Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. is a farm equipment manufacturer with reportable segments in agricultural products, modular buildings, and tools. The company also continued winding down its discontinued pressurized vessels segment. This unaudited Form 10-Q covers the three months ended February 28, 2018, compared with the three months ended February 28, 2017.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $5.366 million | $4.421 million | 21.4% increase |
| Gross profit | $1.120 million | $1.114 million | 0.5% increase |
| Gross margin | 20.9% | 25.2% | 430 basis-point decline |
| Operating income (loss) | $(309) thousand | $(352) thousand | Loss narrowed |
| Operating margin | (5.8%) | (8.0%) | Improved |
| Income (loss) from continuing operations | $(527) thousand | $(254) thousand | Loss increased |
| Net income (loss) | $(566) thousand | $(250) thousand | Loss increased |
| Net loss per share | $(0.14) | $(0.06) | Declined |
| Net cash provided by operating activities | $495 thousand | $302 thousand | Increased |
Sales increased primarily from stronger agricultural product demand and higher modular building revenue. Segment sales were $3.929 million for agricultural products, $739 thousand for modular buildings, and $697 thousand for tools. Gross profit was pressured by sales of older inventory at reduced margins and the sale of the snow blower product line at cost.
The continuing-operations loss included a $221,573 income tax expense, substantially reflecting an approximately $300,000 reduction in the deferred tax asset following the Tax Cuts and Jobs Act rate change from 35% to 21%. Excluding this tax-related adjustment, the filing indicates that the reported continuing-operations loss would have been lower, but it does not provide a formal adjusted earnings measure.
At February 28, 2018, cash was $92,814, compared with $212,400 at November 30, 2017. Total current assets were $13.541 million and total current liabilities were $4.664 million. Inventories were $11.069 million, down from $11.967 million at fiscal year-end.
Total debt consisted of a $1.961 million revolving credit balance and $3.513 million of term debt, including the current portion. The revolving facility had a $5.000 million capacity, with $3.039 million remaining available subject to borrowing-base limitations. The line carried a 5.25% interest rate at quarter-end, was payable on demand, and was renewed March 30, 2018 through March 30, 2019.
Operating cash flow from continuing operations was $546 thousand, supported principally by an $898 thousand reduction in inventories and a $256 thousand increase in accounts payable. Capital expenditures were $64 thousand. Financing activities used $579 thousand, including $502 thousand of line-of-credit repayment, $54 thousand of term-debt repayment, and $21 thousand of share repurchases.
Material Changes Versus the Prior Comparable Period
- Revenue rose 21.4%, but gross margin fell to 20.9% from 25.2% because of inventory clearance and product-mix factors.
- Operating expenses declined to $1.429 million from $1.466 million, mainly from lower selling expenses; administrative expense was essentially unchanged.
- The continuing-operations loss more than doubled, primarily because of the deferred-tax-asset revaluation related to the new corporate tax rate.
- Modular-building revenue increased 90.5%, largely from sales-type capital leases. The company recognized $129 thousand of profit from sales-type leases, versus none in the prior-year quarter.
- Cash generation improved, while cash declined because the company used operating cash to reduce borrowings and repay debt.
- Backlog as of March 29, 2018 was $4.472 million, down from $5.578 million a year earlier. Management attributed the decline partly to prior-year pass-through self-propelled equipment and the use of leasing transactions, which are excluded from backlog.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management stated that operating cash flows and current financing arrangements are expected to provide sufficient funds for operations and debt payments over the next twelve months, and that financing is expected to remain available on reasonable terms. No formal revenue or earnings guidance was provided.
Management has launched lean manufacturing initiatives intended to improve efficiency and gross margins and reported positive results through the first quarter. The company expects capital needs for the remainder of fiscal 2018 to relate primarily to operating and production costs.
The discontinued vessels segment had no revenue in the quarter and generated a $39 thousand after-tax loss. The company sold the remaining vessels-related real estate and other assets on March 29, 2018 for $1.5 million, consistent with the carrying value after the prior-year impairment.
Key risks include weaker demand, seasonal production cycles, material and supply costs, credit-market tightening, the ability to repay debt and comply with covenants, order cancellations, warranty costs, and the ability to renew or obtain financing. The company had received waivers for debt-service-coverage-ratio covenant violations measured at November 30, 2017; the next measurement date is November 30, 2018. Management reported no material pending legal proceedings, no off-balance-sheet arrangements, and effective disclosure controls.
Important Facts for Investors to Verify
- Whether lower gross margins persist after inventory reduction and completion of lean initiatives.
- The effect of the deferred-tax-asset revaluation and the ongoing 21% federal corporate tax rate on future earnings and cash taxes.
- Compliance with the Bank Midwest and Iowa Finance Authority debt covenants at the November 30, 2018 measurement date.
- Availability under the revolving credit facility, which is subject to a borrowing base and payable on demand.
- Conversion of the modular-building sales-type lease activity into recurring cash collections and reported revenue.
- Future backlog trends, including the distinction between manufactured products, pass-through equipment, and lease transactions.
- Final cash proceeds and any remaining obligations associated with the completed disposal of the vessels segment.