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CCA INDUSTRIES INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cautionary Statements Regarding Forward-Looking Statements(Edgar Glimpses Via Acquire Media NewsEdge) Our disclosure and analysis in this report contains forward-looking information that involves risks and uncertainties. Our forward-looking statements express our current expectations or forecasts of possible future results or events, including projections of future performance, liquidity, statements of management's plans and objectives, future contracts, and forecasts of trends and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as "anticipate", "estimate", "expect", "believe", "will likely result", "should", "outlook", "plan" "project" and other words and expressions of similar meaning. No assurance can be given that the results in any forward-looking statement will be achieved and actual results could be affected by one or more factors, which could cause them to differ materially. The cautionary statements made in this Quarterly Report on Form 10-Q should be read as being applicable to all forward-looking statements whenever they appear in this report. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act. In addition to the information in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors and risks and uncertainties included in our Annual Report on Form 10-K for the fiscal year ended November 30, 2013 and other periodic reports filed with the United States Securities and Exchange Commission. Overview Net loss for the quarter ended February 28, 2014 was $1,239,565 compared to net loss of $1,015,390 for the quarter ended February 28, 2013. The loss per share, basic and fully diluted was $0.18 for the quarter ended February 28, 2014 compared to loss per share, basic and fully diluted of $0.14 for the quarter ended February 28, 2013. As of February 28, 2014 the Company had $21,394,460 in current assets and $9,638,698 in current liabilities. The Company does not have any loan or line of credit bank debt. On September 26, 2013, the Company began executing a reduction in work force to reduce overhead and on January 20, 2014, the Company announced that its Board of Directors approved management's plan to restructure the Company's operations, and enter into a key business partnership with The Emerson Group, a premier sales and marketing 19 -------------------------------------------------------------------------------- TABLE OF CONTENTS company located in Wayne, Pennsylvania. As part of this change, the Company outsourced to The Emerson Group certain sales and administrative functions effective February 1, 2014. In addition, warehousing and shipping was outsourced to Ozburn-Hessey Logistics "OHL", one of the largest integrated global supply chain management companies in the United States. The Company's inventory was moved to an OHL-managed facility in Indianapolis, Indiana, and shipping commenced from there the week of February 3, 2014. A key benefit of the outsourcing move is that it shifts a substantial portion of the Company's current fixed costs into a variable cost structure moving forward which can ultimately help keep expenses in better alignment with any future revenue generated by its brands. This action could also potentially save the Company over $3,500,000 per year in overhead expenses over the course of the first twelve months following the effective date of the outsourcing arrangement based on performance of its brands in fiscal 2014. The Company anticipates completion of this restructuring, which includes our outsourcing arrangement and reduction in work force, during the Company's second fiscal quarter of 2014 and that the restructuring will start to deliver substantial savings at that time. The Company estimates incurring costs related to the reduction in work force of $547,047 in the Company's first quarter of fiscal 2014. Emerson Outsourcing Agreement On January 20, 2014, we entered into a Sales Representation Agreement (the "Sales Agreement") with S. Emerson Group, Inc. and an Outsourcing Services Agreement with Emerson Healthcare, LLC (the "Services Agreement"), each of which became effective February 1, 2014. Under the Sales Agreement, the Company appointed S. Emerson as its non-exclusive sales representative to carry out all the Company's selling functions with the retail trade within the United States, including sales, marketing and promotion planning services. The initial term of the Sales Agreement is six months followed by successive six month automatic renewal terms unless six months' prior written notice of non-renewal is provided by either party. The Sales Agreement may be terminated by either party upon six months' prior written notice to the other party, and the Company may terminate the agreement upon less than six months' notice subject to payment of a specified