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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2002
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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
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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 September 15, 2002, 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, 2002. The results of
operations for the quarter ended July 31, 2002 are not necessarily indicative of
the results to be expected for the full year ending January 31, 2003.
MFRI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands except per share information)
Three Months Ended Six Months Ended
July 31, July 31,
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net sales $ 34,326 $ 34,190 $ 61,095 $ 64,882
Cost of sales 26,087 26,011 47,104 49,692
-------- -------- -------- --------
Gross profit 8,239 8,179 13,991 15,190
Selling expense 2,614 2,560 4,875 5,149
General and administrative expense 4,529 3,581 7,807 7,090
-------- -------- -------- --------
Income from operations 1,096 2,038 1,309 2,951
Interest expense 517 689 1,036 1,365
-------- -------- -------- --------
Income before income taxes and
net extraordinary gain 579 1,349 273 1,586
Income taxes 238 553 114 650
-------- -------- -------- --------
Income before net extraordinary gain 341 796 159 936
Net extraordinary gain, net of
tax of $84 129 - 129 -
-------- -------- -------- --------
Net income $ 470 $ 796 $ 288 $ 936
======== ======== ======== ========
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 4,922
Basic earnings per share
Income before net extraordinary gain $0.07 $0.16 $0.03 $0.19
Net extraordinary gain $0.03 - $0.03 -
Net income $0.10 $0.16 $0.06 $0.19
Diluted earnings per share
Income before net extraordinary gain $0.07 $0.16 $0.03 $0.19
Net extraordinary gain $0.03 - $0.03 -
Net income $0.10 $0.16 $0.06 $0.19
See notes to condensed consolidated financial statements.
1
MFRI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands except per share information)
July 31, January 31,
Assets 2002 2002
- --------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 253 $ 119
Restricted cash 439 -
Trade accounts receivable, net 21,431 18,845
Costs and estimated earnings in excess of
billings on uncompleted contracts 3,322 3,324
Inventories 20,378 18,682
Deferred income taxes 2,179 2,179
Prepaid expenses and other current assets 3,290 2,463
-------- --------
Total current assets 51,292 45,612
Property, plant and equipment, net 29,131 30,065
Other Assets:
Patents, net of accumulated amortization 901 962
Goodwill, net of accumulated amortization 12,615 12,445
Other assets 3,797 3,445
-------- --------
Total other assets 17,313 16,852
-------- --------
Total Assets $ 97,736 $ 92,529
======== ========
Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------
Current Liabilities:
Trade accounts payable $ 12,660 $ 9,643
Other accrued liabilities 5,719 4,683
Commissions payable 4,939 4,821
Current maturities of long-term debt 1,988 11,100
Billings in excess of costs and estimated
earnings on uncompleted contracts 738 525
-------- --------
Total current liabilities 26,044 30,772
Long-Term Liabilities:
Long-term debt, less current maturities 30,145 21,100
Deferred income taxes 1,296 1,143
Other 1,575 1,527
-------- --------
Total long-term liabilities 33,016 23,770
Stockholders' Equity:
Common stock, $.01 par value, authorized -
50,000 and 50,000 shares in July 2002 and
January 2002 respectively; 4,922 issued and
outstanding in July 2002 and January 2002
respectively 49 49
Additional paid-in capital 21,397 21,397
Retained earnings 18,013 17,725
Accumulated other comprehensive loss (783) (1,184)
-------- --------
Total stockholders' equity 38,676 37,987
-------- --------
Total Liabilities and Stockholders' Equity $ 97,736 $ 92,529
======== ========
See notes to condensed consolidated financial statements.
2
MFRI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
(In thousands) July 31,
---------------------------
2002 2001
-------- --------
Cash Flows from Operating Activities:
Net income $ 288 $ 936
Adjustments to reconcile net income to
net cash flows from operating activities:
Net extraordinary gain (net of tax of $84) (129) -
Provision for depreciation and amortization 1,919 2,044
Change in operating assets and liabilities,
net of effects of acquisition of certain
assets of a business:
Trade accounts receivable (2,392) 2,204
Costs and estimated earnings in excess
of billings on uncompleted contracts 215 (304)
Inventories (671) (242)
Prepaid expenses and other current assets (765) 343
Current liabilities 4,015 (1,165)
Other operating assets and liabilities (987) 124
-------- --------
Net Cash Flows from Operating Activities 1,493 3,940
-------- --------
Cash Flows from Investing Activities:
Proceeds from sale of property and equipment - 1,366
Purchases of property and equipment (587) (1,909)
Acquisition of certain assets of a business (500) -
Investment in joint venture (60) -
-------- --------
Net Cash Flows from Investing Activities (1,147) (543)
-------- --------
Cash Flows from Financing Activities:
Payments on capitalized lease obligations (68) (69)
Borrowings under revolving, term and mortgage
loans 181,429 717,489
Repayment of debt (181,590) (720,571)
-------- --------
Net Cash Flows from Financing Activities (229) (3,151)
-------- --------
Effect of Exchange Rate Changes on Cash
and Cash Equivalents 17 (39)
-------- --------
Net Increase in Cash and Cash Equivalents 134 207
Cash and Cash Equivalents - Beginning of Period 119 290
-------- --------
Cash and Cash Equivalents - End of Period $ 253 $ 497
======== ========
Supplemental cash flow information:
Cash paid for:
Interest, net of capitalized amounts $ 1,022 $ 1,329
Income taxes, net of refunds received 66 37
See notes to condensed consolidated financial statements.
