Item 2.
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Management's Discussion and Analysis of Financial Condition and Results of Operations (
"
MD&A
"
)
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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.
RESULTS OF OPERATIONS
The Company is engaged in the manufacture and sale of products in one reportable segment. Since the Company focuses on large discrete projects, operating results could be negatively impacted in the future as a result of large variations in the level of project activity in reporting periods.
This discussion 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 the MD&A have been rounded to the nearest percentage point, and may not exactly correspond to the comparative data presented.
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Three Months Ended October 31,
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Nine Months Ended October 31,
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($ in thousands)
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2018
|
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2017
|
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% Favorable (Unfavorable)
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2018
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|
2017
|
|
% Favorable (Unfavorable)
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Net sales
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|
$
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32,806
|
|
|
$
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27,498
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|
|
|
19
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%
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|
$
|
94,020
|
|
|
$
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77,851
|
|
|
|
21
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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Gross profit
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6,883
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|
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3,320
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|
107
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%
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|
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17,001
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|
|
|
8,163
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|
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|
108
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%
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Percentage of net sales
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21%
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12%
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18%
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10%
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|
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|
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|
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General and administrative expenses
|
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4,247
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|
|
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4,314
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|
|
|
2
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%
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|
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12,153
|
|
|
|
12,456
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|
|
|
2
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%
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Percentage of net sales
|
|
|
13%
|
|
|
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16%
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|
|
|
|
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13%
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16%
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Selling expense
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1,554
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1,297
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(20)
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%
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4,017
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3,920
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(2)
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%
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Percentage of net sales
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5%
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5%
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4%
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5%
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Interest expense, net
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280
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193
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(45)
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%
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830
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|
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507
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(64)
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%
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Income/(Loss) from operations before income taxes
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$
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802
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$
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(2,484)
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N/A
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$
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1
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$
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(8,720)
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N/A
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Three months ended
October 31, 2018
(
"
current quarter
"
) vs. Three months ended
October 31, 2017
(
"
prior year quarter
"
)
Net sales:
Net sales increased
19%
to
$32.8
million in the current quarter, from
$27.5
million in the prior year quarter. Higher revenues resulted from increased sales in North America.
Cost of sales and gross profit:
Gross profit increased to
21%
, or $
6.9
million of net sales, in the current quarter from
12%
, or $
3.3
million of net sales, in the prior year quarter. This
107%
increase in gross profit was due to higher volumes combined with improved margins, which were a result of strategic initiative improvements.
General and administrative expenses:
General and administrative expenses were slightly lower at $
4.2
million in the current quarter, compared to $
4.3
million in the prior year quarter. Included in the current quarter expenses is a one-time charge of $0.4 million for the separation agreement between the Company and the prior CFO, who retired on October 31, 2018.
Selling expenses:
Selling expenses were $
1.6
million in the current quarter, compared to $
1.3
million in the prior year quarter. This increase is due to commission expense related to increased sales.
Interest expense:
Net interest expense increased to $
0.3
million in the current quarter from $
0.2
million in the prior-year quarter due to higher borrowings, and higher effective interest rates, both domestic and foreign.
Income from operations before income taxes:
Income from operations before income taxes improved by
$3.3
million, to pre-tax income of
$0.8
million in the current quarter, from a pre-tax loss of $2.5 million in the prior year quarter. The positive contributing factors were:
|
•
|
Increased sales of
$5.3
million;
|
|
•
|
Improved gross profit of
$3.6
million; and
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|
•
|
Selling, general and administration expenses remaining flat in amount and as a percentage of sales.
|
Nine Months Ended October 31,
2018
(
"
year-to-date
"
) vs.
Nine Months Ended October 31,
2017
(
"
prior year year-to-date
"
)
Net sales:
Net sales increased
21%
to
$94.0
million in the current year-to-date, from
$77.9
million in the prior year year-to-date. Higher revenues resulted from increased sales in all geographic regions.
Cost of sales and gross profit:
Gross profit increased to
18%
, or $
17.0
million of sales, in the current year-to-date from
10%
, or $
8.2
million of sales, in the prior year year-to-date. This improvement was due to increased volumes and improved margins, which were a result of strategic initiative improvements.
