Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
Kewaunee Scientific Corporation is a recognized leader in the design, manufacture and installation of laboratory, healthcare and technical furniture products. The Company's corporate headquarters are located in Statesville, North Carolina. Sales offices are located in the United States, India, Saudi Arabia, 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 local, Asian, and African markets. Kewaunee Scientific Corporation's website is located at www.kewaunee.com . The reference to our website does not constitute incorporation by reference of any information contained at that site.
Our products are sold primarily through purchase orders and contracts submitted by customers through our dealers, our subsidiaries in Singapore and India, and a national distributor. Products are sold principally to pharmaceutical, biotechnology, industrial, chemical and commercial research laboratories, educational institutions, healthcare institutions, governmental entities, manufacturing facilities and users of networking furniture. We consider the markets in which we compete to be highly competitive, with a significant amount of the market requiring competitive public bidding.
It is common in the laboratory and healthcare furniture industries for customer orders to require delivery at extended future dates, as products are frequently to be installed in buildings yet to be constructed. Changes or delays in building construction may cause delays in delivery of the orders and our recognition of the sale. Since prices are normally quoted on a firm basis in the industry, we bear the burden of possible increases in labor and material costs between quotation of an order and delivery of the product. The impact of such possible increases is considered when determining the sales price. The principal raw materials and products manufactured by others used in our products are cold-rolled carbon and stainless steel, hardwood lumbers and plywood, paint, chemicals, resins, hardware, plumbing and electrical fittings. Such materials and products are purchased from multiple suppliers and are typically readily available.
CRITICAL ACCOUNTING ESTIMATES
In the ordinary course of business, we have made estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of our consolidated financial statements in conformity with generally accepted accounting principles in the United States of America. Actual results could differ significantly from those estimates. We believe that the following discussion addresses our most critical accounting estimates, which are those that are most important to the portrayal of our financial condition and results of operations, and require management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Allowance for Doubtful Accounts
Evaluation of the allowance for doubtful accounts involves management judgments and estimates. We evaluate the collectability of our trade accounts receivable based on a number of factors. In circumstances where management is aware of a customer's inability to meet its financial obligations to us, or a project dispute makes it unlikely that the outstanding amount owed by a customer will be collected, a specific reserve for bad debts is estimated and recorded to reduce the recognized receivable to the estimated amount we believe will ultimately be collected. In addition to specific customer identification of potential bad debts, a 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.
Pension Benefits
We sponsor pension plans covering all employees who met eligibility requirements as of April 30, 2005. These pension plans were amended as of April 30, 2005, no further benefits have been, or will be, earned under the plans subsequent to the amendment date, and no additional participants have been, or will be, added to the plans. Several statistical and other factors, which attempt to anticipate future events, are used in calculating the expense and liability related to the pension plans. These factors include actuarial assumptions about the discount rate used to calculate and determine benefit obligations and the expected return on plan assets within certain guidelines. The actuarial assumptions used by us may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates, or longer or shorter life spans of participants. These differences may significantly affect the amount of pension income or expense recorded by us in future periods.
Self-Insurance Reserves
The Company's domestic operations are self-insured for employee health care costs. The Company has purchased specific stop-loss insurance policies to limit claims above a certain amount. 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.
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Income Taxes
We are subject to income taxes in the U.S. (federal and state) and numerous foreign jurisdictions. Tax laws, regulations, administrative practices, and interpretations in various jurisdictions may be subject to significant change, with or without notice, due to economic, political, and other conditions, and significant judgment is required in evaluating and estimating our provision and accruals for these taxes. There are many transactions that occur during the ordinary course of business for which the ultimate tax determination is uncertain. In addition, our actual and forecasted earnings are subject to change due to economic, political, and other conditions.
Our effective tax rates could be affected by numerous factors, such as changes in our business operations, acquisitions, investments, entry into new businesses and geographies, intercompany transactions, the relative amount of our foreign earnings, including earnings being lower than anticipated in jurisdictions where we have lower statutory rates and higher than anticipated in jurisdictions where we have higher statutory rates, losses incurred in jurisdictions for which we are not able to realize related tax benefits, the applicability of special tax regimes, changes in foreign currency exchange rates, changes to our forecasts of income and loss and the mix of jurisdictions to which they relate, changes in our deferred tax assets and liabilities and their valuation, and interpretations related to tax laws and accounting rules in various jurisdictions.
