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| MFRI > SEC Filings for MFRI > Form 10-Q on 8-Sep-2009 | All Recent SEC Filings |
8-Sep-2009
Quarterly Report
The statements contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and certain other information contained elsewhere in this report, which can be identified by the use of forward-looking terminology such as "may," "will," "expect," "continue," "remains," "intend," "aim," "should," "prospects," "could," "future," "potential," "believes," "plans," "likely," and "probable," or the negative thereof or other variations thereon or comparable terminology, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbors created thereby. These statements should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment. Such risks and uncertainties could cause actual results to differ materially from those projected. These uncertainties include, but are not limited to, competition, international rapid growth, changes in government policies and laws, worldwide economic conditions, government regulation, economic factors, consumer access to capital funds, backlog, financing, internal control, market demand and pricing, global interest rates, currency exchange rates, labor relations and other risk factors.
Consolidated MFRI, Inc.
MFRI, Inc. ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three reportable business segments: piping systems, filtration products, and industrial process cooling equipment. The Company website address is www.mfri.com.
This discussion should be read in conjunction with the condensed consolidated financial statements, including the notes thereto. An overview of the segment results is provided in Note 2 of the Notes to Condensed Consolidated Financial Statements (Unaudited) contained in Item 1 of this report.
The slowdown in the economy, which accelerated in the fourth quarter of 2008 and has continued into 2009, leads the Company be cautious regarding expected performance for the remainder of 2009. Since the fourth quarter of 2008 and continuing into the first half of 2009, net sales declined in major markets as the economic slowdown continues to impact existing and prospective customers. Should the current credit crisis and general economic recession continue, the Company could continue to experience a period of declining net sales, which could adversely impact the Company's results of operations.
Three months ended July 31, 2009 ("current quarter") vs. Three months ended July 31, 2008 ("prior-year quarter")
Net sales of $61,106,000 decreased 21.3% from $77,645,000 for the prior-year quarter. (See discussion of each business segment below.)
Gross profit of $14,629,000 decreased 5.0% from $15,401,000 in the prior-year quarter, and gross margin increased to 23.9% of net sales in the current quarter from 19.8% of net sales in the prior-year quarter. Gross profit in the piping systems business rose to $11,309,000 for the current quarter from $9,196,000 in the prior-year quarter. As of July 31, 2009, the Company had successfully completed over 99% of the production on the India pipeline project. The Company would not expect a project similar in size to the one in India to be replaced in the 2009 backlog. (See discussion of each business segment below.)
Selling expenses decreased 5.4% to $3,328,000 for the current quarter from $3,518,000 in the prior-year quarter. This was primarily driven by the filtration products business and the industrial process cooling equipment business, which had decreased commission expense from lower sales and a decline in compensation and related expenses due to staff reductions. (See discussion of each business segment below.)
General and administrative expenses increased 10.9% to $8,519,000 for the current quarter from $7,685,000 in the prior-year quarter. The increase was mainly due to increased profit-based management incentive expense. (See discussion of each business segment below.)
Net income rose to a second quarter record of $3,751,000 in the current quarter from $2,405,000 in the prior-year quarter primarily due to the reasons summarized above and discussed in more detail below.
Six months ended July 31, 2009 ("YTD") vs. Six months ended July 31, 2008
("prior-year YTD")
Net sales of $128,685,000 decreased 10.4% from $143,626,000 for the prior-year YTD. (See discussion of each business segment below.)
Gross profit of $33,356,000 increased 25.7% from $26,544,000 in the prior-year YTD, and gross margin increased to 25.9% of net sales YTD from 18.5% of net sales in the prior-year YTD. Gross profit in the piping systems business rose to $25,457,000 YTD from $14,656,000 in the prior-year YTD. As of July 31, 2009, the Company had successfully completed over 99% of the production on the India pipeline project. The Company would not expect a project similar in size to the one in India to be replaced in the 2009 backlog. (See discussion of each business segment below.)
Selling expenses decreased 11.3% to $6,427,000 YTD from $7,244,000 in the prior-year YTD. Primarily driven by the industrial process cooling equipment business and the filtration product business, which had decreased commission expense from lower sales and a decline in compensation and related expenses due to staff reductions. (See discussion of each business segment below.)
General and administrative expenses increased 23.7% to $17,275,000 YTD from $13,967,000 in the prior-year YTD. The increase was mainly due to increased profit-based management incentive expense. (See discussion of each business segment below.)
Net income rose to a record six month high of $9,757,000 YTD from $2,828,000 in the prior-year YTD primarily due to the reasons summarized above and discussed in more detail below.
