UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

      

FORM 10-Q

      

(Mark One)

 

For the quarterly period ended June 30, 2013

Or

 

For the transition period from                 to                 

Commission File Number: 001-13458

      

SCOTT’S LIQUID GOLD-INC.

(Exact name of registrant as specified in its charter

      

   

 

303-373-4860

(Registrant’s telephone number, including area code)

      

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

   

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes  ¨  No  x

As of August 8, 2013, the Registrant had 11,274,397 of its common stock, $0.10 par value per share, outstanding.

      

   

   

   

   

   

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CAUTIONARY NOTE ON FORWARD-LOOKING INFORMATION

This Report may contain “forward-looking statements” within the meaning of U.S. federal securities laws. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements and our performance inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences include, but are not limited to, continued acceptance of each of our significant products in the marketplace; the degree of success of any new product or product line introduction by us; competitive factors; any decrease in distribution of (i.e., retail stores carrying) our significant products; continuation of our distributorship agreements for Montagne Jeunesse skin care products and Batiste Dry Shampoos; the need for effective advertising of our products; limited resources available for such advertising; new competitive products and/or technological changes; dependence upon third party vendors and upon sales to major customers; changes in the regulation of our products, including applicable environmental regulations; continuing losses which could affect our liquidity; the loss of any executive officer; and other matters discussed in our Annual Report on Form 10-K for the year ended December 31, 2012 and this Report. The forward-looking statements in this Report speak as of the filing date of this Report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this Report.

   

   

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TABLE OF CONTENTS

   

 

   

   

   

 

   

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PART I

ITEM 1.  FINANCIAL STATEMENTS.

Consolidated Statements of Operations (Unaudited)

Scott’s Liquid Gold-Inc. & Subsidiaries

   

 

See accompanying notes to these Consolidated Financial Statements (Unaudited).

   

   

   

 

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Consolidated Balance Sheets

Scott’s Liquid Gold-Inc. & Subsidiaries

   

 

See accompanying notes to these Consolidated Financial Statements (Unaudited).

 

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Consolidated Statements of Cash Flows (Unaudited)

Scott’s Liquid Gold-Inc. & Subsidiaries

   

 

See accompanying notes to these Consolidated Financial Statements (Unaudited).

 

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Notes to Consolidated Financial Statements (Unaudited)

Scott’s Liquid Gold-Inc. & Subsidiaries

   

 

Scott’s Liquid Gold-Inc. (a Colorado corporation) was incorporated on February 15, 1954. Scott’s Liquid Gold-Inc. and its wholly-owned subsidiaries (collectively, the “Company”, “we”, “our”, or “us”) develop, manufacture, market and sell quality household and skin and hair care products. We are also an exclusive distributor in the United States of Montagne Jeunesse skin sachets and Batiste Dry Shampoo manufactured by two other companies. Our business is comprised of two segments, household products and skin and hair care products.

 

Our consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.

 

The Consolidated Statements of Operations, Consolidated Balance Sheets, and the Consolidated Statements of Cash Flows included in this Report have been prepared by the Company. In our opinion, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at June 30, 2013 and results of operations and cash flows for all periods have been made.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These consolidated financial statements should be read in conjunction with our financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012. The results of operations for the period ended June 30, 2013 are not necessarily indicative of the operating results for the full year.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts in our financial statements of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include, but are not limited to, the realization of deferred tax assets, reserves for slow moving and obsolete inventory, customer returns and allowances,  and stock-based compensation. Actual results could differ from our estimates.

 

We consider all highly liquid investments with an original maturity of three months or less at the date of acquisition to be cash equivalents.

 

On November 3, 2008, effective as of October 31, 2008, we entered into a financing agreement with Summit Financial Resources, L.P. (“Summit”) for the purpose of providing working capital. The financing agreement with Summit was amended on March 12, 2009, March 16, 2011 (effective March 1, 2011) and then again on June 29, 2012 (effective July 1, 2012). The agreement has a term that expires on January 1, 2014, but it may be renewed for additional 12 month periods unless either party elects to cancel in writing at least 60 days prior to January 1, 2014 and thereafter on the anniversary date of each 12 month period.