3
MFRI, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JULY 31, 2002
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, 2002. Accordingly,
footnote disclosures which would substantially duplicate the disclosures
contained in the January 31, 2002 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.
2. Inventories consisted of the following:
July 31, January 31,
(In thousands) 2002 2002
-------- --------
Raw materials $ 15,136 $ 14,720
Work in process 2,312 1,551
Finished goods 2,930 2,411
-------- --------
Total $ 20,378 $ 18,682
======== ========
3. The basic weighted average shares reconcile to diluted weighted average
shares as follows:
Three Months Ended Six Months Ended
(In thousands) July 31, July 31,
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net Income $ 470 $ 796 $ 288 $ 936
======== ======== ======== ========
Basic weighted average common
shares outstanding 4,922 4,922 4,922 4,922
Dilutive effect of stock options - - - -
-------- -------- -------- --------
Weighted average common shares
outstanding assuming full dilution 4,922 4,922 4,922 4,922
======== ======== ======== ========
Net income per common share - basic $0.10 $0.16 $0.06 $0.19
Net income per common share - diluted $0.10 $0.16 $0.06 $0.19
4
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 926,000 and 500,000 for the three months ended July 31, 2002 and
2001, respectively, and 886,000 and 625,000 for the six months ended July
31, 2002 and 2001, respectively. These options were outstanding at the end
of each of the respective periods.
4. The components of comprehensive income, net of tax, were as follows:
Three Months Ended Six Months Ended
(In thousands) July 31, July 31,
------------------ -------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net Income $ 470 $ 796 $288 $ 936
Change in foreign currency translation
adjustments 339 (25) 401 (153)
Change in minimum pension liability - - - -
-------- -------- -------- --------
Comprehensive income $ 809 $ 771 $ 689 $ 783
======== ======== ======== ========
Accumulated other comprehensive loss presented on the accompanying
condensed consolidated balance sheets consists of the following:
(In thousands) July 31, January 31,
2002 2002
-------- --------
Accumulated translation adjustment $ (291) $ (692)
Minimum pension liability adjustment (net of
tax benefit of $302 and $164, respectively) (492) (492)
-------- --------
Total $ (783) $ (1,184)
======== ========
5. 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 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.
5
Three Months Ended Six Months Ended
(In thousands) July 31, July 31,
------------------ -------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net Sales:
Filtration Products $ 13,575 $ 12,561 $ 25,967 $ 25,954
Piping Systems 14,471 15,316 23,795 27,252
Industrial Process Cooling Equipment 6,280 6,313 11,333 11,676
-------- -------- -------- --------
Total Net Sales $34,326 $ 34,190 $ 61,095 $ 64,882
======== ======== ======== ========
Gross Profit:
Filtration Products $ 2,792 $ 2,420 $ 5,005 $ 4,982
Piping Systems 3,435 3,947 5,577 6,860
Industrial Process Cooling Equipment 2,012 1,812 3,409 3,348
-------- -------- -------- --------
Total Gross Profit $ 8,239 $ 8,179 $ 13,991 $ 15,190
======== ======== ======== ========
Income from Operations:
Filtration Products $ 174 $ 608 $ 544 $ 1,206
Piping Systems 1,776 2,040 2,508 3,241
Industrial Process Cooling Equipment 298 422 299 558
Corporate (1,152) (1,032) (2,042) (2,054)
-------- -------- -------- --------
Total Income from Operations $ 1,096 $ 2,038 $ 1,309 $ 2,951
======== ======== ======== ========
6. On July 11, 2002, the Company executed a loan agreement with a bank,
providing access to a revolving line of credit. Under the terms of the loan
agreement, all payments by the Company's domestic customers are deposited
in a bank account ("Dominion Account") from which all funds may only be
used to pay the debt under the Loan Agreement. At July 31, 2002, the amount
of such restricted cash was $439,000.
7. The Company completed the early extinguishment of a loan with principal
balance of $700,000, resulting in an extraordinary loss on the
extinguishment of $79,000, net of tax. (See note 10 below.)
