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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 For the three months ended August 31, 2014, the company had a net loss from continuing operations of $199,110, and a loss per share, basic and fully diluted of $0.03 as compared to a net loss of $929,300, and a loss per share, basic and fully diluted of $0.13 for the same period in fiscal 2013. For the three months ended August 31, 2014, the Company had net income from discontinued operations of $887,221, and earnings per share, basic and fully diluted of $0.13 as compared to net income of $136,408, and earnings per share, basic and fully diluted, of $0.02 for the same period in 21 -------------------------------------------------------------------------------- TABLE OF CONTENTS fiscal 2013. The total of continuing and discontinued operations for the three months ended August 31, 2014 was net income of $688,111 compared to net loss of $792,892 for the same period ended August 31, 2013. The total earnings per share, basic and fully diluted was $0.10 for the three months ended August 31, 2014 compared to losses per share, basic and fully diluted of $0.11 for the same period ended August 31, 2013. The gain was due to the sale of the Company's dietary supplement brand, Mega-T, in the third quarter of fiscal 2014 (see Note 15 to the financial statements for further information regarding the sale of Mega-T). As of August 31, 2014, the Company had $15,699,175 in current assets and $10,020,170 in current liabilities. The Company had decided to discontinue the Gel Perfect brand in the second quarter of fiscal 2014. Accordingly, the Company has shown the results of operations pertaining to the Gel Perfect and Mega-T brands as Discontinued Operations in the Consolidated Statement of Operations for the quarters and nine months ended August 31, 2014 and August 31, 2013. 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 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 completed most of this restructuring, which includes our outsourcing arrangement and reduction in work force, during the Company's second fiscal quarter of 2014 . The Company is also outsourcing other operations, including shipments to international customers, and estimates that all restructuring will be completed by the end of the first quarter of fiscal 2015. The Company estimated that it would incur costs related to the reduction in work force of $555,343, which was recorded as an expense in the Company's first quarter of fiscal 2014. The Company announced on September 5, 2014, that it had entered into a Loan and Security Agreement (the "Agreement") with Capital Preservation Solutions, LLC ("Capital") for a $5,000,000 working capital line of credit and a term loan for working capital purposes not to exceed $1,000,000 (see Note 16 to the financial statements for further information). In addition, the Company entered into Separation Agreements on the same date with its two founding shareholders, David Edell and Ira Berman, (the "Founders") whereby they are no longer required to perform any consulting services pursuant to their Amended and Restated Employment Agreements. The Company made a payment of $1,000,000 to the Founders on the separation date and is required per the Separation Agreements to make an additional payment of $200,000 to the Founders on October 1, 2015 and pay $794,620 in fifteen equal monthly installments of $52,975 commencing on October 3, 2014. The Company will record the payments of $1,000,000 and $200,000 as an expense in the fourth quarter of fiscal 2014. The payments totaling $794,620 were recorded as an expense on the Company's financial statements during the nine months ended August 31, 2014. Emerson Outsourcing Agreement On January 20, 2014, the Company 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. The Company has continued the agreement. As consideration for the services rendered under the Sales Agreement, Emerson receives monthly commissions equal to 22 -------------------------------------------------------------------------------- TABLE OF CONTENTS a specified percentage of net sales of our products and the Company is responsible for a pro rata portion of certain Emerson expenses associated with this representation. Under the Services Agreement, Emerson provides 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. The Company has continued the agreement. As consideration for the services rendered under the Services Agreement, Emerson is 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 are 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 August 31, 2014 For the three months ended August 31, 2014, the Company had total revenues of $8,017,261 and a net loss from continuing operations of $199,110 after a tax benefit of $114,105. For the same three month period in 2013, total revenues were $7,176,984 and net loss from continuing operations of $929,300 after a tax benefit of $455,160. The basic and fully diluted loss per share from continuing operations was $0.03 for the third quarter of fiscal 2014 as compared to loss of $0.13 per share for the third quarter of fiscal 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 