LEAT Leatt Corporation (QB)

ITEM 2. MANAGEMENT'S 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 "Management's 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, performance 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" in our latest annual report on Form 10-K filed with the SEC. 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:

• our expectations regarding growth in the motor sports market;

• our expectation regarding increasing demand for protective equipment used in the motor sports market;

• our belief that we will be able to effectively compete with our competitors and increase our market share;

• our expectations with respect to increased revenue growth and our ability to achieve profitability resulting from increases in our production volumes; and

• our future business development, results of operations and financial condition.

Also, forward-looking statements represent our estimates and assumptions only as of the date of this annual report. You should read this annual report and the documents that we reference and filed as exhibits to the annual 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 report to:

•  "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;

•  "Leatt SA" are to the Company's 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;

•  "Leatt USA" are to Leatt USA, LLC, a Nevada Limited Liability Company;

•  "PRC", and "China" are to the People's Republic of China;

•  "Two Eleven" refers to Two Eleven Distribution, LLC, a California Limited Liability Company;

•  "Three Eleven" are to Three Eleven Distribution (Pty) Limited, a South African Company;

•  "Securities Act" are to the Securities Act of 1933, as amended, and to "Exchange Act" are to Securities Exchange Act of 1934, as amended;

•  "South Africa" are to the Republic of South Africa;

•  "U.S. dollar," "$" and "US$" are to the legal currency of the United States.

•  "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 Company's chairman, is a Trustee and Beneficiary; and

•  "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 = ZAR17.2708 for its June 30, 2020 balance sheet.

Overview of our Business

We were incorporated in the State of Nevada on March 11, 2005 under the name Treadzone, Inc. We were a shell company with little or no operations until March 1, 2006, when we acquired 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 Company's Chairman and founder, Dr. Christopher Leatt. On May 25, 2005, we changed our name to Leatt Corporation in connection with our anticipated acquisition of the Leatt-Brace® rights. 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 Company's 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 Company's 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 Company's new body protection products which it markets under the Leatt Protection Range brand.

The Company's 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. Depending on the market we have other certifications outside of CE. For the US market our motorcycle helmets comply with the DOT (FMVSS 218) helmet safety standard and our bicycle helmet complies with EN1078, as well as CPSC 1203. Our downhill specific bicycle helmets also comply with ASTM F1952. For our Australian Market our bicycle helmet complies with AS/NZS 2063. For the UK market our motorcycle helmets comply with ACU Gold. We are also in the process of certifying our GPX 3.5 helmet with JIS T 8133 for the Japanese Market.

Our products are predominately manufactured in China under outsource manufacturing arrangements with third-party manufacturers located there subject to agreed standard terms. The Company utilizes outside consultants and its own employees to ensure the quality of its products through regular on-site product inspections. Products sold to our international customers are usually shipped directly from our consolidation warehouse or manufacturers' warehouses 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 dealers in the United States and South Africa, respectively.

Principal Factors Affecting Our Financial Performance

We believe that the following factors will continue to affect our financial performance:

•  Global Economic Fragility - The ongoing turmoil in the global economy, especially in the U.S., Asia 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.

•  Trade Restrictions - We engage in international manufacturing and sales which exposes us to trade restrictions and disruptions that could harm our business and competitive position. Most of our products are manufactured in China, and the US administration has announced tariffs on certain products imported into the United States with China as the country of origin. While these tariffs have not had a significant impact on the shipment of our products to international markets as at June 30, 2020, we believe that the future imposition of, or significant increases in, the level of tariffs, custom duties, export quotas and other barriers and restrictions by the US on China or other countries could disrupt our supply chain, increase the cost of our raw materials and therefore our pricing, and impose the burdens of compliance with foreign trade laws, any of which could potentially affect our bottom line and sales. While we are in continuous discussions with our manufacturers to ensure there are contingencies in place, we cannot assure you that we will not be adversely affected by changes in the trade laws of foreign jurisdictions where we sell and seek to sell our products.

•  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.

•  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 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 would vigorously defend itself in each case. In this case, the plaintiffs subsequently appealed the court's 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.

•  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.

•  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 62% 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.

•  Natural or man-made catastrophic events - We are exposed to natural or man-made catastrophic events that may disrupt our business and may reduce consumer demand for our products. A disruption or failure of our systems or operations in the event of a natural disaster, health pandemic, such as the outbreak and global spread of COVID-19 or the coronavirus, or a man-made catastrophic event could cause delays in completing sales, continuing production or performing other critical functions of our business, particularly if a catastrophic event occurred at our primary manufacturing locations or our distributor locations worldwide. Any of these events could severely affect our ability to conduct normal business operations and, as a result, our operating results could be adversely affected. There may also be secondary impacts that are unforeseeable, such as impacts on our consumers and on consumer purchasing behavior, which could cause delays in new orders, delays in completing sales or even order cancellations.  While we have not seen any significant material impact of COVID-19 on our results of operations for the six months ended June 30, 2020, we expect that the spread of the virus throughout Europe and the U.S., and the extended global quarantine that commenced at the tail of the first quarter, will result in a decrease in revenues for the next several quarters.  We have reviewed all operating costs, adjusted our budgets, accordingly, streamlined staffing requirements in line with expected decreases in revenues, negotiated favorable working capital terms and obtained government assistance where applicable. The continued spread of the virus and its reemergence during the third and fourth quarters in areas that have previously eased quarantine requirements, or the occurrence of any other catastrophic events, could have a negative impact our sales revenue for the remainder of 2020 and beyond.