8. On June 19, 2002, the Company purchased certain assets of a business for
$500,000 in cash. The asset value in accordance with Statement of Financial
Accounting Standards No. 141 (SFAS 141) was $846,000 for inventory and $0
for other assets, resulting in the recognition of an extraordinary gain of
$346,000 ($208,000 net of tax), related to the write-off of negative
goodwill.
9. In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations". The statement requires all business
combinations initiated after June 30, 2001 to be accounted for by the
purchase method. Adoption of SFAS No. 141 did not have a material effect on
reported results of operations, financial condition or cash flows of the
Company.
On February 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142 (SFAS 142), "Goodwill and Other Intangible Assets." SFAS
142 changes the accounting for goodwill from an amortization method to an
impairment-only approach. Amortization of goodwill and intangible assets
with indefinite lives, including such assets recorded in past business
combinations, ceases upon adoption. Thus, no amortization for such goodwill
and indefinite lived intangibles was recognized in the accompanying
condensed consolidated statements of operations for the three and six
months ended July 31, 2002, compared with $133,000 or $0.03 per share and
$266,000 or $0.05 per share for the comparable periods of the prior year.
6
On an annual basis and when there is reason to suspect that their values
have been impaired, these assets must be tested for impairment, and a write
down may be necessary. SFAS 142 allows up to six months from the date of
adoption to complete the initial transitional impairment test, which uses a
fair value methodology. Based on the results of step one of the
transitional impairment test, the Company has identified potential
impairment of goodwill in all three of its reporting units. Step two of the
transitional impairment test, in which the magnitude of any goodwill
impairment will be determined, must be completed by January 31, 2003, and
any resulting impairment loss will be recorded as a cumulative effect of a
change in accounting principle. Initial quantification of the impairment
test, which may vary from the final quantification, indicates that the
amount of the write down could be up to 100% of the Company's approximately
$14,000,000 of goodwill and related intangible assets.
In October 2001, the FASB issued SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," which was effective for the
Company in February 1, 2002. SFAS No. 144 addresses accounting and
reporting of the impairment or disposal of long-lived assets, including
discontinued operations, and establishes a single accounting method for the
sale of long-lived assets. Adoption of SFAS No. 144 did not have a material
effect on the results of operations, financial condition or cash flows of
the Company.
10. On July 11, 2002, the Company entered into secured note purchase agreements
with certain institutional investors ("Note Purchase Agreements"). Under
the terms of the Note Purchase Agreements, the Company entered into a
five-year $6,000,000 term loan replacing prior term loans with certain
institutional investors which had originally provided for senior notes with
an aggregate original principal balance of $25,000,000 ("Prior Term
Loans"). The outstanding principal balance of the Prior Term Loans at July
11, 2002 was $16,000,000. The Company borrowed $10,000,000 from its new
revolving line of credit from another financial institution to pay down
this loan from $16,000,000 to $6,000,000. Interest rates under the Note
Purchase Agreements are 12% per annum if the outstanding principal is
greater than $5,000,000 or 10% per annum if the outstanding principal is
$5,000,000 or less. The Company is required to pay $187,500 in aggregate
principal on the last day of March, June, September and December in each
year, commencing on September 30, 2002 and ending on June 30, 2007. In
addition, the Company is required to make annual prepayments of excess cash
flow (as defined in the Note Purchase Agreements). Finally, the Loan
Agreement and the Note Purchase Agreements permit voluntary prepayments
sufficient to reduce the outstanding term loan principal to $5,000,000
subject to certain conditions. The Company met such conditions and made
such prepayments on July 31, 2002 reducing the principal balance to
$5,000,000. At July 31, 2002, the Company was in compliance with all
covenants contained in the Note Purchase Agreements.
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, which matures on July 10, 2005, the Company can
borrow up to $28,000,000 (reduced to $27,000,000 upon completion of the
Lebanon, Tennessee mortgage borrowing described below), subject to
borrowing base and other requirements, under a revolving line of credit.
Interest rates generally are based on options selected by the Company as
follows: (a) a margin in effect plus a base rate; or (b) a margin in effect
plus the LIBOR rate for the corresponding interest period. At July 31,
2002, the prime rate was 4.75 percent, and the margins added to the prime
rate and the LIBOR rate, which are determined each quarter based on the
applicable financial statement ratio, were 1.00 and 3.00 percentage points
respectively. The Company had borrowed $11,545,000 under the revolving line
7
of credit at July 31, 2002, $10,000,000 of which was used to reduce debt
outstanding under the Prior Term Loans and $700,000 under the Prior Credit
Agreement (see below). The Company's policy is to classify borrowings under
the revolving line of credit as long-term debt, as the Company has the
ability and the intent to maintain this obligation for longer than one
year. In addition, $5,815,000 was drawn under the agreement as letters of
credit to guarantee amounts owed for Industrial Revenue Bond borrowings,
property taxes and insurance premiums. The Loan Agreement replaced a
three-year secured credit agreement with a bank which had provided a
revolving line of credit of $8,000,000 ("Prior Credit Agreement") and a
loan with a principal balance of $700,000. The early extinguishment of the
Prior Credit Agreement resulted in an extraordinary loss of $79,000, net of
tax. The Loan Agreement also 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 July 31, 2002, the amount
of such restricted cash was $439,000. At July 31, 2002 the Company was in
compliance with all covenants contained in the Loan Agreement.
