Art's-Way Manufacturing Co., Inc. (ARTW) Q3 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Today is October 6, and welcome to the Art’s Way Manufacturing Quarterly Investor Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Your call leaders for today’s call are Marc McConnell, Chairman of the Board of Directors of Art’s Way Manufacturing; Carrie Gunnerson, CEO and President of Art’s Way Manufacturing. I’ll now turn the call over to Ms. Gunnerson. You may begin.

Good morning. I’m just going to start by reading our forward-looking statements. You should note that some of the statements made during this call may be considered forward-looking statements. Forward-looking statements include, but are not limited to, statements relating to our market position, strategies for growth and future results of operations. Forward-looking statements are inherently subject to risks and uncertainties such as competitive factors, difficulties and delays in development, manufacturing, marketing and sales of Art’s Way products, general economic conditions, and other risks and uncertainties described in Art’s Way’s periodic reports on file with the Securities and Exchange Commission. Actual results may differ materially from anticipated results and Art’s Way does not undertake to update its forward-looking statements. With that, I’ll hand the call over to Marc.

Yes, thank you. I would like to welcome you all to our third quarter earnings call. As you’ve all seen we've had results for the quarter that are much improved over what we've been experiencing prior to that and we're excited about that, even though we still have ways to go. And are looking forward to talking to you about it answering any questions you may have. And with that I’ll let Carrie start the presentation.