The agreement provides for a factoring line up to $1.5 million and is secured primarily by accounts receivables, inventory, any lease in which we are a lessor and all investment property and guarantees by our active subsidiaries. Under the agreement, Summit will make loans at our request and in its discretion based on: (i) its purchases of our receivables, with recourse against us, at an advance rate of 85% (or such other percentage determined by Summit in its discretion) and (ii) our inventory not to exceed certain amounts, including an aggregate maximum of $500,000. Prior to the recent amendment on June 29, 2012, advances under the agreement had an interest rate of 1.5% over the prime rate (as published in The Wall Street Journal) for the accounts receivables portion of the advances and 4.0% over the prime rate for the inventory portion of the borrowings. The recent amendment reduced

 

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these interest rates to 1.0% over the prime rate for the accounts receivables portion and 2.5% over the prime rate for the inventory portion. Consequently, our interest cost adjusts with changes in the prime rate. At June 30, 2013, the prime rate was 3.25%.

In addition, prior to the recent amendment on June 29, 2012, there was an administrative fee of 1.0% per month on the average monthly outstanding loan on the receivable portion of any advance and 1.35% per month on the average monthly outstanding loan on the inventory portion of any advance. The recent amendment reduced these administrative fees to 0.85% per month on the average monthly outstanding loan on the receivable portion of any advance if the average quarterly loan in the prior quarter was less than or equal to $1,000,000, and to 0.75% if the average quarterly loan in the prior quarter was greater than $1,000,000 and to 1.0% per month on the average monthly outstanding loan on the inventory portion of any advance.

The agreement provides that neither we nor our active subsidiaries may engage in a change in control transaction without the prior written consent of Summit. Events of default include, but are not limited to, our failure to make a payment when due or a default occurring on any of our other indebtedness.

During the six months ended June 30, 2013, we sold approximately $823,800 of our accounts receivables to Summit for approximately $700,300. As the advance rate on these accounts receivables was 85%, we retained an interest equal to 15% of those accounts receivables. On February 4, 2013, we paid $909,778 to Summit to repay the outstanding balance on our credit line and we have maintained a zero loan balance since that time. At June 30, 2013, the entire $1.5 million of this credit line was available for future factoring of accounts receivable invoices and borrowings secured by our inventory.

We report these transactions using the authoritative guidance of the Financial Accounting Standards Board (“FASB”) as a secured borrowing rather than as a sale. As a result, affected accounts receivable are reported under Current Assets within our Consolidated Balance Sheets as “Trade receivables, net.” Similarly, the net liability owing to Summit appears as “Obligations collateralized by receivables and inventory” within the Current Liabilities section of our Consolidated Balance Sheets. Net proceeds received on obligations collateralized by receivables and inventory appear as cash provided by operating activities within our Consolidated Statements of Cash Flows.

On March 16, 2011, under a consent agreement from Summit, we entered into a financing agreement with Wells Fargo Bank, National Association (“Wells Fargo”) for the purpose of further lowering the cost of borrowing associated with the financing of our accounts receivable. Pursuant to this agreement, we may sell accounts receivables from our largest customer, Wal-Mart Stores, Inc. (“Wal-Mart”), at a discount to Wells Fargo; provided, however, that Wells Fargo may reject offers to purchase such receivables in its discretion. These receivables may be purchased by Wells Fargo at a cost to us equal to LIBOR plus 1.15% per annum. The LIBOR rate used depends on the days to maturity of the receivable sold, typically ranging from 102 to 105 days. At June 30, 2013, Wells Fargo used the 104-day LIBOR rate of 0.32%.

The agreement has no fixed termination date, but continues unless terminated by either party giving 30 days prior written notice to the other party. During the six months ended June 30, 2013, we sold approximately $2,302,800 of our relevant accounts receivable to Wells Fargo for approximately $2,292,900. The difference between the invoiced amount of the receivable and the cash that we received from Wells Fargo is a cost to us. This cost is in lieu of any cash discount our customer would have been allowed and, thus, is treated in a manner consistent with standard trade discounts granted to our customers.

The reporting of the sale of accounts receivables to Wells Fargo is treated as a sale rather than as a secured borrowing. As a result, affected accounts receivables are relieved from the Company’s financial statements upon receipt of the cash proceeds.

 

Inventories consist of raw materials and finished goods and are stated at the lower of cost (first-in, first-out method) or market. We record a reserve for slow moving and obsolete products and raw materials. We estimate this reserve based upon historical and anticipated sales.