termination fee. As consideration for the services rendered under the Sales Agreement, Emerson will receive monthly commissions equal to a specified percentage of net sales of our products and will be responsible for a pro rata portion of certain Emerson expenses associated with this representation. Under the Services Agreement, Emerson will provide all order processing, customer service, warehousing of inventory, shipping, logistics management, invoicing and collection of receivables on behalf of the Company. The initial term of the Services Agreement is six months followed by successive six month automatic renewal terms unless six months' prior written notice of non-renewal is provided by either party. The Services Agreement may be terminated by either party upon six months' prior written notice to the other party, and after the initial term, the Company may terminate the agreement upon less than six months' notice subject to payment of a specified termination fee. As consideration for the services rendered under the Services Agreement, Emerson will be entitled to receive a monthly fee equal to a specified percentage of the gross sales of our products under the agreement. In addition, scheduled fees will be payable to Emerson for freight, warehousing (storage and labor) and other itemized services rendered at Emerson's warehouse, logistics terminal and shipping facility. Operating Results for the Three Months Ended February 28, 2014 For the three months ended February 28, 2014, the Company had revenues of $7,750,252 and net loss of $1,239,565 after a benefit from income taxes of $721,793. For the same period of 2013, the Company had revenues of $11,799,649, and net loss of $1,015,390, after a tax benefit $657,730. Other income increased to $236,922 for the first quarter 2014 as compared to $2,698 for the first quarter 2013. The increase was primarily due to realized gain on sales of investments of $146,528 for first quarter 2014 compared to a realized gain on sales of investments of $9,522 in fiscal 2013. The basic and fully diluted loss per share for the first quarter 2014 was $0.18 as compared to basic and fully diluted loss per share of $0.14 for the first quarter 2013. In accordance with ASC Topic 605-10-S99, "Revenue Recognition", the Company has accounted for certain sales incentives offered to customers by charging them directly to sales as opposed to advertising and promotional expenses. Net sales for the first quarter of fiscal 2014 were reduced by $910,899 and offset by an equal reduction of trade promotional expenses, which were included in the Company's advertising expense. 20 -------------------------------------------------------------------------------- TABLE OF CONTENTS In the same period of the prior year, net sales were reduced by $1,527,950 and trade promotion was offset by an equal reduction of that amount. These accounting adjustments under ASC Topic 605-10-S99 do not affect net income. The Company's net sales of health and beauty aid products decreased $4,283,621 to $7,513,330 for the three month period ended February 28, 2014 from $11,796,951 for the three month period ended February 28, 2013, a decrease of 36.3%. Gross sales were primarily impacted by decreases in certain product slaes as discussed below and the transition to the outsourcing structure. The Company's customers were instructed to send all orders to The Emerson Group as of February 1, 2014 rather than to the Company. However some retailers were slow to make the transition, and as a result, orders were not placed. As of February 28, 2014, almost all retailers had transitioned their orders to The Emerson Group, and the normal order flow has resumed. In addition, the Company experienced low inventory on certain high velocity items which impacted first quarter sales. The low inventory problem has now been corrected. Sales returns and allowances, not including sales incentives, were 17.7% of gross sales or $1,859,021 for the three month period ended February 28, 2014 as compared to 12.2% or $1,884,206 for the same period last year. Sales incentives consist of co-operative advertising with the Company's retail partners and coupons. The amount of co-operative advertising included in sales incentives decreased by $633,160 to $1,145,504 in the first quarter 2014 as compared to $1,778,664 in the same period in 2013. The cost of the coupons issued by the Company was $234,605 for the first quarter 2014 as compared to $250,714 for the same period in 2013. The Company uses a national clearing house for the receipt and processing of coupons from our retail partners. The national clearing house renders invoices to the Company on a weekly basis for coupons that they have processed which are recorded as an expense in the period for which the invoice is dated. The Company also records an expense accrual at the end of each period equal to the