Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. filed an unaudited Form 10-Q for the three and nine months ended August 31, 2020. The company manufactures agricultural equipment and replacement parts, modular buildings, and steel cutting tools through its Agricultural Products, Modular Buildings, and Tools segments.
Fiscal 2020 results were affected by the COVID-19 pandemic, including remote work, workforce self-quarantine, delayed customer activity, subcontractor disruptions, and lower oil-and-gas demand. Operations had returned to normal by the end of May 2020 with additional safety precautions.
Financial Performance and Position
| Metric | Three months ended August 31, 2020 | Three months ended August 31, 2019 | Nine months ended August 31, 2020 | Nine months ended August 31, 2019 |
|---|---|---|---|---|
| Sales | $6.465 million | $5.504 million | $16.937 million | $15.375 million |
| Gross profit | $0.925 million | $1.005 million | $2.897 million | $2.569 million |
| Gross margin | 14.3% | 18.3% | 17.1% | 16.7% |
| Operating loss | $(0.513) million | $(0.305) million | $(1.908) million | $(1.397) million |
| Net loss | $(0.424) million | $(0.289) million | $(1.663) million | $(1.251) million |
| Basic and diluted loss per share | $(0.10) | $(0.07) | $(0.38) | $(0.29) |
- Sales increased 17.5% for the quarter and 10.2% year to date. Agricultural Products revenue rose 14.9% for the quarter and 2.7% year to date; Modular Buildings revenue rose 28.7% and 27.2%, respectively; Tools revenue declined 6.5% for the quarter but increased 7.4% year to date.
- The quarterly gross margin decline reflected lower margins in Modular Buildings and Tools. Year-to-date margin improved primarily because of operational improvements, pricing, and product changes in Agricultural Products.
- Operating expenses increased to $1.438 million for the quarter and $4.804 million year to date, driven mainly by administrative costs, management recruiting and transition costs, OEM product-line implementation, employee rewards, bonuses, and stock compensation.
- Cash used in operating activities was $358,939 for the first nine months, compared with $376,642 of cash provided in the prior-year period. Investing activities used $431,562, including $614,443 of capital expenditures. Financing activities provided $791,556.
- Cash was only $4,200 at August 31, 2020. Current assets were $11.088 million and current liabilities were $5.022 million, implying working capital of approximately $6.066 million.
- Inventory was $9.023 million, accounts receivable were $1.723 million, and contract assets declined to $122,289 from $726,667 at November 30, 2019. Contract liabilities increased to $404,725 from $88,931.
- Total liabilities were $9.019 million and stockholders’ equity was $10.300 million at August 31, 2020, compared with $7.553 million and $11.794 million, respectively, at November 30, 2019.
- Debt consisted of a $1.768 million balance on the revolving line of credit and $4.068 million of term debt, for approximately $5.836 million in total borrowings. The revolving line had $3.232 million of stated availability, subject to borrowing-base limitations.
Material Changes Versus the Prior Comparable Period
- Revenue grew, but quarterly gross margin fell 400 basis points and the quarterly net loss widened by $134,395.
- Year-to-date gross profit increased $328,098, but the net loss widened by $411,333 because of higher administrative costs and weaker Modular Buildings and Tools margins.
- Modular Buildings revenue increased substantially because of progress on a large research laboratory contract, but segment gross margin fell to 2.4% for the quarter and 8.6% year to date from 20.0% and 14.7%, respectively. The company cited an initially lower expected margin and unexpected on-site completion costs.
- Agricultural Products gross margin improved to 21.5% for the quarter and 21.3% year to date from 15.7% in both prior-year periods, reflecting efficiency initiatives, price increases, strategic product offerings, and product eliminations.
- Tools gross margin declined to 17.1% for the quarter and 21.1% year to date from 28.0% and 28.4%, respectively, due largely to labor and overhead associated with integrating a new OEM product line.
- Term debt increased by approximately $1.632 million, primarily because of a $1.243 million PPP loan and three SBA EIDL loans totaling approximately $452,000. The company expects all or a significant portion of the PPP loan to be forgiven.
- The company adopted ASC 842 lease accounting in fiscal 2020 and recognized a $30,182 operating lease right-of-use asset and corresponding lease liability at August 31, 2020.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- No formal earnings guidance was provided. Management stated that Agricultural Products sales were approximately 10% below its fiscal 2020 projection as of the filing, although third-quarter sales improved year over year.
- Order backlog was $3.539 million as of October 6, 2020, down from $7.561 million a year earlier. The decline primarily reflected progress on a large Modular Buildings project; excluding that project, management said backlog was down $369,000. Backlog is not necessarily indicative of future revenue because of cancellations and dealer discounts.
- Management expects contracts in progress to consume cash in the fourth quarter as projects are completed. It expects capital needs to include production, contract fulfillment, and debt retirement.
- Management believes existing financing arrangements will provide sufficient cash for operations and debt payments during the next twelve months and has discussed additional financing with Bank Midwest if needed.
- The $5.000 million revolving line of credit matures March 30, 2021. Debt covenants are measured at November 30, 2020. The company was previously noncompliant with a debt service coverage ratio, but Bank Midwest issued a waiver; management reported no event of default.
- COVID-19 risks include further effects on demand, dealer purchasing and shipments, subcontractor availability, employee availability, supply costs, liquidity, and access to financing. Oil-and-gas demand affecting the Tools segment had not recovered to pre-pandemic levels.
- David King became Chief Executive Officer in the third quarter, replacing Carrie Gunnerson, whose final day was July 21, 2020.
- Disclosure controls and procedures were not effective as of August 31, 2020 because of a material weakness involving controls over estimates of completed subcontract work on Modular Buildings contracts. Remediation controls were implemented, but testing had not yet established that the weakness was fully remediated.
- The filing reports no material pending legal proceedings, no off-balance-sheet arrangements, and no subsequent events requiring recognition.
Important Facts for Investors to Verify
- Whether the PPP loan is forgiven in whole or in part and the resulting effect on debt and income.
- Renewal or refinancing of the revolving credit facility before its March 30, 2021 maturity.
- Compliance with all Bank Midwest covenants at the November 30, 2020 measurement date.
- Actual costs, profitability, cash requirements, and completion status of the large Modular Buildings research laboratory contract.
- Whether the material weakness related to subcontract-cost estimates is fully remediated after control testing.
- Recovery of agricultural equipment demand, Modular Buildings backlog, and oil-and-gas-related Tools sales.
- The company’s ability to maintain liquidity despite minimal cash, operating cash usage, expected fourth-quarter contract cash consumption, and scheduled debt obligations.