General and administrative expenses:
General and administrative expenses decreased by
2%
to $
12.2
million in the current year-to-date, from $
12.5
million in the prior year year-to-date. Included in the current year-to-date expenses is a one-time charge of $0.4 million for the separation agreement between the Company and the prior CFO, who retired on October 31, 2018. In the prior year-to-date, the Company recognized foreign exchange losses on the payback of an intercompany loan extended to a foreign subsidiary.
Selling expenses:
Selling expenses increased by
2%
to $
4.0
million in the current year-to-date from $
3.9
million the prior year year-to-date. Current year expenses include commission expense related to increased sales.
Interest expense:
Net interest expense increased to $
0.8
million in the current year-to-date from $
0.5
million in the prior year year-to-date due to higher borrowings, and higher effective interest rates, both domestic and foreign.
Income from operations before income taxes:
Income from operations before income taxes improved by
$8.7
million, to break-even in the current year-to-date, from a pre-tax loss of $8.7 million in the prior year year-to-date. The positive contributing factors were:
|
•
|
Increased sales of
$16.2
million;
|
|
•
|
Improved gross profit of
$8.8
million; and
|
|
•
|
Selling, general and administration expenses remaining flat, in amount and as a percentage of sales.
|
Accounts receivable:
In 2013, the Company started a project in the Middle East as a sub-contractor, with billings in the aggregate amount of approximately $41.9 million. The Company completed all of its deliverables in 2015, and has collected approximately $37.0 million, as of October 31, 2018. The remaining balance due as of October 31, 2018 was $4.9 million. Included in this balance is an amount of $3.7 million, which pertains to retention clauses within the agreements of our customer (contractor), and which become payable by the customer when this project is fully tested and commissioned. In the absence of a firm date for the final commissioning of the project, and due to the long-term nature of this receivable, $3.2 million of this retention amount is carried in a long-term receivable account.
The Company has been engaged in ongoing active efforts to collect this outstanding amount, and has received updated acknowledgment of the outstanding balances and assurances of payment from the customer. The Company has received payments of approximately $0.5 million through the third quarter of 2018, and has received an additional $0.1 million in November 2018. As a result, the Company did not reserve any allowance against this amount, however, if the Company’s efforts to collect on the remaining balance on this account are not successful in fiscal 2018, then the Company may recognize an allowance for all, or substantially all, of any such then uncollected amounts.
Income taxes:
The Company's effective tax rate ("ETR") from operations for the current quarter and current year-to-date was 116% and 122,166%, compared to 32.5% and 2.8% during the respective prior year periods. The change in the ETR from the prior year-to-date to the current year-to-date was in large part due to the changes in net income by jurisdiction. Additional factors include the tax impact of Canadian business combination which occurred in the prior year, the valuation allowance against the domestic deferred tax asset, and the fact that the Company is close to break-even year-to-date for the current year. For additional information, see "Notes to Consolidated Financial Statements, Note 5 Income taxes".
Other
The Company has made a bid to provide insulation of pipes to the East Africa Crude Oil Pipeline ("EACOP") project. The EACOP project is a 1,450 Km (900 mile) long heavy crude oil pipeline from the Lake Albert Basin in Uganda to the Tanga port in Tanzania being developed by French oil company Total E&P, China National Offshore Oil Corporation (CNOOC) and London-based Tullow Oil. The proposed pipeline is 24 inches in diameter, and is electrically heat traced. Once completed, it will be the longest insulated and heat traced pipeline in the world. There can be no assurance that the Company will be successful in its bid for this project, or what the final terms of any such potential engagement will be until the bid is awarded; the timing of which is uncertain.
Liquidity and capital resources
Cash, cash equivalents and restricted cash as of
October 31, 2018
were $12.1 million compared to $8.3 million on January 31, 2018. On
October 31, 2018
, $1.9 million was held in the U.S., and $10.2 million was held at the Company's foreign subsidiaries. From time to time, the Company repatriates cash held at certain of its foreign subsidiaries as needed to help fund the Company's working capital needs. The Company's working capital was $
23.6
million on
October 31, 2018
compared to $
23.1
million on January 31, 2018.