Thank you, Marc. I'm going to start with giving you some information from the consolidated financials. Our consolidated third quarter revenues were $6,555,000 compared to $6,431,000 in the prior year; it’s an increase of $119,000 or 2%. This was our strongest quarter since the second quarter of 2015. Our income before tax for the quarter was $92,000 compared to a loss of $224,000 in the prior year, a shift of $316,000. And again this would be the first profitable quarter as well since the second quarter of 2015. On September 28th of this year, we did restructure our debt with Bank Midwest, and we have discontinued our relationship with U.S. Bank. Bank Midwest is a local bank that really understands the Ag economy and our business and we feel very positive about our relationship with them. Our new loan agreement will greatly improve our liquidity; it will reduce our annual debt service by over 60%, and establishes far more favorable loan covenants for us. We continue to bring more and more focus to our key operations and simplify our business. We still have two facilities on the market, one in Dubuque, Iowa and one in West Union, Iowa. Those two facilities are listed for a combined total of $3.8 million. Our inventory levels are decreasing and we expect to see a significant decline in current liabilities in the fourth quarter. Our new debt agreement will allow us to move our bank debt from current liability to long-term and we also anticipate a decline in our accounts payables due to our improved liquidity. I am going to move on to the agricultural segment now. Revenues for the quarter were $4,978,000 compared to $4,992,000 in the prior year or a decrease of $14,000. Sales of the self-propelled beet harvester equipment, which is -- it’s a pass through product for us, we just distribute, we did not manufacture, were down $932,000 for the quarter. So if you adjust sales for just the Art’s Way produced products, our sales were actually up $918,000 or 28%. Our year-to-date sales are $11,595,000 compared to $12,757,000, or a decrease of 9% or $1,162,000. That is a 7% improvement over the second quarter year-to-date numbers. Again if you adjust out for the Art’s Way only produced products and eliminate the self-propelled beet harvesters, our sales year-to-date are only down $230,000 or 2%. We have just released our early order program, accompanied with some price increases. Our early order program helps us set our production schedule and plans for the coming year and we typically end the calendar year with very high backlogs, as the program ends in December. We expect that this program will be consistent with prior years. Our backlog for Ag products is up by $720,000 compared to last year at this time, or an increase of a 108%. In the second and third quarters, we saw a significant shift in our product mix, which impacted our gross margins fairly significantly. The products with strong gross margins had declined and we were producing and delivering our new products that have been going through R&D and just hitting the shop floor for the first time. Those products we’re trying to gain market share and they have a lot slimmer margins on them. These products have now been proven through the factory and in the field and we are adjusting our pricing and we anticipate increased margins next year. Based on our backlog numbers, we do anticipate a pickup in our gross margins for the fourth quarter, as the product shift will move back to more of our traditional products with favorable gross margins. Our engineering expenses are up 20% over last year, that is a significant increase for us, however we have really been focused on R&D efforts in supporting those products. We believe that our engineering expenses have been level for the last few quarters, but in comparison to prior years they are up. We have announced that we are discontinuing our Agro Trends snow blower line that’s produced in [indiscernible] Canada. We were in a rented facility up there and our lease have come to an end. We do not believe that the sales and the income associated with that product line are worth the complexity of having a facility in Canada. We do have enough finished goods and inventory to enable us to sell through the coming winter season so that will be our fourth quarter and our first quarter of next year in a comparable fashion to the sales that we had in the past years. Our income before tax for the quarter was $159,000 compared to a loss of $91,000 in the third quarter of last year, a shift of $250,000. Year-to-date we still have a loss before tax of just over $1 million, we will continue our efforts to minimize that loss over the fourth quarter. Our inventories had increased fairly significantly over November 30, 2016 as we were bringing in inventory to produce our new products. Those -- that inventory moved through the factory much lower than we had anticipated, so we saw a rise in inventory levels in the second quarter inventories were up over year-end. So both inventories did turn into sales in the third quarter or the bulk of them did. And that coupled with a push to move some of our slow moving whole goods dropped our inventory values in the third quarter. We saw a reduction in inventory over the second quarter of 5.6% and a reduction over year-end of 2.6%. We anticipate further reductions in inventory in the fourth quarter. Next, I'm going to move to our Ohio Metals segment. Sales there increased 35% for the quarter from $530,000 to $718,000. Year-to-date sales are up 28% from $1,000,583 to $2,022,000. Our gross margins have also improved increasing from 24% in 2016 to 33% year-to-date. In September of 2017, we hired a new Director of Sales. He was very well known in the industry and we are really seeing the fruits of his labors pay-off at this point. He is specifically going after sales on our specialty side of the products. This is a key area for us trying to manage the risks with our standard side being tied to the oil and gas markets the specialty side does not have that tied to it. So we have seen an increase in sales on the specialty side specifically of 33% and we anticipate continued increases in that specialty line throughout the year. Our income from operations for the third quarter was $27,000 compared to a loss of $42,000 in the prior year. Our year-to-date income from operations is $3,000 compared to a loss of $122,000 in the prior year. Our income before tax for the quarter was $15,000 compared to a loss of $68,000 in the prior year. We were able to finalize our union negotiations during the quarter and we have a new contract in place with the three year term. We do want to point out that one of our largest customers is located in Houston, Texas and their operations were impacted due to the hurricane. We did not really see an impact in the third quarter, but we do anticipate that our fourth quarter sales will probably be flat on a quarter-to-quarter basis due to the disruption that they have in their production as their employees were not able to be at work. Next I'm going to move to Art Way Scientific. Sales for the quarter were $767,000 compared to $910,000, a decline of 16%. Year-to-date sales were $2,043,000 compared to $3,000,102, a decrease of 34%. The decline in the dairy market is still significantly impacting our sales both for the quarter and for year-to-date. We have been able to secure two leases for our buildings that we have held in inventory. One of those was leases were placed into service in the third quarter and the other will go into service in the fourth quarter. One of those was a 12 month lease with an option of purchase and the other was a straight three years financing lease. I just want to go over backlogs just briefly, for the Ag sector, our current backlog is at $1,000,390 compared to $668,000 in the previous year. So again that's a $721,000 increase or 108%. In Ohio, for Ohio Metals their backlog is at $112,000 compared to $45,000 in the prior year, an increase of $67,000 or 149%. Total backlogs are currently at $1,000,958 compared to $1,163,000 in the prior year. So the increase of $794,000 obviously the lion share of that is in the Ag sector. The total backlogs are up 68%. We believe that the third quarter was a good quarter for us. Our new products are performing well in the field, our sales levels are increasing and we have a new lending agreement in place. This new agreement will allow us much more flexibility, improving our liquidity by reducing our debt service requirements. We are cautiously optimistic that we have turned a corner here. We continue to focus on new products and being relevant in the market. Our image and our dealer relations continue to be a focus for us through customer service and quality. Our backlog numbers are much stronger in comparison to last year and we anticipate that trend to continue through our early order program. While our sales have struggled over the past few years, we believe we've really taken this opportunity to drive cost out of our operation, while focusing on quality and customer service and productivity the entire time. We believe as markets pickup and sales pickup that these efforts will be recognized as we move forward. Marc, I'll turn the call back over to you.

