Item 1. BUSINESS
Company Profile
MFRI, Inc. ("MFRI" or the "Company") is a holding company which has subsidiaries engaged in the manufacture and sale of products in three distinct business segments: filtration products, piping systems and industrial process cooling equipment.
The Company's filtration products business (the "Filtration Products Business") is conducted by Midwesco Filter Resources, Inc. ("Midwesco Filter"). Perma-Pipe, Inc. ("Perma-Pipe") conducts the piping systems business (the "Piping Systems Business"). The industrial process cooling equipment business (the "Industrial Process Cooling Equipment Business") is conducted by Thermal Care, Inc. ("Thermal Care"). Midwesco Filter, Perma-Pipe and Thermal Care are wholly owned subsidiaries of MFRI. As used herein, unless the context otherwise requires, the term "Company" includes MFRI and its subsidiaries, Midwesco Filter, Perma-Pipe, Thermal Care, and their respective predecessors and subsidiaries.
Midwesco Filter manufactures and sells a wide variety of filter elements for air filtration and particulate collection systems. Air filtration systems are used in many industries in the United States and abroad to limit particulate emissions, primarily to comply with environmental regulations. Midwesco Filter markets air-filtration-related products and accessories, and provides maintenance services, consisting primarily of dust collector inspection, filter cleaning and filter replacement.
Perma-Pipe engineers, designs, manufactures and sells specialty piping systems and leak detection and location systems. Perma-Pipe's specialty piping systems include (i) industrial and secondary containment piping systems for transporting chemicals, waste streams and petroleum liquids, (ii) insulated and jacketed district heating and cooling piping systems for efficient energy distribution to multiple locations from central energy plants, and (iii) oil and gas gathering flow lines and long lines for oil and mineral transportation. Perma-Pipe's leak detection and location systems are sold as part of many of its piping systems products and on a stand-alone basis, to monitor areas where fluid intrusion may contaminate the environment, endanger personal safety, cause a fire hazard, impair essential services or damage equipment or property.
Thermal Care engineers, designs and manufactures industrial process cooling equipment, including liquid chillers, mold temperature controllers, cooling towers, plant circulating systems, and related accessories for use in industrial process applications.
Additional information with respect to the Company's lines of business is included in the following discussions of the separate business segments and in the financial statements and related notes thereto.
Filtration Products Business
Air Filtration and Particulate Collection Systems. Air filtration and particulate collection systems have been used for over 55 years in many industrial applications. However, the enactment of federal and state legislation and related regulations and enforcement have increased the demand for air-filtration and particulate-collection systems by requiring industry to meet primary and secondary ambient air quality standards for specific pollutants, including particulate. In certain manufacturing applications, particulate collection systems are an integral part of the production process. Examples of such applications include the production of cement, carbon black and industrial absorbents.
The principal types of industrial air filtration and particulate collection systems in use today are baghouses, cartridge collectors, electrostatic precipitators, scrubbers and mechanical collectors. The type of technology most suitable for a particular application is a function of such factors as the ability of the system to meet applicable regulations, initial investment, operating costs and the parameters of the process, including operating temperatures, chemical constituents present, size of particulate and pressure differential.
Cartridge collectors and baghouses are typically box-like structures, which operate in a manner similar to a vacuum cleaner. They can contain a single filter element or an array of several thousand cylindrical or envelope filter elements (as short as two feet or as long as 30 feet) within a housing, which is sealed to prevent the particulate from escaping. Exhaust gases are passed through the filtration elements, and the particulate is captured on the media of the filter element. The particulate is removed from the filter element by such methods as mechanical shaking, reverse air flow or compressed air pulse.
Cartridge collectors and baghouses are generally used with utility and industrial boilers, cogeneration plants and incinerators and in the chemicals, cement, asphalt, metals, grain and foundry industries, as well as air intake filters for gas turbines.
Because air pollution control equipment represents a substantial capital investment, such systems usually remain in service for the entire life of the plant in which they are installed. A baghouse can last up to 30 years and is typically rebagged six to eight times during its useful life. The useful life of a cartridge collector is 10 to 20 years, with five to ten cartridge changes during its useful life. Although reliable industry statistics do not exist, the Company believes there are more than 26,000 locations in the United States presently using baghouses and/or cartridge collectors, many of which have multiple pieces of such equipment.
Products and Services. The Company manufactures and sells a wide variety of filter elements for cartridge collectors and baghouse air filtration and particulate collection systems. Cartridge collectors and baghouses are used in many industries in the United States and abroad to limit particulate emissions, primarily to comply with environmental regulations. The Company manufactures filter elements in standard industry sizes, shapes and filtration media and to custom specifications, maintaining manufacturing standards for more than 10,000 styles of filter elements to suit substantially all industrial applications. Filter elements are manufactured from industrial yarn, fabric and papers purchased in bulk. Most filter elements are produced from cellulose, acrylic, fiberglass, polyester, aramid or polypropylene fibers. The Company also manufactures filter elements from more specialized materials, sometimes using special finishes.
The Company markets numerous filter-related products and accessories used during the installation, operation and maintenance of cartridge collectors and baghouses, including wire cages used to support filter bags, spring assemblies for proper tensioning of filter bags and clamps and hanger assemblies for attaching filter elements. In addition, the Company markets other hardware items used in the operation and maintenance of cartridge collectors and baghouses. These include sonic horns to supplement the removal of particulate from filter bags and cartridge collectors and baghouse parts such as door gaskets, shaker bars, tube sheets, dampers, solenoid valves, timer boards, conveyors and airlocks. The Company currently manufactures wire cages and purchases all other filter-related products and accessories for resale. The Company also provides maintenance services, consisting primarily of air-filtration system inspection and filter element replacement, using a network of independent contractors. The sale of filter-related products and accessories, collector inspection, maintenance services and leak detection account for approximately 13% of the net sales of the Company's filtration products and services.
Over the past three years, the Company's Filtration Products Business has served more than 4,000 user locations. The Company has particular expertise in supplying filter bags for use with electric arc furnaces in the steel industry. The Company believes its production capacity and quality control procedures make it a leading supplier of filter bags to large users in the electric power industry. Orders from that industry tend to be substantial in size, but are usually at reduced margins. In the fiscal year ended January 31, 2004, no customer accounted for 10% or more of net sales of the Company's filtration products and services.
Marketing. The customer base for the Company's filtration products and services is industrially and geographically diverse. These products and services are used primarily by operators of utility and industrial coal-fired boilers, incinerators and cogeneration plants and by producers of metals, cement, chemicals and other industrial products.
The Company has an integrated sales program for its Filtration Products Business, which consists of field-based sales personnel, manufacturers' representatives, a telemarketing operation and computer-based customer information systems containing data on nearly 18,000 user locations. These systems enable the Company's sales force to access customer information classified by industry, equipment type, operational data and the Company's quotation and sales history. The systems also provide reminders to telemarketing personnel of the next scheduled customer contact date, as well as the name and position title of the customer contact. The Company believes the computer-based information systems are instrumental in increasing sales of filter-related products and accessories and maintenance services, as well as sales of filter elements.
The Company markets its U.S. manufactured filtration products internationally using domestically based sales resources to target major users in foreign countries. Export sales, which were approximately 8% of the domestic filtration company's product sales during the year ended January 31, 2004, were about the same level as the previous year. Nordic Air Filtration A/S ("Nordic Air"), a wholly owned subsidiary of the Company located in Nakskov, Denmark, manufactures and markets pleated filter elements throughout Europe and Asia, primarily to original equipment manufacturers.
Trademarks. The Company owns the following trademarks covering its filtration products: Seamless Tube(R), Leak Seeker(R), Prekote(R), We Take the Dust Out of Industry (R), Pleatkeeper(R), Pleat Plus(R) and EFC(R).
Backlog. As of January 31, 2004, the dollar amount of backlog (uncompleted firm orders) for filtration products was $14,499,000. As of January 31, 2003, the amount of backlog was $11,781,000. A customer has placed an order that is deliverable over multiple years. Therefore, approximately $4,200,000 of the backlog as of January 31, 2004 is not expected to be completed in 2004.
Raw Materials and Manufacturing. The basic raw materials used in the manufacture of the Company's filtration products are industrial fibers and media supplied by leading producers of such materials. The majority of raw materials purchased are woven fiberglass fabric, yarns for manufacturing Seamless Tube(R) products and other woven, felted, spun bond and cellulose media. Only a limited number of suppliers are available for some of these materials. From time to time, any of these materials could be in short supply, adversely affecting the Company's business. The Company believes that supplies of all materials are adequate to meet current demand. The Company's inventory includes substantial quantities of various types of media because lead times from suppliers are frequently longer than the delivery times required by customers. Nevertheless, the Company has implemented an aggressive program to limit inventory to the minimum levels compatible with meeting customer needs.
The manufacturing processes for filtration products include proprietary computer-controlled systems for measuring, cutting, pleating, tubing and marking media. The Company also operates specialized knitting machines and proprietary fabric stabilization equipment to produce the Seamless Tube(R) product. Skilled sewing machine operators perform the finish assembly work on each filter bag using both standard sewing equipment and specialized machines developed by or for the Company. The manufacturing process for pleated filter elements involves the assembly of metal and, sometimes, plastic end components, filtration media and support hardware.
The Company maintains a quality assurance program involving statistical process control techniques for examination of raw materials, work in progress and finished goods. Certain orders for particularly critical applications receive 100% quality inspection.
Competition. The Filtration Products Business is highly competitive. In addition, new installations of cartridge collectors and baghouses are subject to competition from alternative technologies. The Company believes that, based on domestic sales, BHA Group, Inc.; the Menardi division of Beacon Industrial Group; W.L. Gore & Associates, Inc. and the Company are the leading suppliers of filter elements, parts and accessories for baghouses. The Company believes that Donaldson Company, Inc.; Farr Company; Clarcor, Inc. and the Company are the leading suppliers of filter elements for cartridge collectors. There are at least 50 smaller competitors, most of which are doing business on a regional or local basis. In Europe, several companies supply filtration products and Nordic Air is a relatively small participant in that market. Some of the Company's competitors have greater financial resources than the Company.
The Company believes price, service and quality are the most important competitive factors in its Filtration Products Business. Often, a manufacturer has a competitive advantage when its products have performed successfully for a particular customer in the past. Additional effort is required by a competitor to market products to such a customer. In certain applications, the Company's proprietary Seamless Tube(R) product and customer support provide the Company with a competitive advantage. Certain competitors of the Company may have a competitive advantage because of proprietary products and processes, such as specialized fabrics and fabric finishes. In addition, some competitors may have cost advantages with respect to certain products as a result of lower wage rates and/or greater vertical integration.
Government Regulation. The Company's Filtration Products Business is substantially dependent upon governmental regulation of air pollution at the federal and state levels. Federal clean air legislation requires compliance with national primary and secondary ambient air quality standards for specific pollutants, including particulate. The states are primarily responsible for implementing these standards and, in some cases, have adopted more stringent standards than those issued by the U.S. Environmental Protection Agency ("U.S. EPA") under the Clean Air Act Amendments of 1990 ("Clean Air Act Amendments"). Although the Company can provide no assurances about what ultimate effect, if any, the Clean Air Act Amendments will have on the Filtration Products Business, the Company believes the Clean Air Act Amendments are likely to have a positive long-term effect on demand for its filtration products and services. The U.S. Supreme Court decision upholding the right of the U.S. EPA to reduce the minimum size of particulates regulated by the National Air Quality Standard from 10 microns to 2.5 microns could have a significant positive effect on demand for the Company's filtration products in future years.
Piping Systems Business
Products and Services. The Company engineers, designs and manufactures specialty piping systems and leak detection and location systems. The Company's specialty piping systems include (i) industrial and secondary containment piping systems for transporting chemicals, hazardous fluids and petroleum products, (ii) insulated and jacketed district heating and cooling piping systems for efficient energy distribution to multiple locations from central energy plants, and (iii) oil and gas gathering flow lines and long lines for oil and mineral transportation. The Company's leak detection and location systems are sold as part of many of its piping systems, and, on a stand-alone basis, to monitor areas where fluid intrusion may contaminate the environment, endanger personal safety, cause a fire hazard, impair essential services or damage equipment or property.
The Company's industrial and secondary containment piping systems, manufactured in a wide variety of piping materials, are generally used for the handling of chemicals, hazardous liquids and petroleum products. Industrial piping systems often feature special materials, heat tracing, leak detection and special fabrication. Secondary containment piping systems consist of service pipes housed within outer containment pipes, which are designed to contain any leaks from the service pipes. Each system is designed to provide economical and efficient secondary containment protection that will meet all governmental environmental regulations.
The Company's district heating and cooling (DHC) piping systems are designed to transport steam, hot water and chilled water to provide efficient energy distribution to multiple locations from a central energy plant. These piping systems consist of a carrier pipe made of steel, ductile iron, copper or fiberglass; insulation made of mineral wool, calcium silicate or polyurethane foam; and an outer conduit or jacket of steel, fiberglass reinforced polyester resin, polyethylene or PVC. The Company manufactures several types of piping systems using different materials, each designed to withstand certain levels of temperature and pressure.
The Company's oil and gas flow lines are designed to transport crude oil or natural gas from the well head, either on land or on the ocean floor, to the gathering point. Long lines for oil and mineral transportation are used for solution mining and long line transportation of heated hydrocarbons or other substances. These piping systems consist of a carrier pipe made of steel, usually supplied by the customer; insulation made of polyurethane; jackets made of high density polyurethane, polyethylene or polypropylene and sometimes a steel outer pipe, also usually supplied by the customer.
