ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
Special Note Regarding Forward Looking Statements
This report contains forward-looking statements that are
contained principally in the sections entitled Our Business, Risk Factors,
and Managements Discussion and Analysis of Financial Condition and Results of
Operations. These statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements to
be materially different from any future results, performances or achievements
expressed or implied by the forward-looking statements. These risks and
uncertainties include, but are not limited to, the factors described in the
section captioned Risk Factors above. In some cases, you can identify
forward-looking statements by terms such as anticipates, believes, could,
estimates, expects, intends, may, plans, potential, predicts,
projects, should, would and similar expressions intended to identify
forward-looking statements. Forward-looking statements reflect our current views
with respect to future events and are based on assumptions and subject to risks
and uncertainties. Given these uncertainties, you should not place undue
reliance on these forward-looking statements. These forward-looking statements
include, among other things, statements relating to:
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our expectations regarding growth in the motor
sports market;
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our expectation regarding increasing demand for
protective equipment used in the motor sports market;
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our belief that we will be able to effectively
compete with our competitors and increase our market share;
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our expectations with respect to increased
revenue growth and our ability to achieve profitability resulting from
increases in our production volumes; and
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our future business development, results of
operations and financial condition.
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Also, forward-looking statements represent our estimates and
assumptions only as of the date of this quarterly report. You should read this
quarterly report and the documents that we reference and filed as exhibits to
the quarterly report completely and with the understanding that our actual
future results may be materially different from what we expect. Except as
required by law, we assume no obligation to update any forward-looking
statements publicly, or to update the reasons actual results could differ
materially from those anticipated in any forward-looking statements, even if new
information becomes available in the future.
Use of Certain Defined Terms
Except as otherwise indicated by the context, references in
this quarterly report to:
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Leatt, we, us, our, the Registrant or
the Company are to the combined business of Leatt Corporation, a Nevada
corporation, its South African branch, Leatt SA, and its direct,
wholly-owned subsidiaries, Two Eleven and Three Eleven;
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Leatt SA are to the Companys branch office
known as Leatt Corporation (Incorporated in the State of Nevada)
incorporated under the laws of South Africa with registration number:
2007/032780/10;
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Leatt USA are to Leatt USA, LLC, a Nevada
Limited Liability Company;
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PRC, and China are to the Peoples Republic
of China;
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Two Eleven refers to Two Eleven Distribution,
LLC, a California limited liability company;
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Three Eleven are to Three Eleven Distribution
(Pty) Limited, a South African Company;
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Securities Act are to the Securities Act of
1933, as amended, and to Exchange Act are to Securities Exchange Act of
1934, as amended;
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South Africa are to the Republic of South
Africa;
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U.S. dollar, $ and US$ are to the legal
currency of the United States.
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Xceed Holdings refers to Xceed Holdings CC.,
a close corporation incorporated under the laws of South Africa, and
wholly-owned by The Leatt Family Trust, of which Dr. Christopher J. Leatt,
the Companys chairman, is a Trustee and Beneficiary; and
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ZAR refers to the South African Rand, the
legal currency of South Africa. For all ZAR amounts reported, the dollar
amount has been calculated on the basis that $1 = ZAR12.9577 for its June
30, 2017 balance sheet
.
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- 11 -
Overview of our Business
Leatt designs, develops, markets and distributes personal
protective equipment for participants in all forms of motor sports and leisure
activities, including riders of motorcycles, bicycles, snowmobiles and ATVs. The
Company sells its products to customers worldwide through a global network of
distributors and retailers. Leatt also acts as the original equipment
manufacturer for neck braces sold by other international brands.
The Companys flagship products are based on the Leatt-Brace®
system, a patented injection molded neck protection system owned by Xceed
Holdings, designed to prevent potentially devastating injuries to the cervical
spine and neck. The Company has the exclusive global manufacturing,
distribution, sale and use rights to the Leatt-Brace®, pursuant to a license
agreement between the Company and Xceed Holdings, a company owned and controlled
by the Companys Chairman and founder, Dr. Christopher Leatt. The Company also
has the right to use apparatus embodying, employing and containing the
Leatt-Brace® technology and has designed, developed, marketed and distributed
other personal protective equipment using this technology, as well as its own
developed technology, including the Companys new body protection products which
it markets under the Leatt Protection Range brand.
The Companys research and development efforts are conducted at
its research facilities, located at its executive headquarters in Cape Town,
South Africa. The Company employs 4 full-time employees who are dedicated
exclusively to research, development, and testing. The Company also utilizes
consultants, academic institutions and engineering companies as independent
contractors or consultants, from time to time, to assist it with its research
and development efforts. Leatt products have been tested and reviewed internally
and by external bodies. All Leatt products are compliant with applicable
European Union directives, or CE certified, where appropriate. Certain products,
such as the Moto GPX was tested by BMW Motorrad (Germany) and reviewed by KTM
(Austria).
Our products are manufactured in China under outsource
manufacturing arrangements with third-party manufacturers located there. The
Company utilizes outside consultants and its own employees to ensure the quality
of its products through regular on-site product inspections. Products purchased
through international sales are usually shipped directly from our manufacturers
warehouses or points of dispatch to customers or their import agents.
