Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. filed its audited Form 10-K for the fiscal year ended November 30, 2011. The company operates three segments: Agricultural Products, Pressurized Vessels, and Modular Buildings. Agricultural Products generated 81.9% of fiscal 2011 revenue, followed by Modular Buildings at 11.6% and Pressurized Vessels at 6.5%.
The company sells agricultural equipment primarily through approximately 1,800 independent U.S. and Canadian dealers and sells customized vessels and modular buildings directly to customers. The filing identifies the company as a smaller reporting company. Eide Bailly LLP issued an unqualified audit opinion on the consolidated financial statements.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $27.620 million | $28.951 million | Down 4.6% |
| Gross profit | $7.007 million | $6.809 million | Up 2.9% |
| Gross margin | 25.3% | 23.5% | Up 180 basis points |
| Operating income | $1.930 million | $1.895 million | Up 1.8% |
| Net income | $1.249 million | $1.053 million | Up 18.5% |
| Basic and diluted EPS | $0.31 | $0.26 | Up $0.05 |
| Cash flow from operations | $2.368 million | $3.594 million | Down $1.225 million |
| Capital and lease-related investments | $1.092 million | $2.362 million | Down $1.270 million |
| Cash at year-end | $0.119 million | $0.317 million | Down $0.198 million |
Operating expenses increased 3.3% to $5.077 million, while interest expense was $0.429 million. The effective tax rate declined to 21.0% from 32.4%, primarily because of additional deductions and credits related to fiscal 2010 tax filings.
At November 30, 2011, total assets were $25.855 million, total liabilities were $11.125 million, and stockholders’ equity was $14.731 million. Current assets were $16.696 million versus current liabilities of $4.570 million, producing working capital of $12.125 million and a current ratio of 3.65.
Segment Results
| Segment | 2011 Revenue | 2011 Operating Income/(Loss) | 2010 Revenue | 2010 Operating Income/(Loss) |
|---|---|---|---|---|
| Agricultural Products | $22.614 million | $2.428 million | $20.586 million | $1.961 million |
| Pressurized Vessels | $1.797 million | $(0.448) million | $1.534 million | $(0.618) million |
| Modular Buildings | $3.209 million | $(0.050) million | $6.831 million | $0.552 million |
Debt and Liquidity
The company had a $6.000 million revolving credit facility with West Bank, of which $1.389 million was outstanding at year-end, leaving $4.611 million available subject to borrowing-base limitations. The facility carried a 4.0% minimum interest rate and was renewed through April 30, 2012.
Total term debt was $6.456 million, including $0.713 million classified as current. Contractual debt maturities totaled $6.456 million, including $4.814 million due in 2013. The company reduced its line-of-credit borrowings by $0.695 million and other bank notes by $0.612 million during 2011. Management stated that existing financing arrangements were sufficient to fund operations for the next 12 months.
Debt agreements require financial covenants, including minimum debt service coverage, maximum debt-to-tangible-net-worth, and minimum tangible net worth requirements. The company reported compliance with all covenants at November 30, 2011. Debt is secured by substantially all company and subsidiary assets, including real estate, inventory, receivables, machinery, and equipment.
Material Changes Versus the Prior Comparable Period
- Consolidated revenue declined 4.6%, primarily because Modular Buildings revenue fell 53.0% to $3.209 million.
- Agricultural Products revenue increased 9.9% to $22.614 million, led by grinder, land-maintenance, and potato-harvesting equipment and an 8.8% increase in service-part sales. Beet-harvester revenue declined 20.7% and auger revenue declined 41.0%.
- Agricultural Products operating income increased 23.8% to $2.428 million, supported by improved product mix and operating leverage.
- Pressurized Vessels revenue increased 17.1%, but the segment remained unprofitable because production volume was insufficient to absorb fixed overhead. Management hired a plant manager and shifted the former plant general manager to sales leadership.
- Modular Buildings moved from $0.552 million of operating income to a $0.050 million operating loss. Management attributed the decline to the lingering economic downturn but reported improving late-2011 sales activity and backlog.
- Gross margin improved to 25.3% from 23.5%, despite lower revenue.
- Operating cash flow declined from $3.594 million to $2.368 million, while capital and lease-related investment declined from $2.362 million to $1.092 million.
- Current liabilities declined 25.8%, long-term liabilities declined 6.6%, and total liabilities declined by approximately $2.063 million.
- The company moved auger production from Salem, South Dakota, to West Union, Iowa, in July 2011; the Salem facility was listed for sale.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide formal financial guidance. It expected Modular Buildings sales to improve during fiscal 2012 based on improved activity and backlog, intended to expand the auger product line and international presence, and planned to focus Modular Buildings on academic, government, public health, private research, and pharmaceutical customers.
As of February 14, 2012, reported backlogs were approximately $13.602 million for Agricultural Products, $7.092 million for Modular Buildings, and $0.395 million for Pressurized Vessels. Management cautioned that backlogs fluctuate because of new orders, deliveries, cancellations, and dealer discount arrangements and therefore are not necessarily indicative of future revenue.
- Demand is sensitive to farm income, commodity prices, weather, crop damage, government farm programs, interest rates, and agricultural production costs.
- The company faces intense competition, particularly in agricultural equipment and pressurized vessels, and depends substantially on independent dealers.
- Steel and other raw-material prices, supplier performance, product demand, seasonality, and the ability to maintain intellectual property rights may affect results.
- Failure to comply with loan covenants or renew the revolving credit facility could restrict liquidity or accelerate debt repayment. The revolving facility maturity was April 30, 2012.
- Art’s-Way Scientific achieved approximately 48% of certain Iowa job-creation and retention requirements. Its original $190,000 of promissory notes was restructured into three notes, including a $48,830 forgivable loan subject to further measurement in April 2012. Art’s-Way Manufacturing guaranteed these obligations.
- Inventory reserves increased to $2.750 million from $1.816 million. Management stated that additional write-downs could be required if usage or selling assumptions change.
- Warranty liability was $0.202 million at year-end, and future warranty costs could exceed historical experience.
- One customer represented approximately 8.4% of consolidated revenue in 2011. Related-party sales to an entity owned by the chairman were $17,000.
- The company reported no material legal proceedings, no off-balance-sheet arrangements, and no material subsequent events requiring disclosure.
- Management stated that disclosure controls and internal control over financial reporting were effective at year-end. The filing notes that fiscal 2011 procedures addressed a material weakness in inventory accounting reported in the 2010 Form 10-K.
Important Facts for Investors to Verify
- Verify renewal or replacement of the $6.000 million revolving credit facility after its April 30, 2012 maturity and continued compliance with all debt covenants.
- Assess whether the $4.814 million of scheduled 2013 term-debt maturities can be refinanced or repaid without constraining operations.
- Monitor Modular Buildings backlog conversion and whether the segment returns to profitability.
- Evaluate whether Pressurized Vessels can achieve sufficient production volume and delivery performance to eliminate negative gross margins.
- Review inventory aging, reserves, and working-capital requirements, particularly given inventory of $13.249 million and limited year-end cash of $0.119 million.
- Track the April 2012 measurement of Art’s-Way Scientific’s job-retention and creation requirements and the potential treatment of the forgivable Iowa loan.
- Reconcile reported backlog with subsequent orders, cancellations, shipments, and revenue recognition, including $0.532 million of 2011 bill-and-hold revenue.
- Confirm the effectiveness of enhanced inventory controls and whether any material weaknesses or audit findings recur.