Arts Way Manufacturing Co Inc: Form 10-Q for the period ended May 31, 2023

Forward-Looking Statements

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this “report”) and the audited consolidated financial statements and related notes thereto included in Part II, Item 8, “Financial Statements and Supplementary Data,” as well as Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the fiscal year ended November 30, 2022. Some of the statements in this report may be forward-looking statements that reflect our current view on future events, future business, industry and other conditions, our future performance, and our plans and expectations for future operations and actions. In some cases you can identify forward-looking statements by the use of words such as “may,” “should,” “anticipate,” “believe,” “expect,” “plan,” “future,” “intend,” “could,” “estimate,” “predict,” “hope,” “potential,” “continue,” or the negative of these terms or other similar expressions. Many of these forward-looking statements are located in this report under Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but they may appear in other sections as well. Forward-looking statements in this report generally relate to: (i) our expectations with respect to order backlog; (ii) our beliefs regarding the sufficiency of working capital and cash flows; (iii) our expectation that we will continue to be able to renew or obtain financing on reasonable terms when necessary as well as our continued positive relationship with our creditors and lenders; (iv) our beliefs regarding production capabilities; (v) our intentions and beliefs relating to our costs, business strategies, and future performance; (vi) our beliefs regarding the impact and potential actions with respect to discontinuing our Tools segment, including without limitation, beliefs about customer interest in purchasing inventory or other assets, expenses to be incurred in connection with such discontinuation, potential cash generated in connection with such discontinuation activities, staffing needed and timing of runoff activities, and fulfillment of sales orders; (vii) our beliefs regarding the implementation of our accounting ERP system; (viii) our expected financial results, including without limitation, our expected results for the Modular and Tools segments; and (ix) our expectations concerning our primary capital and cash flow needs.

You should read this report thoroughly with the understanding that our actual results may differ materially from those set forth in the forward-looking statements for many reasons, including events beyond our control and assumptions that prove to be inaccurate or unfounded. We cannot provide any assurance with respect to our future performance or results. Our actual results or actions could and likely will differ materially from those anticipated in the forward-looking statements for many reasons, including but not limited to: (i) the impact of changing credit markets on our ability to continue to obtain financing on reasonable terms; (ii) our ability to repay current debt, continue to meet debt obligations and comply with financial covenants; (iii) the effect of inflation as well as general economic conditions, including consumer and governmental spending, on the demand for our products and the cost of our supplies and materials; (iv) any further impact from COVID-19; (v) fluctuations in seasonal demand and our production cycle; (vi) the ability of our suppliers to meet our demands for raw materials and component parts; (vii) fluctuations in the price of raw materials, especially steel; (viii) our ability to predict and meet the demands of each market in which our segments operate; and (ix) other factors described from time to time in our Securities and Exchange Commission filings. We do not intend to update the forward-looking statements contained in this report other than as required by law. We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.

Critical Accounting Policies

Our critical accounting policies involving the more significant judgments and assumptions used in the preparation of our financial statements as of May 31, 2023 remain unchanged from November 30, 2022. Disclosure of these critical accounting policies is incorporated by reference from Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended November 30, 2022.

Results of Operations

Net Sales and Cost of Sales

Our consolidated corporate sales for the three- and six-month periods ended May 31, 2023 were $9,008,000 and $16,903,000, respectively, compared to $7,275,000 and $12,888,000 during the same respective periods in fiscal 2022, a $1,733,000, or 23.8%, increase for the three months and a $4,015,000, or 31.1%, increase for the six months. We saw increased revenue and demand in all three business segments for the three and six months ended May 31, 2023. Consolidated gross margin for the three-month period ended May 31, 2023 was 25.9% compared to 30.1% for the same period in fiscal 2022. Consolidated gross margin for the six-month period ended May 31, 2023 was 27.7% compared to 26.3% for the same period in fiscal 2022.