Inventories were comprised of the following at:

   

 

 

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Property, plant and equipment are recorded at historical cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets ranging from three to 45 years. Building structures and building improvements are estimated to have useful lives of 35 to 45 years and three to 20 years, respectively. Production equipment and production support equipment are estimated to have useful lives of 15 to 20 years and three to 10 years, respectively. Office furniture and office machines are estimated to have useful lives of 10 to 20 and three to five years, respectively. Carpets, drapes and company vehicles are estimated to have useful lives of five to 10 years. Maintenance and repairs are expensed as incurred. Improvements that extend the useful lives of the asset or provide improved efficiency are capitalized.

 

Financial instruments which potentially subject us to concentrations of credit risk include cash and cash equivalents and trade receivables. We maintain our cash balances in the form of bank demand deposits with financial institutions that we believe are creditworthy. Periodically throughout the year, we have maintained balances in various operating accounts in excess of federally insured limits. We establish an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. We have no significant financial instruments with off-balance sheet risk of accounting loss, such as foreign exchange contracts, option contracts or other foreign currency hedging arrangements.

The recorded amounts for cash and cash equivalents, receivables, other current assets, accounts payable and accrued expenses approximate fair value due to the short-term nature of these financial instruments. As of June 30, 2013, we had no long-term debt. Prior to February 1, 2013, our long-term debt bore interest at a fixed rate that adjusted annually on the anniversary date to the then prime rate. The carrying value of our long-term debt approximated fair value as of December 31, 2012.

 

We follow FASB authoritative guidance as it relates to the proper accounting treatment for the impairment or disposal of long-lived assets. This guidance requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

As of September 30, 2012, due to changes in the real estate market in Denver, Colorado, we conducted an evaluation into the fair value of our property, plant and equipment with particular attention to our land and office, warehouse and manufacturing buildings (the “Facilities”).  We found there to be an impairment of $286,900 in the carrying values of our long-lived assets. We determined the impairment amount after concluding that the low end of the range of fair value estimates at September 30, 2012 should be $9.5 million and the depreciated book value of the Facilities at September 30, 2012 was approximately $9,786,900.

On November 5, 2012, pursuant to FASB authoritative guidance, we classified the Facilities as an asset “held for sale.” Upon classification as “held for sale”, the long-lived asset was measured at the lower of its carrying value or fair value less cost to sell, depreciation was ceased and the asset was separately presented on our Consolidated Balance Sheets.

On February 1, 2013, we sold our Facilities for $9.5 million and received net proceeds of $8.9 million after deducting the expenses for selling the Facilities.

 

We follow FASB authoritative guidance for the accounting for income taxes which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective income tax bases. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which related temporary differences become deductible. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

Taxes are reported based on tax positions that meet a more-likely-than-not standard and that are measured at the amount that is more-likely-than-not to be realized. Differences between financial and tax reporting which do not meet this threshold are required to be recorded as unrecognized tax benefits. We classify penalty and interest expense related to income tax liabilities as an income tax expense. There are no significant interest and penalties recognized in the statement of operations or accrued on the balance sheet.

 

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Our revenue recognition policy is significant because the amount and timing of revenue is a key component of our results of operations. We follow guidance issued by FASB, which requires that certain criteria be met in order to recognize revenue. If these criteria are not met, then the associated revenue is deferred until it is met. In our case, the criteria generally are met when we have an arrangement to sell a product, we have delivered the product in accordance with that arrangement, the sales price of the product is determinable and we believe that we will be paid for the sale.

We establish reserves for customer returns of our products and customer allowances. We estimate these reserves based upon, among other things, an assessment of historical trends, information from customers and anticipated returns related to current sales activity. These reserves are established in the period of sale and reduce our revenue in that period.

Our reserve for customer allowances includes primarily reserves for trade promotions to support price features, displays and other merchandising of our products to our customers. The actual level of returns and customer allowances are influenced by several factors, including the promotional efforts of our customers, changes in mix of our customers, changes in the mix of the products we sell and the maturity of the product. We may change our estimates based on actual results and consideration of other factors that cause returns and allowances. In the event that actual results differ from our estimates, the results of future periods may be impacted.

