Mfri Inc (MFRI) SEC Quarterly Report (10-Q) for Q3 2017

For the quarterly period ended July 31, 2017

(Exact name of registrant as specified in its charter)

Delaware	36-3922969
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
6410 W. Howard Street, Niles, Illinois	60714
(Address of principal executive offices)	(Zip Code)

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. Large accelerated filer o Accelerated filer o Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company x Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

On September 7, 2017 , there were 7,713,407 shares of the registrant's common stock outstanding.

(In thousands, except per share data)

See accompanying notes to consolidated financial statements.

Note: Earnings per share calculations could be impacted by rounding.

(In thousands)

See accompanying notes to consolidated financial statements.

PERMA-PIPE INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

PERMA-PIPE INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

See accompanying notes to consolidated financial statements.

(Tabular amounts presented in thousands, except per share amounts)

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.

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 4 Discontinued operations".

For the three months ended July 31, 2017 and 2016, no individual customer accounted for 10% or more of the Company's consolidated net sales. For the six months ended July 31, 2017 , no individual customer accounted for 10% or more of the Company's consolidated net sales, and for the six months ended July 31, 2016 , one customer accounted for 11% of the Company's consolidated net sales.

At July 31, 2017 , one customer accounted for 20% of accounts receivable. Two customers accounted for 33% of accounts receivable at January 31, 2017 .

Pursuant to the guidance of Staff Accounting Bulletin ("SAB") No. 99, Materiality, the Company concluded that the errors were not material to any of its prior period financial statements. The prior period financial statements were revised, in accordance with SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements .

A reconciliation of the effects of the adjustments to the previously reported balance sheet and stockholders' equity at January 31, 2017 follows:

A reconciliation of the effects of the adjustments to the previously reported statement of operations for the three months ending July 31, 2016 follows:

A reconciliation of the effects of the adjustments to the previously reported statement of operations for the six months ending July 31, 2016 follows:

A reconciliation of the effects of the adjustments to the previously reported statement of cash flows for the six months ending July 31, 2016 follows:

Components of assets and liabilities from discontinued operations consist of the following:

Cash flows from discontinued operations:

The Company's effective tax rate ("ETR") from continuing operations for the second quarter and year-to-date was 24.9% and 16.8% , respectively, compared to 47.1% and 15.3% during the respective prior-year periods. The change in the ETR from the prior year-to-date to the current year-to-date was mainly due to changes in the foreign income and loss activities.

The amount of unrecognized tax benefits, including interest and penalties, at July 31, 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 July 31, 2017 associated with unrecognized tax benefits was $47,900 .

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 August 2017, the Company received a 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.

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 July 31, 2017 and January 31, 2017 is attributable to the purchase of Perma-Pipe Canada, Ltd. ("PPC")

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 July 31, 2017.

The decrease in the six months restricted stock-based compensation expense relates to grants that vested in January 2017, and the increase in the three months comparison is due to new grants that were made in June 2017.

As of July 31, 2017 , there was $0.1 million of total unrecognized compensation expense related to unvested stock options. The expense is expected to be recognized over a period of 2.0 years.

As of July 31, 2017 , there was $1.9 million of unrecognized compensation expense related to unvested restricted stock granted under the plans. The cost is expected to be recognized over the weighted-average period of 2.4 years .

11.     Debt. Debt totaled $16.3 million at July 31, 2017 , a net increase of $4.6 million since January 31, 2017 .

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 July 31, 2017 , the Company had borrowed $7.9 million at 5.5% and 4.2% and had $4.8 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.

July 31, 2017 , $7.5 million of availability was used to support letters of credit to guarantee amounts committed for inventory purchases and for performance guarantees. As there were no borrowings under these credit arrangements, an additional $15.5 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.

On May 5, 2017 , Piping Systems obtained two capital leases for a total of 0.94 million CAD (approximately $0.7 million USD at the prevailing exchange rate on the transaction date) to finance vehicle equipment. The interest rate for these capital leases is 7.8% per annum with monthly principal and interest payments of $9 thousand , and these leases mature on April 30, 2021 .

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.

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 determined its adoption methodology. The Company has completed staff education and is currently in discovery and analysis phases of reviewing contracts and identifying potential differences that would result from applying the new standard to current contracts. This step is expected to be complete in October 2017. Then the Company will begin to identify and implement changes to the Company's business processes, systems and controls to support adoption of the new standard in 2018. 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. The 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.