prior six weeks of invoices rendered based on information from the national clearing house that there is an average lag time of six weeks between the time that the retailer receives the coupon and when the Company receives the invoice. The amount recorded as an expense or an accrual includes the retailer cost of the coupon in addition to any processing charges by the national coupon clearing house. Coupons are issued by the Company to be used with the purchase of specific products, with an expiration date noted on the coupon. The Company's net sales, by category, for the first quarter 2014 as compared to the first quarter 2013 were: Three Months Ended February 28, 2014 2013 Category Net Sales Net Sales Skin Care $ 2,605,922 34.7 % $ 3,546,652 30.0 % Oral Care 2,338,195 31.2 % 2,512,008 21.3 % Dietary Supplement 1,174,633 15.6 % 1,717,269 14.6 % Nail Care 938,506 12.5 % 3,696,481 31.3 % Fragrance 276,760 3.7 % 66,246 0.6 % Miscellaneous 113,645 1.5 % 179,199 1.5 % Analgesic 54,249 0.7 % 65,936 0.6 % Hair 11,420 0.1 % 13,160 0.1 % $ 7,513,330 100.0 % $ 11,796,951 100.0 % Net sales were affected by the following factors: • Gross sales of skin care products decreased $1,128,268 or 26.2% for three months ended February 28, 2014, as compared to the same period in 2013, primarily due to discontinued items and inventory out of stocks problems that has now been corrected. Returns of skin care products decreased $74,862 or 18.4% for three months ended February 28, 2014 as compared to the same period in 2013, commensurate with lower sales and returns of discontinued products. • Gross sales of oral care products decreased $230,564 or 7.9% for the three months ended February 28, 2014 as compared to the same period in fiscal 2013 mainly due to inventory out of stock problems that have now been corrected. Returns of oral care products increased 20.9% for three months ended February 28, 2014 as compared to the same period in 2013 due to returns of discontinued products. • Gross sales of the Company's diet products decreased $286,915, or 13.4% for three months ended February 28, 2014 as compared to the same period in 2013. In addition, returns increased 56.0% as a result of discontinued products. The Company is launching three new Mega-T products in fiscal 2014. 21-------------------------------------------------------------------------------- TABLE OF CONTENTS • Gross sales of the Company's nail care products decreased $3,383,714 or 59.9% for three months ended February 28, 2014, as compared to the same period in 2013. The decrease was mainly due to Gel Perfect gross sales which declined $3,267,145 for the three months ended February 28, 2014 as compared to the same period in 2013. Gross sales were lower due to decreased distribution of Gel Perfect as a result of an overall decline in the gel nail polish category. The Company expects that gross sales will decline further during fiscal 2014. Returns of nail care products, primarily Gel Perfect, decreased $625,220 for three months ended February 28, 2014 as compared to 2013. Returns were primarily of Gel Perfect products discontinued at retail. Gross profit margins decreased to 42.7% for the three months ended February 28, 2014 from 53.1% for the same period in 2013. The decrease was primarily due to increases in product returns and allowances, not including sales incentives, which were 17.7% of gross sales in fiscal 2014 as compared to 12.2% of gross sales for same period in 2013; as well as increases in the cost of sales. The total cost of sales as a percentage of gross sales increased to 40.95% in fiscal 2014 as compared to 35.77% in fiscal 2013. The increase in the cost of sales percentage was mainly due to the closeout sales of discontinued Gel Perfect inventory. Selling, general and administrative expenses for the three months ended February 28, 2014 were $3,718,854 as compared to $5,779,409 for the three months ended February 28, 2013, a decrease of $2,060,555. The following factors contributed to the decrease: • Royalty costs decreased $52,651 in the first quarter of fiscal 2014 as compared to the same period in fiscal 2013 reflecting the decline in sales. • Shipping costs decreased $307,874 in the first quarter of fiscal 2014 as compared to the same period in fiscal 2013. The decrease was due to decreased sales as well the outsourcing of logistics to OHL. The cost of shipping to the Company's customers prior to The Emerson Group outsourcing transaction, averaged approximately 4.8% of gross sales while the OHL shipping costs are estimated to average 1.6% of gross sales. • Personnel costs decreased $1,251,222 in the first quarter of fiscal 2014 as compared to the same period in fiscal 2013 due to the reduction in work force implemented as a result of the outsourcing plan, as well as a reduction in work force that took place in the fourth quarter of fiscal 2013. • Legal and