The Company's leak detection and location systems consist of a sensor cable attached to a microprocessor, which uses proprietary software. The system sends pulse signals through the sensor cable, which is positioned in the area to be monitored (e.g., along a pipeline in the ground or in a sub floor), and employs a patented digital mapping technique to plot pulse reflections to continuously monitor the sensor cable for anomalies. The system is able to detect one to three feet of wetted cable in a monitored cable string of up to fifteen miles in length and is able to determine the location of the wetted cable within five feet. Once wetted cable is detected, the microprocessor uses the software to indicate the location of the leak. The Company offers a variety of cables specific to different environments. The Company's leak detection and location systems can sense the difference between water and petroleum products and can detect and locate multiple leaks. With respect to these capabilities, the Company believes that its systems are superior to systems manufactured by other companies. Once in place, the Company's leak detection and location system can be monitored off-site because the system can communicate with computers through telephone or internet connections. The Company's leak detection and location systems are being used to monitor fueling systems at airports, including those located in Denver, Colorado; Atlanta, Georgia; and Frankfurt and Hamburg, Germany. They are also used in facilities used for mission-critical operations such as those operated by web hosts, application service providers, internet service providers, and in many clean rooms, including such facilities operated by IBM, Intel and Motorola. The Company believes that, in the United States, it is the only major supplier of the above-referenced types of specialty piping systems that manufactures its own leak detection and location systems.
The Company's piping systems are frequently custom-fabricated to job site dimensions and/or incorporate provisions for thermal expansion due to varying temperatures. This custom fabrication helps to minimize the amount of field labor required by the installation contractor. Most of the Company's piping systems are produced for underground installations and, therefore, require trenching, which is done by unaffiliated installation contractors. Generally, sales of the Company's piping systems tend to be lower during the winter months, due to weather constraints over much of the country. In the fiscal year ended January 31, 2004, no single customer accounted for more than 10% of the net sales of the Company's piping systems.
The Company's leak detection and location systems and its secondary containment piping systems are used primarily by operators of military and commercial airport fueling systems, oil refineries, pharmaceutical companies, chemical companies, and in museums, dry storage areas, and tunnels. They are also used for water detection by internet service providers, application service providers, and web hosts, as well as financial, telecommunication and other electronic service companies. The Company's district heating and cooling systems are used primarily at prisons, housing developments, military bases, cogeneration plants, hospitals, industrial locations and college campuses. The Company believes many district heating and cooling systems in place are 30 to 50 years old and ready for replacement. Replacement of district heating and cooling systems is often motivated by the increased cost of operating older systems due to leakage and/or heat loss. The primary users of the Company's insulated flow lines are the major oil companies, gas companies and other providers of mineral resources.
Marketing. The customer base for the Company's piping systems products is industrially and geographically diverse. The Company employs a national sales manager and regional sales managers who use and assist a network of approximately 80 independent manufacturers' representatives, none of whom sells products that are competitive with the Company's piping systems.
Patents, Trademarks and Approvals. The Company owns several patents covering the features of its piping and electronic leak detection systems, which expire commencing in 2006. In addition, the Company's leak detection system is listed by Underwriters Laboratories and the U.S. EPA and is approved by Factory Mutual and the Federal Communications Commission. The Company is also approved as a supplier of underground district heating systems under the federal government guide specifications for such systems. The Company owns numerous trademarks connected with its piping systems business. In addition to Perma-Pipe(R), the Company owns other trademarks for its piping and leak detection systems including the following: Chil-Gard(R), Double-Pipe(R), Double-Quik(R), Escon-A(R), Ferro-Shield(R), FluidWatch(R), Galva-Gard(R), Hi Gard(R), Poly-Therm(R), Pal-AT(R), Ric-Wil(R), Ric-Wil Dual Gard(R), Stereo-Heat(R), Safe-T-Gard(R), Therm-O-Seal(R), Uniline(R), LiquidWatch(R), TankWatch(R), PalCom(R), Xtru-therm(R), Ultra-Pipe(R), PEX-GARD(R), and ULTRA-THERM(R). The Company also owns United Kingdom trademarks for Poly-Therm(R), Perma-Pipe(R) and Ric-Wil(R), and a Canadian trademark for Ric-Wil(R).
Backlog. As of January 31, 2004, the dollar amount of backlog (uncompleted firm orders) for piping and leak detection systems was $16,635,000, substantially all of which is expected to be completed in 2004. As of January 31, 2003, the amount of backlog was $15,063,000.
Raw Materials and Manufacturing. The basic raw materials used in the production of the Company's piping systems products are pipes and tubes made of carbon steel, alloy and plastics and various chemicals such as polyols, isocyanate, polyester resin, polyethylene and fiberglass, mostly purchased in bulk quantities. We believe that we currently have adequate supplies or sources of availability of the raw materials necessary to meet our needs. However, there are risks and uncertainties with respect to the supply of certain of these raw materials that could impact their availability in sufficient quantities to meet our needs. In particular, the price of steel and alloy tube has risen rapidly during the early months of 2004 perhaps reflecting growing shortages in supply.
The sensor cables used in the Company's leak detection and location systems are manufactured to the Company's specifications by companies regularly engaged in the business of manufacturing such cables. The Company owns patents for some of the features of its sensor cables. The Company assembles the monitoring component of the leak detection and location system from standard components purchased from many sources. The Company's proprietary software is installed in the system on a read-only memory chip.
The Company's manufacturing processes for its piping systems include equipment and techniques to fabricate piping systems from a wide variety of materials, including carbon steel, alloy and copper piping, and engineered thermoplastics and fiberglass-reinforced polyesters and epoxies. The Company uses computer-controlled machinery for electric plasma metal cutting, filament winding, pipe coating, insulation foam and protective jacket application, pipe bending, pipe cutting and pipe welding. The Company employs skilled workers for carbon steel and alloy welding to various code requirements. The Company is authorized to apply the American Society of Mechanical Engineers code symbol stamps for unfired pressure vessels and pressure piping. The Company's inventory includes bulk resins, chemicals and various types of pipe, tube, insulation, pipe fittings and other components used in its products. The Company maintains a quality assurance program involving lead worker sign-off of each piece at each workstation, statistical process control, and nondestructive testing protocols.
Competition. The piping system products business is highly competitive. The Company believes its competition in the district heating and cooling market consists of two other national companies, Rovanco Piping Systems, Inc. and Thermacor Process, Inc., as well as numerous regional competitors. The Company's secondary containment piping systems face several competitors including Asahi/America and GF Plastics Systems. The Company's oil and gas gathering flow lines face worldwide competition, including Bredero-Price, a subsidiary of Shaw Industries, Inc.; CRP of UK; Soctherm of Italy, Soccoreal of Argentina; and Logstor Rohr of Denmark. In addition to factory-fabricated systems of the type sold by the Company, the Company competes with district heating and cooling systems and secondary containment systems manufactured on the job site by contractors and sellers of component parts of systems. Products competitive with the Company's leak detection and location systems include: (1) cable-based systems manufactured by the TraceTek by Raychem, a Division of Tyco Thermal Controls LLC a subsidiary of Tyco Industries and RLE Technologies; (2) linear gaseous detector systems manufactured by Tracer Technologies and Arizona Instrument Corp.; and (3) probe systems manufactured by Veeder Root and Pneumecator, as well as several other competitors that provide probe systems for the service station and hydrocarbon leak detection industries.
The Company believes that price, quality, service and a comprehensive product line are the key competitive factors in the Company's Piping Systems Business. The Company believes it has a more comprehensive line of piping systems products than any of its competitors. Certain competitors of the Company have cost advantages as a result of manufacturing a limited range of products. Some of the Company's competitors have greater financial resources than the Company.
Government Regulation. The demand for the Company's leak detection and location systems and secondary containment piping systems is driven primarily by federal and state environmental regulation with respect to hazardous waste. The Federal Resource Conservation and Recovery Act requires, in some cases, that the storage, handling and transportation of certain fluids through underground pipelines feature secondary containment and leak detection. The National Emission Standard for Hydrocarbon Airborne Particulates requires reduction of airborne volatile organic compounds and fugitive emissions. Under this regulation, many major refineries are required to recover fugitive vapors and dispose of the recovered material in a process sewer system, which then becomes a hazardous secondary waste system that must be contained. Although there can be no assurances as to the ultimate effects of these governmental regulations, the Company believes they may increase the demand for its piping systems products.
Industrial Process Cooling Equipment Business
Products and Services. The Company engineers, designs and manufactures coolers for industrial purposes. The Company's cooling products include: (i) chillers (portable and central); (ii) cooling towers; (iii) plant circulating assemblies; (iv) hot water, hot oil, and negative pressure temperature controllers; (v) water treatment equipment and various other accessories; (vi) specialty cooling devices for printing presses and ink management; and (vii) replacement parts and accessories relating to the foregoing products. The Company's cooling products are used to optimize manufacturing productivity by quickly removing heat from manufacturing processes. The Company combines chillers and/or cooling towers with plant circulating systems to create plant-wide systems that account for a large portion of its business. The Company specializes in customizing cooling systems and their computerized controls according to customer specifications.
The principal markets for the Company's cooling products are thermoplastics processing and the printing industries. The Company also sells its products to original equipment manufacturers, to other cooling manufacturers on a private branded basis and to manufacturers in the laser, metallizing, and machine tool industries.
Chillers. Chillers are refrigeration units designed to provide cool water to a process for the purpose of removing heat from the process and transferring that heat to an area where it can be dissipated. This heat is either dissipated using air (air-cooled chillers) or water (water-cooled chillers). Water-cooled chillers use a cooling tower to transfer the heat from the chiller using water and then releasing the heat to the atmosphere.
The Company believes it manufactures the most complete line of chillers available in its primary markets. The Company's line of portable chillers is available from 1/2 horsepower to 40 horsepower. It incorporates a microprocessor capable of computer communications to standard industry protocols. While portable chillers are considered to be a commodity product by many customers, the Company believes that its units enable it to provide the customer with quality, features, customization and other benefits at a competitive price.
Central chillers are used for plant-wide cooling and, while some models incorporate their own pump and tank, most are sold with separate pumping systems that are usually attached to reservoirs. These chillers are distinguished by the manner in which the compressor (refrigerant pump) and the evaporator (heat exchanger water-to-refrigerant) are used in the chiller. These chillers also use
unique programmed logic controllers capable of handling either the chillers only or they can be programmed to handle the entire plant cooling system based on customer-plant demand. The Company believes that the ability to offer these chiller systems provides it with a unique, total cooling approach concept sales advantage. The Company's central chillers are available from 20 horsepower to 400 horsepower.
Cooling Towers. A cooling tower is essentially a cabinet with heat transfer fill media in which water flows down across the fill while air is pulled up through the fill. Cooling takes place by evaporation. Cooling towers are located outdoors and are designed to provide water at a temperature of approximately 85(Degree)F to remove heat from water-cooled chillers, air compressors, hydraulic oil heat exchangers and other processes that can effectively be cooled in this manner.
The Company markets two lines of cooling towers. The FT fiberglass tower line was introduced in 1984 and at the time was the first fiberglass cooling tower line to be sold in the United States. The cabinets for these towers are imported from China and are available in sizes ranging from 15 to 120 tons. (One tower ton equals 15,000 BTU's/hour of heat removal.) The FC fiberglass tower line is designed and engineered by the Company and is manufactured in the U.S.A. The FC line is available from 100 to 240 tons.
Plant Circulating Systems. The Company manufactures and markets a variety of tanks in various sizes with pumps and piping arrangements that use alarms and other electrical options. Thus, the Company can provide a plant circulating system which is unique and customized to meet the individual customer's needs. These plant circulating systems are used as an integral part of central tower and chiller systems. These tanks are available in mild steel, stainless steel, fiberglass reinforced polyester and polyethylene.
Temperature Control Units. Most of the Company's temperature control units are used by injection molders of plastic parts and by printing companies. They are designed to remove heat from the molds for the purpose of improving part quality. More than 90% of the temperature control units sold in the industry are water units, while the remaining units use oil as the heat transfer medium. Boe-Therm A/S ("Boe-Therm"), a wholly owned Danish subsidiary of the Company, manufactures a complete line of temperature control units, including oil units and negative pressure units. The Company markets Boe-Therm's oil and negative pressure units under its own name.
Water Treatment Equipment and Accessories. Sold as an accessory to cooling tower systems, water treatment equipment must be used to protect the equipment that is being cooled. The Company sells units manufactured to its specifications by a supplier that provides all the equipment and chemicals needed to properly treat the water. While a relatively small part of the Company's business, this arrangement allows the Company to offer a complete system to its cooling products customers. In addition, the Company provides other items to complement a system, principally heat exchangers, special valves, and "radiator type" coolers. These items are purchased from suppliers and usually drop-shipped directly to customers.
Ink Products. Ink products are products sold specifically for the proper temperature control and distribution of the ink and cooling solutions used by printing companies. These include printers of large newspapers, magazines, forms, etc.
Parts. The Company strives to fill parts orders within 24 hours and sells parts at competitive margins in order to serve existing customers and to enhance new equipment sales.
Marketing. In general, the Company sells its cooling products in the domestic and international thermoplastics and printing markets as well as to manufacturers of digital video discs ("DVDs") and other non-plastics industries that require specialized heat transfer equipment.
Domestic thermoplastics processors are the largest market served by the Company, representing the core of its business.
There are approximately 8,000 companies processing plastic products in the United States, primarily using injection molding, extrusion, and blow molding machinery. The Company believes the total U.S. market for water cooling equipment in the plastics industry is over $100 million annually, and that the Company is one of the three largest suppliers of such equipment to the plastics industry. The Company believes that the plastics industry is a mature industry with growth generally consistent with that of the national economy. Due to the high plastics content in many major consumer items, such as cars and appliances, this industry experiences cyclical economic activity. The Company believes that it is recognized in the domestic plastics market as a quality equipment manufacturer and that it will be able to maintain current market share, with potential to increase its market share through product development. The Company's cooling products are sold through independent manufacturers' representatives on an exclusive-territory basis. Seventeen agencies are responsible for covering the United States and are supported by four regional managers employed by the Company.
