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Item 7. Management’s Discussion and Analysis

2020-07-27 compared with 2019-07-11 · 60 added, 74 removed, 118 unchanged (53% of the section changed)

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changes in raw materials and commodity costs;

the effects of COVID-19;

and acts of terrorism, war, governmental action, natural disasters and other Force Majeure events.

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The Company’s corporate headquarters are located in Statesville, North Carolina.

Direct sales offices are located in the United States, India, Singapore, and China.

Direct sales offices are located in the United States, India, and Singapore.

Three manufacturing facilities are located in Statesville serving the domestic and international markets, and one manufacturing facility is located in Bangalore, India serving the Indian, Middle East and Asian markets.

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In addition to specific customer identification of potential bad debts, a general reserve for bad debts is estimated and recorded based on our recent past loss history and an overall assessment of past due trade accounts receivable amounts outstanding.

The Company’s inventories are valued at the lower of cost or net realizable value.

Prior to August 1, 2018, the Company’s Domestic segment’s inventories were valued under the last-in, first-out (“LIFO”) valuation method.

On August 1, 2018, the Company changed its method of valuing inventory for the Domestic segment from LIFO to first-in, first-out (“FIFO”).

The Company believes that this method change to FIFO will improve financial reporting by better reflecting the current value of inventory on the consolidated balance sheet, more closely aligning the flow of physical inventory with the accounting for the inventory, and providing better matching of revenues and expenses.

Inventories at our International subsidiaries are, and remain, measured on the FIFO method.

The Company’s inventories are valued at the lower of cost or net realizable value using the first-in, first-out (“FIFO”) method.

Pension Benefits

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The Company has purchased specific stop-loss insurance to limit claims above a certain amount.

Estimated medical costs were accrued for claims incurred but not reported (“IBNR”) using assumptions based upon historical loss experiences.

Estimated medical costs were accrued for claims incurred but not reported using assumptions based upon historical loss experiences.

The Company’s exposure reflected in the self-insurance reserves varies depending upon market conditions in the insurance industry, availability of cost-effective insurance coverage, and actual claims versus estimated future claims.

RESULTS OF OPERATIONS

Sales for fiscal year 2019 were $146.6 million, a decrease of 7.3% from fiscal year 2018 sales of $158.1 million.

Domestic sales for fiscal year 2019 were $116.6 million, an increase of 1.7% compared to fiscal year 2018 sales of $114.6 million.

International sales for fiscal year 2019 were $30.0 million, a decrease of 31.0% from fiscal year 2018 sales of $43.5 million.

The decrease in International sales for fiscal year 2019 is primarily due to the year-over-year decline in sales in the Middle East region.

In fiscal year 2018, Kewaunee’s International segment delivered the single largest order ever awarded to Kewaunee for the College of Science complex for Kuwait University's Sabah Al Salem University City, which continues to affect the comparison of operating performance of the International segment in the current fiscal year.

Sales for fiscal year 2020 were $147.5 million, an increase of 0.7% from fiscal year 2019 sales of $146.6 million.

Domestic sales for fiscal year 2020 were $115.1 million, a decrease of 1.3% compared to fiscal year 2019 sales of $116.6 million.

International sales for fiscal year 2020 were $32.4 million, an increase of 8.3% from fiscal year 2019 sales of $30.0 million.

The increase in International sales for fiscal year 2020 is the result of continued deliveries of a large order in the Middle East market.

Our order backlog was $100.9 million at April 30, 2020, as compared to $100.8 million at April 30, 2019.

Gross profit represented 15.9% and 17.3% of sales in fiscal years 2020 and 2019, respectively.

The decrease in gross profit margin percentage was primarily due to an unfavorable shift in product mix, and year-over-year decline in sales, as well as continued increases in raw material and freight costs which negatively affected margins compared to the prior period.

The unfavorable impact due to year-over-year increases in steel and resin material costs was approximately $2.1 million dollars.

The decrease in gross profit margin percentage was a result of a number of low margin orders that the Company aggressively pursued and secured over the past year, which included a strategic Middle East order aggressively secured over two years ago at lower than normal margins which was delivered in the current fiscal year.

Additionally, profitability was impacted during the year as a result of the coronavirus pandemic.