Piping Systems Business
Current quarter vs. Prior-year quarter
Net sales decreased 15.8% to $32,556,000 in the current quarter from $38,687,000 in the prior-year quarter, attributed primarily to a drop in domestic sales in both district heating and cooling, and oil and gas products. This was partially offset by an increase in sales in the U.A.E. and $2,187,000 for the India Pipeline project. As of July 31, 2009, the Company had successfully completed over 99% of the production on the India pipeline project. The Company would not expect a project similar in size to the one in India to be replaced in the backlog in 2009.
Gross profit increased to 34.7% of net sales in the current quarter from 23.8% of net sales in the prior-year quarter due to production efficiencies in both the domestic and international operations, the improved knowledge of procurement and sourcing in the international operation as well as the cost control measures implemented throughout the domestic and international operations.
Selling expenses increased to $666,000 or 2.0% of net sales in the current quarter from $591,000 or 1.5% of net sales for the prior-year quarter. This increase was mainly due to higher sales commissions in the U.A.E. and travel expenses.
General and administrative expenses increased to $3,778,000 or 11.6% of net sales in the current quarter from $2,523,000 or 6.5% of net sales for the prior-year quarter. The increase in general and administrative expense was primarily due to the increased profit-based management incentive expense, foreign exchange loss, and additional staffing in the U.A.E.
YTD vs. Prior-year YTD
Net sales decreased 6.0% to $65,183,000 YTD from $69,364,000 in the prior-year YTD, attributed primarily to a drop in sales in both domestic heating and cooling, and oil and gas products. The insulation of pipe for a crude oil pipeline project in India began full production in the third quarter 2008 and contributed to the increase in sales of $10,138,000 in the first half of 2009. As of July 31, 2009, the Company had successfully completed over 99% of the production on the India pipeline project. The Company would not expect a project similar in size to the one in India to be replaced in the backlog in 2009.
Gross profit increased to 39.1% of net sales YTD from 21.1% of net sales in the prior-year YTD due to production efficiencies in the international operations. Gross profit in the U.A.E. improved with the increased volume without corresponding increases in fixed expenses and achieved significant reductions in raw material costs due to the global economic slowdown.
Selling expenses increased to $1,303,000 or 2.0% of net sales YTD from $1,193,000 or 1.7% of net sales for the prior-year YTD. This increase was mainly due to higher sales commissions in the U.A.E. and travel expenses.
Filtration Products Business
Current quarter vs. Prior-year quarter
Net sales for the current quarter decreased 34.6% to $18,435,000 from $28,197,000 in the prior-year quarter. Sales declines were the result of both lower market demand across all filtration products and increased competition in cartridge filter products. Customers are delaying their purchases thus pushing demand out. In addition, infrastructure projects have been significantly curtailed in response to the current economy.
Gross profit decreased to 6.6% of net sales in the current quarter from 14.0% of net sales in the prior-year quarter primarily due to the highly competitive marketplace across all products and increased cost of raw materials in some cartridge filters.
Selling expenses decreased to $1,779,000 in the current quarter from $1,960,000 for the comparable quarter last year primarily due to fewer selling personnel. Selling expenses as a percentage of net sales increased to 9.7% in the current quarter from 7.0% in the prior-year quarter due to the effect of lower sales.
General and administrative expenses decreased to $1,245,000 in the current quarter from $1,296,000 in the prior-year quarter. General and administrative expenses as a percentage of net sales increased to 6.8% in the current quarter from 4.6% in the prior-year quarter.
YTD vs. Prior-year YTD
YTD net sales decreased 22.7% to $41,740,000 from $54,014,000 in the prior-year YTD. Sales declines were the result of both lower market demand across all filtration products and increased competition in cartridge filter products. Customers are delaying their purchases thus pushing demand out. In addition, infrastructure projects have been significantly curtailed in response to the current economy.
Gross profit decreased to 9.2% of net sales YTD from 13.4% of net sales in the prior-year YTD primarily due to the highly competitive marketplace across all filtration products and increased cost of raw materials in some cartridge filters.
Selling expenses decreased to $3,545,000 YTD from $3,927,000 in the prior-year YTD primarily due to fewer selling personnel. Selling expenses as a percentage of net sales increased to 8.5% YTD from 7.3% in the prior-year YTD due to the effect of lower sales.
General and administrative expenses increased to $2,410,000 or 5.8% of net sales YTD from $2,346,000 or 4.3% of net sales in the prior-year YTD.
Industrial Process Cooling Equipment Business
Current quarter vs. Prior-year quarter
Net sales of $5,563,000 for the current quarter decreased 30.2% from $7,973,000 for prior-year quarter due to lower demand for products in all market sectors, both domestic and international.
Gross profit increased to 26.1% of net sales from 23.9% of net sales in the prior-year quarter primarily due to reduced field product support costs, lower overhead expenses and favorable product mix.
