10QSB 1 aug10q04.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________________________________ FORM 10-QSB QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended August 31, 2004 Commission File No. 0-5131 ART'S-WAY MANUFACTURING CO., INC. (Exact name of small business issuer as specified in its charter) DELAWARE 42-0920725 State of Incorporation I.R.S. Employer Identification No. Hwy 9 West, Armstrong, Iowa 50514 Address of principal executive offices Zip Code Registrant's telephone number, including area code: (712) 864-3131 Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ Number of common shares outstanding as of October 14, 2004: 1,938,176 ART'S-WAY MANUFACTURING CO., INC. CONDENSED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Year to Date August 31, August 31, August 31, August 31, 2004 2003 2004 2003 Net sales $3,398,683 $3,808,199 $9,208,100 $8,876,316 Cost of goods sold 2,484,402 2,854,715 6,672,073 6,579,412 Gross profit 914,281 953,484 2,536,027 2,296,904 Operating expenses: Engineering 57,026 95,600 151,874 129,779 Selling 162,566 219,263 484,444 499,497 General and administrative 393,633 258,995 1,290,845 845,940 Total expenses 613,225 573,858 1,927,163 1,475,216 Income from operations 301,056 379,626 608,864 821,688 Other expenses: Interest expense 48,204 39,889 129,034 88,862 Other (32,444) 16,542 (47,644) 32,389 Total other expenses 15,760 56,431 81,390 121,251 Income before income taxes 285,296 323,195 527,474 700,437 Income tax expense (benefit)(200,000) 0 (300,000) 2,031 Net income $485,296 $323,195 $827,474 $698,406 Net income per share: Basic $0.25 $0.17 $0.43 $0.36 Diluted $0.25 $0.17 $0.42 $0.36 Common shares and equivalent outstanding: Basic 1,938,176 1,938,176 1,938,176 1,938,176 Diluted 1,958,243 1,954,279 1,958,574 1,950,712 See accompanying notes to condensed financial statements. ART'S-WAY MANUFACTURING CO., INC. CONDENSED BALANCE SHEETS (Unaudited) August 31, November 30, 2004 2003 ASSETS Current Assets Cash $83,343 $800,052 Accounts receivable-customers, net of allowance for doubtful accounts of $43,966 and $39,250 in August and November, respectively 969,923 885,890 Inventories 6,417,893 3,446,711 Deferred taxes 283,000 283,000 Other current assets 69,701 150,185 Total current assets 7,823,860 5,565,838 Property, plant and equipment, at cost 11,544,685 11,049,132 Less accumulated depreciation 10,226,945 10,030,222 Net property, plant and equipment 1,317,740 1,018,910 Inventories, noncurrent 323,384 483,432 Real estate loan receivable 165,725 165,725 Deferred taxes 835,000 535,000 Other assets 158,261 192,932 Total assets $10,623,970 $7,961,837 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Notes payable to bank $842,285 $0 Current portion of long-term debt 199,258 178,508 Accounts payable 389,838 83,874 Customer deposits 786,466 53,556 Accrued expenses 738,115 702,117 Total current liabilities 2,955,962 1,018,055 Long-term liabilities 218,428 174,766 Long-term debt, excluding current portion 1,824,938 1,971,848 Total liabilities 4,999,328 3,164,669 Stockholders' Equity Common stock - $.01 par value. Authorized 5,000,000 shares; issued 1,938,176 shares in May and in November 19,382 19,382 Additional paid-in capital 1,634,954 1,634,954 Retained earnings 3,970,306 3,142,832 Total stockholders' equity 5,624,642 4,797,168 Total liabilities and stockholders' equity $10,623,970 $7,961,837 See accompanying notes to condensed financial statements. ART'S-WAY MANUFACTURING CO., INC. CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended August 31, August 31, 2004 2003 CASH FLOW FROM OPERATIONS: Net income $827,474 $698,406 Adjustment to reconcile net income to net cash provided by operatingactivities: Depreciation and amortization 196,723 211,610 Deferred income tax (300,000) 0 Changes in working capital components: (Increase) decrease in: Accounts receivable (84,033) (682,305) Other receivables 0 (14,370) Inventories (2,811,134) (83,190) Other current assets 80,484 (36,044) Other 78,333 (58,716) Increase (decrease) in: Accounts payable 305,964 (93,794) Customer deposits 732,910 (200,644) Accrued expenses 35,998 260,517 Net cash provided by (used in) operating activities (937,281) 1,470 CASH FLOW FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (495,553) (113,226) Purchase of assets of Obeco Inc. 0 (521,723) Net cash provided by (used in) investing activities (495,553) (634,949) CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from (payments of) notes payable to bank 842,285 2,538,789 Principal payments on long term debt (126,160) (1,577,755) Net cash provided by (used in) financing activities 716,125 961,034 Net increase in cash (716,709) 327,555 Cash at beginning of period 800,052 75,358 Cash at end of period $83,343 $402,913 Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $129,034 $88,862 Net Income taxes 12,643 2,031 See accompanying notes to condensed financial statements. ART'S-WAY MANUFACTURING CO., INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Statement Presentation The financial statements are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation ofthe financial position and operating results for the interim periods. The financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended November 30, 2003. The results of operations for the third quarter and year to date ended August 31, 2004 are not necessarily indicative of the results for the fiscal year ending November 30, 2004. Reclassifications Certain 2003 financial statement amounts related to shipping costs have been reclassified to conform to the current year presentation. 