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 (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, 2020. Some of the statements in this report may be 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; (vii) our expectations concerning our primary capital and cash flow needs; and (viii) our expectations regarding the impact of COVID-19 on our business condition and results of operations.
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) the ongoing COVID-19 pandemic; (v) fluctuations in seasonal demand and our production cycle; and (vi) 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 May 31, 2021 remain unchanged from November 30, 2020. 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, 2020.
Results of Operations
Net Sales and Cost of Sales
Our consolidated corporate sales for the three- and six-month periods ended May 31, 2021 were $5,710,000 and $11,111,000, respectively, compared to $5,446,000 and $10,472,000 during the same respective periods in fiscal 2020, a $264,000, or 4.8%, increase for the three months and a $639,000, or 6.1%, increase for the six months. The three and six month increases are due to increased demand in our agricultural products and tools segments. We saw a decrease in sales in our modular buildings segment as we near completion on a large project that generated significant revenue in fiscal 2019 and 2020. Consolidated gross margin for the three-month period ended May 31, 2021 was 30.2% compared to 18.3% for the same period in fiscal 2020. Consolidated gross margin for the six-month period ended May 31, 2021 was 24.9% compared to 18.8% for the same period in fiscal 2020. The increased margin is due largely to our agricultural products segment, as discussed further below.
Our second quarter sales in our agricultural products segment were $3,858,000 compared to $3,071,000 during the same period of fiscal 2020, an increase of $787,000, or 25.6%. Our year-to-date agricultural product sales were $7,357,000 compared to $6,023,000 during the same period in fiscal 2020, an increase of $1,334,000, or 22.1%. We attribute the large increase in revenue to a strengthening agricultural economy that is producing five to ten year highs in commodity and livestock prices along with government assistance programs that provided farmers with much needed government assistance during the COVID-19 pandemic. We saw a 65% increase in our grinder mixer sales year on year and are showing a 25% increase in manure spreader sales year on year. Our backlog continues to be strong heading into the third quarter of fiscal 2021 and we anticipate improved results for the second half of fiscal 2021. However, we have seen lead times increase on our raw materials and components as suppliers in our supply chain struggle to keep up with demand. Fulfilment of our strong backlog will be contingent on whether our suppliers are able to deliver or not. We have seen rising costs for virtually all raw material and components that go in our products and in turn have increased prices twice in fiscal 2021 to offset these rising costs. Gross margin for our agricultural products segment for the three-month period ended May 31, 2021 was 36.4% compared to 23.0% for the same period in fiscal 2020. Gross margin for our agricultural products segment for the six-month period ended May 31, 2021 was 31.1% compared to 21.2% for the same period in fiscal 2020. The increased gross margin for the quarter and year is due to price increases enacted to increase margin on our products in order to cover rising material costs and increased shop efficiency from continuous improvement projects.
Our second quarter sales in our modular buildings segment were $1,194,000 compared to $1,799,000 for the same period in fiscal 2020, a decrease of $605,000, or 33.6%. Our year-to-date sales in our modular buildings segment were $2,485,000 compared to $3,256,000 for the same period in fiscal 2020, a decrease of $771,000, or 23.7%. The decrease in revenue is due to completion of a large construction contract in the second quarter of fiscal 2021 that was actively being worked on in fiscal 2020. The revenue generated from that project was larger than we are accustomed to in a typical year. We have been quoting a substantial number of buildings and believe the market is economically returning to normal. We may also experience a short period of heightened demand. Gross margin for the three- and six-month periods ended May 31, 2021 was 15.7% and 9.1%, respectively, compared to 8.9% and 12.4% for the same respective periods in fiscal 2020. The changes in gross margin are due to completion of the large construction project that negatively affected gross margin. Our expectation is that gross margin will improve going forward.
Our tools segment had sales of $658,000 and $1,269,000 during the three- and six-month periods ended May 31, 2021, respectively, compared to $576,000 and $1,193,000 for the same respective periods in fiscal 2020, a 14.2% increase and a 6.4% increase, respectively. The increase is due to an increase in sales volume from our OEM customer of 77% and 117% for the three and six months ended May 31, 2021, respectively, compared to the same period of 2020. Sales from our other customers and industries (mainly oil and gas) have not fully recovered and are down 18% and 17% for the three and six months ended May 31, 2021, respectively, compared to the same periods of 2020. Oil prices have risen in the second quarter of fiscal 2021, but to this point have had little effect on demand. Gross margin was 19.9% and 19.9% for the three- and six-month periods ended May 31, 2021, respectively, compared to 20.8% and 22.7% for the same respective periods in fiscal 2020. Our gross margin has decreased slightly year on year because of inefficiencies in labor due to the introduction of new products for an OEM customer.
