ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Factors Affecting Forward-Looking Statements
The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, number of our success in recruiting and retaining new consultants, our ability to locate and procure desired books, our ability to ship the volume of orders that are received without creating backlogs, our ability to obtain adequate financing for working capital and capital expenditures, economic and competitive conditions, regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in our Annual Report on Form 10-K for the year ended February 28, 2017 and this Quarterly Report on Form 10-Q, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may or may not occur. See “Cautionary Remarks Regarding Forward-Looking Statements” in the front of this Quarterly Report on Form 10-Q.
Overview
We operate two separate segments: Usborne Books & More (“UBAM”) and Publishing, to sell our Usborne and Kane Miller lines of children’s books. These two segments each have their own customer base. The Publishing segment markets its products on a wholesale basis to various retail accounts. The UBAM segment markets its products through a network of independent sales consultants using a combination of direct sales, home shows, book fairs and internet sales. All other supporting administrative activities are recognized as other expenses outside of our two segments. Other expenses are primarily compensation of our office, warehouse and sales support staff as well as the cost of operating and maintaining our corporate office and distribution facility.
The following table shows our condensed statements of earnings data:
|
|
Three Months Ended May 31,
|
|
|
Nine Months Ended November 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Net revenues
|
|
$
|
26,930,800
|
|
|
$
|
22,784,200
|
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of goods sold
|
|
|
7,424,800
|
|
|
|
6,673,800
|
|
|
|
33.3
|
%
|
|
|
40.0
|
%
|
Gross margin
|
|
|
19,506,000
|
|
|
|
16,110,400
|
|
|
|
66.7
|
%
|
|
|
60.0
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating and selling
|
|
|
5,392,400
|
|
|
|
4,728,900
|
|
|
|
27.9
|
%
|
|
|
28.1
|
%
|
Sales commissions
|
|
|
8,509,200
|
|
|
|
6,974,100
|
|
|
|
27.7
|
%
|
|
|
20.8
|
%
|
General and administrative
|
|
|
3,713,900
|
|
|
|
3,558,100
|
|
|
|
3.3
|
%
|
|
|
5.9
|
%
|
Total operating expenses
|
|
|
17,615,500
|
|
|
|
15,261,100
|
|
|
|
58.9
|
%
|
|
|
54.8
|
%
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
7.8
|
%
|
|
|
5.2
|
%
|
Interest expense
|
|
|
(281,500
|
)
|
|
|
(216,500
|
)
|
|
|
-0.1
|
%
|
|
|
-0.1
|
%
|
Other income
|
|
|
373,200
|
|
|
|
371,800
|
|
|
|
-0.1
|
%
|
|
|
-0.1
|
%
|
Earnings before income taxes
|
|
|
1,982,200
|
|
|
|
1,004,600
|
|
|
|
7.7
|
%
|
|
|
5.1
|
%
|
Income taxes
|
|
|
756,900
|
|
|
|
384,400
|
|
|
|
2.9
|
%
|
|
|
2.0
|
%
|
Net earnings
|
|
$
|
1,225,300
|
|
|
$
|
620,200
|
|
|
|
4.8
|
%
|
|
|
3.1
|
%
|
See the detailed discussion of revenues, costs of services, gross margin, general and administrative expenses by reportable segment below. The following is a discussion of significant changes in the non-segment related general and administrative expenses, other income and expenses and income taxes during the respective periods.
General and administrative expenses
not associated with a reporting segment remained consistent totaling $3,056,800 for the three-month period ending May 31, 2017, compared to $3,007,200 for the same quarterly period a year ago.
Interest expense
increased $65,000 to $281,500 for the three months ended May 31, 2017, from $216,500 for the same quarterly period a year ago. Interest expense increased primarily as a result of increased line of credit borrowings and additional interest associated with the Term Loan #2 totaling $4,000,000 which was borrowed during the second quarter of fiscal 2017. Our additional borrowings associated with the increased line of credit borrowing and Term Loan #2 were used to fund working capital needs associated with our growth in sales and inventory.
Income taxes
increased $372,500 to $756,900 for the three months ended May 31, 2017, from $384,400 for the same quarterly period a year ago. Our effective tax rate was 38.2% for the quarter ended May 31, 2017, and 38.3% for the quarter ended May 31, 2016. These rates are higher than the federal statutory rate due to the inclusion of state income and franchise taxes.
