Art’s-Way Manufacturing Co., Inc. — Form 10-Q Summary
Business context and reporting period
Art’s-Way Manufacturing Co., Inc. manufactures agricultural equipment and related products, modular buildings, and steel cutting tools. The three reportable segments are Agricultural Products, Modular Buildings, and Tools. The pressurized vessels segment was discontinued in 2016 and its remaining real estate was sold on March 29, 2018.
This unaudited Form 10-Q covers the three and nine months ended August 31, 2018, compared with the corresponding 2017 periods. The company is a smaller reporting company and filed the report on October 8, 2018. Common shares outstanding as of October 2, 2018 were 4,207,144.
Financial condition and performance
| Metric | Three months ended August 31, 2018 | Three months ended August 31, 2017 | Nine months ended August 31, 2018 | Nine months ended August 31, 2017 |
|---|---|---|---|---|
| Sales | $5.280 million | $6.550 million | $15.940 million | $15.660 million |
| Gross profit | $1.175 million | $1.445 million | $3.436 million | $3.370 million |
| Gross margin | 22.3% | 22.1% | 21.6% | 21.5% |
| Operating income (loss) | $(559,107) | $109,240 | $(1.326 million) | $(965,000) |
| Net income (loss) | $(766,716) | $23,207 | $(1.999 million) | $(754,382) |
| Basic and diluted loss per share | $(0.18) | $0.01 | $(0.47) | $(0.18) |
At August 31, 2018, total assets were $22.175 million, including cash of only $4,888, accounts receivable of $2.141 million, and net inventories of $10.669 million. Total liabilities were $7.789 million and stockholders’ equity was $14.386 million. Inventory declined from $11.967 million at November 30, 2017, while accrued expenses increased to $1.234 million from $982,000.
Operating cash flow was $(859,453) for the first nine months of 2018, compared with $(50,561) in the prior-year period. Continuing operations used $769,756 of operating cash. Investing activities provided $1.206 million, primarily from the $1.419 million of proceeds associated with discontinued operations, while capital expenditures were $265,418. Financing activities used $554,009, including $164,115 of term-debt repayments and $599,584 of discontinued-operation debt repayment, partially offset by a $231,000 increase in the revolving line of credit. Cash declined by $207,512 from $212,400 at November 30, 2017.
Total term debt was $2.806 million at August 31, 2018, including $225,405 due within one year. The revolving credit line had a balance of $2.694 million, with $2.306 million of borrowing availability subject to the borrowing-base calculation. The line bears interest at 6.00% at quarter-end, is payable on demand, and is scheduled to mature on March 30, 2019.
Material changes versus the prior comparable period
- Third-quarter sales decreased 19.4%, primarily because of lower Agricultural Products and Tools revenue. Nine-month sales increased 1.8%.
- Third-quarter operating results moved from income of $109,240 to a loss of $559,107; nine-month operating loss increased from $965,000 to $1.326 million.
- Third-quarter continuing-operations loss was $767,000 versus income of $42,000 in 2017. The nine-month loss increased to $1.948 million from $721,000.
- Agricultural Products nine-month revenue increased 1.6% and its gross margin improved to 21.8% from 20.2%, aided by lean initiatives, although steel tariffs increased cost pressure.
- Modular Buildings nine-month revenue increased 14.8%, but gross margin declined to 13.7% from 18.5% because of depreciation on leased buildings and production of leased assets without immediate revenue.
- Tools revenue declined 10.2% for the first nine months following the loss of a large-volume customer.
- Engineering and general and administrative expenses increased, including higher research and development, stock compensation, and modular-building management costs.
- The company recognized approximately $300,000 of noncash deferred-tax-asset revaluation expense following the reduction of the federal corporate tax rate to 21%.
- The Canadian subsidiary was liquidated during the second quarter, resulting in a noncash loss of approximately $253,000 from releasing the cumulative translation adjustment.
- The Vessels disposal generated $1.419 million of investing cash inflow during the first nine months, and discontinued-operation assets and liabilities were eliminated from the balance sheet.
Guidance, outlook, risks, contingencies, and unusual items
Management stated that operating cash flows and existing financing arrangements are expected to be sufficient to fund operations and debt payments for the next twelve months, and that the company expects to obtain financing on reasonable terms. The filing provides no formal revenue or earnings guidance.
Order backlog for continuing operations was $1.405 million as of October 2, 2018, down from $1.638 million a year earlier. Agricultural Products backlog was $715,000, Modular Buildings backlog was $609,000, and Tools backlog was $81,000. Management cautioned that backlog is not necessarily indicative of future revenue because of cancellations and dealer discounts.
During the quarter, mold was discovered at the West Union facility. The company accrued approximately $252,000 for remediation, scrapped approximately $67,000 of related inventory, and recorded an approximately $199,000 impairment of the asset held for lease. These items materially affected third-quarter results.
Key risks include limited cash, recurring operating cash outflows, dependence on the revolving credit facility, the line’s demand feature and March 2019 maturity, debt-covenant compliance, seasonal demand, low production volumes, steel and other input costs, customer concentration and loss of large customers, order cancellations, warranty costs, and the ability to renew or obtain financing. The company had received waivers for debt-service-coverage-ratio covenant breaches measured at November 30, 2017; the next measurement date was November 30, 2018. No material legal proceedings were reported.
The company intended to adopt the new revenue standard using the modified retrospective method and expected no material retained-earnings adjustment. It planned to adopt the new lease standard for fiscal 2020 and was evaluating the impact.
Important facts for investors to verify
- Whether operating cash flow improves before the revolving credit line’s March 30, 2019 maturity and whether the company maintains sufficient borrowing-base availability.
- Compliance with the Bank Midwest and Iowa Finance Authority financial covenants at the November 30, 2018 measurement date and any required waivers.
- The final cost and operational impact of West Union mold remediation, inventory losses, and the related asset impairment.
- Whether Agricultural Products demand recovers and whether steel tariffs or other input inflation erode the segment’s improved gross margin.
- The sustainability and profitability of Modular Buildings sales-type and operating leases, including cash requirements and lease receivable collections.
- Whether the Tools segment can replace revenue lost from its large-volume customer.
- The company’s ability to reduce recurring losses and generate positive cash flow without relying on asset sales or additional borrowing.