Perma-Pipe International Holdings, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ( " MD&A " )   The statements contained under the caption MD&A and other information contained elsewhere in this quarterly report, which can be identified by the use of forward-looking terminology such as "may," "will," "expect," "continue," "remains," "intend," "aim," "should," "prospects," "could," "future," "potential," "believes," "plans," "likely" and "probable" or the negative thereof or other variations thereon or comparable terminology, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbors created thereby. These statements should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment. Such risks and uncertainties could cause actual results to differ materially from those projected as a result of many factors, including, but not limited to, those under the heading Item 1A. Risk Factors included in the Company's latest Annual Report on Form 10-K. The Company's fiscal year ends on January 31. Years and balances described as 2023 and 2022 are for the fiscal year ending January 31, 2024 and the fiscal year ended January 31, 2023, respectively.   This MD&A should be read in conjunction with the Company’s consolidated financial statements, including the notes thereto, contained elsewhere in this report. Percentages set forth below in this MD&A have been rounded to the nearest percentage point.    Ukraine War   The ongoing war between Ukraine and Russia has continued to disrupt certain global markets. However, the Company has not experienced any direct impact from the disruption in this region. The Company does not source materials from this region, nor does it serve this market in any material nature.    Supply Chain Constraints and Inflationary Impacts   Due to the current inflationary environment, raw material supply shortages and transportation delays, the Company routinely experiences delays and increased prices for raw materials used in the Company's production processes. To mitigate these impacts, the Company has implemented several strategies, including purchasing from alternative suppliers and planning for material purchases further in advance to ensure the Company has materials when needed. The Company has also updated its pricing to customers to offset the impacts of the raw material price increases. These impacts are expected to continue throughout 2023.   19 Table of Contents   RESULTS OF OPERATIONS   The Company is engaged in the manufacture and sale of products in one reportable segment. Since the Company focuses on discrete projects, operating results can be significantly impacted as a result of large variations in the level of project activity in reporting periods.   ($ in thousands)   Three Months Ended April 30,       2023     2022     Change favorable/(unfavorable)       Amount     Percent of Net Sales     Amount     Percent of Net Sales     Amount   Net sales   $ 29,657             $ 31,222             $ (1,565 )                                           Gross profit     6,774     23 %     7,049       23 %     (275 )                                           General and administrative expenses     5,460     18 %     5,650       18 %     190                                             Selling expense     1,239     4 %     1,239       4 %     -                                             Interest expense, net     512               368               (144 )                                           Other income     72               49               23                                             Loss before income taxes     (365 )             (159 )             (206 )                                           Income tax expense     758               726               (32 )                                           Net loss     (1,123 )             (885 )             (238 )     20 Table of Contents   Three months ended April 30, 2023 vs. Three months ended April 30, 2022   Net sales:   Net sales were $ 29.7 million and $ 31.2 million in the three months ended April 30, 2023 and 2022, respectively.  The  decrease o f $1.5  million, or 5% , was a result of lower sales volumes in North America.   Gross profit:   Gross profit was $6.8 million, or 23% of net sales, and $7.0 million, or 23% of net sales, in the three months ended April 30, 2023 and 2022, respectively. The decrease of $0.2 million was driven by lower sales volumes.   General and administrative expenses:   General and administrative expenses were $5.5 million and $5.7 million in the three months ended April 30, 2023 and 2022, respectively. The decrease of $0.2 million, or 4%, was due to lower payroll costs, primarily related to timing.     Selling expenses:   Selling expenses were consistent at $1.2 million in the three months ended April 30, 2023 and 2022.   Interest expense, net:   Net interest expense remained consistent and was $0.5 million and $0.4 million in the three months ended April 30, 2023 and 2022, respectively.     Other income:   Other income was consistent and less than $0.1 million for  the three months ended April 30, 2023 and 2022 , respectively.    Income tax expense:   The Company's worldwide effective tax rates ("ETR") were (207.7%) and (455.9%) in the three months ended April 30, 2023 and 2022, respectively. The change in the ETR is due to the inability to recognize tax benefits on losses in the United States due to a full valuation allowance and changes in the mix of income and loss in various jurisdictions.   For further information, see Note 5 - Income taxes, in the Notes to Consolidated Financial Statements.   Net loss:   Net loss was consistent at $(1.1) million and $(0.9) million in the three months ended April 30, 2023 and 2022, respectively.     