accounting related costs decreased $32,361 in the first quarter of fiscal 2014 as compared to the first quarter of fiscal 2013. • Travel, meals and entertainment expenses decreased $62,406 in the first quarter of fiscal 2014 as compared to the same period in fiscal 2013 as a result of the decrease in personnel. • Consulting and related costs decreased $96,321 in the first quarter of fiscal 2014 as compared to the first quarter of fiscal 2013. The decrease was due to the termination of most consulting contracts in the second quarter of fiscal 2013. • The balance of the increase or decrease in expenses comprised a number of smaller expense categories. Advertising, cooperative and promotions expenses for the three months ended February 28, 2014 were $1,038,900 as compared to $2,025,103 for the three months ended February 28, 2013. The decreased expense of $986,203 was comprised of: • A decrease in media, trade advertising and related expenses of $925,094. • A decrease in co-operative advertising that is recorded as a sales expense of $61,109. The Company has planned a substantial decrease in cooperative advertising and promotion expense for fiscal 2014, with a large part of the savings reallocated for media spending. The Company is planning a substantial increase to its media advertising expense, beginning in the second quarter of fiscal 2014, with a television advertising campaign focusing on its key brands. The Company's advertising expense changes from year to year based on the timing of the Company's promotions. The loss before benefit from income taxes was $1,961,358 for the quarter ended February 28, 2014, as compared to the loss before benefit from income taxes of $1,673,120 for the quarter ended February 28, 2013. The effective tax provision for the first quarter of fiscal 2014 was a tax benefit of 36.8% of the net loss before tax as compared to a tax benefit of 39.3% of the net loss before tax for the same period in fiscal 2013. As of February 22 -------------------------------------------------------------------------------- TABLE OF CONTENTS 28, 2014, the Company has unrealized gains on its investments of $146,050 which, if realized, would have a tax expense of $54,083. Comprehensive losses were $1,329,474 for the quarter ended February 28, 2014 as compared to comprehensive losses of $965,986 for the quarter ended February 28, 2013. The comprehensive loss for the quarter ended February 28, 2014 reflects the Company's net loss of $1,239,565 together with other comprehensive losses consisting of unrealized gains less reclassification adjustments, net of income tax benefits, of $89,909. The other comprehensive loss is as a result of the loss in the market value of the Company's investments. Further information regarding the Company's investments can be found in Note 3 of the consolidated financial statements. Super Storm Sandy As a result of Super Storm Sandy, the Company made claims for loss against various insurance policies. In the case of one claim for $340,689, the Company did not determine the claim was realizable until May 2013 and received proceeds of $340,689 in June 2013. The Company recorded the proceeds as a reduction of selling, general and administrative expenses on the Consolidated Statements of Operations for the fiscal year ended 2013. Financial Position as of February 28, 2014 As of February 28, 2014, the Company had working capital of $11,755,762 as compared to $12,911,553 as of the year ended November 30, 2013. The ratio of total current assets to current liabilities is 2.2 to 1 as of February 28, 2014, as compared to a ratio of 2.4 to 1 as of November 30, 2013. The Company's cash position and short-term investments at February 28, 2014 were $3,101,026, versus $4,311,460 as of November 30, 2013. The Company had no non-current or long-term investments as of February 28, 2014 and as of November 30, 2013. The Company paid no cash dividends during fiscal 2014 year to date . As of February 28, 2014, there were no dividends declared but not paid. The investment securities the Company purchased are all classified as "Available for Sale Securities", and are reported at fair market value as of February 28, 2014, with the resultant unrealized gains or losses reported as a separate component of shareholders' equity. Due to the current securities market conditions, the Company cannot ascertain the risk of any future change in market value. Our investments include corporate obligations, limited partnership, common stock and fixed income in order to decrease the risk due to any specific concentrations. Accounts receivable as of February 28, 2014 and as of November 30, 2013 were $5,265,058 and $5,473,452, respectively. Included in net accounts receivable are an allowance for doubtful accounts, a reserve for returns and allowances and a reduction based on an estimate of cooperative advertising that will be taken