Our second quarter sales in our Agricultural Products segment were $6,368,000 compared to $5,316,000 during the same period of fiscal 2022, an increase of $1,052,000, or 19.8%. Our year-to-date agricultural product sales were $11,813,000 compared to $9,477,000 during the same period in fiscal 2022, an increase of $2,336,000, or 24.6%. Successful execution of our production plan in fiscal 2023 has led to strong increases in the revenue for our beet, grinders, manure spreaders and bale processing equipment year on year. While some supply chain challenges still exist, proper planning has allowed us to overcome most of these issues. We continue to see improved throughput in our production facility due to automation advances including the utilization of robotic weld cells and from the alleviation of bottleneck constraints with the addition of a high-definition plasma cutter. Our demand has remained steady for the first six months of fiscal 2023 as commodity prices continue to be strong and have not seen an indication that we will see a pullback in fiscal 2023 at this time. Gross margin for our agricultural products segment for the three-month period ended May 31, 2023 was 28.3% compared to 35.5% for the same period in fiscal 2022. Gross margin for our agricultural products segment for the six-month period ended May 31, 2023 was 31.0% compared to 31.3% for the same period in fiscal 2022. Our product mix, primarily beet harvesting equipment, is the reason our gross profit is down for the three months ending May 31, 2023 compared to the same period in fiscal 2022. Our beet harvesting equipment is sold at a lower margin than some of our product lines and was a significant portion of our revenue for the three months ended May 31, 2023. Our beet production run typically occurs in the third quarter of our fiscal year, however, we were able to move our production timeline up in fiscal 2023 to better accommodate our customers’ needs.

Our second quarter sales in our Modular Buildings segment were $1,856,000 compared to $1,209,000 for the same period in fiscal 2022, an increase of $647,000, or 53.5%. Our year-to-date sales in our Modular Buildings segment were $3,498,000 compared to $2,077,000 for the same period in fiscal 2022, an increase of $1,421,000, or 68.4%. While fiscal 2023 sales are up significantly, the first six months to fiscal 2022 were unusually slow for this business segment. Our sales team has capitalized on the strong commodity prices in the agriculture sector over the past two fiscal years. Agricultural building sales made up over 50% of gross revenues in the Modular Buildings segment in fiscal years 2023 and 2022 compared to less than 10% in fiscal 2021. Coupling the strong agricultural market with a few large research modular contracts has made for a successful first six months of fiscal 2023. Gross margin for the three- and six-month periods ended May 31, 2023 was 20.7% and 20.2%, respectively, compared to 15.8% and 11.2% for the same respective periods in fiscal 2022. Our gross margin in the three- and six-month periods of fiscal 2023 has increased due to additional markup we enacted to cover rising costs of overhead from inflationary forces. The increased sales of the Modular Buildings segment also has made it easier to absorb our fixed overhead costs.

As announced in a press release on June 7, 2023, we are discontinuing our Tools segment with the last day of normal operations on July 14, 2023. Our team is working through remaining orders that can be fulfilled without additional inventory purchases and will begin an orderly liquidation process in the weeks following production shutdown. The liquidation process will include sale of remaining inventory, auctioning off machinery and equipment and the sale of real estate. The Company estimates cash generation of approximately $950,000 from the liquidation of receivables, inventory and other assets (excluding real estate) to fund estimated liquidation costs of $200,000. These numbers assume the majority of open sales orders at June 7, 2023 are fulfilled before production ceases on July 14, 2023. Our Tools segment had sales of $784,000 and $1,592,000 during the three- and six-month periods ended May 31, 2023, respectively, compared to $750,000 and $1,334,000 for the same respective periods in fiscal 2022, a 4.5% increase and a 19.3% increase, respectively. Approximately $95,000 of the increased sales for the three months ended May 31, 2023 were related to an inventory buyback for an OEM customer. This customer is required to buy back any inventory we have on hand when we shut down, which was approximately $162,000 as of May 31, 2023.

Expenses

Our second quarter consolidated selling expenses were $577,000 compared to $631,000 for the same period in fiscal 2022. Our year-to-date selling expenses were $1,172,000 in fiscal 2023 compared to $1,118,000 for the same period in fiscal 2022. We saw a decrease in selling expenses for three months ended May 31, 2023 compared to fiscal 2022 due to less marketing staff in fiscal 2023 and from a decrease in commissions as we leveraged internal sales representatives to sell our beet equipment, which made up a large percentage of our Q2 fiscal 2023 sales. For the six months ended May 31, 2023, our selling expenses are up due to the large commissionable sales increases in our Modular Building and Agricultural Products segments. Selling expenses as a percentage of sales were 6.4% for the three and 6.9% six-month periods ended May 31, 2023, compared to 8.7% for the same respective periods in fiscal 2022.