16.     Reclassifications. Reclassifications were made to the prior-year consolidated statement of cash flows to conform to the current-year presentations and were not material to the financial statements.

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.

Perma-Pipe International Holdings, Inc. is engaged in the manufacture and sale of products in one reportable segment: Piping Systems. The Company's website is www.permapipe.com . Since the Piping Systems segment includes large discrete projects, operating results could be negatively impacted in the future as a result of large variations in the level of market demand in reporting periods.

This discussion should be read in conjunction with the consolidated financial statements, including the notes thereto, contained elsewhere in this report.

Three months ended July 31, 2017 ( " current quarter " ) vs. Three months ended July 31, 2016 ( " prior-year quarter " )

Net sales increased 17% to $26.9 million in the current quarter from $22.9 million in the prior-year quarter. Higher revenues resulted from increased business with distributors of coated pipe in Canada and from a pick-up in general project activities in the Middle East.

Gross margin decreased to 11% of net sales in the current quarter from 13% of net sales in the prior-year quarter due to changes in the product mix.

Selling and general and administrative expenses combined decreased by $0.7 million in the current quarter from the prior-year quarter. The prior-year quarter included one-time legal settlement expenses of $0.8 million partially offset by $0.4 million in foreign currency exchange gains.

Net sales increased 10% to $50.4 million in the current year-to-date from $45.9 million in the prior-year year-to-date. Higher volumes resulted from increased project demand in the U.S. and from higher coating volumes for distributors in Canada.

Gross margin decreased to 10% of net sales in the current year-to-date from 11% of net sales in the prior-year year-to-date due to changes in the product mix.

Selling and general and administrative expenses combined decreased by $1.2 million to $6.2 million in the current year-to-date from $7.4 million in the prior-year year-to-date. The prior-year year-to-date expenses included one-time legal settlement expenses of $0.8 million and the current year expenses include $0.4 million in exchange rate losses realized on intercompany loans extended to a foreign subsidiary, recorded in general and administrative expenses during the first quarter of 2017. Realigning support and governance activities between Corporate and the Piping Systems resulted in a benefit of $0.4 million in Piping Systems in comparison to prior-year year-to-date, with the offsetting effect in Corporate general and administrative expenses.

Current quarter vs. prior-year quarter

Corporate operating expenses include general and administrative expenses that are not allocated to the segment. General and administrative expenses increased to $2.2 million in the current quarter from $1.5 million in the prior-year quarter. This increase was related to $0.4 million of additional professional service expenses related to Middle East executive management transition and operations in addition to $0.2 million of additional expenses reported in Corporate after realigning support and governance activities between Corporate and the Piping Systems. The prior-year quarter was affected by a gain of $ 0.4 million on the sale of its former corporate headquarters.

Net interest expense increased to $157 thousand in the current quarter from $97 thousand in the prior-year quarter due to higher borrowings, both domestic and foreign.

Year-to-date vs. prior-year year-to-date

General and administrative expenses increased to $4.5 million in the current year-to-date from $4.4 million in the prior-year year-to-date. This increase was related to $0.4 million of additional professional service expenses related to Middle East executive management transition and operations in addition to $0.4 million of additional expenses reported in Corporate after realigning support and governance activities between Corporate and the Piping Systems. In the prior-year year-to-date, the Company reported a net gain of $0.3 million on the sale of its former corporate headquarters and $0.2 million of executive incentive reductions.

Net interest expense decreased to $314 thousand in the current year-to-date from $323 thousand in the prior-year year-to-date due to lower borrowings, both domestic and foreign, in the first quarter of 2017.

Current quarter vs. prior-year quarter

The pretax loss from continuing operations for the current quarter remained level at $2.3 million due to:

Year-to-date vs. prior-year year-to-date

The pretax loss from continuing operations was $6.2 million year-to-date versus $8.7 million in the prior-year year-to-date. The contributing factors were:

The Company's ETR from continuing operations for the current quarter and year-to-date was 24.9% and 16.8% , respectively, compared to 47.1% and 15.3% during the respective prior-year periods. The change in the ETR from the prior year to the current year was mainly due to the change in foreign income and loss activities. The Company remains in a domestic net operating loss carryforward position. For additional information, see "Notes to Consolidated Financial Statements, Note 5 Income taxes".