third quarter of fiscal 2014 were reduced by $815,363 and offset by an equal reduction of trade promotional expenses, which were included in the Company's advertising expense. In the same period of the prior year, net sales were reduced by $1,692,041 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 increased $622,119 to $7,807,019 for the three months ended August 31, 2014 from $7,184,900 for the three months ended August 31, 2013, an increase of 8.66%. Net sales increased due to higher gross sales. Sales returns and allowances, not including sales incentives, were 10.45% of gross sales or $1,000,679 for the three months ended August 31, 2014 as compared to 10.31% or $935,820 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 $225,880 to $767,684 in the third quarter 2014 as compared to $993,564 in the same period in 2013. The cost of the coupons issued by the Company was $80,199 for the third quarter 2014 as compared to $435,598 for the same period in 2013. The Company has changed its marketing strategy to focus on media advertising rather than coupons. 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 third quarter 2014 as compared to the third quarter 2013 were: 23 -------------------------------------------------------------------------------- TABLE OF CONTENTS Three Months Ended August 31, 2014 2013 Category Net Sales %TTL Net Sales %TTL Skin Care $ 3,842,296 49.2 % $ 3,139,996 43.7 % Oral Care 2,234,621 28.6 % 2,335,560 32.5 % Nail Care 1,151,626 14.8 % 1,161,255 16.2 % Fragrance 324,561 4.2 % 310,678 4.3 % Miscellaneous 143,656 1.8 % 161,654 2.2 % Analgesic 96,078 1.2 % 64,925 0.9 % Hair 14,181 0.2 % 10,832 0.2 % Total Continued Operations $ 7,807,019 100.0 % $ 7,184,900 100.0 % Net sales were affected by the following factors: • Net sales of skin care products increased $702,300 for the three months ended August 31, 2014, as compared to the same period in 2013. The net sales increased due to higher gross sales, lower returns and lower sales incentives. Included in skin care is Sudden Change and Bikini Zone, which the Company advertised as part of its media program for fiscal 2014. • Net sales of oral care products decreased $100,939 for the three months ended August 31, 2014 as compared to the same period in fiscal 2013 due to increase in returns. The Company advertised the Plus White whitening kit as part of its media program for fiscal 2014. • Net sales of nail care products decreased $9,629 for the three months ended May 31, 2014 as compared to the same period in fiscal 2013. The nail care product category does not include Gel Perfect color nail polish , which was discontinued and reported as discontinued operations. The net sales of nail care products decreased due to lower gross sales, partially offset by lower returns and allowances. Gross profit margins decreased to 47.9% for the three months ended August 31, 2014 from 52.2% for the same period in 2013. The gross margin decreased due to close out sales of discontinued product and write offs of obsolete inventory. The Company anticipates that the gross profit margin will increase in fiscal 2015 due to the effects of its restructuring program. Selling, general and administrative expenses for the three months ended August 31, 2014 were $2,691,494 as compared to $4,566,879 for the three months ended August 31, 2013, a decrease of $1,875,385. The following factors contributed to the decrease: • Shipping costs decreased $378,377 in the third quarter of fiscal 2014 as compared to the same period in fiscal 2013. The decrease was mainly due to 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 $1,338,027 in the third 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. • Travel, meals and entertainment expenses decreased $107,088 in the third 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 $138,376 in the third quarter of fiscal 2014 as compared to the second quarter of fiscal 2013. The decrease was due to the termination of consulting contracts. • Commissions decreased $161,338 as a result of the outsourcing to the Emerson Group. • The decreases in selling, general and administrative expenses were offset by fees and expenses from the Emerson Group of $730,080. • 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 August 31, 2014 were $1,440,512 as compared to $318,002 for the three months ended August 31, 2013. The increased expense of $1,122,510 was mainly comprised of an increase of media spending and commercial costs primarily for the Sudden Change, Plus White, Mega-T and Bikini Zone brands. The increased expense is part of the Company's marketing strategy to have a television advertising campaign focusing on its key brands. 