as credit against payments. The allowance for doubtful accounts was $27,633 and $56,513 for February 28, 2014 and November 30, 2013, respectively. The allowance for doubtful accounts is a combination of specific and general reserve amounts relating to accounts receivable. The general reserve is calculated based on historical percentages applied to aged accounts receivable and the specific reserve is established and revised based on individual customer circumstances. The reserve for returns and allowances is based on the historical returns as a percentage of sales in the five preceding months, adjusting for returns that can be put back into inventory, and a specific reserve based on customer circumstances. This allowance decreased to $1,994,072 as of February 28, 2014 from $2,070,223 as of November 30, 2013. Of this amount, allowances and reserves of $1,194,885, which are anticipated to be deducted from future invoices, are included in accrued liabilities. Gross receivables were further reduced by $903,470 as of February 28, 2014, which was reclassified from accrued liabilities, as an estimate of the co-operative advertising that will be taken as a credit against payments. In addition, accrued liabilities include $3,419,879, which is an estimate of co-operative advertising expense which are anticipated to be deducted from future invoices rather than current accounts receivable. Inventories were $8,384,046 and $8,607,567, as of February 28, 2014 and November 30, 2013, respectively. The Company expects that the inventory will increase in the second quarter of fiscal 2014 to ensure that there is a proper level of safety stock in order to prevent any customer orders being shipped short. The reserve for inventory obsolescence is based on a detailed analysis of inventory movement. The inventory obsolescence reserve decreased to $2,833,739 as of February 28, 2014 from $3,030,306 as of November 30, 2013. This decrease was primarily due to the disposal 23 -------------------------------------------------------------------------------- TABLE OF CONTENTS of obsolete inventory during the first quarter of fiscal 2014. Changes to the inventory obsolescence reserves are recorded as an increase or decrease to the cost of sales. Prepaid expenses and sundry receivables increased to $437,163 as of February 28, 2014 from $424,626 as of November 30, 2013. The increase was in the ordinary course of business. Prepaid and refundable income taxes decreased to $677,389 as of February 28, 2014, from $678,889 as of November 30, 2013 due to the recording of minimum state income tax expense. The amount of deferred income tax reflected as a current asset increased to $3,529,778 as of February 28, 2014 from $2,668,747 as of November 30, 2013. The $861,031 increase was primarily due to the Company's net operating losses during the first quarter of fiscal 2014. The amount of deferred income tax recorded as a non-current asset was $1,835,564 as of February 28, 2014. Deferred taxes that the Company estimates will be realized in periods beyond the next twelve months are recorded as a non-current asset. The Company's investment in property and equipment consisted mostly of leasehold improvements, office furniture and equipment, and computer hardware and software to accommodate our personnel in addition to tools and dies used in the manufacturing process. The Company acquired $3,509 of additional property and equipment during the first quarter of fiscal 2014 primarily to replace damaged property from Super Storm Sandy. Current liabilities are $9,638,698 and $9,253,188, as of February 28, 2014 and November 30, 2013 respectively. Current liabilities at February 28, 2014 consisted of accounts payable, accrued liabilities and short-term capital lease obligations. As of February 28, 2014, there was $4,323,349 of open cooperative advertising commitments, of which $742,932 is from 2014, $2,102,436 is from 2013, $847,557 is from 2012, $622,505 is from 2011, and $7,919 is from 2010. Of the total amount of $4,323,349, $903,470 is reflected as a reduction of gross accounts receivables, and $3,419,879 is recorded as an accrued expense. Cooperative advertising is advertising that is run by the retailers in which the Company shares in part of the cost. If it becomes apparent that this cooperative advertising was not utilized, the unclaimed cooperative advertising will be offset against the expense during the fiscal year in which it is determined that it did not run. This procedure is consistent with the prior year's methodology with regard to the accrual of unsupported cooperative advertising commitments. The Company's long-term obligations are for a portion of its capitalized leases, which is for certain office and warehouse equipment. The capitalized lease obligation liability decreased to $28,236 as of February 28, 2014 as compared to $30,195 as of November 30, 