Leatt earns revenues through the sale of its products through
approximately 60 distributors worldwide, who in turn sell its products to
retailers. Leatt distributors are required to follow certain standard business
terms and guidelines for the sale and distribution of Leatt products. Two Eleven
and Leatt SA directly distribute Leatt products to retailers in the United
States and South Africa, respectively. Additionally, Two Eleven sells products
directly to customers via Leatts online store.
Principal Factors Affecting Our Financial Performance
We believe that the following factors will continue to affect
our financial performance:
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Global Economic Fragility
The ongoing
turmoil in the global economy, especially in the U.S. and Europe, may have
an impact on our business and our financial condition, and we may face
challenges if economic conditions do not improve. These economic
conditions impact levels of consumer spending, which have deteriorated and
may remain depressed for the foreseeable future. If demand for our
products fluctuates as a result of these economic conditions or otherwise,
our revenue and gross margin could be harmed.
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Fuel Prices
Significant
fluctuations in fuel prices could have both a positive and negative effect
on our business and operations. A significant portion of our revenue is
derived from international sales and significant fluctuations in world
fuel prices could significantly increase the price of shipping or
transporting our products which we may not be able to pass on to our
customers. On the other hand, fluctuations in fuel prices lead to higher
commuter costs which may encourage the increased use of motorcycles and
bicycles as alternative modes of transportation and lead to an increase in
the market for our protection products.
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Product Liability Litigation
We face an
inherent business risk of exposure to product liability claims arising
from the claimed failure of our products to help prevent the types of
personal injury or death against which they are designed to help protect.
Therefore, we have acquired very costly product liability insurance
worldwide. We have not experienced any material uninsured losses due to
product liability claims, but it is possible that we could experience
material losses in the future. After a two-week trial in the United States
District Court for the Northern District of Ohio (Eastern) ending on April
17, 2014, a federal jury returned a defense verdict for the Company in the
first Leatt- Brace® product liability lawsuit to be tried in the United
States. The plaintiffs in that case had alleged that defective product
design and failure to warn had caused a then fifteen year-old motocross
rider, to suffer multiple mid- thoracic spine fractures, causing immediate
and permanent paraplegia, when he crashed at a relatively low speed on
February 13, 2011. When the accident occurred, he was wearing a helmet and
other safety gear from several different companies, including the
Company's acclaimed Leatt-Brace®. The Company produced evidence at trial
showing that his thoracic paraplegia was an unavoidable consequence of his
fall, not the result of wearing a Leatt- Brace®, and that the neck brace
likely saved his life (or saved him from quadriplegia) by preventing
cervical spine injury. The Company had maintained from the onset that this
and a small handful of other lawsuits are without merit and that it will
vigorously defend itself in each case. In this case, the plaintiffs
subsequently appealed the courts decision and the parties
reached an amicable settlement. Although we carry product liability insurance, a
successful claim brought against us could significantly harm our business and
financial condition and have an adverse impact on our ability to renew our
product liability insurance or secure new coverage.
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- 12 -
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Protection of Intellectual Property
We
believe that the continued success of our business is dependent on our
intellectual property portfolio consisting of globally registered
trademarks, design patents and utility patents related to the
Leatt-Brace®. We believe that a loss of these rights would harm or cause a
material disruption to our business and, our corporate strategy is to
aggressively take legal action against any violators of our intellectual
property rights, regardless of where they may be. From time to time, we
have had to enforce our intellectual property rights through litigation
and we may be required to do so in the future. Such litigation may result
in substantial costs and could divert resources and management attention
from the operations of our business.
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Fluctuations in Foreign Currencies
We are
exposed to foreign exchange risk as our revenues and consolidated results
of operations may be affected by fluctuations in foreign currency as we
translate these currencies into U.S. dollars when we consolidate our
financial results. While our reporting currency is the U.S. Dollar, a
portion of our consolidated revenues are denominated in South African
Rand, or ZAR, certain of our assets are denominated in ZAR, and our
research and marketing operations in South Africa utilize South African
labor sources. A decrease in the value of the U.S. dollar in relation to
the ZAR could increase our cost of doing business in South Africa. If the
ZAR depreciates against the U.S. Dollar, the value of our ZAR revenues,
earnings and assets as expressed in our U.S. Dollar financial statements
will decline. We have not entered into any hedging transactions in an
effort to reduce our exposure to foreign exchange risk. Furthermore since
59% of our sales is derived outside the U.S. where the U.S. dollar is not
the primary currency, significant fluctuations in exchange rates such as
the strengthening of the dollar versus our customers local currency can
adversely affect our ability to remain competitive in those areas.
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Results of Operations
The following summary of our results of operations should be
read in conjunction with our financial statements and the notes thereto for the
three- and six-month periods ended June 30, 2017 and 2016 included herein. The
following tables set forth key components of our results of operations for the
periods indicated, both in dollars and as a percentage of sales revenue and key
components of our revenue for the periods indicated in dollars and
percentages.