24 -------------------------------------------------------------------------------- TABLE OF CONTENTS The loss before benefit from income taxes was $313,215 for the quarter ended August 31, 2014 from continuing operations, and the benefit from income tax from continuing operations was $114,105. The Company, as previously disclosed, discontinued the Gel Perfect nail color brand in the second quarter of fiscal 2014 and sold the Mega-T dietary supplement brand in the third quarter of fiscal 2014. Accordingly, the Company has recorded the results of the operations of both brands as discontinued operations in the consolidated statements of operations. Income before benefit from income taxes was $1,395,662 for the quarter ended August 31, 2014 from discontinued operations, and the provision for income tax was $508,441. The income was due to the sale of the Mega-T brand. The components of discontinued operations for the three months ended August 31, 2014 and 2013 were: Three Months Ended August 31, 2014 August 31, 2013 Revenues: Sales of health and beauty-aid products-net $ 1,454,974 $ 2,557,927 Total revenues 1,454,974 2,557,927 Costs and Expenses: Cost of sales 794,249 1,627,475 Selling, general and administrative expenses (1,463,741 ) 263,423 Advertising, cooperative and promotions 728,804 463,810 Total expenses 59,312 2,354,708 Income before provision for income taxes 1,395,662 203,219 Provision for income taxes 508,441 66,811 Income from Discontinued Operations $ 887,221 $ 136,408 The effective tax benefit for the second quarter of fiscal 2014 was 36.4% of the net loss from continuing operations before tax and a tax provision of 36.4% of the income from discontinued operations as compared to a tax benefit of 32.9% of the net loss before tax for continuing and discontinued operations for the same period in fiscal 2013. Comprehensive income, including continuing and discontinued operations, was $571,316 for the quarter ended August 31, 2014 as compared to comprehensive losses of $755,695 for the quarter ended August 31, 2013. The comprehensive income for the quarter ended August 31, 2014 reflects the Company's net income of $688,111 from continuing and discontinued operations together with other comprehensive income consisting of unrealized gains less reclassification adjustments, net of provision for income tax, of $116,795. Further information regarding the Company's investments can be found in Note 3 of the consolidated financial statements. OPERATING RESULTS FOR THE NINE MONTHS ENDED AUGUST 31, 2014 For the nine months ended August 31, 2014, the Company had total revenues of $25,104,842 and a net loss from continuing operations of $937,178 after a tax benefit of $544,788. For the same nine month period in 2013, total revenues were $23,300,367 and net loss from continuing operations of $2,638,926 after a tax benefit of $1,461,085. The basic and fully diluted loss per share from continuing operations was $0.13 for the first nine months of fiscal 2014 as compared to a loss of $0.38 per share for the first nine months of fiscal 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 nine months ended August 31, 2014 were reduced by $2,570,805 and offset by an equal reduction of trade promotional expenses, which were included in the Company's advertising expense. In the same period of the prior year, net sales were reduced by $4,257,937 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 (loss). 25 -------------------------------------------------------------------------------- TABLE OF CONTENTS The Company's net sales of health and beauty aid products increased $1,400,204 to $24,650,057 for the nine months ended August 31, 2014 from $23,249,853 for the nine months ended August 31, 2013, an increase of 6.02%. Included in net sales are the cost of sales incentives which consist of co-operative advertising with the Company's retail partners and coupons. The amount of cooperative advertising included in sales incentives decreased by $2,323,992 to $2,978,989 in the nine months ended August 31, 2014 as compared to $5,302,981 in the same period in 2013. The cost of the coupons issued by the Company was $408,184 for the nine months ended August 31, 2014 as compared to $1,045,044 for the same period in 2013. The Company has changed its marketing strategy, issuing less coupons and focusing more on media advertising. 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 nine months ended August 31, 2014 as compared to the same period in 2013 were: Nine Months Ended August 31, 2014 2013 Category Net Sales % TTL Net Sales % TTL Skin Care $ 11,723,854 47.6 % $ 10,849,899 46.7 % Oral Care 7,981,693 32.4 % 7,499,733 32.3 % Nail Care 3,242,836 13.2 % 3,676,343 15.8 % Miscellaneous 378,528 1.5 % 597,385 2.6 % Hair 34,087 0.1 % 38,594 0.2 % Fragrance 1,021,380 4.1 % 390,996 1.7 % Dietary Supplement - - % - - % Analgesic 267,679 1.1 % 196,903 0.8 % $ 24,650,057 100.0 % $ 23,249,853 100.2 % The following were factors that affected net sales for the nine months ended August 31, 2014: • Net sales of skin care products increased $873,955 for the nine months ended August 31, 2014, as compared to the same period in 2013. The net sales increased due to higher gross sales, lower returns and lower sales incentives. Included in skin care is Sudden Change and Bikini Zone, which the Company advertised as part of its media program for fiscal 2014. • Net sales of oral care products increased $481,960 for the nine months ended August 31, 2014, as compared to the same period in fiscal 2013 due to higher gross sales of $344,646 and lower returns, allowances and sales incentives. The Company advertised the Plus White whitening kit as part of its media program for fiscal 2014. • Net sales of nail care products decreased $433,507 for the nine months ended August 31, 2014, as compared to the same period in fiscal 2013. The nail care product category does not include Gel Perfect color nail polish , which was discontinued and reported as discontinued operations. The net sales of nail care products decreased due to lower gross sales, partially offset by lower returns and allowances. • Net sales of the Company's fragrance products increased $630,384 for the nine months ended August 31, 2014 as compared to the same period in fiscal 2013. This increase is due to increased international sales. 