Art's-Way Manufacturing Co., Inc. (ARTW) Q2 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Today is July 12th. And welcome to the Art’s Way Manufacturing Second Quarter 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, President and Interim Chief Financial Officer 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 with our forward-looking statements today. 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 our 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. As a result, actual results may differ materially from anticipated results, and Art’s Way does not undertake to update its forward-looking statements. Marc, with that I'll hand it over to you.

Okay, well thank you all for joining us for the call. Obviously, if you're calling in, you've read the results for the quarter. And there's a mixed bag there in terms of some improvement in market and our revenues going up, and that being good. And we also continue to have some challenges to profitability that are related to current challenge as well as some carry over from earlier times, and we'll be talking about that a good deal. And talking a lot about what we're doing internally and that we can control, and allow the external factors that are challenging our industry right now, so we'll be going through all that. At this point, I'll have Carrie go through the numbers.

Okay, I'm going to start with our consolidated information. Our consolidated revenues for the quarter were $5,294,000 compared to $4,689,000 in the prior year, an increase of $605,000 or 13% $605,000. Our year-to-date revenues as of 5/31 were $10,660,000 compared to $9,111,000 million in the prior year, an increase of $1,549,000 or 17%. Right now there is really a lot of noise and uncertainty in really all of our industries and all of our segments in relation to the steel tariffs and how that is also affecting the commodity prices. We have seen significant increases in the inputs across all of our business segments. We have in turn raised our prices. However, with Scientific and Ohio Metals, those price increases really take effect much quicker. For Armstrong, we have a much larger backlog and so it takes a little bit for those price increases really to hit our income statement. We do still have our West Union facility listed for sale. We haven’t had any movement on that this quarter. It is listed for $1.5 million. We continue working aggressively to bring down our inventory levels in order to unlock the cash value, but also to simplify our business and our product offerings. As of May 31st, our consolidated growth inventory was $13,385,000 that is a reduction of $1,201,000 or 8% compared to our November 2017 number. The second quarter usually does mark the highest inventory levels for us for the year. So we would anticipate an additional drop by the end of the third quarter when we move out our beet harvesting equipment. We have had two unusual events in 2018 that have negatively impacted our financial statements. The first was the revaluing of our deferred tax assets. This we did in the first quarter. And that’s for the new income tax rates for 2018. This resulted in a loss of approximately $300,000. The second event was recognizing a loss of approximately $253,000 due to the cumulative translation adjustment, or the foreign currency adjustment. And that was in relation to concluding our operations in Canada. Our loss from operations has improved by $307,000 or 29% year-to-date through May 31st. For our agricultural product segment, our revenues for the quarter were $3,936,000 compared to $3,162,000 in the prior year, or an increase of $774,000 or 25%. Year-to-date, our revenues were $7,866,000 compared to $6,530,000 in the prior year, an increase of $1,335,000 or 20%. Our agricultural segment, which is about 70% of our total business, has definitely felt the largest impact of the tariff issues. Just as we were starting to see orders pick up, this new complication moved into our market space. We have moved quickly to increase our prices. However, a majority of our year-to-date sales were booked in December of 2017, so those prices had already been set. So we have now delivered most of that equipment with the one exception of our sugar beet harvesting equipment, which will be about $1 million of revenue yet in the third quarter where we’re going to have the price impact that’s not there. So any new incoming orders will be at our new higher prices. However, we have seen that our incoming orders have slowed due to the concerns over the commodity prices. Our gross profit did increase significantly quarter-on-quarter, moving from 14% to 23%. I would just remind you that in the second quarter of 2017, we had a lot of challenges that we were dealing with all related to the newly developed products moving through our production for the first time. We really struggled with that last year. Year-on-year, our gross profit is 22% compared to 20% and we anticipate continued improvements in the third quarter due to our pricing increase. We’ve continued our efforts to bring down our inventory levels, especially with our ag products and really trying to simplify the products that we’re offering, and getting rid of that slow moving and obsolete inventory. And the impact that that has had on our margins for the quarter is about 5.9% and year-to-date is about 5.3%; so not immaterial as we work to bring down that inventory level. Our loss from operations has improved by $394,000, or about 60%. Our backlog right now is comparable to last years’. However, we did have the self-propelled sugar beet harvesters in there that are really just a pass through sale for us, and really that have pretty low margins. So when you look at just Art's Way produced products, those products are up about 29%. So we are pleased to see that. Now, I’ll move on to Art's-Way Scientific, our modular building segment. Sales for the quarter were $834,000 compared to $888,000, a slight decrease there for the quarter. Year-to-date, our sales as of May 31st were $1,573,000 compared to $1,276,000, an increase of $297,000 or 23%. We attribute the increase in our sales to our willingness to offer new lease options. As we started doing that, we really noticed the customers were able to finance in a different way and that discussions -- we're looking at both capital leases and just rental leases as well. So that has been beneficial. And in the second quarter, we did see an uptick in our ag production sales, which had been down severely during 2017. As our sales and our quoting activities have increased, we have been adding to our direct staff as we move forward, this will allow us to streamline our operations and reduce costs and decrease the use of our third-party vendors. However, right now we are struggling a little bit with the additional hiring costs and the training costs, and that is impacting our gross profit. Our backlog at Art's-Way Scientific is at $465,000, which is down about 6% compared to a year ago. However, that does not account for buildings that we need to produce that are –leased, and that's another $250,000. So there is a significant increase in what we need to build through the product yet -- build through production yet this year. At Ohio Metal, our tool division, sales for the quarter were $524,000 compared to $639,000, a decrease of about 18%. Year-to-date, sales as of May 31st were $1,221,000 compared to $1,304,000, a decrease of $83,000 or 6%. We did lose a large customer at the beginning of the year, and we’ve been working diligently to increase our sales levels to cover that loss. And that we have done pretty well with in addition to increasing our customers, we have had a positive affect due to the steel tariffs in this segment. We are definitely filling more tools into the steel plants that are cutting pipe. So that has definitely helped diminish that reduction in sales. We continue our focus on growing sales in the specialty departments in order to offset the peaks and valleys on the standard side of our business. And we have seen an increase of 36% year-to-date on that side of the business. And we anticipate continued increases throughout the fiscal year. Our backlog at Ohio Metal is $216,000 compared to $153,000 a year ago, an increase of $63,000 or 41%, so nice increase for that division. In conclusion, we’re pleased that our sales levels are increasing despite the current economic challenges. We have been able to add to our direct workforce to more quickly meet our customers’ demands. And we’re also focusing our efforts on improving our processes and eliminating inefficiencies, and trying to do as much automation as we can, both on the production and the administrative sides as well. This has enabled us to improve our operating income. We are continuing our efforts to stay relevant in the eyes of our end-users through continued research and development efforts, as well as providing superior customer service. We believe that our efforts are strengthening the Company, and we will continue to make these improvements looking at the larger picture as we move through these economic conditions. Marc, with that, I'll turn the call over to you.

