Arts Way Manufacturing Co Inc: Form 10-Q for the period ended Feb 29, 2024

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, 2023. 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, future demand for products, expected product mix and resulting sales; (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, including without limitation, the impact of cost cutting measures, process improvement measures and new product development; (vi) our beliefs regarding the impact and potential actions with respect to discontinuing our Tools segment, including without limitation, potential cash that may be generated by the sale of related real estate and other assets; (vii) our beliefs regarding our early order program providing a picture of future demand; (viii) our expected financial results, including without limitation, our expected results for the Modular and Agricultural Products segments; and (ix) our expectations regarding receiving Employer Retention Credit Refunds; and (x) 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) impacts caused by fluctuating commodity prices and fluctuating farm income; (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; (ix) fluctuating demand for commercial real estate and the assets we are liquidating as part of closing our Tools segment; (x) 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 February 29, 2024 remain unchanged from November 30, 2023. 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, 2023.

Results of Operations

Net Sales and Cost of Sales

Our consolidated corporate sales from continuing operations for the three- month periods ended February 29, 2024 were $ 5,723,000 compared to $7,087,000 during the same respective period in fiscal 2023, a $1,364,000, or 19.2%, decrease for the three months. Consolidated gross margin for the three-month period ended February 29, 2024 was 25.7% compared to 30.9% for the same period in fiscal 2023.

Our first quarter sales in our Agricultural Products segment were $4,236,000 compared to $5,445,000 during the same period of fiscal 2023, a decrease of $1,209,000, or 22.2%. We experienced a decrease in demand on our fall 2023 early order program for the first time in three years. While cattle and sugar commodity prices remain strong through the first fiscal quarter of 2024, corn, soybean, hog and wheat prices are all down significantly from where they were a year ago. With the softening of the agriculture economy, we are expecting decreases in farm income levels from the past two fiscal years and expect that will continue to affect sales in our Agricultural Products segment. We are also seeing increased inventory on dealer lots compared to a year ago and in turn have seen a slowdown in orders. We have put cost cutting measures in place to partially mitigate the effect on cash flow from decreased sales. In our first fiscal quarter for 2024, we began right-sizing our staffing, including layoffs of non-production employees and offering early retirement incentives to employees at retirement age. We plan to continue to focus on investments that move our operational improvement strategy towards increased automation and production efficiency. From a sales standpoint, we are working with dealers to help move field inventory to generate more sales opportunities for our products. We are also focused on new dealer acquisitions to penetrate geographic markets that our competitors have a stronghold on. Our engineering team is developing new products for market including a sonar-leveling kit for our beet defoliator, a litter spreader kit for our manure spreaders and technological updates to our grinder mixers. Gross margin for our agricultural products segment for the three-month period ended February 29, 2024 was 26.9% compared to 34.2% for the same period in fiscal 2023. Our gross margin decreased primarily due to the decrease in sales, but was also burdened by inflationary price increases in supplies used in manufacturing and health and general insurance costs. We expect to be able to operate for fiscal 2024 on decreased sales as we build on the strides we've made as a company over the past five years.

Our first quarter sales in our Modular Buildings segment were $1,487,000 compared to $1,642,000 for the same period in fiscal 2023, a decrease of $155,000, or 9.4%. Despite a larger backlog in the first fiscal quarter of 2024 compared to the prior year, we saw a decrease in sales for the fiscal quarter. Delays on stamped drawings with state agencies hindered further progress on our contracts for the quarter. We were able to get the drawings approved in the second quarter of fiscal 2024 to further progress on the contracts. We reduced some of our workforce's hours when faced with these delays in the first fiscal quarter of 2024 and also built a stock agricultural building for future sale. Our Modular Buildings segment is carrying the largest backlog we have seen in 10 years as we progress into the second quarter of fiscal 2024. Gross margin for the three- month period ended February 29, 2024 was 22.3% compared to 19.7% for the same respective period in fiscal 2023. The Modular Buildings segment typically sees higher margins on research projects, which made up the majority of our revenue for the first quarter of fiscal 2024 compared to a higher percentage of agricultural buildings in the first quarter of fiscal 2023. This, coupled with increased billing rates, has led to improved margins in this segment over the last 15 months. We are expecting increased sales compared to fiscal 2023 based on the projects we currently have under contract and on contracts expected to close.

