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ICPW > SEC Filings for ICPW > Form 10-Q on 13-Aug-2014All Recent SEC Filings

Show all filings for IRONCLAD PERFORMANCE WEAR CORP

Form 10-Q for IRONCLAD PERFORMANCE WEAR CORP


13-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion summarizes the significant factors affecting our operating results, financial condition and liquidity and cash flows for the six months ended June 30, 2014 and 2013. The following discussion of our results of operations and financial condition should be read together with the condensed consolidated financial statements and the notes to those statements included elsewhere in this report. Except for historical information, the matters discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations are forward looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond our control. Our actual results could differ materially from the results anticipated in any forward-looking statements as a result of a variety of factors, including those discussed in "Risk Factors."

Overview

We are a leading designer and manufacturer of branded performance work wear. Founded in 1998, we have grown and leveraged our proprietary technologies to produce task-specific gloves and performance apparel that are designed to significantly improve the wearer's ability to safely, efficiently and comfortably perform general to highly specific job functions. We have built and continue to augment our reputation among professionals in the construction and industrial service markets, and do-it-yourself and sporting goods consumers with products specifically designed for individual tasks or task types. We believe that our dedication to quality and durability and focus on our client needs has created a high level of brand loyalty and has solidified substantial brand equity.

We plan to increase our domestic revenues by leveraging our relationships with existing retailers and industrial distributors, including "Big Box," automotive and sporting goods retailers, increasing our product offerings in new and existing locations, and introducing new products, developed and targeted for specific customers and/or industries.

We believe that our products have international appeal. In 2005, we began selling products in Australia and Japan through independent distributors, which accounted for approximately 4% of total sales. From 2006 through 2013 we entered the Canadian and European markets through distributors and international sales have represented approximately 7% - 19% of total sales. We plan to continue to pursue sales internationally by expanding our distribution into Europe and other international markets in ensuing years.

General

Net sales are comprised of gross sales less returns and discounts. Our operating results are seasonal, with a greater percentage of net sales being earned in the third and fourth quarters of our fiscal year due to the fall and winter selling seasons.

Our cost of goods sold includes the free on board ("FOB") cost of the product plus landed costs and a reserve for slow-moving inventory. Landed costs include freight-in, insurance, duties and administrative costs to deliver the finished goods to our distribution warehouse. Cost of goods sold does not include purchasing, warehousing or distribution costs. These costs are captured as incurred on a separate line in operating expenses. Our gross margins may not be comparable to other entities that may include some or all of these costs in the calculation of gross margin.

Our operating expenses consist primarily of payroll and related costs, marketing costs, corporate infrastructure costs and our purchasing, warehousing and distribution costs. We expect that our operating expenses will decrease as a percentage of net sales if we are able to increase our net sales through expansion and growth. We expect this reduction in operating expenses to be offset by investment in sales and marketing to achieve brand growth, the development of new product lines, and the increased costs of operating as a public company.

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Historically, we have funded our working capital needs through a combination of our existing asset-based credit facility along with subordinated debt and equity financing transactions. On November 30, 2012 we entered into a Business Loan Agreement with Union Bank, N.A. which provides a revolving loan of up to $6,000,000. The first $3,500,000 of advances under this facility are under an open line-of-credit. Advances in excess of $3,500,000, up to the line limit of $6,000,000, are subject to a Borrowing Base report. The term Borrowing Base means an amount equal to (a) 80% of the net amount of all eligible accounts receivable plus, (b) the lesser of (i) 50% of the value of eligible landed inventory and (ii) $2,750,000, plus (c) 35% of eligible in-transit inventory. In addition, during the months of April to October each calendar year, the outstanding principal amount of all advances against eligible inventory shall not exceed 150% of the aggregate outstanding principal amount of advances against eligible accounts receivable. All of our assets secure amounts borrowed under the terms of this agreement. Interest on borrowed funds accrue at Prime minus 0.25% unless we choose to "fix" a portion of the indebtedness (minimum $150,000) at LIBOR plus 2% for fixed periods of time ranging from 30 days to 360 days.

Critical Accounting Policies, Judgments and Estimates

Our Management's Discussion and Analysis of Financial Condition and Results of Operations section discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. To prepare these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities. These estimates also affect our reported revenues and expenses. On an ongoing basis, management evaluates its estimates and judgment, including those related to revenue recognition, accrued expenses, financing operations and contingencies and litigation. Management bases its estimates and judgment on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition

Under our sales model, a customer is obligated to pay us for products sold to it within a specified number of days from the date that title to the products is transferred to the customer. Our standard terms are typically net 30 days from the transfer of title to the products to a customer, however we have negotiated special terms with certain customers and industries. We typically collect payment from a customer within 30 to 60 days from the transfer of title to the products to a customer. Transfer of title occurs and risk of ownership passes to a customer at the time of shipment or delivery, depending on the terms of our agreement with a particular customer. The sale price of our products is substantially fixed or determinable at the date of sale based on purchase orders generated by a customer and accepted by us. A customer's obligation to pay us for products sold to it is not contingent upon the resale of those products. We recognize revenue at the time title is transferred to a customer.

