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 POLICIES AND 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 Credit Losses
Evaluation of the allowance for credit losses 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 credit losses is estimated and recorded based on our recent past loss history and an overall assessment of past due trade accounts receivable amounts outstanding.
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.
Income Taxes
We are subject to income taxes in the U.S. (federal and state) and 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. 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
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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, their valuation, and the assumptions around their realization in connection with any associated valuation, and interpretations related to tax laws and accounting rules in various jurisdictions.
RESULTS OF OPERATIONS
Sales for fiscal year 2024 were $203.8 million, a decrease compared to fiscal year 2023 sales of $219.5 million. Domestic Segment sales for fiscal year 2024 were $137.2 million, a decrease of 6.5% compared to fiscal year 2023 sales of $146.7 million. The decrease in Domestic sales was predominantly related to the reduction in non-product revenue related to the Company's decision to stop selling directly to end users. This revenue typically includes freight, installation services and buyouts. International Segment sales for fiscal year 2024 were $66.5 million, a decrease of 8.6% from fiscal year 2023 sales of $72.8 million. International sales decreased when compared to the prior year period due to the delivery of several large projects in the comparable prior year period that were booked in earlier fiscal years.
Our order backlog was $155.6 million at April 30, 2024, as compared to $147.9 million at April 30, 2023.
Gross profit represented 25.5% and 16.2% of sales in fiscal years 2024 and 2023, respectively. The increase in gross profit margin percentage is primarily being generated from Domestic operations. Specifically, the increase is primarily driven by improved manufacturing productivity, cost containment actions, and the pricing of new orders in response to higher raw material input costs when compared to the prior year.
Operating expenses were $33.8 million and $30.2 million in fiscal years 2024 and 2023, respectively, and 16.6% and 13.8% of sales, respectively. The increase in operating expenses in fiscal year 2024 as compared to fiscal year 2023 was primarily due to increases in SG&A wages, benefits, incentive and stock-based compensation of $2,572,000, corporate governance expenses of $170,000, depreciation expense of $164,000, bad debt expense of $156,000, and increases in international operating expenses of $616,000, partially offset by decreases in consulting and professional services of $557,000.
Pension expense was $4,177,000 and $71,000 in fiscal years 2024 and 2023, respectively. The increase in pension expense was due to the Company successfully annuitizing its pension obligation, which had been in a frozen state since 2005. Terminating the pension resulted in a one-time expense of $4,019,000 for accounting losses that were being amortized from the Balance Sheet based on an annual evaluation of the pension plan. By annuitizing the pension obligation, the Company has eliminated all future responsibility for the plan and future administrative costs associated with maintaining and managing the pension plan.
Other income, net was $814,000 and $939,000 in fiscal years 2024 and 2023, respectively. The decrease in other income in fiscal year 2024 was primarily due to the elimination of interest income earned from the Note Receivable related to the Sale-Leaseback financing transaction that was settled in the prior year, partially offset by interest earned on the increased Domestic cash balances and increased interest on International cash balances when compared to the prior fiscal year. See Note 5 , Sale-Leaseback Financing Transaction for additional information on this transaction.
Interest expense was $1,799,000 and $1,734,000 in fiscal years 2024 and 2023, respectively. The interest expense for fiscal year 2024 was relatively unchanged from the prior fiscal year.
Income tax benefit was $5.9 million for fiscal year 2024, or 45.3% of pretax earnings, as compared to income tax expense of $3.1 million for fiscal year 2023, or 69.8% of pretax earnings. The income tax benefit for fiscal year 2024 is primarily due to the favorable impact of the reduction of the Domestic valuation allowance of $6.6 million that was required to be established in fiscal year 2020 per ASC 740 and $3.9 million related to prior years' unrecognized tax benefits related to the settlement of the Company's domestic pension plans. Income tax expense for fiscal year 2024 excluding these one-time benefits is $4.5 million or 34.4% of pretax earnings. At April 30, 2024, the Company has a Domestic valuation allowance of $808,000 for specific federal and state tax credits as compared to $8.5 million for the Company's Domestic net deferred tax assets at April 30, 2023. See Note 6 , Income Taxes for additional information.