26-------------------------------------------------------------------------------- TABLE OF CONTENTS Nine months ended August 31, 2014 August 31, 2013 Sales of health and beauty aid products - Net $ 24,650,057 $ 23,249,853 Cost of Sales 11,664,448 11,030,601 Gross Margin $ 12,985,609 $ 12,219,252 Gross Margin Percentage 52.7 % 52.6 % Selling, general and administrative expenses decreased to $9,741,090 for the nine months ended August 31, 2014 as compared to $14,303,516 for the same period in 2013, or a decrease of $4,562,426. The following factors contributed to the decrease: • Royalty costs decreased $67,673 in the nine months ended August 31, 2014 as compared to the same period in fiscal 2013 reflecting the decline in sales. • Shipping costs decreased $1,210,517 in the nine months ended August 31, 2014 as compared to the same period in fiscal 2013. The decrease was mainly due to the outsourcing of logistics to OHL which began as of February 1, 2014. 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 $3,680,474 in the nine months ended August 31, 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. • Travel, meals and entertainment expenses decreased $242,615 in the nine months ended August 31, 2014 as compared to the same period in fiscal 2013 as a result of the decrease in personnel and the outsourcing of sales functions to the Emerson Group. • Consulting and related costs decreased $315,104 in the nine months ended August 31, 2014 as compared to the first quarter of fiscal 2013. The decrease was due to the termination of consulting contracts in the first quarter of fiscal 2014. • The decreases in selling, general and administrative expenses were offset by fees and expenses from the Emerson Group of $1,865,808. • The Company received insurance proceeds of $340,689 from claims submitted for Superstorm Sandy, which was recorded as a reduction of expense in the second quarter of fiscal 2013. • The balance of the increase or decrease in expenses comprised a number of smaller expense categories. Advertising expense was $4,278,656 for the nine months ended August 31, 2014 as compared to $1,501,997 for the nine months ended August 31, 2013, The advertising expense increase of $2,776,659 was comprised of increased media spend and commercial costs for the Sudden Change, Plus White, and Bikini Zone brands. The increased expense is part of the Company's marketing strategy to have a television advertising campaign focusing on its key brands. The loss before benefit from income taxes was $1,481,966 for the nine months ended August 31, 2014 from continuing operations, and the benefit from income tax from continuing operations was $544,788. The loss before benefit from income taxes was $4,100,011 for the nine months ended August 31, 2013 from continuing operations, and the income tax benefit from continuing operations was $1,461,085. The Company, as previously disclosed discontinued the Gel Perfect nail color brand in the second quarter of fiscal 2014, and sold the Mega-T dietary supplement brand in the third quarter of fiscal 2014. Accordingly, the Company has recorded the results of the operations of both brands as discontinued operations in the consolidated statements of operations. The loss before benefit from income taxes was $5,931,449 for the nine months ended August 31, 2014 from discontinued operations, and the benefit from income tax was $2,180,468 as compared to income before provision for income taxes of $1,046,871 and a provision for income taxes of $373,064 for the same period in fiscal 2013. The components of discontinued operations for the nine months ended August 31, 2014 and 2013 were: 27 -------------------------------------------------------------------------------- TABLE OF CONTENTS Nine Months Ended August 31, 2014 August 31, 2013 Revenues: Sales of health and beauty-aid products-net $ (2,090,798 ) $ 9,496,405 Total revenues (2,090,798 ) 9,496,405 Costs and Expenses: Cost of sales 3,647,920 5,064,233 Selling, general and administrative expenses (813,574 ) 1,151,437 Advertising, cooperative and promotions 1,006,305 2,233,864 Total expenses 3,840,651 8,449,534 ( Loss) Income before (benefit from) provision for income taxes (5,931,449 ) 1,046,871 (Benefit from) provision for income taxes (2,180,468 ) 373,064 (Loss) Income from Discontinued Operations $ (3,750,981 ) $ 673,807 The effective tax rate for the nine months ended August 31, 2014 was 36.8% versus 35.6% for the nine months ended August 31, 2013. 