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, 2020 and 2019 included herein.

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 abroad. Revenues for the three months ended June 30, 2020 were $6.94 million a 32% increase, compared to revenues of $5.28 million for the quarter ended June 30, 2019. Revenues associated with international customers were $3.44 million and $2.96 million, or 50% and 56% of revenues, respectively, for the three months ended June 30, 2020 and 2019. This increase in global revenues is primarily attributable to a $1.34 million increase in body armor sales, a $0.49 million increase in sales of other products, parts and accessories and a $0.08 million increase in helmet sales, that were partially offset by a $0.24 million decrease in neck brace sales.

The following table sets forth our revenues by product line for the three months ended June 30, 2020 and 2019:

Sales of our flagship neck brace accounted for $1.08 million and $1.32 million, or 15% and 25% of our revenues for the quarters ended June 30, 2020 and 2019, respectively. Although sales volumes of our neck braces designed for mountain biking increased by 13% during the period, the 18% decrease in neck brace revenues during the 2020 second quarter is primarily attributable to a 21% decrease in the volume of off-road motorcycle neck braces sold to our customers worldwide during the period.

Our body armor products are comprised of chest protectors, full upper body protectors, upper body protection vests, back protectors, knee braces, knee and elbow guards, off-road motorcycle boots and mountain biking shoes. Body armor sales accounted for $4.14 million and $2.81 million, or 60% and 53% of our revenues for the quarters ended June 30, 2020 and 2019, respectively. The 48% increase in body armor revenues during the 2020 second quarter is primarily the result of a 46% increase in the volume of upper body protectors sold during the period due to increased worldwide demand for our line of premium, athlete tested full upper body and chest protectors designed for both off-road motorcycle and mountain biking use.

Our helmets accounted for $0.54 million and $0.46 million or 8% and 9% of our revenues for the three months ended June 30, 2020 and 2019, respectively. The $0.08 million increase in helmet sales during the 2020 second quarter is primarily due to a 67% increase in the volume of helmets sold globally during the 2020 period.

Our other products, parts and accessories are comprised of goggles, hydration bags and apparel items including jerseys, pants, shorts and jackets as well as aftermarket support items required primarily to replace worn or damaged parts through our global distribution network. Other products, parts and accessories sales accounted for $1.18 million and $0.70 million, or 17% and 13% of our revenues for the quarters ended June 30, 2020 and 2019, respectively. The 70% increase in revenues from the sale of other products, parts and accessories during the 2020 second quarter is primarily due to continued, consistent consumer demand for our innovative Velocity line of military tested bulletproof goggles.

Cost of Revenues and Gross Profit - Cost of revenues for the quarters ended June 30, 2020 and 2019 were $3.69 million and $2.65 million, respectively. Gross Profit for the quarters ended June 30, 2020 and 2019 were $3.25 and $2.63 million, respectively, or 47% and 50% of revenues respectively. Our neck brace products continue to generate a higher gross margin than our other product categories. Neck brace revenues accounted for 15% and 25% of our revenues for the quarters ended June 30, 2020 and 2019, 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, 2020 and 2019 were $3,182 and $6,995, respectively. The 55% decrease in product royalty income is due to a decrease in the sale of licensed products by licensees in the 2020 period.

Salaries and Wages - Salaries and wages for the quarters ended June 30, 2020 and 2019 were $622,846 and $713,736, respectively. This 13% decrease in salaries and wages during the 2020 period was primarily due to temporary staff cost reduction measures implemented by the Company at all levels globally during the second quarter of 2020, in an effort to partially mitigate the potential effects of the COVID-19 pandemic.

Commissions and Consulting Expense - During the quarters ended June 30, 2020 and 2019, commissions and consulting expenses were $103,906 and $80,499, respectively. This 29% increase in commissions and consulting expenses is primarily due to an increase in commissions paid to internal and external sales personnel in the United States as a result of increased dealer demand and selling activity that commenced in the period post relaxation of the stay in place orders instituted in various states in the United States.

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, 2020 and 2019 were $213,318 and $131,569, respectively. This 62% increase in professional fees is primarily due to increased spending on product liability litigation during the 2020 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, 2020 and 2019 were $357,028 and $471,888, respectively. The 24% decrease in advertising and marketing expenditures during the 2020 period is primarily due to a decrease in race support and contingency sponsorship costs as a result of the cancellation of various race series globally to curb the spread of the COVID-19 pandemic.

Office Lease and Expenses - Office lease and expenses for the quarters ended June 30, 2020 and 2019 were $72,386 and $68,546, respectively. Although utility expenses decreased globally as a result of the COVID-19 pandemic, the 6% increase in office lease and expenses during the 2020 period was primarily due to an increase in warehouse lease expenditure in the United States in line with additional storage required as the Company continues to rapidly expand its assortment of exceptional protective gear.