On April 26, 2002, Midwesco Filter Resources, Inc. ("Midwesco Filter")
borrowed $3,450,000 under two mortgage notes secured by two parcels of real
property and improvements owned by Midwesco Filter in Winchester, Virginia.
Proceeds from the mortgages, net of a prior mortgage loan, were
approximately $2,700,000 and were used to make principal payments to the
Prior Term Loans and the Prior Credit Agreement. The loans each bear
interest at 7.10 percent, and the loans' amortization schedules and terms
are each ten years.
On July 31, 2002, Perma-Pipe, Inc. borrowed $1,750,000 under a mortgage
note secured by its manufacturing facility in Lebanon, Tennessee.
$1,000,000 of the proceeds was used for a required payment of amounts
borrowed under the Loan Agreement with the remaining proceeds used to repay
amounts borrowed under the Note Purchase Agreements. The loan bears
interest at 7.75 percent with monthly payments of $21,001 for both
principal and interest, and has a ten-year term.
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.
On August 10, 1999, the Company obtained a loan from a Danish bank in the
amount of 3,000,000 Danish Krone (DKK) (approximately $425,000) to complete
the permanent financing of the acquisition of Nordic Air A/S. The loan
bears interest at 6.22 percent and has a term of five years.
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 ("Boe-Therm"). The first
loan in the amount of 4,500,000 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.
8
On September 14, 1995, Midwesco Filter in Winchester, Virginia received
$3,150,000 of proceeds of Industrial Revenue Bonds, which mature on August
1, 2007, and on October 18, 1995, Perma-Pipe, Inc. in Lebanon, Tennessee
received $3,150,000 of proceeds of Industrial Revenue Bonds, which mature
on September 1, 2007. These bonds are fully secured by bank letters of
credit, which the Company expects to renew, reissue, extend or replace
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. The bond proceeds were
available for capital expenditures related to manufacturing capacity
expansions and efficiency improvements during a three-year period which
commenced in the fourth quarter of 1995 and ended during the Company's
fiscal quarter ended October 31, 1998. On November 1, 1999, the Company
utilized $1,100,000 of unspent bond proceeds to redeem bonds outstanding as
provided in the indenture.
The Company also has 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. At July 31, 2002, borrowings under these credit
arrangements totaled $341,000; an additional $629,000 remained unused. The
Company also had outstanding letters of credit in the amount of $78,000 to
guarantee performance to third parties of various European trade activities
and contracts.
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 July 31
Net sales of $34,326,000 for the quarter ended July 31, 2002 increased 0.4
percent from $34,190,000 for the comparable quarter in the prior year. (See
discussion of each business segment below.)
Gross profit of $8,239,000 increased 0.7 percent from $8,179,000 in the prior
year quarter, and gross margin increased to 24.0 percent of net sales in the
current year from 23.9 percent of net sales in the prior year. (See discussion
of each business segment below.)
9
Net income decreased 41.0 percent to $470,000 in the current year quarter from
$796,000 in the prior year quarter, and net income per common share (diluted)
declined to $0.10 from $0.16. The decrease in net income was partially due to
increased selling, general and administrative expense and an extraordinary loss
of $79,000 (net of tax) from an early extinguishment of debt, the total of which
is partially offset by an extraordinary gain, net of tax, of $208,000, due to
the purchase of certain assets of a business and increased gross profit.
On June 19, 2002, the Company purchased certain assets of a business for
$500,000 in cash. The asset value in accordance with Statement of Financial
Accounting Standards No. 141 (SFAS 141) was $846,000 for inventory and $0 for
other assets, resulting in the recognition of an extraordinary gain of $346,000
($208,000 net of tax), related to the write-off of negative goodwill.
Six months ended July 31
Net sales of $61,095,000 for the six months ended July 31, 2002 decreased 5.8
percent from $64,882,000 for the comparable period in the prior year. (See
discussion of each business segment below.)
Gross profit of $13,991,000 decreased 7.9 percent from $15,190,000 for the
comparable period in the prior year, while gross margin decreased to 22.9
percent of net sales in the current year from 23.4 percent of net sales in the
prior year. (See discussion of each business segment below.)
