Art’s-Way Manufacturing Co., Inc. — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three and nine months ended August 31, 2017, filed October 6, 2017. Art’s-Way manufactures agricultural equipment, modular buildings, and steel cutting tools. The pressurized vessels segment was discontinued effective October 31, 2016 and is presented as discontinued operations.
Key Financial Metrics
| Metric | Three Months Ended August 31, 2017 | Three Months Ended August 31, 2016 | Nine Months Ended August 31, 2017 | Nine Months Ended August 31, 2016 |
|---|---|---|---|---|
| Sales | $6.55 million | $6.43 million | $15.66 million | $17.44 million |
| Gross profit | $1.44 million | $1.24 million | $3.37 million | $4.35 million |
| Gross margin | 22.1% | 19.3% | 21.5% | 25.0% |
| Income from operations | $109,240 | $(217,165) | $(964,576) | $67,372 |
| Income from continuing operations | $41,648 | $(149,676) | $(720,900) | $807 |
| Net income (loss) | $23,207 | $(288,279) | $(754,382) | $(263,878) |
| Net income (loss) per share | $0.01 | $(0.07) | $(0.18) | $(0.06) |
At August 31, 2017, cash was $393,276, accounts receivable were $2.42 million, inventory was $13.18 million, and total assets were $26.49 million. Current liabilities were $9.35 million, including $3.73 million drawn on the revolving line of credit and $2.37 million of current term debt. Total liabilities were $9.62 million and stockholders’ equity was $16.87 million.
Cash used in operating activities was $110,972 for the first nine months, compared with $1.36 million provided in the prior-year period. Cash used in investing activities was $413,939, including $472,031 of capital expenditures. Cash used in financing activities was $205,940. Cash declined from $1.06 million at November 30, 2016 to $393,276 at August 31, 2017.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 1.9%, but nine-month sales declined 10.2%, primarily because of weaker agricultural-products and modular-building demand.
- Third-quarter gross margin improved to 22.1%, mainly because of stronger margins in the Metals segment. Nine-month gross margin declined to 21.5%, primarily due to Manufacturing production inefficiencies and lower margins.
- Third-quarter operations became profitable, while the nine-month operating result deteriorated to a $964,576 loss.
- Metals sales increased 35.5% in the quarter and 27.7% year to date, with nine-month gross margin rising to 32.1% from 23.1%.
- Scientific sales declined 15.7% in the quarter and 34.1% year to date; project overruns negatively affected margins.
- Discontinued operations generated no revenue in 2017 and produced a nine-month loss of $33,482, compared with a $264,685 loss in the prior-year period.
- Accounts receivable increased by approximately $1.0 million from November 30, 2016, while accounts payable increased by approximately $871,000.
Debt, Liquidity, Outlook, and Risks
The company was not in compliance with its U.S. Bank fiscal 2017 third-quarter EBITDA covenant as of August 31, 2017, primarily because of reduced gross margins. The U.S. Bank revolving facility had $765,886 of stated availability at quarter-end, subject to borrowing-base limitations, and the revolving facility and U.S. Bank term loans matured in September 2017.
On September 28, 2017, the company refinanced substantially all U.S. Bank debt with Bank Midwest. The new facility includes a $5.0 million revolving line, a $2.6 million term loan due October 1, 2037, and a $600,000 term loan due October 1, 2019. Management stated that monthly debt service declined to approximately $20,500 from approximately $65,300 and that the new facility provides longer amortization and greater revolver availability.
Management believes operating cash flows and the Bank Midwest financing will provide sufficient liquidity for the next twelve months, but the company expects to continue relying on financing activities. Management is also seeking to sell two real estate holdings to provide working capital and reduce debt. The filing states that operating losses have depleted working capital and identifies substantial risks relating to debt repayment, covenant compliance, refinancing, demand, seasonal production, asset liquidation, and the company’s ability to continue as a going concern.
Order backlog for continuing operations was $1.96 million as of October 4, 2017, compared with $1.16 million a year earlier. Management attributed the increase to new pricing programs and new products, but cautioned that backlog is not necessarily indicative of future revenue because of cancellations and dealer discounts. No formal earnings guidance was provided.
The company plans to dispose of remaining Vessels assets, primarily real estate. Warranty liabilities were $133,194 at August 31, 2017. Management reported effective disclosure controls, no material pending legal proceedings, and no material changes in internal controls.
Important Facts for Investors to Verify
- Confirm the closing terms, collateral, covenants, demand provisions, and ongoing availability under the Bank Midwest facility.
- Assess whether the company can maintain required working capital, debt-service coverage, leverage, and tangible-equity ratios.
- Monitor the transition from significant nine-month operating losses to third-quarter profitability and determine whether margin improvements are sustainable.
- Evaluate collectibility of the increased accounts receivable and the adequacy of inventory reserves, particularly given the $13.18 million inventory balance.
- Track sales and profitability trends in Manufacturing and Scientific, including the effects of new products, production inefficiencies, and project overruns.
- Verify the timing and proceeds of planned real estate and discontinued Vessels-asset sales.
- Review the company’s going-concern assumptions and its continued dependence on financing and asset dispositions.