Kewaunee Scientific Corporation — Q1 Fiscal 2018 Form 10-Q
Business context and reporting period
The filing covers the three months ended July 31, 2017, the first quarter of fiscal 2018. Kewaunee designs, manufactures and installs laboratory and technical furniture, fume hoods, casework, workstations and related systems. Operations are reported in Domestic and International segments. The company had 2,713,817 common shares outstanding as of September 5, 2017.
Financial performance and condition
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Net sales | $33.881 million | $37.279 million |
| Gross profit | $6.821 million | $7.139 million |
| Gross margin | 20.1% | 19.2% |
| Operating earnings | $1.688 million | $2.061 million |
| Earnings before taxes | $1.797 million | $2.100 million |
| Net earnings attributable to Kewaunee | $1.148 million | $1.300 million |
| Diluted earnings per share | $0.42 | $0.48 |
| Operating cash flow | $0.530 million | $(0.180) million |
Operating expenses increased to $5.133 million, or 15.2% of sales, from $5.078 million, or 13.6% of sales. Interest expense declined to $59,000 from $80,000, and the effective tax rate declined to 33.7% from 36.7%.
At July 31, 2017, cash and cash equivalents were $12.021 million, restricted cash was $1.471 million, and working capital was $34.071 million. The current ratio was 2.6-to-1.0. Total liabilities were $32.377 million and total equity was $44.187 million.
Total bank borrowings and interest-rate swaps were $6.783 million, including $3.4 million outstanding under the revolving credit facility. The $20 million facility had $12.4 million available, while standby letters of credit totaled $4.2 million.
Cash used in investing activities was $471,000, including $435,000 of capital expenditures. Financing activities used $554,000, including $406,000 of dividends and $105,000 of long-term debt repayments. Cash declined by $485,000 during the quarter.
Material changes versus the prior comparable period
- Sales declined 9.1%, primarily because Domestic sales fell to $22.146 million from $29.637 million due to the timing of customer demand within the order backlog.
- International sales increased to $11.735 million from $7.642 million, aided by shipments of a large Middle East order.
- Backlog was $111.2 million at July 31, 2017, compared with $113.5 million at April 30, 2017 and $86.2 million at July 31, 2016.
- Gross margin improved to 20.1% from 19.2%, primarily because of cost-reduction and productivity initiatives.
- Operating earnings declined 18.1%, as higher operating expenses more than offset the improved gross margin.
- Operating cash flow improved from an outflow of $180,000 to an inflow of $530,000, primarily due to a $6.248 million reduction in receivables, partly offset by a $2.066 million inventory increase and a $5.033 million reduction in deferred revenue.
- Domestic earnings before taxes declined to $1.816 million from $2.573 million, while International earnings before taxes increased to $1.370 million from $817,000.
Guidance, outlook, risks and unusual items
Management stated that it is optimistic fiscal 2018 will produce increased sales and earnings, supported by the backlog and marketplace opportunities. No specific quantitative earnings or revenue guidance was provided.
Demand is difficult to predict because the company often acts as a subcontractor or supplier to dealers and depends on laboratory construction activity and project schedules. Risks include competitive and economic conditions, customer demand and delivery timing, international operations and foreign currency fluctuations, raw-material costs, firm-price contracts, labor costs, regulatory changes, and force majeure events.
The company expects to contribute $600,000 to its defined-benefit pension plans during fiscal 2018; no contributions were made during the quarter. Pension expense declined to $163,000 from $231,000.
Management and the chief executive and financial officers concluded that disclosure controls and procedures were not effective at July 31, 2017. A material weakness relating to the application of multi-element and percentage-of-completion revenue recognition policies remained outstanding. Remediation efforts included additional guidance, employee training, and detective and monitoring controls, with completion expected by April 30, 2018, subject to successful operation and testing of the controls.
The company adopted new inventory measurement and stock-compensation standards effective May 1, 2017, with no significant impact reported. It expects to adopt the new revenue recognition standard in fiscal 2019 using the modified retrospective method and does not currently expect a material impact.
Important facts for investors to verify
- Whether the revenue-recognition material weakness was remediated by the expected April 30, 2018 date.
- Whether the large Middle East order and the $111.2 million backlog convert to revenue and cash flow on schedule.
- Whether Domestic demand recovers from the quarter’s 25.3% sales decline.
- Whether improved gross margins are sustained despite firm-price contracts and potential increases in steel, wood, epoxy resin and labor costs.
- The company’s ability to fund the expected $600,000 pension contribution, capital expenditures and dividends while managing revolving-credit borrowings.
- Actual results versus management’s qualitative expectation of increased fiscal 2018 sales and earnings.