Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. is a Delaware-based manufacturer of agricultural equipment and related products, pressurized vessels, modular buildings, and steel cutting tools. The unaudited Form 10-Q covers the three and six months ended May 31, 2015, with comparisons to the corresponding 2014 periods. The company operates through four segments: Agricultural Products, Pressurized Vessels, Modular Buildings, and Tools.
Financial Performance and Position
| Metric | Three Months Ended May 31, 2015 | Three Months Ended May 31, 2014 | Six Months Ended May 31, 2015 | Six Months Ended May 31, 2014 |
|---|---|---|---|---|
| Sales | $7.804 million | $9.469 million | $15.093 million | $15.706 million |
| Gross profit | $2.208 million | $2.328 million | $4.260 million | $3.668 million |
| Gross margin | 28.3% | 24.6% | 28.2% | 23.4% |
| Operating income | $414,000 | $444,000 | $743,000 | $149,000 |
| Net income (loss) | $232,000 | $253,000 | $400,000 | $(5,000) |
| Diluted EPS | $0.06 | $0.06 | $0.10 | $(0.00) |
Six-month net cash provided by operating activities was $306,000, compared with cash used of $450,000 in the prior-year period. Investing activities used $126,000, primarily for capital expenditures, compared with $610,000 used in 2014. Financing activities used $91,000, including $202,000 of dividends, while the company increased borrowings under its line of credit by $750,000 and repaid $638,000 of term debt.
Cash was $602,000 at May 31, 2015, compared with $512,000 at November 30, 2014. Total current assets were $21.353 million and total current liabilities were $7.896 million. Inventories increased to $15.971 million from $15.089 million at fiscal year-end. Total debt consisted of a $3.319 million revolving credit balance and $6.595 million of term debt, including $1.303 million classified as current. Stockholders’ equity was $19.478 million.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales decreased 17.6%, while six-month sales decreased 3.9%. Management attributed much of the quarterly decline to prior-year shipments delayed by extreme weather that shifted revenue into the second quarter of 2014.
- Six-month gross profit increased 16.1% and gross margin expanded to 28.2% from 23.4%, reflecting manufacturing efficiencies and improved inventory management.
- Six-month operating income increased to $743,000 from $149,000, primarily because Agricultural Products operating income increased by approximately $622,000.
- Tools revenue declined 38.1% for the quarter and 25.2% year to date, largely because of a general decline in the energy industry. Tools gross margin also declined.
- Agricultural Products revenue declined year to date by 2.7%, primarily due to lower Universal Harvester reel sales, partly offset by higher grinder mixer sales.
- Pressurized Vessels and Modular Buildings improved year-to-date revenue and gross margins, although Modular Buildings remained unprofitable at the operating level.
- Backlog as of June 25, 2015 was $5.706 million, down from $6.747 million a year earlier. Agricultural Products backlog declined to $3.316 million from $5.821 million, while Modular Buildings backlog increased to $1.388 million from $200,000.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management believes operating cash flows and current financing arrangements are sufficient to fund operations for the next twelve months, but expects to continue relying on financing activities to supplement operating cash flow.
- The company stated that it expects to obtain financing on reasonable terms and expects to renew its revolving credit facility before maturity.
- The $8.0 million U.S. Bank revolving line of credit had $3.319 million outstanding and $4.255 million available at May 31, 2015. Its maturity was extended from May 1 to July 1, 2015, and subsequently extended on June 23, 2015 to May 1, 2016.
- The company was in compliance with its U.S. Bank debt covenants at May 31, 2015, including the maximum 1.5-to-1.0 debt-to-tangible-net-worth ratio and minimum 1.15-to-1.0 fixed-charge-coverage ratio.
- Key risks identified by management include credit-market conditions, the ability to service debt and maintain covenant compliance, economic conditions affecting product demand and material costs, seasonal demand and production cycles, integration of acquired product lines, and the agricultural downturn.
- Product warranties generally cover one year. The accrued warranty liability was $284,000 at May 31, 2015, and future warranty costs could exceed historical experience.
- The company reported no material pending legal proceedings, no off-balance-sheet arrangements, and no defaults upon senior securities. Management concluded that no material subsequent events occurred other than the line-of-credit extension.
- The financial statements are interim, unaudited, and based on normal recurring adjustments; management cautioned that interim results are not necessarily indicative of full-year results.
- Management reported effective disclosure controls and procedures and no material changes to internal control over financial reporting.
Investor Verification Items
- Verify the May 1, 2016 maturity and renewal terms of the U.S. Bank revolving credit facility, including borrowing-base availability and covenant compliance.
- Monitor inventory growth, customer deposits, working-capital requirements, and the company’s continued dependence on financing cash flows.
- Assess whether the agricultural downturn and declining Agricultural Products backlog will affect future sales and margins.
- Evaluate the sustainability of gross-margin improvements and the continuing operating losses in the Tools and Modular Buildings segments.
- Review the decline in Tools sales associated with the energy industry and the potential for further weakness.
- Track warranty claims, inventory reserves, customer order cancellations, and the conversion of backlog into revenue.
- Confirm the effect of the $202,000 dividend and required term-debt repayments on future liquidity and capital allocation.