ARTS WAY MANUFACTURING CO INC quarterly report, Q2 FY2021

Business Context and Reporting Period

Art’s-Way Manufacturing Co., Inc. filed an unaudited Form 10-Q for the quarter and six months ended May 31, 2021. The company manufactures agricultural equipment and parts, modular buildings, and steel cutting tools through three reportable segments: Agricultural Products, Modular Buildings, and Tools.

Financial Performance and Position

Metric	Three Months Ended May 31, 2021	Six Months Ended May 31, 2021
Sales	$5.710 million	$11.111 million
Gross profit	$1.722 million	$2.765 million
Gross margin	30.2%	24.9%
Income (loss) from operations	$149,000	$(220,000)
Net income (loss)	$64,000	$(251,000)
Basic and diluted EPS	$0.01	$(0.06)

Second-quarter sales increased 4.8% year over year; six-month sales increased 6.1%.
Agricultural Products revenue increased 25.6% in the quarter and 22.1% year to date, supported by stronger agricultural demand. Modular Buildings revenue declined 33.6% in the quarter and 23.7% year to date as a large construction project neared completion. Tools revenue increased 14.2% in the quarter and 6.4% year to date.
At May 31, 2021, total assets were $20.670 million, cash was $5,000, current assets were $12.050 million, and current liabilities were $8.177 million.
Net inventory was $8.996 million, up from $7.762 million at November 30, 2020, primarily reflecting higher raw-material holdings and reserves.
Net cash used in operating activities was $1.340 million for the six months, while capital expenditures used $311,000. Financing activities provided $1.654 million, principally from increased line-of-credit borrowings.
Total stockholders’ equity was $9.767 million at May 31, 2021, compared with $9.907 million at November 30, 2020.

Debt, Liquidity, and Capital Resources

The $5.000 million Bank Midwest revolving line of credit had a balance of $4.089 million and approximately $911,000 of stated availability at May 31, 2021, subject to borrowing-base limitations. It matures March 30, 2022 and bears interest at 4.75% at the reporting date.
Term debt totaled $2.772 million, including $2.306 million under the Bank Midwest term loan and approximately $466,000 under three SBA Economic Injury Disaster Loans. Long-term debt, excluding the current portion, was $2.679 million.
The company was $126,496 below its $4.000 million minimum working-capital covenant at May 31, 2021. Management stated that additional EIDL proceeds of $1.050 million were pending and expected to restore covenant compliance. The company had previously received a waiver for covenant noncompliance at November 30, 2020.
Management expects to convert $1.050 million of current debt to long-term debt during the third quarter as EIDL modifications are processed and expects line-of-credit borrowings to decline as inventory is sold.
Management believes existing financing arrangements will provide sufficient cash for operations and debt payments during the following twelve months, although available cash remained minimal and operating cash flow was negative.

Material Changes Versus the Prior Comparable Period

Gross margin improved from 18.3% to 30.2% in the quarter and from 18.8% to 24.9% for the six months, primarily due to Agricultural Products pricing actions and improved manufacturing efficiency.
The company reported second-quarter net income of $64,000 versus a net loss of $802,000 in the prior-year quarter. The six-month net loss narrowed to $251,000 from $1.239 million.
General and administrative expense declined substantially as prior-year COVID-19, management-transition, implementation, and incentive-related costs did not recur. Selling expense increased due partly to approximately $130,000 of agricultural rebranding costs and the addition of a product manager.
Agricultural Products backlog was $6.209 million as of July 6, 2021, up 273% from the prior-year comparable date. Consolidated backlog was $7.531 million, up 40%.
Modular Buildings backlog declined 72% to $987,000, but management stated that backlog quality should improve after completion of a low-margin project. Tools backlog increased to $336,000, primarily due to an OEM customer.

Guidance, Outlook, Risks, and Unusual Items

No formal quantitative earnings guidance was provided. Management expects improved results in the second half of fiscal 2021 and continued strong agricultural demand into 2022.
Material and component costs have risen sharply, supplier lead times have lengthened, and labor availability remains constrained. These conditions may delay fulfillment of the strong backlog and pressure margins.
The company increased prices twice during fiscal 2021 to offset rising input costs. Management expects Agricultural Products margins to benefit from pricing and efficiency initiatives.
COVID-19 operating restrictions have eased, but the pandemic may continue to affect demand, labor availability, supply chains, and financial results. Management reported that approximately 70% of employees were vaccinated and approximately 95% had either been vaccinated or previously contracted COVID-19.
Tools demand from oil and gas customers remained below pre-pandemic levels, although the OEM customer provided significant volume growth.
The company had no material pending legal proceedings, no off-balance-sheet arrangements, and no reported defaults under senior securities. Management concluded that disclosure controls were effective as of May 31, 2021.
Product warranty liabilities were $268,000 at May 31, 2021. The company cautioned that future warranty costs could exceed historical experience.
J. Ward McConnell, Jr., a former vice chairman and significant shareholder who guaranteed approximately 38% of the Bank Midwest term loan, died on May 31, 2021. The USDA is expected to require a qualifying shareholder to provide a replacement guarantee after distribution of the trust assets.

Key Facts for Investors to Verify

Whether the pending $1.050 million of EIDL funding was received and whether it restored compliance with the $4.000 million working-capital covenant.
Whether the company renewed or refinanced the $4.089 million revolving line before its March 30, 2022 maturity.
Whether inventory converts into sales and operating cash flow improves without further substantial line-of-credit borrowing.
Whether supplier delays, labor shortages, and commodity inflation impair fulfillment, backlog conversion, or gross margins.
Whether the strong Agricultural Products backlog translates into revenue and profit, given the company’s warning that backlog may be affected by cancellations and dealer discounts.
The profitability and cash requirements of Modular Buildings projects after completion of the low-margin construction contract.