NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
APRIL 30, 2016
(Tabular amounts presented in thousands, except per share amounts)
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1.
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Basis of presentation.
The interim consolidated financial statements of MFRI, Inc. and subsidiaries ("MFRI," "Company," or "Registrant") are unaudited, but include all adjustments which the Company's management considers necessary to present fairly the financial position and results of operations for the periods presented. These adjustments consist of normal recurring adjustments. Information and footnote disclosures have been omitted pursuant to Securities and Exchange Commission ("SEC") rules and regulations. The consolidated balance sheet as of
January 31, 2016
is derived from the audited consolidated balance sheet as of that date. The results of operations for any interim period are not necessarily indicative of future or annual results. Interim financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's latest Annual Report on Form 10-K. The Company's fiscal year ends on January 31. Years and balances described as
2016
and
2015
are for the
three months ended April 30,
2016
and
2015
, respectively.
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2.
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Business segment reporting.
As of January 31, 2016, MFRI is engaged in the manufacture and sale of products in
one
segment: Piping Systems. As described below, prior to January 29, 2016, the Company was also engaged in the manufacture and sale of products in the Filtration Products segment.
Piping Systems engineers, designs, manufactures and sells specialty piping, leak detection and location systems
. This segment'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 and long lines for oil and mineral transportation. Piping Systems' leak detection and location systems are sold with 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.
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Prior to January 29, 2016, the Company had a Filtration Products segment. This business is reported as discontinued operations in the consolidated financial statements and the notes to consolidated financial statements have been restated to conform to the current year reporting of this business. For further information, see "Notes to Consolidated Financial Statements Note 4 Discontinued operations".
For the
three
months ended
April 30, 2016
, one customer accounted for
15%
of the Company's consolidated net sales, and for the
three
months ended
April 30, 2015
, one customer accounted for
11%
of the Company's consolidated net sales.
At
April 30, 2016
, two customers accounted for
28%
of accounts receivable. Two customers accounted for
46%
of accounts receivable at
January 31, 2016
.
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Three Months Ended April 30,
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2016
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2015
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Net sales
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Piping Systems
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$23,069
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$20,277
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Gross profit
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Piping Systems
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$1,992
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$2,355
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Loss from operations
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Piping Systems
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|
($1,701
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)
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($1,426
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)
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Corporate
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($2,804
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)
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($2,144
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)
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Total loss from operations
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|
($4,505
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)
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($3,570
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)
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3.
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Acquisition.
MFRI entered into a purchase agreement with its joint venture partner Aegion Corporation to acquire the remaining 51% ownership of
Bayou Perma-Pipe Canada, Ltd
. ("BPPC"),
a coating and insulation company in Camrose, Alberta
, which acquisition closed on
February 4, 2016
. MFRI had owned a
49%
interest in BPPC since 2009, when the joint venture was formed with Aegion to serve the oil and gas industry in Western Canada.
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The purchase price was $13.1 million CAD (
$9.6 million
USD) in cash and debt at closing and is subject to certain post-closing adjustments. The initial accounting for this acquisition is not complete pending detailed analyses of the facts and circumstances that existed as of the acquisition date. The following table represents the preliminary allocation of the total consideration in the acquisition of BPPC:
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Total purchase consideration:
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Cash
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$7,587
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Loan payable
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2,000
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Purchase consideration to third party
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9,587
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Fair Value of 49% Previously Held Equity Interest
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7,492
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Total purchase consideration
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$17,079
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Fair value of net assets acquired:
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Cash and cash equivalents
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$2,915
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Property and equipment
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12,670
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Goodwill
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2,693
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Net working capital
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406
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Other assets (liabilities) net
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(1,605
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)
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Net assets acquired
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$17,079
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The acquisition has preliminarily resulted in approximately
$2.7 million
of goodwill. The Company incurred legal, professional and other costs related to this acquisition. These costs were recognized as general and administrative expenses.