2013. Stockholders' equity decreased to $15,735,592 as of February 28, 2014 from $17,062,366 as of November 30, 2013. The decrease was due to decreases in retained earnings as a result of the net loss of $1,239,565 in the first quarter of fiscal 2014 and a decrease in unrealized gains on marketable securities. Unrealized gains or losses reflect the difference between the cost and market price of the Company's marketable securities as of the date of the financial statements, net of any tax expense or benefit. See Note 4 of the consolidated financial statements for further information regarding the Company's marketable securities. The Company issued 100,000 stock options to Richard Kornhauser, the Company's President and Chief Executive Officer on February 1, 2014. As a result, $2,700 was recorded as a deferred compensation expense in the first quarter of fiscal 2014 and additional paid-in capital was increased by the same amount. The Company's cash flow had $1,208,626 that was used in operating activities during the first quarter of fiscal 2014, as compared to $2,891,035 that was used in operating activities during the same period in fiscal 2013. The decrease in operating cash flow in the first quarter of fiscal 2014 was mainly due to the net loss of $1,239,565 and deferred income taxes of $722,993, offset partially by decreases in accounts receivable and inventory and an increase in accounts payable and accrued liabilities. Net cash provided by investing activities was $742,562 in the first quarter of fiscal 2014, generated by the proceeds from the sale of some of the Company's investments less a small amount of acquisition of equipment, as compared to $148,551 used in investing activities in the 2013 comparable period. Net cash used in financing activities during the first quarter of fiscal 2014 was $1,830 as compared to $494,987 for the same period in fiscal 2013. The use of cash in the first quarter of fiscal 2013 was higher due to the issuance of dividends. 24 -------------------------------------------------------------------------------- TABLE OF CONTENTS Liquidity and Capital Resources Liquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term business needs. We assess our liquidity in terms of our total cash flow and the amounts of cash, short-term and long-term marketable securities on hand. Significant factors that could affect our liquidity include the following: • Cash flow generated or used by operating activities; • Dividend payments; • Capital expenditures. Our primary capital needs are seasonal working capital requirements. As of February 28, 2014, the Company had cash of $2,731,126 and $369,900 of short-term marketable securities. The Company's long term liabilities as of February 28, 2014, consist of long-term capitalized lease obligations of $28,236. The Company does not have any bank debt or a bank line of credit. The Company is currently negotiating with potential lenders to strengthen its liquidity and believes that it will have sufficient capital resources to meet its working capital requirements for the next twelve months. This expectation depends upon our future operating performance including the absence of any unforeseen cash requirements, our ability to obtain sufficient financing on favorable or satisfactory terms, and the achievement of anticipated cost savings in connection with our outsourcing agreements. Our ability to obtain financing depends on many factors, including past operating performance, business prospects and external economic conditions. Critical Accounting Estimates Our consolidated financial statements include the use of estimates, which management believes are reasonable. The process of preparing financial statements in conformity with accounting principles generally accepted in the United States ("GAAP") requires management to make estimates and assumptions regarding certain types of assets, liabilities, revenues, and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the financial statements. Accounting estimates and assumptions are those management considers to be most critical to the financial statements because they inherently involve significant judgment and uncertainties. All of these estimates and assumptions reflect management's best judgment about current economic and market conditions and their effects on the information available as of the date of the consolidated financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts. An accounting estimate is deemed to be critical if it is reasonably possible that a subsequent correction could have a material effect on future operating results or financial condition. The following are estimates that management has deemed to be critical: 1 - Reserve for Returns-The allowances and reserves which are anticipated to be deducted from future invoices are included in accrued liabilities. The estimated reserve is based in part on historical returns as a percentage of gross sales. The current estimated return rate is 11.02% of gross sales. Management estimates that 14.85% of returns received are placed back into inventory, and the estimate for returns is adjusted to reflect the value of the returns placed into inventory. Any changes in this accrued liability are recorded as a debit or credit to the reserve for returns and allowances account. 