UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

For the fiscal year ended December 31, 2019

OR

Commission File Number 001-13458

 

SCOTT’S LIQUID GOLD-INC.

(Exact name of Registrant as specified in its Charter)

 

 

Registrant’s telephone number, including area code: (303) 373-4860

 

Securities registered pursuant to Section 12(b) of the Act.

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.10 Par Value

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ NO ☒

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ☐ NO ☒

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 ☒ NO ☐

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). YES ☒ NO ☐

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

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒

The aggregate market value of the common stock held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on June 30, 2019, was $13,635,868.

The number of shares of Registrant’s Common Stock outstanding as of March 12, 2020 was 12,461,963.

Certain information required by Part III is incorporated by reference to the Registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders to be filed within 120 days after December 31, 2019.

 

 

 

 

 

 

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CAUTIONARY NOTE ON FORWARD-LOOKING INFORMATION

This Annual Report on Form 10-K (this “Report”) contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, in addition to historical information. All statements, other than statements of historical facts, included in this Report that address activities, events, or developments with respect to our financial condition, results of operations, or economic performance that we expect, believe, or anticipate will or may occur in the future, or that address plans and objectives of management for future operations, are forward-looking statements. You can typically identify forward-looking statements by the use of words, such as “may,” “could,” “should,” “assume,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “potential,” “plan,” and other similar words. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

The forward-looking statements contained in this Report are based on management’s current expectations and are subject to uncertainty and changes in circumstances. We cannot assure you that future developments affecting us will be those that we have anticipated. 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:

We caution you that forward-looking statements are not guarantees of future performance and that actual results or performance may be materially different from those expressed or implied in the forward-looking statements. The forward-looking statements in this Report speak as of the filing date of this Report. Although we may from time to time voluntarily update our prior forward-looking statements, 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

(in thousands, except per share data)

 

Overview

Scott’s Liquid Gold-Inc., a Colorado corporation, was incorporated on February 15, 1954. In this Report the terms “we”, “us” or “our” refer to Scott’s Liquid Gold-Inc. and our subsidiaries, collectively. We develop, market, and sell high-quality, high-value household and personal care products. Our business is divided into two operating segments; household products and personal care products. Our family of brands include:

We also act as the exclusive brand distributor in certain markets. These products include:

Financial Information About Segments and Principal Products

The table set forth below shows the percentage of our net sales contributed by each operating segment during 2019 and 2018:

 

For more financial information on our operating segments, refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 11 to our Consolidated Financial Statements in Item 8.

Household Products

The principal products in our household products segment include:

Scott’s Liquid Gold^® Wood Care has been our core product since our inception. It has been sold in the United States for over 60 years. Unlike leading furniture polishes, our higher quality product contains natural oils that penetrate the wood’s surface to clean, replace lost moisture, minimize the appearance of scratches and bring out the natural beauty of wood. Our Scott’s Liquid Gold^® Floor Restore product is a quick and easy way to renew and protect hardwood floors.

On October 1, 2019, we acquired Kids N Pets^® brands, which includes Messy Pet^®. Founded in 1989, Kids N Pets^® brands are award winning, biodegradable, safe, nontoxic, stain and odor removing products targeted toward households with children and pets. These high-quality, high-value brands currently encompass 10 SKUs exceptional at controlling odor and cleaning up kid and pet accidents, and food and drink stains while being products that parents can feel safe using around their children and pets. Kids N Pets^®’

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primary channel of sales is through retail stores such as Walmart and Home Depot, and online on websites such as Amazon and Chewy.  

Personal Care Products

The principal products in our personal care products segment include:

Our Alpha^® Skin Care brand was one of the first to use alpha hydroxy acids (“AHAs”) in lines of facial care products, body lotion, and body wash. Products containing AHAs gently slough off dead skin cells to promote a healthier, more youthful appearance and help to diminish fine lines and wrinkles.

In 2016, we acquired the Prell^®, Denorex^® and Zincon^® brands of hair and scalp care products. Prell^® Shampoo, an iconic brand since 1947, is a classic clean shampoo for healthy hair. Our Denorex^® products are dermatologist-recommended medicated hair care products to control the symptoms of dandruff and other scalp conditions. Our Zincon^® product is a medicated anti-dandruff shampoo.

In the United States, we are the exclusive distributor for face and other skin care masque sachets manufactured by Montagne Jeunesse International Ltd. (“Montagne Jeunesse”). These masque sachets are currently sold under the trade name 7^th Heaven. These masques are sold for single use in a wide assortment of types and fragrances.

We have been a distributor in the United States for Batiste Dry Shampoo since 2009. Under our distribution agreement with the manufacturer of Batiste Dry Shampoo, Church & Dwight Co. Inc. (“Church & Dwight”), we are the exclusive specialty retail distributor in the United States of Batiste Dry Shampoo.  The specialty retailer channel includes primarily beauty supply stores, such as Ulta Beauty, Inc. (“Ulta”), our second largest customer, apparel retailers, and department stores. Dry shampoo is a quick and convenient way to refresh hair between washes.

Marketing and Distribution

We primarily market our products through: (1) trade promotions to support price features, displays, slotting fees and other merchandising of our products by our retail customers; (2) consumer marketing in print, social and digital media and television advertising; and (3) to a lesser extent, consumer incentives such as coupons and rebates.

Our products are sold nationally through our sales force and internationally (Canada and China) through independent distributors, to mass merchandisers, drugstores, supermarkets, hardware stores, e-commerce retailers, and other retail outlets and to wholesale distributors.

The table set forth below shows net sales to our significant customers as a percentage of segment and consolidated net sales during 2019 and 2018:

 

As is typical in our industry, we do not have long-term contracts with Walmart, Ulta, or any other retail customer.

We also use our websites for sales of our products directly to consumers. These sales accounted for approximately 2% of total net sales in 2019 and 2018, respectively.

Currently, our international sales are made to distributors who are responsible for the selling and marketing of the products, and we are paid for these products in United States dollars.

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From time to time, our customers return products to us. For our household products, we permit returns only for a limited time. For our personal care products, returns are accepted for a greater period of time in order to maintain or enhance our relationship with the customer. Typically, customers are granted a credit equal to the original sale price plus a handling charge.

Manufacturing and Suppliers

As of December 31, 2019, we owned and operated all our manufacturing equipment. Through March 10, 2020, we manufactured almost all our principal products at our facility located in Denver, Colorado.

On December 3, 2019, we entered into an Asset Purchase Agreement with Colorado Quality Products LLC (“Elevation”) pursuant to which Elevation will (i) acquire certain of our assets, which include all fixed assets utilized in the manufacturing and warehouse operations of the Company, (ii) assume all of the Company’s obligations under its existing real property leases, (iii) manufacture certain products of the Company at a competitive fixed rate, and (iv) pay cash consideration of $500,000 (collectively, the “Elevation Transaction”). See Note 2 of Item 8 “Financial Statements and Supplementary Data.”

On March 10, 2020, we consummated the Elevation Transaction, which included a manufacturing and supply agreement under which Elevation will manufacture certain of our products while we continue to evaluate the cost-effectiveness of potential outsourcing partners. We expect to move product lines to other outsourcing partners in the future.