We also establish reserves for coupons, rebates and certain other promotional programs for consumers. We estimate these reserves based upon, among other things, an assessment of historical trends and current sales activity. These reserves are recorded as a reduction of revenue at the later of the date at which the revenue is recognized or the date at which the sale incentive is offered.

We have also established an allowance for doubtful accounts. We estimate this allowance based upon, among other things, an assessment of the credit risk of specific customers and historical trends. We believe our allowance for doubtful accounts is adequate to absorb any losses which may arise. In the event that actual losses differ from our estimates, the results of future periods may be impacted.

At June 30, 2013 and December 31, 2012 approximately $565,100 and $468,400, respectively, had been reserved for as a reduction of accounts receivable, and approximately $0 and $10,000, respectively, had been reserved as current liabilities. Trade promotions to our customers and incentives such as coupons to the consumer are deducted from gross sales and totaled $993,200 and $892,900 for the six months ended June 30, 2013 and 2012, respectively.

 

Advertising costs are expensed as incurred.

 

During the six months ended June 30, 2013, we granted options to acquire 85,000 shares of our common stock to two executive officers at a price of $0.41 per share, an option to acquire 30,000 shares of our common stock to a board member at a price of $0.55 per share and an option to acquire 15,000 shares of our common stock to a regional sales manager at a price of $0.55 per share. The options which vest ratably over 48 months, or upon a change in control, and which expire after five years, were granted at 120% of the market value as of the date of grant. During the first six months of 2012, we granted an option to acquire 100,000 shares of our common stock to an executive officer at a price of $0.24 per share. Please see Note 2 to our Consolidated Financial Statements (Unaudited) for information regarding the 504,672 fewer stock options outstanding at June 30, 2013 than at June 30, 2012.

The weighted average fair market value of the options granted in the first six months of 2013 and 2012 was estimated on the date of grant, using a Black-Scholes option pricing model with the following assumptions:

   

 

Compensation cost related to stock options recognized in operating results (included in general and administrative expenses) under authoritative guidance issued by the FASB was $24,300 and $27,300 in the six months ended June 30, 2013 and 2012, respectively. Approximately $96,900 of total unrecognized compensation costs related to non-vested stock options is expected to be recognized over the next 48 months. In accordance with this same authoritative guidance, there was no tax benefit from recording the non-cash expense as it relates to the options granted to employees, as these were qualified stock options which are not normally tax

 

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deductible. With respect to the non-cash expense associated with options granted to the non-employee directors, no tax benefit is recognized due to the existence of as yet unutilized net operating losses. At such time as these operating losses have been utilized and a tax benefit is realized from the issuance of non-qualified stock options, a corresponding tax benefit may be recognized.

 

Cost of sales includes costs associated with manufacturing and distribution including labor, materials, freight-in, purchasing and receiving, quality control, internal transfer costs, repairs, maintenance and other indirect costs, as well as warehousing and distribution costs. We classify shipping and handling costs comprised primarily of freight-out as selling expenses. Other selling expenses consist primarily of wages and benefits for sales and sales support personnel, travel, brokerage commissions and promotional costs, as well as certain other indirect costs. Shipping and handling costs totaled $730,800 and $684,000 for the six months ended June 30, 2013 and 2012, respectively.

General and administrative expenses consist primarily of wages and benefits associated with management and administrative support departments, business insurance costs, professional fees, office facility related expenses, and other general support costs.

   

 

We present basic and diluted earnings or loss per share in accordance with authoritative guidance which establishes standards for computing and presenting basic and diluted earnings per share. Per share data is determined by using the weighted average number of common shares outstanding. Common equivalent shares are considered only for diluted earnings per share, unless considered anti-dilutive. Common equivalent shares, determined using the treasury stock method, result from stock options with exercise prices that are below the average market price of the common stock.

The potentially dilutive securities are comprised of outstanding stock options of 928,678 and 1,433,350 at June 30, 2013 and 2012, respectively, a decrease of 504,672 or 35.2%. This decrease is due primarily to stock options expiring as well as a number of stock options being exercised.  At June 30, 2013, those securities for which the average market price for the six months ended June 30, 2013 exceeded the exercise price total 798,678.  At June 30, 2012, potentially dilutive securities were excluded from the computation of weighted average shares outstanding due to their anti-dilutive effect

The following is a reconciliation of the weighted average number of common shares outstanding for the three and six months ended June 30, 2012 and 2013:

   

 

   

 

We have authorized 20,000,000 shares of preferred stock issuable in one or more series, none of which are issued or outstanding as of June 30, 2013.