Three Months Ended June 30, 2017 compared to the Three
Months Ended June 30, 2016
The following table summarizes the results of our operations
during the three-month periods ended June 30, 2017 and 2016 and provides
information regarding the dollar and percentage increase or (decrease) in such
periods:
- 13 -
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Three Months Ended June 30,
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Percentage
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2017
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2016
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$ Increase
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Increase
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Item
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(Decrease)
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(Decrease)
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REVENUES
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$
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3,510,297
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$
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3,693,915
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$
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(183,618
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)
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-5%
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COST OF REVENUES
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1,745,138
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1,710,012
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$
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35,126
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2%
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GROSS PROFIT
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1,765,159
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1,983,903
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$
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(218,744
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-11%
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PRODUCT ROYALTY INCOME
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39,961
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39,649
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$
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312
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1%
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OPERATING EXPENSES
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Salaries and Wages
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555,514
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523,912
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$
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31,602
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6%
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Commissions and
Consulting
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126,273
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133,921
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$
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(7,648
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-6%
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Professional Fees
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119,981
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70,659
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$
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49,322
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70%
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Advertising and
Marketing
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407,781
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352,801
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$
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54,980
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16%
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Office Rent and Expenses
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66,627
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62,962
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$
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3,665
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6%
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Research and
Development Costs
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322,155
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338,244
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$
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(16,089
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-5%
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Bad Debt Expense (Recovery)
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5,291
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(25,384
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)
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$
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30,675
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121%
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General and
Administrative
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434,077
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514,852
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$
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(80,775
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)
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-16%
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Depreciation
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102,490
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106,481
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$
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(3,991
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)
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-4%
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Total Operating
Expenses
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2,140,189
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2,078,448
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$
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61,741
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3%
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LOSS FROM OPERATIONS
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(335,069
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)
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(54,896
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)
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$
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(280,173
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)
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510%
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Other Income (Expenses)
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(2,567
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)
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70,750
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$
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(73,317
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-104%
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INCOME (LOSS) BEFORE INCOME TAXES
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(337,636
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15,854
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$
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(353,490
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-2230%
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Income Taxes
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(116,573
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)
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27,310
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$
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(143,883
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-527%
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NET
LOSS
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$
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(221,063
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)
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$
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(11,456
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)
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$
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(209,607
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)
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1830%
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Revenues
We earn revenues from the sale of our
protective gear comprising of neck braces, body armor, helmets and other
products, parts and accessories both in the United States and internationally.
Revenues for the three months ended June 30, 2017 were $3.51 million, a 5%
decrease, compared to revenues of $3.69 million for the quarter ended June 30,
2016. Revenues associated with international customers were $1.64 million and
$1.83 million, or 47% and 50% of revenues, respectively, for the three months
ended June 30, 2017 and 2016. This decrease in worldwide revenues is primarily
attributable to a $0.20 million decrease in neck brace sales and a $0.09 million
decrease in helmet sales that were partially offset by a $0.06 million increase
in body armor sales and a $0.05 million increase in sales of other products,
parts and accessories.
The following table sets forth our revenues by product line for
the three months ended June 30, 2017 and 2016:
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Three months ended June 30
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%
of
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%
of
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2017
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Revenues
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2016
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Revenues
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Neck braces
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$
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1,095,390
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31%
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$
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1,300,052
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35%
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Body armor
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1,853,412
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53%
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1,790,425
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49%
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Helmets
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281,238
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8%
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374,659
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10%
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Other Products, Parts and Accessories
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280,257
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8%
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228,779
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6%
|
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|
$
|
3,510,297
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100%
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$
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3,693,915
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100%
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Sales of our flagship neck brace accounted for $1.10 million
and $1.30 million, or 31% and 35% of our revenues for the quarters ended June
30, 2017 and 2016, respectively. The 16% decrease in neck brace revenues is
primarily attributable to a 17% decrease in the volume of neck braces sold to
our customers worldwide.
- 14 -
Our body armor products are comprised of chest protectors, full
upper body protectors, upper body protection vests, back protectors, knee braces
and knee and elbow guards. Body armor sales accounted for $1.85 million and
$1.79 million, or 53% and 49% of our revenues for the quarters ended June 30,
2017 and 2016, respectively. The 4% increase in body armor revenues was
primarily the result of an increase in sales of the Companys C-Frame knee brace
line due to continued demand for the C-Frame Pro knee brace both in the United
States and abroad.
Our helmets accounted for $0.28 million and $0.37 million, or
8% and 10% of our revenues for the three months ended June 30, 2017 and 2016,
respectively. Although revenues from the sale of our range of bicycle helmets
increased by 110% during the second quarter of 2017, sales of our motorcycle
range of helmets decreased by 53%. The decrease in helmet sales was due to the
large volume of initial stocking shipments of our GPX 5.5 Composite and GPX 6.5
Carbon helmets for motorcycle use to our customers globally during the second
quarter of 2016.
Our other products, parts and accessories are comprised of
aftermarket support items required primarily to replace worn or damaged parts
through our global distribution network, as well as clothing, outerwear and
accessories that include hats, jackets, bags, hydration kits and cooling
garments. Other products, parts and accessories sales accounted for $0.28
million and $0.23 million, or 8% and 6% of our revenues for the quarters ended
June 30, 2017 and 2016, respectively. The 23% increase in revenues from the sale
of other products, parts and accessories is primarily due to an increase in the
sales volume of GPX and DBX apparel designed for off-road motorcycle and bicycle
use respectively.
Cost of Revenues and Gross Profit
Cost of revenues for
the quarters ended June 30, 2017 and 2016 were $1.75 million and $1.71 million,
respectively. Gross Profit for the quarters ended June 30, 2017 and 2016 were
$1.77 million and $1.98 million, respectively, or 50% and 54% of revenues
respectively. Our
neck brace
products continue to generate a
higher gross margin than our other product categories. Neck brace revenues
accounted for 31% and 35% of our revenues for the quarters ended June 30, 2017
and 2016 respectively.