Under our distribution agreement with Montagne Jeunesse, we are the exclusive distributor of 7^th Heaven skin care sachets in the United States. The current term of our distribution agreement renewed for a two-year term on September 15, 2019 and will continue to automatically renew unless terminated at the end of any such term upon three months prior notice. Under the terms of the distribution agreement, we agreed to develop, promote and sell the products in the United States. The initial pricing terms for the products were negotiated with Montagne Jeunesse. Any changes to the prices must be mutually agreed to by both parties and must be agreed to at least six months in advance.

Under our distribution agreement with Church & Dwight, we are the exclusive distributor of Batiste Dry Shampoo products in the specialty retailer channel in the United States. The specialty retailer channel includes primarily beauty supply stores, such as Ulta, apparel retailers and department stores. Church & Dwight retained the rights to sell Batiste products to the remainder of the market in the United States. The distribution agreement with Church & Dwight provides that we will not be permitted to manufacture, distribute or sell any products that are competitive with Batiste Dry Shampoo products. The initial pricing terms for the Batiste products were negotiated with Church & Dwight but may be increased by Church & Dwight at any time upon 90 days’ prior written notice of any price increase. On August 1, 2019, we renewed our distribution agreement with Church & Dwight for one year from January 1, 2020 to December 31, 2020. We have been a distributor for Church & Dwight since 2009 and have renewed our distribution agreement four times.

Competition

Both the household and personal care product categories are highly competitive and innovative. We compete in both categories against a range of competitors, most of which are significantly larger and have greater financial resources, name recognition, innovation capabilities, and product and market diversification than us. We compete in both categories primarily on the basis of quality, brand recognition, and the distinguishing characteristics of our products. The wood care product category is dominated by a small number of companies that are significantly larger than us and each of these competitors produces several competing products. In the personal care category, several of our competitors are also significantly larger than us and each of these competitors produces several competing products.

Regulation

We are subject to various federal, state and local laws and regulations that pertain to the types of consumer products that we manufacture and sell. Many chemicals used in consumer products, some of which are used in several of our product formulations, have come under scrutiny by various state governments and the Federal government. These chemicals are called volatile organic compounds (“VOCs”). All of our products currently meet the most stringent VOC regulations and may be sold throughout the United States. Many of our skin care products, several of which contain AHAs, are considered cosmetics within the definition of the Federal Food Drug and Cosmetic Act (the “FFDCA”). Our cosmetic products are subject to the regulations under the FFDCA and the Fair Packaging and Labeling Act. The relevant laws and regulations are enforced by the FDA. We believe that we are producing and marketing all of our products in compliance with all applicable laws and regulations in the markets in which we participate.

Our production facility is also subject to Federal, state, and local regulations governing water quality, air quality, and waste related to stationary sources. We have obtained the necessary permits from the state of Colorado, which implements the delegated Federal programs. These programs regulate the emissions, discharges, and waste generated in the production of our products.  Like the Federal standards for our products, we continue to monitor the standards and take measures to comply with them.

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The laws and regulations applicable to our production facility will no longer impact us following the consummation of the Elevation Transaction.

Our advertising is subject to regulation under the Federal Trade Commission Act and related regulations, which prohibit false and misleading claims in advertising. Changes in these regulations, or interpretations or enforcement of these regulations, could adversely affect our profitability, result in regulatory actions, or private or derivative claims.

Our international sales are primarily conducted in China and we rely on the efforts of our exclusive distributor in the PRC to market and sell our products there. As such, we may be impacted by regulations, economic conditions, and tariffs imposed by the PRC. In 2019, we were impacted by regulatory changes imposed on over-the-counter (“OTC”) products by the PRC’s National Medical Products Administration (“NMPA”).

Employees

As of December 31, 2019, we employed 66 people, of which 36 work in plant and production related functions and 30 work in administrative, sales and advertising functions. No contracts exist between us and any union. We consider our employee relations to be satisfactory. The compensation of our executive officers is subject to annual review by the Compensation Committee of our Board of Directors.

On March 10, 2020, our number of employees decreased as a result of our Elevation Transaction.

Patents and Trademarks

At present, we own one patent for our Neoteric Diabetic^® Healing Cream. Additionally, we actively use our registered trademarks for Scott’s Liquid Gold^®, Alpha^® Skin Care, Prell^®, Denorex^®, Zincon^®, and Neoteric^® in the United States and have registered trademarks in a number of additional countries. Our registered trademarks protect names and logos relating to our products as well as the design of boxes for certain of our products.

Public Information

Our website address is www.slginc.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. We make available, free of charge, on our website our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, proxy statements, interactive data files posted pursuant to Rule 405 of Regulation S-T, our Current Reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) as soon as reasonably practicable after we have electronically filed such material with, or furnished it to, the United States Securities and Exchange Commission (the “SEC”). You may also access and read our filings without charge through the SEC’s website at www.sec.gov.

We will also provide to any person without charge, upon request, a copy of our Code of Business Conduct and Ethics Policy. A request for our reports filed with the SEC or our Code of Business Conduct and Ethics Policy may be made to: Corporate Secretary, Scott’s Liquid Gold-Inc., 4880 Havana Street, Suite 400, Denver, Colorado 80239.

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The following is a discussion of certain risks that may affect our business. These risks may negatively impact our existing business, future business opportunities, our financial condition or our financial results. In such case, the trading price of our common stock could also decline. Additional risks and uncertainties not presently known to us, or that we currently see as immaterial, may also negatively impact our business.

A loss of one or more of our major customers could have a material adverse effect on our product sales.

For a majority of our sales, we are dependent upon a small number of major retail customers, including Walmart and Ulta. The easy access of consumers to our products is dependent upon these major retail stores and other retail stores carrying our products. The willingness of retail customers to carry any of our products depends on various factors, including the level of sales of the product at their stores. In addition, private label products sold by retail trade chains, which are typically sold at lower prices than branded products, are a source of competition for certain of our product lines.

Any declines in sales of our products to consumers could result in the loss of retail customers and a corresponding decrease in the distribution of the products, as well as increased costs related to any markdown or return of our products. It is uncertain whether the consumer base served by these stores would purchase our products at other retail stores.

A significant part of our sales of personal care products are represented by the 7^th Heaven sachet products and Batiste Dry Shampoo products, both of which depend upon the continuation of our distributorship agreements with the manufacturers of these products.

If our distribution agreements were terminated with Montagne Jeunesse or Church & Dwight, we would no longer be able to distribute 7^th Heaven products for Montagne Jeunesse or Batiste Dry Shampoo products for Church & Dwight and sales in our personal care segment would be adversely affected. Sales of our distributed products represent a significant portion of our consolidated net sales, and the loss of those products could affect our relationships with customers who purchase those products from us.

On August 1, 2019, we renewed our distribution agreement with Church & Dwight for one year from January 1, 2020 to December 31, 2020. We have been a distributor for Church & Dwight since 2009 and have renewed our distribution agreement four times. The current term of our Montagne Jeunesse distribution agreement renewed for a two-year term on September 15, 2019.