In the quarter, the Company recognized a non-cash loss of
$1.6 million
which represents the difference between the pre-existing book value interest in BPPC immediately prior to the acquisition remeasured to its fair value upon the acquisition date.
Pro Forma results
- The following table summarizes, on a pro forma basis, the combined results of operations of the Company and the acquired business as though the acquisition had occurred as of February 1, 2015. The pro forma amounts presented are not necessarily indicative of either the actual consolidated results had the acquisition occurred as of February 1, 2015, or of future consolidated operating results.
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Three Months Ended April 30,
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2016
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2015
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Revenue
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$23,069
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$26,544
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Net loss
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(6,294
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)
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(3,923
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)
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Loss per share basic and diluted
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($0.86
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)
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($0.54
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)
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Pro forma results presented above primarily reflect revenues that were down due to the effect of oil prices on customer demand in the U.S. and Canada and on certain market conditions in the Middle East. Pro forma
adjustments described above have been tax effected using the Company's effective rate during the respective periods.
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4.
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Discontinued operations.
On
January 29, 2016
, the Company sold certain assets and liabilities of its TDC Filter business based in Bolingbrook, Illinois to the Industrial Air division of CLARCOR. On January 29, 2016, the Company also sold its Nordic Air Filtration, Denmark and Nordic Air Filtration, Middle East businesses to Hengst Holding GmbH. The purchase price of these Illinois and international filtration businesses was
$22.0 million
, including cash proceeds of
$18.4 million
, of which
$0.5 million
is held in escrow until July 2017. The remaining domestic fabric filter business, which is included in discontinued operations, is operational and selling product as of April 30, 2016. The Company is currently engaged in liquidating the assets of this business. The Filtration business segment is reported as discontinued operations in the consolidated financial statements and the notes to consolidated financial statements have been revised to conform to the current year reporting. There was
$16 thousand
of tax benefit for the
three
months ended
April 30, 2016
. Loss from discontinued operations net of tax for the
three months ended April 30,
2016 and 2015
were as follows:
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Three Months Ended April 30,
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2016
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2015
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Net sales
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$7,191
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$17,397
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Gain on disposal of discontinued operations
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$867
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$—
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Loss from discontinued operations
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($1,083
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)
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($1,303
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)
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Loss from discontinued operations before income taxes
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(216
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)
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(1,303
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)
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Income tax benefit
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(16
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)
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—
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Loss from discontinued operations, net of tax
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($200
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)
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($1,303
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)
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Components of assets, and liabilities from discontinued operations consist of the following:
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April 30, 2016
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January 31, 2016
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Current assets
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Cash and cash equivalents
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$—
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$5
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Trade accounts receivable, net
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4,998
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5,720
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Inventories, net
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1,939
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2,000
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Other assets
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1,565
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1,552
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Property, plant and equipment, net of accumulated depreciation
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6,369
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6,456
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Total assets from discontinued operations
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$14,871
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$15,733
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Current liabilities
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Trade accounts payable, accrued expenses and other
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$5,356
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$7,514
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Current maturities of long-term debt
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4,447
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5,322
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Other liabilities
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2,629
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2,629
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Total liabilities from discontinued operations
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$12,432
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$15,465
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Cashflows from discontinued operations:
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Three Months Ended April 30,
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2016
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2015
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Net cash used in discontinued operating activities
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($1,408
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)
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($1,568
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)
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Net cash used in discontinued investing activities
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(1
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)
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(383
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)
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Net cash provided by discontinued financing activities
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858
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1,666
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5.
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Income taxes.
The determination of the consolidated provision for income taxes, deferred tax assets and liabilities and related valuation allowances requires management to make judgments and estimates. As a company with subsidiaries in foreign jurisdictions, the process of calculating income taxes involves estimating current tax obligations and exposures in each jurisdiction as well as making judgments regarding the future recoverability of deferred tax assets. Income earned in the United Arab Emirates ("U.A.E.") is not subject to local country income tax. Additionally, the relative proportion of taxable income earned domestically versus internationally can fluctuate significantly from period to period. Changes in the estimated level of annual pre-tax income, tax laws and the results of tax audits can affect the overall effective income tax rate, which impacts the level of income tax expense and net income. Judgments and estimates related to the Company's projections and assumptions are inherently uncertain; therefore, actual results could differ materially from projections.