   

 

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We operate in two different segments: household products and skin and hair care products. Our products are sold nationally and internationally (primarily Canada), directly through our sales force and indirectly through independent brokers, to mass merchandisers, drugstores, supermarkets, hardware stores and other retail outlets and to wholesale distributors. We have chosen to organize our business around these segments based on differences in the products sold.

Accounting policies for our segments are the same as those described in Note 1. We evaluate segment performance based on segment income or loss before income taxes.

The following provides information on our segments for the three and six months ended June 30:

   

 

   

 

The following is a reconciliation of segment information to consolidated information for the three and six months ended June 30:

   

 

Corporate assets noted above are comprised primarily of our cash and investments, and property and equipment not directly associated with the manufacturing, warehousing, shipping and receiving activities.

   

   

 

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Results of Operations

Our consolidated net sales for the first six months of 2013 were $9,233,800 versus $7,755,900 for the first six months of 2012, an increase of $1,477,900 or 19.1%. We saw a 52.2% increase in net sales of the skin and hair care products that we distribute for other companies and a 7.5% decrease in net sales of our own line of skin care products. We saw a 2.3% increase in net sales of our household products. The reasons for the foregoing changes in net sales of our products are described below.

Our consolidated net sales for the second quarter of 2013 were $4,502,100 versus $3,717,500 for the second quarter of 2012, an increase of $784,600 or 21.1%. We saw a 35.6% increase in net sales of the skin and hair care products that we distribute for other companies and a 15.6% increase in net sales of our own line of skin care products. We saw a 6.1% increase in net sales of our household products. The reasons for the foregoing changes in net sales of our products are described below.

Our net income for the first six months of 2013 was $63,700 versus a net loss of $400,600 in the first six months of 2012. Our net income for the second quarter of 2013 was $123,200 versus a net loss of $354,600 in the second quarter of 2012.  The net income for the first six months of 2013 compared to the net loss for the same period in 2012 resulted primarily from: (1) increased sales; (2) changes in our trade promotions to our customers; (3) changes in costs of sales; and (4) changes in operating expenses.

   

Summary of Results as a Percentage of Net Sales

   

 

Our gross margins may not be comparable to those of other companies because some companies include all of the costs related to their distribution network in cost of sales. In contrast, other companies, like us, exclude a portion of these costs (i.e., freight out to customers) from gross margin. Instead, we include them as part of selling expenses. See Note 1(o), “Operating Costs and Expenses Classification”, to our Consolidated Financial Statements (Unaudited) in Item 1.

   

Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012

   

Comparative Net Sales

   

 

 

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During the first six months of 2013, net sales of skin and hair care products accounted for 71.8% of consolidated net sales compared to 67.1% for the same period in 2012. The net sales of these products for that period were $6,626,700 in 2013 compared to $5,206,200 for the same period in 2012, an increase of $1,420,500 or 27.3%.

The net sales of our Alpha Hydrox^® and other manufactured skin care products were $2,011,500 in the first six months of 2013 versus $2,174,800 for the same period in 2012, a decrease of $163,300 or 7.5%. This decrease is primarily attributable to a decrease in the net sales of our Diabetic cream and shampoo during the first quarter of 2013 due primarily to: (1) a delay in orders for our Diabetic cream in March 2013 while we reduced the number of units in each case of our Diabetic cream; and (2) one of our customers returning Diabetic shampoo from certain of their stores that will no longer carry our Diabetic shampoo.

The net sales of Montagne Jeunesse and Batiste Dry Shampoo were $4,615,200 in the first six months of 2013 versus $3,031,400 for the same period in 2012, an increase of $1,583,800 or 52.2%. This increase is primarily attributable to increased distribution to new and existing customers and the improved placement of our products at existing customers. Our current distribution agreement with Church & Dwight Co. Inc. (“Church & Dwight”) relating to Batiste Dry Shampoo runs through December 31, 2014. We have already begun transition discussions with Church & Dwight in anticipation of the end of the agreement term. We are discussing with Church & Dwight the possibility of us entering into a new distribution agreement with them for certain segments of the marketplace in the United States.