Our international operations in China expose us to a number of risks.

We have limited experience with distribution in China.  There is both cost and risk associated with establishing, developing, and maintaining international sales operations, and promoting our brand internationally. The PRC’s economic, political, and social conditions, and its government policies, could adversely affect our business. We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could have a material adverse effect on our operating results.

Our international operations also subject us to changes in trade policies and agreements and other foreign or domestic legal and regulatory requirements, including those resulting in potentially adverse tax consequences or the imposition of onerous trade restrictions such as tariffs, sanctions, and price controls. Any changes in these international trade policies could adversely affect our profitability and stock price.

A continued change in the consumer product retail market cause our sales to decline.

Our performance depends upon the general health of the economy and of the retail environment in particular. Consumer products, such as those marketed by us, are increasingly being sold by club stores, dollar stores, mass merchandisers, e-commerce retailers and subscription services. The retail environment is changing with the growth of alternative retail channels and this could significantly change the way traditional retailers do business. If these alternative retail channels were to take significant market share away from traditional retailers or we are not successful in these alternative retail channels, our margins and results of operations may be negatively impacted.

In both personal care and household products, our competitors include some of the largest consumer products companies in the United States.

The markets in which our products compete are intensely competitive, and many of the other competitors in these markets are larger multi-national consumer products companies. These competitors have much greater financial, technical, and other resources

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than us, and as a result, are able to regularly introduce new products and spend considerably more on advertising. The distribution and sales of our products can be adversely impacted by the actions of our competitors, and we may have little or no ability to take action to prevent or mitigate these adverse impacts.

We have limited resources to promote our products with advertising and marketing effectiveness.

We believe the growth of our net sales is dependent upon our ability to introduce our products to current and new consumers through advertising and marketing. At present, we have limited resources compared to many of our competitors to spend on advertising and marketing our products. Advertising and marketing can be important in reaching consumers, although the effectiveness of any particular advertisement and marketing cannot be predicted. Additionally, we may not be able to obtain optimal effectiveness at our current advertising and marketing budget. Our limited resources to promote our products through advertising and marketing may adversely affect our net sales and operating results.

 

Unfavorable and uncertain economic conditions could adversely affect our profitability.

Unfavorable and uncertain economic conditions in the past have adversely affected, and in the future may adversely affect, consumer demand for some of our products, resulting in reduced sales volume and a decrease in our overall profitability. Factors that can affect consumer demand for our products include rates of unemployment, consumer confidence, health care costs, fuel and other energy costs and other economic factors affecting consumer spending behavior.

Our products are subject to trucking costs, both in delivery to us at our production facility as well as transportation to our customers. As a result, we are exposed to volatility in the freight industry that could affect our costs, including changes in regulations and labor costs. Any increases in transportation costs could adversely affect our profitability if we are not able to pass those costs on to our customers.

Sales of our existing products are affected by changing consumer preferences.

Our primary market is retail stores in the United States which sell to consumers or end users in the mass market. Consumer preferences can change rapidly and are affected by new competitive products. This situation is true for both personal care and household products. Any changes in consumer preferences can materially affect the sales of our products and the results of our operations.

Our future performance and growth is dependent, in part, on the introduction of new or acquired products that are successful in the marketplace.

Our future performance and growth is partially dependent on our ability to successfully identify, develop and introduce new products and product line extensions. The successful development and introduction of new products involves substantial research, development, marketing and promotional expenditures, which we may be unable to recover if the new products do not gain widespread market acceptance.

We have pursued and may continue to pursue acquisitions of brands or businesses. Acquisitions involve numerous potential risks, including, among other things, the successful integration of the acquired products or brands and realization of the full extent of expected benefits or synergies. Acquisitions could also result in additional debt, exposure to liabilities, the potential impairment of goodwill or other intangible assets, or transaction costs. Any of these risks, should they materialize, could adversely impact our operating results.

We face the risk that raw materials for our products may not be available or that costs for these materials will increase.

We obtain our raw materials from third party suppliers, some of which are sole source suppliers. We have no long-term contracts with our suppliers and are subject to cost increases. We may not have sufficient raw materials for production if there is a shortage in raw materials or one of our suppliers terminates our relationship. In addition, changing suppliers could involve delays that restrict our ability to manufacture or buy products in a timely manner to meet delivery requirements of our customers. Our suppliers can also be subject to the same risk with their vendors.

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Changes in the regulation of our products, including environmental regulations, could have an adverse effect on the distribution, cost or function of our products.

Regulations affecting our products include requirements of the FDA and NMPA for cosmetic products and environmental regulations. In the past, the FDA has mentioned the treatment of products with AHAs as drugs, which could make our production and sale of certain Alpha^® Skin Care products more expensive or prohibitive. Also, in the past, we have been required to change the formulation of our household products to comply with environmental regulations and may be required to do so again in the future if the applicable regulations are further amended. Most recently, in 2019, we were impacted by regulatory changes imposed on OTC products by the PRC’s NMPA, which negatively impacted our sales during the year.

Labeling practices in our industry have recently experienced an increase of warning letters admonishing cosmetics manufacturers for promotional claims on their websites and product labels deemed by the FDA to blur the line between “cosmetics” and “drugs.” The increase of warning letters by the FDA has also triggered a wave of follow-on class action lawsuits against cosmetic manufacturers in general, including manufacturers not singled out via FDA warning letters. Any claims levied against us could have an adverse effect on our operating results.

Any adverse developments in litigation could have a material impact on us.

We are subject to lawsuits from time to time in the ordinary course of business. While we expect those lawsuits not to have a material effect on us, an adverse development in any such lawsuit or the insurance coverage for a lawsuit could materially and adversely affect our operating results.

Any loss of our key executives or other personnel could harm our business.

Our success has depended on the experience and continued service of our executive officers and key employees. If we fail to retain these officers or key employees, our ability to continue our business and effectively compete may be substantially diminished.

Our stock price can be volatile and can decline substantially.

Our stock is traded on the OTC Bulletin Board. The volume of trades in our stock varies from day to day but is relatively limited. As a result, any events can result in volatile movements in the price of our stock and can result in significant declines in the market price of our stock.

We rely on trademark, copyright, and trade secret laws, which may not be sufficient to protect our intellectual property.

We rely on a combination of laws, such as copyright, trademark and trade secret laws, as well as confidentiality provisions and limited licenses, to establish and protect our intellectual property. We have registered U.S. and foreign country trademarks, and HK NFS has contractually agreed to undertake steps to prevent counterfeiting of our products and to otherwise protect our trademarks in the PRC. These forms of intellectual property protection are critically important to our ability to establish and maintain our competitive position. However, it is possible that laws, contractual restrictions, and other efforts may not be sufficient to prevent misappropriation of our property or to deter others from developing similar intellectual property.

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.

In the ordinary course of our business, we collect and store sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers, and business partners on our networks. The secure processing, maintenance and transmission of this information is critical to our operations. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen, resulting in legal claims or proceedings, which could disrupt our operations and damage our reputation, adversely affect our operating results and stock price.

 

We may from time to time expand our business through acquisitions, which could disrupt our business.