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 in the second quarter of fiscal 2013. Financial Position as of August 31, 2014 As of August 31, 2014, the Company had working capital of $5,679,005 as compared to $12,911,553 as of the year ended November 30, 2013. The decrease in working capital was due to lower cash and investments as a results of losses over the first nine months of fiscal 2014, increased reserves for the Gel Perfect brand, which decreased the net accounts receivable and increased accounts payable and accrued liabilities. The ratio of total current assets to current liabilities is 1.6 to 1 as of August 31, 2014, as compared to a ratio of 2.4 to 1 as of November 30, 2013. The Company's cash position, trade date reeivables and short-term investments at August 31, 2014 were $1,465,899, versus $4,311,460 as of November 30, 2013. The Company had no non-current or long-term investments as of August 31, 2014 and as of November 30, 2013. The Company paid no cash dividends during fiscal 2014 year to date . As of August 31, 2014, there were no dividends declared but not paid. The Company sold all of its investments during the third quarter of fiscal 2014. The investment securities the Company had purchased were all classified as "Available for Sale Securities". The investments on the consolidated balance sheet at November 30, 2013 are reported at fair market value as of the same date, with the resultant unrealized gains or losses reported as a separate component of shareholders' equity. Accounts receivable as of August 31, 2014 and as of November 30, 2013 were $4,527,853 and $5,473,452, respectively. The decrease in accounts receivable was due to lower gross receivables and an increase in reserves for returns and markdowns of Gel Perfect. 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 $31,788 and $56,513 for August 31, 2014 and November 30, 2013, respectively. The allowance for doubtful accounts is a combination of specific and general reserve 28 -------------------------------------------------------------------------------- TABLE OF CONTENTS 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 and a specific reserve based on customer circumstances and product lines. This allowance increased to $2,956,501 as of August 31, 2014 from $2,126,736 as of November 30, 2013. Of this amount, allowances and reserves of $874,709 as of August 31, 2014, which are anticipated to be deducted from future invoices, are included in accrued liabilities. Included in the reserve for returns and allowances as of August 31, 2014 is a specific reserve of $1,182,694 for the Gel Perfect brand. Gross receivables were further reduced by $651,764 as of August 31, 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 $2,607,047, 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 $5,821,751 and $8,607,567, as of August 31, 2014 and November 30, 2013, respectively. The reserve for inventory obsolescence is based on a detailed analysis of inventory movement. The inventory obsolescence reserve decreased to $1,708,254 as of August 31, 2014 from $3,030,306 as of November 30, 2013. This decrease was primarily due to the disposal of obsolete inventory during the second and third quarters 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 decreased to $329,858 as of August 31, 2014 from $424,626 as of November 30, 2013. The decrease was in the ordinary course of business. Prepaid and refundable income taxes decreased to $675,596 as of August 31, 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 $2,878,218 as of August 31, 2014 from $2,668,747 as of November 30, 2013. The $209,471 increase was primarily due to the Company's net operating losses during the third quarter of fiscal 2014. The amount of deferred income tax recorded as a non-current asset was $4,524,312 as of August 31, 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 $64,357 of additional property and equipment during the third quarter of fiscal 2014. Current liabilities are $10,020,170 and $9,253,188, as of August 31, 2014 and November 30, 2013 respectively. Current liabilities at August 31, 2014 consisted of accounts payable, accrued liabilities and short-term capital lease obligations. As of August 31, 2014, there was $3,258,811 of open cooperative advertising commitments, of which $1,164,839 is from 2014, $1,462,333 is from 2013, $445,333 is from 2012, and $186,306 is from 2011. Of the total amount of $3,258,811, $651,764 is reflected as a reduction of gross accounts receivables, and $2,607,047 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 $24,215 as of August 31, 2014 as compared to $30,195 as of November 30, 2013. Stockholders' equity decreased to $12,210,728 as of August 31, 2014 from $17,062,366 as of November 30, 2013. The decrease was due to decreases in retained earnings as a result of the combined net loss in the first nine months of fiscal 2014 and the elimination of unrealized gains on marketable securities due to the sale of all investments in the 29 -------------------------------------------------------------------------------- TABLE OF CONTENTS third quarter of fiscal 2014. 