Business Context and Reporting Period
Art’s-Way Manufacturing Co., Inc. filed this Form 10-K for the fiscal year ended November 30, 2012. The company manufactures agricultural equipment, pressurized steel vessels, and modular research and animal-containment buildings through three operating segments: Agricultural Products, Pressurized Vessels, and Modular Buildings.
- Agricultural Products represented 67.8% of 2012 revenue.
- Modular Buildings represented 26.5% of revenue.
- Pressurized Vessels represented 5.7% of revenue.
- In May 2012, the company acquired Universal Harvester Co., adding pickup-reel products under the UHC by Art’s-Way brand.
Financial Highlights
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Net sales | $36.46 million | $27.62 million | +32.0% |
| Gross profit | $10.03 million | $7.01 million | +43.2% |
| Gross margin | 27.5% | 25.4% | +210 basis points |
| Operating income | $4.33 million | $1.93 million | +124% |
| Net income | $2.67 million | $1.25 million | +113.4% |
| Basic and diluted EPS | $0.66 | $0.31 | +106% |
| Operating cash flow | $5.00 million | $2.37 million | +111% |
Net income margin was approximately 7.3%, compared with approximately 4.5% in 2011. The effective tax rate increased to 33.2% from 21.0%, primarily because of reduced research and development tax credits and prior-year adjustments recognized in 2011.
Segment Results
| Segment | 2012 Revenue | 2012 Operating Income/(Loss) | Key Change |
|---|---|---|---|
| Agricultural Products | $24.72 million | $2.37 million | Revenue increased 9.3%; UHC contributed $3.09 million after acquisition, partly offset by a $986,000 decline in potato harvesting revenue. |
| Pressurized Vessels | $2.09 million | $(127,000) | Revenue increased 16.3%; gross margin improved to 7.0% from negative 6.2%, but the segment remained unprofitable. |
| Modular Buildings | $9.65 million | $2.08 million | Revenue increased 200.6%, driven principally by a large Stanford University project; management stated that 2012 revenue levels are unlikely to continue. |
Liquidity, Cash Flow, Debt and Capital Resources
- Cash was $1.55 million at November 30, 2012, compared with $119,000 in 2011.
- Current assets were $20.13 million and current liabilities were $5.96 million, producing working capital of $14.17 million and a current ratio of approximately 3.38. Management reported working capital of $14.12 million and a 3.37 current ratio elsewhere in the filing.
- The $6.0 million revolving credit facility had no borrowings at year-end, compared with $1.39 million outstanding in 2011. The facility was scheduled to mature April 30, 2013, and the company intended to renew it.
- Total term debt was $8.47 million, including $1.17 million classified as current; total long-term debt excluding current maturities was $7.30 million.
- Cash flow from operations was $5.00 million. Investing cash flow was $(3.80) million, including $3.00 million paid for the Universal Harvester acquisition and approximately $800,000 for property and equipment. Financing cash flow was $227,000, reflecting new term debt, debt repayments, line-of-credit repayment, and $404,000 of dividends.
- Contractual obligations totaled $9.66 million, including $1.46 million due within one year. Amounts include principal and interest.
- The company was in compliance with its loan covenants at November 30, 2012. Debt is secured by company assets and includes financial-ratio requirements and restrictions on acquisitions, investments, guarantees, and dividends.
Material Changes, Outlook and Unusual Items
- The Universal Harvester acquisition cost approximately $3.07 million and contributed to agricultural revenue beginning May 10, 2012. Pro forma 2012 revenue and net income would have been approximately $38.71 million and $2.76 million, respectively, if the acquisition had occurred at the beginning of the year.
- The Modular Buildings segment benefited from approximately $9 million of work for a Stanford University facility, including approximately $7 million of fabrication, delivery and installation work and approximately $1.7 million of installation work. Management cautioned that the resulting 2012 sales level is unlikely to be sustained.
- Backlog as of February 5, 2013 was approximately $10.30 million in Agricultural Products, $919,000 in Modular Buildings, and $635,000 in Pressurized Vessels. Management cautioned that backlog fluctuates and is not necessarily indicative of future revenue.
- Management expected Pressurized Vessels to have a profitable 2013 based on improved quality, delivery performance, and repeat business, but the segment remained loss-making in 2012.
- The company sold its Salem, South Dakota facility in December 2012 for $87,500 after recording an approximately $95,000 impairment in 2012. It also sold Armstrong farm and pasture land for $776,000 and expected to recognize an approximately $658,000 gain in the first quarter of 2013, before transaction expenses.
- On February 1, 2013, the company refinanced its Iowa Finance Authority loan, reducing the stated interest rate from 3.50% to 2.75%; maturity and other terms remained unchanged.
- The company paid a $0.10-per-share dividend in November 2012, up from $0.06 per share in 2011. Future dividends depend on financial condition and are subject to loan covenant restrictions.
Key Risks and Contingencies
- Demand is substantially tied to farm income, commodity prices, weather, crop conditions, government farm programs, interest rates, and dealer purchasing decisions.
- Raw-material availability and pricing, particularly steel, may affect margins. The company also uses certain foreign suppliers, although management identified alternative sources.
- Customer concentration increased risk: one Modular Buildings customer represented approximately 25% of consolidated revenue in 2012, and another Agricultural Products customer represented approximately 12%.
- The company faces strong competition, especially in agricultural equipment and pressurized vessels, and must manage seasonal demand and fluctuating backlogs.
- Key execution risks include integrating Universal Harvester, delivering modular construction projects, maintaining product quality, managing inventory, and estimating percentage-of-completion contracts.
- Warranty liabilities increased to $579,000 from $202,000, and future warranty costs could exceed historical estimates.
- The company disclosed ordinary-course legal claims but no material pending or threatened legal proceedings. No off-balance-sheet arrangements were reported.
- Auditors issued an unqualified opinion on the consolidated financial statements. The company’s management concluded that disclosure controls and internal control over financial reporting were effective; no auditor attestation was required because the company is a smaller reporting company.
Most Important Facts to Verify
- Whether the revolving credit facility was renewed on acceptable terms after its April 30, 2013 maturity date.
- Whether Modular Buildings revenue and margins declined after completion of the Stanford-related project.
- Whether Pressurized Vessels achieved management’s expectation of profitability in 2013.
- Integration results, recurring revenue, and profitability from the Universal Harvester acquisition.
- Compliance with debt-service, leverage, tangible-net-worth, and other loan covenants.
- Actual proceeds and accounting treatment for the land and facility sales disclosed as subsequent events.
- Customer concentration, backlog conversion, inventory reserves, contract estimates, and warranty-cost trends.