# PARK AEROSPACE CORP (PKE) FY 2024 MD&A

Verbatim Item 7 Management's Discussion and Analysis from PARK AEROSPACE CORP's 10-K for fiscal year 2024.

SEC filing source: https://www.sec.gov/Archives/edgar/data/76267/000143774924019951/pke20240225_10k.htm
Accession: 0001437749-24-019951
Filing date: 2024-06-11
Report date: 2024-03-03
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/PKE/
All MD&A years: /company/PKE/mda/
Previous year: /company/PKE/mda/fy2023/ (FY 2023)
Next year: /company/PKE/mda/fy2025/ (FY 2025)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

General:

Park Aerospace Corp. (“Park” or the “Company”) is an aerospace company which develops and manufactures solution and hot-melt advanced composite materials used to produce composite structures for the global aerospace markets. Park’s advanced composite materials include film adhesives and lightning strike protection materials. Park offers an array of composite materials specifically designed for hand lay-up or automated fiber placement (AFP) manufacturing applications. Park’s advanced composite materials are used to produce primary and secondary structures for jet engines, large and regional transport aircraft, military aircraft, Unmanned Aerial Vehicles (UAVs commonly referred to as “drones”), business jets, general aviation aircraft and rotary wing aircraft. Park also offers specialty ablative materials for rocket motors and nozzles and specially designed materials for radome applications. As a complement to Park’s advanced composite materials offering, Park designs and fabricates composite parts, structures and assemblies and low volume tooling for the aerospace industry. Target markets for Park’s composite parts and structures (which include Park’s proprietary composite SigmaStrut™ and AlphaStrut™ product lines) are, among others, prototype and development aircraft, special mission aircraft, spares for legacy military and civilian aircraft and exotic spacecraft.

The Company’s fiscal year is the 52- or 53-week period ending the Sunday nearest to the last day of February. The 2024, 2023 and 2022 fiscal years ended on March 3, 2024, February 26, 2023 and February 27, 2022, respectively. The 2024 fiscal year consisted of 53 weeks and the 2023 and 2022 fiscal years each consisted of 52 weeks. Unless otherwise indicated in this Discussion and Analysis, all references to years and quarters in this Discussion and Analysis are to the Company’s fiscal years and fiscal quarters, and all annual and quarterly information in this Discussion and Analysis is for such fiscal years and quarters, respectively.

2024 Financial Overview

On February 9, 2023, the Company’s Board of Directors declared a special dividend of $1.00 per share payable April 6, 2023 to shareholders of record at the close of business on March 9, 2023. The total amount of this special dividend was approximately $20.5 million.

The Company's total net sales worldwide in 2024 were 4% higher than in 2023. The increase in sales was primarily driven by an increase in military market sales, while sales to each of the other markets the Company serves were relatively even with the prior year sales levels.

The Company’s gross profit margin, measured as a percentage of sales, decreased to 29.5% in 2024 from 30.5% in 2023. Higher costs for labor, employee benefits, depreciation, utilities, and property taxes more than offset a favorable sales mix and higher pricing.

The Company’s earnings from operations in 2024 were 16% lower than in 2023, primarily as a result of higher selling, general and administrative expenses, including higher incentive payments, as well as higher legal expenses resulting from shareholder defense actions, costs to settle an insurance claim as the result of the bankruptcy of an insurer and higher recruiting fees. The Company’s net earnings from operations in 2024 were 30% lower than in 2023, primarily due to a higher tax rate in 2024 compared to 2023 and the increased costs described above offset by higher interest income. The increase in the 2024 tax rate compared to the 2023 tax rate resulted from a lower benefit from the reduction in uncertain tax positions in 2024 as compared to 2023.

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The Company continues to experience inflation in costs of raw materials and supplies, freight costs and other costs and expenses. The impact of inflation on the Company’s profits has been partially mitigated by the Company’s ability to adjust pricing for a large portion of its sales to pass the impact of inflation through to its customers.

Programs in which the Company participates as a supplier are, in some cases, experiencing supply chain issues from other suppliers to the programs that could result in delays in production for certain customers of the Company. The Company’s sales could be impacted by supply chain challenges its customers are experiencing from other suppliers.