Net income decreased 69.2 percent to $288,000 or $0.06 per common share
(diluted) in the current year from $936,000 or $0.19 per common share (diluted)
in the comparable period in the prior year. The decrease in net income was
partially due to decreased gross profit, increased general and administrative
expense and an extraordinary loss of $79,000 (net of tax) from an early
extinguishment of debt, the total of which is partially offset by a decrease in
selling expense and an extraordinary gain, net of tax, of $208,000, due to the
purchase of certain assets of a business.
On June 19, 2002, the Company purchased certain assets of a business for
$500,000 in cash. The asset value in accordance with Statement of Financial
Accounting Standards No. 141 (SFAS 141) was $846,000 for inventory and $0 for
other assets, resulting in the recognition of an extraordinary gain of $346,000
($208,000 net of tax), related to the write-off of negative goodwill.
Filtration Products Business
Three months ended July 31
Net sales for the quarter ended July 31, 2002 increased 8.1 percent to
$13,575,000 from $12,561,000 for the comparable quarter in the prior year. This
increase is the result of higher sales of fabric and pleated-filter elements,
partially offset by decreased sales of non-filtration products.
Gross profit as a percent of net sales increased from 19.3 percent in the prior
year to 20.6 percent in the current year, primarily as a result of improved
manufacturing efficiencies and higher sales volume.
Selling expense for the quarter ended July 31, 2002 increased to $1,406,000 or
10.4 percent of net sales from $1,173,000 or 9.3 percent of net sales for the
comparable quarter last year. The increase is attributable to higher salaries,
payroll taxes and travel expenses.
General and administrative expenses increased to $1,212,000 or 8.9 percent of
net sales in the current year quarter from $639,000 or 5.1 percent of net sales
for the comparable period in the prior year, primarily due to higher legal
expenses related to defending a patent infringement suit partially offset by
cost reduction measures that were implemented in the second half of 2001.
10
Six months ended July 31
Net sales for the six months ended July 31, 2002 increased 0.1 percent to
$25,967,000 from $25,954,000 for the comparable period in the prior year. This
increase is the result of higher sales of fabric and pleated-filter elements,
partially offset by decreased sales of baghouse services.
Gross profit as a percent of net sales increased from 19.2 percent in the prior
year to 19.3 percent in the current year, primarily as a result of improved
manufacturing efficiencies and higher sales volume.
Selling expense for the six months ended July 31, 2002 increased to $2,628,000
or 10.1 percent of net sales from $2,434,000 or 9.4 percent of net sales for the
comparable period in the prior year. The increase is attributable to higher
salaries, payroll taxes and travel expenses.
General and administrative expenses increased to $1,833,000 or 7.1 percent of
net sales in the current year period from $1,342,000 or 5.2 percent of net sales
for the comparable period in the prior year, due to higher legal expenses
related to defending a patent infringement suit, partially offset by cost
reduction measures that were implemented in the second half of 2001.
Piping Systems Business
Three months ended July 31
Net sales decreased 5.5 percent from $15,316,000 in the prior year quarter to
$14,471,000 for the quarter ended July 31, 2002. This decrease is primarily due
to lower domestic sales, and from loss of sales of $244,000 generated by a
former UK subsidiary, Perma-Pipe Services Limited (PPSL), in the prior year
period. The contract for the sale of PPSL became effective in December 2001.
Gross profit as a percent of net sales decreased from 25.8 percent to 23.7
percent, mainly as a result of the drop in domestic volume.
Selling expense decreased from $563,000 or 3.9 percent of net sales for the
prior year quarter to $370,000 or 2.6 percent of net sales in the current year
quarter. The dollar decrease is primarily due to lower commissions.
General and administrative expense decreased from $1,345,000 in the prior year
quarter to $1,289,000 in the current year quarter, however, increased as a
percent of net sales from 8.8 percent to 8.9 percent. The dollar decrease is
primarily due to eliminated general and administrative expenses due to the sale
of PPSL and partially offset by higher legal expense in the current year period.
Six months ended July 31
Net sales of $23,795,000 for the six months ended July 31, 2002 decreased 12.7
percent from $27,252,000 for the comparable period in the prior year. This
decrease is primarily due to lower domestic sales, particularly a sale of
$2,000,000 for a high-temperature oil-recovery project in Canada in the prior
year and from loss of sales of $870,000 generated in the prior year period by
PPSL.
Gross profit as a percent of net sales decreased from 25.2 percent to 23.4
percent, mainly as a result of the drop in domestic volume and loss of sales
generated in the prior year period by PPSL.
Selling expense decreased from $1,085,000 or 4.0 percent of net sales in the
prior year period to $709,000 or 3.0 percent of net sales in the current year
period. The dollar decrease is primarily due to lower commissions and eliminated
selling expenses due to the sale of PPSL.
11
General and administrative expense decreased from $2,534,000 in the prior year
period to $2,360,000 in the current year period, however, increased as a percent
of net sales from 9.3 percent to 9.9 percent. The dollar decrease is primarily
due to eliminated general and administrative expenses due to the sale of PPSL
and partially offset by higher legal expense in the current year period.