Revenue Disclosures

Our revenues are derived from the sale of our core line of task specific work gloves plus our line of work wear apparel products, available to all of our customers, both domestically and internationally. Below is a table outlining this breakdown for the comparative periods:

                      Six Months Ended June 30, 2014               Six Months Ended June 30, 2013
  Net Sales        Gloves        Apparel         Total          Gloves        Apparel         Total
Domestic        $ 7,461,389     $ 81,252     $ 7,542,641     $ 8,237,799     $ 41,709     $ 8,279,508
International     2,352,207          739       2,352,946       1,554,642          717       1,555,359
Total           $ 9,813,596     $ 81,991     $ 9,895,587     $ 9,792,441     $ 42,426     $ 9,834,867

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Inventory Obsolescence Allowance

We review the inventory level of all products quarterly. For most products that have been in the market for one year or greater, we consider inventory levels of greater than one year's sales to be excess. Products that are no longer part of the current product offering are considered obsolete. The potential for re-sale of slow-moving and obsolete inventories is based upon our assumptions about future demand and market conditions. The recorded cost of obsolete inventories is then reduced to zero and a reserve is established for slow moving products. Both the write down and reserve adjustments are recorded as charges to cost of goods sold. As of June 30, 2014 and December 31, 2013, our inventory reserve was $547,800 and $621,000, respectively. All adjustments for obsolete inventory establish a new cost basis for that inventory as we believe such reductions are permanent declines in the market price of our products. Generally, obsolete inventory is sold to companies that specialize in the liquidation of these items or contributed to charities, while we continue to market slow-moving inventories until they are sold or become obsolete. As obsolete or slow-moving inventory is sold or disposed of, we reduce the reserve. In the first six months of 2014, the Company sold some of its slow-moving inventory and reduced its inventory reserve by $73,200.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our current customers consist primarily of large national, regional and smaller independent customers with good payment histories with us. We perform periodic credit evaluations of our customers and maintain allowances for potential credit losses based on management's evaluation of historical experience and current industry trends. If the financial condition of our customers were to deteriorate, resulting in the impairment of their ability to make payments, additional allowances may be required. New customers are evaluated for credit worthiness before terms are established. Although we expect to collect all amounts due, actual collections may differ. The allowance for doubtful accounts was $30,000 at June 30, 2014 and $48,000 at December 31, 2013.

Product Returns, Allowances and Adjustments

Product returns, allowances and adjustments is a broad term that encompasses a number of offsets to gross sales. Included herein are warranty returns of defective products, returns of saleable products and accounting adjustments.

Warranty Returns - We have a warranty policy that covers defects in workmanship. It allows customers to return damaged or defective products to us following a customary return merchandise authorization process.

Saleable Product Returns - We may allow from time to time, depending on the customer and existing circumstances, stock adjustment returns, whereby the customer is given the opportunity to 'trade out' of a style of product that does not sell well in their territory, usually in exchange for another product, again following the customary return merchandise authorization process. In addition we may allow from time to time other saleable product returns from customers for other business reasons, for example, in settlement of an outstanding accounts receivable, from a discontinued distributor customer or other customer service purpose.

Accounting Adjustments - These adjustments include pricing and shipping corrections and periodic adjustments to the product returns reserve.

For both warranty and saleable product returns we utilize actual historical return rates to determine our allowance for returns in each period, adjusted for unique, one-time events. Gross sales is reduced by estimated returns. We record a corresponding accrual for the estimated liability associated with the estimated returns which is based on the historical gross sales of the products corresponding to the estimated returns. This accrual is offset each period by actual product returns.

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Our current estimated future warranty product return rate is approximately 1.5% and our current estimated future stock adjustment return rate is approximately 0.5%. As noted above, our return rate is based upon our past history of actual returns and we estimate amounts for product returns for a given period by applying this historical return rate and reducing actual gross sales for that period by a corresponding amount. We believe that using a trailing 12-month return rate provides us with a sufficient period of time to establish recent historical trends in product returns for two primary reasons: (i) our products' useful life is approximately 3-4 months and (ii) we are able to quickly correct any significant quality issues as we learn about them. If an unusual circumstance exists, such as a product that has begun to show materially different actual return rates as compared to our average 12-month return rates, we will make appropriate adjustments to our estimated return rates. Factors that could cause materially different actual return rates as compared to the 12-month return rates include a new product line, a change in materials or product being supplied by a new factory. Although we have no specific statistical data on this matter, we believe that our practices are reasonable and consistent with those of our industry. Our warranty terms under our arrangements with our suppliers do not provide for individual products returned by retailers or retail customers to be returned to the vendor.