Sales of the Company's cooling products outside the United States have mainly been in Latin America. Some international sales have been obtained elsewhere as a result of the assembly of complete worldwide PET (plastic bottle) plants by multinational companies. The Company believes that it has a significant opportunity for growth due to the high quality of its equipment and the fact that it offers complete system design. Many United States competitors do not provide equipment outside the U.S. and, while European competitors sell equipment in Latin America, the Company believes that they lack system design capabilities and have a significant freight disadvantage. The Company markets its cooling products through a combination of manufacturers' representatives, distributors and consultants managed by regional managers, reporting to a National Sales and Marketing Manager.
The Company has increased sales to non-plastics industries that require specialized heat transfer equipment, usually sold to end users as a package by the supplier of the primary equipment, particularly in the laser industry, metallizing industry, and machine tool industry. The Company believes that the size of this market is more than $200 million annually. The original equipment manufacturer generally distributes products to the end user in these markets.
Trademarks. The Company has registered the trademarks Thermal Care(R), AWS(R) and Applied Web Systems(R).
Backlog. As of January 31, 2004, the dollar amount of backlog (uncompleted firm orders) for industrial process cooling equipment was $3,825,000, substantially all of which is expected to be completed in 2004. As of January 31, 2003, the amount of backlog was $3,521,000.
Raw Materials and Manufacturing. The Company's domestic production and inventory storage facility occupies approximately 88,000 square feet. The plant layout is designed to facilitate movement through multiple work centers. The Company uses an enterprise resource planning system installed in 2001 to support its sales, manufacturing production, inventory, customer relations and accounting operations. The status of a customer order at any given moment can be determined through the system.
The Company uses prefabricated sheet metal and subassemblies manufactured by both Thermal Care and outside vendors for temperature controller fabrication. The production line is self-contained to reduce handling required to assemble, wire, test, and crate the units for shipment.
FT towers up to 120 tons in capacity are assembled to finished goods inventory, which allows the Company to meet quick delivery requirements. FT cooling towers are manufactured using fiberglass and hardware components purchased from a Chinese manufacturer, which is the Company's sole source for such products. The wet deck is cut from bulk fill material and installed inside the tower. Customer-specified options can be added at any time.
We believe that the Company s access to sheet metal, subassemblies, fiberglass and hardware components is adequate.
The FC towers are designed and engineered by the Company. Two different cabinet sizes of the FC tower account for eight different model variations. All FC cooling towers are assembled at the Company's Niles facility.
The Company assembles all plant circulating systems by fabricating the steel to meet the size requirements and adding purchased components to meet customers' specifications. Electrical control boxes assembled in the electrical panel shop are then added to the tank and hardwired to all electrical components. The interior of the steel tanks are coated with an immersion service epoxy and the exterior is painted in a spray booth. The Company also sells a fiberglass tank for nonferrous applications.
Portable chillers are assembled utilizing components both manufactured by the Company and supplied by outside vendors. Portable chillers are assembled using refrigeration components, a non-corrosive tank, hose, and pre-painted sheet metal. Many of the components used in these chillers are fabricated as subassemblies and held in inventory. Once the water and refrigeration components have been assembled, the unit is moved to the electrical department for the addition of control subassemblies and wiring. The chillers are then evacuated, charged with refrigerant and tested under fully loaded conditions. The final production step is to clean, insulate, label, and crate the chiller for shipment.
Central chillers are manufactured to customer specifications. Many of the components are purchased to the job requirements and production is planned so that subassemblies are completed to coincide with the work center movements.
After mechanical and electrical assembly, the chiller is evacuated, charged with refrigerant and tested at full and partial load conditions. The equipment is then insulated and prepared for painting. The final production step is to complete the quality control inspection and prepare the unit for shipment.
Competition. The Company believes that there are about 15 competitors selling cooling equipment in the domestic plastics market. The Company further believes that three manufacturers, including the Company, collectively share approximately 60% of the domestic plastics cooling equipment market. Many international customers, with relatively small cooling needs, are able to purchase small refrigeration units (portable chillers) that are manufactured in their respective local markets at prices below that which the Company can offer due to issues such as freight cost and customs duties. However, such local manufacturers often lack the technology and products needed for plant-wide cooling systems. The Company believes that its reputation for producing quality plant-wide cooling products results in a significant portion of the Company's business in this area.
The Company believes that price, quality, service and a comprehensive product line are the key competitive factors in its Industrial Process Cooling Equipment Business. The Company believes that it has a more comprehensive line of cooling products than any of its competitors. Certain competitors of the Company have cost advantages as a result of manufacturing in non-union shops and offering a limited range of products. Some of the Company's competitors may have greater financial resources than the Company.
Government Regulation. The Company does not expect compliance with federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment to have a material effect on capital expenditures, earnings or the Company s competitive position. Management is not aware of the need for any material capital expenditures for environmental control facilities for the foreseeable future. Regulations, promulgated under the Federal Clean Air Act, prohibit the manufacture and sale of certain refrigerants. The Company does not use these refrigerants in its products. The Company expects that suitable refrigerants conforming to federal, state and local laws and regulations will continue to be available to the Company, although no assurances can be given as to the ultimate effect of the Clean Air Act and related laws on the Company.
Employees
As of March 31, 2004, the Company had 674 full-time employees, 73 of whom were engaged in sales and marketing, 179 of whom were engaged in management, engineering and administration, and the remainder of 422 was engaged in production. Hourly production employees of the Company's Filtration Products Business in Winchester, Virginia are covered by a collective bargaining agreement with the International United Automobile, Aerospace & Agricultural Implement Workers of America, which expires in October 2006. Most of the production employees of the Company's Industrial Process Cooling Equipment Business are represented by two unions, the United Association of Journeymen and Apprentices of the Plumbing and Pipefitting Industry of the United States (UAJAPPI) and the International Brotherhood of Electrical Workers Union (IBEW). The collective bargaining agreement for UAJAPPI is scheduled to expire on June 1, 2004, but will automatically continue to be in effect until terminated. The collective bargaining agreement for IBEW expires on May 31, 2004. The collective bargaining agreement of the Piping Systems Business in Lebanon, Tennessee, with the Metal Trades Division of UAJAPPI expires in March 2007.
Executive Officers of the Registrant
The following table sets forth information regarding the executive officers of the Company as of March 31, 2004:
All of the officers serve at the discretion of the Board of Directors.
David Unger has been employed by the Company and its predecessors in various executive and administrative capacities since 1958, served as President of Midwesco, Inc. from 1972 through January 1994 and was Vice President from February 1994 through December 1996. He was a director of Midwesco, Inc. from 1972 through December 1996, and served that company in various executive and administrative capacities from 1958 until the consummation of the merger of Midwesco, Inc. into MFRI, Inc. (the "Midwesco Merger"). He is a director of the company formed to succeed to the non-Thermal Care businesses of Midwesco, Inc.
Henry M. Mautner has been employed by the Company and its predecessors in various executive capacities since 1972, served as chairman of Midwesco, Inc., from 1972 through December 1996, and served that company in various executive and administrative capacities from 1949 until the consummation of the Midwesco Merger. Since the consummation of the Midwesco Merger, he has served as the chairman of the company formed to succeed to the non-Thermal Care businesses of Midwesco, Inc. Mr. Mautner is the father of Bradley E. Mautner.
Bradley E. Mautner has served as Executive Vice President of the Company since December 2002, was Vice President of the Company from December 1996 to December 2002 and has been a director of the Company since 1995. From 1994 to the consummation of the Midwesco Merger, he served as President of Midwesco, Inc. and since December 30, 1996 he has served as President of the company formed to succeed to the non-Thermal Care businesses of Midwesco, Inc. Bradley E. Mautner is the son of Henry M. Mautner.
Gene K. Ogilvie has been employed by the Company and its predecessors in various executive capacities since 1969. He has been general manager of Midwesco Filter or its predecessor since 1980 and President and Chief Operating Officer of Midwesco Filter since 1989. From 1982 until the consummation of the Midwesco Merger, he served as Vice President of Midwesco, Inc.
Fati A. Elgendy, who has been associated with the Company and its predecessors since 1978, was Vice President, Director of Sales of the Perma-Pipe Division of Midwesco, Inc. from 1990 to 1991. In 1991, he became Executive Vice President of the Perma-Pipe Division, a position he continued to hold after the acquisition by the Company to form Perma-Pipe. In March 1995, Mr. Elgendy became President and Chief Operating Officer of Perma-Pipe.
Don Gruenberg has been employed by the Company and its predecessors in various executive capacities since 1974, with the exception of a period in 1979-1980. He has been general manager of Thermal Care or its predecessor since 1980, and was named President and Chief Operating Officer of Thermal Care in 1988. He has been a Vice President and director of the Company since December 1996.
Michael D. Bennett has served as the Chief Financial Officer and Vice President of the Company and its predecessors since August 1989.
Thomas A. Benson has served as Vice President Sales and Marketing of Thermal Care since May 1988.
Billy E. Ervin has been Vice President, Director of Production of Perma-Pipe since 1986.
Robert A. Maffei has been Vice President, Director of Sales and Marketing of Perma-Pipe since August 1996. He had served as Vice President, Director of Engineering of Perma-Pipe since 1987 and was an employee of Midwesco, Inc. from 1986 until the acquisition of Perma-Pipe by the Company in 1994.
Herbert J. Sturm has served the Company since 1975 in various executive capacities including Vice President, Materials and Marketing Services of Midwesco Filter.
Item 2.
Item 2. PROPERTIES
The Company's Filtration Products Business has three production facilities of which it owns the land and buildings in Winchester, Virginia and Cicero, Illinois and Nakskov, Denmark. The Winchester, Virginia facility has a total area of 164,500 square feet and is located on 15 acres in Winchester, Virginia. The building occupied by TDC Filter Manufacturing has a total area of 130,700 square feet and is located on 2.75 acres in Cicero, Illinois. The Company owns a newly constructed 48,900 square-foot facility on a 3.5-acre site in Nakskov, Denmark.
In February, 2004 the Company signed a contract to sell one of its buildings located in Winchester, Virginia. The building consists of 66,998 square feet on 10 acres. The Company will be leasing from the Buyer 7,000 square feet of the building. The sale is expected to close in May 2004 and there will not be a material gain or loss on the sale.
The production facilities for the Company's piping systems products are located in Lebanon, Tennessee and New Iberia, Louisiana. The Lebanon facility is located on approximately 24 acres and is housed in five buildings totaling 152,000 square feet, which contain manufacturing, warehouse and office facilities, as well as a quality assurance laboratory. The Company owns the buildings and the land for the Tennessee facility. The New Iberia production facility is comprised of two buildings with a total area of 12,000 square feet, which contain automated manufacturing and warehouse facilities. In September 2000, the Company purchased the buildings and signed a long-term lease for the land, with lease expiring in 2017.
The Company's principal executive offices and the production facilities for the Company's Industrial Process Cooling Equipment Business are located in a 131,000 square foot building on 8.1 acres in Niles, Illinois owned by the Company. The Industrial Process Cooling Equipment Business uses approximately 88,000 square feet of this facility for production and offices. The Industrial Process Cooling Equipment Business also owns a 20,000 square foot manufacturing and office facility in Assens, Denmark, which was purchased as part of the Boe-Therm acquisition in June 1998.
The Company believes its properties and equipment are well maintained and in good operating condition and that productive capacities will generally be adequate for present and currently anticipated needs.
Compliance with environmental regulations by the Company in its manufacturing operations has not had, and is not anticipated to have, a material effect on the capital expenditures, earnings or competitive position of the Company.
Item 3.
Item 3. LEGAL PROCEEDINGS
None
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's fiscal year ends on January 31. Years described as 2003, 2002 and 2001 are the fiscal years ended January 31, 2004, 2003 and 2002, respectively. Balances described as balances as of 2003 and 2002 are balances as of January 31, 2004 and 2003, respectively.
The Company's Common Stock is traded on the Nasdaq National Stock Market under the symbol "MFRI." The following table sets forth, for the periods indicated, the high and low sale prices as reported by the Nasdaq National Market for 2002 and for 2003.
As of January 31, 2004, there were approximately 100 stockholders of record.
The Company has never declared or paid a cash dividend and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. Management presently intends to retain all available funds for the development of the business and for use as working capital. Future dividend policy will depend upon the Company's earnings, capital requirements, financial condition and other relevant factors. The Company's line of credit agreement and note agreements contain certain restrictions on the payment of dividends.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following selected financial data for the Company for the years 2003, 2002, 2001, 2000 and 1999 are derived from the financial statements of the Company. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein in response to Item 7
Item 7. 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 annual 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.
2003 Compared to 2002
Net sales of $120,889,000 in 2003 decreased 1.6% from $122,897,000 in 2002. Sales declined in the Piping Systems and the Industrial Process Cooling Equipment businesses due to the weak economy which was partially offset by increased sales from the Filtration Products business. Gross profit of $24,598,000 in 2003 decreased 8.7% from $26,940,000 in 2002. Gross margin decreased to 20.3% of net sales in 2003 from 21.9% in 2002. Overall gross margin
decreased primarily as the result of competitive pricing pressures and the unfavorable effect of spreading fixed manufacturing costs over lower production volumes. (See discussion of each business segment below.)
Selling, general and administrative expenses decreased 2.7% to $25,319,000 in 2003 from $26,026,000 in 2002. The prior-year period included significant legal expense associated with a patent-infringement suit that has been settled, a warranty claim that has been settled, higher data processing expenses and recognition of uncollectible receivables. Additionally, cost-reduction measures implemented in the current year have led to reductions in current general and administrative expense. (See discussion of each business segment below.)
Loss before extraordinary items and cumulative effect of an accounting change was $1,097,000 or $0.22 per common share, compared with a loss of $824,000 or $0.17 per common share in 2002. This loss is due to decreased sales and decreased gross profit.
