Arts Way Manufacturing Co Inc: Form 10-Q for the period ended Aug 31, 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 and our belief that Modular and Agricultural Products present greater opportunity for long-term stockholder returns in comparison to our discontinued Tools segment; (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 August 31, 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- and nine-month periods ended August 31, 2024 were $ 5,876,000 and $18,329,000 compared to $8,117,000 and $23,429,000 during the same respective periods in fiscal 2023, a $2,241,000, or 27.6%, decrease for the comparative three months and a decrease of $5,100,000, or 21.8%, for the comparative nine months. Consolidated gross margin for the three and nine months ended August 31, 2024 was 28.9% and 27.7% compared to 28.3% and 28.5% for the same periods in fiscal 2023.

Our third quarter sales in our Agricultural Products segment were $2,988,000 compared to $5,530,000 during the same period of fiscal 2023, a decrease of $2,542,000, or 46.0%. For the nine months ended August 31, 2024, our Agricultural Products segment sales were $11,779,000 compared to $17,343,000, during the same period of 2023, a decrease of $5,564,000, or 32.1%. In February of 2024, the US Department of Agriculture reported a 25% expected decline in farm income levels for 2024 due to weaker row crop prices and expected increases in production expenses. Our sales year to date have fallen in line with the USDA's early sentiments on projected farm income. In September 2024, the USDA revised their projection to an expected 9.6% decrease in net farm income. This number is propped up by large feedlot operations where livestock prices remain above the five-year average and in general animal/animal product cash receipts are expected to be up 7.1% from 2023. Incoming whole good orders remained scarce in the third quarter of fiscal 2024 as row crop prices, including corn, soybeans and wheat, were down 18-24% from the five-year average. Sugar prices remain around 8% above the five-year average as of this report, but the overall agriculture economy sentiment is negative. High interest rates continue to put pressure on farmer's bottom lines, are prohibitive to equipment financing arrangements and floorplan programs. We enacted initial cost cutting measures in the first quarter of fiscal 2024 to partially mitigate the effect on cash flow from decreased sales, including layoffs of non-production employees and offering early retirement incentives to employees at retirement age. We also entered the Iowa Work Force Development's voluntary workshare program in April 2024, which eliminates the need for additional production layoffs by allowing us to cut employee's hours while employees receive unemployment benefits for lost hours. We remain focused on trimming operating expenses and reducing overall inventory while remaining efficient in our production process. From a sales standpoint, we continue to work with dealers to help move field inventory to generate more sales opportunities for our products. We are targeting new dealer acquisitions to penetrate geographic markets in which we lack a substantial presence. Gross margin for our Agricultural Products segment for the three-month and nine-month periods ended August 31, 2024 was 27.2% and 27.8%, respectively, compared to 26.0% and 29.4% for the same periods in fiscal 2023. We primarily attribute our year to date gross margin decrease to the decrease in sales, which have diminished our economies of scale, but also our margins are burdened by inflationary price increases in supplies used in manufacturing and health and general insurance costs. We expect a continued focus on driving overheads costs down for the remainder of fiscal 2024 and fiscal 2025.

Our third quarter sales in our Modular Buildings segment were $2,888,000 compared to $2,587,000 for the same period in fiscal 2023, an increase of $301,000, or 11.6%. For the nine months ended August 31, 2024, our Modular Buildings sales were $6,550,000, compared to $6,086,000 for the same period of fiscal 2023, an increase of $464,000, or 7.6%. Two large research projects are driving the sales increase for the three- and nine- month periods. We expect a strong finish to fiscal 2024 as we expect to close out one of the two large research products in the fourth quarter. Gross margin in the Modular Buildings segment for the three- and nine-month periods ended August 31, 2024 was 30.7% and 27.5%, respectively, compared to 33.4% and 25.8% for the same respective periods 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 nine months of fiscal 2024, compared to a higher percentage of agricultural buildings in fiscal 2023. This, coupled with increased billing rates, has led to improved margins in this segment over the last 24 months.

Expenses

Consolidated selling expenses from continuing operations for the three months ended August 31, 2024 were $381,000, compared to $566,000 for the same period in fiscal 2023. Our consolidated selling expenses from continuing operations for the nine months ended August 31, 2024 were $1,241,000, compared to $1,609,000 for the same period in fiscal 2023, a decrease of $368,000, or 22.9%. 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. Our Modular Buildings segment also utilizes commissions on agricultural building sales and we saw a significant decrease in these sales comparatively. Selling expenses as a percentage of sales was 6.8% for the nine months ended August 31, 2024 compared to 6.9% for nine months ended August 31, 2023.