General and administrative expenses decreased in the current quarter to $859,000 or 15.4% of net sales from $1,243,000 or 15.6% of net sales in the prior-year quarter. The change in spending was a result of reduced outside product development services incurred in the current period, lower compensation and related expenses due to workforce reductions, and lower bad debt expense.
YTD vs. Prior-year YTD
YTD net sales of $10,616,000 decreased 37.7% from $17,040,000 for prior-year YTD due to lower demand for products in all market sectors, both domestic and international.
Gross profit decreased to 23.6% of net sales from 25.2% of net sales in the prior-year YTD primarily due to lower sales volume to spread fixed overhead expenses.
Selling expenses decreased to $1,579,000 YTD from $2,124,000 in the prior-year YTD. This was primarily driven by decreased commission expense from lower sales, and a decline in compensation and related expenses due to workforce reductions. Selling expense as a percentage of net sales increased to 14.9% YTD from 12.5% of net sales in the prior-year YTD due to the effect of lower sales.
General and administrative expenses decreased YTD to $1,708,000 from $2,518,000 in the prior-year YTD. The change in spending was a result of reduced outside product development services incurred in the current period, and lower compensation and related expenses due to workforce reductions. General and administrative expenses as a percentage of net sales increased 16.1% YTD from 14.8% of net sales in the prior-year YTD due to the effect of lower sales.
General Corporate and Other
Current quarter vs. Prior-year quarter
Net sales of $4,552,000 for the current quarter increased from $2,788,000 in the prior-year quarter due to increased activity on large projects. New construction activity is affected by the current economy.
General and administrative expenses increased to $2,637,000 or 4.3% of net sales in the current quarter from $2,623,000 or 3.4% of net sales in the prior-year quarter. The increase was mainly due to increased deferred compensation expense and profit-based management incentive expense.
Interest expense decreased to $530,000 for the current quarter from $654,000, net of capitalized interest in the prior-year quarter primarily due to decreased borrowings and lower interest rates. Capitalized interest of $132,000 was recorded in 2008 and was attributable to the building preparations for the relocation of the filtration products business operations from Cicero, Illinois to Bolingbrook, Illinois which occurred in the second and third quarters of 2008.
YTD vs. Prior-year YTD
YTD net sales of $11,146,000 increased from $3,208,000 in the prior-year YTD due to increased activity on large projects. New construction activity is affected by the current economy.
General and administrative expenses increased to $5,819,000 or 4.5% of net sales YTD from $4,655,000 or 3.2% of net sales in the prior-year YTD. The increase was due mainly to increased profit-based management incentive expense, increased deferred compensation expense, hiring of the Vice President of Human Resources and additional stock compensation expense.
YTD interest expense decreased to $1,218,000 from $1,277,000, net of capitalized interest in the prior-year YTD primarily due to lower interest rates. Capitalized interest of $132,000 was recorded in 2008 and was attributable to the building preparations for the relocation of the filtration products business operations from Cicero, Illinois to Bolingbrook, Illinois, which occurred in the second and third quarters of 2008.
Income Taxes
The effective tax rate in the periods presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. Income earned in the U.A.E. is not subject to any local country income tax. Taxes are based on an estimated annual effective rate. The effective tax rate was (74.8%) and (17.1%) for the three and six months ending July 31, 2009, respectively. The effective tax rate was less than the statutory U.S. federal income tax rate, mainly due to the impact of income earned in the U.A.E. The Company re-evaluated the need for a valuation allowance against deferred tax assets. During the first quarter, the Company established a full valuation allowance for the research and development credits of $844,000, as the Company no longer believes that it is more likely than not that the research and development credits will be utilized before January 2014. For additional information, see Note 3 Income Taxes in the Notes to the Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents as of July 31, 2009 were $5,801,000 as compared to $2,735,000 at January 31, 2009. The Company's working capital was $69,949,000 at July 31, 2009 compared to $57,984,000 at January 31, 2009. The Company provided $16,282,000 from operating activities during the first six months of 2009. Compared to January 31, 2009, inventories decreased by $8,876,000 mainly in the filtration products business for orders in production at January 31, 2009 and shipped in the first quarter, and trade receivables decreased by $12,279,000 mainly in the piping systems business. Restricted cash at July 31, 2009 included $3,824,000 pledged in lieu of an account receivable retention, pending wrap up of matters related to the India pipeline project.
Net cash used in investing activities for the six months ended July 31, 2009 consisted of $3,462,000 for capital expenditures, mainly in the piping systems business. Purchases were primarily for machinery and equipment.
Debt totaled $46,871,000 at July 31, 2009, a decrease of $8,012,000 compared to the beginning of the current fiscal year. Net cash used in financing activities was $11,065,000. Stock option activity resulted in $20,000 of cash inflow, which included a $5,000 tax benefit of stock options exercised in addition to stock option proceeds of $15,000.
