Summary of MFRI INC - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations ("MD&A")

The statements contained under the caption MD&A and other information contained elsewhere in this quarterly 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 as a result of many factors, including but not limited to those under the heading Item 1A. Risk Factors included in the Company's latest Annual Report on Form 10-K/A.

RESULTS OF OPERATIONS

Consolidated MFRI, Inc.

MFRI, Inc. ("MFRI", the "Company" or the "Registrant") is engaged in the manufacture and sale of products in three reportable segments: piping systems, filtration products and industrial process cooling. The Company website is www.mfri.com.

In the latest recession, the economy experienced a severe and prolonged downturn which adversely impacted all of the Company's businesses, directly or indirectly. Although improvement is expected, the timing of economic recovery in the markets we serve remains uncertain. Because economic and market conditions vary within the Company's segments, the Company's future performance by segment will vary. Should current economic conditions continue, or a further downturn occur in one or more of our significant markets, the Company could experience a period of declining net sales, which could adversely impact the Company's results of operations.

This discussion should be read in conjunction with the consolidated financial statements, including the notes thereto, contained elsewhere in this report. An overview of the segment results is provided in "Notes to Consolidated Financial Statements, Note 2 Business segment reporting" contained in Item 1 of this report.

Three months ended October 31, 2012 ("current quarter") vs. Three months ended October 31, 2011 ("prior-year quarter")

Net sales decreased 18% to $58 million in the current quarter from $71 million in the prior-year quarter. Piping systems sales decreased $8.9 million in the quarter driven by a decline in U.S. sales partially offset by an increase in sales in the Middle East. Filtration products decreased by $3.3 million due primarily to reduced demand for fabric filters.

Gross profit was $11.4 million in the current quarter down from $12.4 million in the prior-year quarter mainly due to the sales decrease in filtration products. Even with 18% less sales than the prior year quarter, gross margin increased 2 percentage points from 17.4% to 19.6%. Higher volume for both piping systems delivered by the U.A.E. facility and industrial process cooling led to the increased margin result. In response to lower demand for fabric filters and domestic piping systems, staff was reduced to match market needs. In addition, the filtration group has replaced some key management, increased marketing activities to drive sales growth and is actively sourcing lower cost but high quality materials to improve margins.

Operating expenses increased 6% to $10.8 million in the current quarter from $10.2 million in the prior-year quarter. This increase was due to start-up costs of $209 thousand for the Saudi Arabia facility, $170 thousand higher non-cash deferred compensation expense, $97 thousand for audit, tax consulting and other professional service expenses and one-time domestic severance payments partially offset by a reduction in stock-based compensation expense.

Third quarter produced net income of $0.5 million compared to net income of $0.7 million in the comparable prior-year's quarter.

Nine months ended October 31, 2012 ("YTD") vs. Nine months ended October 31, 2011 ("prior-year YTD")

YTD net sales of $163.3 million decreased 13.5% from $188.7 million in the prior-year YTD. Piping systems sales decreased $11.6 million driven by a decline in U.S. sales in the second and third quarters partially offset by an increase in sales in the Middle East. Reduced market demand for fabric filters led to a decreased $11.1 million in filtration products. Corporate and other decreased by $5.6 million partly due to customer decisions to extend project completion dates. Industrial process cooling sales increased $2.9 million as order intake continued to improve.

Despite the decrease in sales, gross margin improved by 2 percentage points to 19% of net sales YTD from 17% of net sales in the prior-year YTD. Gross profit increased significantly in piping systems due to higher volume delivered by the U.A.E. facility and strong sales in industrial process cooling while filtration products gross profit decreased due to lower demand.

General and administrative expenses increased 7% to $20.9 million YTD from $19.5 million in the prior-year YTD. The increase was due to start-up costs of $0.8 million for the Saudi Arabia facility, $0.6 million for audit, tax

consulting and other professional service expenses, higher non-cash deferred compensation expense partially offset by a reduction in stock-based compensation expense.

