Art’s-Way Manufacturing Co., Inc. — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three months ended February 28, 2014, filed April 14, 2014. Art’s-Way manufactures agricultural equipment, pressurized vessels, modular buildings, and steel cutting tools. The company operates four reportable segments: Agricultural Products, Pressurized Vessels, Modular Buildings, and Tools.
The quarter includes contributions from the Agro Trend acquisition completed in June 2013 and the Ohio Metal Working Products acquisition completed in September 2013. The Tools segment was established through the Ohio acquisition.
Financial Results and Key Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $6.237 million | $8.415 million | Down 25.9% |
| Gross profit | $1.340 million | $2.369 million | Down 43.4% |
| Gross margin | 21.5% | 28.2% | Down 670 basis points |
| Operating income (loss) | $(0.295) million | $0.713 million | Declined $1.008 million |
| Income (loss) before taxes | $(0.343) million | $1.261 million | Declined $1.605 million |
| Net income (loss) | $(0.258) million | $0.819 million | Declined $1.078 million |
| Basic and diluted EPS | $(0.06) | $0.20 | Declined $0.26 |
| Cash flow from operations | $0.167 million | $1.606 million | Down $1.439 million |
Segment sales were $4.441 million in Agricultural Products, $0.424 million in Pressurized Vessels, $0.461 million in Modular Buildings, and $0.911 million in Tools. Tools generated $66,000 of operating income; the other three segments reported operating losses.
At February 28, 2014, total assets were $33.766 million and stockholders’ equity was $18.036 million. Cash was $85,949 on the balance sheet. The cash flow statement reports ending cash of $86,915; the filing text does not explain the $966 difference.
Inventories increased to $15.921 million from $14.923 million at November 30, 2013. Accounts receivable declined to $2.411 million from $3.000 million. Customer deposits increased to $1.282 million from $148,000.
Total debt consisted of a $3.803 million revolving line of credit and $7.173 million of term debt, for approximately $10.975 million in total borrowings. Term debt declined from $7.481 million at November 30, 2013. The revolving facility has an $8.0 million capacity, bears interest at a 3.50% minimum rate, and was scheduled to mature on May 1, 2014.
Material Changes Versus the Prior Comparable Period
- Sales decreased $2.178 million, primarily from a $2.563 million decline in Agricultural Products and a $556,000 decline in Modular Buildings.
- Agricultural Products revenue fell 36.6%, with management citing an unusually cold winter, lost and disrupted labor hours, employee training, constrained production, and lower sugar beet harvester demand.
- Modular Buildings revenue fell 54.7%. The prior-year quarter benefited from the completion of major contracts, resulting in an unusually high 44.9% segment gross margin versus 13.5% in the current quarter.
- Pressurized Vessels sales increased 7.6% and its gross margin improved to 8.6% from negative 12.5%.
- The newly acquired Tools segment contributed $911,000 of sales and a 30.6% gross margin, but also increased selling expenses.
- Consolidated selling and engineering expenses increased, while general and administrative expense decreased primarily because of lower bonus accruals. Expenses represented a larger percentage of sales.
- First-quarter 2013 included a $630,000 gain on the sale of land and facilities; there was no comparable gain in 2014. Other income consequently declined from $638,000 to $6,000.
- Operating cash flow declined substantially as the company invested $998,000 in additional inventory and generated lower earnings, partially offset by increased customer deposits and collections of receivables.
Outlook, Risks, Contingencies, and Unusual Items
Management reported consolidated order backlog of $10.378 million at March 31, 2014, up from $9.603 million at March 31, 2013. The increase was attributed primarily to Tools demand and agricultural equipment demand, partly offset by weaker beet harvester demand. Management cautions that backlog may not convert fully to revenue because of cancellations and dealer discounts.
Management stated that dairy and livestock demand was robust and supported a significant Agricultural Products backlog, providing optimism for the balance of 2014. The company expects production costs and capital expenditures to be its primary capital needs and expects to rely on financing activities to supplement operating cash flow.
Management believed existing financing arrangements were sufficient to fund operations for the next twelve months and expected to obtain financing on reasonable terms. This outlook depends on renewal of the revolving line of credit, which was scheduled to mature on May 1, 2014.
The company was not in compliance with its required fixed charge coverage ratio of at least 1.15 to 1.00 as of February 28, 2014, primarily because of the operating loss. U.S. Bank issued a waiver for the first-quarter violation, and no event of default occurred. The next measurement date was May 31, 2014. A continuing violation could permit higher interest rates, termination of additional lending commitments, acceleration, or enforcement against collateral.
Other principal risks include agricultural cyclicality, seasonal demand, material and supply costs, labor and production constraints, integration of acquired businesses, credit-market conditions, debt and covenant compliance, warranty costs, and the ability to convert backlog into sales.
The company reported no material pending legal proceedings, no off-balance-sheet arrangements, and no material changes to internal controls. Management stated that disclosure controls were effective.
Investor Verification Checklist
- Verify renewal or replacement of the $8.0 million revolving credit facility after its May 1, 2014 maturity date.
- Verify compliance with the fixed charge coverage covenant at the May 31, 2014 measurement date and whether any further waivers were required.
- Assess whether the reported backlog, particularly in Agricultural Products and Tools, converted into revenue and improved utilization and margins.
- Monitor inventory growth, inventory reserves, customer deposits, and operating cash flow given the low cash balance and reliance on borrowing.
- Evaluate the integration, profitability, and permanent financing of the Ohio Metal acquisition, which was initially financed through the revolving credit line.
- Reconcile the $85,949 balance-sheet cash amount with the $86,915 ending cash amount reported in the cash flow statement.