Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. manufactures agricultural equipment, pressurized vessels, and modular buildings through three operating segments. This unaudited Form 10-Q covers the three and six months ended May 31, 2012, compared with the corresponding 2011 periods. The company reported 4,035,852 common shares outstanding as of June 29, 2012.
Financial Performance and Position
| Metric | Three Months Ended May 31, 2012 | Three Months Ended May 31, 2011 | Six Months Ended May 31, 2012 | Six Months Ended May 31, 2011 |
|---|---|---|---|---|
| Net sales | $11.685 million | $7.845 million | $17.997 million | $12.509 million |
| Gross profit | $3.158 million | $1.956 million | $4.634 million | $2.432 million |
| Gross margin | 27.0% | 24.9% | 25.7% | 19.4% |
| Income from operations | $1.494 million | $0.548 million | $1.856 million | $(0.111) million |
| Net income/(loss) | $0.936 million | $0.291 million | $1.129 million | $(0.194) million |
| Diluted EPS | $0.23 | $0.07 | $0.28 | $(0.05) |
- Six-month operating cash flow was $120,493, compared with cash used in operations of $131,699 in the prior-year period. Working-capital investment included a $5.397 million increase in accounts receivable and a $559,868 increase in inventories.
- Investing cash outflow was $3.207 million, including $3.004 million paid for the Universal Harvester acquisition and $203,129 of capital expenditures.
- Financing activities provided $3.258 million, primarily from $2.880 million of term debt proceeds and net line-of-credit borrowings.
- Cash increased to $290,664 from $118,924 at November 30, 2011.
- At May 31, 2012, current assets were $23.957 million and current liabilities were $10.343 million. Total assets were $35.076 million and stockholders’ equity was $15.939 million.
- Total term debt was $9.008 million, compared with $6.456 million at November 30, 2011. The company also had $2.086 million outstanding under its $6.000 million revolving line of credit, leaving $3.914 million available.
- Interest expense was $202,069 for the six-month period. The filing states that the company expects its financing arrangements to provide sufficient cash for operations over the next twelve months.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 48.9%, and six-month sales increased 43.9%, driven primarily by modular buildings and improved agricultural product sales.
- Gross margins improved substantially due to increased manufacturing efficiencies, stronger contract performance, and improved results in the pressurized vessels segment.
- Administrative expense increased 27.8% year to date, primarily because of accrued bonuses tied to performance measures. Selling and engineering expenses declined.
- The company acquired Universal Harvester’s pickup-reel business and related assets on May 10, 2012, for approximately $3.067 million, funded with cash, debt, and 5,000 shares of common stock. The preliminary allocation included $699,900 of goodwill and intangible assets.
- Order backlog increased to $13.633 million from $9.670 million at May 31, 2011, with the largest increase in modular buildings.
Outlook, Risks, Contingencies, and Unusual Items
- Management stated that it expects the Universal Harvester acquisition to be accretive to fiscal 2012 earnings. No quantitative earnings or revenue guidance was provided.
- Modular-building revenue benefited from an approximately $7 million fabrication and delivery contract executed in January 2012 and an approximately $1.7 million installation contract executed in April 2012. The company uses percentage-of-completion accounting for these contracts.
- Backlog is not necessarily indicative of future revenue because of potential cancellations and dealer discount arrangements.
- The company’s debt-service coverage ratio was below the minimum required under its West Bank and Iowa Finance Authority agreements at May 31, 2012. The company stated that it remained in compliance because the covenants are measured annually, with the next measurement date on November 30, 2012.
- The West Bank revolving credit facility was renewed through April 30, 2013. The facility carries a minimum interest rate of 4.00% and is secured by company assets.
- Key risks include access to financing, compliance with debt covenants, integration of Universal Harvester, economic demand, material costs, production delays, customer retention, and execution or counterparty risks related to modular-building contracts.
- Warranty liabilities were $277,965 at May 31, 2012, compared with $199,395 a year earlier. The company cautioned that future warranty costs could exceed historical levels.
- The company reported no material pending legal proceedings, no defaults upon senior securities, and no off-balance-sheet arrangements. Management concluded that disclosure controls were effective.
Investor Verification Items
- Verify the November 30, 2012 measurement of debt-service coverage, debt-to-tangible-net-worth, and minimum tangible-net-worth covenants.
- Assess whether the Universal Harvester acquisition delivers the expected earnings contribution and whether its preliminary purchase-price allocation changes.
- Monitor accounts receivable, inventory, customer deposits, and operating cash conversion, particularly after the significant working-capital investment.
- Review execution, margins, cash requirements, and potential cancellations associated with the modular-building contracts and reported backlog.
- Confirm availability and renewal terms of the revolving credit facility and the company’s ability to refinance or repay term debt as scheduled.