Product Royalty Income
Product royalty income is
earned on sales to distributors that have royalty agreements in place, as well
as on sales of licensed products by third parties that have licensing agreements
in place. Product royalty income for the quarters ended June 30, 2017 and 2016
were $39,961 and $39,649, respectively. The 1% increase in product royalty
income is due to a marginal increase in the sale of licensed products by
licensees in the 2017 period.
Salaries and Wages
Salaries and wages for the quarters
ended June 30, 2017 and 2016 were $555,514 and $ 523,912, respectively. This 6%
increase in salaries and wages during the 2017 period was primarily due to the
employment of additional sales and marketing personnel based in Europe.
Commissions and Consulting Expense
During the quarters
ended June 30, 2017 and 2016, commissions and consulting expenses were $126,273
and $133,921, respectively. This 6% decrease in commissions and consulting
expenses is primarily due to the restructuring of commissions paid to the
Companys US external sales representatives.
Professional Fees
Professional fees consist of costs
incurred for audit, tax and regulatory filings, as well as patent protection and
product liability litigation expenses incurred as the Company continues to
expand. Professional fees for the quarters ended June 30, 2017 and 2016 were
$119,981 and $70,659, respectively. This 70% increase in professional fees is
primarily due to increased spending on product liability litigation during the
2017 period.
Advertising and Marketing
The Company places paid
advertising in various motorsport magazines and online media, and sponsors a
number of events, teams and individuals to increase product and brand
visibility. Advertising and marketing expenses for the quarters ended June 30,
2017 and 2016 were $407,781 and $352,801, respectively. The 16% increase in
advertising and marketing expenditures during the 2017 period is primarily due
to the production and implementation of global marketing campaigns designed to
support and promote the Companys widening product range and target market
reach.
Office Rent and Expenses
Office rent and expenses for
the quarters ended June 30, 2017 and 2016 were $66,627 and $62,962,
respectively. This 6% increase in office rent and expenses during the 2017
period is in line with lease escalation clauses for the Companys worldwide
facilities.
Research and Development Costs
These costs consist of
the salaries of personnel who are directly involved in the research and
development of innovative products, as well as the direct costs associated with
developing these products. Research and development costs for the quarters ended
June 30, 2017 and 2016, decreased to $322,155, from $338,244, during the same
2016 quarter. The 5% decrease in research and development costs is primarily due
to a restructuring of the salaries paid to personnel in the research and
development department.
Bad Debt Expense (Recovery)
Bad Debt Expense
(Recovery) for the quarters ended June 30, 2017 and 2016 were $5,291 and
($25,384), respectively. This increase in Bad Debt Expense is primarily the
result of the recovery of previously unrecoverable debts during the 2016 period.
General and Administrative Expenses
General and
administrative expenses consist of insurance, travel, merchant fees, telephone,
office and computer supplies. General and administrative expenses for the
quarters ended June 30, 2017 and 2016 were $434,077 and $514,852, respectively.
The 16% decrease in general and administrative expenses is primarily due to a
decrease in product liability insurance premiums.
- 15 -
Depreciation Expense
Depreciation Expense for
the quarters ended June 30, 2017 and 2016 were $102,490 and $106,481,
respectively. This 4% decrease in depreciation is primarily due to certain
assets being fully depreciated during the period as they had reached the end of
their economic useful lives.
Total Operating Expenses
Total operating expenses
increased by $61,741, to $2.14 million in the three months ended June 30, 2017,
or 3%, compared to $2.08 million in the 2016 period. This increase is primarily
due to increased professional fees as well as advertising and marketing expenses
that were partially offset by decreased general and administrative costs
discussed above.
Net loss
The net loss after income taxes for the
quarter ended June 30, 2017 was $221,063 as opposed to a net loss after income
taxes of $11,456 for the quarter ended June 30, 2016. This increase in net loss
is primarily due to the decrease in revenues and increase in operating costs
discussed above.