2 - Allowance for Doubtful Accounts - The allowance for doubtful accounts is an estimate of the loss that could be incurred if our customers do not make required payments. Trade receivables are periodically evaluated by management for collectability based on past credit history with customers and their current financial condition. Changes in the estimated collectability of trade receivables are recorded in the results of operations for the period in which the estimate is revised. Estimates are made based on specific disputes and additional reserves for bad debt based on the accounts receivable aging ranging from 0.35% for invoices currently due to 2.00% for invoices more than ninety-one days overdue. Trade receivables that are deemed uncollectible are offset against the allowance for uncollectible accounts. The Company generally does not require collateral for trade receivables. 3 - Inventory Obsolescence Reserve - Management reviews the inventory records on a monthly basis. Management deems to be obsolete finished good items that are no longer being sold, and have no possibility of sale within the ensuing twelve months. Components and raw materials are deemed to be obsolete if management has no planned usage of those items within the ensuing twelve months. In addition, management conducts periodic testing of inventory to 25 -------------------------------------------------------------------------------- TABLE OF CONTENTS make sure that the value reflects the lower of cost or market. If the value is below market, a provision is made within the inventory obsolescence reserve. This reserve is adjusted monthly, with changes recorded as part of cost of sales in the results of operations. 4 - Deferred Taxes - The deferred taxes are an estimate of the future tax consequences attributable to the temporary differences between the carrying amounts of assets and liabilities as recorded on the Company's financial statements and the carrying amounts as reflected on the Company's income tax return. In addition, the portion of charitable contributions that cannot be deducted in the current period and are carried forward to future periods are also reflected in the deferred tax assets. A substantial portion of the deferred tax asset is due to the loss incurred in fiscal 2013 and the first quarter of fiscal 2014, the benefit of which will be carried forward into future tax years. Deferred tax assets and liabilities are valued using the tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all of the deferred tax asset will not be realized. Management has estimated that it will utilize the entire deferred tax asset in future years based on anticipated future profitability which is contingent on the successful realization of anticipated cost savings associated with the outsourcing of many functions to The Emerson Group, the substantial reduction in personnel and a reduction in other expenses. However, anticipated future profitability may be impacted if the Company's sales decrease from current levels or due to other factors discussed under Item 1A - Risk Factors in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2014 as supplemented in this Quarterly Report on Form 10-Q. The portion that management expects to utilize in fiscal 2014 is recorded as a short term asset, and the portion that management expects to utilize in fiscal years subsequent to fiscal 2014 is recorded as a long term asset. 5 - Co-operative Advertising Reserve - The co-operative advertising reserve is an estimate of the amount of the liability for the co-operative advertising agreements with the Company's customers. A portion of the reserve that is estimated to be deducted from future payments is a direct reduction of accounts receivable. The portion that the Company estimates to be deducted from future invoices rather than current accounts receivable is recorded as an accrued expense. Management reviews the co-operative advertising agreements for the current fiscal year with its customers on a monthly basis and adjusts them based on actual co-operative advertising events. The Company maintains an open liability for co-operative advertising contracts for which a customer has not claimed a deduction for the three years prior to the current fiscal year. Management evaluates the open liability for the prior three years on a monthly basis to determine if the liability continues to exist. Changes to the reserve are charged as a current period expense. |