Okay, thank you. So the result really is on paper is not what we would hope for it to be, obviously, from a P&L standpoint. We do continue, however, to make pretty significant progress internally, I feel like, and positioning the Company for long-term sustainable profitability to be a better Company going into improving markets. And I think that we're making progress. This is repetitive and will be for a long time on every call, but quality customer service, product development continuous improvement those are all cornerstones of how we're moving this thing forward. And there's some pain and some expense in the short term, but we really feel like the long-term benefit will be there. We've been building the sales and dealer network, and just overall, improving our positioning in the marketplace, improving what customers and dealers think about Art's Way, when they hear the name what they think about it and what their dealings with us are. We want that to always be better, and we seek to be the best in the industry. With that, and that's a lofty goal, but we're trying to chip away at that. We continue to be and will forever be in a really cyclical business. And for us to be able to withstand the ups and downs and we're in an extended downturn now that's the worst in 35 years in our industry. But we’ve got to do so with low and debt load. And so focusing on our balance sheet continues to be a major thing for us. As Carrie mentioned, reducing nonstrategic inventory, we keep chipping away at it and we’ll continue to be doing that this year, our West Union building being for sale. Having progress on those two fronts on an ongoing basis and positive EBITDA, going forward, we feel is really going to help us build cash and eliminate borrowings. And all that helps us focus the business and simplify operations, and give us the stability that we need to be sustainably profitable here on out. These are the things that we can do within our control to succeed long-term. As Carrie mentioned, the external factors have been difficult. I mean, that's been going on for three four years. It just got significantly more complicated. And we feel it on both sides, buying material going way up really affects us. And at the same time when the price of every commodity really drops severely here lately, it just really leaves a lot of question marks. So I think a lot of people in the industry are taking a wait-and-see approach. We feel and I think a lot of other people in the industry feel that when it all shakes out with the tariffs and trade war, when we get to the other side of this that we'll probably be in a better position than we were when we entered it. The fact that it's an election-year means in my view that there's probably going to be some urgency to get beyond some of this in the fall I believe. And so I think that some of this will settle and perhaps return to a little bit of stability in the marketplace. And maybe some commodity prices that would allow people to actually do some buying, because over these three, four years, there's been a lot of use on whole goods and not a lot of replacement. And I think that just -- the demand will continue to -- the pent up demand will continue to build. So we get the other side of it, we plan on being in a good position to respond to an improving market and part of that is increasing our production capacity, which has been very difficult to do after coming out of really lean times to build staff and efficiency and productivity all up to a level that will allow us to produce profitable revenue number month-in month-out, that's hard to do. And in a business that is not very big but has a lot of moving pieces to it has a lot of different product lines, it doesn't lend itself that well to economy of scale. So really we've got to be able to produce a revenue number that's going to cover a lot of overheads, that's one of our current challenges. We're hiring and we're running over time at the same -- and we've got backlog, at the same time that things are a little uncertain in the industry. It's a hard thing to manage when there's a lot of push for product, there’s a lot of uncertainty that would lead to new orders. So it’s really a challenging situation right now. As we’re looking to the second half, it’s very hard to predict how things will go. Third quarter is generally pretty good for us and been that we have backlog and are improving we would expect it to have a better outcome certainly than the first two quarters. We would hope to turn to EBITDA positive for the third quarter. And as Carrie said, we’d be reducing inventory and reducing debt, accordingly. When you get beyond the third quarter, it's really hard to say because the uncertainty right now affecting incoming orders that’s when some of that would affect us. And I think that our early order writing period generally is around September, and we certainly know that we’re busy past September in production. But I think we'll start to see more order activity around that time, that’s generally what happens seasonally. So we’ve got a whole lot to do, but exactly what it’s going look like out in the fourth quarter is really hard to say. So in any case, overall, we’ll keep managing it and keep reducing our exposure, reducing risk and trying to improve on our execution and putting ourselves in a better position to succeed after if it shakes out. So with that, we’d be glad to take any questions.