 

We have completed, and may pursue in the future, acquisitions of businesses or assets that are complementary to our business. Such acquisitions involve a number of risks, including:

                          

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If we fail to properly evaluate acquisitions, we may not achieve the anticipated benefits of such acquisitions, we may incur costs in excess of what is anticipated, and management resources and attention may be diverted from other necessary or valuable activities. Any acquisition may not result in short-term or long-term benefits to us. If we are unable to integrate or successfully manage any business that we acquire, we may not realize anticipated cost savings, improved efficiencies or revenue growth, which may result in reduced profitability or operating losses.

 

Manufacturing relationships with third parties.

 

We currently outsource certain of our manufacturing to one or more third parties, which we intend to expand. Failure by one or more of these third parties to complete activities on schedule or in accordance with our expectations, meet their contractual or other obligations to us, or comply with applicable laws or regulations, or any disruption in the relationships between us and one or more of these third parties, could delay or prevent the development, approval, manufacturing, or commercialization of our products, could expose us to suboptimal quality of service delivery or deliverables, could result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or reputational harm, all with potential negative implications for our product pipeline and business.

 

Our sales in China may be materially adversely impacted due to the coronavirus 2019 (“COVID-19”) outbreak.

 

Our business could be adversely affected by the effects of a widespread outbreak of contagious disease, including the recent outbreak of respiratory illness caused by COVID-19, first identified in Wuhan, China. We have operations in China related to the sale of our products. In an effort to halt the outbreak of COVID-19, the Chinese government has placed significant restrictions on travel within China, leading to extended business closures. These travel restrictions and business closures could adversely impact our operations in China, including our ability to sell or distribute our products, as well as cause temporary closures of the facilities of our distributors or customers. Any disruption of our distributors or customers could impact our global sales and operating results. We cannot at this time accurately predict what effects these conditions will have on our operations, including due to uncertainties relating to the ultimate geographic spread of the virus, the severity of the disease, the duration of the outbreak, and the length of the travel restrictions and business closures imposed by the Chinese government and governments of other impacted countries. In addition, a significant outbreak of contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and impact our operating results.

 

Not applicable.

 

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We lease facilities in Denver, Colorado that house our corporate headquarters. Please see Note 7 to our Consolidated Financial Statements in Item 8 for more information on our facilities.

 

ITEM 3.          LEGAL PROCEEDINGS.

We are subject to lawsuits from time to time in the ordinary course of business. While we expect those lawsuits not to have a material effect on us, an adverse development in any such lawsuit or the insurance coverage for a lawsuit could materially and adversely affect our financial condition and cash flow.

 

Not applicable.

 

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PART II

(in thousands, except per share data)

 

Market Information

Our $0.10 par value common stock is traded on the OTC Bulletin Board (an electronic inter-dealer quotation system) under the ticker symbol “SLGD.” Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The high and low prices of our common stock as traded on the OTC Bulletin Board were as follows:

 

Shareholders of Record

As of March 12, 2020, based on inquiry, we had approximately 637 shareholders of record.

Dividends

We did not pay any cash dividends during the two most recent fiscal years. No decision has been made as to future dividends.

 

Not applicable.

 

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company’s consolidated financial statements. This Item 7 contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risk, uncertainties, and other factors that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. Please refer to "Item 1A. Risk Factors" for a discussion of the uncertainties, risks and assumptions associated with these statements.

Executive Overview

Our Business

Scott’s Liquid Gold-Inc. exists to positively impact consumers’ lives in the markets we serve and create shareholder value. We develop, market, and sell high-quality, high-value household and personal care products nationally and internationally to mass merchandisers, drugstores, supermarkets, hardware stores, e-commerce retailers, other retail outlets, and to wholesale distributors. Our long history of selling household products has generated strong consumer and customer loyalty for our brands.

On an ongoing basis, management focuses on a variety of key indicators to monitor our business health and performance. These key indicators include (but are not limited to) the following:

To achieve our business and financial objectives, we focus on initiatives to drive the growth of the key indicators above. Our ability to drive and generate growth depends on consumer demand for our products and retail customers’ willingness to carry our products in a competitive marketplace. In this environment, we intend to continue to focus on our key indicators to remain competitive, sustain our current level of operations, and drive further growth in future periods.

Outlook

Looking forward, we are focused on both short- and long-term strategies that we believe will enhance our financial health and deliver shareholder value. While the marketplace in which we operate has always been highly competitive, we expect that the category challenges and the level of competition will continue to rise. We believe that some of the trends in our business and industry could adversely affect our profitability, including the following:

We believe our history of providing high-quality, high-value products to consumers positions us to meet the challenges in our marketplace by continuing to focus on the following key priorities in 2020:

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Results of Operations

 

Net (loss) income changed primarily due to the following:

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Segment Results

We implemented a change in the allocation of certain operational and administrative expenses to more precisely match the activity to which they relate. For comparison purposes, we re-allocated 2018 results to reflect the revised allocation of these costs.

The following tables show comparative net sales, gross margin, gross profit, income (loss) from operations, volume and percentage changes for our household and personal care products between periods:

Household products

 

 

Personal care products

 

Liquidity and Capital Resources

Financing Agreements

Please see Note 6 to our Consolidated Financial Statements in Item 8 for information on our Credit Agreement with Chase.

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Liquidity and Changes in Cash Flows

At December 31, 2019, we had our maximum commitment of $4,000 available and unused on our revolving credit facility and approximately $1,094 in cash on hand, down $5,138 from December 31, 2018 due to our acquisition of Kids N Pets, which will help grow our household segment.

The following is a summary of cash provided by or used in each of the indicated types of activities:

 

We anticipate that our existing cash and our cash flow from operations, together with our current Credit Agreement with Chase, will be sufficient to meet our cash requirements for the 12 months following the filing date of this Report. During 2020, we expect to incur additional capital expenditures associated with the implementation of our ERP system to begin in the latter part of 2020, which will be partially offset by decreased purchases of property and equipment and proceeds from sale of equipment.

 

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to use judgment and make estimates. The level of uncertainty in estimates and assumptions increases with the length of time until the underlying transactions are completed. Actual results could ultimately differ from those estimates. The accounting policies that are most critical in the preparation of the Company’s Consolidated Financial Statements are those that are both important to the presentation of the Consolidated Financial Statements and require significant or complex judgments and estimates on the part of management.

Revenue Recognition

Our revenue recognition policy is significant because the amount and timing of revenue is a key component of our results of operations. See Note 1(m), “Revenue Recognition” in our Consolidated Financial Statements for additional discussion.

Intangible Assets and Goodwill

Our intangible assets and goodwill policy is significant because the amount is a significant component of our consolidated balance sheets. Further, determining estimated useful lives of our intangible assets is subjective and can change the impact on our results of operations. See Note 1(i), “Intangible Assets and Goodwill” in our Consolidated Financial Statements for additional discussion.

Income Taxes

Our income taxes policy is significant because our estimate for taxes is a key component of our results of operations. See Note 1(l), “Income Taxes” in our Consolidated Financial Statements for additional discussion.

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Recently Issued Accounting Pronouncements

For information on recently issued accounting pronouncements, see Note 1(q), “Recently Issued Accounting Pronouncements,” to our Consolidated Financial Statements in Item 8.