While the wars in Ukraine and the Middle East have had a negative impact on the Company’s results of operations due to delayed shipments, the Company may experience an increase in future sales due to increases in spending worldwide on missile defense systems and other defense programs. The Company does not have any significant customers in Russia or Ukraine but does have customers in Israel. The Company has experienced some increases to raw material costs from overseas suppliers due to the impacts of the wars in Ukraine and the Middle East.

The Company has a number of long-term contracts pursuant to which certain of its customers, some of which represent a substantial portion of the Company’s revenue, place orders. Long-term contracts with the Company’s customers are primarily requirements based and do not guarantee quantities. An order forecast is generally agreed concurrently with pricing for any applicable long-term contract. This order forecast is then typically updated periodically during the term of the underlying contract. Purchase orders are generally received in excess of three months in advance of delivery.

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Results of Operations:

2024 Compared to 2023

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[[/GREPCENT_TABLE]]

Net Sales

The Company’s total net sales worldwide in 2024 were 4% higher than in 2023. Higher sales in 2024 were primarily driven by increased sales in the military markets.

Gross Profit

The Company’s gross profit margin, measured as a percentage of sales, decreased to 29.5% in 2024 from 30.5% in 2023. The decrease in gross margin was primarily due to higher costs for labor, employee benefits, depreciation, utilities, property taxes and other items, partially offset by a favorable sales mix and higher pricing.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $1.6 million, or 25%, during 2024 compared to 2023. Such expenses, measured as percentages of sales, were 14.6% and 12.1% during 2024 and 2023, respectively.

The increase in selling, general and administrative expenses in 2024 was primarily due to shareholder activist defense costs in 2024, higher research and development costs, higher stock option expense due to the modification of previously granted stock options, costs to settle an insurance claim as the result of the bankruptcy of an insurer, higher recruiting fees, higher incentive compensation and the additional week in 2024 compared to 2023, which resulted in higher fixed expenses.

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Earnings from Operations         

For the reasons set forth above, the Company’s earnings from operations were $8.4 million for 2024 compared to earnings from continuing operations of $10.0 million for 2023.

Interest and Other Income

Interest and other income were $1.1 million in both 2024 and 2023. Higher weighted average interest rates in 2024 were offset by lower levels of marketable securities in 2024 due to the payment of the special dividend in the first quarter. During 2024 and 2023, the Company earned interest income principally from its investments, which were primarily in short-term instruments and money market funds.

Income Tax Provision

The Company’s effective income tax rate was 20.8% for 2024 compared to an effective rate of 2.7% for 2023. The increased rate was due primarily to the U.S. Federal rate and state income tax reductions in uncertain tax positions. The benefits from the reductions in 2024 and 2023 were $574,000 and $2,800,000, respectively, related to the expirations of statutes of limitations on tax positions taken in prior years regarding the taxability of funds repatriated from the Company’s subsidiary in Singapore in 2023 and to the expiration of statutes of limitations related to state throw-back rates in 2024.

Net Earnings from Operations

The Company’s net earnings from continuing operations for 2024 were $7.5 million compared to $10.7 million in 2023. As noted above, net earnings in 2024 included shareholder activist defense costs, a charge related to the modification of previously issued stock options, legal costs stemming from the settlement of an insurance claim due to the bankruptcy of an insurance carrier and recruiting fees, partially offset by the tax benefit from the reduction in uncertain tax positions. The 2023 earnings included the benefit from the reduction in uncertain tax positions of $2.8 million.

Basic and Diluted Earnings Per Share         

Basic and diluted earnings per share for 2024 were $0.37 compared to basic and diluted earnings per share for 2023 of $0.52. The lower earnings per share in 2024 reflects the impact of the higher costs in 2024 and the tax benefit from the reduction in uncertain tax positions in 2023.

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2023 Compared to 2022

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[[/GREPCENT_TABLE]]

Net Sales

The Company’s total net sales worldwide in 2023 were 1% higher than in 2022. Sales in 2023, to each of the markets the Company serves, were relatively even with the prior year sales levels.