Cash used in operating activities during the first nine months of 2018 was $0.6 million, compared to $4.2 million during the same period in 2017. Net cash used in investing activities during the first nine months of 2018 amounted to $0.9 million, compared to $1.9 million during the same period in 2017.
Debt totaled $21.6 million on
October 31, 2018
, a net increase of $5.8 million compared to the beginning of the current fiscal year. For additional information, see "Notes to Consolidated Financial Statements, Note 9 Debt". Net cash provided by financing activities during the first nine months of 2018 was $5.9 million compared to $6.0 million for the same period in 2017.
On September 20, 2018, the Company and certain of its U.S. and Canadian subsidiaries (collectively, together with the Company, the “North American Loan Parties”) entered into a new Revolving Credit and Security Agreement (the “Credit Agreement”) with PNC Bank, National Association, as administrative agent and lender (“PNC”), providing for a new three-year $18 million Senior Secured Revolving Credit Facility, subject to a borrowing base including various reserves (the “Senior Credit Facility”). The Senior Credit Facility replaced the Company’s then existing $15 million Credit and Security Agreement, dated September 24, 2014, among various subsidiaries of the Company and Bank of Montreal, as successor by assignment to BMO Harris Bank N.A., as amended (the “Prior Credit Agreement”).
The Company initially used borrowings under the new Senior Credit Facility to pay off outstanding amounts under the Prior Credit Agreement (which totaled approximately USD $3,773,823 plus CAD 4,794,528) and cash collateralize a letter of credit (USD $154,500). The Company expects to use additional borrowings under the new Senior Credit Agreement to fund future capital expenditures and on-going working capital needs, and for other corporate purposes. Borrowings under the Senior Credit Facility bear interest at a rate equal to an alternate base rate or London Interbank Offered Rate ("LIBOR"), plus, in each case, an applicable margin. The applicable margin is based on average quarterly undrawn availability with respect to the Senior Credit Facility. Interest on alternate base rate borrowings are generally payable monthly in arrears and interest on LIBOR borrowings are generally be payable in arrears on the last day of each interest period. Additionally, the Company is required to pay a 0.375% per annum facility fee on the unused portion of the Senior Credit Facility. The facility fee is payable quarterly in arrears.
Subject to certain exceptions, borrowings under the Senior Credit Facility are secured by substantially all of the assets of the Company and certain of its North American subsidiaries. The North American Loan Parties’ obligations under the Senior Credit Facility are guaranteed by Perma-Pipe Canada, Inc. North American Loan Parties’ assets. The Senior Credit Facility will mature on September 20, 2021. Subject to certain qualifications and exceptions, the Senior Credit Facility contains covenants that, among other things, restrict the North American Loan Parties’ ability to create liens, merge or consolidate, consummate acquisitions, make investments, dispose of assets, incur debt, and pay dividends and other distributions. In addition, the North American Loan Parties cannot allow capital expenditures to exceed $3 million annually (plus a limited carryover of unused amounts).
The Senior Credit Facility also contains financial covenants requiring (i) the North America Loan Parties to achieve consolidated net income (excluding the financial performance of the Company’s foreign subsidiaries not party to the Credit Agreement) before interest, taxes, depreciation, amortization and certain other adjustments (“EBITDA”) of at least $1,807,000 for the period from August 1, 2018 through October 31, 2018; (ii) the North America Loan Parties to achieve EBITDA of at least $2,462,000 for the period from August 1, 2018 through January 31, 2019; (iii) the North America Loan Parties to achieve a ratio of its EBITDA (with certain additional adjustments) to the sum of scheduled cash principal payments on indebtedness for borrowed money and interest payments on the advances under the Senior Credit Facility (excluding from the calculation items related to the financial performance of the Company’s foreign subsidiaries not party to the Credit Agreement) to be not less than 1.10 to 1.00 for the nine-month period ending April 30, 2019 and for the quarter ending July 31, 2019 and each quarter end thereafter on a trailing four-quarter basis; and (iv) the Company and its subsidiaries (including the Company’s foreign subsidiaries not party to the Credit Agreement) to achieve a ratio of its EBITDA (with certain additional adjustments) to the sum of scheduled cash principal payments on indebtedness for borrowed money and interest payments on the advances under the Senior Credit Facility of not less than 1.10 to 1.00 for the nine-month period ending October 31, 2018 and for the quarter ending January 31, 2019 and each quarter end thereafter on a trailing four-quarter basis. The Company was in compliance with this requirement as of
October 31, 2018
.