Operating expenses were $25.8 million and $23.2 million in fiscal years 2020 and 2019, respectively, and 17.5% and 15.8% of sales, respectively.

The increase in operating expense dollars in fiscal year 2019 as compared to fiscal year 2018 is related primarily to management separation expenses of $502,000, audit and tax services of $637,000, and an increase of $893,000 in operating expense for the Company’s International operations, partially offset by a decrease in incentive compensation of $1.2 million.

The increase in operating expense dollars in fiscal year 2020 as compared to fiscal year 2019 is related primarily to an increase in personnel expenses of $798,000, incentive and stock compensation of $385,000, restructuring expenses of $312,000, and depreciation expense of $136,000.

The increased personnel expenses were driven by investments in talent to accelerate our strategy to modernize our manufacturing capabilities and information technology platform.

Also contributing to the increase was an increase of bad debt expense of $299,000 related primarily to the closure of our China subsidiary, other China closure expenses of $48,000, $134,000 of expenses related to our new Indian subsidiary, and increases of $510,000 in other International subsidiary operating expenses, partially offset by decreases in management separation expenses of $388,000 and professional and consulting fees of $308,000.

See Note 11 of the Notes to the Consolidated Financial Statements included in Item 8 for additional information concerning the Company's restructuring costs.

Other income (expense) was $426,000 and $684,000 in fiscal years 2020 and 2019, respectively.

The increase in other income in fiscal year 2019 was primarily due to the decrease in pension plan expense as discussed in Note 9 of the Notes to the Consolidated Financial Statements included in Item 8.

The decrease in other income (expense) in fiscal year 2020 was primarily due to the decrease in interest income related to the repatriation of foreign cash utilized to reduce debt as discussed in Note 9 of the Notes to the Consolidated Financial Statements included in Item 8.

Interest expense was $493,000 and $367,000 in fiscal years 2020 and 2019, respectively.

The increase in interest expense for fiscal year 2020 was primarily due to increases in the levels of bank borrowings.

Domestic pre-tax earnings were impacted by a significant decline in the Company’s operating volumes during the second half of the fiscal year which resulted in the Company operating at levels below the rate we believe is necessary to generate favorable financial results.

The Company's financial results were unfavorably impacted by shifts in the manufacturing demand which occurred more rapidly than the Company's ability to reduce its fixed cost structure.

Profitability was also impacted by higher raw material costs in steel and resin that we were not able to pass along to customers.

International pre-tax earnings were impacted by the year-over-year decline in sales as well as the year-over-year decline in the exchange rate of the Indian rupee versus the US dollar.

Finally, profitability was impacted by one-time non-operating costs related to management changes.

Income tax expense was $446,000 and $4,161,000 in fiscal years 2019 and 2018, respectively, or 20.9% and 43.3% of pretax earnings, respectively.

The effective tax rate decreased in fiscal year 2019, primarily due to the effect of the enactment of the Tax Cuts and Jobs Act ("2017 Tax Act").

The effective rate increased in fiscal year 2018 primarily due to the enactment of the 2017 Tax Act which imposed a one-time transition tax on the unrepatriated earnings of our foreign subsidiaries.

The impact of this one-time transition tax recorded for fiscal year 2018 was $649,000.

Income tax expense was $1.8 million and $446,000 in fiscal years 2020 and 2019, respectively, or -61.3% and 20.9% of pretax earnings, respectively.

The unfavorable effective rate for fiscal year 2020 compared to the prior fiscal year is primarily due to additional tax expense of $2.0 million as a result of the Company’s elimination of its indefinite reinvestment of foreign unremitted earnings and an increase in valuation allowances of $1.7 million, partially offset by the favorable tax benefit of $939,000 for net operating losses to be carried back to prior years with higher enacted tax rates as discussed in Note 5 of the Notes to the Consolidated Financial Statements included in Item 8.

Net earnings attributable to the noncontrolling interest related to our subsidiaries that are not 100% owned by the Company were $63,000 and $159,000 for fiscal years 2020 and 2019, respectively.

The changes in the net earnings attributable to the noncontrolling interest for each year were due to changes in the levels of net income of the subsidiaries.

Net earnings in fiscal year 2019 were $1,529,000, or $0.55 per diluted share.

Net loss in fiscal year 2020 was $4,687,000, or $1.70 per diluted share.