Reserve for Product Returns, Allowances and Adjustments

Reserve Balance 12/31/13                                  $  75,000
Payments Recorded During the Period                         (90,968 )
                                                            (15,968 )
Accrual for New Liabilities During the Reporting Period      90,968
Reserve Balance 3/31/14                                      75,000
Payments Recorded During the Period                         (45,214 )
                                                             29,786
Accrual for New Liabilities During the Reporting Period      45,214
Reserve Balance 6/30/14                                   $  75,000

Stock Based Compensation

We follow the provisions of FASB ASC 718, "Share-Based Payment." This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, as well as transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements based on the fair value of the share-based payment. ASC 718 establishes fair value as the measurement objective in accounting for share-based payment transactions with employees, such as the options issued under our stock incentive plans.

Income Taxes

Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. 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 assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates as of the date of enactment.

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When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be effectively sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution of appeals or litigation, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. We have reported losses for 2003, 2004, 2005, 2006, 2007, 2008 and 2009, and uncertainty exists as to whether benefits from deferred tax assets will be utilized. In the past we have fully reserved our deferred tax assets, however, we have now had several years in a row of sustained profits and believe it would now be appropriate to reduce this valuation allowance. Accordingly the Company reversed approximately 30% of its valuation allowance for its current deferred tax assets and recorded a deferred tax benefit of $857,500 in 2012. At December 31, 2013 we once again reviewed our current profitability and forecasted future results and concluded that it is more likely than not that we would be able to realize some more of our deferred tax assets. At December 31, 2013 we reversed approximately 7% of our valuation allowance for our current deferred tax assets and recorded an additional deferred tax benefit of $214,500. These deferred tax benefits are recorded on the balance sheet as current deferred tax assets of $274,000 and long term deferred tax assets of $798,000.

Interest and penalties associated with unrecognized tax benefits would be classified as additional income taxes in the statement of operations.

Results of Operations

Comparison of Three and Six Months Ended June 30, 2014 and 2013

Net Sales increased $300,041 or 6.6%,to $4,819,252 in the quarter ended June 30, 2014 from $4,519,211 for the corresponding period in 2013. Two customers accounted for 60.5% of Net Sales during the quarter ended June 30, 2014 and three customers accounted for 47.7% of Net Sales during the quarter ended June 30, 2013. Net Sales increased $60,720 or 0.6%,to $9,895,587 in the six months ended June 30, 2014 from $9,834,867 for the corresponding period in 2013. Three customers accounted for 55.9% of Net Sales during the six months ended June 30, 2014 and three customers accounted for 55.2% of Net Sales for the six months ended June 30, 2013. The Net Sales increase for the quarter is due to increased sales in our industrial/safety segments, offset in part by decreases in the automotive and private label segments. The Net Sales increase for the six month period is due to increased sales in our industrial/safety and private label segments, offset in part by decreases in the retail automotive, co-op and independent hardware segments. We continue to focus our sales efforts on those areas where we see growth opportunities, the industrial and safety markets and job specific and specialty glove styles.

Gross Profit increased $99,444 to $1,657,657 for the quarter ended June 30, 2014 from $1,558,213 for the corresponding period in 2013. Gross Profit, as a percentage of net sales, or gross margin, decreased to 34.4% in the second quarter of 2014 from 34.5% in the same quarter of 2013. The decrease in Gross Profit of 0.1% for the second quarter was primarily due to customer and product
mix. Gross Profit decreased $411,296 to $3,126,803 for the six months ended June 30, 2014 from $3,538,099 in the prior year period. Gross Profit, as a percentage of net sales, or gross margin, decreased to 31.6% on a year-to-date basis from 36.0% for the same period of 2013. The decrease in Gross Profit of 4.4% for the first half of the year was primarily due to a decrease in higher margin sales plus several large promotional incentives incurred earlier in the year.