 

Subsequent Events

On March 10, 2020, we consummated the Elevation Transaction pursuant to which Elevation will (i) acquire certain assets of the Company, which include all fixed assets utilized in the manufacturing and warehouse operations of the Company, (ii) assume all of the Company’s obligations under its existing real property leases, (iii) manufacture certain products of the Company at a competitive fixed rate, and (iv) pay cash consideration of $500,000

 

Not applicable.

 

 

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Report of Independent Registered Public Accounting Firm

 

To the Shareholders and Board of Directors of

Scott’s Liquid Gold - Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Scott’s Liquid Gold - Inc. (the “Company”) as of December 31, 2019, and 2018, the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years ended December 31, 2019, and 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and 2018, and the results of its operations and its cash flows for each of the years ended December 31, 2019, and 2018, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Plante & Moran, PLLC

 

We have served as the Company’s auditor since 2003.

 

 

March 17, 2020

Denver, Colorado

 

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SCOTT’S LIQUID GOLD-INC. & SUBSIDIARIES

Consolidated Statements of Operations

(in thousands, except per share data)

 

 

See accompanying notes to these Consolidated Financial Statements.

 

 

 

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SCOTT’S LIQUID GOLD-INC. & SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except par value amounts)

 

 

See accompanying notes to these Consolidated Financial Statements.

 

 

 

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SCOTT’S LIQUID GOLD-INC. & SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

(in thousands)

 

 

See accompanying notes to these Consolidated Financial Statements.

 

 

 

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SCOTT’S LIQUID GOLD-INC. & SUBSIDIARIES

Consolidated Statements of Cash Flows

(in thousands)

 

 

See accompanying notes to these Consolidated Financial Statements.

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SCOTT’S LIQUID GOLD-INC. & SUBSIDIARIES

Notes to Consolidated Financial Statements

(in thousands, except per share data)

 

Note 1. Organization and Summary of Significant Accounting Policies

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, market, and sell quality household and personal care products. We are also a distributor in the United States of personal care products manufactured by two other companies. Our business is comprised of two segments; household products and personal 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 accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, the accompanying consolidated financial statements contain all adjustments and eliminations, consisting only of normal recurring adjustments necessary for a fair presentation in conformity with GAAP.

Due to changes in our business as we acquired and began manufacturing new products in recent periods, the Company implemented a change in the allocation of certain operational and administrative expenses between our two operating segments to more accurately reflect our operational activity. For comparison purposes, the Company presented 2018 results to reflect the revised allocation of these costs. This segment reporting change has no impact on our operating results. See Note 11 “Segment Information,” of the Notes to the Consolidated Financial Statements for further information.

The preparation of financial statements in conformity with GAAP 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, intangible asset useful lives and amortization method, fair value of assets acquired in business combinations, 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.

Inventories consist of raw materials and finished goods and are stated at the lower of cost (first-in, first-out method) or net realizable value, which is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. We estimate an inventory reserve, which is generally not material to our financial statements, for slow moving and obsolete products and raw materials based upon, among other things, an assessment of historical and anticipated sales of our products. In the event that actual results differ from our estimates, the results of future periods may be impacted.

Property 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 20 years. 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. Maintenance and repairs are expensed as incurred. Improvements that extend the useful lives of the asset or provide improved efficiency are capitalized.

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Lease assets and lease liabilities are recognized at the commencement of an arrangement where it is determined at inception that a lease exists. Lease assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. These assets and liabilities are initially recognized based on the present value of lease payments over the lease term calculated using our incremental borrowing rate generally applicable to the location of the lease asset, unless the implicit rate is readily determinable. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised.

Certain nonlease components, such as maintenance and other services provided by the lessor, are included in the valuation of the lease. Leases with an initial term of 12 months or less, which are not material to our financial statements, are not recorded on the balance sheet, and the expense for these short-term leases and for operating leases is recognized on a straight-line basis over the lease term. Lease agreements with lease and nonlease components are combined as a single lease component.

Intangible assets consist of customer relationships, trade names, formulas, batching processes, and a non-compete agreement.  The fair value of the intangible assets is amortized over their estimated useful lives and range from a period of five to 25 years. Goodwill consists of the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired.

Internal-use software costs recognized as an intangible asset relates to capitalizable costs of computer software obtained for internal-use as defined by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 350-40-30-1. All other internal-use software costs are expensed as incurred by the Company. Amortization will be recorded straight-line over the estimated useful life of the software once the software is ready for its intended use. As of December 31, 2019, our internal-use software was not ready for its intended use. The estimated useful life for internal-use software will be determined and periodically reassessed based on considerations for obsolescence, technology, competition, and other economic factors.

Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment tests, and in certain circumstances these assets are written down to fair value if impaired. In accordance with ASC 350, on December 31, 2019, we assessed and determined that our goodwill and intangible assets were not impaired.

Financial instruments which potentially subject us to concentrations of credit risk include cash and cash equivalents and accounts receivable. We maintain our cash balances in the form of bank demand deposits with financial institutions that we believe are creditworthy. As of December 31, 2019, and 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, which is generally not material to our financial statements, 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.

We apply the acquisition method of accounting for a business combination. In general, this methodology requires us to record assets acquired and liabilities assumed at their respective fair values at the date of acquisition. Any amount of the purchase price paid that is in excess of the estimated fair value of the net assets acquired is recorded as goodwill. For certain acquisitions, we also record a liability for contingent consideration based on estimated future business performance. We monitor our assumptions surrounding these estimated future cash flows and, if there is a significant change, would record an adjustment to the contingent consideration liability and a corresponding adjustment to either income or expense. We determine fair value using widely accepted valuation techniques, primarily discounted cash flow and market multiple analyses. These types of analyses require us to make assumptions and estimates regarding industry and economic factors, the profitability of future business strategies, discount rates and cash flow.

If actual results are not consistent with our assumptions and estimates, or our assumptions and estimates change due to new information, we may be exposed to an impairment charge in the future. If the contingent consideration paid for any of our acquisitions differs from the amount initially recorded, we would record either income or expense associated with the change in liability.

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Income taxes reflect the tax effects of transactions reported in the Consolidated Financial Statements and consist of taxes currently payable plus deferred income taxes related to certain income and expenses recognized in different periods for financial and income tax reporting purposes. Deferred income tax assets and liabilities are recognized for the future income tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases. A valuation allowance is established 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 or expense. 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 Consolidated Statements of Income or accrued on the Consolidated Balance Sheets.

The effective tax rate for the years ended December 31, 2019 and 2018 was 43.8% and 21.7% respectively, which can differ from the statutory income tax rate due to permanent book-to-tax differences.

Our revenue recognition policy is significant because the amount and timing of revenue is a key component of our results of operations. Certain criteria are required to be met in order to recognize revenue. If these criteria are not met, then the associated revenue is deferred until it is met. When consideration is received in advance of the delivery of goods or services, a contract liability is recorded. Our revenue contracts are identified when purchase orders are received and accepted from customers and represent a single performance obligation to sell our products to a customer.