Okay, thank you. I would just say that we're feeling a lot better about things than we were in some of the previous quarters, but also at this time a year ago we really started to experience a great deal struggle around this time a year ago after things had already been tough, but it was especially tough in the last quarter of last year. Really the sentiment that we seem to see in the marketplace is better than it was at that time the order activity, the quoting activity actually incoming orders I mean all that stuff is better. And the products that are more active are our higher margin products, which is good. And as we go forward in the months ahead, I think that we've got a lot of the toughest part behind us. So we've got some backlog to work from and we continue to simplify and improve our business and I think we're finally starting to see some of the benefits of the efforts that we've been undertaking over of the last couple of years. Our highest priorities remain for long-term to have high product quality, great customer service to keep developing product. And from a business standpoint to improve our balance sheet and reduce inventory and focus our business all of these things have been very important and I think they all lead to us positioning ourselves very well for when market returns to more normal circumstances. While we think it's maybe some better the market still pretty challenged. And I just think that we're getting ourselves and geared to benefit greatly as things start to improve a little bit. So, with that, I’d be glad to take any questions.

[Operator Instructions] Our first question comes from Sam Rebotsky from SER Asset Management. Please state your question.

Yes, good morning Carrie and Marc.

Good morning.

It's good to have an improvement. Marc, you sort of indicated the fourth quarter will be an improvement, the fourth quarter sales last year were in the $4 million range, does that indicate you will also where you this current quarter you had $6.5 million sales and were profitable you expect to be profitable in the fourth quarter.

I think that we've got a chance at it. And for sure we should have positive EBITDA I think and just tremendous improvement over last year's fourth quarter, I mean that quarter was just terrible. And we saw sales levels that were lower than we've ever seen in some of the months in the fourth quarter of last year. So we really don't expect that at all. I don't think we would expect our revenue level to be on par with the third quarter of this year just because of the time of the year it is and what products we shipped during that time and that kind of thing. But our cost structure is lower than it was a year ago, our sales activity is better than it was a year ago. Basically all things point to having just a much, much better quarter I think than what we had at this time a year ago. But to say, which side on net income it's early to really make that prediction, but I just think that it will certainly be good comparatively when it's done.

Well that sounds good. And as far as the buildings held for sale, do we expect closure soon, what's going on with these facilities?

Well in both cases we're working very actively and have some prospects, but don't have a contract, don't have anything to report. And really until it's all signed in the wire is in the bank it would be kind of not much to promise there.

Okay.

So we're working that hard and that represents half of our borrowings. So it will be quite significant to us when we're able to sell those.

Okay. And so it appears do you see some industry turnaround that is attributable to the improvement or do you see the new sales director that has been significant in helping you achieve what you want to achieve. Or what do you attribute the improvements to?

So the new sales director that Carrie referred to, that was for Ohio specifically. And we have a new sales director for Arts Way Manufacturing going back nearly two years ago. I think that some of those efforts are certainly helping us. And I think that developing new products is part of what's helped us stay particularly relevant during the year and give us the revenue numbers we did. I mean if we hadn't kept progress on new products our sales levels would be I think much worse than they are for the year. And even it's not that they’re that wonderful, but it would be a degree worse. So I think it’s some of what we've been doing for sure. And as far as the overall market, I think some of the recent sentiment is better in the marketplace, but that doesn't really explain I don't think too much or completely anyway why things were better for the third quarter versus last year. And a lot of it has to do with products that we weren't able to offer last year. But without question, dealers are more actively quoting product than they were earlier in the year and certainly at the end of last year.

That sounds good. Good luck. Continue the improvement.

Thank you, Sam.

[Operator Instructions] Our next question comes from Roger Miller from Frontier Investment. Please state your question.

Good morning.

Good morning.

Can you speak more on the modular market and what is going on there?