21 Table of Contents   Liquidity and capital resources   Cash and cash equivalents as of April 30, 2023 were $8.8 million compared to $5.8 million on January 31, 2023. On April 30, 2023, $0.5 million was held in the United States, and $8.3 million was held at the Company's foreign subsidiaries. The Company's working capital was $38.5 million on April 30, 2023 compared to $41.9 million on January 31, 2023. Of the working capital components, accounts receivable decreased by $2.1 million and cash and cash equivalents increased by $3.0 million as the result of the movements discussed below. As of April 30, 2023, the Company ha d $7.5  million of borrowing capacity under the Renewed Senior Credit Facility in North America and $10.0  million of borrowing capacity under its foreign revolving credit agreements. The Company had $4.1  million borrowed under the Renewed Senior Credit Facility and $8.9  million borro wed under its foreign revolving credit agreements at April 30, 2023.   Net cash provided by operating activities in the three months ended April 30, 2023 and 2022 was $3.8 million and net cash used in operating activities was $7.1 million in the three months ended April 30, 2022. This increase of $10.9 million was due primarily to decreases in unbilled accounts receivable, inventory and costs and estimated earnings in excess of billings on uncompleted contracts, offset by changes to accounts receivable and accounts payable.    Net cash used in investing activities in the three months ended April 30, 2023 and 2022 was $3.2 million and $0.3 million, respectively. The increase of $2.9 million was due primarily to investment in the Middle East.   Net cash provided by financing activities in the three months ended April 30, 2023 and 2022 was $2.5 million and $5.1 million, respectively. The main source of cash from financing activities during the three months ended April 30, 2023 was net proceeds from borrowings of approximately $2.8 million under the Company's credit facilities, as compared to the three months ended April 30, 2022 , when net proceeds were approximately $5.3 million. Debt totaled $27.0 million and $24.3 million as of April 30, 2023 and January 31, 2023, respectively. For additional information, see Note 9 - Debt, in the Notes to Consolidated Financial Statements.   Treasury stock. On December 7, 2022 the Board of Directors authorized the use of $1.0 million remaining under the share repurchase program previously approved on October 4, 2021 that expired on October 3, 2022. Share repurchases may be executed through open market or in privately negotiated transactions over the course of the 12 months following the Board of Directors authorization.   The repurchase program approved on October 4, 2021 authorized the Company to use up to $3.0 million for the purchase of its outstanding shares of common stock. Stock repurchases were permitted to be executed through open market or privately negotiated transactions, depending upon current market conditions and other factors. During the three months ended April 30, 2023, the Company has not made any repurchases of its outstanding shares of common stock.   On July 26, 2022, the Company retired 239,168 shares of treasury stock previously repurchased under the stock repurchase program. The retirement was recorded as a reduction to common stock based on the par value of the shares, and the excess over par value was recorded as a decrease to retained earnings in accordance with ASC 505-30, Equity - Treasury Stock.   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 the Credit Agreement with 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”).   On September 17, 2021, the North American Loan Parties executed an extension of the Credit Agreement with PNC, providing for a new five-year $18 million Renewed Senior Credit Facility. The Company's obligations under the Renewed Senior Credit Facility are currently guaranteed by Perma-Pipe Canada, Inc. Each of the North American Loan Parties other than Perma-Pipe Canada, Inc. is a borrower under the Renewed Senior Credit Facility (collectively, the “Borrowers”).   The Borrowers have used and will continue to use borrowings under the Renewed Senior Credit Facility (i) to fund future capital expenditures; (ii) to fund ongoing working capital needs; and (iii) for other corporate purposes, including potentially additional stock repurchases. Borrowings under the Renewed Senior Credit Facility bear interest at a rate equal to an alternate base rate or the Secured Overnight Financing Rate ("SOFR"), plus, in each case, an applicable margin. The applicable margin is based on a fixed charge coverage ratio ("FCCR") range. Interest on alternate base rate borrowings is the alternate base rate (as defined in the Renewed Senior Credit Facility) plus an applicable margin ranging from 1.00% to 1.50%, based on the FCCR in the most recently reported period. Interest on SOFR borrowings is the SOFR rate (as defined in the Renewed Senior Credit Facility) plus an applicable margin ranging from 2.00% to 2.50%, based on the FCCR in the most recently reported period, as well as an additional SOFR adjustment ranging from 0.10% to 0.25%, based on the term of the interest period. Additionally, the Borrowers pay a 0.25% per annum facility fee on the unused portion of the Renewed Senior Credit Facility.   Subject to certain exceptions, borrowings under the Renewed Senior Credit Facility are secured by substantially all of the North American Loan Parties’ assets. The Renewed Senior Credit Facility matures on September 20, 2026. Subject to certain qualifications and exceptions, the Renewed 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 may not make capital expenditures in excess of $5.0 million annually, plus a limited carryover of unused amounts. Further, the North American Loan Parties may not make repurchases of the Company's common stock in excess of $3.0 million.    