2. INCOME PER SHARE Basic net income per common share is computed on the basis of weighted average number of common shares outstanding. Diluted net income per share has been computed on the basis of weighted average number of common shares outstanding plus equivalent shares assuming exercise of stock options. The difference in shares utilized in calculating basic and diluted net income per share represents the number of shares issued under the Company's stock option plans less shares assumed to be purchased with proceeds from the exercise of the stock options. The reconciling item between the shares used in the computation of basic and diluted earnings per share for the third quarter ended August 31, 2004 is 20,067 equivalent shares, 20,398 shares year to date, for the effect of dilutive stock options. 3. INVENTORIES Major classes of inventory are: August 31, 2004 November 30, 2003 Raw material $1,803,636 $744,549 Work-in-process 2,470,610 805,142 Finished goods 2,467,031 2,380,452 Total $6,741,277 3,930,143 Less inventories classified as noncurrent 323,384 483,432 Inventories, current $6,417,893 $3,446,711 4. ACCRUED EXPENSES Major components of accrued expenses are: August 31, 2004 November 30, 2003 Salaries, wages and commissions $378,725 $366,842 Accrued warranty expense 112,710 59,207 Other 246,680 276,068 Total $738,115 $702,117 5. Product Warranty The Company offers warranties of various lengths to its customers depending on the specific product and terms of the customer purchase agreement. The average length of the warranty period is one year from date of purchase. The Company's warranties require it to repair or replace defective products during the warranty period at no cost to the customer. The Company records a liability for estimated costs that may be incurred under its warranties. The costs are estimated based on historical experience and any specific warranty issues that have been identified. Although historical warranty costs have been within expectations, there can be no assurance that future warranty costs will not exceed historical amounts. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the balance as necessary. Changes in the Company's product warranty liability for the three and nine months ended August 31, 2004 and August 31, 2003 are as follows: Three Months ended Nine Months ended August 31, August, 31 August 31, August, 31 2004 2003 2004 2003 Balance, beginning $72,283 59,496 $59,207 60,232 Settlements made in cash or in-kind (12,852) (17,036) (64,364) (75,191) Warranties issued 53,279 54,262 117,867 111,681 Balance, ending $112,710 96,722 $112,710 96,722 6. LOAN AND CREDIT AGREEMENTS Line of Credit The Company has financing through West Bank consisting of two loan agreements totaling $5,500,000. Facility #1 is a revolving line of credit for $2,500,000 with advances funding the working capital, letter of credit and corporate credit card needs that mature on February 28, 2005. The interest rate is West Bank's prime interest rate plus 1%, adjusted daily. Monthly interest only payments are required and the unpaid principal is due on the maturity date. Collateral consists of a first position on assets owned by the Company including, but not limited to inventories, accounts receivable, machinery and equipment. The draw on the line of credit financed 20 completed beat harvesters into inventory. As of August 31, 2004, the Company had borrowed $842,285 against Facility #1. Facility #2 is long-term financing for up to $3,000,000 that is supported by a guarantee issued by the United States Department of Agriculture (USDA) for 75% of the loan amount outstanding. The loan refinanced existing debt to UPS Capital (approximately $1,500,000), finance equipment (approximately $250,000), provide permanent working capital (approximately $500,000) and satisfy closing costs (approximately $50,000). Approximately $700,000 will be reserved for future acquisitions. The variable interest rate is West Bank's prime interest rate plus 1.5%, adjusted daily. Monthly principal and interest payments are amortized over 20 years, with final maturity at March 31, 2023. Collateral for Facility #2 is primarily real estate with a second position on assets of Facility #1. The USDA subordinates collateral rights in all assets other than real estate in an amount equal to West Bank's other credit commitments. As of August 31, 2004, the outstanding balance on Facility #2 was $1,879,560. Other terms and conditions include providing monthly internally prepared financial reports including accounts receivable aging schedules and borrowing base certificates and year-end audited financial statements. The borrowing bases limit advances from Facility #1 to 60% of accounts receivable less than 90 days, 60% of finished goods inventory, 50% of raw material inventory and 50% of work-in-process inventory plus 40% of appraisal value of machinery and equipment. Covenants include restrictions on debt service coverage ratio, debt/tangible net worth ratio, current ratio, limit capital expenditures and tangible net worth. During