Perma-Pipe International Holdings, Inc. - Quarter Report: 2019 October (Form 10-Q)

 

 

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		Three Months Ended October 31,								Nine Months Ended October 31,
		2019				2018				2019				2018
Net sales		$	34,457			$	32,806			$	95,400			$	94,020
Cost of sales			26,814				25,923				73,382				77,019
Gross profit			7,643				6,883				22,018				17,001
Operating expenses
General and administrative expenses			4,541				4,247				13,556				12,153
Selling expenses			1,354				1,554				4,030				4,017
Total operating expenses			5,895				5,801				17,586				16,170
Income from operations			1,748				1,082				4,432				831
Interest expense, net			194				280				612				830
Income from operations before income taxes			1,554				802				3,820				1
Income tax expense			1,699				934				1,747				1,525
Net (loss)/income		$	(145	)		$	(132	)		$	2,073			$	(1,524	)
Weighted average common shares outstanding
Basic			8,037				7,877				7,970				7,806
Diluted			8,037				7,877				8,047				7,806
(Loss)/income per share
Basic			(0.02	)			(0.02	)			0.26				(0.20	)
Diluted			(0.02	)			(0.02	)			0.26				(0.20	)

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		Three Months Ended October 31,								Nine Months Ended October 31,
		2019				2018				2019				2018
Net (loss)/income		$	(145	)		$	(132	)		$	2,073			$	(1,524	)
Other comprehensive income/(loss)
Foreign currency translation adjustments, net of tax			12				(551	)			53				(1,538	)
Other comprehensive income/(loss)			12				(551	)			53				(1,538	)
Comprehensive (loss)/income		$	(133	)		$	(683	)		$	2,126			$	(3,062	)

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		October 31, 2019				January 31, 2019
ASSETS
Current assets
Cash and cash equivalents		$	12,221			$	10,156
Restricted cash			1,138				2,581
Trade accounts receivable, less allowance for doubtful accounts of $355 at October 31, 2019 and $536 at January 31, 2019			28,235				32,508
Inventories, net			16,270				12,289
Prepaid expenses and other current assets			3,620				3,773
Contract assets			4,363				1,653
Total current assets			65,847				62,960
Property, plant and equipment, net of accumulated depreciation			29,357				30,398
Other assets
Operating lease right-of-use asset			11,717				-
Deferred tax assets - long-term			747				458
Goodwill			2,264				2,269
Other assets			7,518				6,120
Total other assets			22,246				8,847
Total assets		$	117,450			$	102,205
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Trade accounts payable		$	12,735			$	12,006
Accrued compensation and payroll taxes			1,675				1,544
Commissions and management incentives payable			1,600				1,866
Revolving line North America			7,758				8,890
Current maturities of long-term debt			1,644				640
Customers' deposits			3,005				3,708
Outside commissions payable			2,185				1,743
Contract liability			1,351				1,569
Operating lease liability short-term			1,130				-
Other accrued liabilities			3,234				3,856
Income taxes payable			1,352				1,266
Total current liabilities			37,669				37,088
Long-term liabilities
Long-term debt, less current maturities			6,931				6,751
Deferred compensation liabilities			3,731				3,883
Deferred tax liabilities long-term			1,434				1,435
Operating lease liability long-term			10,617				-
Other long-term liabilities			1,620				688
Total long-term liabilities			24,333				12,757
Stockholders' equity
Common stock, $.01 par value, authorized 50,000 shares; 8,042 issued and outstanding at October 31, 2019 and 7,854 issued and outstanding at January 31, 2019			80				79
Additional paid-in capital			59,754				58,793
Accumulated deficit			(1,559	)			(3,632	)
Accumulated other comprehensive loss			(2,827	)			(2,880	)
Total stockholders' equity			55,448				52,360
Total liabilities and stockholders' equity		$	117,450			$	102,205