Expenses

Our consolidated selling expenses from continuing operations for the three months ended February 29, 2024 were $463,000 compared to $531,000 for the same period in fiscal 2023, a decrease of $68,000, or 12.8%. The decrease in selling expenses is related mainly to decreases in commission expense. Decreased sales in the Agricultural Products segment and the addition of an inside salesperson contributed to the decrease in commission expense. We did attend a tradeshow in the first quarter of fiscal 2024 that we don't typically attend and did see increased selling expenses comparatively from that. Our Modular Buildings segment also utilizes commissions on agricultural building sales and we saw a significant decrease in these sales comparatively. We would have experienced further decreases in selling expenses year on year, but we did attend a large tradeshow in Q1 of fiscal 2024 for our Agricultural Products segment. Selling expenses as a percentage of sales was 8.1% for the three months ended February 29, 2024 compared to 7.5% for three months ended February 28, 2023.

Consolidated engineering expenses from continuing operations were $160,000 for the three- month period ended February 29, 2024 compared to $128,000 for the same period in fiscal 2023. The increase in engineering expense is related to increased health insurance costs and rising wages. Engineering expenses as a percentage of sales were 2.8% for the three- month periods ended February 29, 2024 compared to 1.8% for the same respective periods in fiscal 2023.

Consolidated administrative expenses from continuing operations for the three- month period ended February 29, 2024 were $1,230,000 compared to $984,000 for the same respective period in fiscal 2023. Administrative expenses as a percentage of sales were 21.5% for the three- month period ended February 29, 2024 compared to 13.9% for the same respective period in fiscal 2023. Administrative expenses increased year on year primarily due to the addition of skilled staff in accounting and human resources. We also accrued approximately $100,000 of early retirement incentives for employees of retirement age that are retiring mid-March of 2024. The retirement incentive was offered to help right-size our workforce. We also saw increased administrative costs year on year from the amortization of our cloud computing arrangement implementation.

Net income (loss) from continuing operations

Consolidated net loss from continuing operations was $424,000 for the three-month period ended February 29, 2024, compared to net income of $350,000 for the same period in fiscal 2023. Our Modular Buildings segment remained profitable for the first fiscal quarter of 2024, despite the reduced sales. We are expecting strong sales in this segment for the remainder of fiscal 2024 as we work through our large backlog. Our Agricultural Products segment incurred a loss for the first fiscal quarter of 2024 due primarily to decreased sales and rising overhead costs. While first quarters of fiscal 2022 and 2023 brought heightened demand in the Agricultural Products segment due to strong commodity prices sales and resulting net income in the first fiscal quarter of 2024 were down due to lower commodity prices and resulting decreased demand. In addition, historically, sales in the first fiscal quarter is the slowest quarter of our fiscal year. We expect the second fiscal quarter of 2024 to be improved over the first quarter as we work through our beet equipment backlog and begin to realize some of our more recent cost savings initiatives.

Order Backlog

The consolidated order backlog net of discounts for continuing operations as of April 3, 2024 was $11,416,000 compared to $12,007,000 as of April 3, 2023, a 4.9% decrease. The Agricultural Products segment order backlog was $2,476,000 as of April 3, 2024 compared to $7,798,000 in fiscal 2023, a 68.2% decrease. Our incoming orders slowed in the fall of 2023 as backlog of the previous year’s pent-up demand was filled. In February 2024, the USDA estimated a 25.5% decrease in net farm income tied to lower crop and livestock cash receipts and continued increases in production costs. We will rely on our brand reputation, strength of sales team and product availability to drive sales activity for fiscal 2024. The backlog for the Modular Buildings segment was $8,940,000 as of April 3, 2024, compared to $4,209,000 in fiscal 2023, a 112.4% increase. Two large research projects make up the bulk of our current backlog. We expect completion of these projects in fiscal 2024 which would put us on track for nearly a 48% revenue increase from the 2023 fiscal year. We have additional contracts and quoting activity that we expect could provide additional upside for fiscal 2024. 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 sources of funds for the three months ended February 29, 2024 were cash generated by our receivables, contracts in progress, customer deposits and line of credit. We carried over close to $1.9 million in accounts receivable from the end of fiscal 2023 that we expect to be strong source of cash for fiscal 2024. We also expect the backlog of our contracts in progress in the Modular Buildings segment to be a primary source of cash in fiscal 2024 along with the increased inventory balance in our Agricultural Products segment. Despite incoming orders being down, we received a significant amount of deposits on our early order program in the first fiscal quarter which also helped fund operations for the three months ended February 29, 2024. We expect the sale of real estate of our Tools segment and $1.2 million of net Employer Retention Credit refunds to provide material inflows of cash, although the timing of these transactions are unknown. We expect our primary capital needs for the remainder of fiscal 2024 to relate to operating costs, purchases of equipment that improve our operations, and the retirement of debt.

We have $5,500,000 on a revolving line of credit with Bank Midwest that, as of February 29, 2024, had an outstanding principal balance of $4,880,437. This line of credit was renewed on March 4, 2024 and is scheduled to mature on March 30, 2025.

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 February 29, 2024. 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.