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 Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the fiscal year ended November 30, 2017. 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 “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 and changes to tax laws; (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) obstacles related to liquidation of product lines and segments; (iv) 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; (v) fluctuations in seasonal demand and our production cycle; and (vi) 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 August 31, 2018 remain unchanged from November 30, 2017, with the exception of the addition of a critical accounting policy regarding sales-type lease activity. Other than this new policy regarding sales-type lease activity, 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, 2017.
Sales-Type Lease Activity
We lease modular buildings to certain customers and account for these transactions as sales-type leases. These leases have terms of up to 36 months and are collateralized by a security interest in the related modular building. The lessee has a bargain purchase option available at the end of the lease term. A minimum lease receivable is recorded net of unearned interest income and profit on sale at the time the building is substantially complete. Profit related to the sale of the building is recorded upon substantial completion.
Results of Operations
– Continuing Operations
Net Sales and Cost of
Goods Sold
Our consolidated corporate sales for continuing operations for the three- and nine-month periods ended August 31, 2018 were $5,280,000 and $15,940,000 compared to $6,550,000 and $15,660,000 during the same respective periods in 2017, a $1,270,000 or 19.4%, decrease for the three months and a $280,000, or 1.8%, increase for the nine months. The decrease for the three months is primarily due to a decrease in revenue from our agricultural products and tools segments. Consolidated gross margin for the three-month period ended August 31, 2018 was 22.3% compared to 22.1% for the same period in fiscal 2017. Consolidated gross margin for the nine-month period ended August 31, 2018 was 21.6% compared to 21.5% for the same period in fiscal 2017. These increased gross margins are largely attributable to increased efficiency in our agricultural products segment, as discussed below, as margins have decreased in our modular buildings and tools segments.
Our third quarter sales at Manufacturing were $3,913,000 compared to $5,065,000 during the same period of 2017, a decrease of $1,152,000, or 22.7%. Our year-to-date sales at Manufacturing were $11,778,000 compared to $11,595,000 during the same period in 2017, an increase of $183,000, or 1.6%. The three-month decrease in revenue is due to decreased demand for forage box equipment and the absence of pass-through self-propelled beet equipment that was sold in 2017. The year-to-date increase in sales is due to increased demand for portable feed equipment, manure spreaders and UHC reels. Gross margin for Manufacturing for the three-month period ended August 31, 2018 was 21.6% compared to 20.9% for the same period in 2017. Gross margin for Manufacturing for the nine-month period ended August 31, 2018 was 21.8% compared to 20.2% for the same period in 2017. The increase in gross margin in 2018 is due to increased efficiency from our direct labor as a part of recently-launched lean initiatives. Although our gross margin is up we did receive downward pressure from rising costs of goods sold, which have been impacted by steel tariffs.
Our third quarter sales at Scientific were $773,000 compared to $767,000 for the same period in 2017, an increase of $6,000, or 0.8%. Our year-to-date sales at Scientific were $2,346,000 compared to $2,043,000 for the same period in 2017, an increase of $303,000, or 14.8%. Our year-to-date increase in revenue is largely attributable to using sales-type and operating leases to expand our customer base. Gross margin for the three- and nine-month periods ended August 31, 2018 was 15.8% and 13.7% compared to 21.4% and 18.5% for the same respective periods in 2017. The decrease in gross margin is due to added depreciation from buildings out on lease and the production of leased assets in the third quarter, which don’t provide immediate revenue.
Metals had sales of $594,000 and $1,816,000 during the three- and nine-month periods ended August 31, 2018 compared to $718,000 and $2,022,000 for the same respective periods in 2017, a 17.3% and 10.2% decrease, respectively. The decrease is mainly due to the loss of a large volume customer. Gross margin was 34.7% and 30.1% for the three- and nine-month periods ended August 31, 2018 compared to 30.9% and 32.1% for the same respective periods in 2017. The increased gross margin for the three-months is due mainly to price increases and better margins on our sales. 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 $476,000 compared to $433,000 for the same period in 2017. Our year-to-date selling expenses were $1,448,000 compared to $1,401,000 for the same period in 2017. The increase in selling expenses is due to increased commissions as a result of higher sales and the reclassification of an employee to an independent sales representative. Selling expenses as a percentage of sales were 9.0% and 9.1% for the three- and nine-month periods ended August 31, 2018 compared to 6.6% and 8.9% for the same respective periods in 2017.
Consolidated engineering expenses were $202,000 and $458,000 for the three- and nine-month periods ended August 31, 2018 compared to $108,000 and $373,000 for the same respective periods in 2017. The increase in engineering expenses is directly related to research and development of new agricultural products and modular building engineering. Engineering expenses as a percentage of sales were 3.8% and 2.9% for the three- and nine-month periods ended August 31, 2018 compared to 1.6% and 2.4% for the same respective periods in 2017.
Consolidated administrative expenses for the three- and nine-month periods ended August 31, 2018 were $858,000 and $2,656,000 compared to $795,000 and $2,561,000 for the same respective periods in 2017. These increases are largely related to increased stock compensation expense and the addition of a general manager at the modular buildings segment. Administrative expenses as a percentage of sales were 16.3% and 16.7% for the three- and nine-month periods ended August 31, 2018 compared to 12.1% and 16.4% for the same respective periods in 2017.
(Loss)
from Continuing Operations
Consolidated net (loss) from continuing operations was $(767,000) for the three-month period and $(1,948,000) for the nine-month period ended August 31, 2018 compared to net income (loss) of $42,000 and $(721,000) for the same respective periods in 2017. The increased net loss for the three months ended August 31, 2018 was due to the discovery of mold in one of our facilities. We estimate approximately $253,000 for mold remediation and $67,000 in damaged inventory, and we recognized an impairment of approximately $199,000 of this asset held for lease. The increased net loss from continuing operations for the nine-months was largely due to the revaluing of our deferred tax asset at the new income tax rates for the 2018 tax year, which resulted in a loss of approximately $300,000. We also recognized a loss of approximately $253,000 from the liquidation of our Canadian subsidiary related to the cumulative translation adjustment in the second quarter of fiscal 2018. These expenses were non-cash expenses and one-time adjustments. Our margins are generally depressed from historic levels because low volumes caused by market conditions continue to impact our ability to cover our fixed costs. Margins are also impacted as we continue to right-size our inventories to focus on products we feel our customers will want to purchase in the future.
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 earnings 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 $300,000, which was recorded as an adjustment to our tax provision in the first quarter of fiscal 2018.
Order Backlog
The consolidated order backlog net of discounts for continuing operations as of October 2, 2018 was $1,405,000 compared to $1,638,000 as of October 2, 2017. The agricultural products segment order backlog was $715,000 as of October 2, 2018 compared to $1,069,277 in fiscal 2017. The backlog for the modular buildings segment was $609,000 as of October 2, 2018, compared to $456,000 in fiscal 2017. The backlog for the tools segment was $81,000 as of October 2, 2018, compared to $113,000 in fiscal 2017. 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 sources of funds for the nine months ended August 31, 2018 were funds received from the sale of real estate from discontinued operations and the reduction of inventory. Our primary uses of cash were costs of operation, the execution of sales-type leases, the fulfillment of customer deposits and retirement of debt related to discontinued operations. We expect our primary capital needs for the remainder of fiscal 2018 to relate to costs of operation, including production.
We have a $5,000,000 revolving line of credit with Bank Midwest that, as of August 31, 2018, had an outstanding principal balance of $2,693,530. The revolving line of credit was renewed on March 30, 2018 and is scheduled to mature on March 30, 2019.
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.