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Operating Expenses was consistent at $1.9 million in the three month periods ending June 30, 2014 and June 30, 2013. As a percentage of net sales, Operating Expenses represented 40.2% for the three months ended June 30, 2014, compared to 42.6% of net sales for the same period in 2013. Operating Expenses were $3.9 million for the six months ended June 30, 2014, compared to $4.0 million for the corresponding period in 2013. As a percentage of net sales, Operating Expenses represented 39.3% for the six months ended June 30, 2014, compared to 40.9% of net sales for the same period in 2013. The decrease in actual dollars and percentage of net sales for the six month period is primarily driven by decreased personnel costs. Our number of employees was 29 at June 30, 2014 and 29 at June 30, 2013.

Loss from Operations decreased by $87,173, to a loss of $281,948 in the second quarter of 2014, from a loss of $369,121 in the second quarter of 2013. Loss from operations as a percentage of net sales decreased to 5.9% in the second quarter of 2014 from 8.2% in the second quarter of 2013. The decrease in loss from operations in the second quarter was primarily due to increased sales partially offset by increased operating expenses. Loss from Operations increased by $284,949 to a loss of $766,343 for the six months ended June 30, 2014, from a loss of $481,394 in the corresponding period of 2013. The increase in loss from operations in the six month period was primarily due to higher cost of goods sold, partially offset by reduced operating expenses.

Interest Expense decreased $21,905 to $-0- in the second quarter of 2014 from $21,905 in the same period of 2013. This decrease is due to no borrowings under our bank line of credit agreement, the outstanding balance under which was reduced to $-0- during the first quarter of 2014. Interest expense decreased $24,446 in the first six months of 2014 from $31,359 in the same period of 2013.

Net Loss increased $66,917 to a loss of $281,705 in the second quarter of 2014 from a loss of $214,718 in the second quarter of 2013. Net Loss increased $436,574 to a loss of $773,006 for the six months ended June 30, 2014 from a loss of $336,432 in the prior year period. This increased loss was primarily the result of lower margin sales due to customer and product mix.

Seasonality and Quarterly Results

Our glove business generally shows an increase in sales during the third and fourth quarters due primarily to an increase in the sale of our winter glove line during this period and fall promotions. We typically generate 55% - 65% of our glove net sales during these months. The first and second quarters of the year are generally considered our slower season. Even though the overall economy continues to exhibit moderate and uneven growth, which affects some of our channels, we have been experiencing some mixed growth in certain channels - international and private label - which helps offset declines in other areas.

Our working capital, at any particular time, reflects the seasonality of our glove business and plans to expand product lines and enter new markets. We expect inventory and current liabilities to be higher in the third and fourth quarters for these reasons.

Liquidity and Capital Resources

Our cash requirements are principally for working capital. Our need for working capital is seasonal, with the greatest requirements from June through the end of October each year as a result of our inventory build-up during this period for the fall and winter selling seasons. Historically, our main sources of liquidity have been borrowings under our existing revolving credit facility, the issuance of subordinated debt and the sale of equity. In the short term we monitor our credit issuances and cash collections to maximize cash flows and investigate opportunities to reduce our current inventories to convert these assets into cash. Over the past several years, and continuing in the near and longer term we are focused on controlling our operating costs, managing margins and improving operating procedures to generate sustained profitability.

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On November 30, 2012 we entered into a Business Loan Agreement with Union Bank, N.A. which provides a revolving loan of up to $6,000,000. The first $3,500,000 of advances under this facility are under an open line-of-credit. Advances in excess of $3,500,000, up to the line limit of $6,000,000, are subject to a Borrowing Base report. The term Borrowing Base means an amount equal to (a) 80% of the net amount of all eligible accounts receivable plus, (b) the lesser of
(i) 50% of the value of eligible landed inventory and (ii) $2,750,000, plus (c) 35% of eligible in-transit inventory. In addition, during the months of April to October each calendar year, the outstanding principal amount of all advances against eligible inventory shall not exceed 150% of the aggregate outstanding principal amount of advances against eligible accounts receivable. All of our assets secure amounts borrowed under the terms of this agreement. Interest on borrowed funds will accrue at Prime minus 0.25% unless we choose to "fix" a portion of the indebtedness (minimum $150,000) at LIBOR plus 2% for fixed periods of time ranging from 30 days to 360 days.

The Company generated positive cash flow from operations of $2,647,000 in the first half of 2014. The increase in operating cash flow is primarily the result of decreases in accounts receivable and increases in accounts payable and accrued expenses, offset by increases in inventory, deposits on inventory and prepaid expenses. Combined with a pay down on our line of credit to $-0-, we generated positive cash flow for the first half of $449,000.

At June 30, 2014 and December 31, 2013 we had available, but unused credit under this facility of approximately $5,462,000 and $3,831,000, respectively.

Off Balance Sheet Arrangements

At June 30, 2014, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

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Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this report before purchasing our common stock. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any of the following risks occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of the money you paid to purchase our common stock.

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