Consolidated engineering expenses from continuing operations were $79,000 and $346,000 for the three- and nine-month periods ended August 31, 2024, respectively, compared to $171,000 and $439,000 for the same periods in fiscal 2023. The decrease in engineering expenses is related to budget cuts made at the beginning of fiscal 2024. Engineering expenses as a percentage of sales were 1.9% for the nine months ended August 31, 2024, compared to 1.9% for the same respective periods in fiscal 2023.

Consolidated administrative expenses from continuing operations for the three- and nine-month periods ended August 31, 2024 were $1,087,000 and $3,550,000, respectively, compared to $1,095,000 and $3,178,000 for the same respective period in fiscal 2023. Administrative expenses as a percentage of sales were 19.4% for the nine months ended August 31, 2024, compared to 13.6% 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 paid out approximately $188,000 of early retirement incentives for employees of retirement age that retired mid-March of 2024. The retirement incentive was offered to help right-size our workforce. We also saw increased information technology costs year on year from rising prices and the amortization of our cloud computing arrangement implementation which will be fully amortized after the second quarter of fiscal 2025.

Net income (loss) from continuing operations

Consolidated net income from continuing operations was $2,000 for the three-month period ended August 31, 2024, compared to net income of $241,000 for the same period in fiscal 2023. For the nine months ended August 31, 2024, our consolidated net loss was $427,000 compared to net income of $921,000 for the same period of fiscal 2023. While we had positive operating income from continuing operations for the second straight fiscal quarter, high interest rates have put strain on our bottom line in fiscal 2024. We expect it may be another twelve months before we see some sales stabilization in the Agricultural Products segment due to ongoing market conditions. Inventory reduction, debt retirement and cost cutting to maximize cash flow will be key over the next 18 months to weather the current conditions. The Modular Buildings segment recorded revenue increases and profitability for both the three and nine months ended August 31, 2024. We anticipate continued positive performance from this segment for the remainder of fiscal 2024 as we close out current backlog.

Order Backlog

The consolidated order backlog net of discounts for continuing operations as of October 3, 2024 was $5,600,000 compared to $5,605,000 as of October 3, 2023, a 0.1% decrease. The Agricultural Products segment order backlog was $708,000 as of October 3, 2024 compared to $4,143,000 in fiscal 2023, an 82.9% decrease. Expected decreases in net farm income from struggling row crop prices coupled with high interest rates in fiscal 2024 has suppressed demand for agricultural products across the North American market. We expect future rate cuts to have a positive effect on the agriculture equipment market and expect a period of maybe 6 to 12 months where incoming orders remain slow while existing inventory is consumed from dealer lots. As of the date of this report we are in the first phase of our early order program. We will have a better gauge on how fiscal 2025 is going to shape up once our early order program expires. The backlog for the Modular Buildings segment was $4,892,000 as of October 3, 2024, compared to $1,462,000 in fiscal 2023, an 234.6% increase. We continue to see strong demand for research-type modulars in our Modular Buildings segment as we progress through the fourth quarter of fiscal 2024. We have also noticed an uptick in Agricultural modular building demand in the past 30 days or so. 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 nine months ended August 31, 2024 was cash generated by operating activities bolstered by contracts in progress in the Modular Buildings segment. Favorable billing terms have allowed us to stay cash positive while we complete large research projects we have under contract. Our inventory levels at November 30, 2023 were heightened compared to recent history and the reduction of those inventory levels over the nine months ended August 31, 2024 generated positive cash for us. We also carried over close to $1.9 million in accounts receivable from floorplan sales in our Agricultural Products segment at the end of fiscal 2023 that provided a strong cash influx over the first nine months of fiscal 2024. A large reduction in accounts payable was our biggest cash outflow for the first nine months of fiscal 2024. The heightened inventory balance at November 30 coupled with reduced inventory spending drove this decrease. For the remainder of fiscal 2024, we expect our primary sources of cash to be collection of receivables and inventory reduction activities. While we are over billed in our Modular Buildings contracts, close to $1 million of these billings are still in accounts receivable. We expect our construction contracts cash in and outflows to be close to even for the remainder of the fiscal year while operating expenses and retirement of debt will be our biggest cash consumption activities. The sale of real estate of our Tools segment in October 2024 for $1.8 million should net close to $1.7 million in cash after closing expenses. We expect to retire short and long-term debt with the proceeds. We also expect $1.2 million of net Employer Retention Credit refunds to provide a material inflow of cash, although the timing of this transaction is unknown.

We have $5,500,000 on a revolving line of credit with Bank Midwest that, as of August 31, 2024, had an outstanding principal balance of $3,867,437. 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 August 31, 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.