2002 Compared to 2001
Net sales of $122,897,000 in 2002 decreased 2.1% from $125,534,000 in 2001. Sales declined in the Filtration Products and the Piping Systems businesses due to the weak economy and loss of sales from Perma-Pipe Services Limited ("PPSL"), a European subsidiary that was sold in 2001, which was partially offset by increased sales from the newly-acquired product line associated with the purchase of a business by acquiring specified assets and assuming specified liabilities by the Industrial Process Cooling Equipment business. Gross profit of $26,940,000 in 2002 increased 2.3% from $26,332,000 in 2001. Gross margin increased to 21.9% of net sales in 2002 from 21.0% in 2001. Overall gross margin improved, primarily the result of Thermal Care's product mix due to the addition of a new product line and improved manufacturing efficiencies in Perma-Pipe, partially offset by competitive pricing pressures and the unfavorable effect of spreading fixed manufacturing costs over lower production volumes.
Selling, general and administrative expenses increased 7.7% to $26,026,000 in 2002 from $24,160,000 in 2001 primarily due to additional sales, engineering and administrative people associated with the newly-acquired product line (approximately $300,000), increase in outside professional services, bank fees (approximately $100,000) and loan cost amortization (approximately $125,000) from the debt restructuring and increased legal and settlement costs mostly related to a warranty claim and a patent dispute (approximately $800,000), which were partially offset by the elimination of expenses related to PPSL and by cost-reduction measures that were implemented in the second half of 2001.
Loss before extraordinary items and cumulative effect of an accounting change was $824,000 or $0.17 per common share, compared with a net loss of $374,000 or $0.08 per common share in 2001. This loss is due to decreased sales and increased selling, general and administrative expenses.
The 2002 net loss of $11,528,000 or $2.34 per common share is mainly the result of an adjustment for a write-off of impaired goodwill, and the operating results described above. In February 2002, the Company adopted Statement of Financial Accounting Standards No. 142, which requires that goodwill be analyzed for impairment on an annual basis. The Company's analysis of its goodwill in 2002 resulted in a loss on impairment of $11,849,000 or $10,739,000 net of a tax benefit of $1,110,000.
Filtration Products Business
The Company's Filtration Products Business is characterized by a large number of relatively small orders and a limited number of large orders, typically from electric utilities and original equipment manufacturers. In 2003, the average order amount was approximately $3,623. The timing of large orders can have a material effect on the comparison of net sales and gross profit from period to period. Large orders generally are highly competitive and result in a lower gross margin. In 2003, 2002 and 2001, no customer accounted for 10% or more of the net sales of the Company's filtration products and services.
The Company's Filtration Products Business, to a large extent, is dependent on governmental regulation of air pollution at the federal and state levels. The Company believes that growth in the sale of its filtration products and services will be materially dependent on continued enforcement of environmental laws such as the Clean Air Act Amendments. Although there can be no assurances as to what ultimate effect, if any, the Clean Air Act Amendments will have on the Company's Filtration Products Business, the Company believes that the Clean Air Act Amendments are likely to have a long-term positive effect on demand for the Company's filtration products and services.
2003 Compared to 2002
Net sales increased 3.2% to $54,872,000 in 2003 from $53,174,000 in 2002. This increase is the result of increased sales of pleated filter elements, which are partially offset by lower filter bag sales.
Gross profit as a percent of net sales decreased to 17.8% in 2003 from 17.9% in 2002, primarily as a result of product mix and competitive pricing pressures in the marketplace.
Selling expense decreased to $5,531,000 or 10.1% of net sales in 2003 from $5,598,000 or 10.5% of net sales in 2002. The decrease is primarily as a result of staff reductions.
General and administrative expenses decreased to $3,106,000 or 5.7% of net sales in 2003 from $3,500,000 or 6.6% of net sales in 2002. The prior-year period included significant legal expense associated with a patent-infringement suit that has been settled, a warranty claim that has been settled, higher data processing expenses and recognition of uncollectible receivables. Additionally, cost-reduction measures implemented in the current year have led to reductions in current general and administrative expense.
2002 Compared to 2001
Net sales decreased 2.3% to $53,174,000 in 2002 from $54,434,000 in 2001. This decrease is the result of lower sales in fabric filter elements and the products and services related to collection systems, partially offset by significant growth in pleated filter element sales, particularly in the international market.
Gross profit as a percent of net sales decreased to 17.9% in 2002 from 18.5% in 2001, due to continuing competitive pricing pressure and manufacturing inefficiencies caused by the sales volume decline.
Selling expense increased to $5,598,000 or 10.5% of net sales in 2002 from $4,865,000 or 8.9% of net sales in 2001. The dollar and percentage increases are primarily due to aggressive marketing programs that did not generate the expected sales volume.
General and administrative expense increased from $3,030,000 or 5.6% of net sales in 2001 to $3,500,000 or 6.6% of net sales in 2002, primarily due to legal expenses associated with a patent-infringement suit that has been settled and a warranty claim dispute (approximately $800,000), partially offset by cost-reduction measures that were implemented in the second half of 2001.
Piping Systems Business
Generally, the Company's leak detection and location systems have higher profit margins than its DHC piping systems and secondary containment piping systems. The Company has benefited from continuing efforts to have its leak detection and location systems included as part of the customers' original specifications for construction projects.
Although demand for the Company's secondary containment piping systems is generally affected by the customer's need to comply with governmental regulations, purchases of such products at times may be delayed by customers due
to adverse economic factors. In 2003, 2002 and 2001, no customer accounted for 10% or more of net sales of the Company's Piping Systems Business.
The Company's Piping Systems Business is characterized by a large number of small and medium orders and a small number of large orders. The average order amount for 2003 was approximately $38,000. The timing of such orders can have a material effect on the comparison of net sales and gross profit from period to period. Most of the Company's piping systems are produced for underground installations and, therefore, require trenching, which is performed directly for the customer by installation contractors unaffiliated with the Company. Generally, sales of the Company's piping systems tend to be lower during the winter months, due to weather constraints over much of the country.
2003 Compared to 2002
Net sales decreased 8% to $40,523,000 in 2003 from $44,037,000 in 2002. This decrease is primarily due to lower sales in product lines that are mainly dependent on state and federal government spending.
Gross profit as a percent of net sales decreased from 23.1% in 2002 to 18.5% in 2003, mainly due to accepting lower margin jobs to maintain work levels.
Selling expense decreased from $1,430,000 or 3.2% of net sales in 2002 to $1,250,000 or 3.1% of net sales in 2003. The decrease is primarily due to reduced commissions due to lower sales.
General and administrative expense decreased to $3,985,000 or 9.8% of net sales in 2003 from $4,435,000 or 10.1% of net sales in 2002. A settlement of $510,000 and $360,000 in related legal fees were incurred in the current year. This was offset by lower MIS expenses, currency exchange gains from the collection of Canadian Dollar accounts receivable, lower management incentive expenses, and reduced salaries charged to general and administrative expense.
2002 Compared to 2001
Net sales decreased 10.9% to $44,037,000 in 2002 from $49,417,000 in 2001, mainly due to a decrease in DHC business, a sale of $2,000,000 for a high-temperature oil-recovery project in Canada in 2001, and the loss of sales of $1,766,000 from PPSL, a subsidiary that was sold in 2001.
Gross profit as a percent of net sales increased from 20.7% in 2001 to 23.1% in 2002, mainly as a result of improved manufacturing efficiencies and elimination of lower-margin sales generated by PPSL in 2001.
Selling expense decreased from $1,849,000 in 2001 to $1,430,000 in 2002, primarily due to the decrease in sales-volume-related expenses, cost-sharing with a joint venture for oil and gas and a decrease in selling expense by $105,000 for PPSL. Selling expense as a percent of net sales decreased from 3.7% in 2001 to 3.2% in 2002.
General and administrative expense decreased from $5,012,000 or 10.1% of net sales in 2001 to $4,435,000 or 10.1% of net sales in 2002. The dollar decrease is mainly due to the elimination of expenses related to PPSL, partially offset by higher legal expense.
Industrial Process Cooling Equipment Business
The Company's Industrial Process Cooling Equipment Business is characterized by a large number of relatively small orders and a limited number of large orders. In 2003, the average order amount was approximately $2,252.The average sales order decrease from the prior year is primarily due to a higher sales mix of parts, service and start-up orders in 2002 versus 2003 which reflects the increasing sales mix of printing and OEM customers. In 2003, 2002 and in 2001, no customer accounted for 10% or more of net sales of the Cooling Equipment Business. In 2002, the Company purchased a business by acquiring specified assets and assuming specified liabilities, resulting in a new product line to broaden the industry penetration. This new product line complements the Cooling Equipment Business and resulted in sales growth in 2002 over 2001.
2003 Compared to 2002
Net sales decreased 0.7% from $25,686,000 in 2002 to $25,494,000 in 2003. Demand for equipment was down, but largely offset by increased orders for installation and other services and new product sales from the July 2002 purchase of a business (by acquiring specified assets and assuming specified liabilities).
Gross profit as a percentage of net sales increased to 28.6% in 2003 from 28.2% in 2002, primarily due increased sales for services, new product features and some new products associated with the July 2002 purchase of a business (by acquiring specified assets and assuming specified liabilities) to competitive pricing pressures and higher production costs associated with new products.
Selling expense decreased to $3,361,000 or 13.2% of net sales in 2003 from $3,418,000 or 13.3% in 2002. This decrease is primarily due to increased sales to direct manufacturers, which results in lower selling expenses, partially offset by the additional sales employees associated with the July 2002 purchase of a business (by acquiring specified assets and assuming specified liabilities).
General and administrative expense increased to $3,201,000 or 12.6% of net sales in the current year period from $3,136,000 or 12.2% of net sales in the prior year. The dollar increase is due to additional employees and certification expenses for the ISO partially offset by elimination of expenses associated with the prior-year completion of a new ERP business applications software.
2002 Compared to 2001
Net sales increased 18.5% from $21,683,000 in 2001 to $25,686,000 in 2002. The increase is due to sales from the product line associated with the purchase of a business by acquiring specified assets and assuming specified liabilities, and increased demand for temperature control and chiller products.
Gross profit as a percentage of net sales increased to 28.2% in 2002 from 28.0% in 2001, primarily due to the newly acquired product line.
Selling expense increased from $3,061,000 in 2001 to $3,418,000 in 2002, but decreased as a percent of net sales from 14.1% in 2001 to 13.3% in 2002. The increased spending is due to higher commissions expense based on sales volume and additional sales people (approximately $150,000) associated with the newly acquired product line.
General and administrative expense increased from $2,372,000 or 10.9% of net sales in 2001 to $3,136,000 or 12.2% of net sales in 2002. The increase is due to expenses associated with implementation of a new enterprise resource planning system that was installed in late 2001 and additional administrative and engineering people (approximately $150,000) associated with the newly acquired product line.
General Corporate Expense
General corporate expense includes general and administrative expense not allocated to business segments and interest expense.
2003 Compared to 2002
General and administrative expense increased 8.4% from $4,509,000 in 2002 to $4,886,000 in 2003, and increased as a percentage of net sales from 3.7% in 2002 to 4.0% in the current year period. Adoption of SFAS No. 145 resulted in the reclassification of an extraordinary loss of $133,000 recorded in the quarter ended July 31, 2002 to an operating expense in the current year's presentation of prior-year financial information. The increase in the current year is mainly due to increased salaries due to filled positions that were vacant in the prior-year, partially offset by reduced expenses for temporary help, increased costs related to maintenance of director and officer insurance, increased loan amortization expense due to debt restructuring in July 2002 and amendments thereafter, and increased utilities costs.
Interest expense decreased 4.9% from $2,107,000 in 2002 to $2,003,000 in 2003. The decrease is primarily due to reduced interest rates from the July 2002 debt restructuring.
2002 Compared to 2001
General corporate expense not allocated to business segments increased 13.6% from $4,509,000 in 2001 to $4,430,000 in 2002, primarily due to increased outside professional services, bank fees (approximately $100,000) and loan cost amortization (approximately $125,000) from debt restructuring. These were partially offset by decreases in goodwill amortization, management incentives, building repairs and maintenance.
Interest expense decreased 19.0% from $2,600,000 in 2001 to $2,107,000 in 2002 due to a reduction of net borrowings by $6,804,000 in the fourth quarter of 2001 and slightly lower average cost of borrowing.
Income Taxes
The effective income tax (benefit) rates were (50.8%), (27.5%) and (12.6%) in 2003, 2002 and 2001, respectively. The difference between the effective income tax rate and the U.S. Statutory tax rate for 2003 was:
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents as of January 31, 2004 were $154,000 as compared to $346,000 at January 31, 2003. The Company generated $6,791,000 from operations in 2003. Operating cash flows increased by $3,958,000 from 2002. The $476,000 proceeds from the sale of property, plant and equipment mainly resulted from the sale of certain equipment to a third party in July 2003. The Company leased back the equipment from the third-party purchaser. Cash distributions of $160,000 in October 2003 and $267,000 in January 2004 were received from the Company's investment in a joint venture. These cash flows were used to support $4,102,000 in capital spending and net payment of debts of $3,599,000.
Trade receivables increased $547,000 in 2003. Inventories decreased $1,594,000 in 2003 due to the reduction of specialized inventories at January 2003 being held for custom orders . This decrease is also a result of higher levels of work in process inventories from January 2003 that have been completed and sold, and a focused effort to reduce levels of inventory on hand. Prepaid expenses and other current assets decreased $1,922,000 in 2003 due to the receipt of a remaining $1,053,000 receivable from the Danish bank loan that was obtained in January 2003, partially offset by an increased income tax receivable and an increased receivable from related companies. Other operating assets and liabilities increased $1,044,000 in 2003. Net cash provided by operating activities in 2002 was $2,890,000. Such cash came mainly from earnings from operations and cash from decreases in accounts receivable and prepaid expenses and other current assets, partially offset by an increase in other assets and liabilities and a decrease in accounts payable. Net cash provided by operating activities was $8,562,000 in 2001, mainly due to earnings from operations and cash from decreases in accounts receivable and inventories, partially offset by a decrease in accounts payable and an increase in income taxes receivable.