UBAM Operating Results for the Three Months Ended May 31, 2017
The following table summarizes the operating results of the UBAM segment for the three months ended May 31, 2017 and 2016:
|
|
For the Three Months Ended May 31,
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
$ Change
|
|
|
% Change
|
|
Gross sales
|
|
$
|
26,648,400
|
|
|
$
|
22,147,800
|
|
|
$
|
4,500,600
|
|
|
|
20.3
|
|
Less discounts and allowances
|
|
|
(4,533,200
|
)
|
|
|
(3,764,300
|
)
|
|
|
(768,900
|
)
|
|
|
20.4
|
|
Transportation revenue
|
|
|
2,693,500
|
|
|
|
2,266,700
|
|
|
|
426,800
|
|
|
|
18.8
|
|
Net revenues
|
|
|
24,808,700
|
|
|
|
20,650,200
|
|
|
|
4,158,500
|
|
|
|
20.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
6,299,700
|
|
|
|
5,572,800
|
|
|
|
726,900
|
|
|
|
13.0
|
|
Gross margin
|
|
|
18,509,000
|
|
|
|
15,077,400
|
|
|
|
3,431,600
|
|
|
|
22.8
|
|
Gross margin percentage
|
|
|
75
|
%
|
|
|
73
|
%
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating and selling
|
|
|
4,330,100
|
|
|
|
4,028,900
|
|
|
|
301,200
|
|
|
|
7.5
|
|
Sales commissions
|
|
|
8,423,700
|
|
|
|
6,895,800
|
|
|
|
1,527,900
|
|
|
|
22.2
|
|
General and administrative
|
|
|
1,377,000
|
|
|
|
955,200
|
|
|
|
421,800
|
|
|
|
44.2
|
|
Total Operating Expenses
|
|
|
14,130,800
|
|
|
|
11,879,900
|
|
|
|
2,250,900
|
|
|
|
18.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
$
|
4,378,200
|
|
|
$
|
3,197,500
|
|
|
$
|
1,180,700
|
|
|
|
36.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average number of active consultants
|
|
|
25,600
|
|
|
|
20,600
|
|
|
|
5,000
|
|
|
|
24.3
|
|
The UBAM segment’s sales consist of fundraiser sales, home party sales and school and library sales that are primarily processed through internet orders. Gross sales increased $4,500,600, or 20.3%, during the three-month period ending May 31, 2017, when compared with the same quarter a year ago. The sales increase primarily resulted from an increase in the number of active consultants. The average number of active sales consultants increased 5,000, or 24.3% from 20,600 in the first quarter of fiscal year 2017 to 25,600 in the first quarter of fiscal 2018. Our consultant growth is driven by existing active consultants recruiting and retaining new consultants.
Gross margin increased $3,431,600, or 22.8%, during the three-month period ending May 31, 2017, when compared to the same quarter a year ago, due primarily to increase in sales. Gross margins, as a percentage of net revenues, grew to 75% for the three-month period ending May 31, 2017 from 73% when compared to the same period a year ago. Gross margins increased due to reduced inventory costs associated with volume discounts received on inventory purchases.
Operating and selling expenses primarily consists of freight expenses and hostess awards associated with sales orders. Sales commissions include amounts paid to consultants for new sales and promotions. These operating expenses are directly tied to the sales volumes of the UBAM segment. General and administrative expenses include payroll, travel and entertainment expenses, outside services, inventory reserves and other expenses directly associated with the UBAM segment. Operating expenses increased 2,250,900, or 18.9%, during the three-month period ending May 31,2017, when compared with the same quarter a year ago, due primarily to the similar percentage growth in sales.
Operating income of the UBAM segment increased $1,180,700, or 36.9%, during the three-month period ending May 31, 2017, when compared to the same quarter a year ago, due to primarily to sales growth and lower cost of goods as a percentage of net revenue.