Gross Profit

The Company’s gross profit margin, measured as a percentage of sales, decreased to 30.5% in 2023 from 33.4% in 2022. Higher costs for raw materials, supplies, freight, utilities, costs related to the new equipment trials and qualifications and higher waste costs from increased change-over resulting from supply chain challenges and uncertainties led to a decrease in gross margins.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $270,000, or 4%, during 2023 compared to 2022. Such expenses, measured as percentages of sales, were 12.1% and 11.7% during 2023 and 2022, respectively.

Selling, general and administrative expenses in 2023 included $369,000 of stock option expenses compared to $285,000 of such expenses in 2022.

Restructuring Charges         

Restructuring charges were nil in 2023 compared to $259,000 in 2022 related to the closure of the Company’s Park Aerospace Technologies Asia, Pte. Ltd. facility located in Singapore.

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Earnings from Operations         

For the reasons set forth above, the Company’s earnings from operations were $10.0 million for 2023. The Company’s earnings from continuing operations were $11.4 million for 2022, including the pretax charges of $259,000 for the closure of the facility located in Singapore.

Interest and Other Income

Interest and other income were $1.1 million and $375,000 for 2023 and 2022, respectively. The increase from 2022 was due primarily higher weighted average interest rates. During 2023 and 2022, the Company earned interest income principally from its investments, which were primarily in short-term instruments and money market funds.

Income Tax Provision

The Company’s effective income tax rate of 2.7% for 2023 was due primarily to the U.S. Federal rate and state income taxes, including $214,000 of additional tax due to tax deductions becoming unavailable related to stock options expiring unexercised in the 2023 fiscal year, offset by a reduction in uncertain tax positions related to the expiring statute of limitations of tax positions taken in prior years regarding the taxability of funds repatriated from the Company’s subsidiary in Singapore of $2.8 million. The Company’s effective income tax rate of 28.2% was higher in 2022, due to the lack of the uncertain tax position reduction as occurred in 2023.

Net Earnings from Operations

The Company’s net earnings from continuing operations for 2023 were $10.7 million, including the reduction in uncertain tax positions of $2.8 million and $214,000 of additional tax due to tax deductions becoming unavailable as a result of stock options expiring unexercised. The Company’s net earnings from continuing operations for 2022 were $8.5 million, including the pretax charges of $259,000 for the closure of the facility located in Singapore.

Basic and Diluted Earnings Per Share         

Basic and diluted earnings per share for 2023 were $0.52, including the additional tax due to tax deductions becoming unavailable as a result of stock options expiring unexercised and the reduction in uncertain tax positions, compared to basic and diluted earnings per share for 2022 of $0.41, including the pretax charges for the closure of the facility located in Singapore. The net impact of the items described above was to increase basic and diluted earnings per share by $0.13 in 2023 and decrease basic and diluted earnings per share by $0.01 in 2022.

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Liquidity and Capital Resources:

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[[/GREPCENT_TABLE]]

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[[/GREPCENT_TABLE]]

Cash and Marketable Securities

The Company believes it has sufficient liquidity to fund its operating activities for the 12 months from the date of the filing of this Form 10-K Annual Report and for the foreseeable future thereafter.

The change in cash and marketable securities at March 3, 2024 compared to February 26, 2023 was primarily the result of the special dividend of $1.00 per share paid in April 2023, which totaled $20.5 million, stock repurchases of $2.9 million in the second and third quarters of 2024, as well as regular dividends of $10.2 million. The significant changes in cash provided by operating activities were as follows:

[[GREPCENT_TABLE]]
[["","\u25cf","accounts receivable increased by 24% at March 3, 2024 compared to February 26, 2023 due primarily to the increase in total net sales in the last month of 2024;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","inventory decreased 5% due primarily to higher sales in the fourth quarter of 2024 compared to the fourth quarter of 2023 and higher raw material purchases at the end of February 2023, offset by higher material costs and an increase of RAYCARB C2B material inventoried in support of the distributor agreement with ArianeGroup;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","accounts payable decreased 23% due primarily to higher raw material purchases at the end of February 2023 and timing of other payments;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","accrued liabilities increased 48% due primarily to higher property tax accruals and higher incentive payroll accruals; and"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u25cf","income taxes payable increased 89% at March 3, 2024 compared to February 26, 2023 due to higher transition tax installment due in fiscal 2025."]]
[[/GREPCENT_TABLE]]

In addition, the Company paid $30.6 million and $8.2 million in cash dividends during 2024 and 2023, respectively.