In July 2011, the Company recorded $1.8 million in tax expense associated with the $3.1 million repatriation of foreign earnings. These foreign earnings were previously considered to be indefinitely reinvested outside the United States. The repatriation was a one-time nonrecurring event. This tax expense included a payment of $0.5 million to the foreign tax authority and an accrual of $1.3 million U.S. tax on foreign source income. No cash was paid for this tax in the U.S. since the Company has a net operating loss carryforward.

Net loss was $3 million in 2012 compared to a net loss of $2.6 million in the comparable prior-year's period.

Piping Systems
Current quarter vs. prior-year quarter

The manufacturing facility in Dammam, Saudi Arabia opened in April 2012. Expenses aggregating $1.8 million for the third quarter relating to this start-up facility were recorded to cost of goods sold, general and administrative and selling expenses.

Net sales decreased 25% to $26.5 million in the current quarter from $35.4 million in the prior-year quarter, attributed to a decrease in sales of domestic district heating and cooling products ("DHC") and the prior-year quarter included large domestic oil and gas projects. In 2011, the oil and gas projects were underway for all of the third quarter whereas in 2012, they began later in the third quarter. Sales increased in the U.A.E.

Gross margin increased to 23% of net sales in the current quarter from 18% of net sales in the prior-year quarter. Gross profit increased due to higher volume produced at the U.A.E. facility.

Operating expenses increased by $0.3 million in the current quarter, which included one-time domestic severance payments and start-up costs for the Saudi Arabia facility.

YTD vs. prior-year YTD

YTD net sales of $69 million declined 14% from $80.7 million in the prior-year YTD attributed to a decrease in sales of DHC and the prior year included a difference in timing of large domestic oil and gas projects. In 2011, the oil and gas projects were underway for all of the third quarter whereas in 2012, they began later in the third quarter.

Gross margin rose to 21% of net sales YTD from 17% of net sales in the prior year. Gross profit increased due to higher volume produced at the U.A.E. facility. Additionally, in the first quarter, domestic DHC had increased sales and improved margins due to product mix.

General and administrative expenses increased to $7.3 million or 11% of net sales YTD from $6.8 million or 8% of net sales for the prior-year YTD, which is related to operational start-up costs for the Saudi Arabia facility.

Selling expenses decreased to $2.8 million or 4% of net sales YTD from $3.1 million or 4% of net sales for the prior-year YTD. This decrease was due to decreased commission expense due to lower sales.

Filtration Products
Current quarter vs. prior-year quarter

Net sales decreased 14% to $20.7 million from $24 million in the prior-year quarter. Sales declines were the result of lower market demand across most filtration products. Gross profit decreased 24% to $2.6 million from $3.4 million due to lower sales volume and extremely competitive market conditions. In response to lower demand for fabric filters, the Company has reduced staff to better match market needs. In addition, management has increased

marketing activities and taken other actions to drive sales growth and improve margins. Operating expenses remained level during the period.

YTD vs. prior-year YTD

YTD net sales decreased 15% to $63 million from $74 million in the prior-year period. Sales declines were the result of lower market demand across most filtration products. YTD gross profit decreased 20% to $8 million from $10 million in the prior-year period due to lower sales volume and gross margin decreased from 14% to 13%. Operating expenses remained level during the period.

Industrial Process Cooling
Current quarter vs. prior-year quarter

Net sales increased 3% to $9.2 million in the current quarter from $8.9 million in the prior-year quarter due to improving business conditions in the North American plastic and industrial market sectors. Gross margin increased to 28.4% from 27.8%. Operating expenses increased slightly in the current quarter.

YTD vs. prior-year YTD

YTD net sales of $27.2 million increased 12% from $24.3 million in the prior-year six months due to improving business conditions in the North American plastic and industrial market sectors. Gross margin increased to 27.9% from 27.4%.

General and administrative expenses increased YTD to $2.9 million from $2.6 million in the prior-year period. The change in spending was a result of additional staffing, professional costs and increased management incentive compensation expense related to improved performance partially offset by lower legal costs. General and administrative expense as a percentage of net sales was level. YTD selling expenses increased to $3.3 million from $3.0 million in the prior-year period driven by additional sales that led to higher commission expense, increased staffing after the 2011 first quarter and additional advertising expenses.