The effective tax 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 during the fiscal year. The primary impact of this change was 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.
Net earnings attributable to the non-controlling interest related to our subsidiaries that are not 100% owned by the Company were $304,000 and $621,000 for fiscal years 2024 and 2023, 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.
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Net earnings were $18,753,000, or $6.38 per diluted share, as compared to $738,000, or $0.25 per diluted share, for fiscal years ended April 30, 2024 and April 30, 2023, 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 2025.
At April 30, 2024, we had $3,000,000 outstanding under our $15.0 million revolving credit facility. See Note 4 , Long-term Debt and Other Credit Arrangements , of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report for additional information concerning our credit facility. In fiscal year 2022, we executed a Sale-Leaseback financing transaction with respect to our manufacturing and corporate facilities in Statesville, North Carolina to provide additional liquidity. See Note 5 , Sale-Leaseback Financing Transaction for more information. We did not have any off balance sheet arrangements at April 30, 2024 or 2023.
The following table summarizes the cash payment obligations for our lease and financing arrangements as of April 30, 2024:
PAYMENTS DUE BY PERIOD
($ in thousands)
Contractual Cash Obligations Total 1 Year 2-3 Years 4-5 Years After 5 years
Operating Leases $ 9,802 $ 2,437 $ 3,612 $ 1,859 $ 1,894
Financing Lease Obligations 419 131 152 80 56
Sale-Leaseback Financing Transaction 41,986 1,970 4,058 4,222 31,736
Total Contractual Cash Obligations $ 52,207 $ 4,538 $ 7,822 $ 6,161 $ 33,686
The Company's operating activities provided cash of $19,564,000 in fiscal year 2024, primarily from operations and decreases in receivables of $741,000, decreases in inventories of $1,210,000, increases in accounts payable and accrued expenses of $691,000, and increases in deferred revenue of $277,000. 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.
The Company's financing activities used cash of $3,014,000 during fiscal year 2024 as a result of the net decrease in short-term borrowings of $488,000, repayments on our financing liability of $642,000, and the repurchase of outstanding shares as part of our announced share repurchase program for $1,998,000, partially offset by net proceeds from long-term debt of $114,000. The Company's financing activities provided cash of $14,931,000 during fiscal year 2023 from proceeds of $13,629,000 from the Sale-Leaseback transaction 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 majority of the April 30, 2024 accounts receivable balances are expected to be collected during the first quarter of fiscal year 2025, 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.
Capital expenditures were $4,373,000 and $4,148,000 in fiscal years 2024 and 2023, respectively. Capital expenditures in fiscal year 2024 were funded primarily from financing activities. Fiscal year 2025 capital expenditures are anticipated to be approximately $4.0 million. The fiscal year 2025 expenditures are expected to be funded primarily by operating activities, supplemented as needed by borrowings under our revolving credit facility.
Working capital was $56.0 million at April 30, 2024, up from $47.9 million at April 30, 2023, and the ratio of current assets to current liabilities was 2.4-to-1.0 at April 30, 2024, up from a ratio of 2.2-to-1.0 at April 30, 2023.
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.
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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. The Company's earnings are also impacted by fluctuations in prevailing pricing for projects in the laboratory construction marketplace and costs of raw materials, including steel, wood, and epoxy resin.
The Company is operating more efficiently than in the past due to its ability to focus solely on supporting its dealers and distribution channel partners domestically while continuing to provide turnkey solutions in the international markets it serves. The improved focus of the organization, combined with a strong global management team, a healthy backlog, improved manufacturing capabilities, and end-use markets that continue to prioritize investment in projects that require the products Kewaunee designs and manufactures, positions the Company well.