Industrial Process Cooling Equipment Business
Three months ended July 31
Net sales of $6,280,000 for the quarter ended July 31, 2002 decreased 0.5
percent from $6,313,000 for the comparable quarter in the prior year. The
decrease is due to the slow recovery of the economy.
Gross profit increased from 28.7 percent of net sales in the prior year quarter
to 32.0 percent of net sales in the current year quarter, primarily due to
product mix.
Selling expense increased to $838,000 or 13.3 percent of net sales in the
current year quarter from $825,000 or 13.1 percent of net sales in the prior
year quarter. The increase is due to the salary and employee benefits of
increased headcount.
General and administrative expense increased from $565,000 or 9.0 percent of net
sales in the prior year quarter to $876,000 or 13.9 percent of net sales in the
current year quarter. The increase is primarily due to new ongoing general and
administrative expenses and integration costs related to the operations of
certain newly acquired assets of a business. The remaining increase is because
of more engineering costs charged to general and administrative expense.
Six months ended July 31
Net sales of $11,333,000 for the six months ended July 31, 2002 decreased 2.9
percent from $11,676,000 for the comparable period in the prior year, mainly due
to the slow recovery of the economy.
Gross margin increased from 28.7 percent of net sales in the prior year to 30.1
percent of net sales in the current year, primarily due to product mix.
Selling expense decreased to $1,538,000 or 13.6 percent of net sales in the
current year period from $1,630,000 or 14.0 percent of net sales in the prior
year. The dollar decrease is primarily due to decreased spending on advertising
and cost reduction measures that were implemented in the second half of 2001.
General and administrative expense increased from $1,160,000 or 9.9 percent of
net sales in the prior year to $1,572,000 or 13.9 percent of net sales in the
current year. The increase is due to more engineering costs charged to general
and administrative expense, and new ongoing general and administrative expenses
and integration costs related to the operations of certain newly acquired assets
of a business.
General Corporate Expense
General corporate expense includes interest expense and general and
administrative expense incurred by MFRI, Inc.-Corporate that has not been
allocated to the business segments.
12
Three months ended July 31
General and administrative expense increased from $1,032,000 in the prior year
quarter to $1,152,000 in the current year quarter, and increased as a percentage
of net sales from 3.0 percent in the prior year quarter to 3.4 percent in the
current year quarter. The dollar increase is mainly due to increased
hospitalization expense and outside professional service costs, partially offset
by decreased salary expense and elimination of goodwill amortization.
Interest expense decreased to $517,000 for the current year quarter from
$689,000 in the prior year quarter. The decrease is primarily due to net debt
reductions in the current and prior years.
Six months ended July 31
General and administrative expense decreased from $2,054,000 in the prior year
period to $2,042,000 in the current year period, but increased as a percentage
of net sales from 3.2 percent in the prior year period to 3.3 percent in the
current year period. The dollar decrease is mainly due to reductions in
salaries, repairs and maintenance, utility costs and elimination of goodwill
amortization, partially offset by increases in outside professional service,
hospitalization and loan amortization costs.
Interest expense decreased to $1,036,000 in the current year period from
$1,365,000 for the comparable period in the prior year. The decrease is due to
net debt reductions in the current and prior years.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and Operating Cash Flow
Cash and cash equivalents as of July 31, 2002 were $253,000 as compared to
$497,000 at July 31, 2001. For the current year period, net cash provided from
operating activities was $1,493,000, net payment on long-term debt was $161,000,
purchases of property and equipment was $587,000 and acquisition of certain
assets of a business was $500,000.
Net cash provided by operating activities was $1,493,000 for the six months
ended July 31, 2002, compared with $3,940,000 for the six months ended July 31,
2001. The increase in current liabilities of $4,015,000 was partially offset by
increases in trade receivables, inventories and prepaid expenses and other
assets.
Net cash used for investing activities for the six months ended July 31, 2002
and 2001 were $1,147,000 and $543,000, respectively. Capital expenditures
decreased from $1,909,000 in the prior year to $587,000 in the current year. In
the current year, the Company acquired certain assets of a business and invested
in a joint venture for $500,000 and $60,000 respectively. No property or
equipment was sold in the current year, compared with proceeds of $1,366,000
from sale and lease back transactions in the prior year period.
For the six months ended July 31, 2002, $161,000 was used for net payments on
long-term debt and $68,000 was used for payments on capitalized lease
obligations. In the comparable prior year period, the Company used $3,082,000
for net payments of long-term debts and utilized $69,000 to pay capitalized
lease obligations.
13
The Company's current ratio was 2.0 to 1 and 1.5 to 1 at July 31, 2002 and
January 31, 2002, respectively. Debt to total capitalization at July 31, 2002
decreased to 45.4 percent from 45.9 percent at January 31, 2002.