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		Common Stock				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Loss				Total Stockholders' Equity
Total stockholders' equity at January 31, 2019		$	79			$	58,793			$	(3,632	)		$	(2,880	)		$	52,360
Net loss											(1,502	)							(1,502	)
Common stock issued under stock plans, net of shares used for tax withholding							79												79
Stock-based compensation expense							154												154
Foreign currency translation adjustment															(317	)			(317	)
Total stockholders' equity at April 30, 2019		$	79			$	59,026			$	(5,134	)		$	(3,197	)		$	50,774
Net income											3,720								3,720
Common stock issued under stock plans, net of shares used for tax withholding			1				43												44
Stock-based compensation expense							406												406
Foreign currency translation adjustment															358				358
Total stockholders' equity at July 31, 2019		$	80			$	59,475			$	(1,414	)		$	(2,839	)		$	55,302
Net loss											(145	)							(145	)
Common stock issued under stock plans, net of shares used for tax withholding							53												53
Stock-based compensation expense							226												226
Foreign currency translation adjustment															12				12
Total stockholders' equity at October 31, 2019		$	80			$	59,754			$	(1,559	)		$	(2,827	)		$	55,448

Shares		2019				2018
Balances at beginning of year			7,854,322				7,716,542
Shares issued			187,359				137,780
Balances at period end			8,041,681				7,854,322

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(In thousands)		Nine Months Ended October 31,
		2019				2018
Operating activities
Net income/(loss)		$	2,073			$	(1,524	)
Adjustments to reconcile net income/(loss) to net cash flows provided by/(used) in operating activities
Depreciation and amortization			3,349				3,482
Deferred tax (income)/expense			(288	)			346
Equity-based compensation expense			786				999
Loss on disposal of fixed assets			154				46
Provision on uncollectible accounts			49				14
Changes in operating assets and liabilities
Accounts receivable			2,960				(165	)
Inventories			(3,980	)			2,269
Contract assets and contract liabilities			(2,929	)			(1,221	)
Accounts payable			525				(5,460	)
Accrued compensation and payroll taxes			(199	)			1,468
Customers' deposits			(704	)			(1,194	)
Income taxes receivable and payable			80				54
Prepaid expenses and other current assets			1,523				(801	)
Other assets and liabilities			(601	)			1,061
Net cash provided by/(used in) operating activities			2,798				(626	)
Investing activities
Capital expenditures			(1,423	)			(885	)
Net cash used in investing activities			(1,423	)			(885	)
Financing activities
Proceeds from revolving lines			61,281				42,201
Payments of debt on revolving lines of credit			(61,613	)			(35,152	)
Debt issuance costs			-				(930	)
Payments of other debt			(276	)			(266	)
Decrease in drafts payable			(162	)			(20	)
Payments on finance lease obligations			(185	)			(205	)
Stock options exercised and restricted shares retired for tax			176				249
Net cash provided by/(used in) financing activities			(779	)			5,877
Effect of exchange rate changes on cash, cash equivalents and restricted cash			26				(569	)
Net increase in cash, cash equivalents and restricted cash			622				3,797
Cash, cash equivalents and restricted cash - beginning of period			12,737				8,321
Cash, cash equivalents and restricted cash - end of period		$	13,359			$	12,118
Supplemental cash flow information
Interest paid		$	609			$	917
Income taxes paid			1,961				1,118
Fixed assets acquired under capital leases - non-cash			848				-

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Note 1 - Basis of presentation

 

The interim consolidated financial statements of Perma-Pipe International Holdings, Inc., and subsidiaries (collectively, "PPIH", "Company", or "Registrant") are unaudited, but include all adjustments that 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, 2019 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 2019 and 2018 are for the three and nine months ended October 31, 2019 and 2018, and for the fiscal years ended January 31, 2020 and 2019, respectively.