Net cash used for investing activities in 2003 and 2002 were $3,199,000 and $1,685,000, respectively. Capital expenditures increased from $1,185,000 in the prior year to $4,102,000 in the current year. Capital additions of $2,042,000 relate to the Company's construction of a new building for one of its foreign subsidiaries, $281,000 relate to new ERP business applications software, and the remainder relates to equipment purchases. In 2002, the Company purchased a business by acquiring specified assets and assuming specified liabilities for $500,000 in cash paid to the seller and also invested $10,000 in a joint venture. In 2002, proceeds from the sale of property and equipment were $10,000, compared with $1,380,000 in 2001. The 2001 proceeds mainly resulted from the sale of certain equipment in Lebanon, Tennessee to a third party in June 2001. The Company leased back the equipment from the third party purchaser.
We estimate that capital expenditures for 2004 will be approximately $2,500,000. Capital expenditures primarily will relate to machinery and equipment, building and leasehold improvements, and new ERP business applications software equipment purchases. We may finance capital expenditures through internally generated funds or the revolving line of credit.
Debt totaled $28,525,000, down $3,151,000 since the beginning of the year. Net cash outflows from financing activity were $3,599,000, consisting of $3,458,000 from net payments and $141,000 used for payments on capitalized lease obligations. In the prior-year, the Company paid a net $560,000 of long-term debts and utilized $142,000 to pay capitalized lease obligations.
The following table summarizes the Company's estimated contractual obligations at January 31, 2004.
(1) Scheduled maturities, excluding the revolving line of credits. (2) Purchase commitments are for purchases made in the normal course of business to meet operational and capital expenditure requirements.
Other long term liability of $2,275,000 is composed of accrued pension cost and deferred compensation.
The Company's working capital was approximately $8,759,000 at January 31, 2004 compared to approximately $23,989,000 at January 31, 2003.
The Company's current ratio was 1.3 to 1 and 2.1 to 1 at January 31, 2004 and January 31, 2003, respectively. Debt to total capitalization at January 31, 2004 decreased to 51.5% from 54.3% at January 31, 2003.
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 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 (described below) 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 scheduled to pay $188,000 in aggregate principal on the last days 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 scheduled to make annual prepayments of excess cash flow (as defined in the Note Purchase Agreements). Finally, the Loan Agreement (defined below) 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 a prepayment on July 31, 2002.
At January 31, 2004, the Company was not in compliance with one covenant under the Note Purchase Agreements. The Company and the lenders are discussing a waiver. Also, the Company's noncompliance with a covenant under the Loan Agreement constitutes an event of default under the Note Purchase Agreements (see the paragraphs below that refer to the Loan Agreement). Although this noncompliance constitutes an event of default under the Note Purchase Agreement, the lender has not declared an event of default or accelerated the indebtedness of the Company evidenced by the Notes. The Company has made all required payments of principal and interest under the Note Purchase Agreements to date.
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 $27,000,000, 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 prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At January 31, 2004, the prime rate was 4.00%, 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 1.25 and 3.25 percentage points, respectively. As of January 31, 2004, the Company had borrowed $7,229,000 and had $2,300,000 available to it under the revolving line of credit. In addition, $6,521,000 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts owed for Industrial Revenue Bond borrowings. 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 January 31, 2004, the amount of restricted cash was $238,000. Cash required for operations is provided by draw-downs on the line of credit.
At January 31, 2004, the Company was not in compliance with two covenants under the Loan Agreement. The Company and the lenders are discussing a waiver. Although this noncompliance constitutes an event of default under the Loan Agreement, the lender has not declared an event of default or accelerated the indebtedness of the Company under the Loan Agreement. The Company has made all required payments of principal and interest under the Loan Agreement to date.
The Company and the lenders under the Note Purchase Agreements and the Loan Agreement are discussing waivers and amendments. The Company believes it is probable that agreements will be reached for the waivers and amendments, although agreement is not assured. If it does not occur, the Company believes it will be able to obtain replacement financing on acceptable terms, although there is no assurance that any such financing will be obtained. As required by accounting principles generally accepted in the United States, due to the unwaived covenant noncompliance discussed above, all amounts owing under the Note Purchase Agreements and the Loan Agreement have been classified as current as of January 31, 2004.
The Company is in compliance with all terms and covenants of the following loans.
On January 29, 2003, the Company obtained a loan from a Danish bank to purchase a building, in the amount of 1,050,000 Euro, approximately $1,136,000 at the exchange rate prevailing at the time of the transaction. The loan has a term of twenty years. The loan bears interest at 6.1% with quarterly payments of $19,000 for both principal and interest.
On April 26, 2002 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 lenders under the Prior Term Loans and the Bank. The notes each bear interest at 7.10% with a combined monthly payment of $40,235 for both principal and interest, and the note's amortization schedules and terms are each ten years. Upon completion of the pending sale of the building, one of the mortgages will be paid. The relating mortgage had a balance of $1,242,500 at January 31, 2004.
On July 31, 2002 Perma-Pipe, Inc. borrowed $1,750,000 under a mortgage note secured by its manufacturing facility in Lebanon, Tennessee. From the proceeds, $1,000,000 was used for a payment of amounts borrowed under the Note Purchase Agreements with the remaining proceeds used to repay amounts borrowed under the Loan Agreement. The loan bears interest at 7.75% 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 included the assumption of a $2,500,000 mortgage note with a remaining balance of $2,405,000. The loan bears interest at 7.52% with monthly payments of $18,507 for both principal and interest based on an amortization schedule of 25 years with a balloon payment at the end of the ten-year term. 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 at the prevailing exchange rate at the time of the transaction, to complete the permanent financing of the acquisition of Nordic Air A/S, a subsidiary of Midwesco Filter. The loan bears interest at 6.22% 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% with monthly payments of $9,682 for both principal and interest based on an amortization schedule of 25 years with a balloon payment at the end of the ten-year term.
On June 1, 1998, the Company obtained a loan in the amount of 4,500,000 DKK (approximately $650,000 at the prevailing exchange rate at the time of the transaction) from a Danish bank to partially finance the acquisition of Boe-Therm A/S ("Boe-Therm"). It is secured by the land and building of Boe-Therm, bears interest at 6.48% and has a term of twenty years. Another loan in the amount of 850,000 DKK (approximately $134,000 at the prevailing exchange rate at the time of the transaction) was obtained on January 1, 1999 to acquire land and a building, bears interest at 6.1% and has a term of twenty years. The interest rates on both the twenty-year loans are guaranteed for the first ten years, after which they will be renegotiated based on prevailing market conditions.
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 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 4.5% 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 used $1,100,000 of unspent bond proceeds to redeem bonds outstanding as provided in the indenture.
The Company also has short-term credit arrangements used 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 January 31, 2004, borrowings under these credit arrangements totaled $1,215,000; an additional $510,000 remained unused. The Company also had outstanding letters of credit in the amount of $69,000 to guarantee performance to third parties of various foreign trade activities and contracts.
CRITICAL ACCOUNTING POLICIES
Revenue Recognition: Perma-Pipe recognizes revenues on contracts under the "percentage of completion" method. The percentage of completion is determined by the relationship of costs incurred to the total estimated costs of the contract. Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements may result in revisions to costs and income. Such revisions are recognized in the period in which they are determined. Claims for additional compensation due the Company are recognized in contract revenues when realization is probable and the amount can be reliably estimated.
All other subsidiaries of the Company recognize revenues at the date of shipment.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company has five accounting policies which it believes are important to the Company's financial condition and results of operations, and which require the Company to make estimates about matters that are inherently uncertain. These critical accounting policies include revenue recognition, realizability of inventories, collectibility of accounts receivable, depreciation of plant and equipment, and income taxes. The Company believes that the above critical policies have resulted in past actual results approximating the estimated amounts in those areas.
Inventories: Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method for substantially all inventories.
Goodwill and other intangible assets with indefinite lives: Goodwill, which represents the excess of acquisition cost over the net assets acquired in business combinations, was amortized in 2001 on a straight-line basis over periods ranging from 25 to 40 years. On February 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 changes the accounting for goodwill and other intangible assets with indefinite lives 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, ceased upon adoption. Thus, no amortization for such goodwill and indefinite lived intangibles was recognized in the accompanying consolidated statements of operations for the years ended January 31, 2004 and 2003. SFAS No. 142 requires that goodwill and other intangible assets with indefinite lives be analyzed for impairment upon adoption with any resulting impairment loss recorded as a cumulative effect of change in accounting principle. Subsequent to the initial impairment test, SFAS No. 142 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. The Company has designated the beginning of its fiscal year as the date of its annual goodwill impairment test. The Company's initial impairment analysis of its goodwill in 2002 resulted in an impairment loss of $11,849,000 or $10,739,000 net of a tax benefit of $1,110,000 for the year ended January 31, 2003. As required by SFAS No. 142, the impairment loss was recognized in the first quarter of 2002 to reflect the cumulative effect of accounting change. The Company's annual impairment test at February 1, 2003 did not result in an impairment. Goodwill was $2,549,000 and $2,353,000 at January 31, 2004 and January 31, 2003, respectively. The change in Goodwill was due to foreign currency translation.
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 is effective for fiscal years ending after December 15, 2003, and for quarters beginning after December 15, 2003. The adoption of SFAS 132R did not have a material impact on the Company's financial statements, however required disclosures have been reflected in the current financial statements.
In May 2003, the FASB issued SFAS No. 150, :Accounting for certain financial instruments with characteristics of both liabilities and equity," effective in June 2003. SFAS No. 150 requires an issuer to classify, as liabilities, any financial instruments that fall within the scope of this pronouncement. Adoption of SFAS 150 did not have a material effect on the results of operations, financial condition, or cash flows of the Company.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," parts of which apply to existing contracts, but which is generally effective for contracts entered into after June 30, 2003. Adoption of SFAS No. 149 did not have a material effect on the results of operations, financial condition or cash flows of the Company.
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 did not have a material effect on the results of operations, financial condition or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation" which was effective for the Company on December 15, 2002. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair-value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both the annual and interim financial statements about the Company's method of accounting for stock-based employee compensation and the effects of the method used on reported results. Adoption of SFAS No. 148 did not have a material effect on the results of operations, financial condition or cash flows of the Company.
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 and will not have a material effect on the financial statements of the Company, based on guarantees in effect on January 31, 2004.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The Statement is effective for fiscal years beginning after May 15, 2002 and rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." Under SFAS No. 4, all gains and losses from extinguishments of debt were required to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. SFAS No. 145 eliminated SFAS No. 4 and, thus, the exception to applying Accounting Principles Board (APB) No. 30 to all gains and losses related to extinguishments of debt (other than extinguishments of debt to satisfy sinking-fund requirements. As a result, gains and losses from extinguishments of debt should be classified as extraordinary items only if they meet the criteria in APB No. 30. Adoption of SFAS No. 145 resulted in the reclassification of an extraordinary loss of $133,000 ($79,000 net of tax) recorded in 2002 to an operating expense.
Item 7A.
Item 7A. 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 has used 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 January 31, 2004, 2003 and 2002.
The changeover from national currencies to the Euro began on January 1, 2002 and it has not materially affected 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 maintaining a balance of fixed-rate long-term debt and 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 we use in the production of piping systems. The Company attempts to mitigate such risks by obtaining price commitments from its commodity suppliers and, when it appears appropriate, purchasing quantities in advance of likely price increases.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company as of January 31, 2004 and January 31, 2003 and for each of the three years in the period ended January 31, 2004 and the notes thereto are set forth elsewhere herein.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES
As of January 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 are effective in timely alerting them to material information relating to us required to be included in the Company's periodic SEC filings. 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 III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors of the Company is incorporated herein by reference to the table under the caption "Nominees for Election as Directors" and the textual paragraphs following the aforesaid table in the Company's proxy statement for the 2004 annual meeting of stockholders.
Information with respect to executive officers of the Company is included in Item 1, Part I hereof under the caption "Executive Officers of the Registrant."
Item 11.
Item 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is incorporated herein by reference to the information under the caption "Executive Compensation" in the Company's proxy statement for the 2004 annual meeting of stockholders.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information with respect to security ownership of certain beneficial owners and management of the Company and related stockholder matters is incorporated herein by reference to the information under the captions "Beneficial Ownership of Common Stock" and "Equity Compensation Plan Information" in the Company's proxy statement for the 2004 annual meeting of stockholders.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and transactions is incorporated herein by reference to the information under the caption "Certain Transactions" in the Company's proxy statement for the 2004 annual meeting of stockholders.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information with respect to certain relationships and transactions is incorporated herein by reference to the information under the caption "Certain Transactions" in the Company's proxy statement for the 2004 annual meeting of stockholders.
PART IV
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a. List of documents filed as part of this report:
(1) Financial Statements - Consolidated Financial Statements of the Company Refer to Part II, Item 8 of this report.
(2) Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts
b. Reports on Form 8-K: MFRI filed no reports on Form 8-K with the Securities and Exchange Commission during the last quarter of the fiscal year ended January 31, 2004.
c. Exhibits: The exhibits, as listed in the Exhibit Index included herein, are submitted as a separate section of this report.
d. The response to this portion of Item 15 is submitted under 15a(2) above.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of MFRI, Inc. and subsidiaries Chicago, IL
We have audited the accompanying consolidated balance sheets of MFRI, Inc. and subsidiaries as of January 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended January 31, 2004. Our audits also included the financial statement schedule listed in the Index at Item 15a(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of MFRI, Inc. and subsidiaries at January 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended January 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 2, effective February 1, 2002, MFRI, Inc. changed its method of accounting for goodwill and intangible assets upon adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
DELOITTE & TOUCHE LLP
Chicago, Illinois May 12, 2004
MFRI, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except per share information)
See notes to consolidated financial statements.
MFRI, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except per share information)
See notes to consolidated financial statements.
MFRI INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
See notes to consolidated financial statements.