Net sales reflect the transaction prices for contracts, which include products shipped at selling list prices reduced by variable consideration. Variable consideration includes estimates for expected customer allowances, promotional programs for consumers, and sales returns. Based on our customer-by-customer history, our variable consideration estimates are generally accurate and subsequent adjustments are generally immaterial.

Variable consideration is primarily comprised of customer allowances. Customer allowances primarily include reserves for trade promotions to support price features, displays, slotting fees, and other merchandising of our products to our customers. Promotional programs for consumers primarily include coupons, rebates, and certain other promotional programs, and do not represent a significant portion of variable consideration. The costs of customer allowances and promotional programs for consumers are estimated using either the expected value or most likely amount approach, depending on the nature of the allowance, using all reasonably available information, including our historical experience and current expectations. Customer allowances and promotional programs for consumers are reflected in the transaction price when sales are recorded. We may adjust our estimates based on actual results and consideration of other factors that cause allowances. In the event that actual results differ from our estimates, the results of future periods may be impacted.

Sales returns are generally not material to our financial statements, and do not comprise a significant portion of variable consideration. Estimates for sales returns are based on, among other things, an assessment of historical trends, information from customers, and anticipated returns related to current sales activity. These estimates are established in the period of sale and reduce our revenue in that period.

Sales are recorded at the time that control of the products is transferred to customers. In evaluating the timing of the transfer of control of products to customers, we consider several indicators, including significant risks and rewards of products, our right to payment, and the legal title of the products. Based on the assessment of control indicators, sales are generally recognized when products are delivered to customers.

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.

Customer allowances for trade promotions and allowance for doubtful accounts at December 31 were as follows:

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Trade promotions to our customers and incentives such as coupons to our consumers are deducted from gross sales and totaled $3,309 and $3,335 for the years ended December 31, 2019 and 2018, respectively.

We expense advertising costs as incurred.

We account for share based payments by recognizing compensation expense based upon the estimated fair value of the awards on the date of grant. We determine the estimated grant-date fair value of stock options with only service conditions using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made regarding the components of the model, including the estimated fair value of underlying common stock, risk-free interest rate, volatility, expected dividend yield and expected option life. Changes to the assumptions could cause significant adjustments to the valuation. We recognize compensation costs ratably over the vesting period using the straight-line method, which approximates the service period.

The Company issues restricted stock unit ("RSUs") awards with restrictions that lapse upon the passage of time (service vesting) and satisfaction of market conditions targeted to our Company’s stock price. For those restricted stock unit awards with only service vesting, the Company recognizes compensation cost on a straight-line basis over the service period. For awards with both market and service conditions, the Company starts recognizing compensation cost over the requisite service period, with the effect of the market conditions reflected in the calculation of the award's fair value at grant date. The Company values awards with only service vesting requirements based on the grant date share price. The Company values awards with market and service conditions using a Monte Carlo simulation. The Company determines the requisite service period for awards with both market and service conditions based on the longer of the explicit service period and the derived service period. Stock awards that contain market vesting conditions are included in the computations of diluted EPS reflecting the average number of shares that would be issued based on the highest 30-day average market price at the end during the reporting periods, if their effect is dilutive. If the condition is based on an average of market prices over some period of time, the corresponding average for the period is used.

Cost of sales includes costs associated with manufacturing and distribution including labor, materials, freight-in, purchasing and receiving, quality control, repairs, maintenance, and other indirect costs, as well as warehousing and distribution costs. We classify freight-out as selling expenses. Other selling expenses consist primarily of costs for sales and sales support personnel, brokerage commissions and promotional costs. Freight-out costs included in selling expenses totaled $2,523 and $2,791, for the years ended December 31, 2019 and 2018, 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.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments —Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). This guidance, as amended by subsequent ASUs on the topic, requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. This guidance is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently evaluating to determine the full impact at adoption, but ASU 2016-13 is not expected to have a material impact on our financial statements.

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). The new guidance modifies disclosure requirements related to fair value measurement.  The amendments in ASU 2018-13 are effective for fiscal years, and interim periods

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within those fiscal years, beginning after December 15, 2019.  Implementation on a prospective or retrospective basis varies by specific disclosure requirement.  Early adoption is permitted. The standard also allows for early adoption of any removed or modified disclosures upon issuance of this ASU while delaying adoption of the additional disclosures until their effective date. The Company is currently evaluating to determine the full impact at adoption, but ASU 2018-13 is not expected to have a material impact on our financial statements.

In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). The new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. For public companies, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021, with early adoption permitted. An entity that elects to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. ASU 2019-12 is not expected to have a material impact on our financial statements.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). This guidance, as amended by subsequent ASUs on the topic, requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with such classification affecting the pattern of expense recognition in the income statement.

Effective January 1, 2019, we adopted the guidance and elected the option not to restate comparative periods. We also elected the package of practical expedients within the standard which permits us not to reassess prior conclusions about lease identification, lease classification, and initial direct costs. Additionally, we elected not to separate lease and non-lease components for all leases. The adoption of the new standard resulted in the recognition of operating lease liabilities on January 1, 2019 of approximately $141, with corresponding right of use assets, and no material cumulative effect adjustment to our Consolidated Balance Sheets, and $2,862 of net assets obtained in exchange for new operating lease liabilities during the year ended December 31, 2019. Adoption of the new standard did not have a material impact on our Consolidated Statements of Income or Cash Flows.

Note 2. Inventories

Inventories, consisting of materials, labor and overhead at December 31 were comprised of the following:

 

 

Note 3. Property and Equipment

On December 3, 2019, we entered into an Asset Purchase Agreement with Colorado Quality Products LLC (“Elevation”) pursuant to which Elevation will (i) acquire certain of our assets, which include all fixed assets utilized in the manufacturing and warehouse operations of the Company, (ii) assume all of the Company’s obligations under its existing real property leases, (iii) manufacture certain products of the Company at a competitive fixed rate, and (iv) pay cash consideration of $500 (collectively, the “Elevation Transaction”). The Elevation Transaction closed on March 10, 2020.

We concluded that the property and equipment we will conveyed as part of the Elevation Transaction met held for sale classification and treatment as of the effective Purchase Agreement date. These long-lived assets did not qualify as a discontinued operation.

As a result of held for sale classification for certain of our property and equipment under the Elevation Transaction, we compared the carrying value of the assets to the fair value of the assets less cost to sell, resulting in an impairment to our property and equipment of approximately $342 for the year ended December 31, 2019. Given that much of our property and equipment is specific to our own products and intended use, and therefore unrealistic to actively market, we concluded that the most appropriate representation of the assets’ fair value was the unsolicited offer presented by Elevation. For the year ended December 31, 2019, our household products and personal care products segments included impairment of $188 and $154, respectively.

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As of December 31, 2019, the net book value of our held for sale fixed assets, before our impairment charge, was $842, comprised of gross property and equipment of $4,222 and accumulated depreciation of $3,380.

Property and equipment at December 31 were comprised of the following:

 

Depreciation expense for the years ended December 31, 2019 and 2018 was $105 and $160, respectively.

