on the line of credit.
8
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.
MFRI, Inc. ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three distinct business segments: filtration products, piping systems and industrial process cooling equipment. Generally, sales of the Company's piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the northern hemisphere. The Company’s other businesses do not demonstrate seasonality.
Our analysis presented below is organized to provide instructive information for understanding the business going forward. However, this discussion should be read in conjunction with the consolidated financial statements, including the notes thereto. An overview of the segment results is provided in Note 9 of the Notes to Condensed Consolidated Financial Statements (Unaudited) contained in Item 1 of this report.
Three months ended April 30
Net sales of $46,932,000 for the quarter increased 29.6% from $36,202,000 for the comparable quarter in the prior-year. (See discussion of each business segment below.)
Gross profit of $9,805,000 increased 24.6% from $7,867,000 in the prior-year quarter, and gross margin decreased to 20.9% of net sales in the current year from 21.7 % of net sales in the prior-year. (See discussion of each business segment below.)
Selling expenses increased 30.0% to $3,706,000 for the quarter from $2,849,000 in the prior-year quarter due primarily to increased number of selling personnel and related commissions. (See discussion of each business segment below.)
General and administrative expenses increased 12.5% to $4,967,000 for the quarter from $4,414,000 in the prior-year quarter. General administrative expenses increases included $351,000 in start up costs described in the Piping Systems Business section of this report. (See discussion of each business segment below.)
Net income declined to $151,000 in the current quarter from $218,000 in the prior-year quarter primarily for reasons summarized above and discussed in more detail below, including the unfavorable income tax effect of $380,000 of PPME start-up expenses which were not tax deductible. Because PPME is located in an area with no income taxes, future earnings generated there will also be free of income taxes.
9
Filtration Products Business
Net sales for the quarter increased 9.0% to $18,565,000 from $17,037,000 for the comparable quarter in the prior-year. This increase was primarily the result of increased sales of filter bags and related services.
Gross profit as a percent of net sales declined to 17.8% in the current year from 18.4% in the prior-year primarily as a result of product mix and a highly competive market place.
Selling expenses increased to $1,726,000 from $1,456,000 for the comparable quarter last year and increased as a percentage of sales to 9.3% from 8.5% of net sales for the comparable quarter last year. The increase was primarily due to additional selling personnel, related commissions and travel expenses.
General and administrative expenses increased to $897,000 or 4.8% of net sales in the current-year quarter from $838,000 or 4.9% of net sales in the prior-year quarter. The increase was primarily due to increased depreciation expenses at our Danish facility related to upgrading its business applications software.
Piping Systems Business
Generally, sales of the Company’s piping systems have had a tendency to be lower during the winter months, due to weather constraints over much of the northern hemisphere.
Net sales increased 26.0% to $14,246,000 in the current quarter from $11,306,000 in the prior-year quarter. This increase was primarily due an increase in the oil and gas business.
Gross profit as a percent of net sales decreased to 20.4% from 21.4% primarily because of higher unabsorbed manufacturing costs.
Selling expenses increased to $425,000 or 3.0% of net sales in the current year quarter from $392,000 or 3.5% of net sales for the prior-year quarter. The increase was primarily due to $29,000 of selling expenses for the new facility in the United Arab Emirates (“U.A.E.”).
General and administrative expenses increased to $1,390,000 or 9.8% of net sales in the current year quarter from $994,000 or 8.8% of net sales for the prior-year quarter. In March, 2006 the Company opened a new facility (PPME), in the U.A.E. The company will manufacture specialty pre-insulated piping systems for Dubai, other parts of the U.A.E., and other markets in the region. The increase in general and administrative expenses was primarily due to $351,000 in start-up costs related to PPME.
Industrial Process Cooling Equipment Business
Net sales of $11,636,000 for the quarter increased 48.1% from $7,859,000 for the comparable quarter in the prior-year. The increase was due primarily to improved conditions in plastic molding and printing markets.
Gross profit increased to 30.2% of net sales from 29.4% of net sales in the prior-year quarter, primarily due to fixed overhead costs over larger volume.
Selling expenses increased to $1,556,000 or 13.4% of net sales in the current-year quarter from $1,001,000 or 12.7% of net sales in the prior-year quarter. The increase was due to additional sales personnel and higher commissions due to increased sales.
10
General and administrative expenses increased to $1,057,000 or 9.1% of net sales from $947,000 or 12.0% of net sales in the prior-year quarter. This dollar increase was primarily due to increased salary expense and increased group insurance expense.
General Corporate and Other
The first quarter 2006, included Sales of $2,485,000 and gross profit of $80,000 not related to the Company’s three reportable business segments.
General corporate expenses included interest expense and general and administrative expenses that were not allocated to the business segments.
General and administrative expenses decreased to $1,626,000 in the current year quarter from $1,636,000 in the prior-year quarter, and decreased as a percentage of total company net sales to 3.5% in the current year quarter from 4.5% in the prior-year quarter. The decrease was mainly due to expenses incurred in the prior year to comply with Sarbanes-Oxley 404 (including consulting fees) that were not incurred this year.