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The Company's consolidated effective tax rate ("ETR") from continuing operations was
4.1%
and
(0.8)%
for the
three months ended April 30,
2016
and
2015
, respectively. The change in the ETR from the prior year to the current year is mainly due to the addition of the Canadian activity.
The amount of unrecognized tax benefits, including interest and penalties, at
April 30, 2016
, recorded in other long-term liabilities was
$0.1 million
, all of which would impact the Company’s effective tax rate if recognized. The Company includes accrued interest and penalties related to uncertain tax positions in income tax expense, with
$1 thousand
included in expense for the current quarter. The amount of accrued interest and penalties at
April 30, 2016
, associated with unrecognized tax benefits was
$46 thousand
.
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6.
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Impairment of long-lived assets and assets held for sale.
The Company evaluates long-lived assets (including intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. An asset is considered impaired if its carrying amount exceeds the undiscounted future net cash flow the asset is expected to generate.
There was no impairment of long-lived assets as of April 30, 2016 and January 31, 2016
.
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The Company's former headquarters in Niles, Illinois is presented as held for sale at fair market value as of
April 30, 2016
. There are no indications of impairment related to these assets.
Goodwill.
Goodwill represents the excess of purchase price over the fair value of the net assets acquired in conjunction with the Company’s acquisition of BPPC.
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7.
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Other intangible assets with definite lives.
The Company owns several patents, including those covering features of its piping and electronic leak detection systems.
Patents are capitalized and amortized on a straight-line basis over a period not to exceed the legal lives of the patents.
The Company expenses costs incurred to renew or extend the term of intangible assets
. Gross patents were
$2.60 million
and
$2.59 million
as of
April 30, 2016
and
January 31, 2016
, respectively. Accumulated amortization was approximately
$2.35 million
and
$2.33 million
as of
April 30, 2016
and
January 31, 2016
, respectively. Future amortizations over the next five years ending January 31 will be
$34,929
in
2017
,
$41,100
in
2018
,
$32,100
in
2019
,
$29,100
in
2020
,
$22,850
in
2021
, and
$92,850
thereafter. Patents are included in other assets in the balance sheet.
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Three Months Ended April 30,
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2016
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2015
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Patent amortization expense
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$11
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$13
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8.
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Stock-based
compensation.
The Company has stock-based compensation awards that can be granted to eligible employees, officers or directors.
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Three Months Ended April 30,
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2016
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2015
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Stock-based compensation (benefit) expense
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($2
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)
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$59
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Restricted stock based compensation expense
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$390
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$89
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Stock-based compensation for 2016 was a benefit year-to-date due to cancellations. Most of these cancellations related to former employees from the Company's discontinued operations. The increase in the restricted stock based compensation expense relates to a grant in March 2016 and the conversion of performance restricted stock units to time-based restricted shares. This increase is partially offset by a decrease in management incentive compensation expense.
Stock Options
The fair value of the outstanding option awards was estimated on the grant dates using the Black-Scholes option pricing model.
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Three Months Ended April 30,
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Fair value assumptions
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2016
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2015
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Expected volatility
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40.88% - 57.02%
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40.88% - 59.39%
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Risk free interest rate
|
.74% - 1.77%
|
.74% - 1.77%
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Dividend yield
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none
|
none
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Expected life
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5.0 - 5.1 years
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4.9 - 5.1 years
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Option activity
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Options
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Weighted Average Exercise Price
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Weighted Average Remaining Contractual Term
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Aggregate Intrinsic Value
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Outstanding at January 31, 2016
|
720
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$11.38
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5.1
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$34
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Expired or forfeited
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(42
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)
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9.63
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Outstanding end of period
|
678
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|
11.49
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4.7
|
118
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Exercisable end of period
|
535
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|
$12.00
|
|
3.9
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|
$92
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Unvested option activity
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Options
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Weighted Average Grant Date Fair Value
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Aggregate Intrinsic Value
|
Outstanding at January 31, 2016
|
166
|
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|
$9.51
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$—
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Vested
|
(2
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)
|
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Expired or forfeited
|
(21
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)
|
9.07
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Outstanding end of period
|
143
|
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|
$9.57
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|
$—
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As of
April 30, 2016
, there was
$0.4 million
of total unrecognized compensation expense related to unvested stock options. The expense is expected to be recognized over a period of
1.8
years.