Working Capital

Working capital at March 3, 2024 was lower compared to February 26, 2023. Decreases in cash and cash equivalents and marketable securities, and inventories and increases in accrued expenses and accrued income taxes were partially offset by higher accounts receivable and lower dividends payable and accounts payable.

The Company's current ratio (the ratio of current assets to current liabilities) was 10.2 to 1 at March 3, 2024 compared to 4.4 to 1 at February 26, 2023.

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Cash Flows

During 2024, the Company's net earnings before depreciation and amortization, stock-based compensation, amortization of bond premium and gain on sale of fixed assets, were $11.1 million. Such earnings were decreased by changes in operating assets and liabilities of $6.7 million, resulting in $4.4 million of cash provided by operating activities from continuing operations. During 2024, the Company expended $0.6 million for the purchase of property, plant and equipment compared to $1.0 million during 2023, and the Company paid $30.6 and $8.2 million in cash dividends in 2024 and 2023, respectively. The 2024 dividends paid included a special dividend of $20.5 million paid in the first quarter of 2024. 

Other Liquidity Factors         

On December 22, 2017, the U.S. government enacted comprehensive tax reform commonly referred to as the Tax Cuts and Jobs Act (“TCJA” or “Tax Act”) and significantly revised U.S. corporate income tax by, among other things, lowering corporate income tax rates, imposing a one-time transition tax on deemed repatriated earnings of non-U.S. subsidiaries, and implementing a territorial tax system. As a result of the Tax Act, the Company recorded taxes payable to be paid in installments over eight years. The remaining balance of these installment payments, as of March 3, 2024, was approximately $9.5 million to be paid over the next two years.

The Company believes that its existing cash, cash equivalents and marketable securities, and cash flow from operations will be sufficient to fund necessary capital expenditures and operating cash requirements for at least the next twelve months from the date of the filing of this Form 10-K Annual Report. The Company further believes that its consolidated balance sheet and financial position are very strong. 

Contractual Obligations:

The Company's contractual obligations and other commercial commitments to make future payments under contracts, such as lease agreements, consist only of operating lease commitments, commitments to purchase raw materials and commitments to purchase equipment, as described in Note 10 of the Notes to Consolidated Financial Statements included elsewhere in this Report. The Company has no other long-term debt, capital lease obligations, unconditional purchase obligations or other long-term obligations, standby letters of credit, guarantees, standby repurchase obligations or other commercial commitments or contingent commitments, other than two standby letters of credit in the total amount of $0.1 million to secure the Company's obligations under its workers’ compensation insurance program.

Environmental Matters:

The Company is subject to various Federal, state and local govern‐ment and foreign government requirements relating to the protection of the environment. The Company believes that, as a general matter, its policies, practices and procedures are properly designed to prevent unreasonable risk of environmental damage and that its handling, manufacture, use and disposal of hazardous or toxic substances are in accord with environmental laws and regulations. However, mainly because of past operations of the Company’s former Electronics Business and operations of predecessor companies, which were generally in compliance with applicable laws at the time of the operations in question, the Company, like other companies engaged in similar businesses, is a party to claims by govern‐ment agencies and third parties and has incurred remedial response and voluntary cleanup costs associated with environmental matters. Additional claims and costs involving past environmental matters may continue to arise in the future. It is the Company's policy to record appropriate liabilities for such matters when remedial efforts are probable and the costs can be reasonably estimated.

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In 2024, 2023 and 2022, the Company incurred approximately $29,000, $14,000 and $13,000, respectively, for remedial response and voluntary cleanup costs and related legal fees, and the Company received, or expects to receive, reimbursement pursuant to general liability insurance coverage for approximately $29,000, $14,000 and $13,000, respectively, of such amounts. While annual environmental remedial response and voluntary cleanup expenditures, including legal fees, have generally been constant from year to year, and may increase over time, the Company expects it will be able to fund such expenditures from cash flow from operations. The timing of expenditures depends on a number of factors, including regulatory approval of cleanup projects, remedial techniques to be utilized and agreements with other parties. At March 3, 2024 and February 26, 2023, there were no amounts recorded in accrued liabilities for environmental matters.