The Renewed Senior Credit Facility also contains a free cash flow financial covenant (the "FCF covenant") requiring the North American Loan Parties to achieve a ratio of its EBITDA to the sum of scheduled cash principal payments on indebtedness for borrowed money and interest payments on the advances under the Renewed Senior Credit Facility to be not less than 1.10 to 1.00 for any five consecutive days in which the undrawn availability is less than $3.0 million or any day in which the undrawn availability is less than $2.0 million. As of April 30, 2023, the calculated ratio was greater than 1.10 to 1.00. In order to cure any future breach of the FCF covenant by the North American Loan Parties, the Company may repatriate cash from any of its foreign subsidiaries that are otherwise not a party to the Renewed Senior Credit Facility in an amount which, when added to the amount of the North American Loan Parties' EBITDA (as defined in the Renewed Senior Credit Facility), would result in pro forma compliance with the FCF covenant. The Company was in compliance with these covena nts as of April 30, 2023.   22 Table of Contents   The Renewed 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 Renewed 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 Renewed Senior Credit Facility will automatically become immediately due and payable. Loans outstanding under the Renewed Senior Credit Facility will bear interest at a rate of 2.00% per annum in excess of the otherwise applicable rate (i) while a bankruptcy event of default exists or (ii) upon the lender's request, during the continuance of any other event of default.   As of April 30, 2023 , the Company had borrowed an aggregate of $4.1  million at a rate of 9.0%  and had $7.5  million available under the Renewed Senior Credit Facility. As of January 31, 2023, the Company had borrowed an aggregate of $4.4 million and had $9.9 million available under the Renewed Senior Credit Facility.   Revolving lines - foreign .  The Company also has credit arrangements used by its Middle Eastern subsidiaries in the U.A.E., Egypt, and Saudi Arabia as discussed further below.   United Arab Emirates   The Company has a revolving line for 8.0 million U.A.E. Dirhams (approximately $2.2 million at April 30, 2023) from a bank in the U.A.E. As of April 30, 2023 the facility has an interest rate of approximately 8.4% and is set to expire in May 2024.   The Company has a revolving line for 17.5 million U.A.E. Dirhams (approximately $4.8 million at April 30, 2023) from a bank in the U.A.E. As of April 30, 2023 the facility has an interest rate of approximately 8.4% and is set to expire in May 2024.   The Company has a credit agreement for capital expenditure financing with a bank in the U.A.E. for 2.0 million U.A.E. Dirhams (approximately $0.5 million at April 30, 2023). As of April 30, 2023 the facility has an interest rate of approximately 8.7% and is expected to expire in July 2023.   Egypt   In June 2021, the Company's Egyptian subsidiary entered into a credit arrangement with a bank in Egypt for a revolving line of 100.0 million Egyptian Pounds (approximately $3.2  million at April 30, 2023). This credit arrangement is in the form of project financing at rates competitive in Egypt. The line is secured by certain assets (such as accounts receivable) of the Company's Egyptian subsidiary. Among other covenants, the credit arrangement established a maximum leverage ratio allowable and restricted the Company's Egyptian subsidiary's ability to undertake any additional debt. As of April 30, 2023 the facility has an interest rate of approximately 8.0%  and expired in June 2022 , however the Company has started the renewal process for this credit arrangement. The Company is in regular communication with the bank throughout the renewal process and the facility has continued without interruption or penalty.   In December 2021, the Company entered into a credit arrangement for project financing with a bank in Egypt for 28.2 million Egyptian Pounds. As this project has progressed and the Company has made collections, the facility has decreased to a current amount of 8.9 million Egyptian Pounds (approximatel y $0.3  mi llion at April 30, 2023). This credit arrangement is in the form of project financing at rates competitive in Egypt. The line is secured by the contract for a project being financed by the Company's Egyptian subsidia ry. The facility has an interest rate of approximately  21.1% and, as of November 2022, is no longer available for borrowings by the Company. The facility will expire in connection with final customer balance collections and the completion of the project.    In August 2022, the Company's Egyptian subsidiary entered into a credit arrangement with a bank in Egypt for a revolving line of 100.0 million Egyptian Pounds (approximately $3.2  million at April 30, 2023). This credit arrangement is in the form of project financing at rates competitive in Egypt. The line is secured by certain assets (such as accounts receivable) of the Company's Egyptian subsidiary. Among other covenants, the credit arrangement established a maximum leverage ratio allowable, to be tested annually at fiscal year-end. As of April 30, 2023 the facility has an interest rate of approximately 8.0%  and is set to expire in August 2023 .   Saudi Arabia   In March 2022, the Company's Saudi Arabian subsidiary entered into a credit arrangement with a bank in Saudi Arabia for a revolving line of 25.0 million Saudi Riyal (approximately $6.7 million at April 30, 2023) This credit arrangement is in the form of project financing at rates competitive in Saudi Arabia. The line is secured by certain assets (such as accounts receivable) of the Company's Saudi Arabian subsidiary. The facility was set to expire in April 2023. Upon renewal of the credit arrangement in May 2023, the line was increased to 37.0 million Saudi Riyal (approximately $9.9 million at April 30, 2023). As of April 30, 2023 the facility has an interest rate of approximately 9.2% and is set to expire in May 2024.   