Note 4. Acquisition

On October 1, 2019, we entered into an Asset Purchase Agreement (the “Paramount Purchase Agreement”) with Paramount Chemical Specialties, Inc. (“Paramount”). Pursuant to the Purchase Agreement, we purchased all of Paramount’s intangible assets, finished goods inventory, and assets used in connection with the manufacture, sale and distribution of the Kids N Pets^® and Messy Pet^® brands (collectively, the “Acquisition”).

 

The total consideration paid for the Acquisition was $5,500, plus or minus any inventory adjustment based on the value of finished goods inventory as of the closing compared to the target inventory of $223. Subsequently, the inventory adjustment of $83 increased the total consideration we paid to approximately $5,583.

 

In addition to the above consideration, the Paramount Purchase Agreement included contingent consideration, requiring us to pay Paramount 20% of brand-specific GAAP revenue in excess of $3,500 for each of calendar years 2021, 2022, 2023, and 2024 (the “Earnout Payment”).

 

The Company concluded that the Acquisition qualified as a business combination under ASC 805.

 

For the year ended December 31, 2019, we incurred approximately $116 of transaction costs related to the Acquisition. These expenses were recorded in general and administrative expense in the consolidated statement of operations.

 

 

 

The following summarizes the aggregate fair values of the assets acquired during 2019 as of the date of the Acquisition:

 

 

Intangible assets in the table above consist of the following:

 

 

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In addition to the assets described above, the Company recorded a $27 liability associated with the Earnout Payment, as fair valued through the use of a Monte Carlo Simulation. The Earnout Payment liability is presented in other liabilities on the consolidated balance sheets.

 

The estimates of the fair value of the assets acquired assumed at the date of the Acquisition are subject to adjustment during the measurement period (up to one year from the Acquisition date). The primary areas of the accounting for the Acquisition that are not yet finalized relate to the fair value of intangible assets acquired, residual goodwill and any related tax impact. The fair value of these net assets acquired are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. While the Company believes that such preliminary estimates provide a reasonable basis for estimating the fair value of assets acquired, it evaluates any necessary information prior to finalization of the fair value. During the measurement period, the Company will adjust assets if new information is obtained about facts and circumstances that existed as of the Acquisition date that, if known, would have resulted in the revised estimated values of those assets as of that date. The impact of all changes that do not qualify as measurement period adjustments are included in current period earnings. If the actual results differ from the estimates and judgments used in these fair values, the amounts recorded in the condensed consolidated financial statements could be subject to a possible impairment of the intangible assets or goodwill, or require acceleration of the amortization expense of intangible assets in subsequent periods.

 

Goodwill recorded in connection with the Acquisition represents, among other things, future economic benefits expected to be recognized from the Company’s expansion of the products it offers to the household segment, as well as expected future synergies and operating efficiencies from combining the acquired products with the brands we market and distribute. All of the recorded goodwill is tax-deductible.

 

The following table summarizes selected unaudited pro forma condensed consolidated statements of operations data for the years ended December 31, 2019 and 2018 as if the Paramount Acquisition had been completed on January 1, 2018.

 

 

This selected unaudited pro forma condensed consolidated financial data is included only for the purpose of illustration and does not necessarily indicate what the operating results would have been if the Acquisition had been completed on that date. Moreover, this information does not indicate what our future operating results will be. The information for 2018 and 2019 prior to the Acquisition is based on prior accounting records maintained by Paramount. In some cases, Paramount’s accounting policies may differ materially from accounting policies adopted by the Company following the Acquisition. For 2019, this information includes actual operating results recorded in the financial statements for the period subsequent to the date of the Acquisition on October 1, 2019. The Company’s consolidated statements of operations for the year ended December 31, 2019 includes net sales and net income of $755 and $447, respectively, attributable to the Acquisition.

 

The pro forma amounts included in the table above reflect the application of accounting policies and adjustment of the results of the Acquisition to reflect: (1) the additional amortization that would have been charged to the acquired intangible assets; (2) additional interest expense relating to the borrowings on the our line of credit; and (3) the tax impacts.

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Note 5. Goodwill and Intangible Assets

Intangible assets consisted of the following:

 

 

Amortization expense for the years ended December 31, 2019 and 2018 was $690 and $620, respectively.

 

Estimated amortization expense for 2020 and subsequent years is as follows:

 

 

 

Note 6. Long-Term Debt and Line-of-Credit

 

On June 30, 2016, the Company and Neoteric Cosmetics, Inc., a wholly-owned subsidiary of the Company, collectively as borrowers, entered into a credit agreement, as amended (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (“Chase”), as lender, pursuant to which Chase provided a term loan and a revolving credit facility that were related to our acquisition of the Prell®, Denorex®, and Zincon® brands.

In October 2019, we drew $4,000 and repaid $3,000 on our revolving credit facility. In December 2019, we repaid the remaining $1,000 balance on our revolving credit facility. There were no debt issuance costs associated with our 2019 line of credit activity.

In June 2018, we paid the remaining principal balance of the term loan ahead of schedule in the amount of $1,000. There were no additional costs incurred associated with the prepayment of the term loan.

The revolving credit facility amount is $4 million with interest of: (i) the LIBO Rate + 2.5%; or (ii) the Prime Rate, with a floor of the one month LIBO Rate + 2.5%, and will terminate on June 30, 2021 or any earlier date on which the revolving commitment is otherwise terminated pursuant to the Credit Agreement. Under the Credit Agreement we are obligated to pay quarterly an unused commitment fee equal to 0.5% per annum on the daily amount of the undrawn portion of the revolving line-of-credit. The loans are collateralized by all of the assets of the Company and its subsidiaries.

The Credit Agreement requires the Company to be subject to affirmative, negative, and financial covenants on a quarterly basis. The Company was in compliance with the covenants in the Credit Agreement as of December 31, 2019 and 2018, respectively.

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Note 7. Leases

As part of the Elevation Transaction disclosed in Note 2 above, Elevation assumed our warehouse leases on March 10, 2020 and will assume our office lease at the end of March 2020, at which point we will enter into a sublease agreement with Elevation as our lessor of half of our office space. Given that the sublease will result in the termination of the right to use our warehouse office space, and the lease conveyances were probable and estimable as of December 31, 2019, we reduced our previously capitalized right-of-use assets and lease liabilities to reflect two months of our warehouse leases and three months of our office lease as of December 31, 2019.

The accounting treatment for our leases remains the same. We treat our leases as a single lease component as we have elected the practical expedient to combine these components for all leases. As most of the leases do not provide an implicit rate, we calculated the right-of-use assets and lease liabilities using our secured incremental borrowing rate at the lease commencement date. We currently do not have any finance leases outstanding.

Information related to leases was as follows:

Future minimum annual lease payments are as follows:

 

Note 8. Income Taxes

The provision for income tax for the years ended December 31 is as follows:

 

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Income tax expense at the statutory tax rate is reconciled to the overall income tax expense for the years ended December 31 as follows:

 

 

ASC 740 requires that the tax benefit of net operating losses, temporary differences and credit carryforwards be recorded as an asset to the extent that management assesses that realization is "more likely than not." Realization of the future tax benefits is dependent on the Company's ability to generate sufficient taxable income within the carryforward period.The net deferred tax assets and liabilities as of December 31, 2019 and 2018 are comprised of the following:

 

 

Net operating losses and tax credit carryforwards as of December 31, 2019 are as follows:

 

 

Accounting for uncertainty in income taxes is based on a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We recognize in our consolidated financial statements only those tax positions that are more-likely-than-not to be sustained as of the adoption date, based on the technical merits of the position. Each year we perform a comprehensive review of our material tax positions.