Expenses
Our second quarter consolidated selling expenses were $544,000 compared to $401,000 for the same period in fiscal 2020. Our year-to-date selling expenses were $1,017,000 in fiscal 2021 compared to $856,000 for the same period in fiscal 2020. The increased selling expenses are due to approximately $130,000 spent on rebranding efforts for our agricultural products segment completed by a third party consulting firm. The rebranding effort includes updated color schemes on products, a new-age logo, new tag lines and promotional product videos that we feel will help farmers associate us with a hardworking, “get work done” company. We also added a product manager at the beginning of fiscal 2021 to help us with new product development and to improve existing products, which is contributing to the increase in selling expense. Selling expenses as a percentage of sales were 9.5% and 9.2% for the three- and six-month periods ended May 31, 2021, respectively, compared to 7.4% and 8.2% for the same respective periods in fiscal 2020.
Consolidated engineering expenses were $122,000 and $244,000 for the three- and six-month periods ended May 31, 2021, respectively, compared to $123,000 and $232,000 for the same respective periods in fiscal 2020. The increase in engineering expenses for the six months ended May 31, 2021 was due to annual wage increases. Engineering expenses as a percentage of sales were 2.1% and 2.2% for the three- and six-month periods ended May 31, 2021, respectively, compared to 2.3% and 2.2% for the same respective periods in fiscal 2020.
Consolidated administrative expenses for the three- and six-month periods ended May 31, 2021 were $907,000 and $1,724,000, respectively, compared to $1,396,000 and $2,277,000 for the same respective periods in fiscal 2020. The decrease in administrative expenses is related to one-time expenses incurred in fiscal year 2020 to navigate the COVID-19 pandemic including increased wages as an incentive for shop employees to remain at work, expenses related to the transition of a new CEO and supply chain manager, implementation costs for an OEM customer in our tools segment, and additional bonus expense for operational improvements. Administrative expenses as a percentage of sales were 15.9% and 15.5% for the three- and six-month periods ended May 31, 2021, respectively, compared to 25.6% and 21.7% for the same respective periods in fiscal 2020.
Net Income (Loss)
Consolidated net income was $64,000 for the three-month period ended May 31, 2021, compared to net loss of $(802,000) for the same period in fiscal 2020. Our consolidated net loss for the six months ended May 31, 2021, was $(251,000) compared to $(1,239,000) in the same period in fiscal 2020. We are reporting vast improvement on our bottom line year on year due to many factors. First and foremost, the overall health of the agricultural economy has brought some stability to our primary business segment. We are continuing to strive for operational improvement and have seen the benefits through increased labor efficiency and reduced manufacturing costs. Fiscal 2020 brought many administrative expenses that were not repeated in fiscal 2021 as we battled a global pandemic and transitioned two long-time members of management. Our business is better positioned to succeed in times of economic boom than we were five years ago. We will continue to push for operational excellence as we face the challenges of an ever changing economy.
Order Backlog
The consolidated order backlog net of discounts as of July 6, 2021, was $7,531,000 compared to $5,383,000 as of July 6, 2020, an increase of $2,148,000 or 40%. The agricultural products segment order backlog was $6,209,000 as of July 6, 2021, compared to $1,666,000 in fiscal 2020 an increase of $4,543,0000 or 273%. It has been five years or more since we have seen backlogs this strong during this time of year. We expect this pent up demand from years of agricultural economic struggle to continue into 2022 and believe we are positioned well to take advantage of the improved economic conditions. The backlog for the modular buildings segment was $987,000 as of July 6, 2021, compared to $3,553,000 in fiscal 2020. While our backlog is down $2,566,000 or 72% in this segment, the quality of revenue in backlog is expected to be improved as we finished up a large project that had a very low profit margin. If we were to exclude this project’s revenue from our 2020 backlog numbers, our backlog is actually $544,000 higher, or 123% higher in fiscal 2021. The backlog for the tools segment was $336,000 as of July 6, 2021, compared to $163,000 in fiscal 2020. The increase in backlog for our tools segment is largely due to an OEM customer that has strengthened our business. The oil and gas industry business we were accustomed to has not yet returned to pre-pandemic levels. Recovery in this industry would be very good for our business. 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.