the year ended November 30, 2003, the Company violated certain debt covenants that were waived. J. Ward McConnell, Jr. was required to personally guarantee Facility #1 and Facility #2 on an unlimited and unconditional basis. The guarantees of Facility #1 and Facility #2 shall be reduced after the first three years to a percentage representing his ownership of the Company. Mr. McConnell's guarantees shall be removed from Facility #1 and Facility #2 in the event that his ownership interest in the Company is reduced to a level less than 20% after the first three years of the loan. The Company compensates Mr. McConnell for his personal guarantees at an annual percentage rate of 2% of the outstanding balances paid monthly. As a result of the outstanding balances on Facility #1 and Facility #2 Mr. McConnell received $11,519 under this compensation agreement, for the three months ended August 31, 2004. A summary of the Company's term debt is as follows: August 31, November 30, 2004 2003 West Bank Facility #2 payable in monthly Installments of $17,776 including interest at Bank's prime rate plus 1.5% (5.75%) $1,879,560 $1,950,975 State of Iowa Community Development Block Grant promissory notes at zero percent interest, maturity 2006, with quarterly principal payments of $11,111 $88,889 $122,223 State of Iowa Community Development Block Grant local participation promissory notes at 4% interest, Maturity 2006, with quarterly payments of $7,007 $55,747 $77,158 Total term debt $2,024,196 $2,150,356 Less current portion of term debt $199,258 $178,508 Term debt, excluding current portion $1,824,938 $1,971,848 Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Financial results discussed in Item 2, Management's Discussion and Analysis or Plan of Operation, are rounded to the nearest thousands from those reported on the financial statements. (a) Liquidity and Capital Resources The Company's main source of funds for the three months ended August 31, 2004 was payments received from customers for advance payments on sugar beet equipment to be delivered in the third and fourth quarters. The increase in accounts receivable resulted from the shipments of beet service parts and beet equipment delivered in the third quarter of 2004, which are sold on special terms. These funds were offset by a lag in production, resulting in increased inventory. The negative cash flow from operations of ($937,000) was offset through financing, specifically draws on the line of credit through West Bank, totaling $842,000. Investing activities totaled $496,000, for the purchase and installation of a new paint system, and fixturing for a new beet harvester. Long term debt was paid down by $144,000 and the remaining $83,000 was retained for future needs. See footnote 5 in the notes to the condensed financial statements for a discussion of the Company's credit facilities. The Company is mindful of the necessity to continue to control its costs. (b) Results of Operations The third quarter net sales decreased by 11%, as compared to the same period one-year ago. This decrease was due to timing of delivery of sugar beet equipment. Last year the majority of the equipment was delivered in the third quarter, whereas this year, the majority will be delivered in the fourth quarter. Year to date net sales have increased 4%. The first nine months of 2004 revenues included increased sales from the truck body line acquired in July 2003, of $458,000, and Art's-Way's branded products of $969,000. These increases were offset by a decrease in OEM sales of $1,095,000. Art's-Way products with increased sales include land planes ($422,000), grinder mixers ($318,000), beet equipment ($15,000) and plows ($316,000), offset by various decreases in other Art's-Way Products. The increased Art's-Way sales, offset by the OEM decrease is due to a licensing agreement with Case New Holland, Inc., to sell the plows directly to dealers. In 2003 Case placed large orders that were filled in the first six months of the fiscal year. In 2004 these orders have been, and we expect them to continue to be, spread more evenly throughout the year now that the Company is selling plows directly to the dealers. Gross profit, as a percent of sales was 27% for the quarter ended August 31, 2004 compared to 25% for the same period in 2003. Year to date through August 31, 2004, gross profit was 28% compared to 26% for the prior year. Our beet harvesting equipment was sold on a contractual basis prior to the steel price increases, consequently our gross profit suffered, as we had to absorb the steel price increase of approximately $225,000. Increasing steel prices have now been offset through Art's-Way product price increases. We are starting to see a decline in operating expenses, as we expected, due to the consolidation of the Cherokee Truck Bodies operation into the Art's-Way manufacturing facility. Operating expenses as a percentage of sales, for the third quarter of 2004, were 18% compared to 15% for the same period of 2003. Year to date 2004, operating expenses were 21% compared to 17% for the same period of 2003. We expect the percentage of operating expenses, year to date 2004, to continue to decline in the fourth quarter. The increased operating expenses year to date in 2004, over the same period in 2003, are due to our continued developmental