Our policy is to recognize interest and penalties related to uncertain tax benefits in income tax expense. As we had no uncertain tax benefits during 2019 and 2018, we had no accrued interest or penalties related to uncertain tax positions in either year.

We and our subsidiaries are subject to the following material taxing jurisdictions: United States and Colorado. The tax years that remain open to examination by the Internal Revenue Service are 2016 and years thereafter. The tax years that remain open to examination by the State of Colorado are 2015 and years thereafter.

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Note 9. Shareholders’ Equity

2005 Plan:

In 2005, we adopted a stock option plan for our employees, officers and directors (the “2005 Plan”). At the Annual Shareholders’ Meeting in May 2011, shareholders approved an amendment to the 2005 Plan to increase the number of shares issuable under the plan from 1.5 million shares to a total of 3 million shares. As of December 31, 2019, there were no shares available for issuance under the 2005 Plan.

2015 Plan:

In 2015, we adopted, and shareholders approved, a stock option plan for our employees, officers and directors (the “2015 Plan”) to replace the 2005 Plan, which expired on March 31, 2015.

Under the 2015 Plan, we awarded 20,000 RSUs to our four independent directors on November 14, 2019 (the “Grant Date”). The director RSUs will vest one-third, ratably, over three years on each anniversary of the Grant Date. Additionally, under the 2015 Plan and on the Grant Date, we awarded RSUs to our named executive officers (“NEO”) and employees, vesting of which is subject to specific market conditions as well as service conditions. The NEO and employee RSUs will vest on the third anniversary of the Grant Date, or November 14, 2022 (the “Vest Date”), if the Company’s average stock price for any consecutive 30-day period is at or above $2.75 (Tier 1 – 133,445 shares vest), $3.50 (Tier 2 – 208,643 shares vest), or $4.25 (Tier 3 – 257,078 shares vest) during the three year vesting period (the “Restricted Period”). Both grants were approved by our Compensation Committee as of the Grant Date.

During 2019, we did not grant any options to acquire shares of our common stock.

During 2018, we granted options to acquire: (i) 40 thousand shares of our common stock to employees at prices ranging from $2.17 to $3.35 per share; (ii) 105 thousand shares of our common stock to executive officers at prices ranging from $2.09 to $2.17 per share; and (iii) 90 thousand shares of our common stock to non-employee board members at a price of $2.17 per share.

The weighted average fair market value of the options granted during the years ended December 31 were 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) totaled $141 and $227 for the years ended December 31, 2019 and 2018, respectively. Approximately $176 of total unrecognized compensation costs related to non-vested stock options is expected to be recognized over the next three years, depending on the vesting provisions of the options. 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 deductible.

Compensation cost related to RSUs recognized in operating results (included in general and administrative expenses) totaled $8 for the year ended December 31, 2019. Approximately $175 of total unrecognized compensation costs related to non-vested RSUs is expected to be recognized over the next three years.

 

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Stock option activity under the expired 2005 and current 2015 Plans are as follows:

 

 

A summary of additional information related to the options outstanding as of December 31, 2019 under the 2005 and 2015 Plans are as follows:

 

 

We have an Employee Stock Ownership Plan (“Plan”) to provide retirement benefits for our employees. The Plan is designed to invest primarily in our common stock and is non-contributory on the part of our employees. Contributions to the Plan are discretionary

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as determined by our Board of Directors. We expense the cost of contributions to the Plan. No contributions were made to the Plan in 2019 and 2018. At December 31, 2019 and 2018, a total of 473 and 491 shares of our common stock, respectively, have been allocated and earned by our employees.

Note 10. 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.

Basic earnings per share include no dilution and are computed by dividing income available to common shareholders by the weighted-average number of shares outstanding during the period. Diluted earnings per share reflect the potential of securities that could share in our earnings.

A reconciliation of the weighted average number of common shares outstanding (in thousands) for the years ended December 31 is as follows:

 

 

 

Common stock equivalents (in thousands) that have been excluded from the calculation of earnings per share as of December 31 because they would have been anti-dilutive are as follows:

 

None of our RSUs met vesting conditions during 2019.

Note 11. Segment Information

Segments

We operate in two different segments: household products and personal care products. 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.

Due to changes in our business as we acquired and began to manufacture additional products in recent periods under our Personal Care Products segment, the Company implemented a change in the allocation of certain operational and administrative expenses to more accurately reflect our operational activity. For comparison purposes, the Company presented 2018 results to reflect the revised allocation of these costs.

The following provides information on our segments as of and for the years ended December 31:

 

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Corporate assets noted above are comprised of our income tax receivable and deferred tax assets.

Customers

Net sales to significant customers were the following for the years ended December 31, 2019 and 2018, respectively:

 

Outstanding accounts receivable from significant customers represented the following percentages of our total accounts receivable as of December 31, 2019 and 2018, respectively:

 

A loss of any of our significant customers could have a material adverse effect on us because it is uncertain whether our consumer base served by these customers would purchase our products at other retail outlets. Our distribution agreement with HK NFS renewed on January 1, 2020 and is effective for a one-year term. This agreement automatically renews for additional successive one-year terms unless and until either party provides notice of nonrenewal at least 90 days before the end of the then-current term. No long-term contracts exist between us and our other significant customers.

Note 12. Commitments and Contingencies

As of December 31, 2019, the Company had no material commitments or contingencies.

Note 13. Subsequent Events

On March 10, 2020, we consummated the Elevation Transaction pursuant to which Elevation will (i) acquire certain assets of the Company, which include all fixed assets utilized in the manufacturing and warehouse operations of the Company, (ii) assume all of the Company’s obligations under its existing real property leases, (iii) manufacture certain products of the Company at a competitive fixed rate, and (iv) pay cash consideration of $500,000.

 

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None.

Disclosure Controls and Procedures

As of December 31, 2019, 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 December 31, 2019.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management, including our Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, based on the criteria for effective internal control described in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2019.

This Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permits us to provide only management’s report in this Report.

Management’s report shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liabilities of that section, and is not incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during the quarter ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

None.

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PART III

For Part III, the information set forth in our definitive Proxy Statement for our Annual Meeting of Shareholders to be filed within 120 days after December 31, 2019, hereby is incorporated by reference into this Report.

PART IV

Consolidated Financial Statements:

Report of Independent Registered Public Accounting Firm

Consolidated Statements of Income for the years ended December 31, 2019 and 2018

Consolidated Balance Sheets as of December 31, 2019 and 2018

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2019 and 2018

Consolidated Statements of Cash Flows for the years ended December 31, 2019 and 2018

Notes to Consolidated Financial Statements

Exhibits

 

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**Furnished, not filed.

None.

 

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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.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

 

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