Financing
On July 11, 2002, the Company entered into secured note purchase agreements with
certain institutional investors ("Note Purchase Agreements"). Under the terms of
the Note Purchase Agreements, the Company entered into a five-year $6,000,000
term loan replacing prior term loans with certain institutional investors which
had originally provided for senior notes with an aggregate original principal
balance of $25,000,000 ("Prior Term Loans"). The outstanding principal balance
of the Prior Term Loans at July 11, 2002 was $16,000,000. The Company borrowed
$10,000,000 from its new revolving line of credit from another financial
institution to pay down this loan from $16,000,000 to $6,000,000. Interest rates
under the Note Purchase Agreements are 12% per annum if the outstanding
principal is greater than $5,000,000 or 10% per annum if the outstanding
principal is $5,000,000 or less. The Company is required to pay $187,500 in
aggregate principal on the last day of March, June, September and December in
each year, commencing on September 30, 2002 and ending on June 30, 2007. In
addition, the Company is required to make annual prepayments of excess cash flow
(as defined in the Note Purchase Agreements). Finally, the Loan Agreement and
the Note Purchase Agreements permit voluntary prepayments sufficient to reduce
the outstanding term loan principal to $5,000,000 subject to certain conditions.
The Company met such conditions and made such prepayments on July 31, 2002
reducing the principal balance to $5,000,000. At July 31, 2002, the Company was
in compliance with all covenants contained in the Note Purchase Agreements.
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, which matures on July 10, 2005, the Company can borrow up to
$28,000,000 (reduced to $27,000,000 upon completion of the Lebanon, Tennessee
mortgage borrowing described below), subject to borrowing base and other
requirements, under a revolving line of credit. Interest rates generally are
based on options selected by the Company as follows: (a) a margin in effect plus
a base rate; or (b) a margin in effect plus the LIBOR rate for the corresponding
interest period. At July 31, 2002, the prime rate was 4.75 percent, and the
margins added to the prime rate and the LIBOR rate, which are determined each
quarter based on the applicable financial statement ratio, were 1.00 and 3.00
percentage points respectively. The Company had borrowed $11,545,000 under the
revolving line of credit at July 31, 2002, $10,000,000 of which was used to
reduce debt outstanding under the Prior Term Loans and $700,000 under the Prior
Credit Agreement (see below). The Company's policy is to classify borrowings
under the revolving line of credit as long-term debt, as the Company has the
ability and the intent to maintain this obligation for longer than one year. In
addition, $5,815,000 was drawn under the agreement as letters of credit to
guarantee amounts owed for Industrial Revenue Bond borrowings, property taxes
and insurance premiums. The Loan Agreement replaced a three-year secured credit
agreement with a bank which had provided a revolving line of credit of
$8,000,000 ("Prior Credit Agreement") and a loan with a principal balance of
$700,000. The early extinguishment of the Prior Credit Agreement resulted in an
extraordinary loss of $79,000, net of tax. The Loan Agreement also 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
July 31, 2002, the amount of such restricted cash was $439,000. At July 31, 2002
the Company was in compliance with all covenants contained in the Loan
Agreement.
14
On April 26, 2002, Midwesco Filter Resources, Inc. ("Midwesco Filter") borrowed
$3,450,000 under two mortgage notes secured by two parcels of real property and
improvements owned by Midwesco Filter in Winchester, Virginia. Proceeds from the
mortgages, net of a prior mortgage loan, were approximately $2,700,000 and were
used to make principal payments to the Prior Term Loans and the Prior Credit
Agreement. The loans each bear interest at 7.10 percent, and the loans'
amortization schedules and terms are each ten years.
On July 31, 2002, Perma-Pipe, Inc. borrowed $1,750,000 under a mortgage note
secured by its manufacturing facility in Lebanon, Tennessee. $1,000,000 of the
proceeds was used for a required payment of amounts borrowed under the Loan
Agreement with the remaining proceeds used to repay amounts borrowed under the
Note Purchase Agreements. The loan bears interest at 7.75 percent with monthly
payments of $21,001 for both principal and interest, and has a ten-year term.
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.
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 acquisition of Nordic Air A/S. The loan bears interest at 6.22 percent and
has a term of five years.
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 ("Boe-Therm"). 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.
On September 14, 1995, Midwesco Filter in Winchester, Virginia received
$3,150,000 of proceeds of Industrial Revenue Bonds, which mature on August 1,
2007, and on October 18, 1995, Perma-Pipe, Inc. in Lebanon, Tennessee received
$3,150,000 of proceeds of Industrial Revenue Bonds, which mature on September 1,
2007. These bonds are fully secured by bank letters of credit, which the Company
expects to renew, reissue, extend or replace 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. The bond proceeds were available for capital expenditures related to
manufacturing capacity expansions and efficiency improvements during a
three-year period which commenced in the fourth quarter of 1995 and ended during
the Company's fiscal quarter ended October 31, 1998. On November 1, 1999, the
Company utilized $1,100,000 of unspent bond proceeds to redeem bonds outstanding
as provided in the indenture.