RESULTS OF OPERATIONS
Sales for fiscal year 2023 were $219.5 million, an increase compared to fiscal year 2022 sales of $168.9 million. Domestic Segment sales for fiscal year 2023 were $146.7 million, an increase of 15.7% compared to fiscal year 2022 sales of $126.8 million. The increase in Domestic Segment sales is primarily driven by the pricing of new orders in response to higher raw material input costs. International Segment sales for fiscal year 2023 were $72.8 million, an increase of 73.2% from fiscal year 2022 sales of $42.0 million. The increase in International Segment sales in fiscal year 2023 is due to the delivery of several large projects in India, Asia, and Africa that were awarded over the course of the past eighteen months.
Our order backlog was $147.9 million at April 30, 2023, as compared to $173.9 million at April 30, 2022. The decrease in backlog is primarily attributable to the substantial completion of the previously announced Dangote Oil project in Nigeria during the fiscal year and a reduction in new orders within the ASEAN marketplace. The Company's backlog for the United States and Indian markets on April 30, 2023 is similar to prior fiscal year levels as order rates in these markets remain strong.
Gross profit represented 16.2% and 14.3% of sales in fiscal years 2023 and 2022, respectively. The increase in gross profit margin percentage for fiscal year 2023 is driven by the significant increase in International Segment sales, which has a higher gross profit rate than the Domestic Segment, coupled with an increase in Domestic Segment sales that had improved pricing as noted above.
Operating expenses were $30.2 million and $26.8 million in fiscal years 2023 and 2022, respectively, and 13.8% and 15.9% of sales, respectively. The increase in operating expense in fiscal year 2023 as compared to fiscal year 2022 was primarily due to increases in consulting and professional fees of $552,000, corporate governance expenses of $113,000, and increases in International Segment operating expenses of $2,286,000 as a result of the significant sales growth experienced. These increases were partially offset by reductions in administrative wages, benefits, and stock-based compensation of $142,000, and marketing expense of $223,000. The increase in operating expenses for fiscal year 2023 also included a one-time charge related to the write-down of a prior year insurance claim in the amount of $260,000. The increase in international operating expenses for fiscal year 2023 is related to the continued sales growth in the International operating segment.
Pension expense was $71,000 in fiscal year 2023, compared to pension income of $355,000 in fiscal year 2022. The increase in pension expense was primarily due to the lower expected return on plan assets driven by a decrease in plan assets in the prior fiscal year.
Other income, net was $939,000 and $400,000 in fiscal years 2023 and 2022, respectively. The increase in other income in fiscal year 2023 was primarily due to interest income earned on the cash balances held by the Company's international subsidiaries and the increased interest earned on the Note Receivable related to the Sale-Leaseback financing transaction when compared to the prior fiscal year. See Note 5 , Sale-Leaseback Financing Transaction for additional information on this transaction.
Interest expense was $1,734,000 and $632,000 in fiscal years 2023 and 2022, respectively. The increase in interest expense for fiscal year 2023 was primarily due to the Sale-Leaseback financing transaction noted above, partially offset by a decrease in interest expense related to the Company's revolving credit facility.
Income tax expense was $3.1 million and $3.5 million for fiscal years 2023 and 2022, respectively, or 69.8% and 141.6% of pretax earnings (loss), respectively. The effective rate for fiscal year 2023 was unfavorably impacted by the increase in the valuation allowance attributable to changes to Internal Revenue Code Section 174 Research and Experimental Expenditures, which became effective in the current fiscal year. The primary impact of this change is the amortization of current year expenditures over a five year period, as compared to prior fiscal years where research expenditures were deductible in the year incurred. The effective rate change for fiscal year 2022 was also unfavorably impacted due to changes in the valuation allowance
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attributable to the net increase in deferred tax assets of $4,170,000 before valuation allowance as a result of the book to tax differences primarily related to the Company's execution of a Sale-Leaseback transaction for owned real property, which was treated as a taxable sale transaction for tax purposes and a financing transaction for financial statement reporting purposes.
Net earnings attributable to the non-controlling interest related to our subsidiaries that are not 100% owned by the Company were $621,000 and $123,000 for fiscal years 2023 and 2022, respectively. The changes in the net earnings attributable to the non-controlling interest for each year were due to changes in the levels of net income of the subsidiaries.
Net earnings were $738,000, or $0.25 per diluted share, as compared to net loss of $6,126,000, or $2.20 per diluted share, for fiscal years ended April 30, 2023 and April 30, 2022, respectively. The increase in net earnings was attributable to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity have historically been funds generated from operating activities, supplemented as needed by borrowings under our revolving credit facility. Additionally, certain machinery and equipment are financed by non-cancelable operating and financing leases. We believe that these sources of funds will be sufficient to support ongoing business requirements, including capital expenditures, through fiscal year 2024.