Net sales of household products for the first six months of 2013 accounted for 28.2% of net sales compared to 32.9% for the same period in 2012. During the first six months of 2013, the sales of our household products were $2,607,100 as compared to $2,549,700 for the same period in 2012, an increase of $57,400 or 2.3%. The increase is attributable primarily to increased sales on certain of our wood care products due to television advertising and coupons and decreased customer returns and allowances.

We paid our customers a total of $993,200 in the first six months of 2013 versus $892,900 for the same period in 2012, an increase of $100,300 or 10.1% for trade promotions to support price features, displays and other merchandising of our products. This increase is primarily attributable to higher, but more efficient, spending on Montagne Jeunesse and Batiste Dry Shampoo to generate $1,583,800 or 52.2% more net sales in the first six months of 2013 compared to the first six months of 2012.

From time to time, our customers return products to us. For our household products, we permit returns only for a limited time. With regard to our skin and hair care products, returns are more frequent under an unwritten industry standard that permits returns for a variety of reasons. In the event a skin and hair care customer requests a return of a product, we will consider the request, and may grant such request in order to maintain or enhance our relationship with the customer, even in the absence of an enforceable right of the customer to do so. Typically, customers that return products to us take a credit on our invoice equal to the original sale price plus a handling charge ranging from 8-10% of the original sales price. Our product returns (as a percentage of net sales) were 1.4% percent for the first six months of 2013 compared to 0.9% for the same period in 2012. This increase is primarily attributable to one of our customers returning Diabetic shampoo from certain of their stores that will no longer carry our Diabetic shampoo.

On a consolidated basis, cost of sales was $4,998,000 during the first six months of 2013 compared to $4,287,100 for the same period in 2012, an increase of $710,900 or about 16.6%, on a net sales increase of 19.1%. As a percentage of consolidated net sales, cost of sales was 54.1% in the first six months of 2013 versus 55.3% for the same period in 2012.

The cost of sales for our skin and hair care products increased to 53.9% in the first six months of 2013 as compared to 50.6% for the same period in 2012. This increase reflects primarily a higher percentage of net sales of the skin and hair care products that we distribute for other companies which have a higher cost than the skin and hair care products that we manufacture.

The costs of sales for our household products decreased to 54.6% in the first six months of 2013 as compared to 64.7% for the same period in 2012. This decrease is primarily attributable to reducing the fill amount and reducing the number of colors in the graphics on our cans of Scott’s Liquid Gold^® Wood Cleaner and Preservative to reduce costs as well as a decrease in our costs for certain raw materials.

   

 

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Operating Expenses, Interest Expense and Other Income

   

 

Our operating expenses increased by $312,800 or 8.2% in the first six months of 2013 when compared to the same period in 2012. These expenses consist primarily of advertising, selling and general and administrative expenses, which are discussed below.

Advertising expenses for the first six months of 2013 were $419,100 compared to $195,400 for the same period in 2012, an increase of $223,700 or 114.5%, primarily related to television advertising and coupons for Scott’s Liquid Gold^® Wood Cleaner and Preservative in the first three months of 2013.

Selling expenses for the first six months of 2013 were $2,281,500 compared to $2,254,800 for the same period in 2012, an increase of $26,500 or 1.2%.

General and administrative expenses for the first six months of 2013 were $1,418,200 compared to $1,355,900 for the same period of 2012, an increase of $62,600 or 4.6%. This increase is primarily related to the sale of our Facilities and the need to incur a non-cash expense for brokerage commissions relating to the leasing of office space in the Facilities that were previously capitalized on our balance sheet.

Rental and other income for the first six months of 2013 of $21,400 included $11,000 of net rental receipts and $6,900 in interest earned on our cash reserves. This compares to total rental and other income for the first six months of 2012 of $64,600 which included $63,300 of net rental receipts and $800 in interest earned on our cash reserves. The decrease in rental income is a result of the sale of our Facilities on February 1, 2013, part of which were being leased to unaffiliated tenants.

Interest expense for the first six months of 2013 was $65,600 and included $17,400 in administrative fees incurred relative to the sale of accounts receivable invoices to Summit. Interest expense for the first six months of 2012 was $127,900 and included $45,500 in collateral management and/or administrative fees paid to Summit. The decrease in interest expense is due to us paying off our mortgage as a result of the sale of our Facilities on February 1, 2103 and maintaining since that time a zero balance on our line of credit with Summit.