Net earnings in fiscal year 2019 were $1,529,000, or $0.55 per diluted share.

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We believe that these sources of funds will be sufficient to support ongoing business requirements, including capital expenditures, through fiscal year 2021.

At April 30, 2019, we had advances of $9.5 million and standby letters of credit aggregating $5.2 million outstanding under our unsecured $20 million revolving credit facility.

At April 30, 2020, we had advances of $4.7 million and standby letters of credit aggregating $512,000 outstanding under our unsecured revolving credit facility.

On June 19, 2019 we entered into a Security Agreement pursuant to which we granted a security interest in substantially all of our assets to secure our obligations under the credit facility.

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We did not have any off balance sheet arrangements at April 30, 2020.

The following table summarizes the cash payment obligations for our lease arrangements and long-term debt as of April 30, 2019:

The following table summarizes the cash payment obligations for our lease arrangements as of April 30, 2020:

PAYMENTS DUE BY PERIOD

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Operating Leases

Long-term Debt and Capital Lease Obligations

Capital Lease Obligations

Total Contractual Cash Obligations

Operating activities provided cash of $2,490,000 in fiscal year 2019, primarily from operating earnings, and a decrease in inventories, partially offset by increases in receivables, and decreases in deferred revenue.

Operating activities provided cash of $3,183,000 in fiscal year 2018, primarily from operating earnings, and an increase in accounts payable and other accrued expenses, partially offset by increases in receivables, inventories, and deferred revenue.

Operating activities provided cash of $4,161,000 in fiscal year 2020, primarily from operations, and decreases in inventories of $1,876,000 and receivables of $4,833,000, partially offset by decreases in accounts payable and accrued expenses of $2,016,000.

Operating activities provided cash of $2,490,000 in fiscal year 2019, primarily from operating earnings, and an increase in accounts payable and other accrued expenses, partially offset by increases in inventories and deferred revenue.

The Company’s financing activities used cash of $7,458,000 during fiscal year 2020 for payments on short-term borrowings of $4,794,000, cash dividends of $1,044,000 paid to stockholders, cash dividends of $324,000 paid to minority interest holders and repayment of long-term debt of $1,282,000.

The Company’s financing activities provided cash of $2,334,000 during fiscal year 2019 as a result of an increase in short-term borrowings of $5,628,000, which was partially utilized for cash dividends of $2,030,000 paid to stockholders, cash dividends of $51,000 paid to minority interest holders and repayment of long-term debt of $1,177,000.

The Company’s financing activities used cash of $2,484,000 during fiscal year 2018 for cash dividends of $1,794,000 paid to stockholders, cash dividends of $74,000 paid to minority interest holders, and repayment of long-term debt of $918,000, partially offset by an increase in short-term borrowings of $294,000.

See Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for additional information concerning our credit facility.

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As discussed above, no further benefits have been, or will be, earned under our pension plans after April 30, 2005, and no additional participants have been, or will be, added to the plans.

We do not expect to make any contributions to the plans in fiscal year 2020.

We made contributions of $1,000,000 and $600,000 to the plans in fiscal years 2019 and 2018, respectively.

There were no contributions to the plans in fiscal year 2020 and we expect to make contributions of $30,000 to the plans in fiscal year 2021.

We made contributions of $1,000,000 to the plans in fiscal year 2019.

Capital expenditures were $2.5 million and $4.2 million in fiscal years 2020 and 2019, respectively.

Capital expenditures in fiscal year 2020 were funded primarily from operations.

Fiscal year 2020 capital expenditures are anticipated to be approximately $2.5 million, with the majority of these expenditures for manufacturing equipment and facilities improvements.

During fiscal 2020, the Company established a strategy for a multi-year transformation of the business, which is designed to lead to sustained profitability and growth.

Fiscal year 2021 capital expenditures are anticipated to be approximately $2.0 million, with the majority of these expenditures related to investing in modernizing our manufacturing capabilities and information technology platform.

The fiscal year 2021 expenditures are expected to be funded primarily by operating activities, supplemented as needed by borrowings under our revolving credit facility.

Working capital was $32.6 million at April 30, 2019, down from $36.8 million at April 30, 2018, and the ratio of current assets to current liabilities was 2.0-to-1.0 at April 30, 2019 and 2.3-to-1.0 at April 30, 2018.