 

Note 2 - Business segment reporting

 

The Company is engaged in the manufacture and sale of products in one segment: Piping Systems. The Company engineers, designs, manufactures and sells specialty piping systems, and leak detection systems. Specialty piping systems include: (i) insulated and jacketed district heating and cooling piping systems for efficient energy distribution from central energy plants to multiple locations, (ii) primary and secondary containment piping systems for transporting chemicals, hazardous fluids and petroleum products, and (iii) the coating and/or insulation of oil and gas gathering and transmission pipelines. The Company's leak detection systems are sold with its piping systems or 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.

 

Note 3 - Accounts receivable

 

The majority of the Company's accounts receivable are due from geographically dispersed contractors and manufacturing companies. Credit is extended based on an evaluation of a customer's financial condition, including the availability of credit insurance. In the U.S., collateral is not generally required. In the United Arab Emirates and Saudi Arabia, letters of credit are usually obtained for significant orders. Accounts receivable are due within various time periods specified in the terms applicable to the specific customer and are stated at amounts due from customers net of an allowance for claims and doubtful accounts. The allowance for doubtful accounts is based on specifically identified amounts in customers' accounts, where future collectability is deemed uncertain. Management may exercise its judgment in adjusting the provision as a consequence of known items, such as current economic factors and credit trends. Past due trade accounts receivable balances are written off when the Company's collection efforts have been unsuccessful in collecting the amount due and the amount is deemed uncollectible. The write-off is recorded against the allowance for doubtful accounts. 

 

One of the Company’s accounts receivable in the total amount of $4.7 million as of January 31, 2019 has been outstanding for several years. Included in this balance is a retention receivable amount of $3.7 million, of which, due to the long-term nature of the receivable, $3.5 million was included in the balance of other long-term assets as of October 31, 2019 and January 31, 2019.The Company completed all of its deliverables in 2015 under the related contract, and has been engaged in ongoing active efforts to collect this outstanding amount. During the first nine months of fiscal 2019 the Company received $0.5 million, thus reducing this balance to $4.2 million as of October 31, 2019. As a result, the Company did not reserve any allowance against this receivable as of October 31, 2019. The Company continues to engage with the customer to ensure full payment of open balances, and during fiscal 2019 has received an updated acknowledgment of the outstanding balances and assurances of payment from the customer. However, if the Company’s efforts to collect on this account are not successful, the Company may recognize an allowance for all, or substantially all, of any such then uncollected amounts. 

 

For the three months ended October 31, 2019, one individual customer accounted for 16% of the Company’s consolidated net sales, and during the same period in 2018, no individual customer accounted for more than 10% of the Company's consolidated net sales. For the nine months ended October 31, 2019, one customer accounted for 11% of the Company’s consolidated net sales, and during the same period in 2018, no individual customer accounted for more than 10% of the Company's consolidated net sales.

 

At October 31, 2019 and January 31, 2019, three customers collectively accounted for 29.8% and 39.4% of the Company's accounts receivable, respectively. 

 

 

 

Note 4 - Revenue recognition 

 

Revenue from contracts with customers:

 

The Company defines a contract as an agreement that has approval and commitment from both parties, defined rights and identifiable payment terms, which ensures the contract has commercial substance and that collectability is reasonably assured.

 

The Company’s standard revenue transactions are classified into two main categories:

 

1)

Systems - which include all bundled products in which the Company designs, engineers, and manufactures pre-insulated specialty piping systems, insulates subsea flowline pipe, subsea oil production equipment, and land-lines. Additionally, this systems classification also includes coating applied to pipes and structures.

 

2)

Products - which include cables, leak detection products, heat trace products sold under the PermAlert brand name, material/goods not bundled with piping or flowline systems, and field services not bundled into a project contract.

 

In accordance with ASC 606-10-25-27 through 29, the Company recognizes specialty piping and coating systems revenue over time as the manufacturing process progresses because one of the following conditions exist:

 

1)

the customer owns the material that is being insulated or coated, so the customer controls the asset and thus the work-in-process; or

 

2)

the customer controls the work-in-process due to the custom nature of the pre-insulated, fabricated system being manufactured as evidenced by the Company’s right to payment for work performed to date plus seller’s profit margin for products that have no alternative use for the Company.