The Company also has 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.
15
At July 31, 2002, borrowings under these credit arrangements totaled $341,000;
an additional $629,000 remained unused. The Company also had outstanding letters
of credit in the amount of $78,000 to guarantee performance to third parties of
various European trade activities and contracts.
ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". The
statement requires all business combinations initiated after June 30, 2001 to be
accounted for by the purchase method. Adoption of SFAS No. 141 did not have a
material effect on reported results of operations, financial condition or cash
flows of the Company.
On February 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142 (SFAS 142), "Goodwill and Other Intangible Assets." SFAS 142
changes the accounting for goodwill from an amortization method to an
impairment-only approach. Amortization of goodwill and intangible assets with
indefinite lives, including such assets recorded in past business combinations,
ceases upon adoption. Thus, no amortization for such goodwill and indefinite
lived intangibles was recognized in the accompanying condensed consolidated
statements of operations for the three and six months ended July 31, 2002,
compared with $133,000 or $0.03 per share and $266,000 or $0.05 per share for
the comparable periods of the prior year. On an annual basis and when there is
reason to suspect that their values have been impaired, these assets must be
tested for impairment, and a write down may be necessary. SFAS 142 allows up to
six months from the date of adoption to complete the initial transitional
impairment test, which uses a fair value methodology. Based on the results of
step one of the transitional impairment test, the Company has identified
potential impairment of goodwill in all three of its reporting units. Step two
of the transitional impairment test, in which the magnitude of any goodwill
impairment will be determined, must be completed by January 31, 2003, and any
resulting impairment loss will be recorded as a cumulative effect of a change in
accounting principle. Initial quantification of the impairment test, which may
vary from the final quantification, indicates that the amount of the write down
could be up to 100% of the Company's approximately $14,000,000 of goodwill and
related intangible assets.
In October 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets," which was effective for the Company in February
1, 2002. SFAS No. 144 addresses accounting and reporting of the impairment or
disposal of long-lived assets, including discontinued operations, and
establishes a single accounting method for the sale of long-lived assets.
Adoption of SFAS No. 144 did not have a material effect on the results of
operations, financial condition or cash flows of the Company.
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. 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 July 31, 2002 or January 31, 2002.
16
The changeover from national currencies to the Euro began 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 by combining
fixed-rate long-term debt with floating rate debt.
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a vote of Security Holders
The annual meeting of the stockholders of the Company was held on June 27, 2002.
David Unger, Henry M. Mautner, Gene K. Ogilvie, Fati A. Elgendy, Bradley E.
Mautner, Don Gruenberg, Arnold F. Brookstone, Eugene Miller, Stephen B. Schwartz
and Dennis Kessler were elected as directors of the Company at the meeting. The
following is a tabulation of the votes cast for, or withheld, with respect to
each nominee:
For Withheld
-------------- ----------------
David Unger 4,335,381 22,800
Henry M. Mautner 4,335,881 22,300
Gene K. Ogilvie 4,335,881 22,300
Fati A. Elgendy 4,335,881 22,300
Bradley E. Mautner 4,335,881 22,300
Don Gruenberg 4,335,881 22,300
Arnold F. Brookstone 4,343,481 14,700
Eugene Miller 4,343,481 14,700
Stephen B. Schwartz 4,343,481 14,700
Dennis Kessler 4,343,481 14,700
There were no votes cast against, nor were there any abstentions or broker
non-votes with respect to, any nominee.
Item 6. Exhibits and Reports on Form 8-K
(b) Reports on Form 8-K:
The following current report on Form 8-K was filed by the Company
during the Company's third fiscal quarter:
(1) Current report on Form 8-K dated July 17, 2002 filed under
Item 5 disclosing the completion of the Company's new
financing arrangements and describing the material terms
thereof.
17
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: September 16, 2002 /s/ David Unger
---------------------------------------------
David Unger
Chairman of the Board of Directors
(Principal Executive Officer)
Date: September 16, 2002 /s/ Michael D. Bennett
---------------------------------------------
Vice President, Secretary and Treasurer
(Principal Financial and Accounting Officer)
CERTIFICATIONS
- --------------
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 quarterly 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 quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report.
September 16, 2002
/s/ Michael D. Bennett
---------------------------------------------
Michael D. Bennett
Vice President, Secretary and Treasurer
(Principal Financial and Accounting Officer)
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 quarterly 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 quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report.
September 16, 2002
/s/ David Unger
---------------------------------------------
David Unger
Chairman of the Board of Directors
(Principal Executive Officer)