The Senior Credit Facility contains customary events of default. If an event of default occurs and is continuing, then PNC may terminate all commitments to extend further credit and declare all amounts outstanding under the Senior Credit Facility due and payable immediately. In addition, if any of the North American Loan Parties or certain of their subsidiaries become the subject of voluntary or involuntary proceedings under any bankruptcy, insolvency or similar law, then any outstanding obligations under the Senior Credit Facility will automatically become immediately due and payable. Borrowings under the Senior Credit Facility will bear interest at a rate of 2.00% per annum in excess of the otherwise applicable rate while a bankruptcy event of default exists or, upon the lenders’ request, during the continuance of any other event of default.
As of October 31, 2018, the Company had borrowed an aggregate of $13.7 million at 7.75% and 5.78%, with a weighted average rate of 6.45%, and had $2.9 million available to them under the Senior Credit Facility.
Revolving lines foreign
.
The Company also has credit arrangements used by its Middle Eastern subsidiaries. These credit arrangements are in the form of overdraft facilities and project financing at rates competitive in the countries in which the Company operates. The lines are secured by certain equipment, certain assets (such as accounts receivable and inventory), and a guarantee by the Company. Some credit arrangement covenants require a minimum tangible net worth to be maintained, including maintaining certain levels of intercompany subordinated debt. In addition, some of the revolving credit facilities restrict payment of dividends. On
October 31, 2018
, the Company was in compliance with the covenants under the credit arrangements. On
October 31, 2018
, interest rates were based on the Emirates Inter Bank Offered Rate (EIBOR) plu
s 3.5% pe
r annum, with a minimum interest ra
te of 4.5% per
annum. On
October 31, 2018
, the Company's interest rates ranged from 6.11% to 6.14%, with a weighted average rate of 6.14%, and the Company could borrow
$9.1 million
under these credit arrangements. On
October 31, 2018
,
$6.6 mi
llion of availability was used to support letters of credit to guarantee amounts committed for inventory purchases and for performance guarantees. On
October 31, 2018
, the Company had borrowed
$0.5 milli
on, and had an addition
al $2.1 mill
ion available. The foreign revolving lines balances as of
October 31, 2018
and January 31, 2018, were included as current maturities of long-term debt in the Company's consolidated balance sheets.
Mortgages.
On July 28, 2016, the Company borrowed 8.0 million CAD (approximately $6.1 million at the prevailing exchange rate on the transaction date) from a bank in Canada under a mortgage note secured by the manufacturing facility located in Alberta, Canada that matures on December 23, 2042. The interest rate is variable, currently at 6.1%, with monthly payments of 37 thousand CAD (approximately $28 thousand) for interest; and monthly payments of 27 thousand CAD (approximately $20 thousand) for principal. Principal payments began January 2018.
On June 19, 2012, the Company borrowed $1.8 million under a mortgage note secured by its manufacturing facility in Lebanon, Tennessee. The proceeds were used for payment of amounts borrowed. The loan bears interest at 4.5% with monthly payments of $13 thousand for both principal and interest and matures July 1, 2027. On June 19, 2022, and on the same day of each year thereafter, the interest rate shall adjust to the prime rate, provided that the applicable interest rate shall not adjust more than 2.0% per annum and shall be subject to a ceiling of 18.0% and a floor of 4.5%.
Capital Leases.
In 2017, the Company obtained three capital leases for 1.1 million CAD (approximately $0.8 million at the prevailing exchange rates on the transaction dates) to finance vehicle equipment. The interest rates for these capital leases were from 4.0% to 7.8% per annum with monthly principal and interest payments of less than $0.1 million. These leases mature from April 30, 2021 to September 29, 2022.
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, 2018 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.