Publishing Operating Results for the Three Months Ended May 31, 2017
The following table summarizes the operating results of the Publishing segment for the three months ended May 31, 2017 and 2016:
|
|
For the Three Months Ended May 31,
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
$ Change
|
|
|
% Change
|
|
Gross sales
|
|
$
|
4,525,500
|
|
|
$
|
4,553,500
|
|
|
$
|
(28,000
|
)
|
|
|
(0.6
|
)
|
Less discounts and allowances
|
|
|
(2,410,500
|
)
|
|
|
(2,424,700
|
)
|
|
|
14,200
|
|
|
|
(0.6
|
)
|
Transportation revenue
|
|
|
7,100
|
|
|
|
5,200
|
|
|
|
1,900
|
|
|
|
36.5
|
|
Net revenues
|
|
|
2,122,100
|
|
|
|
2,134,000
|
|
|
|
(11,900
|
)
|
|
|
(0.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
|
1,125,100
|
|
|
|
1,101,000
|
|
|
|
24,100
|
|
|
|
2.2
|
|
Gross margin
|
|
|
997,000
|
|
|
|
1,033,000
|
|
|
|
(36,000
|
)
|
|
|
(3.5
|
)
|
Gross margin percentage
|
|
|
47
|
%
|
|
|
48
|
%
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating and selling
|
|
|
244,900
|
|
|
|
230,200
|
|
|
|
14,700
|
|
|
|
6.4
|
|
Sales commissions
|
|
|
83,500
|
|
|
|
78,300
|
|
|
|
5,200
|
|
|
|
6.6
|
|
General and Administrative
|
|
|
99,500
|
|
|
|
65,500
|
|
|
|
34,000
|
|
|
|
51.9
|
|
Total Operating Expenses
|
|
|
427,900
|
|
|
|
374,000
|
|
|
|
53,900
|
|
|
|
14.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
$
|
569,100
|
|
|
$
|
659,000
|
|
|
$
|
(89,900
|
)
|
|
|
(13.6
|
)
|
Our Publishing segment’s net revenues, gross margins and operating income results for the three months ended May 31, 2017, were consistent with the amounts reported for the same quarter last year. Sales in our Publishing segment are seasonal and our fiscal fourth and first quarters are traditionally lower than the second and third fiscal quarters sales.
Liquidity and Capital Resources
Our primary source of cash is typically operating cash flow. However, we have recently begun to use more cash than we generate due to our rapid growth. The majority of our cash outflow has been associated with increasing our inventory to keep up with our increased demand for our products. We have utilized a bank credit facility and other term loan borrowings to meet our short-term cash needs when necessary.
During the first quarter of fiscal year 2018, we experienced cash outflow from our operations of $342,000. Net earnings of $1,225,300 were reduced by the following items:
•
|
an increase in prepaid expenses and other assets of $109,400,
|
•
|
an increase in accounts receivable of $614,100,
|
•
|
a decrease in accounts payable of $7,133,900, and
|
•
|
a decrease in deferred revenue of $86,100,
|
Offset by:
•
|
depreciation expense of $293,300
|
•
|
an increase in the provision for inventory valuation allowance of $15,000,
|
•
|
an increase in the provision for doubtful accounts and sales returns of $282,900,
|
•
|
a decrease in inventories of $4,516,200
|
•
|
a decrease in deferred income taxes of $54,500,
|
•
|
an increase in accrued salaries and commissions of $359,900,
|
•
|
an increase in other liabilities of $191,300, and
|
•
|
an increase in net income tax payable of $663,100.
|
The significant decrease in accounts payable from the end of the fiscal year 2017 was primarily a result of continued payments owed to our suppliers for increased inventory purchases made over the last six months of the fiscal year.
The significant decrease in inventory was primarily the result of management efforts to reduce excess inventory volumes that were purchased in recent quarters. These inventory purchases were made based on sales forecast assumptions that were greater than our actual sales results.
Cash used in investing activities was $236,800 for capital expenditures, which was primarily comprised of improvements to our warehouse picking and inventory management systems of $158,700 and various other improvements to the warehouse and facility.
Cash provided by financing activities was $467,400, which was primarily comprised of borrowings under our line of credit of $677,400 offset by payments on long-term debt of $219,000.
During fiscal year 2018, we expect our cash from operations and our expanded line of credit with our bank will provide us the ability to meet our liquidity requirements. We have a history of profitability and positive cash flow. Consequently, cash generated from operations will be used to increase inventory in anticipation of continued sales growth and to liquidate existing debt.
We have a Loan Agreement with the Bank including Term Loan #1 comprised of Tranche A of $13.4 million and Tranche B of $5.0 million both with the maturity date of December 1, 2025. The Loan Agreement also provided a $4.0 million revolving loan (“line of credit”) through December 1, 2016. Effective March 10, 2016, we signed a First Amendment Loan Agreement with the Bank which provided an increase to $6.0 million from our original $4.0 million line of credit through June15, 2017. Tranche A has a fixed interest rate of 4.23% and interest is payable monthly. For Tranche B and the line of credit, interest is payable monthly at the bank adjusted LIBOR Index plus 3.25% (4.25% at May 31, 2017). Term Loan #1 is secured by the primary office, warehouse and land.
