Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. is a Delaware-based manufacturer of agricultural equipment, modular buildings, and steel cutting tools. This unaudited Form 10-Q covers the three- and six-month periods ended May 31, 2018, compared with the same periods in 2017. The company is a smaller reporting company. The former pressurized vessels segment is presented as discontinued operations.
Key Financial Metrics
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Sales | $5.294 million | $4.689 million | $10.660 million | $9.111 million |
| Gross profit | $1.107 million | $0.811 million | $2.260 million | $1.925 million |
| Gross margin | 20.9% | 17.3% | 21.2% | 21.1% |
| Operating loss | $(0.458) million | $(0.721) million | $(0.767) million | $(1.074) million |
| Net loss | $(0.666) million | $(0.528) million | $(1.232) million | $(0.778) million |
| Net loss per diluted share | $(0.16) | $(0.12) | $(0.29) | $(0.18) |
- Six-month operating cash flow was $(0.424) million, compared with $(0.622) million in the prior-year period. Continuing-operations operating cash flow was $(0.334) million.
- Investing activities provided $1.283 million, including $1.419 million from discontinued operations, primarily reflecting proceeds from the sale of Vessels real estate. Capital expenditures were $0.165 million.
- Financing activities used $1.068 million, including a $0.338 million reduction in the revolving line of credit and $0.109 million of term-debt repayments.
- Cash declined from $0.212 million at November 30, 2017 to $3,622 at May 31, 2018.
- At May 31, 2018, total debt included a $2.125 million revolving credit balance and $2.861 million of term debt. The revolving facility had $2.875 million of stated availability, subject to borrowing-base limits, and carried a 6.0% interest rate.
- Total assets were $22.594 million and stockholders’ equity was $15.106 million at May 31, 2018.
Material Changes Versus the Prior Comparable Period
- Sales increased 12.9% in the quarter and 17.0% year to date, driven primarily by stronger demand for agricultural products and modular buildings.
- Agricultural Products sales increased 24.5% in the quarter and 20.4% year to date. Segment gross margin improved to 22.6% in the quarter and 21.9% year to date, aided by lean-production initiatives, although steel tariffs increased cost pressure.
- Modular Buildings quarterly sales declined 6.1%, while year-to-date sales increased 23.3%, partly due to sales-type leases. Segment gross margins declined to 10.0% for the quarter and 12.7% year to date because of staffing, production inefficiencies, and depreciation on leased buildings.
- Tools sales declined 18.0% in the quarter and 6.4% year to date following the loss of a large-volume customer. Segment margins also declined.
- Operating losses narrowed, but net losses increased because of a roughly $300,000 deferred-tax-asset remeasurement following the Tax Cuts and Jobs Act and a roughly $253,000 noncash loss from liquidating the Canadian subsidiary.
- The company recognized $129,104 of profit from sales-type leases during the first six months of 2018; no comparable profit was recorded in 2017.
- The Vessels segment’s remaining real estate was sold on March 29, 2018 for $1.500 million. Discontinued operations produced a six-month loss of $50,853, compared with $15,041 in the prior year.
- Order backlog as of July 8, 2018 was $3.156 million, down from $3.270 million as of July 8, 2017.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management stated that operating cash flows and current financing arrangements are expected to be sufficient to fund operations and debt payments for the next twelve months, and expects to obtain financing on reasonable terms. The filing does not provide quantitative earnings or revenue guidance.
- The $5.0 million revolving line of credit was renewed March 30, 2018 and is payable on demand, with scheduled maturity on March 30, 2019 if not demanded earlier.
- Debt agreements require working-capital, leverage, equity, and debt-service coverage compliance. The company was not in compliance with certain debt-service coverage covenants at November 30, 2017, but received lender waivers; the next measurement date is November 30, 2018.
- Key risks include limited cash, recurring operating losses, dependence on revolving financing, covenant compliance, refinancing and interest-rate risk, seasonal demand, steel tariffs and material costs, order cancellations, production inefficiencies, and loss of major customers.
- The company offers product warranties, generally averaging one year. Accrued warranty liability was $71,216 at May 31, 2018, compared with $152,964 a year earlier.
- Revenue-recognition and lease accounting standards were under evaluation. Management expected the new revenue standard to affect the Scientific segment most significantly and expected to adopt the lease standard for fiscal 2020.
- Management reported no material pending legal proceedings, no off-balance-sheet arrangements, and effective disclosure controls.
Investor Verification Items
- Verify whether the company can sustain operations with only $3,622 of reported cash and continued negative operating cash flow.
- Review borrowing-base availability, the demand feature and March 2019 maturity of the revolving credit facility, and compliance with all November 30, 2018 debt covenants.
- Assess whether agricultural-product margin improvements can offset steel tariffs and whether modular-building and tools margins recover.
- Evaluate the sustainability and collectability of sales-type lease receivables and related future lease receipts.
- Confirm that the reported backlog converts to revenue given stated cancellation and discount risks.
- Separate recurring operating performance from the noncash tax remeasurement, Canadian liquidation charge, and discontinued-operations activity.