Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. is an agricultural equipment manufacturer with three reportable segments: agricultural products, modular buildings, and tools. This unaudited Form 10-Q covers the three and six months ended May 31, 2019, with comparisons to the same periods in 2018. The company is a smaller reporting company and its common stock trades on Nasdaq under ARTW.
The company discontinued its pressurized vessels segment in 2016; related activity was classified as discontinued operations in prior-period results. The Canadian subsidiary was liquidated during the second quarter of fiscal 2018.
Key Financial Metrics
| Metric | Three months ended May 31, 2019 | Three months ended May 31, 2018 | Six months ended May 31, 2019 | Six months ended May 31, 2018 |
|---|---|---|---|---|
| Sales | $5.747 million | $5.294 million | $9.871 million | $10.660 million |
| Gross profit | $0.959 million | $1.107 million | $1.564 million | $2.260 million |
| Gross margin | 16.7% | 20.9% | 15.8% | 21.2% |
| Operating income (loss) | $(0.370) million | $(0.458) million | $(1.092) million | $(0.767) million |
| Net income (loss) | $(0.356) million | $(0.666) million | $(0.962) million | $(1.232) million |
| Basic and diluted loss per share | $(0.08) | $(0.16) | $(0.23) | $(0.29) |
At May 31, 2019, cash was $4,401, accounts receivable were $2.668 million, net inventory was $10.105 million, and total assets were $21.359 million. Total liabilities were $9.175 million and stockholders’ equity was $12.184 million.
Operating cash flow was negative $516,064 for the first six months of fiscal 2019, compared with negative $423,792 in the prior-year period. Investing activities provided $707,498, principally from $893,713 of proceeds from asset sales, while financing activities used $190,545. Ending cash increased by only $889 to $4,401.
The company had $3.600 million outstanding on its $5.000 million 2017 revolving credit line, leaving $1.400 million available, subject to borrowing-base limitations. The line carried a 6.50% interest rate at May 31, 2019 and is payable on demand, with scheduled maturity on March 30, 2020 if not earlier demanded. Term debt totaled $2.477 million, including $2.394 million classified as long-term.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 8.6%, but first-half sales declined 7.4%.
- Second-quarter net loss improved by $310,000, primarily because of higher modular-building revenue and lower selling and administrative expenses. The first-half net loss improved by $270,000, but the operating loss worsened by $325,000 because of lower gross profit.
- Gross margin declined materially, from 20.9% to 16.7% for the quarter and from 21.2% to 15.8% year to date. Management attributed the decline primarily to lower agricultural-product margins, lower fixed-cost absorption, reduced plant efficiency, and higher modular-building production and depreciation costs.
- Agricultural-products revenue declined 7.6% in the quarter and 20.6% year to date, reflecting spring flooding, delayed or uncertain planting, weaker agricultural conditions, liquidation of the Canadian subsidiary, and the absence of certain prior-year OEM and product sales.
- Modular-buildings revenue increased 86.8% in the quarter and 64.0% year to date, primarily due to an $8.4 million modular research facility project that began in the second quarter and higher lease revenue. Segment gross margins nevertheless declined to 9.4% for the quarter and 10.3% year to date.
- Tools revenue increased 5.5% in the quarter but declined 14.5% year to date due primarily to the loss of a large-volume customer. Tools gross margins improved.
- Selling expenses declined 18.6% for the quarter and 23.8% year to date; general and administrative expenses declined 14.2% and 8.2%, respectively. Cost reductions included lower commissions, fewer trade shows, a shift from print to digital advertising, and reduced staffing.
- Accounts receivable increased to $2.668 million from $1.537 million at November 30, 2018, contributing to negative operating cash flow. Contract liabilities increased to $1.220 million from $185,000, reflecting a modular-building milestone invoice and agricultural equipment deposits.
- The company adopted ASC 606 using the modified retrospective method effective December 1, 2018. Management stated that adoption had no material impact on previously reported amounts or retained earnings.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management stated that corn prices were beginning to rise and expressed optimism that this could benefit the second half of fiscal 2019. The company expects to continue reducing costs and improving operating processes. No formal earnings or revenue guidance was provided.
Order backlog as of July 6, 2019 was $8.446 million, compared with $3.175 million a year earlier. Modular-building backlog was $6.914 million, including the $8.4 million research facility project scheduled for completion in 2019. Agricultural-products backlog declined to $1.369 million from $2.495 million, while tools backlog declined to $163,000 from $216,000. Management cautioned that backlog is not necessarily indicative of future revenue because of potential cancellations and dealer discounts.
Liquidity remains dependent on operating cash flow, asset-sale proceeds, working-capital management, and continued access to financing. The company believes current cash flows and financing arrangements will fund operations and debt payments for the next twelve months, but it also identifies risks related to debt repayment, covenant compliance, financing availability, economic conditions, seasonal demand, production cycles, and material costs.
The company previously failed its debt-service-coverage covenant at November 30, 2018, but Bank Midwest waived the noncompliance; no event of default occurred. The next covenant measurement date is November 30, 2019. The company also maintains a $4.000 million 2019 revolving facility supporting an irrevocable letter of credit for the modular laboratory project; the funds remained undisbursed and held by the bank at May 31, 2019.
Warranty liabilities were $89,637 at May 31, 2019. Future warranty costs could exceed historical estimates. The company reported no material pending legal proceedings, no off-balance-sheet arrangements, and no subsequent events requiring recognition. It plans to adopt lease accounting under ASC 842 in fiscal 2020 and is evaluating the effect.
Important Facts for Investors to Verify
- Whether the $8.4 million modular research facility project is completed on schedule and converts backlog and milestone billings into cash and profit.
- Whether agricultural demand recovers after flooding and delayed planting, including the effect of corn prices and crop yields.
- Whether gross margins recover from the substantial year-to-date decline, particularly in agricultural products and modular buildings.
- Whether operating cash flow improves, given the very low cash balance and significant receivables, inventory, and contract-related working-capital requirements.
- Availability, renewal, and demand terms of the $5.0 million revolving credit line, including the March 2020 maturity and borrowing-base availability.
- Compliance with Bank Midwest financial covenants at the November 30, 2019 measurement date.
- Potential effects of warranty claims, production inefficiencies, project cost overruns, order cancellations, and dealer discounts on future results.