Interest expense increased to $556,000 for the current year quarter from $386,000 in the prior-year quarter. The increase was primarily due to additional borrowings at higher interest rates.
Taxes on earnings reflect the estimated annual effective rates for the first quarter 2006. The 77.1% effective tax rate for the first quarter 2006 is more than the statutory U.S. federal income tax rate due mainly to the unfavorable income tax effect of PPME start-up expenses without income tax benefit. In the first quarter 2006, an expense of $106,000 was incurred relating to prior years’ state taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents as of April 30, 2006 were $1,373,000 as compared to $1,114,000 at January 31, 2006. The Company used $974,000 from operations during the first three months. Operating cash flows decreased by $302,000 from the corresponding period in the prior year. Net borrowings of $2,984,000 from the Company’s credit facility, and operating cashflow were used to support $2,035,000 in capital spending. Exercise of stock options resulted in proceeds of $16,000.
Trade receivables increased $8,060,000 primarily due to the piping systems business’ trade receivables up by $3,259,000 from an increase in the oil and gas business. Inventories increased $1,589,000 from January 31, 2006 due to increased production. Other operating assets and liabilities increased $791,000 from January 31, 2006.
Net cash used for investing activities for the three months ended April 30, 2006 was $2,035,000. Capital expenditures increased $1,022,000 from the prior year period primarily due to PPME facility asset additions of $1,129,000.
Debt totaled $34,420,000, an increase of $3,134,000 since the beginning of the year. Net cash inflows from financing activities were $3,016,000, primarily to support higher working capital investments. Stock option activity resulted in $32,000 of cash inflow.
The Company’s working capital was approximately $31,074,000 at April 30, 2006 compared to approximately $28,543,000 at January 31, 2006. The change was primarily due to the increase in accounts receivable.
The Company’s current ratio was 2.0 to 1 for April 30, 2006 and 2.2 to 1 for January 31, 2006, respectively. Debt to total capitalization at April 30, 2006 increased to 51.6% from 49.6% in January 31, 2006.
11
ACCOUNTING PRONOUNCEMENTS
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.
At January 31, 2006 one interest rate swap agreement was in effect with a notional value of $8,000,000 maturing in 2008. The swap agreement exchanges the variable rate to fixed interest rate payments of 4.72% plus LIBOR margin. The interest rate swap was effective as a cash flow hedge and no charge to earnings was required during the period ended April 30, 2006. The fair value of the derivative financial instrument was $89,300, and $59,000, net of deferred tax benefits of $30,300, was recorded in other assets and accumulated other comprehensive income associated with the cash flow hedge at April 30, 2006.
A hypothetical ten percent change in market interest rates over the next year would increase interest on the Company's floating rate debt instruments by approximately $84,000.
12
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 April 30, 2006, 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.
Changes in Internal Controls.
There was a material weakness in internal control described in Item 9A of the Company’s January 31, 2006 10-K filed on May 12, 2006. When processing inventory transactions using an Enterprise Resources Planning system installed in December 2004 at the Company's production facility for filtration products in Winchester, VA ("Winchester Facility"), errors were made subsequent to Winchester Facility's January 31, 2005 physical inventory, and during each of the interim fiscal quarters of 2005, which were discovered by Registrant's accounting personnel only when analyzing the Winchester Facility physical inventory as of January 31, 2006. The errors did not affect the quantity of physical inventory, and no restatement for any such period affects the Registrant's sales, cash flows, or business prospects. However, the errors did result in the overstatement of inventories, current assets, total assets, income before income taxes, and net income for each of the interim fiscal quarters of 2005.
Since January 31, 2006, the Company has taken steps to correct transaction processing procedures, accounting controls and reporting controls at the Winchester Facility to prevent recurrence of such errors. The Company has also examined controls and procedures at the Registrant's other locations to detect the presence of possible weaknesses similar to those that caused the above errors, and has analyzed the inventory accounts at Registrant's other locations to detect the possible presence of errors similar to those described above. No such weaknesses or errors were detected.
Other than the change discussed above, there have been no significant changes in the Company's internal controls, or in other factors that could significantly affect these controls, subsequent to the date of that evaluation.
PART II – OTHER INFORMATION
Item 6.
Exhibits
(31)
Rule 13a – 14(a)/15d – 14(a) Certifications
(1)
Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
(2)
Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-
(32)
Section 1350 Certifications
Chief Executive Officer certification pursuant to Section 906 of the Sarbanes-
Chief Financial Officer certification pursuant to Section 906 of the Sarbanes-
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.
Date:
June 14, 2006
/s/ David Unger
David Unger
Chairman of the Board of Directors, and
Chief Executive Officer
(Principal Executive Officer)
/s/ Michael D. Bennett
Michael D. Bennett
Vice President, Secretary and Treasurer
(Principal Financial and Accounting Officer)
14