Effective June 15, 2016, we signed a Second Amendment Loan Agreement with the Bank which provides a further increase to $7.0 million from our previous $6.0 million line of credit and extends it through June 15, 2017. Under the amendment, interest is payable monthly at a tiered rate based on our funded debt to EBITDA ratio (“ratio”), whereby pricing tier one is effective for a ratio greater than 4.00 and has a bank adjusted LIBOR Index plus 3.25% and pricing tier two applies for a ratio less than or equal to 4.00, with a bank adjusted LIBOR Index plus 2.75%. EBITDA is defined as earnings before interest expense, income tax expense (benefit) and depreciation and amortization expenses.
We had $5,560,300 in borrowings outstanding on our revolving credit agreement at May 31, 2017 and $4,882,900 in borrowings at February 28, 2017. Available credit under the revolving credit agreement was $1,439,700 at May 31, 2017.
Effective June 28, 2016, we signed a Third Amendment Loan Agreement with the Bank which includes Term Loan #2 in the amount of $4.0 million with the maturity date of June 28, 2021, and interest payable monthly at the bank adjusted LIBOR Index plus 3.25%. Term Loan #2 is secured by a warehouse and land. Effective February 7, 2017, we signed a Fourth Amendment Loan Agreement with the Bank which modified certain debt covenant calculations and waived an existing default that occurred in the fourth quarter of fiscal year 2017.
Subsequent to the quarter end, June 15, 2017, the Company executed the Fifth Amendment Loan Agreement with the Bank which modifies the Loan Agreement to increase the maximum revolving principal amount from $7.0 million to $10.0 million and extends the termination date of the Loan Agreement to June 15, 2018. Under the terms of the Amendment, the maximum revolving principal amount can be further extended to $15.0 million based on the Company completing certain requirements and based on the approval of the Bank.
The Amendment also modifies the Loan Agreement to include an Advancing Term Loan of $3.0 million which the Company will use to cover the cost of the planned fiscal 2018 capital improvements to increase its daily shipping capacity. The Company expects the amount of the planned fiscal 2018 capital improvements will be less than the Advancing Term Loan facility. The Advancing Term Loan accrues interest only monthly, at the bank adjusted LIBOR Index plus a tiered pricing rate based on the Company’s Adjusted Funded Debt to EBITDA Ratio, between June 9 and December 9, 2017, at which time the amount advanced will be converted to a term loan and will amortize over a thirty-six-month period.
The Loan Agreement also contains a provision for our use of the Bank’s letters of credit. The Bank agrees to issue, or obtain issuance of commercial or stand-by letters of credit provided that the sum of the line of credit plus the letters of credit issued would not exceed the borrowing base in effect at the time. The agreement contains provisions that require us to maintain specified financial ratios, restrict transactions with related parties, prohibit mergers or consolidation, disallow additional debt, and limit the amount of compensation, salaries, investments, capital expenditures and leasing transactions. For the quarter ended May 31, 2017, we had no letters of credit outstanding.
The following table reflects aggregate future maturities of long-term debt during the next five fiscal years and thereafter as follows:
Year ending February 28(29),
|
|
|
|
2018
|
|
$
|
679,500
|
|
2019
|
|
|
952,200
|
|
2020
|
|
|
989,600
|
|
2021
|
|
|
1,026,500
|
|
2022
|
|
|
1,069,000
|
|
Thereafter
|
|
|
16,628,500
|
|
|
|
$
|
21,345,300
|
|
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to our valuation of inventory, allowance for uncollectible accounts receivable, allowance for sales returns, long-lived assets and deferred income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results may materially differ from these estimates under different assumptions or conditions. Historically, however, actual results have not differed materially from those determined using required estimates. Our significant accounting policies are described in the notes accompanying the financial statements included elsewhere in this report. However, we consider the following accounting policies to be more significantly dependent on the use of estimates and assumptions.
Revenue Recognition
Sales are generally recognized and recorded when products are shipped. Products are shipped FOB shipping point. The UBAM segment’s sales are paid at the time the product is ordered. These sales accounted for 92.1% of net revenues for the three-month period ended May 31, 2017, and 90.6% for the three-month period ended May 31, 2016. Sales that have been paid for but not shipped are classified as deferred revenue on the balance sheet. Sales associated with consignment inventory are recognized when reported and payment associated with the sale has been remitted. Transportation revenue represents the amount billed to the customer for shipping the product and is recorded when the product is shipped.