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, $18,900 was recorded as a deferred compensation expense in the first nine months of fiscal 2014 and additional paid-in capital was increased by the same amount. The Company's cash flow had $2,837,009 that was used in operating activities for the first nine months of fiscal 2014, as compared to $3,492,042 that was used in operating activities during the same period in fiscal 2013. The decrease in operating cash flow use for the first nine months of fiscal 2014 as compared to the same period in fiscal 2013 was mainly due to the combined net loss from continuing and discontinued operations of $4,688,159 and deferred income taxes of $2,706,124, 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 $684,639 for the first nine months of fiscal 2014, generated by the proceeds from the sale of the Company's investments less a small amount of acquisition of equipment, as compared to $443,815 used in investing activities in the 2013 comparable period. Net cash used in financing activities during the first nine months of fiscal 2014 was $5,589 as compared to $1,120,985 for the same period in fiscal 2013. Cash used in financing activities was higher in the first nine months of fiscal 2013 due to dividends paid of $987,622 during that period. 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; • Loss from continuing operations; • Large product returns from customers which are deducted from cash remittances; • Dividend payments; • Capital expenditures. Our primary capital needs are seasonal working capital requirements. As of August 31, 2014, the Company had cash of $1,041,061, trade date receivables of $424,838 and $0 of short-term marketable securities. The Company's long term liabilities as of August 31, 2014, consist of long-term capitalized lease obligations of $24,215. The Company did not have any bank debt or a bank line of credit as of August 31, 2014. The Company had net cash used in operations of $2,837,009 for the nine months of fiscal 2014. Of that amount, $1,208,626 was used in the first quarter of fiscal 2014, $1,170,308 was used in the second quarter and $458,075 was used in the third quarter. The Company previously announced that on September 5, 2014, the Company entered into a Loan and Security Agreement (the "Agreement") with Capital Preservation Solutions, LLC ("Capital") for a $5,000,000 working capital line of credit and a term loan for working capital purposes not to exceed $1,000,000 (see Note 16 to the financial statements for further information regarding the financing agreement). The Company believes that the financing agreement entered into on September 5, 2014 together with its restructuring plan will provide sufficient cash resources over the next twelve months to support its operations, vendor payments, media and marketing programs. Cash used in operations was driven by the large deductions from customers cash remittances as a result of returns of Gel Perfect and Mega-T during the first nine months of fiscal 2014. As previously disclosed, the Company sold the Mega-T brand in the third quarter of fiscal 2014. The purchaser assumed all liabilities for returns, markdown and co-operative advertising deductions up to a cap of $2,250,000. The Company does not expect that there will be any claims that exceed the cap. Accordingly, the Company eliminated all reserves pertaining to the Mega-T brand as of the date of sale. The Company recorded a reserve for mark down allowances and returns for the discontinued Gel Perfect brand during the second quarter of fiscal 2014, which has a balance of $1,182,694 as of August 31, 2014. The reserves are the amounts that the Company estimates will be deducted from future accounts receivable cash remittances from its retail customers. The Company is continuing its work to complete its outsourcing of operations which is expected to result in additional cash flow savings to be realized over future quarters. Critical Accounting Estimates 30 -------------------------------------------------------------------------------- TABLE OF CONTENTS 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 7.11% of gross sales. Management estimates that none of the returns received are placed back into inventory and will be disposed of. 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 - Special Reserve for Gel Perfect - The special reserve for the Gel Perfect brand was calculated based on an estimate of the inventory held by the Company's retail customers that could be returned to the Company. In addition, the Company considered the current mark down contracts that had been issued as of August 31, 2014, new mark down contracts that will be issued and the potential success of the mark down programs. To the extent that mark down programs are successful, the Company's liability for returns is reduced. 4 - 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 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. 5 - 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 nine months 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. 31 -------------------------------------------------------------------------------- TABLE OF CONTENTS 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. 6 - 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. |