Item 2.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Forward-Looking Statements
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this “report”) and the audited consolidated financial statements and related notes thereto included in Part II, Item 8 “Financial Statements and Supplementary Data,” as well as Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the fiscal year ended November 30, 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 Securities and Exchange Commission filings. We do not intend to update the forward-looking statements contained in this report other than as required by law. We caution you not to put undue reliance on any forward-looking statements, which speak only as of the date of this report. You should read this report and the documents that we reference in this report and have filed as exhibits completely and with the understanding that our actual future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements.
Critical Accounting Policies
Our critical accounting policies involving the more significant judgments and assumptions used in the preparation of our financial statements as of August 31, 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 Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended November 30, 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 fiscal 2019, 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:
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1.
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Identify the contract(s) with a customer;
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2.
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Identify each performance obligation in the contract;
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3.
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Determine the transaction price;
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4.
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Allocate the transaction price to each performance obligation; and
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5.
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Recognize revenue when or as each performance obligation is satisfied.
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Our revenues primarily result from contracts with customers. The agricultural products and tools segments generally execute short-term contracts that contain a single performance obligation – the delivery of product to the common carrier. We recognize revenue for the production and sale of farm equipment, service parts, and cutting tools upon shipment of the good(s). 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. Our implementation process for ASC 606 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 in the notes to our financial statements, including but not limited to:
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Disaggregation of revenue that depicts how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors;
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The opening and closing balances of receivables, contract assets, and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed;
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Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period;
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Information about performance obligations in contracts with customers; and
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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.
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Results of Operations – Continuing Operations
Net Sales and Cost of Sales
Our consolidated corporate sales for continuing operations for the three- and nine-month periods ended August 31, 2019 were $5,504,000 and $15,375,000, respectively, compared to $5,280,000 and $15,940,000 during the same respective periods in fiscal 2018, a $224,000, or 4.2%, increase for the three months and a $565,000, or 3.5%, decrease for the nine months. The increase for the three months is primarily due to an increase in revenue from our modular buildings segment due to a large contract. This contract is approximately 31% complete and is expected to carry over into the spring of 2020. Consolidated gross margin for the three-month period ended August 31, 2019 was 18.3% compared to 22.3% for the same period in fiscal 2018. Consolidated gross margin for the nine-month period ended August 31, 2019 was 16.7% compared to 21.6% for the same period in fiscal 2018. This overall decreased gross margin is attributable to decreased gross margin in both our agricultural products and modular buildings segments, as discussed in further detail below.
Our third quarter sales at our agricultural products segment were $3,194,000 compared to $3,913,000 during the same period of 2018, a decrease of $719,000, or 18.4%. Our year-to-date sales from our agricultural products segment were $9,441,000 compared to $11,778,000 during the same period in fiscal 2018, a decrease of $2,337,000, or 19.8%. Our three-month decrease in revenue is due to crop uncertainty driven by spring flooding across the United States. Many farmers planted on historically late dates during the 2019 planting season, which drove a decrease in demand for our portable feed equipment. The year-to-date decrease in sales is due to decreased demand for portable feed equipment, forage and receiver boxes, and UHC reels. Additionally, the liquidation of our Canadian subsidiary accounted for a decrease of approximately $420,000 in sales in fiscal 2019. Moreover, our year-to-date fiscal 2018 revenue reflects liquidation of an old model of manure spreader, which was sold at a decreased margin, and OEM blower revenue of approximately $262,000 that was not repeated in fiscal 2019 as our OEM blower customer elected not to purchase any blowers from us in fiscal 2019 due to slow-moving inventory on their dealer lots relating to poor agricultural market conditions. Despite the overall sales decrease, we did see increased sales for the nine months ended August 31, 2019 in land maintenance equipment, plows, beet equipment, bale processors and dump boxes compared to the same period in fiscal 2018. Gross margin for our agricultural products segment for the three-month period ended August 31, 2019 was 15.7% compared to 21.6% for the same period in fiscal 2018. Gross margin for our agricultural products segment for the nine-month period ended August 31, 2019 was 15.7% compared to 21.8% for the same period in fiscal 2018. The decrease in gross margin in fiscal 2019 is due to lower revenues with less variable margin to absorb fixed costs coupled with labor inefficiencies in our plant. With the absence of steady demand for portable feed equipment, our most efficient equipment to build, we have struggled to gain operational efficiencies that are generally gained by continued production of a single product. Our efficiency has also been affected by the diversion of direct labor for operational changes that will have long-term benefits. We have partially completed warehouse reorganization, which we expect will improve inventory accuracy and decrease travel time for material handlers and machine operators. We have also implemented a material review board to decrease scrap and eliminate production errors. We believe our continued operational improvement projects will put us in a position to meet increased demand in an improved agriculture economy.