Six Months Ended June 30, 2017 Compared to the Six Months
Ended June 30, 2016
The following table summarizes the results of our operations
during the six-month periods ended June 30, 2017 and 2016 and provides
information regarding the dollar and percentage increase or (decrease) in such
periods:
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|
Six Months Ended June 30,
|
|
|
|
|
|
Percentage
|
|
|
|
2017
|
|
|
2016
|
|
|
$ Increase
|
|
|
Increase
|
|
Item
|
|
|
|
|
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REVENUES
|
$
|
9,328,066
|
|
$
|
8,521,407
|
|
$
|
806,659
|
|
|
9%
|
|
COST OF REVENUES
|
|
4,652,808
|
|
|
4,023,669
|
|
$
|
629,139
|
|
|
16%
|
|
GROSS PROFIT
|
|
4,675,258
|
|
|
4,497,738
|
|
$
|
177,520
|
|
|
4%
|
|
PRODUCT ROYALTY INCOME
|
|
50,917
|
|
|
53,531
|
|
$
|
(2,614
|
)
|
|
-5%
|
|
OPERATING EXPENSES
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and Wages
|
|
1,314,757
|
|
|
1,205,214
|
|
$
|
109,543
|
|
|
9%
|
|
Commissions and
Consulting
|
|
279,321
|
|
|
299,992
|
|
$
|
(20,671
|
)
|
|
-7%
|
|
Professional Fees
|
|
430,772
|
|
|
252,318
|
|
$
|
178,454
|
|
|
71%
|
|
Advertising and
Marketing
|
|
809,335
|
|
|
714,394
|
|
$
|
94,941
|
|
|
13%
|
|
Office Rent and Expenses
|
|
132,678
|
|
|
127,152
|
|
$
|
5,526
|
|
|
4%
|
|
Research and
Development Costs
|
|
645,398
|
|
|
681,059
|
|
$
|
(35,661
|
)
|
|
-5%
|
|
Bad Debt Expense (Recovery)
|
|
650
|
|
|
(22,557
|
)
|
$
|
23,207
|
|
|
103%
|
|
General and
Administrative
|
|
835,490
|
|
|
961,798
|
|
$
|
(126,308
|
)
|
|
-13%
|
|
Depreciation
|
|
191,455
|
|
|
210,998
|
|
$
|
(19,543
|
)
|
|
-9%
|
|
Total Operating
Expenses
|
|
4,639,856
|
|
|
4,430,368
|
|
$
|
209,488
|
|
|
5%
|
|
INCOME FROM OPERATIONS
|
|
86,319
|
|
|
120,901
|
|
$
|
(34,582
|
)
|
|
-29%
|
|
Other Income (Expenses)
|
|
(5,555
|
)
|
|
68,809
|
|
$
|
(74,364
|
)
|
|
-108%
|
|
INCOME BEFORE INCOME TAXES
|
|
80,764
|
|
|
189,710
|
|
$
|
(108,946
|
)
|
|
-57%
|
|
Income Taxes
|
|
29,867
|
|
|
88,186
|
|
$
|
(58,319
|
)
|
|
-66%
|
|
NET
INCOME
|
$
|
50,897
|
|
$
|
101,524
|
|
$
|
(50,627
|
)
|
|
-50%
|
|
Revenues
We earn revenues from the sale of our
protective gear comprising of neck braces, body armor, helmets and other
products, parts and accessories both in the United States and internationally.
Revenues for the six months ended June 30, 2017 were $9.33 million, an 9%
increase, compared to revenues of $8.52 million for the quarter ended June 30,
2016. Revenues associated with international customers were $5.61 million and
$4.80 million, or 60% and 56% of revenues, respectively, for the six months
ended June 30, 2017 and 2016. This increase in global revenues is attributable
to a $0.21 million increase in neck brace sales, a $0.63 million increase in
body armor sales and a $0.26 million increase in sales of other products, parts
and accessories that was partially offset by a $0.29 million decrease in helmet
sales.
The following table sets forth our revenues by product line for
the six months ended June 30, 2017 and 2016:
- 16 -
|
|
Six months ended June 30
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
%
of
|
|
|
2016
|
|
|
%
of
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
Revenues
|
|
Neck braces
|
$
|
3,105,964
|
|
|
33%
|
|
$
|
2,893,782
|
|
|
34%
|
|
Body armor
|
|
4,606,934
|
|
|
49%
|
|
|
3,980,901
|
|
|
47%
|
|
Helmets
|
|
892,490
|
|
|
10%
|
|
|
1,183,214
|
|
|
14%
|
|
Other Products, Parts and Accessories
|
|
722,678
|
|
|
8%
|
|
|
463,510
|
|
|
5%
|
|
|
$
|
9,328,066
|
|
|
100%
|
|
$
|
8,521,407
|
|
|
100%
|
|
Sales of our flagship neck brace accounted for $3.11 million
and $2.89 million, or 33% and 34% of our revenues for the six-month periods
ended June 30, 2017 and 2016, respectively. The 7% increase in neck brace
revenues is primarily attributable to an increase in the volume of neck braces
sold to our customers both in the United States and abroad.
Our body armor products are comprised of chest protectors, full
upper body protectors, upper body protection vests, back protectors, knee braces
and knee and elbow guards. Body armor sales accounted for $4.61 million and
$3.98 million, or 49% and 47% of our revenues for the six-month periods ended
June 30, 2017 and 2016, respectively. The 16% increase in body armor revenues
was primarily the result of increased sales of the Companys C-Frame knee brace
line in the United States and abroad due to the successful introduction of the
C-Frame Pro Knee Brace.
Our Helmets accounted for $0.89 million and $1.18 million, or
10% and 14% of our revenues for the six-month periods ended June 30, 2017 and
2016, respectively. Although the Company successfully shipped initial stocking
shipments of our DBX All Mountain helmet during the first half of 2017, the 25%
decrease in Helmet revenues is due to initial stocking shipments of our GPX 5.5
Composite, GPX 6.5 Carbon, DBX 6.0 Carbon and DBX 5.0 Composite helmets to our
international customers during the six months ended June 30, 2016.
Our other products, parts and accessories are comprised of
aftermarket support items required primarily to replace worn or damaged parts
through our global distribution network, as well as clothing, outerwear and
accessories that include hats, jackets, bags, hydration kits and cooling
garments. Other products, parts and accessories sales accounted for $0.72
million and $0.46 million, or 8% and 5% of our revenues for the six-month
periods ended June 30, 2017 and 2016, respectively. The 56% increase in revenues
from the sale of other products, parts and accessories is primarily due to the
inclusion of our GPX and DBX apparel lines designed for off-road motorcycle and
bicycle use respectively.