   

   

Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012

   

Comparative Net Sales

   

 

During the second quarter of 2013, net sales of our skin and hair care products accounted for 71.4% of consolidated net sales compared to 67.4% for the same period in 2012. The net sales of these products for that period were $3,216,400 in 2013 compared to $2,505,300 for the same period in 2012, an increase of $711,100 or 28.4%.

 

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The net sales of our Alpha Hydrox^® and other manufactured skin care products were $1,044,300 in the second quarter of 2013 versus $903,600 for the same period in 2012, an increase of $140,700 or 15.6%. This increase is primarily attributable to increased distribution to existing customers and the improved placement of our products at existing customers as well as increased sales directly to consumers through our Neoteric Cosmetics website.

The net sales of Montagne Jeunesse and Batiste Dry Shampoo were $2,172,100 in the second quarter of 2013 versus $1,601,700 for the same period in 2012, an increase of $570,400 or 35.6%. This increase is primarily attributable to increased distribution to new and existing customers and the improved placement of our products at existing customers.

Net sales of household products for the second quarter of 2013 accounted for 28.6% of net sales compared to 32.6% for the same period in 2012. During the second quarter of 2013, the sales of our household products were $1,285,700 as compared to $1,212,200 for the same period in 2012, an increase of $73,500 or 6.1%.  The increase is attributable primarily to increased sales on certain of our wood care products due to television advertising and coupons and decreased customer returns and allowances.

We paid our customers a total of $448,100 in the second quarter of 2013 versus $536,500 for the same period in 2012, a decrease of $88,400 or 16.5% for trade promotions to support price features, displays and other merchandising of our products. This decrease is primarily attributable to recognizing greater benefits from our trade promotion spending on Montagne Jeunesse and Batiste Dry Shampoo in the second quarter of 2013 compared to the same period in 2012.

From time to time, our customers return products to us. For our household products, we permit returns only for a limited time. With regard to our skin and hair care products, returns are more frequent under an unwritten industry standard that permits returns for a variety of reasons. In the event a skin and hair care customer requests a return of a product, we will consider the request, and may grant such request in order to maintain or enhance our relationship with the customer, even in the absence of an enforceable right of the customer to do so. Typically, customers that return products to us take a credit on our invoice equal to the original sale price plus a handling charge ranging from 8-10% of the original sales price. Our product returns (as a percentage of net sales) were 1.7% percent for the second quarter of 2013 compared to 0.9% for the same period in 2012. This increase is primarily attributable to one of our customers returning Diabetic shampoo from certain of their stores that will no longer carry our Diabetic shampoo.

On a consolidated basis, cost of sales was $2,415,500 during the second quarter of 2013 compared to $2,097,800 for the same period in 2012, an increase of $317,800 or about 13.2%, on a net sales increase of 21.1%. As a percentage of consolidated net sales, cost of sales was 53.7% in the second quarter of 2013 versus 56.4% for the same period in 2012.

The cost of sales for our skin and hair care products increased to 53.7% in the second quarter of 2013 as compared to 50.8% for the same period in 2012. This increase reflects primarily a higher percentage of net sales of the skin and hair care products that we distribute for other companies which have a higher cost than the skin and hair care products that we manufacture.

The costs of sales for our household products decreased to 53.5% in the second quarter of 2013 as compared to 68.0% for the same period in 2012. This decrease is primarily attributable to reducing the fill amount and reducing the number of colors in the graphics on our cans of Scott’s Liquid Gold^® Wood Cleaner and Preservative to reduce costs as well as a decrease in our costs for certain raw materials.

   

Operating Expenses, Interest Expense and Other Income

   

 

Our operating expenses increased by $10,700 or 0.6% in the second quarter of 2013 when compared to the same period in 2012. These expenses consist primarily of advertising, selling and general and administrative expenses, which are discussed below.

Advertising expenses for the second quarter of 2013 were $123,600 compared to $107,800 for the same period in 2012, an increase of $15,700 or 14.6%. This increase is primarily due to limited television advertising for our Diabetic cream.

