Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. is a Delaware-based manufacturer headquartered in Armstrong, Iowa, serving agricultural equipment, modular buildings, and steel cutting tools markets. The company operates through three segments: Agricultural Products, Modular Buildings, and Tools.
This unaudited Form 10-Q covers the three months ended February 29, 2020, compared with the three months ended February 28, 2019. The company is a smaller reporting company and non-accelerated filer.
Financial Results and Key Metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Sales | $5.026 million | $4.124 million | Up 21.9% |
| Gross profit | $977,162 | $604,844 | Up 61.6% |
| Gross margin | 19.4% | 14.7% | Up 4.7 percentage points |
| Operating loss | $(469,696) | $(722,625) | Improved $252,929 |
| Net loss | $(437,192) | $(605,932) | Improved $168,740 |
| Basic and diluted loss per share | $(0.10) | $(0.14) | Improved |
| Cash used in operating activities | $(960,128) | $(713,407) | Higher use of cash |
Segment sales were $2.953 million for Agricultural Products, $1.457 million for Modular Buildings, and $616,000 for Tools. Segment operating results were losses of approximately $435,000 and $41,000 for Agricultural Products and Tools, respectively, and income of approximately $6,000 for Modular Buildings.
At February 29, 2020, total assets were $21.000 million, including $3,287 of cash, $2.657 million of net customer receivables, and $9.314 million of net inventory. Total liabilities were $9.625 million and stockholders’ equity was $11.375 million. Working capital was approximately $5.596 million, based on current assets of $12.867 million and current liabilities of $7.271 million.
Debt consisted primarily of a $3.845 million balance on the $5.000 million Bank Midwest revolving line of credit and $2.415 million of term debt, including the current portion. The revolver had $1.155 million of stated availability at quarter-end, subject to borrowing-base limitations. The company also maintained a separate $4.000 million revolving facility related to a letter of credit for a modular laboratory project; the funds remained undisbursed and were held by the bank.
Operating cash consumption was driven principally by increases in accounts receivable of $988,000 and inventory of $536,000. Financing activities provided $1.226 million, primarily from a $1.266 million increase in the line of credit. Capital expenditures were $267,000.
Material Changes Versus the Prior Comparable Period
- Sales increased $902,000, with growth in all three segments.
- Agricultural Products revenue rose 13.1%, supported by manure spreaders, dump boxes, and grinders. Segment gross margin increased to 19.3% from 12.7%.
- Modular Buildings revenue rose 42.6%, largely from progress on a large construction contract continuing into the third quarter. Segment gross margin increased to 17.6% from 11.7%.
- Tools revenue increased 25.2%, primarily from an OEM agreement signed in fiscal 2019, but gross margin declined to 24.5% from 29.5% because of higher staffing costs.
- Consolidated gross margin improved primarily from labor-efficiency initiatives, price increases, improved workforce efficiency, and better absorption of fixed costs.
- Selling expense increased to $456,000 from $343,000 due to additional personnel, higher commissions, and advertising. Engineering expense declined to $110,000 from $147,000.
- Administrative expense increased modestly to $882,000 from $837,000, including one-time Tools segment costs and an additional employee-retention bonus accrual.
- Inventory increased from $8.779 million at November 30, 2019 to $9.314 million, while the allowance for inventory reserves declined from $2.775 million to $2.637 million.
- The company adopted ASC 842 lease accounting and recognized a $34,316 operating lease right-of-use asset and corresponding lease liability.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal quantitative fiscal-year guidance. Management stated that COVID-19 had little effect on the first quarter but was expected to reduce second-quarter and potentially later-period results. As of the filing, approximately 17% of the workforce was unavailable because of self-quarantine, although operations continued with limited disruption.
- Management expected lower revenue than fiscal 2019 and initial fiscal 2020 expectations because of workforce reductions and supply-chain disruptions.
- The company identified risks from further employee absences, supplier disruptions, travel restrictions, customer delays, depressed oil prices, and possible production stoppages in the Tools and Modular Buildings segments.
- As of April 6, 2020, consolidated backlog was $7.451 million versus $10.209 million a year earlier. The decline primarily reflected progress on an unusually large modular-building contract; excluding that project, management stated backlog was $962,000 higher year over year.
- Agricultural Products backlog was $2.699 million, Modular Buildings backlog was $4.528 million, and Tools backlog was $224,000 as of April 6, 2020. Backlog is not necessarily indicative of future revenue because of potential cancellations and dealer discounts.
- Management believed existing financing arrangements would fund operations and debt payments for the next twelve months, while acknowledging potential slower operating cash inflows and the need for additional financing if COVID-19 had a significant impact.
- The company was in compliance with Bank Midwest covenants at November 30, 2019 except for the debt service coverage ratio; the bank waived that noncompliance, and no default had occurred. The next measurement date is November 30, 2020.
- Disclosure controls were deemed ineffective because of a material weakness involving estimates of completed subcontract work on modular-building contracts. New controls were implemented, but insufficient time had passed to conclude that the weakness was fully remediated.
- The $5.000 million revolving credit facility was renewed on March 30, 2020, and the $4.000 million facility was renewed on February 13, 2020. Both facilities mature or become payable in 2021 under the disclosed terms.
- David A. King joined as Executive Vice President on March 23, 2020 and is expected to become Chief Executive Officer in the third quarter of fiscal 2020. His annual base salary is $265,000, with potential incentive compensation of up to 75% of base salary.
- The company reported no material pending legal proceedings, no defaults upon senior securities, and no off-balance-sheet arrangements.
Important Facts for Investors to Verify
- Whether COVID-19-related workforce and supply-chain disruptions reduce production, backlog conversion, revenue, or operating cash flow after the first quarter.
- The company’s ability to renew or replace revolving credit facilities and maintain covenant compliance, particularly the debt service coverage ratio.
- Whether the material weakness related to modular-building subcontract estimates is fully remediated and whether future estimates require adjustments.
- The collectability and timing of the sharp increase in accounts receivable and contract receivables, including the large modular-building milestone invoice.
- The profitability and completion risk of the large modular-building contract, including potential effects of labor, vendor, travel, and construction delays.
- Whether the reported backlog converts to revenue at expected margins, given the year-over-year headline decline and the possibility of cancellations or discounts.
- The sustainability of improved Agricultural Products margins and the impact of increased staffing costs on Tools segment margins.
- The effect of the expected CEO transition, retention-related compensation, and the proposed 2020 equity incentive plan, which would add 500,000 shares subject to stockholder approval.