The decrease in working capital for fiscal year 2019 was primarily due to the increase in current liabilities related to the outstanding line of credit at year end along with the decrease in inventories, partially offset by an increase in cash and receivables.

Working capital was $27.2 million at April 30, 2020, down from $32.6 million at April 30, 2019, and the ratio of current assets to current liabilities was 2.0-to-1.0 at April 30, 2020 and April 30, 2019.

The decrease in working capital for fiscal year 2020 was primarily due to the decrease in cash and accounts receivable partially offset by a decrease in outstanding debt.

We paid cash dividends of $0.38 per share in fiscal year 2020.

We paid cash dividends of $0.74 per share in fiscal year 2019.

We expect to pay a dividend in the future in line with our actual and anticipated future operating results.

The declaration and payment of future dividends under the quarterly dividend policy will be at the discretion of the Board of Directors and will depend upon many factors, including the Company’s earnings, capital requirements, financial conditions, the terms of the Company’s indebtedness and other factors that the Board of Directors may deem to be relevant.

On December 16, 2019, the Company announced that the Board of Directors had elected to suspend the Company's dividend.

The declaration and payment of any future dividends will be at the discretion of the Board of Directors and will depend upon many factors, including the Company’s earnings, capital requirements, investment and growth strategies, financial conditions, the terms of the Company’s indebtedness, which currently contains provisions that could limit the payment of dividends in certain circumstances, and other factors that the Board of Directors may deem to be relevant.

RECENT ACCOUNTING STANDARDS

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In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”).

This update outlined a new comprehensive revenue recognition model that

supersedes most prior revenue recognition guidance and required companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflected the consideration to which the entity expected to be entitled in exchange for those goods or services.

The Company adopted this standard effective May 1, 2019.

See Note 2 of the Notes to Consolidated Financial Statements included in Item 8 for a discussion of the impact of the adoption of this standard.

In July 2015, the FASB issued ASU 2015-11, “Inventory—Simplifying the Measurement of Inventory.” This guidance changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value.

Net realizable value is defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016.

This update outlined a new comprehensive revenue recognition model that supersedes most prior revenue recognition guidance and required companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflected the consideration to which the entity expected to be entitled in exchange for those goods or services.

The Company adopted this standard effective May 1, 2018.

The adoption of this standard did not have a significant impact on the Company’s consolidated financial position or results of operations.

In February 2016, the FASB issued ASU 2016-02, “Leases.” This guidance establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.

Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.

In February 2016, the FASB issued ASU 2016-02, “Leases.” This guidance establishes a right-of-use ("ROU") model that requires a lessee to record an ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.

Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the

income statement.

A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.

This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018.

The Company will adopt this standard in fiscal year 2020.

Based on the Company's assessment to date, the Company expects that the adoption of ASU 2016-02 will result in the recognition of right-to-use assets and corresponding lease liabilities with a material impact on the Company's consolidated financial position and an immaterial impact on the Company's consolidated results of operations and cash flows.

In March 2016, the FASB issued ASU 2016-09, “Stock Compensation—Improvements to Employee Share-Based Payment Accounting.” This guidance simplifies various aspects related to how share-based payments are accounted for and presented in the financial statements.

This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016.

This guidance became effective for fiscal years, and interim periods within those years, beginning after December 15, 2018.

The Company adopted this standard effective May 1, 2019.

Prior periods were not retrospectively adjusted.

The adoption of this standard did not have a significant impact on the Company’s consolidated financial position or results of operations.

The adoption of ASU 2016-02 resulted in the recognition of ROU assets and corresponding lease liabilities on the Company's consolidated financial position.

See Note 8 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for additional information.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments,” which replaces the current incurred loss method used for determining credit losses on financial assets, including trade receivables, with an expected credit loss method.

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The Company does not expect the adoption of this standard to have a significant impact on the Company’s consolidated financial position or results of operations.

In August 2016, the FASB issued ASU 2016-15, “Cash Flow Classification of Certain Cash Receipts and Cash Payments,” which clarifies guidance on classification of certain transactions in the statement of cash flows, including classification of debt prepayments, debt extinguishment costs and contingent consideration payments after a business combination.

This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017.

The Company adopted this standard effective May 1, 2018.