Our third quarter sales at our modular buildings segment were $1,802,000 compared to $773,000 for the same period in 2018, an increase of $1,029,000, or 133.1%. Our year-to-date sales from our modular buildings segment were $4,382,000 compared to $2,346,000 for the same period in 2018, an increase of $2,036,000, or 86.8%. Our increase in revenue is largely attributable to a $8.5 million project that began in the spring of 2019 and increased lease revenue from modular building rentals. Gross margin for the three- and nine-month periods ended August 31, 2019 was 20.0% and 14.7% compared to 15.8% and 13.7% for the same respective periods in fiscal 2018. The increase in gross margin is due to increased revenue from leasing and modular construction providing more variable margin to cover fixed costs.
Our tools segment had sales of $508,000 and $1,552,000 during the three- and nine-month periods ended August 31, 2019 compared to $594,000 and $1,816,000 for the same respective periods in fiscal 2018, a 14.5% decrease for both the three- and nine-month periods. The year to date decrease is primarily due to the loss of a large volume customer at the end of the first quarter of fiscal 2018. Gross margin was 28.0% and 28.4% for the three- and nine-month periods ended August 31, 2019 compared to 34.7% and 30.1% for the same respective periods in fiscal 2018. Our decreased gross margin for the nine-months is largely due to lower revenues with less variable margin to absorb fixed costs.
Expenses
Our third quarter consolidated selling expenses were $379,000 compared to $476,000 for the same period in fiscal 2018. Our year-to-date selling expenses were $1,119,000 compared to $1,448,000 for the same period in fiscal 2018. The decrease in selling expenses is due to decreased commissions as a result of lower sales along with refocused marketing techniques. Our new marketing efforts include a shift to social media from more expensive print advertisements along with less participation in trade shows in fiscal 2019. Selling expenses as a percentage of sales were 6.9% and 7.3% for the three- and nine-month periods ended August 31, 2019 compared to 9.0% and 9.1% for the same respective periods in fiscal 2018.
Consolidated engineering expenses were $116,000 and $380,000 for the three- and nine-month periods ended August 31, 2019 compared to $202,000 and $458,000 for the same respective periods in fiscal 2018. The decrease in engineering expenses is related to lower research and development costs in fiscal 2019 due to an internal focus on process improvement and product cost reductions. We also moved an hourly engineer into a production role and reduced our salaried staff. Engineering expenses as a percentage of sales were 2.1% and 2.5% for the three- and nine-month periods ended August 31, 2019 compared to 3.8% and 2.9% for the same respective periods in fiscal 2018.
Consolidated administrative expenses for the three- and nine-month periods ended August 31, 2019 were $815,000 and $2,466,000 compared to $858,000 and $2,656,000 for the same respective periods in fiscal 2018. The decrease in administrative expenses is largely due to a reduction in indirect employees in the agricultural products segment and a reduction in the number of temporary employees used in our tools segment. Administrative expenses as a percentage of sales were 14.8% and 16.0% for the three- and nine-month periods ended August 31, 2019 compared to 16.2% and 16.7% for the same respective periods in fiscal 2018.
(Loss) from Continuing Operations
Consolidated net (loss) from continuing operations before income taxes was $(370,000) for the three-month period and $(1,610,000) for the nine-month period ended August 31, 2019 compared to net (loss) from continuing operations before income taxes of $(949,000) and $(2,034,000) for the same respective periods in fiscal 2018. The decrease in our net (loss) for the quarter and year-to-date is primarily related to the success of our modular buildings segment on an $8.5 million project and elimination of indirect positions at our agricultural products segment. In the third quarter of fiscal 2018, we also incurred costs of $520,000 related to the impairment and mold remediation of our West Union Facility, which were not repeated in fiscal 2019.
Income Tax Adjustment
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was enacted, which reduced 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 October 6, 2019 was $7,565,000 compared to $1,384,000 as of October 6, 2018. The agricultural products segment order backlog was $1,174,000 as of October 6, 2019 compared to $682,000 in fiscal 2018. The increase in backlog from the agricultural products segment is due to increasing confidence in crop yields following the spring flooding. The backlog for the modular buildings segment was $6,173,000 as of October 6, 2019, compared to $609,000 in fiscal 2018. This increase in backlog is due to a modular research facility contracted at $8.5 million that is scheduled to be completed in the spring of 2020 and a very active modular research sales market. The backlog for the tools segment was $218,000 as of October 6, 2019 compared to $94,000 in fiscal 2018. The increase in backlog for our tools segment is largely due to an OEM agreement that was signed in the third quarter of fiscal 2019. 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 pressurized vessels segment at a selling price of $1,500,000.
Liquidity and Capital Resources
Our primary source of funds for the nine months ended August 31, 2019 was cash generated by investing activities, which includes the proceeds from the sale of our prior facility in West Union, Iowa. Our operating activities provided positive cash flow by utilizing a favorable draw schedule on our $8.5 million modular building contract and through the reduction of inventory. Financing activities, including the retirement of debt, were our primary uses of cash for the third quarter of fiscal 2019. We expect our primary capital needs for the remainder of fiscal 2019 to relate to operating costs, primarily production and contract fulfilment, and retirement of debt.
We have a $5,000,000 revolving line of credit with Bank Midwest that, as of August 31, 2019, had an outstanding principal balance of $2,909,530. The line of credit is scheduled to mature on March 30, 2020 if no earlier demand is made.
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.