MFRI, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
See notes to consolidated financial statements.
MFRI, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JANUARY 31, 2004, 2003 AND 2002
Note 1 - Basis of Presentation
MFRI, Inc. ("MFRI" or the "Company") was incorporated on October 12, 1993. MFRI is a holding company which has subsidiaries engaged in the manufacture and sale of products in three distinct business segments: filtration products, piping systems and industrial process cooling equipment. MFRI became successor by merger to Midwesco Filter Resources, Inc. ("Midwesco Filter") on January 28, 1994, when all the assets of the Perma-Pipe division of Midwesco, Inc. ("Perma-Pipe") were acquired, subject to specified liabilities, in exchange for cash and common stock of MFRI.
Through the merger of Midwesco, Inc. ("Midwesco") into MFRI on December 30, 1996 (the "Midwesco Merger"), MFRI acquired all the assets of Midwesco's Thermal Care business, subject to specified liabilities, which included the following: all liabilities associated with three lawsuits arising from warranty obligations of Perma-Pipe; Midwesco's rights under leases, primarily its lease of the building in Niles, Illinois that serves as the principal offices of both MFRI and Midwesco and as the manufacturing facility of the Thermal Care business; the deferred tax assets of Midwesco and 1,718,000 shares of the common stock of MFRI owned by Midwesco. Prior to the Midwesco Merger, Midwesco was primarily owned by certain management stockholders of MFRI and their families.
Fiscal Year: The Company's fiscal year ends on January 31. Years described as 2003, 2002 and 2001 are the fiscal years ended January 31, 2004, 2003 and 2002, respectively. Balances described as balances as of 2003, 2002 and 2001 are balances as of January 31, 2004, 2003 and 2002, respectively.
Nature of Business: Midwesco Filter is engaged principally in the manufacture and sale of filter elements for use in industrial air filtration systems and particulate collection systems. Air filtration systems are used in a wide variety of industries to limit particulate emissions, primarily to comply with environmental regulations. Midwesco Filter markets air-filtration-related products and accessories, and provides maintenance services, consisting primarily of dust collector inspection, filter cleaning and filter replacement. Perma-Pipe is engaged in engineering, designing, manufacturing and sells specialty piping systems and leak detection and location systems. Perma-Pipe's specialty piping systems include (i) industrial and secondary containment piping systems for transporting chemicals, waste streams and petroleum liquids, (ii) insulated and jacketed district heating and cooling piping systems for efficient energy distribution to multiple locations from central energy plants, and (iii) oil and gas gathering flow lines and long lines for oil and mineral transportation. Perma-Pipe's leak detection and location systems are sold as part of many of its piping system products and, on a stand-alone basis, to monitor areas where fluid intrusion may contaminate the environment, endanger personal safety, cause a fire hazard, impair essential services or damage equipment or property. Thermal Care is engaged in engineering, designing and manufacturing industrial process cooling equipment, including chillers, cooling towers, plant circulating systems, and related accessories for use in industrial process applications. The Company's products are sold both within the United States and internationally.
Reclassifications: Certain minor reclassifications and additional disclosures have been made to prior-year financial statements to conform to the current-year presentation.
Note 2 - Significant Accounting Policies
Revenue Recognition: Perma-Pipe recognizes revenues on contracts under the "percentage of completion" method. The percentage of completion is determined by the relationship of costs incurred to the total estimated costs of the contract. Provisions are made for estimated losses on uncompleted contracts in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements may result in revisions to costs and income. Such revisions are recognized in the period in which they are determined. Claims for additional compensation due the Company are recognized in contract revenues when realization is probable and the amount can be reliably estimated.
All other subsidiaries of the Company recognize revenues at the date of shipment.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company has five accounting policies which it believes are important to the Company's financial condition and results of operations, and which require the Company to make estimates about matters that are inherently uncertain. These critical accounting policies include revenue recognition, realizability of inventories, collectibility of accounts receivable, depreciation of plant and equipment, and income taxes. The Company believes that the above critical policies have resulted in past actual results approximating the estimated amounts in those areas.
Operating Cycle: The length of Perma-Pipe contracts vary, but are typically less than one year. The Company includes in current assets and liabilities amounts realizable and payable in the normal course of contract completion unless completion of such contracts extends significantly beyond one year.
Contingencies: The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, including those involving environmental, tax, product liability and general liability claims. The Company accrues for such liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, the Company's estimates of the outcomes of these matters, its experience in contesting, litigating and settling other similar matters, and any related insurance coverage.
The Company does not currently anticipate the amount of any ultimate liability with respect to these matters will materially affect the Company's financial position, liquidity or future operations.
Other: MFRI has no material exposures to off-balance sheet arrangements; no variable interest entities; nor activities that include non-exchange-traded contracts accounted for at fair value.
Principles of Consolidation: The consolidated financial statements include the accounts of MFRI; its principal wholly owned subsidiaries, Midwesco Filter, Perma-Pipe and Thermal Care, Inc. ("Thermal Care"); and the majority-owned and controlled domestic and foreign subsidiaries of MFRI, Midwesco Filter, Perma-Pipe and Thermal Care (collectively referred to as the "Company"). All significant intercompany balances and transactions have been eliminated. Acquired businesses are included in the results of operations since their acquisition dates.
Cash Equivalents: All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.
Restricted Cash: 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.
Inventories: Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method for substantially all inventories. Inventories consist of the following:
(In thousands)
Long-Lived Assets: Property, plant and equipment are stated at cost. Interest is capitalized in connection with the construction of facilities and amortized over the asset's estimated useful life. No interest was capitalized during 2003 and 2002.
Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from 3 to 30 years. Amortization of assets under capital leases is included in depreciation and amortization.
The Company's investment in property, plant and equipment as of January 31 is summarized below:
(In thousands)
Goodwill and other intangible assets with indefinite lives: Goodwill, which represents the excess of acquisition cost over the net assets acquired in business combinations, was amortized in 2001 on a straight-line basis over periods ranging from 25 to 40 years. On February 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 changes the accounting for goodwill and other intangible assets with indefinite lives 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, ceased upon adoption. Thus, no amortization for such goodwill and indefinite lived intangibles was recognized in the accompanying consolidated statements of operations for the years ended January 31, 2004 and 2003. SFAS No. 142 requires that goodwill and other intangible assets with indefinite lives be analyzed for impairment upon adoption with any resulting impairment loss recorded as a cumulative effect of change in accounting principle. Subsequent to the initial impairment test, SFAS No. 142 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. The Company has designated the beginning of its fiscal year as the date of its annual goodwill impairment test. The Company's initial impairment analysis of its goodwill in 2002 resulted in an impairment loss of $11,849,000 or $10,739,000 net of a tax benefit of $1,110,000 for the year ended January 31, 2003. As required by SFAS No. 142, the impairment loss was recognized in the first quarter of 2002 to reflect the cumulative effect of accounting change. The Company's annual impairment test at February 1, 2003 did not result in an impairment. Goodwill was $2,549,000 and $2,353,000 at January 31, 2004 and January 31, 2003, respectively. The change in Goodwill was due to foreign currency translation.
The following is a reconciliation of reported net income adjusted for adoption of SFAS No. 142:
The changes in the carrying amount of goodwill for the year ended January 31, 2004, are as follows:
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 $716,000 and $844,000 at January 31, 2004 and January 31, 2003, respectively. Accumulated amortization was $1,453,000 and $1,273,000 at January 31, 2004 and January 31, 2003, respectively. Future amortizations over the next five years ending January 31, will be 2005 - $182,000, 2006 - $182,000, 2007 - $175,000, 2008 - $29,000 and 2009 - $26,000.
Assets held for sale: Certain machinery in Perma-Pipe had previously been classified as held-for-sale. In October 2003, management determined it was not probable that these assets would be sold within one year from their classification as held for sale. As a result, these fixed assets have been reclassified as held for use and are included in property, plant and equipment at January 31, 2004. Additional depreciation of $40,000 was recorded when the property was transferred to held for use.
Investment in Joint Venture: In April 2002, the Company's Piping Systems Business and two unrelated companies formed an equally owned joint venture to more efficiently market their complementary thermal insulation products and systems for use in undersea pipeline flow assurance projects worldwide. During the year ended January 31, 2003, the Company invested $10,000 as its initial capital contribution and loaned $50,000, its share of advances to fund costs and expenses. The $50,000 loan was paid in July 2003. In October 2003 and January 2004, the Company received a partner distribution of $160,000 and $266,700 respectively from its investment in the joint venture. The Company accounts for its joint venture investment using the equity method. The Company's share of income for the current year is $492,000.
Financial Instruments: The Company uses foreign currency forward contracts to reduce exposure to exchange rate risks primarily associated with transactions in the regular course of the Company's export and international operations. The Company uses forward contracts which are short-term in duration, generally one year or less. The major currency exposure hedged by the Company is the Canadian dollar. The contract amount, carrying amount and fair value of these contracts were not significant at January 31, 2004, 2003 and 2002.
Net Loss Per Common Share: Earnings (loss) per share are computed by dividing net income by the weighted average number of common shares outstanding (basic) plus all potentially dilutive common shares outstanding during the year (diluted).
The basic weighted average shares reconcile to diluted weighted average shares as follows:
In 2003, 2002 and 2001, the weighted average number of stock options not included in the computation of diluted (loss) per share of common stock because the options exercise price exceeded the average market price of the common shares were 775,000, 910,000 and 846,000, respectively. Additionally in 2003 225,000 stock options had an exercise price below the average stock price however, the inclusion of such stock options would be anti dilutive and as a result these stock options are excluded from the computation of weighted average common shares oustanding assuming full dilution. These options were outstanding at the end of each of the respective years, except for options for 8,975, 14,750 and 4,000 shares, which expired in 2003, 2002 and 2001, respectively.
Stock Options: The Company's stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, using the intrinsic value method and, accordingly, no compensation cost has been recognized. The Company's net loss and loss per share would have been reduced to the amounts shown below if compensation cost related to stock options had been determined based on fair value at the grant dates in accordance with Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation ("SFAS 148"). The pro forma net income effect of applying SFAS 148 was as follows:
The weighted average fair value of options granted during 2003 (net of options surrendered), 20021 and 2001 are estimated at $1.14, $1.17 and $1.14, per share, respectively, on the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions:
Fair Value of Financial Instruments: The carrying values of cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair value due to their short-term nature. The carrying values of the Company's unsecured senior notes at January 31, 2004 and 2003 are also reasonable estimates of their fair value, as evidenced by the renegotiation of interest rates and terms that occurred recently as described in Note 7.
Accumulated Other Comprehensive Income (Loss): Accumulated other comprehensive loss consists of the following:
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 is effective for fiscal years ending after December 15, 2003, and for quarters beginning after December 15, 2003. The adoption of SFAS 132R did not have a material impact on the Company's financial statements, however required disclosures have been reflected in the current financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for certain financial instruments with characteristics of both liabilities and equity," effective in June 2003. SFAS No. 150 requires an issuer to classify, as liabilities, any financial instruments that fall within the scope of this pronouncement. Adoption of SFAS 150 did not have a material effect on the results of operations, financial condition, or cash flows of the Company.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," parts of which apply to existing contracts, but which is generally effective for contracts entered into after June 30, 2003. Adoption of SFAS No. 149 did not have a material effect on the results of operations, financial condition or cash flows of the Company.
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 did not have a material effect on the results of operations, financial condition or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation" which was effective for the Company on December 15, 2002. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair-value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both the annual and interim financial statements about the Company's method of accounting for stock-based employee compensation and the effects of the method used on reported results. Adoption of SFAS No. 148 did not have a material effect on the results of operations, financial condition or cash flows of the Company.
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 and will not have a material effect on the financial statements of the Company, based on guarantees in effect on January 31, 2004.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The Statement is effective for fiscal years beginning after May 15, 2002 and rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." Under SFAS No. 4, all gains and losses from extinguishments of debt were required to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. SFAS No. 145 eliminated SFAS No. 4 and, thus, the exception to applying Accounting Principles Board (APB) No. 30 to all gains and losses related to extinguishments of debt (other than extinguishments of debt to satisfy sinking-fund requirements. As a result, gains and losses from extinguishments of debt should be classified as extraordinary items only if they meet the criteria in APB No. 30. Adoption of SFAS No. 145 resulted in the reclassification of an extraordinary loss of $133,000 ($79,000 net of tax) recorded in 2002 to an operating expense.
Note 3 - Related Party Transactions
The Company provides certain services and facilities to a company (affiliate) primarily owned by two principal stockholders who are also members of management and purchases certain services from those companies under a management services agreement. The Company billed the affiliate $260,000 and was invoiced $171,000 by the affiliate under such agreements in 2003. The Company billed $250,000 and was invoiced $167,000 under such agreements in 2002. During 2001, the Company billed $244,000 and was invoiced $170,000 under such agreements.
Until February 28, 2001, the Company leased certain office and warehouse facilities substantially all of which were occupied by a company primarily owned by the two management stockholders. The Company made rental payments of $236,000 directly to the lessor in 2000, and allocated the expense to users based on space occupied. The Company paid $54,000 in 2001 to the related company for space occupied. On February 28, 2001, the affiliated company began leasing the facilities directly from the lessor.
The lease agreement and the management services agreements were approved by the Company's Committee of Independent Directors. Management of the Company believes the amounts paid and received under these agreements were comparable to those which would have been paid and received in arm's-length transactions.
Note 4 - Acquisitions and Divestitures
Perma-Pipe Services Limited
In December 2001, the Company sold its subsidiary, Perma-Pipe Services Ltd. Cash proceeds of $358,000 were received in May 2002. The aggregate value of the book basis of the investment and a related intercompany receivable was $562,000 resulting in a loss of $204,000.
