Art’s-Way Manufacturing Co., Inc. — Form 10-Q Summary
Business context and reporting period
Art’s-Way manufactures agricultural equipment and replacement parts, modular buildings, and steel cutting tools through three reportable segments: Agricultural Products, Modular Buildings, and Tools. This unaudited report covers the three and six months ended May 31, 2020, compared with the corresponding 2019 periods. The company identified COVID-19 as a significant operating factor during the second quarter.
Financial performance and position
| Metric | Three months ended May 31, 2020 | Three months ended May 31, 2019 | Six months ended May 31, 2020 | Six months ended May 31, 2019 |
|---|---|---|---|---|
| Sales | $5.446 million | $5.747 million | $10.472 million | $9.871 million |
| Gross profit | $995 thousand | $959 thousand | $1.972 million | $1.564 million |
| Gross margin | 18.3% | 16.7% | 18.8% | 15.8% |
| Loss from operations | $(925) thousand | $(370) thousand | $(1.394) million | $(1.092) million |
| Net loss | $(802) thousand | $(356) thousand | $(1.239) million | $(962) thousand |
| Basic and diluted loss per share | $(0.18) | $(0.08) | $(0.28) | $(0.23) |
- At May 31, 2020, total assets were $20.380 million, total liabilities were $9.699 million, and stockholders’ equity was $10.681 million.
- Cash was only $2,948, compared with $3,145 at November 30, 2019. Accounts receivable increased to $2.153 million and net inventory increased to $9.533 million.
- Operating activities used $1.319 million of cash during the first six months. Investing activities used $407 thousand, including $412 thousand of capital expenditures.
- Financing activities provided $1.726 million, including $552 thousand of additional line-of-credit borrowings and $1.243 million of proceeds from the Paycheck Protection Program loan.
- Debt at May 31, 2020 included $3.131 million outstanding on a $5.000 million revolving line of credit and $3.636 million of term debt, including the PPP loan. The revolving line had $1.869 million of stated availability and matures March 30, 2021.
Material changes versus the prior comparable period
- Second-quarter sales declined 5.2%, while year-to-date sales increased 6.1%. The quarterly decline was primarily attributable to weaker Agricultural Products sales and adverse market conditions.
- Agricultural Products sales decreased 15.6% in the quarter and 3.6% year to date. COVID-19-related disruptions in livestock demand, restaurant closures, meat-packing disruptions, and product mix contributed to the decline.
- Modular Buildings sales increased 15.5% in the quarter and 26.2% year to date, reflecting more projects under contract. Tools sales increased 4.3% and 14.3%, respectively, helped by a large OEM customer.
- Gross margins improved, primarily because of agricultural manufacturing efficiencies, product mix and pricing actions, and higher Modular Buildings volume. Tools margins declined because of labor and overhead costs associated with integrating the OEM product line.
- Operating losses widened substantially because general and administrative expense increased by $581 thousand in the quarter and $625 thousand year to date. The company cited management recruitment, transition costs, OEM implementation, bonuses and employment rewards related to the pandemic.
- Retained earnings declined from $8.547 million at November 30, 2019 to $7.308 million at May 31, 2020, reflecting the year-to-date net loss.
Guidance, outlook, risks, contingencies, and unusual items
- Management stated that it expects all or a significant portion of the $1.243 million PPP loan to be forgiven; any unforgiven balance remains payable with interest.
- Three SBA Economic Injury Disaster Loans totaling $450 thousand were executed after quarter-end on June 18 and June 24, 2020. The loans bear interest at 3.75%, are secured by substantially all company assets, and have 30-year maturities.
- Management believes existing financing arrangements will provide sufficient funds for operations and debt service for the next twelve months, while acknowledging that additional financing may be needed if COVID-19 materially affects operations.
- Order backlog was $5.315 million as of July 6, 2020, down from $8.585 million a year earlier. The decrease primarily reflected progress on a large Modular Buildings project; excluding that project, management stated backlog was down approximately $65 thousand.
- Management expected a slight recovery in Agricultural Products order activity but noted continuing uncertainty regarding farmers’ purchasing decisions. Modular Buildings faced subcontractor quarantines and installation delays, while Tools remained exposed to oil and gas market conditions.
- The company adopted ASC 842 lease accounting in fiscal 2020 and recognized a $34 thousand right-of-use asset and corresponding lease liabilities.
- Disclosure controls were deemed ineffective as of May 31, 2020 because of a material weakness concerning controls over estimates of completed subcontract work on Modular Buildings contracts. New controls were implemented, but insufficient testing time had elapsed to conclude that the weakness was fully remediated.
- Bank covenants are measured annually at November 30. The company previously required a waiver for noncompliance with its debt service coverage ratio; management reported no event of default.
- No material pending legal proceedings were reported. The filing states that no other subsequent events requiring recognition occurred.
Most important facts for investors to verify
- Whether the PPP loan is forgiven and the resulting effect on debt, liquidity, and earnings.
- Whether cash generation improves from the reported negative operating cash flow and very low cash balance.
- Renewal or refinancing of the $5.000 million revolving line before its March 30, 2021 maturity.
- Progress toward remediating the material weakness in Modular Buildings contract-cost estimates.
- The sustainability of improved gross margins after COVID-19 effects, product-mix changes, and one-time administrative costs normalize.
- Conversion of the $5.315 million backlog into revenue, including potential cancellations, installation delays, and customer discount arrangements.
- Compliance with debt covenants at the November 30, 2020 measurement date.