Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. filed this unaudited Form 10-Q for the three months ended February 28, 2017. The company manufactures agricultural equipment, modular buildings, and steel cutting tools through its Manufacturing, Scientific, and Metals segments. The Vessels segment was discontinued in the third quarter of fiscal 2016 and is presented as discontinued operations.
As of March 17, 2017, 4,156,752 common shares were outstanding. The company is a smaller reporting company.
Financial Performance and Position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $4.421 million | $5.713 million | Down 22.6% |
| Gross profit | $1.114 million | $1.628 million | Down 31.6% |
| Gross margin | 25.2% | 28.5% | Down 3.3 percentage points |
| Operating income (loss) | $(352,000) | $221,000 | Declined $573,000 |
| Continuing operations income (loss) | $(254,000) | $134,000 | Unfavorable change |
| Net income (loss) | $(250,000) | $81,000 | Unfavorable change |
| Basic and diluted EPS | $(0.06) | $0.02 | Declined $0.08 |
| Net cash provided by operating activities | $291,000 | $620,000 | Down $329,000 |
Segment sales were $3.368 million for Agricultural Products, $388,000 for Modular Buildings, and $665,000 for Tools. Segment operating results were losses of $220,000 and $154,000 for Agricultural Products and Modular Buildings, respectively, and income of $21,000 for Tools.
Cash was $751,000 at February 28, 2017, compared with $1.064 million at November 30, 2016. Total current assets were $16.255 million and total current liabilities were $8.695 million. Inventories were $13.233 million, net of reserves, and accounts receivable were $1.459 million.
Capital expenditures were $195,000, while investing activities used $144,000. Financing activities used $470,000, including $250,000 of line-of-credit repayments, $182,000 of term-debt repayments, and $6,000 of common-stock repurchases. Ending cash was $751,000.
Total term debt was $3.697 million at quarter-end, including $2.673 million classified as current and $340,000 classified as long-term debt excluding discontinued operations. The revolving line of credit had $3.034 million outstanding and $1.699 million of remaining availability under the borrowing-base calculation. Total liabilities were $9.035 million and stockholders’ equity was $17.258 million.
Material Changes Versus the Prior Comparable Period
- Sales declined 22.6%, primarily because of lower demand for agricultural products and lower modular-building revenue.
- Agricultural Products sales decreased 19.8% and its gross margin declined to 25.1% from 30.8%.
- Modular Buildings sales decreased 58.9% and its gross margin declined to 8.0% from 20.6%.
- Tools sales increased 16.3%, and its gross margin improved to 35.3% from 24.3%, partly due to improved energy-industry demand.
- Operating expenses increased to $1.466 million from $1.407 million. Selling and engineering costs increased due to a larger sales force and development of new products.
- Operating results shifted from a $221,000 profit to a $352,000 loss, and continuing-operations results shifted from $134,000 of income to a $254,000 loss.
- Operating cash flow declined to $291,000 from $620,000, while capital expenditures increased to $195,000 from $26,000.
- Discontinued operations generated $4,000 of pre-tax income compared with a $75,000 pre-tax loss in the prior-year quarter; discontinued operations had no revenue in Q1 2017 versus $679,000 in Q1 2016.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal revenue or earnings guidance. Management stated that backlog for continuing operations was $5.717 million as of March 28, 2017, up from $4.510 million a year earlier, largely reflecting six new agricultural products. Management cautioned that backlog is not necessarily indicative of future revenue because of potential cancellations and dealer discounts.
Management expects operating cash flows and financing arrangements to support operations and debt payments over the next twelve months, but acknowledged that the company expects to rely on financing activities and that there is no assurance financing will remain available on reasonable terms.
After quarter-end, the company entered into a Third Loan Modification Agreement with U.S. Bank. The modification extended the maturity of the revolving line and certain term loans to September 25, 2017, reduced the line’s stated availability from $5.0 million to $4.5 million, reduced the borrowing-base inventory component from $3.75 million to $3.375 million, and changed interest rates to 1.5% plus prime, subject to a 5.0% minimum.
The company was not compliant at February 28, 2017 with the fiscal-year-to-date fixed-charge coverage covenant because of its continuing-operations loss. U.S. Bank waived the breach and stated that no event of default occurred. The amended terms removed that fixed-charge covenant and require fiscal-year-to-date EBITDA of at least $1 as of May 31, 2017 and $648,000 as of August 31, 2017, together with minimum liquidity of $500,000. U.S. Bank may require the company to engage a turnaround consulting firm.
The company was also not compliant with the Iowa Finance Authority loan’s debt-service coverage ratio as measured at November 30, 2016; the lender issued a waiver. Key risks include weak agricultural demand, seasonality, credit and refinancing risk, covenant compliance, debt repayment, liquidation of discontinued-operation assets, warranty costs, supply costs, and possible order cancellations. No material pending legal proceedings or off-balance-sheet arrangements were reported.
The company adopted guidance concerning going concern, inventory measurement, and the classification of deferred taxes during fiscal 2017; management reported no material impact from these adoptions.
Important Facts for Investors to Verify
- Confirm the company’s ability to refinance or repay the U.S. Bank facilities maturing September 25, 2017.
- Monitor compliance with the amended EBITDA and minimum-liquidity requirements, including the May 31 and August 31, 2017 testing dates.
- Assess whether the higher agricultural backlog converts into revenue and whether cancellations or dealer discounts reduce its value.
- Evaluate the sustainability of positive operating cash flow amid continuing losses, reduced sales, and required debt repayments.
- Track the disposal and carrying values of the remaining Vessels assets and related liabilities.
- Verify the effect of lower demand, fixed-cost absorption, and increased selling and engineering spending on future margins.