Other
On June 19, 2002, the Company purchased a business by acquiring specified assets and assuming specified liabilities for $500,000 in cash. In accordance with SFAS No. 141, the purchase price plus purchase-related expenses is first applied to
current assets and any excess of value over the current assets is allocated to extraordinary gain. The asset values were $815,000 and $0 for inventory and other assets, which mainly consisted of property, plant and equipment, respectively, which, combined with purchase-related expenses of $257,000, resulted in the recognition of an extraordinary gain of $58,000 ($35,000 net of tax).
Note 5 - Retention Receivable
Retention is the amount withheld by a customer until a long-term contract is completed. Retentions of $64,000 and $193,000 are included in the balance of trade accounts receivable at January 31, 2004 and 2003, respectively.
Note 6 - Costs and Estimated Earnings on Uncompleted Contracts
Costs and estimated earnings on uncompleted contracts are as follows:
(In thousands)
Note 7 - Debt
Long-term debt consists of the following:
(In thousands)
The following table summarizes the Company's scheduled maturities, excluding the revolving line of credits at January 31, 2004.
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 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 (described below) 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 scheduled to pay $188,000 in aggregate principal on the last days 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 scheduled to make annual prepayments of excess cash flow (as defined in the Note Purchase Agreements). Finally, the Loan Agreement (defined below) 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 a prepayment on July 31, 2002.
At January 31, 2004, the Company was not in compliance with one covenant under the Note Purchase Agreements. The Company and the lenders are discussing a waiver. Also, the Company's noncompliance with a covenant under the Loan Agreement constitutes an event of default under the Note Purchase Agreements (see the paragraphs below that refer to the Loan Agreement). Although this noncompliance constitutes an event of default under the Note Purchase Agreement, the lender has not declared an event of default or accelerated the indebtedness of the Company evidenced by the Notes. The Company has made all required payments of principal and interest under the Note Purchase Agreements to date.
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 $27,000,000, 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 prime rate; or (b) a margin in effect plus the LIBOR rate for the corresponding interest period. At January 31, 2004, the prime rate was 4.00%, 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 1.25 and 3.25 percentage points, respectively. As of January 31, 2004, the Company had borrowed $7,229,000 and had $2,300,000
available to it under the revolving line of credit. In addition, $6,521,000 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts owed for Industrial Revenue Bond borrowings. 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 January 31, 2004, the amount of restricted cash was $238,000. Cash required for operations is provided by draw-downs on the line of credit.
At January 31, 2004, the Company was not in compliance with two covenants under the Loan Agreement. The Company and the lenders are discussing a waiver. Although this noncompliance constitutes an event of default under the Loan Agreement, the lender has not declared an event of default or accelerated the indebtedness of the Company under the Loan Agreement. The Company has made all required payments of principal and interest under the Loan Agreement to date.
The Company and the lenders under the Note Purchase Agreements and the Loan Agreement are discussing waivers and amendments. The Company believes it is probable that agreements will be reached for the waivers and amendments, although agreement is not assured. If it does not occur, the Company believes it will be able to obtain replacement financing on acceptable terms, although there is no assurance that any such financing will be obtained. As required by accounting principles generally accepted in the United States, due to the unwaived covenant noncompliance discussed above, all amounts owing under the Note Purchase Agreements and the Loan Agreement have been classified as current as of January 31, 2004.
The Company is in compliance with all terms and covenants of the following loans.
On January 29, 2003, the Company obtained a loan from a Danish bank to purchase a building, in the amount of 1,050,000 Euro, approximately $1,136,000 at the exchange rate prevailing at the time of the transaction. The loan has a term of twenty years. The loan bears interest at 6.1% with quarterly payments of $19,000 for both principal and interest.
On April 26, 2002 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 lenders under the Prior Term Loans and the Bank. The notes each bear interest at 7.10% with a combined monthly payment of $40,235 for both principal and interest, and the note's amortization schedules and terms are each ten years. Upon completion of the pending sale of the building, one of the mortgages will be paid. The relating mortgage had a balance of $1,242,500 at January 31, 2004.
On July 31, 2002 Perma-Pipe, Inc. borrowed $1,750,000 under a mortgage note secured by its manufacturing facility in Lebanon, Tennessee. From the proceeds, $1,000,000 was used for a payment of amounts borrowed under the Note Purchase Agreements with the remaining proceeds used to repay amounts borrowed under the Loan Agreement. The loan bears interest at 7.75% 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 included the assumption of a $2,500,000 mortgage note with a remaining balance of $2,405,000. The loan bears interest at 7.52% with monthly payments of $18,507 for both principal and interest based on an amortization schedule of 25 years with a balloon payment at the end of the ten-year term. 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 at the prevailing exchange rate at the time of the transaction, to complete the permanent financing of the acquisition of Nordic Air A/S, a subsidiary of Midwesco Filter. The loan bears interest at 6.22% 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% with monthly payments of $9,682 for both principal and interest based on an amortization schedule of 25 years with a balloon payment at the end of the ten-year term.
On June 1, 1998, the Company obtained a loan in the amount of 4,500,000 DKK (approximately $650,000 at the prevailing exchange rate at the time of the transaction) from a Danish bank to partially finance the acquisition of Boe-Therm A/S ("Boe-Therm"). It is secured by the land and building of Boe-Therm, bears interest at 6.48% and has a term of twenty years. Another loan
in the amount of 850,000 DKK (approximately $134,000 at the prevailing exchange rate at the time of the transaction) was obtained on January 1, 1999 to acquire land and a building, bears interest at 6.1% and has a term of twenty years. The interest rates on both the twenty-year loans are guaranteed for the first ten years, after which they will be renegotiated based on prevailing market conditions.
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 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 4.5% 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 used $1,100,000 of unspent bond proceeds to redeem bonds outstanding as provided in the indenture.
The Company also has short-term credit arrangements used 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 January 31, 2004, borrowings under these credit arrangements totaled $1,215,000; an additional $510,000 remained unused. The Company also had outstanding letters of credit in the amount of $69,000 to guarantee performance to third parties of various foreign trade activities and contracts.
Note 8 - Lease Information
The following is an analysis of property under capitalized leases:
(In thousands)
The Company sold equipment for $1,359,000 in June 2001. The equipment was leased back from the purchaser under a master lease agreement for a period of seven years. No gain or loss was recognized on this transaction and the lease is being accounted for as an operating lease. The lease requires the Company to pay customary operating and repair expenses. The lease also contains a renewal option at lease termination and a purchase option at the higher of fair market value or 20% of cost.
The Company leases manufacturing and warehouse facilities, land, transportation equipment and office space under non-cancelable operating leases, which expire through 2017. Management expects that these leases will be renewed or replaced by other leases in the normal course of business.
At January 31, 2004, future minimum annual rental commitments under non-cancelable lease obligations were as follows:
Rental expense for operating leases was $807,000, $914,000 and $834,000 in 2003, 2002 and 2001, respectively.
Note 9 - Income Taxes
The following is a summary of domestic and foreign income (loss) before income taxes, extraordinary items and cumulative effect of accounting change:
Components of income tax expense (benefit) are as follows:
The difference between the provision (benefit) for income taxes and the amount computed by applying the federal statutory rate is as follows:
Components of the current deferred income tax asset balance are as follows:
Components of the long-term deferred income tax asset (liability) balances are as follows:
At January 31, 2004 the Company had net operating loss carryforwards available to offset future taxable income in the United States and certain foreign jurisdictions, which expire as follows:
Note 10 - Employee Retirement Plans
Pension Plan
Midwesco Filter has a defined benefit plan covering its hourly rated employees. The benefits are based on fixed amounts multiplied by years of service of retired participants. The Company engages outside actuaries to calculate its obligations and costs. The funding policy is to contribute such amounts as are necessary to provide for benefits attributed to service to date and those expected to be earned in the future. The amounts contributed to the plan are sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974. Midwesco Filter may contribute additional amounts at its discretion.
The market related value of plan assets at January 31, 2004 was $2,682,942. The plans hold no securities of MFRI, Inc. 100% of the assets are held for benefits under the plan. The target asset allocation is 95% to 100% mutual funds. The investment policy is to invest all funds in the Vanguard Balanced Index Fund except for cash needed to pay benefits and investment expenses for the year. 97% of plan assets are held in a mutual fund, and the remaining 3% is in a money market fund at January 31, 2004. The expected long-term rate-of-return-on-assets is based on historical long-term rates of equity and fixed income investments and the asset mix objective of the fund.
The following provides a reconciliation of benefit obligations, plan assets and funded status of the plan:
401(k) Plan
The domestic employees of the Company participate in the MFRI, Inc. Employee Savings and Protection Plan, which is applicable to all employees except certain employees covered by collective bargaining agreement benefits. The plan allows employee pretax payroll contributions of up to 16% of total compensation. The Company matches 50% of each participant's contribution, up to a maximum of 2% of each participant's salary.
Contributions to the 401(k) Plan and its predecessors were $347,000, $329,000 and $319,000 for the years ended January 31, 2004, 2003 and 2002, respectively. The Company estimates that it will contribute $347,000 for the year ending January 31, 2005.
Deferred Compensation Plans
The Company also has deferred compensation agreements with key employees. Vesting is based on years of service. Life insurance contracts have been purchased which may be used to fund the Company's obligation under these agreements. The cash surrender value of the life insurance contracts is included in other assets and the deferred compensation liability is included in other long-term liabilities in the consolidated balance sheet. The charges to expense were $209,000, $187,000 and $150,000 in 2003, 2002 and 2001, respectively.
Note 11 - Business Segment and Geographic Information
Business Segment Information
The Company has three reportable segments: the Filtration Products Business, the Piping Systems Business and the Industrial Process Cooling Equipment Business. 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.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. (See Note 2.) The Company evaluates performance based on gross profit and income or loss from operations.
Intersegment sales and transfers are accounted for as if sales or transfers were to third parties (i.e., at current market prices) and were not material for 2003, 2002 and 2001.
MFRI's reportable segments are strategic businesses that offer different products and services. Each is managed separately based on fundamental differences in their operations. Each strategic business was acquired as a unit and management at the time of acquisition was retained.
The following is information relevant to the Company's business segments:
Geographic Information
Net sales are attributed to a geographic area based on the destination of the product shipment. Long-lived assets are based on the physical location of the assets and consist of property, plant and equipment used in the generation of revenues in the geographic area.
Note 12 - Supplemental Cash Flow Information
A summary of annual supplemental cash flow information follows:
Note 13 - Stock Options
Under the 1993 and 1994 Stock Option Plans ("Option Plans"), 100,000 and 250,000 shares of common stock, respectively, are reserved for issuance to key employees of the Company and its affiliates as well as certain advisors and consultants to the Company. In addition, under the 1994 Option Plan, an additional one percent of shares of the Company's common stock outstanding have been added to the shares reserved for issuance each February 1, beginning February 1, 1995 and ending February 1, 1997, and an additional two percent of shares of the Company's common stock outstanding are added to the shares reserved for issuance each February 1, beginning February 1, 1998. Option exercise prices will be no less than fair market value for the common stock on the date of grant. The options granted under the Option Plans may be either non-qualified options or
incentive options. Such options vest ratably over four years and are exercisable for up to ten years from the date of grant.
Pursuant to the 2001 Independent Directors' Stock Option Plan (the "Directors' Plan"), an option to purchase 10,000 shares of common stock is granted automatically to each director who is not an employee of the Company (an "Independent Director") on the date the individual is first elected as an Independent Director, an option to purchase 1,000 shares was granted to each Independent Director on December 31, 2001, and options to purchase 1,000 shares are granted to each Independent Director upon each date such Independent Director is re-elected as an Independent Director, commencing with the Company's annual meeting for the year 2002. Provisions of a predecessor plan, the 1990 Independent Directors' Stock Option Plan, were the same as those of the Directors' Plan in every significant respect.
The MFRI 2001 Stock Option Exchange Plan ("Exchange Plan"), offered eligible optionees an opportunity to replace their stock options with new options. On the Exchange Plan offer's expiration date of June 26, 2001, the Company accepted and canceled 728,800 options. Pursuant to the terms of the Exchange Plan, the Company granted 674,600 new options to those tendering optionees who were active employees at December 31, 2001. Additionally, 54,200 options were tendered by individuals no longer employed by the Company at December 31, 2001.
In connection with the purchase agreement relating to the acquisition of TDC Filter Manufacturing, Inc., (acquired in December 1997 as part of the Filtration business), the Company issued stock options to purchase 75,000 shares of common stock at $9.60. These options may be exercised through November 2008.
The following summarizes the changes in options under the plans:
The following table summarizes information concerning outstanding and exercisable options at January 31, 2004:
The Company's stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, using the intrinsic value method and, accordingly, no compensation cost has been recognized. The Company's net loss and loss per share would have been reduced to the amounts shown below if compensation cost related to stock options had been determined based on fair value at the grant dates in accordance with Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation ("SFAS 148"). The pro forma net income effect of applying SFAS 148 was as follows:
The weighted average fair value of options granted during 2003 (net of options surrendered), 20021 and 2001 are estimated at $1.14, $1.17 and $1.14, per share, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Note 14 - Stock Rights
On September 15, 1999, the Company's Board of Directors declared a dividend of one common stock purchase right (a "Right") for each share of MFRI's common stock outstanding at the close of business on September 22, 1999. The stock issued after September 22, 1999 and before the redemption or expiration of the Rights are also entitled to one Right for each such additional share. Each Right entitles the registered holders, under certain circumstances, to purchase from the Company one share of MFRI's common stock at $25.00, subject to adjustment. At no time will the Rights have any voting power.
The Rights may not be exercised until 10 days after a person or group acquires 15% or more of the Company's common stock, or announces a tender offer that, if consummated, would result in 15% or more ownership of the Company's common stock. Separate Rights certificates will not be issued and the Rights will not be traded separately from the stock until then.
