Kewaunee Scientific Corporation Form 10-Q Summary
Business context and reporting period
Kewaunee Scientific Corporation designs, manufactures, and installs laboratory and technical furniture, fume hoods, casework, workstations, and related systems. Its operations are reported in Domestic and International segments. This unaudited Form 10-Q covers the three and six months ended October 31, 2017, with comparisons to the same periods of 2016. The company is a smaller reporting company.
Key financial metrics
| Metric | Three months ended October 31, 2017 | Three months ended October 31, 2016 | Six months ended October 31, 2017 | Six months ended October 31, 2016 |
|---|---|---|---|---|
| Net sales | $41.471 million | $36.329 million | $75.352 million | $73.608 million |
| Gross profit | $7.911 million | $7.104 million | $14.732 million | $14.243 million |
| Gross margin | 19.1% | 19.6% | 19.6% | 19.3% |
| Operating earnings | $2.655 million | $2.288 million | $4.343 million | $4.349 million |
| Net earnings attributable to Kewaunee | $1.724 million | $1.486 million | $2.872 million | $2.786 million |
| Diluted earnings per share | $0.62 | $0.54 | $1.04 | $1.02 |
- Operating expenses were $5.256 million for the quarter and $10.389 million for the six-month period, representing 12.7% and 13.8% of sales, respectively.
- Effective tax rates were 35.7% for the quarter and 34.9% for the six-month period. The quarterly rate included an unfavorable tax adjustment related to foreign subsidiary dividend distributions.
- Cash and cash equivalents were $11.792 million at October 31, 2017, compared with $12.506 million at April 30, 2017. Restricted cash was $1.392 million.
- Working capital was $34.2 million, and the current ratio was 2.1-to-1.0.
- Operating activities used $2.113 million of cash during the six months, compared with $2.206 million provided in the prior-year period. Investing activities used $1.394 million, including $1.437 million of capital expenditures.
- Financing activities provided $2.852 million, primarily reflecting a $4.120 million net increase in short-term borrowings, partially offset by $868,000 of dividends to stockholders and $334,000 of long-term debt payments.
- Bank borrowings and interest rate swaps totaled $10.7 million at October 31, 2017. Revolving-facility advances were $7.2 million, with $8.6 million available under the $20 million facility. Standby letters of credit totaled $4.2 million.
- Total liabilities were $40.550 million and total equity was $45.318 million at October 31, 2017.
Material changes versus the prior comparable period
- Second-quarter sales increased 14.2%, driven primarily by a large Middle East order that increased International sales to $12.931 million from $8.118 million. Domestic sales increased modestly to $28.540 million from $28.211 million.
- Six-month sales increased 2.4% according to management. International sales rose to $24.666 million from $15.760 million, while Domestic sales declined to $50.686 million from approximately $57.8 million because of lower dealer orders.
- The filing contains an inconsistency: the consolidated statements report six-month 2017 sales of $75.352 million, while the MD&A text states $76.352 million. The segment table agrees with $75.352 million.
- Quarterly gross margin declined to 19.1% from 19.6% because of a shift toward lower-value products. Six-month gross margin improved to 19.6% from 19.3%, reflecting cost-reduction and productivity programs, partly offset by product mix.
- Quarterly operating earnings increased 16.0%, while six-month operating earnings were essentially unchanged. Higher operating expenses, including governance, marketing, compensation, depreciation, bad debt, and International expenses, offset much of the gross-profit improvement.
- Six-month net earnings attributable to Kewaunee increased 3.1%, and diluted EPS increased from $1.02 to $1.04.
- Order backlog was $118.0 million at October 31, 2017, up from $113.5 million at April 30, 2017 and $101.1 million at October 31, 2016.
- Cash flow from operations deteriorated from positive $2.206 million to negative $2.113 million, primarily because of higher receivables and inventories and a $4.300 million decrease in deferred revenue.
Guidance, outlook, risks, contingencies, and unusual items
- Management stated that it expects fiscal 2018 sales and earnings growth, supported by the order backlog and market opportunities. The filing does not provide quantitative guidance.
- On December 7, 2017, after the reporting period, a criminal network cyber-attack disrupted Domestic manufacturing, engineering, administration, and sales operations. Nearly all Domestic operations had been restored by December 12, 2017.
- Management believes the temporary disruption will have an immaterial effect on fiscal 2018 sales and earnings, but the company has not yet estimated potential costs or losses. Insurance may cover some recovery and business-interruption costs, but coverage may be insufficient.
- Disclosure controls and procedures were deemed ineffective at October 31, 2017 because of an existing material weakness involving multi-element and percentage-of-completion revenue recognition. Remediation efforts are under way, with completion expected by April 30, 2018, subject to successful operation and testing of controls.
- Management had not determined whether the cyber-attack created a related internal-control issue.
- Key operating risks include uncertain project demand, dependence on dealer and subcontractor schedules, firm-price contracts, raw-material and labor cost inflation, pricing pressure, foreign-currency fluctuations, international operations, and cybersecurity incidents.
- The company paid $600,000 into its defined-benefit pension plans during the six months and does not expect additional contributions during the remainder of the fiscal year.
- The company adopted updated inventory and share-based compensation accounting guidance effective May 1, 2017; management reported no significant impact.
Facts investors should verify
- Reconcile the $75.352 million sales figure in the financial statements and segment disclosures with the $76.352 million figure stated in MD&A.
- Monitor the effect of the December 2017 cyber-attack on production, revenue, cash flow, insurance recoveries, and fiscal 2018 results.
- Assess remediation and testing of the revenue-recognition material weakness before relying on subsequent reported revenue and backlog metrics.
- Evaluate liquidity in light of negative operating cash flow, increased revolving borrowings, $4.2 million of standby letters of credit, and $8.6 million of remaining revolver availability.
- Confirm whether the large Middle East order is substantially complete and whether future results remain dependent on similarly large projects.
- Track raw-material costs, firm-price contract exposure, product mix, and the sustainability of the reported margin improvement for the first six months.