Well it is -- obviously year-over-year our sales have been -- are down and they weren't great year ago. So without question we've continue to struggle, I feel like we had -- the first half of the year for scientific was quite rough and I feel like things have been better since that time, but we really got off to a slow start. And our backlog is about even with the year ago. And so it's sort of -- it's certainly not doing great it's not dead either for sure. I mean we do have a lot of activity and we're really pleased to set up a couple of leases from inventory building so that's really good. And helps us address some overall inventory and that kind of thing. But we remain very active in the marketplace and have a lot of an opportunity and some of it is the same old story you’ve heard from us before as the sales cycle is long and it’s difficult and we haven’t really gotten over the hump in that business yet, but we certainly continue to see lot of opportunity and if we didn’t, we would be finding a way out of it. You’ve heard us talk about wanting to simplify our business and if there are businesses that we’re in that we don’t see them being or activities that we don’t see being worth the effort or not having the opportunity to someday it would be worth it, than we don’t to be in them. I don’t put scientific in that category at all, because there’s plenty good there and we’re building and developing. And I don’t have much result to brag about yet clearly.

Well once you sell the buildings or at least one, May I suggest you might want to invest more into scientific?

Yes, I certainly would love to expand…

Obviously I can’t say you ought to do that, but maybe personnel side for one.

Yes, that’s it, I mean we have the facility and there is not - that businesses isn’t one that’s really driven by a lot of equipment or anything that requires a lot of investment in that respect. So continuing to build out the team, build out the sales force, marketing, a lot of it is more operational expense that you’re willing to incur, that’s more the investment than hard asset. And so we have been doing some of that, but I think probably to make a bigger impact in the market, we are going to have to accelerate with some of that. And during these hard times that we have been the last couple of years particularly with Ag being so tough and our overall finances being more strained, it’s been very difficult for us to do that. But I think coming out of this that certainly helps us accelerate with Scientific.

And would you like to expound on Ohio Metals. You are talking about specialty sales, what would that include, what industries?

A lot of it goes to machining, titanium and other metals of that type, if you go in aerospace, it’s other precision machining for all kinds of other industry type; I can’t I guess rattle them all off, but it’s pretty widespread. And in places where there are machining or cutting aluminum and titanium and some of these things, it need a hard cutting surface. That’s where we see it. And Ohio Metals been in that business for a number of years, but it had been the sort of under optimized piece of the business and we always saw a lot more opportunity with it and we have brought on new sales manager September of ‘16 and he is from the industry and he is focused on that market specifically quite a bit and is making an impact with some large customers and some are more automotive by the way, actually quite a bit of it is automotive. And I think the sky is a limit, that might end up requiring more investment to get a lot bigger, but that has all been good and the business is cash flowing and really all things are improving in that business. So that’s been very good.

The margins are really improving.

Yes, they are.

In Ohio Metals, I mean that’s substantial improvement.

That’s right.

And if you increase revenue there and it should have an impact on your bottom-line as a company.

That’s right, yes.

So the Ag business will continue to increase, but nothing dramatic, correct? Due to the price of commodities.

I don’t think it can be real dramatic until commodities change more materially than they have. I think, some of the activity we feel now is just simple, the need for replacement, historically a lot of buying was done for tax reasons and a lot of farmers always had new equipment, because they needed to for tax reasons. And really more of the purchasing has been out of necessity the last couple of years and they keep using the equipment and using it up. And at some point have to -- just have to spend some money. And that's kind of feedback that we get from some of the dealers that you can put something off for a year and put something off for two years. And after a while you just got to spend the money and replace. And that's what seems to be happening, because there hasn't been much activity for two or three years.

So, it looks like your sales primarily in-house now rather than quite a bit of your sales were those beet harvesters in the past, correct?

As a percentage it wasn't extremely high, I mean, they are big dollar units. And so the difference between selling one and selling two that shows up for sure. But in terms of what we are actually producing and selling as Carrie said that's higher.

Going forward into the next year beyond the fourth quarter, can you predict anything there?

That's really hard to say obviously, our early order program that Carrie alluded to is when we started to get some visibility further out and we're in the order writing period. And so it's really not till the end that you get a good picture of that. So, I would say it's really hard to say. But as we go into the year just for the sentiment to be better and for our cost basis to be lower and for our business to be simpler and for us not to be building several new projects -- products for the first time. All those things would suggest that we could do well at lower level next year than we would have needed to have for revenue this year to make money. It will be easier in that respect, but the demand will probably ultimately tell the tale.