Management does not expect that environmental matters will have a material adverse effect on the liquidity, capital resources, business, consolidated results of operations or consolidated financial position of the Company. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Report for a discussion of the Company's contingencies, including those related to environmental matters.

Critical Accounting Policies and Estimates:

The following information is provided regarding critical accounting policies that are important to the Consolidated Financial Statements and that entail, to a significant extent, the use of estimates, assumptions and the application of management's judgment.

General

The Company’s Discussion and Analysis of its Financial Condition and Results of Operations are based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these Consolidated Financial Statements requires the Company to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to sales allowances, allowances for doubtful accounts, inventories, valuation of long-lived assets, income taxes, restructurings, contingencies and litigation, and employee benefit programs. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its Consolidated Financial Statements.

Recently Adopted Accounting Pronouncement         

See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Report for a discussion of the Company’s recently adopted accounting pronouncements.

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Revenue Recognition

The Company recognizes revenue when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the providing entity expects to be entitled in exchange for those goods or services. We recognize revenue when all of the following criteria are met: (1) we have entered into a binding agreement, (2) the performance obligations have been identified, (3) the transaction price to the customer has been determined, (4) the transaction price has been allocated to the performance obligations in the contract, and (5) the performance obligations have been satisfied. The majority of the Company’s shipping terms define the performance obligation to be satisfied upon shipment.

Accounts Receivable

The Company’s accounts receivable are due from purchasers of the Company’s products. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are due within established payment terms and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than established payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the conditions of the general economy and the aerospace industry. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company writes off accounts receivable when they become uncollectible.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. The Company writes down its inventory for estimated obsolescence or unmarketability based upon the age of the inventory and assumptions about future demand for the Company’s products and market conditions.

Valuation of Long-Lived Assets

The Company assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In addition, the Company assesses the impairment of goodwill at least annually. Important factors that could trigger an impairment review include, but are not limited to, significant negative industry or economic trends and significant changes in the use of the Company’s assets or strategy of the overall business.

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Income Taxes

As part of the processes of preparing its consolidated financial statements, the Company is required to estimate the income taxes in each of the jurisdictions in which it operates. This process involves estimating the actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s Consolidated Balance Sheets. Deferred income taxes are provided for temporary differences in the reporting of certain items, such as depreciation and undistributed earnings of foreign subsidiaries, for income tax purposes compared to financial accounting purposes. In evaluating the Company’s ability to recover the deferred tax assets within the jurisdiction from which they arise, all positive and negative evidence is considered, including the scheduled reversal of deferred tax liabilities, projected future taxable income, tax planning strategies and results of recent acquisitions. If these estimates and assumptions change in the future, the Company may be required to record additional valuation allowances against its deferred tax assets, resulting in additional income tax expense in the Company’s Consolidated Statements of Operations, or conversely to further reduce the existing valuation allowance, resulting in less income tax expense. The Company evaluates the realizability of the deferred tax assets and assesses the need for additional valuation allowances quarterly.

Tax benefits are recognized for an uncertain tax position when, in the Company’s judgment, it is more likely than not that the position will be sustained upon examination by a taxing authority. For a tax position that meets the more-likely-than-not recognition threshold, the tax benefit is measured as the largest amount that is judged to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. The liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances and when new information becomes available. Such adjustments are recognized entirely in the period in which they are identified. The effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent adjustments as considered appropriate by the Company. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, the Company believes its liability for unrecognized tax benefits is adequate. Interest and penalties recognized on the liability for unrecognized tax benefits are recorded as income tax expense.

Contingencies and Litigation

The Company is subject to a number of proceedings, lawsuits and other claims related to environmental, employment, product and other matters. The Company is required to assess the likelihood of any adverse judgments or outcomes in these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach, such as a change in settlement strategy in dealing with these matters.

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