Cost of Revenues and Gross Profit
Cost of revenues for
the six-months ended June 30, 2017 and 2016 were $4.65 million and $4.02
million, respectively. Gross Profit for the six-month periods ended June 30,
2017 and 2016 were $4.68 million and $4.50 million, respectively, or 50% and 53%
of revenues respectively. Neck brace
products continue to generate a
higher gross margin than our other product categories. Neck brace revenues
accounted for 33% and 34% of our revenues for the six months ended June 30, 2017
and 2016 respectively.
Product Royalty Income
Product royalty income is
earned on sales to distributors that have royalty agreements in place, as well
as on sales of licensed products by third parties that have licensing agreements
in place. Product royalty income for the six-month periods ended June 30, 2017
and 2016 were $50,917 and $53,531, respectively. The 5% decrease in product
royalty income is due to a decrease in the sale of licensed products by
licensees in the 2017 period.
Salaries and Wages
Salaries and wages for the
six-month periods ended June 30, 2017 and 2016 were $1,314,757 and $1,205,214,
respectively. This 9% increase in salaries and wages during the 2017 period was
primarily due to the employment of additional sales and marketing staff based in
Europe as well as the vesting of share options issued to key personnel during
the six-month period ended June 30, 2017.
Commissions and Consulting Expense
During the
six-month periods ended June 30, 2017 and 2016, commissions and consulting
expenses were $279,321 and $299,992, respectively. This 7% decrease in
commissions and consulting expenses is primarily due to the restructuring of
commissions paid the Companys US internal and external sales staff and
representatives.
Professional Fees
Professional fees consist of costs
incurred for audit, tax and regulatory filings, as well as patent protection and
product liability litigation expenses incurred as the Company continues to
expand. Professional fees for the six-month periods ended June 30, 2017 and 2016
were $430,772 and $252,318, respectively. This 71% increase in professional fees
is primarily due to increased spending on product liability litigation during
the 2017 period.
Advertising and Marketing
The Company places paid
advertising in various motorsport magazines and online media, and sponsors a
number of events, teams and individuals to increase product and brand
visibility. Advertising and marketing expenses for the six-months ended June 30,
2017 and 2016 were $809,335 and $714,394, respectively. The 13% increase in
advertising and marketing expenditures during the 2017 period is primarily due
to the production and implementation of marketing campaigns designed to globally
support and promote the Companys widening product range, target market reach
and brand awareness.
- 17 -
Office Rent and Expenses
Office rent and expenses for
the six-month periods ended June 30, 2017 and 2016 were $132,678 and $127,152,
respectively. The 4% increase in office rent and expenses during the 2017 period
is in line with lease escalation clauses for the Companys worldwide
facilities.
Research and Development Costs
These costs consist of
the salaries of personnel who are directly involved in the research and
development of innovative products, as well as the direct costs associated with
developing these products. Research and development costs for the six-month
periods ended June 30, 2017 and 2016, decreased to $645,398, from $681,059,
during the same 2016 quarter. The 5% decrease in research and development costs
is primarily due to a restructuring of the salaries paid to personnel in the
research and development department.
Bad Debt Expense (Recovery)
Bad Debt Expense
(Recovery) for the six-month periods ended June 30, 2017 and 2016 were $650 and
($22,557), respectively. This increase in Bad Debt Expense is primarily the
result of the recovery of previously unrecoverable debts during the 2016 period.
General and Administrative Expenses
General and
administrative expenses consist of insurance, travel, merchant fees, telephone,
office and computer supplies. General and administrative expenses for the
six-month periods ended June 30, 2017 and 2016 were $835,490 and $ 961,798,
respectively. The 13% decrease in general and administrative expenses is
primarily as a result of a decrease in product liability insurance premiums.
Depreciation Expense
Depreciation Expense for the
six-month periods ended June 30, 2017 and 2016 were $191,455 and $210,998,
respectively. This 9% decrease in depreciation is primarily due to certain
assets that were fully depreciated during the period as they had reached the end
of their economic lives.
Total Operating Expenses
Total operating expenses
increased by $209,488, to $4.64 million in the six month periods ended June 30,
2017, or 5%, compared to $4.43 million in the 2016 period. This increase is
primarily due to increased salaries and wages, professional fees as well as
advertising and marketing expenses that were partially offset by decreased
general and administrative costs discussed above.
Net income
Net income after income taxes for the
six-month period ended June 30, 2017 was $50,897 as opposed to a net income
after income taxes of $101,524 for the six-month period ended June 30, 2016.
This decrease in net income is primarily due to the increase in operating
expenses that were partially offset by increased revenues and gross margin
discussed above.