Restricted stock
The following table summarizes restricted stock activity for the year:
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Restricted stock activity
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Restricted Shares
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Weighted Average Grant Price Per Share
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Aggregate Intrinsic Value
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Outstanding at January 31, 2016
|
163
|
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$8.60
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$1,040
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Granted
|
90
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|
7.25
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Issued
|
(10
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)
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Forfeited
|
(1
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)
|
6.38
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Outstanding end of period
|
242
|
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|
$8.17
|
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|
$1,686
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As of
April 30, 2016
, there was
$0.8 million
of unrecognized compensation expense related to unvested restricted stock granted under the plans. The cost is expected to be recognized over the weighted-average period of
2.4 years
.
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Three Months Ended April 30,
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2016
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2015
|
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Basic weighted average common shares outstanding
|
7,351
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|
7,252
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Dilutive effect of equity compensation plans
|
—
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|
—
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Weighted average common shares outstanding assuming full dilution
|
7,351
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7,252
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Stock options not included in the computation of diluted earnings per share of common stock because the option exercise prices exceeded the average market prices of the common shares
|
415
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|
643
|
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Stock options with an exercise price below the average market price
|
263
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|
106
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10.
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Interest expense, net.
|
|
|
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Three Months Ended April 30,
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2016
|
|
2015
|
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Interest expense
|
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$253
|
|
|
$196
|
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Interest income
|
(27
|
)
|
(275
|
)
|
Interest expense (income), net
|
|
$226
|
|
|
($79
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)
|
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11.
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Debt.
Debt totaled
$15.3 million
at
April 30, 2016
, a net
decrease
of
$0.2 million
since
January 31, 2016
.
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Revolving lines domestic
.
On September 24, 2014, the Company entered into a Credit and Security Agreement with a financial institution as amended, ("Credit Agreement"). Under the terms of the Credit Agreement, which matures on
September 24, 2019
, the Company can borrow up to
$15.0 million
, subject to borrowing base availability from secured domestic assets and other requirements, under a revolving line of credit. The Loan Agreement covenants restrict debt, liens, and investments, and
require attainment of specific levels of profitability and cash flows
. At
April 30, 2016
, the Company was
in compliance
with loan covenants. The domestic revolving line balance as of January 31, 2016 and
April 30, 2016
was included as a current liability on the consolidated balance sheets.
Interest rates vary based on the average availability in the preceding fiscal quarter and are:
(a) a margin in effect plus a base rate, if below certain availability limits; or (b) a margin in effect plus the Eurodollar rate for the corresponding interest period.
As of
April 30, 2016
, the Company had borrowed
$7.2 million
at
3.5%
and
2.19%
and had
$5.6 million
available to it under the revolving line of credit. In addition,
$0.3 million
of availability was used under the Credit Agreement primarily to support letters of credit to guarantee amounts committed for inventory purchases. Cash required for operations, as needed, is provided by draw downs on the line of credit.
Revolving lines foreign
.
The Company also has credit arrangements used by its Middle Eastern subsidiaries. These credit arrangements are in the form of overdraft facilities and project financing at rates competitive in the countries in which the Company operates. The lines are secured by
certain equipment, certain assets, such as accounts receivable and inventory, and a guarantee by the Company
.
Some credit arrangement covenants require a minimum tangible net worth to be maintained
. At
April 30, 2016
, the Company was
in compliance with the covenants under the credit arrangements.
At
April 30, 2016
,
interest rates were 4.0% per annum below National Bank of Fujairah Base Rate, minimum 3.5% per annum, and Emirates Inter Bank Offered Rate (EIBOR) plus 3.5% per annum. At April 30, 2016, the Company's interest rates range from 3.5% to 6.0%
. At
April 30, 2016
, the Company had available borrowing capacity of
$43.8 million
under these credit arrangements. In addition,
$7.4 million
of availability was used to support letters of credit to guarantee amounts committed for inventory purchases. At
April 30, 2016
, borrowings under these credit arrangements totaled
$1.7 million
; an additional
$34.7 million
remained unused. The foreign revolving lines balance as of January 31, 2016 and
April 30, 2016
were included as a current liability on the consolidated balance sheets.
On February 1, 2016, the Company entered into a promissory note with United Pipeline Systems Limited, an affiliate of Aegion, Inc. for
$2.0 million
. The promissory note b
ears interest at prime, which was 3.25% at April 30, 2016, plus 5%
and matures on
August 1, 2016
.
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12.
|
Fair Value.
In relation to the acquisition of BPPC, the Company estimated the fair value of the assets acquired and liabilities assumed at acquisition date. See "Notes to Consolidated Financial Statements Note 3 Acquisition", for a further discussion of this purchase. 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 amount of the Company's short-term debt, revolving line of credit and long-term debt approximate fair value because the majority of the amounts outstanding accrue interest at variable rates.
|
The Company held a marketable equity security of approximately
$0.1 million
at
April 30, 2016
, which it classified as available-for-sale and recorded in other non-current assets on the Consolidated Balance Sheet. This security is carried at estimated fair value with unrealized gains and losses reflected in Accumulated Other Comprehensive Income and classified as Level 1 in the fair value hierarchy. The assessment for impairment of marketable equity securities as available-for sale is based on established financial methodologies, including quoted market prices for publicly traded securities. If the Company determines that a loss in the value of the investment is other than temporary, any such losses are recorded in other expense (income), net.
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13.
|
Recent accounting pronouncements
.
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). This ASU requires entities to recognize assets and liabilities for most leases on their balance sheets. It also requires additional qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU No. 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect that this standard will have on the consolidated financial statements and related disclosures.
|
In April 2015, the FASB issued authoritative guidance to simplify the balance sheet presentation of debt issuance costs. Under the new guidance, debt issuance costs is presented as a reduction of the carrying amount
of the debt liability. The guidance was effective for the Company beginning February 1, 2016 and was applied retrospectively for all periods presented. The Company adopted this guidance and it did not have a material impact on the Company's financial statements.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40) - Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. The adoption of ASU 2014-15 is not expected to have an impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This new standard provides for a single comprehensive model and supersedes most current revenue recognition guidance, including industry specific guidance, and provides for enhanced disclosure requirements. The objective of the new guidance is to improve the consistency, comparability and usefulness to users of financial statements. On April 1, 2015, FASB decided to defer the effective date of the new revenue standard by one year. As a result, public entities would apply the new revenue standard for fiscal years, and interim periods within those years, beginning after December 15, 2017. ASU 2014-09 provides for two implementation methods (1) full retrospective application to each prior period or (2) modified retrospective application with the cumulative effect as of the date of adoption. The Company is evaluating the financial statement impacts of the guidance in this ASU and determining which transition method will be utilized.
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|
14.
|
Reclassifications.
Reclassifications were made to the prior-year statement of cashflow to conform to the current-year presentations.
|
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|
15.
|
Subsequent events
.
In May, 2016, the Company completed the sale of its former corporate headquarters, land and building, to a third party at a purchase price of
$4.4 million
. The sale generated approximately
$0.4 million
in net cash after expenses and mortgage payoffs.
|
In May, 2016, the Company also completed the sale of its Bolingbrook Filtration facility to a third party at a purchase price of
$7.1 million
. The sale generated approximately
$1.9 million
in net cash after expenses and mortgage payoffs.