Ladies and gentlemen, at this time, we’ll conduct the question-and-answer session [Operator Instructions]. Our first question comes from Sam Rebotsky. Please state your question.

Tell me, the steel that you use, is it imported or is it domestic, or what percentage would you say it and what percentage would be affected by the tariff?

I would say that we can't exactly put a number on how much is - offhand how much is imported or not. But the real takeaway is that it all went up. I mean all the domestically sourced stuff went up in price immediately to account for the tariff. And so whether it's domestic or not, it all went up. And so that's -- even some of our domestic sources are sourcing it foreign, and so we don't necessarily know where all of it comes from but certainly, the price has affected us all around. And for some specific things I mean, it's been 30%, 40% went up. For things that are maybe have more labor into them and the cost isn’t all material, it's been less than that but anything that steel has gone up majorly.

So you, at this point, you’re passing this on and the acceptance, I mean, I guess there is reduction of acceptance for orders, or what would you say is the acceptance of price increases?

From our customers?

Yes?

I would say that the one good thing about it is that everybody in the industry is doing it. It's in the news, everyone knows it, it’s coming. Everyone expects it. So because of that, we don't really stand out as being gougey or anything like that. So I would say that that just being in everyone's mind helps with the acceptance of it. But in terms of the willingness to go spend money, I mean our incoming orders have been slow. But I think that has -- I mean recently, I think that has a whole lot more to do with what's happening with the price of corn, soybeans, milk, et cetera than it does what the new price for our equipment is.