 

 Products revenue is recognized when goods are shipped or services are performed (ASC 606-10-25-30).

 

A breakdown of the Company's revenues by revenue class for the three and nine months ended October 31, 2019 and 2018 are as follows:

 

 

 

The input method, as noted in ASC 606-10-55-20, is used by the U.S. operating entities to measure revenue by the costs incurred to date relative to the estimated costs to satisfy the contract using the percentage-of-completion method. Generally, these contracts are considered a single performance obligation satisfied over time and due to the custom nature of the goods and services, the percentage-of-completion method is the most faithful depiction of the Company’s performance as it measures the value of the goods and services transferred to the customer. Costs include all material, labor and direct costs incurred to satisfy the performance obligations of the contract. Revenue recognition begins when projects costs are incurred. 

 

The output method, as noted in ASC 606-10-55-17, is used by all other operating entities to measure revenue by the direct measurement of the outputs produced relative to the remaining goods promised under the contract. Due to the types of end customers, generally these contracts require formal inspection protocols or specific export documentation for units produced, or produced and shipped, therefore, the output method is the most faithful depiction of the Company’s performance. Depending on the conditions of the contract, revenue may be recognized based on units produced, inspected and held by the Company prior to shipment or on units produced, inspected and shipped. 

 

Some of the Company’s operating entities invoice and collect milestones or other contractual obligations prior to the transfer of goods and services, but do not recognize revenue until the performance obligations are satisfied under the methods discussed above. 

 

Contract modifications that occur prior to the start of the manufacturing process will supersede the original contract and revenue is recognized using the modified contract value. Contract modifications that occur during the manufacturing process (changes in scope of work, job performance, material costs, and/or final contract settlements) are recognized in the period in which the revisions are known. Provisions for losses on uncompleted contracts are made in contract liabilities account in the period such losses are identified.

Contract assets and liabilities:

Contract assets represent revenue recognized in excess of amounts billed (unbilled receivables) for contract work in progress for which the Company has a valid contract and an enforceable right to payment for work completed. Contract liabilities represent billings in excess of costs (unearned revenue) for contract work in progress for which the Company has a valid contract and an enforceable right to payment for work completed. Both customer billings and the satisfaction (or partial satisfaction) of the performance obligation(s) occur throughout the manufacturing process and impacts the period end balances in these accounts.

 

The Company anticipates that substantially all costs incurred for uncompleted contracts as of October 31, 2019 will be billed and collected within one year.

 

The following tables set forth the changes in the Company's contract assets and liabilities for the periods indicated. The Company expects to recognize the remaining balances as of October 31, 2019 within one year.

 

 

 

Practical expedients:

 

Costs to obtain a contract are not considered project costs as they are not usually incremental, nor does job duration span more than one year. The Company applies practical expedient for these types of costs and as such are expensed in the period incurred.

 

As the Company's contracts are less than one year, the Company has applied the practical expedient regarding disclosure of the aggregate amount and future timing of performance obligations that are unsatisfied or partially satisfied as of the end of the reporting period.

 

 

 

Note 5 - 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 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. 

 

The Company's effective tax rate ("ETR") from operations for the third quarter and year-to-date in fiscal 2019 was 109.3% and 45.7% compared to 116.3% and 122,166.4% during the respective prior year periods. The change in the ETR from the prior year quarter to the current year quarter is largely due to changes in the mix of income and loss in various jurisdictions. Additionally, the Company was near break-even in the prior year which resulted in a large impact on the overall rate. In the prior year the Company was accruing taxes in jurisdictions where it was generating income, while applying a valuation allowance in the U.S., which attributed to the unusually large ETR for that quarter.

 

The amount of unrecognized tax benefits, including interest and penalties at October 31, 2019, recorded in other long-term liabilities was $0.1 million, all of which would impact the Company’s ETR if recognized. 