Potential Impact of COVID-19
The COVID-19 pandemic did impact financial results in the second quarter of fiscal 2020 and the hangover of the global pandemic is starting to affect our operations in fiscal 2021. From March 23, 2020 until May 18, 2020, the majority of our office staff in all three segments worked remotely with the exception of key operations support. At the height of the initial outbreak our workforce was down approximately 17% due to self-quarantine. By the end of May 2020 our entire workforce had returned, and operations have continued as normal with additional safety precautions in place. As COVID-19 cases began to rise in November 2020, we allowed employees that could perform their job functions remotely do so at their discretion. At the beginning of April 2021, we brought all remote employees back to the office after leading a voluntary sitewide vaccination effort. Approximately 70% of our employees are currently vaccinated while close to 95% of our employees have either received the vaccine or had previously contracted COVID-19. At the end of April 2021, we lifted our mask mandates for our operations and have resumed operations normally but are still asking employees to self-report any symptoms.
In our Agricultural Products segment, we did not experience any order cancellations; however, calls for new whole goods slowed significantly in the second quarter of fiscal 2020 and many dealers held off on the shipping or pickup of their completed units. Our sales levels were comparatively steady to the last few years in the third and fourth quarters of fiscal 2020 and we ultimately ended the year down 3.1% on sales. We had a very successful early order program to start 2021 which left us with backlogs higher than we have seen in the last five years. We attribute the large increase in backlog to stimulus payments that farmers received in 2020 along with conservative spending by farmers in 2020. This conservatism allowed farmers to retire debt in 2020 and increase spending in 2021. Our sales are up approximately 22% year to date in fiscal 2021 and we continue to see strong demand for our products. Our supply chain is currently struggling to keep up as many companies struggle to find people willing to work. We have been fortunate to be able to retain and hire a few positions as needed but believe the hangover from the pandemic is going to slow down our production in the months ahead as we wait for components.
Our Modular Buildings segment started fiscal 2020 with a more diverse backlog than we had at the beginning of fiscal 2019; however, we had some setbacks on site work as subcontractors were forced to quarantine after testing positive for COVID-19. Our workers were hesitant to travel during the pandemic and, as a result, we had some challenges completing site work in the third and fourth quarters of fiscal 2020. Because of COVID-19, many companies were also hesitant to enter into long-term contracts in fiscal 2020. As a result, our modular building rental fleet remained largely unused in fiscal 2020, which is evidenced by our decrease in lease revenue. Our quoting activity has picked up significantly in 2021 for both agricultural and research modular buildings and we believe there will be significant opportunity for this segment in 2021 as companies start spending again.
In our Tools segment, oil prices dropped significantly at the start of the pandemic, which caused our sales to drop significantly in the second quarter of fiscal 2020. The diversification of our business with our new OEM customer helped us get through the oil and gas industry lows during that time; however, since oil and gas prices have not yet reached their pre-pandemic levels, we have not seen our sales levels from these customers return. We are optimistic that we have passed the low point in our Tools segment and expect improved sales in fiscal 2021.
While our sales were affected in fiscal 2020 by the COVID-19 pandemic, government programs including the Paycheck Protection Program and Economic Injury Disaster Loan program helped protect our liquidity that may have otherwise been materially impacted. At the start of 2021, economic conditions improved in all three segments. In turn, we have seen rises in commodity prices (steel and lumber) driven by the current high demand for these products. In addition, our supplier lead times have increased providing new challenges in fulfilling our large backlog. Travel restrictions and border closures have not had a major impact on our ability to operate and achieve business goals. While we did minimize our travel in 2020 our operations were not materially affected by the inability to travel. Many trade shows shifted to online and some canceled altogether, however, our sales volumes were not significantly affected by the cancellation of these shows. As vaccinations continue to occur in 2021, we expect travel and trade show participation to pick up. We believe the worst of the economic hardship caused by COVID-19 has passed for us. We have built and improved our business over the last few years to help us better weather any economic storms that come our way.
Liquidity and Capital Resources
Our primary source of funds for the six months ended May 31, 2021 was cash provided by financing activities, mainly the use of our line of credit. We did also have a successful early order program that provided cash in the form of customer deposits in the first quarter of fiscal 2021. Our primary use of cash was related to increasing inventory levels. With uncertainty on component availability, prolonged lead times and rising prices, we have been bringing in inventory far earlier than previous years, which is consuming the availability on our line of credit. We are doing all we can to ensure we meet customer delivery dates. We expect our primary capital needs for the remainder of fiscal 2021 to relate to operating costs, primarily production costs, fulfillment of customer deposits, and the retirement of debt. We expect to convert $1,050,000 of current debt to long-term debt in the third quarter of fiscal 2021 as our EIDL loan modifications are processed with the SBA and also expect our line of credit to decrease as we turn through inventory in the third and fourth fiscal quarters.
We have a $5,000,000 revolving line of credit with Bank Midwest that, as of May 31, 2021, had an outstanding principal balance of $4,088,530. This line of credit is scheduled to mature on March 30, 2022.
We believe our 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.