And what percentage are you utilizing your capacity presently? Are you one shift and what percentage utilization?

Well, we are one shift with a small -- small second shift of certain key operations, so just a few people but essentially one shift and…

And presumably you're comfortable to work a full second shift provided you have the orders and you have the staff to do that?

Well, we would always prefer to add staff on first shift to the extent that we can, and really it’s just bottleneck operations that cause us to run a second. So it’s sorted to balance the flow we would really not hope to have a big second shift. And for one thing, the availability of labor, I think would always make that a distant possibility. It is hard to find labor everywhere, it's a nationwide problem. But in our specific area the unemployment is extremely low, it’s 2 point something percent. And I don't think that growing beyond what first shifts could handle, I don't think that that’s likely.

Now the stock could run up on one day or so, did you examine and find out where the buying happened and what happened, what occurred to do this. What do you think that was attributable to?

We were quite puzzled and concerned about it. I mean that's really a ton of movement that needs explanation. And so worked with NASDAQ and SEC to try to find out what was going on, and they were unable to really give us any meaningful information. None of the trades individually were very large it’s just a really high number of trades. And so -- and there were no filings of anyone accumulating over 5% those statements have positioned in that way. Really there was no clear answer that either could help us uproot or un-root, which is surprising. You would think that it would be able to be identified by those people and they can’t.

So with this increase in trading for that short timeframe, is there any possibility to take advantage of putting -- doing more -- tell your story. I mean, even though it was probably a buying and selling, because the stock ran up and came back down. Is there any way to take advantage of that activity to Art's-Way benefit? In other words, is there any way to find these people that move the stock to become permanent stockholders, or any way to possibly, as a base to increase activity on a regular basis, not just on a one shot.

Well, we haven’t seen that as a big opportunity. It seemed like more of a fluke. And if anything, we feel like we need to have more to brag about before we go shouting from the mountain tops too hard.

And I think -- in previous quarters did you referred to profitability. What was the terminology referred to, did you expect profitability in this quarter before, or what was your expectations for the coming quarter?

We expect it to be closer to breakeven. We didn’t expect to lose this much, no we do not. The $253,000, we did not expect that. We expect it to have a better efficiency during the quarter that would have impacted this. We expected higher revenue in Ohio Metal, and have some unforeseen expenses also at Scientific. So I would say that there were some things like that we didn't foresee and we also need to continue improving on our execution.

And normally the third quarter is a more active quarter and you could see profitability at this point. But what about the fourth quarter, do we have any visibility there? What would that normally be?

Fourth quarter is usually pretty challenging to make money. And certainly the last three or four years it’s been not good in the fourth quarter. So right now our visibility is not that great. Our backlog really would -- really would refer to third quarter, and I wouldn’t expect much of that to bleed into fourth quarter. And so I think that what the incoming order activity is, the August September, it’s really going to drive how that fourth quarter goes. I know that from a production standpoint that we have a lot that we need to work on regardless of what that order activity is. But in terms of what were going to be shipping in the fourth quarter that I don't know right now and we often don't know. This is not the time of year where we generally receive a lot of orders. In the fourth quarter dealers are generally not in a hurry to pick up anything, which is a problem.

Marc, it sounds like you're doing what you can do and hopefully, the tariffs become clearer whatever that's going to be so that people could do -- could factor this in that it's not a problem and hopefully things will improve as your plan is. Good luck.

Our next question comes from [Roger Miller]. Please state your question.

Starting off with the tariffs since you mentioned it frequently in the conference call. My opinion right now is China has got almost a wait-and-see attitude with her rhetoric slowing down and waiting to see how the U.S. probes with the tariffs. And in my opinion, the tariffs aren't good for any of the businesses. Going forward, what have you done to examine solar for the modular buildings. Can you answer any of that?

Very little, I mean, for us to be installing solar on building…

Yes.