Should an acquirer become the beneficial owner of 15% or more of the Company's common stock, Rights holders other than the acquirer would have the right to buy common stock in MFRI, or in the surviving enterprise if MFRI is acquired, having a value of two times the exercise price then in effect. Also, MFRI's Board of Directors may exchange the Rights (other than those of the acquirer which will have become void), in whole or in part, at an exchange ratio of one share of MFRI common stock (and/or other securities, cash or other assets having equal value) per Right subject to adjustment. The Rights described in this paragraph and the preceding paragraph shall not apply to an acquisition, merger or consolidation approved by the Company's Board of Directors.
The Rights will expire on September 15, 2009, unless exchanged or redeemed prior to that date. The redemption price is $0.01 per Right. MFRI's Board of Directors may redeem the Rights by a majority vote at any time prior to the 20th day following public announcement that a person or group has acquired 15% of MFRI's common stock. Under certain circumstances, the decision to redeem requires the concurrence of a majority of the independent directors.
Note 15 - Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results of operations for the years 2003 and 2002:
(1) First quarter net loss is restated to reflect the cumulative effect of accounting change.
Note 16 - Product Warranties
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 2003 are summarized below:
Schedule II MFRI, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS For the Years Ended January 31, 2004, 2003 and 2002
(1) Disposed with sale of business.
(2) Uncollectible accounts charged off.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: May 12,2004 By: /s/ David Unger David Unger, Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant and in the capacities and on the date indicated.
DAVID UNGER* Director and Chairman of the ) Board of Directors, President ) and Chief Executive Officer ) (Principal Executive Officer) ) ) HENRY M. MAUTNER* Director )May 12, 2004 ) BRADLEY E. MAUTNER* Director ) ) MICHAEL D. BENNETT* Vice President, Secretary and ) Treasurer (Principal Financial ) and Accounting Officer) ) ) ARNOLD F. BROOKSTONE* Director ) ) EUGENE MILLER* Director ) ) STEPHEN B. SCHWARTZ* Director ) ) DENNIS KESSLER* Director ) ) *By: /s/ David Unger Individually and as Attorney-in-Fact ) David Unger )
EXHIBIT INDEX
Exhibit No. Description - ----------- ------------------------------------------------------------------- 3(i) Certificate of Incorporation of MFRI, Inc. [Incorporated by reference to Exhibit 3.3 to Registration Statement No. 33-70298]
3(ii) By-Laws of MFRI, Inc. [Incorporated by reference to Exhibit 3.4 to Registration Statement No. 33-70298]
4 Specimen Common Stock Certificate [Incorporated by reference to Exhibit 4 to Registration Statement No. 33-70794]
10(a) 1993 Stock Option Plan [Incorporated by reference to Exhibit 10.4 of Registration Statement No. 33-70794]
10(b) 1994 Stock Option Plan [Incorporated by reference to Exhibit 10(c) to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1994 (SEC File No. 0-18370)]
10(c) 2001 Independent Directors Stock Option Plan, as amended [Incorporated by reference to Exhibit 10(d)(5) to the Company's Schedule TO filed on May 25, 2001 (SEC File No. 0-18370)]
10(d) Form of Directors Indemnification Agreement [Incorporated by reference to Exhibit 10.7 to Registration Statement No.33-70298]
10(e) MFRI 2004 Stock Incentive Plan
21* Subsidiaries of MFRI, Inc.
23* Consent of Deloitte & Touche LLP
24* Power of Attorney executed by directors and officers of the Company
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
- --------------------------------- * Filed herewith
Exhibit 10(e) MFRI, INC. 2004 STOCK INCENTIVE PLAN
MFRI, Inc. (the "Company") may from time to time on or before November 30, 2013 grant to key employees (including officers, whether or not directors) of the Company, any of its subsidiaries, any parent of the Company or any of such parent's affiliates options to purchase shares of the Company's common stock, restricted or unrestricted stock awards, other stock-based awards, or any combination of the foregoing (the "Plan"). All stock options and stock awards granted pursuant to this Plan are referred to herein as "Awards." Key employees, for the purposes of the MFRI, Inc. 2004 Stock Incentive Plan with respect to the grant of non-statutory options only, shall also include advisors and consultants to the Company (including employees of such advisors and consultants) provided that such advisors and consultants render bona fide services to the Company that are not connected with the offer or sale of securities in a capital-raising transaction. Subject to adjustment for corporate transactions and other events as specifically described herein, the aggregate number of shares of such stock which may be issued with respect to Awards pursuant to this Plan shall not exceed 250,000; provided, however, that on January 31, 2005 and each January 31 thereafter until January 31, 2013, the aggregate number of shares that may be issued with respect to Awards pursuant to the terms of this Plan shall be increased by the number equal to 2% of the aggregate number of shares of common stock outstanding as of the last day of the most recently ended fiscal year of the Company. The Board of Directors may provide for the exercise of Awards under this Plan from time to time in installments or otherwise, and may authorize the granting of such Awards upon such other terms and conditions and for such periods up to ten years from the date of grant as it may in its discretion determine; provided, however, that (1) except as otherwise determined by the Company, and in any event in the case of an incentive stock option (as defined below) or a stock appreciation right granted with respect to an incentive stock option, no Award granted under the Plan shall be transferable by the grantee otherwise than by will or the laws of descent and distribution, (2) except as otherwise determined by the Company, any Award granted hereunder may be exercisable during such grantee's lifetime only by the grantee or by such grantee's guardian or legal representative, and (3) the aggregate fair market value (determined at the time an Award is granted) of shares with respect to which incentive stock options are exercisable for the first time by an option holder during any calendar year (under all incentive stock option plans of the Company, any parent and any subsidiary corporations of the Company) shall not exceed $100,000. Notwithstanding anything contained herein to the contrary, the aggregate number of shares of common stock which may be issued to all grantees or holders pursuant to the exercise of incentive stock options pursuant to the Plan shall not exceed 250,000.
The Company may from time to time grant to eligible participants Awards of stock options under this Plan. Options granted under this Plan may be either options which are intended to be incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended ("incentive stock options"), or options which are not intended to be incentive stock options ("non-statutory options"). The purchase price per share to be specified in any option granted pursuant to this Plan shall be not less than the fair market value of such stock on the date such option is granted, and may be paid in cash, in common stock of the Company or in any combination thereof.
The Company may from time to time grant to the holder of any option issued hereunder the right to elect to exercise stock appreciation rights with respect to all or any portion of the shares subject to such option in lieu of such option rights thereunder by surrendering the option rights as to all or such portion of the shares as to which option rights shall at such time be exercisable under such option, and receiving, with respect to each share as to which option rights are so surrendered, an amount in payment equal to the excess of the fair market value of such share on the date of surrender over the purchase price specified for such share in the option. Such payment may be made in cash, in common stock of the Company, or in any combination thereof, subject, in the case of cash, to the consent of the Company. The number of shares of common stock to be issued and delivered by the Company upon the exercise of stock appreciation rights hereunder shall be determined by dividing the amount of the payment to be made in the form of common stock by the fair market value of a share of the Company's common stock as of the date of surrender, and the value of any fractional share shall be paid by the Company in cash. No stock appreciation right shall, in any event, be exercisable within six months of the date of its grant. For purposes of determining the aggregate number of shares of the Company's common stock sold to all Award grantees pursuant to this Plan, each share as to which option rights have been surrendered upon the exercise of stock appreciation rights shall be treated as if it were a share sold under this Plan.
The Company may from time to time grant restricted or unrestricted stock Awards or other stock-based Awards to eligible participants in such amounts, on such terms and conditions and for such consideration, including no consideration or such minimum consideration as may be required by law, as it shall determine.
Grantees and holders of Awards shall pay to the Company or its affiliate, or make provision satisfactory to the Company for the payment of, any taxes required to be withheld in respect of Awards under the Plan no later than the date of the event creating the tax liability. The Company or its affiliate may, to the extent permitted by law, deduct any such tax obligations from any payment of any kind otherwise due to the grantee or holder of an Award. At any time when an Award grantee is required to pay to the grantee's employer an amount required to be withheld under applicable income tax laws in connection with the exercise of a non-statutory Award, the Award grantee may satisfy this obligation in whole or in part by electing (the "Election") to have the Company withhold shares of common stock having a value equal to the amount required to be withheld. The value of the shares to be withheld shall be based on the fair market value of such shares on the date that the amount of tax to be withheld shall be determined ("Tax Date"). Each Election must be made prior to the Tax Date. The Board may disapprove of any Election or may suspend or terminate the right to make Elections. An Election is irrevocable.
If the Award grantee is an officer of the Company within the meaning of section 16 of the Securities Exchange Act of 1934, as amended, then the Election is subject to the following additional restrictions:
(1) No Election shall be effective for a Tax Date which occurs within six months of the grant of the Award.
(2) The Election must be made either six months prior to the Tax Date or must be made during a period beginning on the third business day following the date of release for publication of the Company's quarterly or annual summary statements of sales and earnings and ending on the twelfth business day following such date.
In the event of a stock dividend, stock split, or combination or other reduction in the number of issued shares of common stock of the Company, the Board of Directors of the Company shall make such adjustments in the number of unpurchased shares subject to this Plan, the number of shares subject to Awards outstanding in this Plan, the exercise price specified in Awards outstanding under this Plan, and the number of shares subject to stock appreciation rights outstanding under this Plan as it shall determine to be appropriate and equitable. In the event of a merger, consolidation, reorganization or dissolution of the Company, or the sale or exchange of substantially all of the Company's assets, (i) the rights under Awards, including stock appreciation rights, outstanding hereunder shall terminate, except to the extent and subject to such adjustments as may be provided by the Board of Directors of the Company or by the terms of the plan or agreement of merger, consolidation, reorganization, dissolution or sale or exchange of such assets, and (ii) the Company shall notify the holders of outstanding Awards of such event at least 30 days prior to the effective date of such event.
The Board of Directors of the Company, or a committee or committees of the Board of Directors as may be appointed by the Board of Directors from time to time, shall have full power and authority, in its sole and absolute discretion, to (1) take all actions necessary to carry out the purpose and intent of the Plan, (2) administer and interpret the Plan, options and other Award grant agreements and all other documents relevant to the Plan and/or to Awards issued thereunder, (3) adopt and interpret such rules, regulations, agreements, guidelines and instruments for the implementation and administration of the Plan as it deems necessary or advisable, and (4) select the grantees, determine the type of any Award to be granted, determine the time or times at which Awards shall be granted, impose such terms, limitations, restrictions and conditions upon any such Award as it shall deem appropriate, determine the number of shares to be allocated to each Award grantee, and to modify, amend, extend or renew outstanding Awards, or accept the surrender of outstanding Awards and substitute new Awards, provided, however, that, subject to modifications, amendments or terminations expressly described in this Plan, any modification that would materially adversely affect any outstanding Award shall not be made without the consent of the holder. The Board of Directors of the Company may, without stockholder consent, amend this Plan; provided, however, any amendment that would (i) materially increase the benefits accruing to participants hereunder, (ii) materially increase the number of shares which may be issued hereunder, or (iii) materially modify the requirements as to eligibility for participation hereunder, must be approved by a vote of the stockholders of the Company.
Exhibit 21 MFRI, Inc. has the following wholly owned subsidiaries:
1. Midwesco Filter Resources, Inc. (Delaware corporation)
2. Perma-Pipe, Inc. (Delaware corporation)
3. TDC Filter Manufacturing, Inc. (Delaware corporation)
4. Thermal Care, Inc. (Delaware corporation)
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No. 333-21951 on Form S-3, Registration Statement No. 333-44787 on Form S-3, and Registration Statement No. 333-08767 on Form S-8, of MFRI, Inc. of our report dated, May 12, 2004, (which report expresses an unqualified opinion and includes an explanatory paragraph as to MFRI, Inc.'s change in its method of accounting for goodwill and intangible assets) appearing in this Annual Report on Form 10-K of MFRI, Inc. and subsidiaries for the year ended January 31, 2004.
DELOITTE & TOUCHE LLP Chicago, Illinois May 17, 2004
Exhibit 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being a director or officer, or both, of MFRI, INC., a Delaware corporation (the "Company"), does hereby constitute and appoint DAVID UNGER, HENRY M. MAUTNER and MICHAEL D. BENNETT, with full power to each of them to act alone, as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of said attorneys to execute, file or deliver any and all instruments and to do all acts and things which said attorneys and agents, or any of them, deem advisable to enable the Company to comply with the Securities Exchange Act of 1934, as amended, and any requirements or regulations of the Securities and Exchange Commission in respect thereof, in connection with the Company's filing of an annual report on Form 10-K for the Company's fiscal year 2003, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign his name as a director or officer, or both, of the Company, as indicated below opposite his signature, to the Form 10-K, and any amendment thereto; and each of the undersigned does hereby fully ratify and confirm all that said attorneys and agents, or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has executed this Power of Attorney as of this 12th day of May, 2004.
/s/ David Unger /s/ Arnold F. Brookstone David Unger, Chairman of the Board Arnold F. Brookstone, Director of Directors, President and Chief Executive Officer (Principal Executive Officer)
/s/ Henry M. Mautner /s/ Eugene Miller Henry M. Mautner, Vice Chairman Eugene Miller, Director of the Board of Directors
/s/ Bradley E. Mautner /s/ Stephen B. Schwartz Bradley E. Mautner, Director and Stephen B. Schwartz, Director Executive Vice President
/s/ Michael D. Bennett /s/ Dennis Kessler Michael D. Bennett, Vice President, Dennis Kessler, Director Secretary and Treasurer (Principal Financial and Accounting Officer)
Exhibit 31.1 I, David Unger, certify that:
1. I have reviewed this annual report on Form 10-K 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:
(b) 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;
(c) 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
(d) 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: May 17, 2004
/s/ David Unger_________ David Unger Director and Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer)
Exhibit 31.2 I, Michael D. Bennett, certify that:
1. I have reviewed this annual report on Form 10-K 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: May 17, 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, President and 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 Annual Report on Form 10-K for the period ended January 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, President and Chief Executive Officer (Principal Executive Officer) May 17, 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 Annual Report on Form 10-K for the period ended January 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) May 17, 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.