On July 11, 2002, the Company entered into a secured loan and security agreement with a financial institution ("Loan Agreement"). The Loan Agreement was amended and restated on December 15, 2006. Under the terms of the Loan Agreement, which matures on November 13, 2010, the Company can borrow up to $38,000,000, subject to borrowing base and other requirements, under a revolving line of credit. The Loan Agreement covenants restrict debt, liens, and investments, do not permit payment of dividends, and require attainment of certain levels of profitability and cash flows. At July 31, 2009 and January 31, 2009, the Company was in compliance with covenants under the Loan Agreement as defined below. 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 July 31, 2009, the prime rate was 3.25%, 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 0.25 and 1.75 percentage points, respectively. Monthly interest payments were made. As of July 31, 2009, the Company had borrowed $23,825,000 and had $8,202,000 available to it under the revolving line of credit. In addition, $220,000 of availability was used under the Loan Agreement primarily to support letters of credit to guarantee amounts committed for inventory purchases. 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 July 31, 2009, the amount of such restricted cash was $466,000. Cash required for operations is provided by draw-downs on the line of credit.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
Reclassifications: Reclassifications were made to prior-year financial statements to conform to the current-year presentations.
Revenue Recognition: The Company recognizes revenues including shipping and
handling charges billed to customers, when all the following criteria are met:
(i) persuasive evidence of an arrangement exists, (ii) the seller's price to the
buyer is fixed or determinable, and (iii) collectability is reasonably assured.
All subsidiaries of the Company, except as noted below, recognize revenues upon
shipment or delivery of goods or services when title and risk of loss pass to
customers.
Percentage of completion revenue recognition: All divisions recognize revenues under the above stated revenue recognition policy except for sizable complex contracts that require periodic recognition of income. For these contracts, the Company uses "percentage of completion" accounting method. Under this approach, income is recognized in each reporting period based on the status of the uncompleted contracts and the current estimates of costs to complete. The choice of accounting method is made at the time the contract is received based on the expected length and complexity of the project. 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.
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.
Stock options: Stock compensation expense for employee equity awards are
recognized ratably over the requisite service period of the award. The
Black-Scholes option-pricing model is utilized to estimate the fair value of
awards. Determining the fair value of stock options using the Black-Scholes
model requires judgment, including estimates for (1) risk-free interest rate -
an estimate based on the yield of zero-coupon treasury securities with a
maturity equal to the expected life of the option; (2) expected volatility - an
estimate based on the historical volatility of the Company's Common Stock; and
(3) expected life of the option - an estimate based on historical experience
including the effect of employee terminations. If any of these assumptions
differ significantly from actual, stock-based compensation expense could be
impacted.
Income tax provision: Deferred income taxes have been provided for temporary differences arising from differences in basis of assets and liabilities for tax and financial reporting purposes. Deferred income taxes on temporary differences have been recorded at the current tax rate. The Company assesses deferred tax assets for realizability at each reporting period. For additional information, see Note 3 Income Taxes in the Notes to the Financial Statements.
New accounting pronouncements: In June 2009, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) No.
168, "The FASB Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles" (SFAS 168 or the "Codification"), a replacement of SFAS
162. SFAS 168 will become the source of authoritative U.S. generally accepted
accounting principles (GAAP) recognized by the FASB to be applied by
nongovernmental entities. Rules and interpretive releases of the U.S. Securities
and Exchange Commission (SEC) under authority of federal securities laws are
also sources of authoritative GAAP for SEC registrants. On the effective date of
SFAS 168, the Codification will supersede all then-existing non-SEC accounting
and reporting standards. All other non-grandfathered, non-SEC accounting
literature not included in the Codification will become non-authoritative. SFAS
168 is effective for financial statements issued for interim and annual periods
ending after September 15, 2009. The Company does not expect the adoption of
SFAS 168 to have a material effect on its consolidated financial statements.
In April 2009, the FASB issued Staff Position FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments," to require fair value disclosures for interim financial statements. This was effective for interim periods ending after June 15, 2009. Adoption of FSP FAS 107-1 and APB 28-1did not have a material effect on the Company's consolidated financial statements.
In December 2008, the FASB issued "Employers' Disclosures about Postretirement Benefit Plan Assets" ("FSP 132(R)-1"). FSP 132(R)-1 requires additional disclosures for plan assets of defined benefit pension or other postretirement plans. The required disclosures include a description of the investment policies and strategies, the fair value of each major category of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets, and the significant concentrations of risk within plan assets. FSP 132(R)-1 does not change the accounting treatment for postretirement benefit plans. FSP 132(R)-1 is effective for the Company on January 31, 2010 and does not require disclosures on an interim basis.
Other accounting standards that have been issued by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.
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