Estimated allowances for sales returns are recorded as sales are recognized and recorded. Management uses a moving average calculation to estimate the allowance for sales returns. We are not responsible for product damaged in transit. Damaged returns are primarily from retail stores. These returns primarily result from damage that occurs in the stores, not in shipping to the stores. It is industry practice to accept returns from retail customers. Transportation revenue, the amount billed to the customer for shipping the product, is recorded when products are shipped. Management has estimated and included a reserve for sales returns of $100,000 as of May 31, 2017, and $190,000 February 28, 2017.
Allowance for Doubtful Accounts
We maintain an allowance for estimated losses resulting from the inability of our customers to make required payments. An estimate of uncollectable amounts is made by management based upon historical bad debts, current customer receivable balances, age of customer receivable balances, the customer’s financial condition and current economic trends. Consignment inventory related to inactive consultants is reclassified to accounts receivable and the associated reserve is included within our allowance. If the actual uncollected amounts significantly exceed the estimated allowance, then our operating results would be significantly adversely affected. Management has estimated and included an allowance for doubtful accounts of $866,000 at May 31, 2017, and $675,000 at February 28, 2017.
Included within this allowance is $409,100 and $217,000 as of May 31, 2017 and February 28, 2017, respectively, of reserve related to consignment inventory held by inactive consultants.
Inventory
Our inventory contains approximately 2,200 titles, each with different rates of sale, depending upon the nature and popularity of the title. Almost all of our product line is saleable as the books are not topical in nature and remain current in content today as well as in the future. Most of our products are printed in Europe, China, Singapore, India, Malaysia and Dubai resulting in a three to four-month lead-time to have a title printed and delivered to us.
Certain inventory is maintained in a noncurrent classification. Management continually estimates and calculates the amount of noncurrent inventory. Noncurrent inventory arises due to occasional purchases of titles in quantities in excess of what will be sold within the normal operating cycle, due to minimum order requirements of our suppliers. Noncurrent inventory was estimated by management using the current year turnover ratio by title. All inventory in excess of 2 ½ years of anticipated sales is classified as noncurrent inventory. Noncurrent inventory balances prior to valuation allowances were $475,400 and $467,100 at May 31, 2017 and February 28, 2017, respectively.
Consultants that meet certain eligibility requirements are allowed to receive inventory on consignment. We believe allowing our consultants to have consignment inventory greatly increases their ability to be successful in making effective presentations at home shows, book fairs and other events; and having consignment inventory leads to additional sales opportunities. Approximately 11% of our active consultants maintained consignment inventory at May 31, 2017 and February 28, 2017. Consignment inventory is stated at cost, less an estimated reserve for consignment inventory that is not expected to be sold or returned to the Company. The total value of inventory on consignment with active consultants was $950,100 and $1,140,700 at May 31, 2017 and February 28, 2017, respectively. Inventory related to inactive consultants is reclassified to accounts receivables and amounted to $438,100 and $309,000 as of May 31, 2017 and February 28, 2017, respectively.
Inventories are presented net of a valuation allowance, which includes reserves for inventory obsolescence and active consultant consignment inventory that is not expected to be sold or returned. Management estimates the allowance for both current and noncurrent inventory. The allowance is based on management’s identification of slow moving inventory and estimated consignment inventory that will not be sold or returned. Management has estimated a valuation allowance for both current and noncurrent inventory of $313,000 and $300,000 as of May 31, 2017 and February 28, 2017, respectively.
Our principal supplier, based in England, generally requires a minimum reorder of 6,500 or more of a title in order to get a solo print run. Smaller orders would require a shared print run with the supplier’s other customers, which can result in lengthy delays to receive the ordered title. Anticipating customer preferences and purchasing habits requires historical analysis of similar titles in the same series. We then place the initial order or re-order based upon this analysis.
These factors and historical analysis have led our management to determine that 2 ½ years represents a reasonable estimate of the normal operating cycle for our products.
Stock-
Based Compensation
We account for stock-based compensation whereby share-based payment transactions with employees, such as stock options and restricted stock, are measured at estimated fair value at date of grant and recognized as compensation expense over the vesting period, net of estimated forfeitures.