expenses for new products, which we expect to continue to materially increase sales. We also experienced one time expenses as a result of the physical move of Cherokee Truck Bodies, to Armstrong, Iowa. We introduced a new sugar beet harvester with the industry's first 12 row harvesting capabilities, the units delivered in the third quarter are currently in the fields, and we have received positive customer responses, in regards to overall performance. We will also begin shipments of our next generation grinder-mixer in the fourth quarter of 2004. This new grinder-mixer has an increased capacity and a significant reduction in cycle time per feed batch. The increase in engineering expenses of $22,000 for 2004 compared to 2003, has allowed us to introduce these new product offerings that we expect to continue to improve our revenue and earnings. Year to date selling expenses have decreased by $15,000 compared to the same period in 2003, as a result of decreased commissions for our Cherokee Truck Bodies line of products. The reduction in commissions paid has been offset somewhat through increased show expenses, as we have been attending more trade shows in the farm industry. It is our goal to enhance visibility for our Art's-Way and Cherokee Truck Bodies branded products through the strategic participation in selected trade shows. Our year to date general and administrative expenses increased by $445,000, due to additional expenses related to the truck body line acquired in July 2003. Our operating expenses, year to date 2004, are higher when compared to the same period in 2003, in part because the 2003 results only contained two months of operations for our newly acquired truck body line. Interest expense has increased year to date compared to 2003, by $40,000. This increase is due to the line of credit and the long term financing secured in the second quarter of 2003. Increased long term financing and the line of credit draw has allowed Art's-Way to invest in new equipment and to build inventory of key products. Other income has increased year to date by $80,000, as a result of a settlement with Agri-Dynamics, and interest income. See (c) below for a discussion on the utilization of deferred tax assets. The order backlog as of August 31, 2004 is $2,564,000, compared to $782,000 one year ago. Current year back log remains high in part due to beet equipment yet to be delivered; and increased sales in grinder mixers. The majority of the increase in current year backlog is the result of $1,193,000 in orders for beet equipment compared to $115,000 last year at this time, and $537,000 in feed grinders compared to $14,000 last year at this time. (c) Utilization of Deferred Tax Assets At year ending November 30, 2003, we had established a deferred tax asset valuation allowance of approximately $818,000. In assessing our deferred tax assets, management considers whether it is more likely than not that some portion of all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. During the second and third quarters of 2004 we reduced the deferred tax asset valuation allowance by $100,000, and $200,000 respectively. We also utilized another $200,000 of the deferred tax related to income before income taxes, leaving a remaining deferred tax asset valuation of approximately $318,000. (d) Critical Accounting Policies The Company's critical accounting policies involving the more significant judgments and assumptions used in the preparation of the financial statements as of August 31, 2004 have remained unchanged from November 30, 2003. These policies involve revenue recognition, inventory valuation and income taxes. Disclosure of these critical accounting policies is incorporated by reference under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation" in our Annual Report on Form 10-K for the year ended November 30, 2003. Item 3 CONTROLS AND PROCEDURES Senior management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation process, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. Since that evaluation process was complete there have been no significant changes in disclosure controls or in other factors that could significantly affect these controls. Part II - Other Information ITEM 1. LEGAL PROCEEDINGS Various legal actions and claims resulting from the ordinary course of business are pending against the Company. In the opinion of management, adequate provisions have been made in the accompanying financial statements for all pending legal actions and other claims. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 3.0 Certificate of Incorporation and Bylaws for Art's-Way Manufacturing, Inc. (incorporated by reference to Exhibit 3 to the Form 10-K for the year ended May 27, 1989.) 3.1 Amendments to Bylaws of Art's-Way Manufacturing, Inc. adopted as of February 27, 2004 (incorporated by reference to Exhibit 3.1 to the Form 10-QSB for the quarter ended May 31, 2004). 31.1 Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer under 18 U.S.C. Section 1350. 32.2 Certification of Chief Financial Officer under 18 U.S.C. Section 1350. (b) Reports on Form 8-K: Form 8-K filed July 27, 2004; Item 5, announcing change in corporate officer Form 8-K filed October 14, 2004; Item 8.01, regarding press release with financial information on the Company's quarter ended August 31, 2004