Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
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 and the audited consolidated financial statements and related notes thereto and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended November 30, 2018. Some of the statements in this report may contain 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 warranty costs and order backlog; (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; (iv) the impact of recently issued accounting pronouncements; (v) our intentions and beliefs relating to our costs, business strategies, and future performance; (vi) our expected financial results; and (vii) 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 general economic conditions, including consumer and governmental spending, on the demand for our products and the cost of our supplies and materials; (iv) fluctuations in seasonal demand and our production cycle; and (v) other factors described from time to time in our reports to the Securities and Exchange Commission. 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 the financial statements as of February 28, 2019 remain unchanged from November 30, 2018 with the exception of the addition of a critical accounting policy regarding revenue recognition from contracts with customers, which is set forth below. Disclosure of these critical accounting policies is incorporated by reference from Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended November 30, 2018.
Revenue from Contracts with Customers
Effective December 1, 2018 we adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASC 606 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and is to be applied retrospectively, with early application not permitted. We adopted ASC 606 for the 2019 fiscal year, including interim periods within that reporting period.
We have evaluated the new standard and applied the core principle to our contract revenue streams. To be consistent with this core principle, an entity is required to apply the following five-step approach:
1. Identify the contract(s) with a customer;
2. Identify each performance obligation in the contract;
3. Determine the transaction price;
4. Allocate the transaction price to each performance obligation; and
5. Recognize revenue when or as each performance obligation is satisfied.
Our revenues primarily result from contracts with customers. The agricultural products and tools segments are generally short-term contracts and contain a single performance obligation – the delivery of product to the common carrier. We recognize revenue for the sale of agriculture parts, equipment and tools upon shipment of the good. The modular buildings segment executes contracts with customers that can be short or long-term in nature. These contracts can have multiple performance obligations and revenue from these can be recognized over time or at a point in time depending on the nature of the contracts. Payment terms generally are short-term and vary by customer and segment. The implementation process included modifications to the contracts of the modular buildings segment.
We use discounts as a form of variable consideration for our agricultural products and tools segments. The variable consideration is allocated to the transaction price at contract inception and is generally not contingent on future outcomes. The agricultural products and tools segments do not offer rebates or credits. The modular buildings segment does not offer discounts, credits or rebates.
Our product warranty is included in the price of the product and provides assurance that the product will function in accordance with agreed-upon specifications. Product warranty is expensed at the time of sale for the agricultural products and modular buildings segments. A small reserve is kept on the balance sheet as consideration for the tools segment warranty. This product warranty does not represent a separate performance obligation under ASC 606.
We adopted ASC 606 using the modified retrospective method. We have determined that amounts reported under ASC 606 are not materially different than amounts reported under the previous revenue guidance of ASC 605 and therefore, we were not required to make an adjustment to retained earnings.
We, upon adoption of ASC 606, have increased the amount of required disclosures, including but not limited to:
• Disaggregation of revenue that depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors;
• The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed;
• Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period;
• Information about performance obligations in contracts with customers; and
• Judgments that significantly affect the determination of the amount and timing of revenue from contracts with customers, including the timing satisfaction of performance obligation, and the transaction price and the amounts allocated to performance obligations.
Results of Operations
– Continuing Operations
Net Sales and Cost of Sales
Our consolidated corporate sales for continuing operations for the three-month period ended February 28, 2019 were $4,124,000 compared to $5,366,000 during the same period in fiscal 2018, a decrease of $1,242,000, or 23.1%. The decrease in consolidated revenue is primarily due to decreased demand for our agricultural products and liquidation of our Canadian subsidiary. Consolidated gross margin for the three-month period ended February 28, 2019 was 14.7% compared to 20.9% for the same period in fiscal 2018.
Our first quarter sales at Manufacturing were $2,610,000 compared to $3,930,000 for the same period in fiscal 2018, a decrease of $1,320,000, or 33.6%. The decrease in revenue is due to decreased demand across our grinder, manure spreader and OEM blower product lines and the liquidation of our Canadian subsidiary. Some of the decreased demand is due to economic factors such as commodity prices and price increases we implemented to our customers due to increased material costs, mainly steel. In 2018, we were selling off old manure spreader inventory at decreased margins, which accounts for the decreased sales for manure spreaders in 2019. Our OEM blower sales are down as our OEM blower customer elected not to purchase any blowers from us in 2019 due to slow-moving inventory on their dealer lots relating to poor agricultural market conditions. Our Canadian subsidiary accounted for $422,000 of sales in the first quarter of fiscal 2018. Gross margin for the three-month period ended February 28, 2019 was 12.7% compared to 20.3% for the same period in fiscal 2018. Our decreased gross margin is attributable to less revenue available to cover fixed overhead.