Liquidity and Capital Resources
At June 30, 2017, we had cash and cash equivalents of $1.36
million and $0.06 million of short-term investments. The following table sets
forth a summary of our cash flows for the periods indicated:
|
|
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Net cash provided by
operating activities
|
$
|
1,107,711
|
|
$
|
331,894
|
|
Net cash used in investing activities
|
$
|
(603,191
|
)
|
$
|
(52,641
|
)
|
Net cash used in financing
activities
|
$
|
(275,890
|
)
|
$
|
(348,014
|
)
|
Effect of exchange rate changes on cash and
cash equivalents
|
$
|
30,404
|
|
$
|
14,770
|
|
Net increase (decrease) in
cash and cash equivalents
|
$
|
259,034
|
|
$
|
(53,991
|
)
|
Cash and cash equivalents at the beginning of
period
|
$
|
1,103,003
|
|
$
|
1,054,750
|
|
Cash and cash equivalents at the end of period
|
$
|
1,362,037
|
|
$
|
1,000,759
|
|
Cash increased by $259,034, or 23%, for the six months ended
June 30, 2017. The primary sources of cash for the six months ended June 30,
2017 were decreased inventory of $1.2 million and decreased accounts receivables
of $582,146. The primary uses of cash for the six months ended June 30, 2017
were decreased accounts payable and accrued expenses of $945,555, increased
prepaid expenses and other current assets of $172,633, capital expenditures of
$603,180, and the repayment of the short-term loan amount for $275,890. As of
June 30, 2017, we did not have any credit facilities or significant amounts owed
to third party lenders.
The Company is currently meeting its working capital needs
through cash on hand as well as internally generated cash from operations.
Management believes that its current cash and cash equivalent balances, along
with the net cash generated by operations are sufficient to meet its anticipated
operating cash requirements for at least the next twelve months. There are
currently no plans for any major capital expenditures in the next twelve months.
Our long-term financing requirements depend on our growth strategy, which
relates primarily to our desire to increase revenue both domestically as well as
internationally.
Obligations under Material Contracts
Pursuant to our Licensing Agreement with Xceed Holdings, a
company owned and controlled by Dr. Christopher Leatt, our founder and chairman,
we pay Xceed Holdings, 4% of all neck brace sales revenue billed and received by
the Company on a quarterly basis, based on sales of the previous quarter. In addition, pursuant
to a separate license agreement between the Company and Mr. J. P. De Villiers,
our former director, the Company is obligated to pay a royalty fee of 1% of all
our billed and received neck brace sales revenue, in quarterly installments,
based on sales of the previous quarter, to a trust that is beneficially owned
and controlled by Mr. De Villiers.
- 18 -
Pursuant to a Premium Finance Agreement, dated October 13,
2016, between the Company and AFCO Acceptance Corporation AFCO, the Company is
obligated to pay AFCO an aggregate sum of $637,260 in eleven payments of
$58,921, at an annual interest rate of 3.397%, commencing on November 1, 2016
and ending on September 1, 2017. Any late payment during the term of the
agreement will be assessed a late penalty of 5% of the payment amount due, and
in the event of default AFCO has the right to accelerate the payment due under
the agreement. As of June 30, 2017, the Company had not defaulted on its payment
obligations under this agreement.
Pursuant to a Premium Finance Agreement, dated May 22, 2017,
between the Company and AFCO, the Company is obligated to pay AFCO an aggregate
sum of $89,708 in eleven payments of $8,315 at a 3.900% annual interest rate,
commencing on June 1, 2017 and ending on April 1, 2018. Any late payment during
the term of the agreement will be assessed a late penalty of 5% of the payment
amount due, and in the event of default AFCO has the right to accelerate the
payment due under the agreement. As of June 30, 2017, the Company had not
defaulted on its payment obligations under this agreement.
Pursuant to a Premium Finance Agreement, dated March 30, 2017,
between the Company and AFCO, the Company is obligated to pay AFCO an aggregate
sum of $7,195 in five payments of $1,453 at a 3.397% annual interest rate,
commencing on May 1, 2017 and ending on September 1, 2018. Any late payment
during the term of the agreement will be assessed a late penalty of 5% of the
payment amount due, and in the event of default AFCO has the right to accelerate
the payment due under the agreement. As of June 30, 2017, the Company had not
defaulted on its payment obligations under this agreement.
On July 8, 2015, the Company entered into a consulting
agreement with Innovate Services Limited, or Innovate, a Seychelles limited
company in which, Dr. Leatt is an indirect beneficiary. Pursuant to the terms of
the Consulting Agreement, Innovate has agreed to serve as the Companys
exclusive research, development and marketing consultant, in exchange for a
monthly fee of $35,639; provided that Dr. Leatt personally performs the services
to be performed by Innovate under the Agreement, pursuant to a separate
employment agreement between Innovate and Dr. Leatt. The parties further agreed
that all intellectual property generated in connection with the services
provided under the Consulting Agreement will be the sole property of the
Company. The Consulting Agreement was effective as of May 15, 2015, and will
continue unless terminated by either party in accordance with its terms. Either
party has the right to terminate the Consulting Agreement upon 6 months' prior
written notice, except that the Consulting Agreement may be terminated
immediately without notice if the services to be performed under the Consulting
Agreement cease to be performed by Dr. Leatt, or for any other material breach
of the Agreement. The parties have agreed to settle any dispute under the
Consulting Agreement through arbitration in accordance with the Commercial
Arbitration Rules of the American Arbitration Association (AAA), and that the
resulting arbitration award will be final and binding on both parties and will
not be subject to any appeal. The foregoing description does not purport to be a
complete statement of the parties rights and obligations under the Consulting
Agreement and the transactions contemplated thereby or a complete explanation of
the materials thereof.
