Kewaunee Scientific Corporation Form 10-Q Summary
Business context and reporting period
Kewaunee Scientific Corporation designs, manufactures and installs laboratory, healthcare and technical furniture and related infrastructure. The filing covers the three and six months ended October 31, 2018, the second quarter and first half of fiscal 2019. Operations comprise Domestic and International segments. The company had 2,744,325 common shares outstanding as of December 4, 2018.
Key financial metrics
| Metric | Three months ended October 31, 2018 | Three months ended October 31, 2017 | Six months ended October 31, 2018 | Six months ended October 31, 2017 |
|---|---|---|---|---|
| Net sales | $37.3 million | $41.5 million | $79.4 million | $75.4 million |
| Gross profit | $7.8 million | $7.9 million | $15.2 million | $14.7 million |
| Gross margin | 20.9% | 19.1% | 19.2% | 19.6% |
| Operating earnings | $1.8 million | $2.7 million | $3.5 million | $4.3 million |
| Net earnings attributable to Kewaunee | $1.4 million | $1.7 million | $2.8 million | $2.9 million |
| Diluted earnings per share | $0.51 | $0.62 | $1.01 | $1.04 |
Second-quarter operating margin was approximately 4.9%, compared with 6.4% in the prior-year quarter. Six-month operating margin was approximately 4.4%, compared with 5.8% in the prior-year period. Effective tax rates declined to 22.2% from 35.7% for the quarter and to 21.4% from 34.9% for the six-month period, primarily reflecting the lower federal tax rate under the Tax Cuts and Jobs Act.
For the six months, operating activities provided $2.3 million of cash, compared with $2.1 million used in the prior-year period. Capital expenditures were $1.3 million, dividends paid were $1.0 million, and financing activities used $0.8 million. Cash, cash equivalents and restricted cash totaled $10.2 million at October 31, 2018, compared with $13.2 million at October 31, 2017.
At October 31, 2018, current assets were $60.3 million and current liabilities were $24.0 million, producing working capital of $36.3 million and a current ratio of 2.5-to-1. Total borrowings and interest rate swaps were $6.7 million, including $4.6 million outstanding under the revolving credit facility. The $20 million revolving facility had $10.2 million available, and standby letters of credit totaled $5.2 million.
Material changes versus the prior comparable period
- Second-quarter sales decreased 10.1%, while six-month sales increased 5.4%.
- Domestic second-quarter sales increased 7.3% to $30.6 million; International sales decreased 48.5% to $6.7 million. The International comparison was affected by delivery of a large Middle East order in the prior year and unfavorable Indian rupee exchange-rate movements.
- Six-month Domestic sales increased to $66.7 million from $50.7 million, while International sales declined to $12.7 million from $24.7 million.
- Operating expenses increased 13.4% for the quarter and 12.9% for the six-month period, driven primarily by professional and consulting fees, compliance costs and investment in International operations.
- Order backlog was $101 million at October 31, 2018, compared with $118 million a year earlier and $102 million at July 31, 2018. The prior-year backlog included the large Middle East order.
- The company changed its Domestic inventory accounting method from LIFO to FIFO effective August 1, 2018. The change was applied retrospectively. For the six months, reported FIFO net earnings attributable to Kewaunee were $2.8 million; under the former LIFO method, the filing indicates they would have been approximately $2.7 million.
- The company adopted ASC 606 revenue recognition effective May 1, 2018 using the modified retrospective approach, increasing retained earnings by $217,000. For the six months, reported net earnings attributable to Kewaune were $2.8 million, compared with $2.5 million without ASC 606 adoption.
Guidance, outlook, risks and unusual items
Management states that the third quarter is historically the most challenging, but cites a solid backlog, substantial outstanding quotations and expectations for significant project awards during the balance of the fiscal year. The company continues cost-reduction and productivity initiatives to offset higher raw-material and freight costs and does not expect raw-material cost pressures to subside given the current geopolitical environment.
- Demand is difficult to forecast because the company often serves as a subcontractor or supplier to dealers and depends on laboratory construction activity and project schedules.
- Firm project pricing exposes the company to labor and material cost increases between quotation and delivery, particularly for stainless steel, wood and epoxy resin.
- International operations are exposed to foreign-currency fluctuations, including the Indian rupee, and to geopolitical, regulatory and economic risks.
- Other disclosed risks include competition, customer-demand changes, quarter-to-quarter earnings volatility, legal and regulatory changes, terrorism, war, natural disasters and other force majeure events.
- The company contributed $1.0 million to its frozen defined-benefit pension plans during the first six months and did not expect additional contributions during the remainder of the fiscal year.
- Management concluded that disclosure controls and procedures were adequate and effective as of October 31, 2018, with no material change in internal control over financial reporting during the quarter.
Investor verification points
- Verify the sustainability of Domestic sales growth and whether International sales normalize after the prior-year Middle East order comparison.
- Track gross-margin performance against raw-material, freight and labor inflation, including the effect of the FIFO inventory method.
- Reconcile reported results under ASC 606 with comparable results under the prior revenue-recognition method when assessing trends.
- Monitor backlog conversion, new project awards and the historically difficult third quarter.
- Assess liquidity relative to revolving-facility availability, standby letters of credit, dividends, capital expenditures and short-term borrowing needs.
- Review foreign-currency exposure, particularly the Indian rupee, and the company’s ability to manage International operating investments.