I think, there's probably been some discussion with some customers that had been interested in that. But we build to a customers' need and that's what would drive where we put resources in anything really. And so that hasn't been…

Let me interrupt you, Real Goods Solar, which is not a company on firm footing but they do have a product from Dow Solar, the solar shingles. So Dow has come up with this powerhouse shingle and it recently passed UL Class A fire test, and it still needs to get its solar certification, which is anticipated by September. So these are shingles that go on the roof. And I think they would fit very well with what you're doing, and maybe give you an advantage going forward. You can find more news in the PV magazine, that's Paul, Victor and that's online. And if look into RGS Energy, which is real good solar, you'll find more about it.

Okay, we'll take a look at that.

I think that is something you need to consider, and possibly make in your building stand out even more than they do. And should it fit well with some of the corporations that you’ve had talks to but haven't done a lot of business with, and even the University should be interested in that.

You expect that…

And I think the medical industries would be interested too, for labs. So when you lost that big account in the tool industry and then you stated that you're replacing it with, I assume smaller accounts. Is that correct?

Yes.

This got to do with the drill bits or what, and the oil industry?

Yes, it’s cutting tools -- you mean that was lost?

Yes.

Yes, cutting tools that had steel -- a plant that was a big customer and it’s competitive situation, so we have a direct competitor and I think that they -- I think we’re fairly desperate I think and undercut in price. And we've been struggling to convince the buyers to stay with us really and this is at the same time that the price of -- the cost of everything has gone up. So I don’t know that they can sustainably be done at the price that they’re buying it now. But it’s a competitive situation and we got undercut and that’s what’s happened.

And were they imported?

No.

How do you see that division as a whole, because you really didn’t talk much about that?

We had this particular competitive situation, not resulting in losing that customer. I would think that our year would be looking a lot better. Overall, you think about what drives that industry at least the standard part of that business a lot of it being oil and gas, pipe mills that's what drives a lot of it that should be gaining steam. And we are seeing some of the other customers that we have getting busier, so that's good. So this may be a temporary lag with that. And manufacturing overall just nationwide doing well, that bodes well for the precision part of that business. So I really think that we had the short short-term hiccup on revenue and I think that we’ll be overcoming that. I think that the general economic activities out there should be to their benefit, if not to the others.

There is a company in Canada, [PFIE] is the symbol, and they sell burners and they distribute chemical management. Would you manufacture may be a perfect fit for them. So I'm just throwing that out at you…

Okay…

And they’re cash rich, at any one quarter they have $20 million sitting in the bank with no debt. As far as modular buildings go, have you thought about entering any other businesses outside of what you're doing now?

We’re always looking for new markets where we could stand out and not be completely commoditized in the modular building business. And so that's a bit difficult. But as we stand right now, particularly since we became more active in leasing, our activity has just really increased. So I mean we are increasing staff significantly. I mean we’re building up our production capacity to respond to the demand that we’ve created here. So we’re pretty loaded up right now and we need to be looking beyond that as well to continue to grow it…

So, [Dan Palmer] swamped is what you're saying?

I would say he is, yes.

I mean it seems like you could go into the office field too, I don't know, consider that?

That’s commoditize…

Upscale -- what’s that?

I’d say the offices are generally commoditized already. They’re using upscale office…

Yes, upscale completely.

Yes, maybe so…

I wouldn’t try to compete on the low level, every side I look at right now is low level, it's all bare bones. It’s just shells, basically. So any more comments on the tariffs you’d like to make?

I would just say that, well, I said it before. I mean, I think this will shake out and the fact that it’s election probably would cause it to shake out faster. And I just think that until it is there’s per going to be a lot of waiting on the sidelines in our industry I think from a buying standpoint. I mean I would expect that. And short-term it’s not good, long-term I think it'll be all right, that might have been…

Well, if I assume that theory then I would assume after the elections when the shakeout occurs and who's who in the zoo, you'll know how this is going to work out, because it may take a shock factor the change of strategy. Okay, well that’s all I have. Thank you for taking my call.

[Operator Instructions] At this time, we have no further questions.

Well, thank you all for joining us on the call. We appreciate you making investment in the company and continuing to follow us and support us. And we look forward to better times ahead and we’re trying to put ourselves in a position to benefit from that. And I have no doubt that we will. So we’ll look forward to talking to you next quarter. Thank you very much.

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