For the three months ended July 31, 2017 and 2016, no individual customer accounted for 10% or more of the Company's consolidated net sales. For the six months ended July 31, 2017 , no individual customer accounted for 10% or more of the Company's consolidated net sales, and for the six months ended July 31, 2016 , one customer accounted for 11% of the Company's consolidated net sales.

At July 31, 2017 , one customer accounted for 20% of accounts receivable. Two customers accounted for 33% of accounts receivable at January 31, 2017 .

Cash, cash equivalents and restricted cash as of July 31, 2017 were $9.4 million compared to $8.7 million on January 31, 2017 . On July 31, 2017 , $0.2 million was held in the U.S., and $9.2 million was held at the foreign subsidiaries. The Company's working capital was $24.8 million on July 31, 2017 compared to $27.8 million on January 31, 2017 . Of the working capital components, accounts receivable decreased $4.7 million as a result of collections from higher sales in previous quarters, and inventory increased $2.5 million in preparation for fulfilling an increased backlog of orders. Net cash used in operating activities during the first six months of 2017 was $2.8 million compared to $0.9 million during the first six months of 2016 .

Foreign earnings in the Middle East are considered to be indefinitely reinvested outside the U.S. The Company has not provided U.S. Federal tax on unremitted earnings of its Middle East subsidiaries. The Company does not believe that it will be necessary to repatriate investments from these subsidiaries. The $9.3 million cash held at the foreign subsidiaries are designated for working capital expansion and other operational investments outside the U.S. Also, some foreign credit arrangement covenants require a minimum tangible net worth to be maintained overseas, including intercompany subordinated debt.

Net cash used in investing activities for the six months ended July 31, 2017 was $1.4 million .

Debt totaled $16.3 million on July 31, 2017 , a net increase of $4.6 million compared to the beginning of the current fiscal year. For additional information, see "Notes to Consolidated Financial Statements, Note 11 Debt". Net cash provided by financing activities was $4.3 million for the six months ended July 31, 2017 .

On September 24, 2014, the Company entered into the 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 achieving a minimum fixed charge coverage ratio with respective performance metrics as defined by the Credit Agreement if a minimum availability is not met . On July 31, 2017 , the Company was in compliance with all covenants under the Credit Agreement. The North American revolving line balances as of July 31, 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 July 31, 2017 , the Company had borrowed $7.9 million at 5.5% and 4.2% and had $4.8 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.

On May 5, 2017, Piping Systems obtained two capital leases for a total of 0.94 million CAD (approximately $0.7 million USD at the prevailing exchange rate on the transaction date) to finance vehicle equipment. The interest rate for these capital leases is 7.8% per annum with monthly principal and interest payments of $9 thousand, and these leases mature on April 30, 2021.

The Company believes its current cash and cash flow from operations, together with borrowing capacity under the revolving credit facilities, will be sufficient to fund anticipated operations, working capital and capital spending needs for at least the next 12 months.

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, 2017 contained in the Company's most recent 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.

The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of July 31, 2017 . Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were not effective as of July 31, 2017 to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. This determination was based on the matters discussed below under Changes in Internal Control over Financial Reporting.

Notwithstanding the material weaknesses described below, management, including the Chief Executive Officer and Chief Financial Officer, has concluded that the financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, the financial position, results of operations, and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

Changes in Internal Control Over Financial Reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.

An error was identified during the preparation and review of the current quarter financial statements related to stock-based compensation cost. The material weakness in internal control over financial reporting resulted from the lack of technical accounting knowledge. Specifically, we did not have adequate controls in place to properly account for stock-based compensation cost, because the stock-based compensation had been reversed for vested equity awards that expired, terminated or were cancelled unexercised. The error was corrected, and the financial statements presented properly reflect these adjustments as an entry to additional paid in capital.

This material weakness did not result in any material adjustments to the Registrant's financial statements, notes thereto, or other disclosures in this Quarterly Report on Form 10-Q.

Other than the material weakness noted above, there was no change in internal control over financial reporting during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

Remediation Plan for the Material Weakness in Internal Control over Financial Reporting: To address the material weakness regarding the adjustment for awards that expired unexercised, the Company will do the following:

Management will monitor the remediation progress of this material weakness against the revised procedures that have been implemented.

We anticipate the actions described above and resulting improvements in controls will strengthen the Company's processes, procedures and controls related to recording stock-based compensation cost and will address the related material weakness that was identified as of July 31, 2017 . However, the material weakness cannot be remediated fully until the remediation processes have been in operation for a period of time and successfully tested.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.