The adoption of this standard did not have a significant impact on the Company’s consolidated financial position or results of operations.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows—Restricted Cash,” which requires that the statement of cash flows reconcile the change during the period in total cash, cash equivalents and restricted cash.

This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017.

The Company adopted this standard effective May 1, 2018.

The adoption of this standard did not have a significant impact on the Company’s consolidated financial position or results of operations.

In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge.

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The Company will adopt this standard in fiscal year 2021.

The Company does not expect the adoption of this standard to have any impact on the Company’s consolidated financial position or results of operations.

The Company does not expect the adoption of this standard to have a significant impact on the Company’s consolidated financial position or results of operations.

In March 2017, the FASB issued ASU 2017-07, “Compensation—Retirement Benefits—Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” which requires that the service cost component of net periodic pension cost is presented in the same line as other compensation costs arising from services rendered by the respective employees during the year.

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This guidance allows for the service cost component to be eligible for capitalization when applicable.

This guidance is effective for fiscal years, and interim

periods within those years, beginning after December 15, 2017.

This guidance became effective for fiscal years, and interim periods within those years, beginning after December 15, 2017.

The Company adopted this standard effective May 1, 2018 using the full retrospective approach.

The Company reclassified $694,000 of non-service components of net benefits cost to other (income)/expense, net from operating expenses on the Consolidated Statements of Operations.

During 2019, the Company recorded $295,000 of non-service components of net benefits cost to other (income)/expense, net.

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation—Scope of Modification Accounting.” This guidance was issued in an effort to reduce diversity in practice as it relates to applying modification accounting for changes to the terms and conditions of share-based payment awards.

This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted.

In February 2018, the FASB issued ASU 2018-2, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This guidance provides the Company with an option to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act ("2017 Tax Act") from accumulated other comprehensive income to retained earnings.

This guidance became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted.

The Company adopted this standard effective May 1, 2019 and did not elect to reclassify tax effects as a result of tax reform;

therefore, the adoption did not have a significant impact on the Company's consolidated financial position or results of operations.

In March 2018, the FASB issued ASU 2018-09, “Compensation - Stock Compensation ("Topic 718"):

Improvements to Employee Share-Based Payment Accounting” ("ASU 2018-09").

This ASU makes several modifications to Topic 718 related to the accounting for forfeitures, employer tax withholding on share-based compensation, and the financial statement presentation of excess tax benefits or deficiencies.

ASU 2018-09 also clarifies the statement of cash flows presentation for certain components of share-based awards.

The standard is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted.

The Company adopted this standard effective May 1, 2019.

The adoption of this standard did not have a significant impact on the Company's consolidated financial position or results of operations.

In February 2018, the FASB issued ASU 2018-2, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This guidance provides the Company with an option to reclassify stranded tax effects resulting from the 2017 Tax Act from accumulated other comprehensive income to retained earnings.

This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted.

In August 2018, the FASB issued ASU 2018-14, “Compensation -Retirement Benefits -Defined Benefit Plans -General (Subtopic 715-20) - Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans" ("ASU 2018-14").

The amendments in this update remove defined benefit plan disclosures that are no longer considered cost-beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant.

ASU 2018-14 is effective for fiscal years ending after December 15, 2020.

Early adoption is permitted.

The Company will adopt this standard in fiscal year 2021.

The Company does not expect the adoption of this standard to have a significant impact on the Company’s consolidated financial position or results of operations.

In December 2019, the FASB issued ASU No.

2019-12 , "Income Taxes ("Topic 740"):

Simplifying the Accounting for Income Taxes." This update simplifies the accounting for income taxes through certain targeted improvements to various subtopics within Topic 740.

The amendments in this update are effective for fiscal years and interim periods beginning after December 15, 2020.

The Company expects to adopt this guidance when effective and is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.

Financial Outlook

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Additionally, since prices are normally quoted on a firm basis in the industry, the Company bears the burden of possible increases in labor and material costs between the quotation of an order and delivery of a product.

Looking forward, the Company is optimistic in its ability to secure the volumes necessary to return to profitability, and that fiscal year 2020 will result in sales and earnings growth.

Looking forward, we are optimistic about our opportunities for growth within our existing end-markets and are committed to investing and modernizing our capabilities to succeed.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis