NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
APRIL 30, 2017
(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 Perma-Pipe International Holdings, Inc. and subsidiaries ("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, 2017
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
2017
and
2016
are for the
three months ended April 30,
2017
and
2016
, respectively.
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In February 2017, the Company announced that the board of directors had authorized Company management to move forward with the re-naming and re-branding of MFRI, Inc. under the Perma-Pipe name now that the Company operates in a single business segment under the Perma-Pipe brand, and the Company believes this decision will better serve its strategy, position it well in the industry and global market, and better reflect the Company’s mission and strategy, and positions it to leverage the strong reputation Perma-Pipe has established since beginning operations. The name change to Perma-Pipe International Holdings, Inc. was effective March 20, 2017. The Company's common stock has been and will continue to be reported under its new ticker symbol “PPIH” since March 21, 2017.
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2.
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Business segment reporting.
As of January 31, 2016, PPIH 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. For further information, see "Notes to Consolidated Financial Statements Note 3 Discontinued operations".
For the three months ended
April 30, 2017
, one customer accounted for
11%
of the Company's consolidated net sales, and for the three months ended
April 30, 2016
, one customer accounted for
15.2%
of the Company's consolidated net sales.
At
April 30, 2017
, one customer accounted for
28%
of accounts receivable. Two customers accounted for
33%
of accounts receivable at
January 31, 2017
.
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Three Months Ended April 30,
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2017
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2016
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Net sales
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Piping Systems
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$23,501
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$23,069
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Gross profit
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|
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Piping Systems
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$1,785
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$1,992
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Loss from operations
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Piping Systems
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|
($1,459
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)
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($1,701
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)
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Corporate
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($2,358
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)
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($2,804
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)
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Total loss from operations
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($3,817
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)
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($4,505
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)
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3.
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Discontinued operations.
The domestic fabric filter business, which was included in discontinued operations, was operational and selling product as of April 30, 2016. 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
$16 thousand
of tax benefit for the three months ended April 30, 2016. Loss from discontinued operations net of tax for the three months ended April 30, 2016 was as follows:
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Three Months Ended April 30,
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2017
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2016
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Net sales from discontinued operations
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$—
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$7,191
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Gain on disposal of discontinued operations
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$—
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$867
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Loss from discontinued operations
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$—
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($1,083
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)
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Loss from discontinued operations before income taxes
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—
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(216
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)
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Income tax benefit
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—
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(16
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)
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Loss from discontinued operations, net of tax
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$—
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($200
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)
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Components of assets and liabilities from discontinued operations consist of the following:
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April 30, 2017
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January 31, 2017
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Current assets
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Trade accounts receivable, net
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$—
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$25
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Total assets from discontinued operations
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$—
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$25
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Current liabilities
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Trade accounts payable, accrued expenses and other
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$201
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$199
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Total liabilities from discontinued operations
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$201
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$199
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Cash flows from discontinued operations:
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Three Months Ended April 30,
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2017
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2016
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Net cash provided by (used in) discontinued operating activities
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$25
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($1,408
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)
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Net cash used in discontinued investing activities
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—
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(1
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)
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Net cash provided by discontinued financing activities
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—
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858
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4.
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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
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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.
The Company's effective tax rate ("ETR") from continuing operations was
12%
and
4.0%
for the three months ended April 30, 2017 and 2016, respectively. The change in the ETR from the prior year to the current year was mainly due to the foreign income activity.
The amount of unrecognized tax benefits, including interest and penalties, at
April 30, 2017
, recorded in other long-term liabilities was
$0.2 million
, all of which would impact the Company’s ETR if recognized. The Company includes accrued interest and penalties related to uncertain tax positions in income tax expense, with
$1,200
included in expense for the current quarter. The amount of accrued interest and penalties at
April 30, 2017
associated with unrecognized tax benefits was
$46,800
.
The Company files income tax returns in U.S. federal and state jurisdictions.
The Internal Revenue Service, ("IRS") began an audit of the fiscal year ended January 31, 2015 in August 2016. In March 2017, the Company received an informal notice from the IRS that it had concluded the tax audit for the year ended January 31, 2015. No changes were made to the reported tax.
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5.
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Impairment of long-lived assets.
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. A factor considered important that could trigger an impairment review includes a year-to-date loss from operations. An asset is considered impaired if its carrying amount exceeds the undiscounted future net cash flow the asset is expected to generate. Piping Systems has a year-to-date loss, but based on the Company's review,
there was no impairment of long-lived assets as of April 30, 2017 or January 31, 2017
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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 April 30, 2017 and January 31, 2017 is attributable to the purchase of Perma-Pipe Canada, Ltd.
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January 31, 2017
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Foreign exchange change
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April 30, 2017
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Goodwill
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$2,279
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($97
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)
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$2,182
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In January 2017, the Financial Accounting Standards Board ("FASB") issued authoritative guidance that simplifies the assessment of goodwill for impairment when the estimated fair value of a reporting unit is less than its carrying value by eliminating the requirement to determine the fair value of goodwill. Under the new guidance, the amount of goodwill impairment will be determined by the amount the carrying value of the reporting unit exceeds its fair value. The new guidance is effective for the Company beginning January 1, 2020, with early adoption permitted. The Company adopted this new guidance in the fourth quarter of 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 to goodwill as of April 30, 2017.
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6.
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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
$2.63 million
as of
April 30, 2017
and
January 31, 2017
. Accumulated amortization was approximately
$2.39 million
and
$2.38 million
as of
April 30, 2017
and
January 31, 2017
, respectively. Full year amortizations for the next five years ending January 31 will be
$45,100
in
2018
,
$36,600
in
2019
,
$33,700
in
2020
,
$27,100
in
2021
,
$17,500
in
2022
, with the residual balance of
$92,660
to be amortized in future periods thereafter. Patents are included in other assets in the consolidated balance sheets.
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Three Months Ended April 30,
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2017
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2016
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Patent amortization expense
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$11
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$11
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7.
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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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2017
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2016
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Stock-based compensation benefit
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($6
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)
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($2
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)
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Restricted stock based compensation expense
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$192
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$390
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Stock-based compensation was a benefit due to cancellations. The decrease in the restricted stock based compensation expense relates to grants vested in January 2017.
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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2017
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2016
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Expected volatility
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43.2%
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43.4%
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Risk free interest rate
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1.2%
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1.7%
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Dividend yield
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0
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0
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Expected life
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5.0
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5.0
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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, 2017
|
524
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$11.55
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4.5
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$534
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Exercised
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(19
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)
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6.78
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23
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Expired or forfeited
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(13
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)
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11.54
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Outstanding end of period
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492
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11.73
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4.2
|
308
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Exercisable end of period
|
423
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$12.16
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3.6
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$266
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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
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Outstanding at January 31, 2017
|
74
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$9.31
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$69
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Expired or forfeited
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(5
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)
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11.81
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Outstanding end of period
|
69
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$9.14
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$42
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As of
April 30, 2017
, there was
$0.2 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, 2017
|
290
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$8.75
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$2,540
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Granted
|
5
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8.74
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Issued
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(3
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)
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Forfeited
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(2
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)
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6.92
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Outstanding end of period
|
290
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$8.03
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$2,331
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As of
April 30, 2017
, there was
$1.0 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
2.0 years
.
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Three Months Ended April 30,
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2017
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2016
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Basic weighted average common shares outstanding
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7,610
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7,351
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Dilutive effect of equity compensation plans
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—
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—
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Weighted average common shares outstanding assuming full dilution
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7,610
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7,351
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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
|
229
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|
415
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Stock options with an exercise price below the average market price
|
263
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|
263
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9.
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Interest expense, net.
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Three Months Ended April 30,
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2017
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2016
|
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Interest expense
|
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$165
|
|
|
$253
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Interest income
|
(8
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)
|
(27
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)
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Interest expense, net
|
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$157
|
|
|
$226
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10.
Debt.
Debt totaled
$13.1 million
at
April 30, 2017
, a net
increase
of
$1.3 million
since
January 31, 2017
.
Revolving lines North America
.
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, 2018
, the Company can borrow up to a combined
$15.0 million
in the U.S. and Canada, subject to borrowing base availability from secured domestic and certain Canadian assets, such as accounts receivable and inventory, and other requirements, under a revolving line of credit. The Credit Agreement covenants restrict debt, liens, share repurchases and investments, and
require attainment of specific levels of profitability and cash flows
. On
April 30, 2017
, the Company was
in compliance
with all covenants under the Credit Agreement. The North American revolving line balances as of
April 30, 2017
and January 31, 2017 were included as current liabilities in the consolidated balance sheets, because the Credit Agreement has a subjective acceleration clause.
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.
On
April 30, 2017
, the Company had borrowed
$5.8 million
at
5.25%
,
3.99%
and
3.95%
and had
$4.2 million
available to it under the revolving line of credit. In addition,
$0.2 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 had 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. Some credit arrangement covenants require a minimum tangible net worth to be maintained, including intercompany subordinated debt. In addition, some of the revolving credit facilities restrict payment of dividends. On
April 30, 2017
, the Company was
in compliance with the covenants under the credit arrangements.
On
April 30, 2017
,
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. On April 30, 2017, the Company's interest rates ranged from 3.5% to 6.0%
, and the Company could borrow
$24.6 million
under these credit arrangements. On
April 30, 2017
,
$5.5 million
of availability was used to support letters of credit to guarantee amounts committed for inventory purchases, and as there were no borrowings under these credit arrangements, an additional
$19.1 million
remained unused. The foreign revolving lines balances as of January 31, 2017 were included as current maturities of long-term debt in the consolidated balance sheets.
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11.
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Restricted cash.
Restricted cash held by foreign subsidiaries was
$1.1 million
as of
April 30, 2017
and
January 31, 2017
. Restricted cash held by foreign subsidiaries related to an escrow account from the sale of Nordic Air Filtration and fixed deposits that also serve as security deposits and guarantees.
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Three Months Ended April 30,
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2017
|
|
2016
|
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Cash and cash equivalents
|
|
$9,059
|
|
|
$12,858
|
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Restricted cash
|
1,140
|
|
944
|
|
Cash, cash equivalents and restricted cash shown in the statement of cashflows
|
|
$10,199
|
|
|
$13,802
|
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12.
Fair Value.
In relation to the acquisition of Perma-Pipe Canada, Ltd. ("PPC"), the Company estimated the fair value of the assets acquired and liabilities assumed at acquisition date. See "Notes to Consolidated Financial Statements Note 13 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, 2017
, which it classified as available-for-sale and recorded in other non-current assets on the consolidated balance sheets. 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.
|
Acquisition.
On
February 4, 2016
PPIH acquired the remaining 51% ownership of
PPC.
,
a coating and insulation company in Camrose, Alberta that serves the oil and gas industry in Western Canada
, The purchase price was $13.1 million CAD (
$9.6 million
USD) in cash and debt at closing. This transaction was accounted for under the acquisition method of accounting. The following table represents the allocation of the total consideration in the acquisition of PPC:
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Total purchase consideration:
|
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|
Cash
|
|
|
$7,587
|
|
Loan payable
|
|
2,000
|
|
Purchase consideration to third party
|
|
9,587
|
|
|
|
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Fair value of 49% previously held equity interest
|
|
7,492
|
|
Total purchase consideration
|
|
|
$17,079
|
|
|
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Fair value of net assets acquired:
|
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|
Cash and cash equivalents
|
|
|
$2,915
|
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Property and equipment
|
|
13,124
|
|
Goodwill
|
|
2,279
|
|
Net working capital
|
|
406
|
|
Other assets (liabilities) net
|
|
(1,645
|
)
|
Net assets acquired
|
|
|
$17,079
|
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The acquisition resulted in
$2.3 million
of goodwill. Goodwill is not deductible for income tax purposes. The Company incurred legal, professional and other costs related to this acquisition. These one-time costs of
$0.2 million
were recognized as general and administrative expenses.
In the first quarter of 2016, the Company recognized a non-cash loss of
$1.6 million
, which represents the difference between the pre-existing book value interest in PPC immediately prior to the acquisition remeasured to its fair value upon the acquisition date.
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14.
|
Recent accounting pronouncements
.
In October 2016, the FASB issued authoritative guidance requiring the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs rather than when transferred to a third party as required under the current guidance. The new guidance is effective for the Company beginning February 1, 2018, with early adoption permitted. The Company is currently assessing the potential impact the guidance will have upon adoption.
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In August 2016, the FASB issued Accounting Standards Update ("ASU") 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The new standard provides guidance on eight targeted areas and how they are presented and classified in the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017. The Company adopted this new guidance in the first quarter of 2017, and it did not have a material impact on the Company's operating results, financial position or cash flows.
In March 2016, the FASB issued guidance relating to the accounting for share-based payment transactions. This guidance involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classifications of awards as either equity or liabilities and classification on the statement of cash flows. The standard is effective for the Company beginning in its fiscal year 2017, including interim periods within those fiscal years, and early adoption is permitted. The Company adopted this new guidance in the first quarter of 2017, and it did not have a material impact on the Company's operating results, financial position or cash flows.
In February 2016, the FASB issued 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 May 2014, FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers ("Topic 606")", with several clarifying updates issued during 2016. This new standard will replace all current GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition guidance provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. The mandatory adoption will require new qualitative and quantitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments, information about contract balances and performance obligations, and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for the Company beginning February 1, 2018, with early adoption permitted. The new revenue standards may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company has not yet selected the transition method. The Company currently expects to adopt the new revenue standards in the first quarter of 2018.
The Company is currently evaluating the impact of adopting the standard on the Company’s financial position, results of operations, cash flows and related disclosures and has not concluded on its adoption methodology. Although it is early in the evaluation process, the Company does not expect Topic 606 to have a material impact on the financial statements, though internal processes, record keeping and disclosures may be significantly impacted. As a portion of the Company’s sales are generated from the sale of finished products to customers, these sales predominantly contain a single delivery element, and revenue is recognized at a single point in time when ownership, risks, and rewards transfer. These are largely un-affected by the new standard. The remaining sales are not believed to be material, because Topic 606 generally supports the recognition of revenue over time under the cost-to-cost method for the majority of the contracts, which is consistent with the current percentage of completion revenue recognition model.
The Company evaluated other recent accounting pronouncements and does not expect them to have a material impact on the consolidated financial statements.
15.
Reclassifications.
Reclassifications were made to the prior-year cashflow to conform to the current-year presentations which was not material to the financial statements.