Corporate and Other
Current quarter vs. prior-year quarter

Net sales of $1.9 million in the current quarter decreased from $3 million in the prior-year quarter. Sales volume is lower than the same quarter last year.

Corporate expenses include interest expense and general and administrative expenses that are not allocated to the segments. General and administrative expenses increased to $2.2 million or 4% of consolidated net sales in the current quarter from $1.9 million or 3% of consolidated net sales in the prior-year quarter. This increase was due to $170 thousand higher deferred compensation expense, $97 thousand for audit, tax consulting and other professional service expenses partially offset by a reduction in stock-based compensation expense.

Net interest expense increased to $594 thousand in the current quarter from $395 thousand in the prior-year quarter, due to less interest income earned overseas by piping systems as this cash was primarily deployed for the Saudi Arabia facility .

YTD vs. prior-year YTD

YTD net sales of $4 million decreased from $9.5 million in the prior-year YTD partly due to customer decisions to extend project completion dates.

General and administrative expenses increased to $7.1 million or 4% of consolidated net sales YTD from $6.3 million or 3% of consolidated net sales in the prior-year YTD. This increase was due to $0.6 million for audit, tax

consulting and other professional service expenses, $149 thousand higher deferred compensation expense partially offset by a reduction in stock-based compensation expense.

YTD net interest expense increased to $1.4 million from $1 million in the prior-year YTD primarily due to less interest income earned overseas by piping systems as this cash was primarily deployed for the Saudi Arabia facility

INCOME TAXES

The Company's consolidated ETR was (8)% for the nine months ended October 31, 2012, which was affected primarily by the change in the mix of the projected tax-free earnings in the U.A.E. versus total projected earnings and losses. For additional information, see "Notes to Consolidated Financial Statements, Note 3 Income taxes".

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents as of October 31, 2012 were $5.6 million compared to $4.2 million at January 31, 2012. Cash and cash equivalents were primarily held at the foreign subsidiaries. The Company's working capital was $45 million at October 31, 2012 compared to $43 million at January 31, 2012. Net cash used in operating activities during the first nine months of 2012 was $1.6 million compared to $9.2 million during the first nine months of 2011. The Company does not believe that it will be necessary to repatriate cash held outside of the U.S.

Net cash used in investing activities for the nine months ended October 31, 2012 included $5.3 million for capital expenditures, primarily for machinery and equipment in piping systems of which $2.2 million was related to the new plant in Saudi Arabia. In February 2012, the Company loaned $1 million to its Canadian joint venture to be used mainly for capital expenditures.

Debt totaled $47.4 million at October 31, 2012, a net increase of $10 million compared to the beginning of the current fiscal year. For additional information, see "Notes to Consolidated Financial Statements, Note 9 Debt". Net cash provided by financing activities was $9.3 million.

On July 11, 2002, the Company entered into the Loan Agreement. Under the terms of the Loan Agreement as amended, which matures on November 30, 2013, the Company can borrow up to $38 million, subject to borrowing base and other requirements, under a revolving line of credit. The Loan Agreement covenants restrict debt, liens, investments, do not permit payment of dividends and require attainment of levels of profitability and cash flows. At October 31, 2012, the Company was in compliance with all covenants under the Loan Agreement. Interest rates 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 October 31, 2012, 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 0.50 and 2.75 percentage points, respectively. Monthly interest payments were made during the Nine months ended October 31, 2012 and 2011. As of October 31, 2012, the Company had borrowed $17.8 million and had $8.7 million available to it under the revolving line of credit. In addition, $0.3 million 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 domestic receipts are deposited in a bank account from which all funds may only be used to pay the debt under the Loan Agreement. At October 31, 2012, the amount of such restricted cash was $0.9 million. Cash required for operations is provided by draw downs on the line of credit.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies are described in Item 7. MD&A and in the Notes to the Consolidated Financial Statements for the year ended January 31, 2012 contained on Form 10-K/A. Any new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements have been discussed in Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q. The application of critical accounting policies may require management to make assumptions, judgments and estimates about the amounts reflected in the

Consolidated Financial Statements. Management uses historical experience and all available information to make these estimates and judgments and different amounts could be reported using different assumptions and estimates.