Our first quarter sales at Scientific were $1,022,000 compared to $739,000 for the same period in fiscal 2018, an increase of $283,000, or 38.3%. Our increase in revenue is due to operating lease revenue from buildings put in service in fiscal 2018 and an increase in agriculture building sales for the first quarter of fiscal 2019. Gross margin for the three-month period ended February 28, 2019 was 11.7% compared to 15.7% for the same period in fiscal 2018. The decrease in gross margin is attributable to depreciation on rental buildings put into service after the first quarter of fiscal 2018 and an increase in direct employees in fiscal 2019.
Metals had sales of $492,000 during the first quarter compared to $697,000 for the same period in fiscal 2018, a 29.4% decrease. The decrease is due to the loss of a high-volume customer during the first quarter of fiscal 2018. Gross margin was 29.5% for the three-month period ended February 28, 2019 compared to 29.7% for the same period in fiscal 2018.
Expenses
Our first quarter consolidated selling expenses were $343,000 compared to $451,000 for the same period in fiscal 2018. The decrease in selling expenses is due to decreased commissions as a result of fewer sales and decreases in advertising and tradeshow expense as we shift our advertising strategy to more digital and social media. Selling expenses as a percentage of sales were 8.3% for the three-month period ended February 28, 2019 compared to 8.4% for the same period in fiscal 2018.
Consolidated engineering expenses were $147,000 for the three-month period ended February 28, 2019 compared to $129,000 from the same period in fiscal 2018. The increase is due to research and development costs on development of new products. Engineering expenses as a percentage of sales were 3.6% for the three-month period ended February 28, 2019 compared to 2.4% for the same period in fiscal 2018.
Consolidated administrative expenses for the three-month period ended February 28, 2019 were $837,000 compared to $849,000 for the same period in fiscal 2018. Administrative expenses as a percentage of sales were 20.3% for the three-month period ended February 28, 2019 compared to 15.8% for the same period in fiscal 2018.
(Loss)
from Continuing Operations
Consolidated net (loss) from continuing operations before income taxes was $(781,000) for the three-month period ended February 28, 2019 compared to net (loss) from continuing operations before income taxes of $(306,000) for the same period in fiscal 2018. The increased net (loss) from continuing operations is due to decreased sales and gross margin. We have taken steps to reduce expenses as a result of the soft market conditions for our Manufacturing segment, while continuing to invest in product development and improvements to support our customers for the long term.
Income Tax Adjustment
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was enacted, which reduces the top corporate income tax rate from 35% to 21%. We have assessed the impact of the law on our reported assets, liabilities, and results of operations, and we believe that going forward, the overall rate reduction will have a positive impact on our net income in the long run. However, during the first quarter of fiscal 2018, we substantially reduced our net deferred tax asset using the new lower rates. Based on our recorded deferred tax asset at November 30, 2017, we reduced the deferred tax asset by approximately $298,000, which was recorded as an adjustment to our tax provision in the first quarter ended February 28, 2018.
Order Backlog
The consolidated order backlog net of discounts for continuing operations as of April 4, 2019 was $10,233,000 compared to $4,186,000 as of April 4, 2018. The agricultural products segment order backlog was $2,064,000 as of April 4, 2019 compared to $3,578,000 in fiscal 2018. The decrease in backlog is due to decreased demand from stagnant market conditions from our grinder, reels, and forage box product lines. The backlog for the modular buildings segment was $7,976,000 as of April 4, 2019, compared to $522,000 in fiscal 2018. This increase in backlog is due to a modular research facility contracted at $8.4 million that is scheduled to be complete entirely in 2019. The backlog for the tools segment was $193,000 as of April 4, 2019 compared to $86,000 in fiscal 2018. 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.
Results of Operations – Discontinued Operations
During the third quarter of fiscal 2016, we made the decision to exit the pressurized vessels industry. On March 29, 2018 we disposed of the remaining assets of our Vessels segment at a selling price of $1,500,000.
Liquidity and Capital Resources
Our primary source of funds for the three months ended February 28, 2019 was cash generated by investing activities, which includes the proceeds from the sale of our prior facility in West Union, Iowa. Our fall beet pre-order program also was a significant source of funds as we incentivize down payments by offering a discount to purchase price. Operations was our primary use of cash for the first quarter of fiscal 2019. We expect our primary capital needs for the remainder of fiscal 2019 to relate to operating costs, primarily production, and retirement of debt.
We have a $5,000,000 revolving line of credit with Bank Midwest that, as of February 28, 2019, had an outstanding principal balance of $3,641,530. The line of credit was renewed on March 30, 2019 and is scheduled to mature on March 30, 2020.
We believe that our cash flows from operations and 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.
Off Balance Sheet Arrangements
None.