Critical Accounting Policies
Our discussion and analysis of financial condition and results
of operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported revenues and expenses
during the reporting period. We have identified the following as the items that
require the most significant judgment and often involve complex estimation:
revenue recognition, estimating allowances for doubtful accounts receivable,
inventory valuation, impairment of long-lived assets and accounting for income
taxes.
Revenue and Cost Recognition
- All manufacturing
of Leatt-Brace products is performed by third party subcontractors in China. The
Company's products are sold worldwide to a global network of distributors and
dealers, and directly to consumers when there are no dealers or distributors in
their geographic area (collectively the "customers"). Revenues from product
sales are recognized when earned, net of applicable provisions for discounts and
returns and allowances in the event of product defect. Revenue is considered to
be realized or realizable and earned when all of the following criteria are met:
title and risk of loss have passed to the customer, persuasive evidence of an
arrangement exists, delivery has occurred, the price is fixed and determinable
and collectability is reasonably assured. Our distributor payment terms range
from pre-payment in full to 60 days after shipment and subsequent sales of our
products by distributors have no effect on the amount and timing of payments due
to us. Furthermore, products purchased by distributors may not be returned to us
in the event that any such distributor relationship is terminated.
Since the Company (through its wholly-owned subsidiary) serves
as the distributor of Leatt products in the United States, the Company records
its revenue and related cost of revenue for its product sales in the United
States upon shipment of the merchandise to the dealer or to the ultimate
consumer when there is no dealer in the geographic area and the sales order was
received directly from, and paid by, the ultimate consumer. Since the Company
(through its South African branch) serves as the distributor of Leatt products
in South Africa, the Company records its revenue and related cost of revenue for
its product sales in South Africa upon shipment of the merchandise from the branch to the dealer. International
sales (other than in South Africa) are generally drop-shipped directly from the
third party manufacturer to the international distributors.
- 19 -
Revenue and related cost of revenue is recognized at the time
of shipment from the manufacturer's port when the shipping terms are Free On
Board ("FOB") shipping point. Cost and Freight ("CFR") or Cost and Insurance to
named place ("CIP") as legal title and risk of loss to the product pass to the
distributor. Sales to all customers (distributors, dealers and consumers) are
generally final; however, in limited instances, product may be returned due to
product quality issues. Historically, returns due to product quality issues have
not been material and there have been no distributor terminations that resulted
in product returns. Cost of revenues also includes royalty fees associated with
sales of Leatt-Brace products. Product royalty income is recorded as the
underlying product sales occur, in accordance with the related licensing
arrangements.
Allowance for Doubtful Accounts Receivable
-
Accounts receivable consist of amounts due to the Company from normal
business activities. Credit is granted to substantially all distributors on an
unsecured basis. We continuously monitor collections and payments from customers
and maintain an allowance for doubtful accounts receivable based upon historical
experience and any specific customer collection issues that have been
identified. In determining the amount of the allowance, we are required to make
certain estimates and assumptions. Accounts receivable balances that are still
outstanding after we have used reasonable collection efforts are written off as
uncollectible. While such credit losses have historically been minimal, within
our expectations and the provisions established, we cannot guarantee that we
will continue to experience the same credit loss rates that we have in the past.
A significant change in the liquidity or financial position of any of our
significant customers could have a material adverse effect on the collectability
of our accounts receivable and our future operating results.
Inventory Valuation
Inventory is stated at the
lower of cost or market. Cost is determined using the first-in first-out (FIFO)
method. Inventory consists primarily of finished goods. Shipping and handling
costs are included in the cost of inventory. In assessing the inventory value,
we make estimates and judgments regarding reserves required for product
obsolescence, aging of inventory and other issues potentially affecting the
saleable condition of products. In performing such evaluations, we utilize
historical experience as well as current market information. The reserve for
obsolescence as of the six-month periods ended June 30, 2017 and 2016 was
$292,767 and $173,695, respectively.
Impairment of Long-Lived Assets
Our
long-lived assets include property and equipment. We evaluate our long-lived
assets for recoverability whenever events or changes in circumstances indicate
that an asset may be impaired. In evaluating an asset for recoverability, we
estimate the future cash flow expected to result from the use of the asset and
eventual disposition. If the expected future undiscounted cash flow is less than
the carrying amount of the asset, an impairment loss, equal to the excess of the
carrying amount over the fair value of the asset, is recognized. We have
determined there was no impairment charge during the quarters ended June 30,
2017 and 2016.
Income Taxes
- As part of the process of
preparing our consolidated financial statements, we are required to estimate our
income tax provision (benefit) in each of the jurisdictions in which we operate.
This process involves estimating our current income tax provision (benefit)
together with assessing temporary differences resulting from differing treatment
of items for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included within our consolidated balance
sheets. We regularly evaluate our ability to recover the reported amount of our
deferred income taxes considering several factors, including our estimate of the
likelihood of the Company generating sufficient taxable income in future years
during the period over which the temporary differences reverse.
Recent Accounting Pronouncements
See Note 8, Summary of Significant Accounting Policies in the
Notes to Consolidated Financial Statements for a full description of recent
accounting pronouncements, including the respective dates of adoption, or
expected adoption and effects of our consolidated financial position, results of
operations and cash flows.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect on its financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that is
material to its stockholders.