At April 30, 2023, we had $3,548,000 outstanding under our $15.0 million revolving credit facility. See Note 4 , Long-term Debt and Other Credit Arrangements , of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for additional information concerning our credit facility. In fiscal year 2022, we executed a Sale-Leaseback financing transaction with respect to our manufacturing and corporate facilities in Statesville, North Carolina to provide additional liquidity. See Note 5 , Sale-Leaseback Financing Transaction for more information. We did not have any off balance sheet arrangements at April 30, 2023 or 2022.
The following table summarizes the cash payment obligations for our lease and financing arrangements as of April 30, 2023:
PAYMENTS DUE BY PERIOD
($ in thousands)
Contractual Cash Obligations Total 1 Year 2-3 Years 4-5 Years After 5 years
Operating Leases $ 10,636 $ 2,373 $ 4,095 $ 2,788 $ 1,380
Financing Lease Obligations 254 91 163 — —
Sale-Leaseback Financing Transaction 43,917 1,931 3,979 4,140 33,867
Total Contractual Cash Obligations $ 54,807 $ 4,395 $ 8,237 $ 6,928 $ 35,247
The Company's operating activities used cash of $3,790,000 in fiscal year 2023, primarily for increases in receivables of $4,947,000 and decreases in accounts payable and accrued expenses of $5,558,000, partially offset by cash from operations, decreases in inventories of $1,907,000, and increases in deferred revenue of $568,000. Operating activities used cash of $7,885,000 in fiscal year 2022, primarily for operations, increases in inventories of $7,279,000 and receivables of $8,464,000, partially offset by increases in accounts payable and accrued expenses of $11,886,000 and a decrease in income tax receivable of $955,000.
The Company's financing activities provided cash of $14,931,000 during fiscal year 2023 as a result of the collection of $13,629,000 in final proceeds from the Sale-Leaseback transaction executed in the prior fiscal year and proceeds from the net increase in short-term borrowings of $1,998,000, partially offset by repayment of long-term debt of $121,000. The Company's financing activities provided cash of $11,031,000 during fiscal year 2022 from proceeds of $15,893,000 from the Sale-Leaseback transaction, including redemption of preferred shares from the buyer, net of debt issuance costs, partially offset by payments of $5,239,000 for short-term borrowings.
The majority of the April 30, 2023 accounts receivable balances are expected to be collected during the first quarter of fiscal year 2024, with the exception of retention amounts on fixed-price contracts which are collected when the entire construction project is completed and all retention funds are paid by the owner.
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. In fiscal years 2023 and 2022, we made no contributions to the plans. We expect to make no contributions to the plans for fiscal year 2024.
Capital expenditures were $4,148,000 and $1,908,000 in fiscal years 2023 and 2022, respectively. Capital expenditures in fiscal year 2023 were funded primarily from financing activities. Fiscal year 2024 capital expenditures are anticipated to be
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approximately $4.4 million. The fiscal year 2024 expenditures are expected to be funded primarily by operating activities, supplemented as needed by borrowings under our revolving credit facility.
Working capital was $47.9 million at April 30, 2023, down from $49.3 million at April 30, 2022, and the ratio of current assets to current liabilities was 2.2-to-1.0 at April 30, 2023 unchanged from April 30, 2022.
No dividends were declared or paid on the Company's common stock during the last two fiscal years. The declaration and payment of any future dividends is 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 condition, the terms of the Company's indebtedness, which 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
See Note 1 , Summary of Significant Accounting Policies , to our Consolidated Financial Statements in this Form 10-K for a discussion of new accounting pronouncements, which is incorporated herein by reference.
OUTLOOK
Financial Outlook
The Company's ability to predict future demand for its products continues to be limited given its role as subcontractor or supplier to dealers for subcontractors. Demand for the Company's products is also dependent upon the number of laboratory and healthcare construction projects planned and/or current progress in projects already under construction.
Fiscal year 2023 was a transition year for the Company as it emerged from a generally disruptive three-year period that included a global pandemic, rapid broad-based inflation, labor shortages, and supply chain disruptions. The Company believes it is well-positioned for the next fiscal year due to its strong global management team, a healthy backlog, improved manufacturing capabilities, and end-use markets that will continue to prioritize investment in projects that require the products Kewaunee designs and manufactures.