 

The U.S. Tax Cuts and Jobs Act ("Tax Act") was enacted on December 22, 2017 and introduced significant changes to U.S. income tax law. The Tax Act reduced the U.S. statutory tax rate from 35% to 21%, effective January 1, 2018 and created new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax ("GILTI") and the base erosion anti-abuse tax, respectively. The Company currently projects a GILTI inclusion for fiscal 2019, but there is no impact on tax expense due to its offset by loss carryovers with a full valuation allowance applied against it. 

 

Note 6 - Impairment of long-lived assets

 

The Company's assessment of long-lived assets, and other identifiable intangibles is based upon factors that market participants would use in accordance with the accounting guidance for the fair value measurement of assets. The Company will continue testing for potential impairment at least annually or as otherwise required by applicable accounting standards. There was no impairment of long-lived assets for the three and nine months ended October 31, 2019 and 2018.

 

Goodwill. The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business with the residual of the purchase price recorded as goodwill. All identifiable goodwill as of October 31, 2019 and January 31, 2019 was attributable to the purchase of Perma-Pipe Canada, Ltd., which occurred in 2016.

 

 

The Company performs an impairment assessment of goodwill annually as of January 31, or more frequently if triggering events occur, based on the estimated fair value of the related reporting unit or intangible asset. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. There was no impairment of goodwill for the three and nine months ended October 31, 2019 and 2018.

 

 

 

Note 7 - Stock-based compensation 

 

The Company’s 2017 Omnibus Stock Incentive Plan dated June 13, 2017, as amended, which the Company's stockholders approved in June 2017 ("2017 Plan"), is the only incentive stock plan under which new equity incentive awards may be granted.

 

The Company has prior incentive plans under which previously granted awards remain outstanding, but under which no new awards may be granted. At October 31, 2019 the Company had reserved a total of 694,989 shares for grants and issuances under these incentive stock plans, which includes a reserve for issuances pursuant to unvested or unexercised prior awards, and shares for new grants or issuances pursuant to the 2017 Plan.

 

While the 2017 Plan provides for the grant of deferred shares, non-qualified stock options, incentive stock options, restricted shares, restricted stock units, and performance-based restricted stock units intended to qualify under section 422 of the Internal Revenue Code, to date the Company has issued only restricted shares and restricted stock units under the 2017 Plan and currently intends to continue this practice. The 2017 Plan authorizes awards to officers, employees, consultants and independent directors.

 

The Company has stock-based compensation awards that can be granted to eligible employees, officers or independent directors. The following is the stock-based compensation expense:

 

 

Stock Options

 

The Company did not grant any stock options during the three or nine months ended October 31, 2019. The following tables summarizes the Company's stock option activity:

 

 

The Company received approximately $0.3 million during the nine months ended October 31, 2019 for stock options exercised. 

 

 

 

As of October 31, 2019, there was less than $0.1 million of total unrecognized compensation expense related to unvested stock options. The expense is expected to be recognized over a weighted average period of 0.6 years.

 

Restricted stock

 

The following table summarizes the Company's restricted stock activity for the first nine months of fiscal 2019:

 

 

As of October 31, 2019, there was $1.7 million of unrecognized compensation expense related to unvested restricted stock granted under the plans. That cost is expected to be recognized over a weighted average period of 2.3 years.

 

Note 8 - Earnings per share

 

 

 

 

 

Note 9 - Debt

 

Debt totaled $16.3 million at October 31, 2019 and January 31, 2019, respectively.

 

Revolving lines North America. On September 20, 2018, the Company and certain of its U.S. and Canadian subsidiaries (collectively, together with the Company, the “North American Loan Parties”) entered into a Revolving Credit and Security Agreement (the “Credit Agreement”) with PNC Bank, National Association, as administrative agent and lender (“PNC”), providing for a three-year $18 million Senior Secured Revolving Credit Facility, subject to a borrowing base including various reserves (the “Senior Credit Facility”). The Senior Credit Facility replaced the Company’s then existing $15 million Credit and Security Agreement, dated September 24, 2014, among various subsidiaries of the Company and Bank of Montreal, as successor by assignment to BMO Harris Bank N.A., as amended (the “Prior Credit Agreement”).

 

The Company initially used borrowings under the Senior Credit Facility to pay off outstanding amounts under the Prior Credit Agreement (which totaled approximately USD $3,773,823 plus CAD 4,794,528) and a cash collateralized letter of credit (USD $154,500). The Company has used proceeds from the Senior Credit Facility for on-going working capital needs, and expects to continue using this facility to fund future capital expenditures, working capital needs and other corporate purposes. Borrowings under the Senior Credit Facility bear interest at a rate equal to an alternate base rate or London Interbank Offered Rate ("LIBOR"), plus, in each case, an applicable margin.  The applicable margin is based on average quarterly undrawn availability with respect to the Senior Credit Facility.  Interest on alternate base rate borrowings are generally payable monthly in arrears and interest on LIBOR borrowings are generally payable in arrears on the last day of each interest period.  Additionally, the Company is required to pay a 0.375% per annum facility fee on the unused portion of the Senior Credit Facility.  The facility fee is payable quarterly in arrears.

 

Subject to certain exceptions, borrowings under the Senior Credit Facility are secured by substantially all of the assets of the Company and certain of the assets of its North American subsidiaries. The North American Loan Parties’ obligations under the Senior Credit Facility are guaranteed by Perma-Pipe Canada, Inc. The Senior Credit Facility will mature on September 20, 2021. Subject to certain qualifications and exceptions, the Senior Credit Facility contains covenants that, among other things, restrict the North American Loan Parties’ ability to create liens, merge or consolidate, consummate acquisitions, make investments, dispose of assets, incur debt, and pay dividends and other distributions. In addition, the North American Loan Parties cannot allow capital expenditures to exceed $3.0 million annually (plus a limited carryover of unused amounts).

 

The Senior Credit Facility also contains financial covenants requiring (i) the North America Loan Parties to achieve a ratio of their EBITDA (with certain additional adjustments) to the sum of scheduled cash principal payments on indebtedness for borrowed money and interest payments on the advances under the Senior Credit Facility (excluding from the calculation items related to the financial performance of the Company’s foreign subsidiaries not party to the Credit Agreement) to be not less than 1.10 to 1.00 for the nine-month period ending April 30, 2019 and for the quarter ending July 31, 2019 and each quarter end thereafter on a trailing four-quarter basis; and (ii) the Company and its subsidiaries (including the Company’s foreign subsidiaries not party to the Credit Agreement) to achieve a ratio of their EBITDA (with certain additional adjustments) to the sum of scheduled cash principal payments on indebtedness for borrowed money and interest payments on the advances under the Senior Credit Facility of not less than 1.10 to 1.00 for each quarter end on a trailing four-quarter basis. The Company was in compliance with these requirements as of October 31, 2019. 

 

The Senior Credit Facility contains customary events of default. If an event of default occurs and is continuing, then PNC may terminate all commitments to extend further credit and declare all amounts outstanding under the Senior Credit Facility due and payable immediately. In addition, if any of the North American Loan Parties or certain of their subsidiaries become the subject of voluntary or involuntary proceedings under any bankruptcy, insolvency or similar law, then any outstanding obligations under the Senior Credit Facility will automatically become immediately due and payable. Borrowings under the Senior Credit Facility will bear interest at a rate of 2.00% per annum in excess of the otherwise applicable rate while a bankruptcy event of default exists or, upon the lenders’ request, during the continuance of any other event of default.

 

 

As of October 31, 2019, the Company had borrowed an aggregate of $7.8 million at a rate of 7.75%, 5.80%, and 5.94% resulting in a weighted average rate of 6.01% and had $4.9 million available under the Senior Credit Facility. 

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, including maintaining certain levels of intercompany subordinated debt. In addition, some of the revolving credit facilities restrict payment of dividends. On October 31, 2019 the Company was in compliance with the covenants under the credit arrangements. On October 31, 2019, interest rates were based on the Emirates Inter Bank Offered Rate (EIBOR) plus 3.5% per annum, with a minimum interest rate of 4.5% per annum. On October 31, 2019, the Company's interest rates ranged from 5.4% to 5.9%, with a weighted average rate of 5.74%, and the Company could borrow $9.0 million under these credit arrangements. On October 31, 2019, $5.2 million of availability was used to support letters of credit to guarantee amounts committed for inventory purchases and for performance guarantees. On October 31, 2019, the Company had borrowed $0.9 million, and had an additional $2.9 million of borrowing remaining available. The foreign revolving lines balances as of October 31, 2019 and January 31, 2019, were included as current maturities of long-term debt in the Company's consolidated balance sheets. 

Mortgages. On July 28, 2016, the Company borrowed CAD 8.0 million (approximately USD $6.1 million at the prevailing exchange rate on the transaction date) from a bank in Canada under a mortgage note secured by the Company's manufacturing facility located in Alberta, Canada that matures on December 23, 2042. The interest rate is variable, currently at 6.05%, with monthly payments of CAD 37 thousand (approximately USD $28 thousand) for interest; and monthly payments of CAD 27 thousand (approximately USD $20 thousand) for principal. Principal payments began January 2018.

On June 19, 2012, the Company borrowed $1.8 million under a mortgage note secured by its manufacturing facility in Lebanon, Tennessee. The proceeds were used for payment of amounts borrowed. The loan bears interest at 4.5% with monthly payments of $13 thousand for both principal and interest and matures July 1, 2027. On June 19, 2022, and on the same day of each year thereafter, the interest rate shall adjust to the prime rate, provided that the applicable interest rate shall not adjust more than 2.0% per annum and shall be subject to a ceiling of 18.0% and a floor of 4.5%.

 

 

 

Note 10 - Leases

 

Effective February 1, 2019, the Company accounts for its leases under ASC 842, Leases.  Under this guidance, arrangements meeting the definition of a lease are classified as operating or financing leases, and are recorded on the consolidated balance sheet. Operating leases are included in operating lease right-of-use (“ROU”) assets, operating lease liabilities short-term, and operating lease liabilities long-term in the Company's consolidated balance sheets. Finance leases are included in property, plant and equipment, current maturities of long-term debt, and long-term debt less current maturities in the Company's consolidated balance sheets. 

 

ROU assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make lease payments arising from the lease calculated by discounting fixed lease payments over the lease term at the rate implicit in the lease or the Company’s incremental borrowing rate.  Lease liabilities are increased by interest and reduced by payments each period, and the ROU asset is amortized over the lease term.  For operating leases, interest on the lease liability and the amortization of the ROU asset result in straight-line rent expense over the lease term.  For finance leases, interest on the lease liability and the amortization of the ROU asset results in front-loaded expense over the lease term.  Variable lease expenses are recorded when incurred. ROU assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term.

 

As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term and amount equal to the lease payments in a similar economic environment.

 

In calculating the ROU asset and lease liability, the Company elects to combine lease and non-lease components.  The Company excludes short-term leases having initial terms of 12 months or less from the new guidance as an accounting policy election, and recognizes rent expense on a straight-line basis over the lease term. 

 

The Company continues to account for leases in the prior period financial statements under ASC Topic 840.

 

Finance Leases. In 2017, the Company obtained three finance leases for CAD 1.1 million (approximately USD $0.8 million at the prevailing exchange rates on the transaction dates) to finance vehicle equipment. The interest rates for these finance leases range from 4.0% to 7.8% per annum with monthly principal and interest payments of less than $0.1 million. These leases mature between April 2021 to September 2022.

 

In 2019, the Company obtained two finance leases for CAD 1.1 million (approximately USD $0.8 million at the prevailing exchange rates on the transaction dates) to finance vehicle equipment. The interest rates for these finance leases were 8.0% per annum with monthly principal and interest payments of less than $0.1 million. These leases mature in August 2023. 

 

In August 2016, the Company obtained a finance lease for 0.6 million Indian Rupees (approximately USD $8 thousand at the prevailing exchange rate on the transaction date) to finance vehicle equipment. The interest rate for this finance lease was 15.6% per annum with monthly principal and interest payments of less than USD $1 thousand. This lease expired in July 2019. 

 

The Company has several significant operating lease agreements, with lease terms of one to 14 years, which consist of real estate, vehicles and office equipment leases. These leases do not require any contingent rental payments, impose any financial restrictions or contain any residual value guarantees.  Certain of the Company’s leases include renewal options and escalation clauses; renewal options have not been included in the calculation of the lease liabilities and ROU assets as the Company is not reasonably certain to exercise the options.  Variable expenses generally represent the Company’s share of the landlord’s operating expenses.  The Company does not have any arrangements where it acts as a lessor, other than one sub-lease arrangement. 

 

At October 31, 2019, the Company had operating lease liabilities of $11.7 million and operating ROU assets of $11.7 million, which are reflected in the consolidated balance sheet. At October 31, 2019, the Company also had finance lease liabilities of $1.2 million included in current maturities of long-term debt and long-term debt less current maturities, and finance ROU assets of $1.2 million which were included in property plant and equipment, net of accumulated depreciation in the consolidated balance sheet.

 

 

Supplemental balance sheet information related to leases is as follows: 

 

 

Total lease costs consist of the following: 

 

 

(1) Includes variable lease costs, which are immaterial

 

 

Supplemental cash flow information related to leases is as follows:

 

 

 

Weighted-average lease terms and discount rates are as follows: 

 

 

Maturities of lease liabilities as of October 31, 2019, are as follows:

 

 

Rent expense on operating leases, which is recorded on straight-line basis, was $0.7 million for the three months ended October 31, 2019 and 2018, and $2.0 million for the nine months ended October 31, 2019 and 2018, respectively. 

 

 

Note 11 - Restricted cash

 

Restricted cash held by foreign subsidiaries was $1.1 million for both October 31, 2019 and January 31, 2019 and is related to fixed deposits that also serve as security deposits and guarantees. 

 

 

 

Note 12 - Fair value

 

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 market rates.

 

Note 13 - Recent accounting pronouncements

 

In February 2016, the FASB issued Accounting Standard 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 adoption of this ASU using the alternative transition approach resulted in the recognition of operating lease ROU assets, net of deferred rent of $10.7 million and lease liability for operating leases of $11.0 million as of February 1, 2019. The Company accounts for existing finance lease assets and liabilities in the same way under the new standard.  Adoption of this ASU did not have an effect on retained earnings. The Company availed itself of the practical expedients provided under this ASU and its subsequent amendments regarding identification of leases, lease classification, indirect costs and the combination of lease and non-lease components. The Company continues to account for leases in the prior period financials statements under ASC Topic 840.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The new guidance affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. A recently adopted amendment has delayed the effective date until fiscal years beginning after December 15, 2022. The Company is currently evaluating this standard and the impact to the financial statements of the Company. 

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits entities to reclassify the disproportionate income tax effects of the Tax Act on items within accumulated other comprehensive income/(loss) to reinvested earnings. These disproportionate income tax effect items are referred to as "stranded tax effects." The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income from continuing operations is not affected by this update. The Company adopted ASU 2018-02 effective February 1, 2019 and has elected to not reclassify any amounts to retained earnings. Under the Company's existing policy, any existing stranded tax effects will be eliminated when the underlying circumstances upon which it was premised cease to exist.   

 

The Company evaluated other recent accounting pronouncements and does not expect them to have a material impact on its consolidated financial statements or related disclosures.

 

 

 

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