Kewaunee Scientific Corporation: Fiscal 2020 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended January 31, 2020, compared with the corresponding periods ended January 31, 2019. Kewaunee designs, manufactures, and installs laboratory and technical furniture and provides international laboratory design, engineering, construction, and project-management services. The interim financial statements are unaudited.
Financial Highlights
| Metric | Three Months Ended Jan. 31, 2020 | Three Months Ended Jan. 31, 2019 | Nine Months Ended Jan. 31, 2020 | Nine Months Ended Jan. 31, 2019 |
|---|---|---|---|---|
| Net sales | $34.2 million | $32.4 million | $113.3 million | $111.8 million |
| Gross profit | $5.3 million | $5.2 million | $18.5 million | $20.5 million |
| Gross margin | 15.4% | 16.2% | 16.4% | 18.3% |
| Operating earnings (loss) | $(2.1) million | $(0.0) million | $(1.3) million | $3.7 million |
| Net earnings (loss) attributable to Kewaunee | $(1.9) million | $(0.0) million | $(3.6) million | $2.8 million |
| Diluted earnings (loss) per share | $(0.70) | $(0.01) | $(1.32) | $1.00 |
- Third-quarter sales increased 5.7%; nine-month sales increased 1.3%.
- Domestic sales increased 5.9% in the quarter but declined 4.7% for the nine-month period. International sales increased 5.2% in the quarter and 29.3% year to date, partly reflecting continued deliveries under a large Middle East order.
- Operating expenses increased to $7.4 million in the quarter and $19.9 million for the nine-month period, compared with $5.2 million and $16.8 million, respectively, in the prior-year periods.
- Interest expense increased to $150,000 in the quarter and $452,000 year to date, primarily due to changes in borrowing levels.
- The nine-month effective tax rate was 104.5%, including tax effects associated with the change in the reinvestment assertion for certain foreign earnings and a $2.2 million India dividend distribution tax withholding expense.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash provided by operating activities was $4.6 million for the nine months ended January 31, 2020, compared with $4.5 million in the prior-year period.
- Capital expenditures were $1.4 million, versus $2.3 million in the prior-year period.
- Financing activities used $8.2 million, primarily reflecting a $5.5 million reduction in short-term borrowings, $1.0 million of dividends to stockholders, $324,000 of dividends to noncontrolling interests, and $1.3 million of debt and lease repayments.
- Cash, cash equivalents, and restricted cash declined to $6.1 million at January 31, 2020, from $11.2 million at April 30, 2019. Unrestricted cash was $3.6 million and restricted cash was $2.5 million.
- Working capital was $27.7 million, compared with $32.6 million at April 30, 2019. The current ratio was 2.1-to-1.0.
- Borrowings and interest rate swaps totaled approximately $4.2 million at January 31, 2020, compared with $10.9 million at April 30, 2019. Revolving credit advances were approximately $3.3 million, with $10.2 million available; standby letters of credit were $344,000.
- The company paid off its term loan and terminated its interest-rate swaps in September 2019. A December 2019 amendment converted the revolving facility to an asset-based lending arrangement, added minimum liquidity and EBITDA covenants, required repatriation of certain foreign cash, and restricted dividends. The company reported compliance with the applicable covenants at January 31, 2020.
- Operating lease right-of-use assets totaled $11.1 million, with operating lease liabilities of $11.0 million, following adoption of the lease accounting standard on May 1, 2019.
Material Changes Versus the Prior Comparable Period
- Revenue growth did not translate into profitability: gross margins fell 80 basis points in the quarter and 190 basis points for the nine-month period, while operating expenses rose substantially.
- Management attributed margin pressure to several low-margin orders, including a large Middle East order secured at below-normal margins.
- The company moved from a small quarterly loss in the prior year to a $1.9 million quarterly loss and from nine-month earnings of $2.8 million to a nine-month loss of $3.6 million.
- December 2019 restructuring actions included domestic workforce reductions, recruitment of a new information technology vice president, and a plan to close the China subsidiary. Third-quarter restructuring expenses were $628,000, including $254,000 related to China and $374,000 of domestic costs.
- Management expects the restructuring to produce annualized cost savings of approximately $1.0 million to $1.3 million, although the filing does not provide a detailed implementation schedule or quantified one-time cash cost beyond the amounts recognized.
- Order backlog was $93 million at January 31, 2020, down from $96 million at January 31, 2019 and $101 million at April 30, 2019.
Outlook, Risks, and Unusual Items
- Management’s fourth-quarter priorities are to maximize domestic production loads, improve manufacturing efficiency, and recover profitability. It also cited a multi-year plan to invest in manufacturing capabilities and information technology.
- Demand visibility is limited because the company often acts as a subcontractor or supplier to dealers and subcontractors. Results depend on laboratory construction activity, project schedules, competitive pricing, and delivery requirements.
- Firm-price quotations expose the company to labor and raw-material cost inflation, including stainless steel, wood, and epoxy resin, when costs rise after quoting.
- The company disclosed a new coronavirus-related risk: potential disruption to manufacturing, supply chains, employee availability, job-site access, project schedules, and product delivery or installation. Certain key supplies are sourced solely from China.
- Foreign-currency movements, international operations, customer concentration or project timing, commodity costs, and general economic conditions may materially affect results.
- The company changed its assertion regarding the indefinite reinvestment of unremitted earnings of subsidiaries in Singapore, China, and India, increasing current-period tax expense and creating a $1.1 million deferred tax liability for foreign unremitted earnings at January 31, 2020.
- Management stated that disclosure controls and procedures were adequate and effective and that no significant change in internal control over financial reporting occurred during the quarter.
Important Investor Verification Items
- Verify whether the restructuring delivers the projected $1.0 million to $1.3 million annualized savings and whether additional restructuring or closure costs arise.
- Assess the profitability and remaining delivery risk of the low-margin Middle East and other aggressively priced orders.
- Monitor backlog conversion, new bookings, and the decline from $101 million at April 30, 2019 to $93 million at January 31, 2020.
- Review compliance with the amended asset-based lending facility, including minimum liquidity and EBITDA covenants and the post-January 31, 2020 borrowing limit of $15 million.
- Assess coronavirus-related supply-chain, labor, project-access, and customer-delivery effects, particularly for China-sourced materials and India operations.
- Reconcile the reported tax expense, India dividend distribution tax, foreign-earnings tax liabilities, and future cash-tax requirements.
- Determine whether recurring operating cash flow remains sufficient to fund capital expenditures, dividends, lease obligations, pension obligations, and working-capital needs while maintaining liquidity.