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 or undertaking of additional debt. The Company guarantees only a portion of the subsidiaries' debt, including foreign debt. As of April 30, 2023, the amount of foreign subsidiary debt guaranteed by the Company was approxim ately $1.2 million.    23 Table of Contents   The Company was in compliance with the covenants under the credit arrangements in the U.A.E., Egypt and Saudi Arabia as of April 30, 2023, with the exception of those arrangements that have expired and have not yet been renewed. Although certain of the arrangements have expired and the borrowings could be required to be repaid immediately by the banks, the Company is in regular communication with the respective banks throughout the renewal process and all of the arrangements have continued without interruption or penalty. On April 30, 2023, interest rates were based on (i) the Emirates Inter Bank Offered Rate plus 3.0% to 3.5% per annum for the U.A.E. credit arrangements, two of which have a minimum interest rate of 4.5% per annum; (ii) either the Central Bank of Egypt corporate loan rate plus 3.5% per annum or the stated interest rate in the agreements for the Egypt credit arrangements; and (iii) the Saudi Inter Bank Offered Rate plus 3.5% for the Saudi Arabia credit arrangement. Based on these base rates, as of April 30, 2023, the Company's interest rates ranged from 8.0% to 21.1%, with a weighted average rate of 11.5%, and the Company had facility limits totaling $21.2  million under these credit arrangements. As of April 30, 2023 ,  $2.7  million o f availability was used to support letters of credit to guarantee amounts committed for inventory purchases and for performance guarantees. Additionally, as of April 30, 2023 , the Company had borrow ed $8.9  million  and had an additional $10.0  million of borrowing remaining available under the foreign revolving credit arrangements. The foreign revolving lines balances as of April 30, 2023 and January 31, 2023, were included as current maturities of long-term debt in the Company's consolidated balance sheets.    Finance obligation - buildings and land.  On April 14, 2021, the Company entered into a purchase and sale agreement (the "Purchase and Sale Agreement"). Pursuant to the terms of the Purchase and Sale Agreement, the Company sold the Property for $10.4 million. The transaction generated net cash proceeds of $9.1 million. Concurrently with the sale of the Property, the Company paid off the approximately $0.9 million remaining on the mortgage note on the Property to its lender.  The Company used the remaining proceeds to repay its borrowings under the Senior Credit Facility, for strategic investments, and for general corporate needs. Concurrent with the sale of the Property, the Company entered into a 15-year lease agreement (the “Lease Agreement”), whereby the Company is leasing back the Property at an annual rental rate of approximately $0.8 million, subject to annual rent increases of 2.0%. Under the Lease Agreement, the Company has four consecutive options to extend the term of the lease by five years for each such option.     In accordance with ASC 842, Leases , this transaction was recorded as a failed sale and leaseback as the present value of lease payments exceeded substantially all of the fair value of the underlying asset. The Company utilized an incremental borrowing rate of 8.0% to determine the finance obligation to record for the amounts received and will continue to depreciate the assets.  The current portion of the finance obligation of $0.1 million is recognized in current maturities of long-term debt and the long-term portion of $9.2 million is recognized in long-term finance obligation on the Company's consolidated balance sheets as of  April 30, 2023 . T he net carrying amount of the financial liability and remaining assets will be zero at the end of the lease term.   Accounts receivable:  In 2015, the Company completed a project in the Middle East with billings in the aggregate amount of approximately $41.9 million. The system has not yet been commissioned by the customer. Nevertheless, the Company has settled appro ximately $ 39.1  million as of April 30, 2023 , with a remaining balance due in the amount of $2.7  million , all of w hich pertains to retention clauses within the agreements with the Company's customer, and which become payable by the customer when this project is fully tested and commissioned. Of this retention amount, $1.6  million is classified in a long-term receivable account.   The Company has been engaged in ongoing active efforts to collect the outstanding amount. The Company continues to engage with the customer to ensure full payment of open balances, and during June 2022 received a partial payment to settle $0.9 million of the customer's outstanding balances. Further, the Company has been engaged by the customer to perform additional work in 2022 and 2023 under customary trade terms that supports the continued cooperation between the Company and the customer. As a result, the Company did not reserve any allowance against the remaining outstanding balances as of April 30, 2023. 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.   CRITICAL ACCOUNTING POLICIES AND ESTIMATES   Critical accounting policies are described in Item 7. MD&A and in the Notes to the Consolidated Financial Statements for the year ended January 31, 2023 contained in the Company's latest Annual Report on Form 10-K. Any new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements have been discussed in the Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q. The application of critical accounting policies may require management to make assumptions, judgments and estimates about the amounts reflected in the Consolidated Financial Statements. Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.   24 Table of Contents