 

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Selling expenses for the second quarter of 2013 were $1,184,000 compared to $1,164,200 for the same period in 2012, an increase of $19,800 or 1.7%.

General and administrative expenses for the second quarter of 2013 were $643,800 compared to $668,600 for the same period of 2012, a decrease of $24,800 or 3.7%.

Rental and other income for the second quarter of 2013 of $4,000 included $0 of net rental receipts and $4,000 in interest earned on our cash reserves. This compares to total rental and other income for the second quarter of 2012 of $32,300 which included $31,500 of net rental receipts and $800 in interest earned on our cash reserves. The decrease in rental income is a result of the sale of our Facilities on February 1, 2013, part of which were being leased to unaffiliated tenants.

Interest expense for the second quarter of 2013 was $7,000 and included $7,000 in administrative fees incurred relative to the sale of accounts receivable invoices to Summit. Interest expense for the second quarter of 2012 was $66,000 and included $24,000 in collateral management and/or administrative fees paid to Summit. The decrease in interest expense is due to us paying off our mortgage as a result of the sale of our Facilities on February 1, 2103 and maintaining since that time a zero balance on our line of credit with Summit.

   

   

Liquidity and Capital Resources

Citywide Loan

On June 28, 2006, we entered into a loan with a fifteen year amortization with Citywide Banks  for $5,156,600 secured by the land, building and fixtures at our Denver, Colorado facilities. Interest on the bank loan was at the prime rate as published in The Wall Street Journal, adjusted annually each June. The loan required 180 monthly payments of approximately $38,200 each. The principal and accrued interest on the loan was repaid in full on February 1, 2013 at the closing of the sale of the Facilities.

   

Financing Agreements

Please see Note 1(f) to our Consolidated Financial Statements (Unaudited) for information on our financing agreements with Summit and Wells Fargo.

   

Liquidity

At June 30, 2013, we had $3.0 million in cash and the entire $1.5 million of our credit line with Summit was available for future borrowing. Our net cash used by operating activities in the first six months of 2013 increased by $2,434,200 to $2,682,600 as compared to 2012. For the first six months of 2013, the primary components of working capital (exclusive of cash that was $2,783,100 more at June 30, 2013 compared to December 31, 2012) that significantly affected operating cash flows are the following: (1) net trade receivables were $141,600 more at June 30, 2013 than at December 31, 2012 due primarily to increased gross sales activity and the timing of receiving payment; (2) obligations collateralized by those receivables and inventory were $1,201,400 less at June 30, 2013 than at December 31, 2012 due to repaying the outstanding balance on our credit line with Summit on February 4, 2013 following the sale of our Facilities; (3) inventory at June 30, 2013 was $879,300 more than at December 31, 2012 due primarily to increased gross sales activity; and (4) accounts payable and other accrued expenses at June 30, 2013 were $614,700 less than at December 31, 2012 due primarily to paying real estate property taxes for 2012 at the closing for the sale of our Facilities and paying certain other financial obligations to suppliers and vendors in February 2013.

We anticipate that our existing cash, especially given the cash proceeds from the sale of our Facilities, and our cash from operations, together with our current borrowing arrangements with Summit and Wells Fargo, will be sufficient to meet our cash requirements for the next 12 months.

During the first six months of 2013, we made total capital expenditures of approximately $160,800 as a result of the sale of our Facilities on February 1, 2013. These capital expenditures primarily included: (1) the construction of a specially designed room and sprinkler system for the storage of certain of our aerosol products necessitated when we sold the Facilities and had to vacate the building where they were previously stored; (2) the installation of a separate security system for the parts of the Facilities that we lease; and (3) the relocation of our telecom and data systems to the parts of the Facilities that we lease. We do not have any significant capital expenditures planned for the remainder of 2013.

   

 

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Not applicable.

   

ITEM 4.  CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures

As of June 30, 2013, we conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of June 30, 2013.

   

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during the six months ended June 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

   

PART II

   

ITEM 1A.  RISK FACTORS.

In addition to the other information set forth in this Report, you should carefully consider the factors discussed in Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, and subsequent quarterly reports on Form 10-Q which could materially affect our business, financial condition or future results.

   

ITEM 6.  EXHIBITS.

   

 

      

   

   

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

   

 

Date: August 9, 2013

   

   

 

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EXHIBIT INDEX

   

 

      

   

 

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