Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. filed an unaudited Form 10-Q for the quarter ended August 31, 2014, covering the three- and nine-month periods ended that date. The company manufactures agricultural equipment, pressurized vessels, modular buildings and steel cutting tools through four reportable segments. The tools segment reflects the Ohio Metal Working Products acquisition completed in September 2013.
The company had 4,048,552 common shares outstanding as of September 22, 2014. It is a smaller reporting company and stated that its disclosure controls were effective.
Financial Highlights
| Metric | Three Months Ended August 31, 2014 | Three Months Ended August 31, 2013 | Nine Months Ended August 31, 2014 | Nine Months Ended August 31, 2013 |
|---|---|---|---|---|
| Net sales | $11.585 million | $9.350 million | $27.291 million | $27.016 million |
| Gross profit | $2.704 million | $1.728 million | $6.372 million | $6.662 million |
| Gross margin | 23.3% | 18.5% | 23.3% | 24.7% |
| Income from operations | $908,000 | $54,000 | $1.057 million | $1.566 million |
| Net income | $558,000 | $26,000 | $553,000 | $1.360 million |
| Basic and diluted EPS | $0.14 | $0.01 | $0.14 | $0.34 |
Third-quarter sales increased 23.9%, while nine-month sales increased 1.0%. Third-quarter operating margin was approximately 7.8%, compared with 0.6% in the prior-year quarter. Nine-month operating margin was approximately 3.9%, compared with 5.8% in the prior-year period. Interest expense was $94,000 in the quarter and $269,000 year to date.
Liquidity, Cash Flow and Debt
- Cash was $237,000 at August 31, 2014, compared with $208,000 at November 30, 2013.
- Accounts receivable increased to $4.984 million from $3.000 million, primarily reflecting the timing of sugar beet harvester sales.
- Inventory was $14.970 million, approximately unchanged from $14.923 million at November 30, 2013.
- Net cash used in operating activities was $885,000 for the nine months, compared with $696,000 of cash provided in the prior-year period. The primary adverse driver was a $2.023 million increase in accounts receivable.
- Investing activities used $650,000, including $651,000 of capital expenditures.
- Financing activities provided $1.564 million, including a $1.489 million increase in the line of credit and $1.000 million of new term debt, partially offset by $933,000 of term-debt repayments.
- The company had an $8.0 million revolving line of credit, with $4.839 million outstanding at August 31, 2014. The facility bears interest at prime, subject to a 3.50% minimum, and matures May 1, 2015.
- Total term debt was $7.548 million, including $1.274 million classified as current. Total liabilities were $16.222 million and stockholders’ equity was $18.869 million.
- Management stated that operating cash flows and existing financing arrangements should provide sufficient liquidity for the next twelve months, although financing activities are expected to supplement operating cash flow.
Material Changes Versus Prior Comparable Period
- Third-quarter revenue growth was driven primarily by higher agricultural-product sales and the addition of the tools segment. Agricultural-product sales rose 17.0% to $9.362 million.
- Nine-month agricultural-product sales declined 6.0% to $21.366 million because of lower demand for Universal Harvester reels and sugar beet harvesters, partly offset by International and grinder-mixer sales.
- Pressurized-vessel sales declined 4.5% in the quarter and 9.9% year to date. Its gross margin fell to 6.8% for the quarter and 6.4% year to date, from 16.4% and 10.0%, respectively.
- Modular-building sales increased 15.6% in the quarter but declined 30.5% year to date. The prior-year period benefited from completion of large contracts; 2014 margins were affected by lower revenue against relatively steady overhead.
- The tools segment generated $797,000 of quarterly sales and $2.603 million year to date, with operating income of $28,000 year to date. No comparable 2013 results were available because the acquisition occurred late in 2013.
- Third-quarter net income increased substantially because of improved agricultural-product operating income. Nine-month net income declined 59.3%, largely because the prior-year period included an approximately $630,000 gain on property sales and because of weaker Scientific and Vessels results.
- Accounts receivable rose materially, contributing to negative year-to-date operating cash flow. Total debt also increased modestly from November 30, 2013, while the company added the Ohio Metal property mortgage loan and continued repaying existing term loans.
Guidance, Outlook, Risks and Unusual Items
- Order backlog was $4.741 million as of September 16, 2014, versus $2.888 million one year earlier. Management cautioned that backlog is not necessarily indicative of future revenue because of cancellations and dealer discounts.
- The company described agricultural markets as cyclical and identified risks including seasonal demand, production timing, economic conditions, material costs, credit availability, integration of acquired businesses, debt obligations and financial-covenant compliance.
- The company was not in compliance with its 1.15-to-1.00 fixed-charge coverage covenant as of August 31, 2014, primarily because of a first-quarter operating loss. U.S. Bank waived the noncompliance for the first three quarters, and management stated that no event of default occurred. The next measurement date was November 30, 2014.
- The company remained in compliance with its other stated U.S. Bank covenants and with the Iowa Finance Authority loan covenants based on the disclosures provided.
- A default could permit higher interest rates, termination of further lending, acceleration of debt and foreclosure or seizure of collateral.
- The company had no material pending legal proceedings, no off-balance-sheet arrangements and reported no material subsequent events.
- The filing states that recently issued accounting standards concerning unrecognized tax benefits and revenue recognition were not expected to have a material impact, although the revenue standard was still under evaluation.
Investor Verification Priorities
- Verify the company’s ability to refinance or renew the $8.0 million revolving facility before its May 1, 2015 maturity.
- Confirm continued compliance with the fixed-charge coverage covenant at the November 30, 2014 measurement date and review the scope and duration of the lender waiver.
- Monitor accounts receivable collection, inventory levels and operating cash flow, given the $885,000 year-to-date operating cash outflow.
- Assess whether the tools acquisition can sustain positive operating income and whether Vessels and Scientific margins recover.
- Evaluate the sustainability of the higher third-quarter agricultural-product revenue, including the effect of delayed shipments and cyclical agricultural demand.
- Reconcile segment performance, debt maturities, working-capital availability and backlog conversion against subsequent filings.