So, once you sell these buildings over the next quarter or two possibly, is that going to be primarily used to pay down debt was that what I was hearing?

That would probably be what we aim to do, yes, we could pay-off part of the line or pay-off some of the fix, but with our new loans our debt service coverage is or debt service is a lot lower. And so there is less pressure on all of that. But yes I am ultimately trying to get to as little debt as possible. And we still have a lot of opportunity inventory wise to shrink that and I think that it’s not crazy to think that we could get down having the debt being close to zero in not too distant feature. But we'll have more things that need to be reinvested in because we haven’t done a lot of careful expenditures for the last couple of years for obvious reasons. And we did invest in product development but not so much in CapEx and some of that stuff will come up I'm sure. And just for strategic growth we will be looking to deploy capital, but ultimately I rather operate in this cyclical business with the lower debt load than what we've had even though I don't think we were over leveraged.

So you are completely out of U.S. bank, is that correct?

Yes.

And your interest payments they were lowered, but how about the interest rate, were they maintain about the same or…?

Interest rates very close to what we were paying towards the end with U.S. bank. So the U.S. bank had raised our rate a couple of times over the last year plus.

Most likely some of that was because of the risk factor and because of the interest rates going up as a whole.

Well, yes, and when we needed to get an amendment or anything like that or a waiver or anything that's an opportunity for them to jack it and they did.

That's pretty standard to our business. I'm sure…

Yes, that's right.

They weren’t treating you as a preferred customer I would say that.

They stop doing that a while ago.

But you are not alone.

Right.

It seems like that the shift at the present time is the direction you are taking, by the way. My personal experience is some of the larger regional banks have gotten pretty concern of this?

Yes.

Well, that’s all I had today. Thank you for allowing me to speak and yet I am very pleased with the margins at Ohio Metals, that’s very surprising considering how far you have gone with that and it’s too bad you had to close down Canada. I always thought maybe sometime that would blossom, but I guess in this environment that would be difficult.

Well, I could just hit on that a little bit. I think that -- so Canada what they did was build snow blowers and that business is I think it’s just really hard long-term to make any money, I think that you can’t -- obviously you can’t guess the weather, but the difference between a good year and a bad year, it could be like 300 snow blowers or like 1,800. So you can’t guess that right and it seems to be one good year followed by three or four bad ones. And it just doesn’t seem to be worth -- the risk doesn’t seem to worth the reward, it does tie up a lot of cash and inventory and it’s somewhat of a commodity, so the margins are difficult, so you kind of add all those things together and the fact that it’s in Canada, it’s a Canadian entity, there is complexity that goes with that, it kind of wasn’t -- it just doesn’t seem to be worth the risk for us. And I think that we help ourselves by simplifying our business and putting resources towards the things that do have a better risk return profile. And a lot of what we are in has a much better risk return profile and it just didn’t fit from my standpoint, it didn’t fit my tolerance for all that.

Was there any interest in someone purchasing that business up there?

Yes, we are working on that. And we think by announcing it there may be other people that surface too, but we are working on that to try to maximize the value.

They may take whatever employees you still have and the inventory I would imagine, right, for parts and what not?

They may, but I don’t have anything to announce. So I guess it depends on the buyer and what they want to do with it and that kind of thing. But we will continue selling snow blowers, we have a lot of inventory and it’s also possible that we may end up with a supply agreement with whoever buys it, where we continue to distribute it or through our dealer network, I am not sure, but we will just see how that plays out. But we will be trying to maximize value and there is lot of inventory there to turn to dollars it’s over $1 million.

So what does the average snow blower cost?

I don’t know the average…

I mean retail wise, what the sale is or even wholesale what you selling for?

A lot of it, $2,000, $3,000, $4,000, $5,000, I mean there is some that are higher than that, but a lot of it’s in that range.

So it’s not a great expense on the farmers?

No, it’s not.

Okay, well thank you then.

Yes, thank you for your questions.

At this time there are no further questions.

Okay. Well thanks all for participating in the call I thank everyone for the questions that we had. We appreciate your interest and support and obviously we are pleased to have some improvement, but realize we don’t have high earnings to brag about yet, but we will keep putting the building block in place to where we will have that in the future. And we look forward to talking to you in the next call. Thank you very much.

This concludes today's conference call. Thank you for attending.