Consolidated engineering expenses were $140,000 and $269,000 for the three- and six-month periods ended May 31, 2023, respectively, compared to $144,000 and $278,000 for the same respective periods in fiscal 2022. The decrease in engineering expenses year on year is due to decreased participation on the Company health plan in fiscal 2023. Engineering expenses as a percentage of sales were 1.6% for the three- and six-month periods ended May 31, 2023, respectively, compared to 2.0% and 2.2% for the same respective periods in fiscal 2022.

Consolidated administrative expenses for the three- and six-month periods ended May 31, 2023 were $1,195,000 and $2,273,000, respectively, compared to $1,097,000 and $2,105,000 for the same respective periods in fiscal 2022. Administrative expenses as a percentage of sales were 13.3% and 13.4% for the three- and six-month periods ended May 31, 2023, respectively, compared to 15.1% and 16.3% for the same respective periods in fiscal 2022. While administrative expenses are up period over period, they have decreased steadily as a percentage of sales. The increased overall amount of administrative expenses is due primarily to addition of staff in accounting and quality assurance and additional expense related to the implementation of a new accounting ERP system, which is expected to go-live date in the second half of fiscal 2023.

Net income (loss)

Consolidated net income was $307,000 for the three-month period ended May 31, 2023, compared to $175,000 for the same period in fiscal 2022. Our consolidated net income for the six months ended May 31, 2023, was $649,000 compared to a net loss of $(231,000) in the same period in fiscal 2022. Our Agricultural Products and Modular Buildings segments recorded profitability for the three- and six-months ending May 31, 2023. We attribute the positive results in fiscal 2023 to strong demand for our products paired with successful production execution.

Order Backlog

The consolidated order backlog net of discounts as of July 7, 2023 was $10,359,000 compared to $10,378,000 as of July 7, 2022. The Agricultural Products segment order backlog was $6,499,000 as of July 7, 2023 compared to $8,538,000 in fiscal 2022. The decrease in our agricultural products segment is due to the ability of our production crew to finish our beet equipment run in the early summer months of fiscal 2023, which led to large revenue increases for the six months ended May 31, 2023. The backlog for the Modular Buildings segment was $3,480,000 as of July 7, 2023, compared to $1,056,000 in fiscal 2022, an increase of 229%. The Modular Buildings segment has a large research project in back log as of July 7, 2023 along with a steady mix of agriculture buildings. The backlog for the Tools segment was $380,000 as of July 7, 2023 compared to $783,000 in fiscal 2022. The decrease in the Tools segment backlog is due to our team turning down incoming sales orders after the announcement to discontinue production on July 14, 2023. Our order backlog is not necessarily indicative of future revenue to be generated from such orders due to the possibility of order cancellations and dealer discount arrangements we may enter into from time to time.

Liquidity and Capital Resources

Our primary source of funds for the six months ended May 31, 2023 was cash generated by financing activities. We utilized our line of credit and proceeds from a finance lease to increase our inventory levels to meet continued customer demand and combat supply chain delays. We also utilized our floor plan program to generate additional sales for the first six months of fiscal 2023 which led to a cash outflow of approximately $1.2 million from the increase of receivables. Our contracts in progress in the Modular Buildings segment generated approximately $583,000 in cash in the first six months of fiscal 2023. We expect our primary capital needs for the remainder of fiscal 2023 to relate to operating costs, purchases of equipment that improve our operations, and the retirement of debt. We expect the liquidation of our Tools segment, collection of accounts receivable and reduction of inventory levels to provide additional cash that we expect will be used for the above capital needs and debt reduction.

We have a $5,000,000 revolving line of credit with Bank Midwest that, as of May 31, 2023, had an outstanding principal balance of $4,704,059. This line of credit was renewed on March 30, 2023 and is scheduled to mature on March 30, 2024.

We believe our current financing arrangements will provide sufficient cash to finance operations and pay debt when due during the next twelve months. We expect to continue to be able to procure financing upon reasonable terms.

Evaluation of Disclosure Controls and Procedures

The persons serving as our principal executive officer and principal financial officer have evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period subject to this report. Based on this evaluation, the persons serving as our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of May 31, 2023. Our management has concluded that the consolidated financial statements included in this report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

Changes in Internal Control over Financial Reporting

There were no changes in our internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.