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 quarter ended June 30, 2020 decreased to $336,608, from $366,219 during the same 2019 quarter. Although CE certification and homologation costs increased during the 2020 period, the 8% decrease in research and development costs during the 2020 second quarter is as a result of a decreased significant expenditure on product prototyping refinement costs incurred during the 2019 period.

Bad Debt Expense (Recovery) - Bad Debt Expense (Recovery) for the quarters ended June 30, 2020 and 2019 were $41,900 and ($7,022), respectively. This increase in Bad Debt Expense (Recovery) is primarily the result of an increase in the provision for doubtful accounts in line with an increase in the accounts receivable balances.

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, 2020 and 2019 were $410,128 and $521,420, respectively. The 21% decrease in general and administrative expenses is primarily due to a decrease in travel expenditures incurred as a result of the worldwide travel restrictions imposed to curtail the spread of the COVID-19 pandemic.

Depreciation Expense - Depreciation Expense for the quarters ended June 30, 2020 and 2019 were $190,749 and $188,300, respectively. This 1% increase in depreciation during the 2020 second quarter is primarily due to the addition of molds and tooling utilized in the production of the Company's widening product range.

Total Operating Expenses - Total operating expenses decreased by $186,286 to $2.35 million in the three months ended June 30, 2020, or 7%, compared to $2.54 million in the 2019 period. This decrease is primarily due to decreased general and administrative costs, salaries and wages and advertising and marketing expenditure that were partially offset by an increase in professional fees incurred during the 2020 period.

Net income - The net income after income taxes for the quarter ended June 30, 2020 was $674,507, as opposed to a net income of $73,700 for the quarter ended June 30, 2019. This increase in net income is primarily due to the increase in revenues and gross profit and decrease in operating expenses discussed above.

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, 2020 were $14.49 million, a 27% increase, compared to $11.37 million for the six months ended June 30, 2019. Revenues generated from sales to our customers in the United States increased from $4.40 million to $5.46 million, for the six months ended June 30, 2020 and 2019, respectively. Revenues associated with international customers were $9.02 million and $6.97 million, or 62% and 61% of revenues, respectively, for the six months ended June 30, 2020 and 2019. This increase in global revenues during the 2020 period is attributable to a $3.02 million increase in body armor sales and a $.0.54 million increase in sales of other products, parts and accessories that were partially offset by a $0.29 million decrease in neck brace sales and a $0.16 million decrease in helmet sales.

The following table sets forth our revenues by product line for the six months ended June 30, 2020 and 2019:

Sales of our flagship neck brace accounted for $2.39 million and $2.68 million, or 16% and 24% of our revenues for the six-month periods ended June 30, 2020 and 2019, respectively. Although sales volumes and revenue generated from the sale of our neck brace products designed for mountain biking increased during the 2020 period, the 11% decrease in neck brace revenues is primarily attributable to a decrease in the volume of motorcycle neck braces sold to our customers globally and particularly in the United States during the six months ended June 30, 2020.

Our body armor products are comprised of chest protectors, full upper body protectors, upper body protection vests, back protectors, knee braces, knee and elbow guards, off-road motorcycle boots and mountain biking shoes.  Body armor sales accounted for $8.25 million and $5.23 million, or 57% and 46% of our revenues for the six-month period ended June 30, 2020 and 2019, respectively. The 58% increase in body armor revenues was primarily the result of a 60% increase in the volume full upper body and chest protectors sold during the six months ended June 30, 2020 due to increased customer demand in the United States and abroad. Additionally, sales of our footwear products consisting of motorcycle boots and shoes designed for mountain biking at all levels, exceeded our expectations.

Our Helmets accounted for $1.27 million and $1.43 million, or 9% and 12% of our revenues for the six-month periods ended June 30, 2020 and 2019, respectively. The $0.16 million decrease in helmet sales during the 2020 period is primarily due to a 14% decrease in the volume of off-road motorcycle helmets sold during the 2020 period. The Company continues to build a pipeline of innovative helmet products containing cutting edge safety technology with both end consumer and athlete input and endorsement to appeal to our growing segments of global consumers.

Our other products, parts and accessories are comprised of goggles, hydrations bags and apparel items including jerseys, pants, shorts and jackets as well as aftermarket support items required primarily to replace worn or damaged parts through our global distribution network.  Other products, parts and accessories sales accounted for $2.57 million and $2.02 million, or 18% and 18% of our revenues for the six-month periods ended June 30, 2020 and 2019, respectively. The 27% increase in revenues from the sale of other products, parts and accessories is primarily due to a 49% increase in the sales volume of our innovative Velocity line of goggles that were shipped to our customers in the United States and abroad during the 2020 period.

Cost of Revenues and Gross Profit - Cost of revenues for the six-months ended June 30, 2020 and 2019 were $7.71 million and $5.88 million, respectively. Gross Profit for the six-month periods ended June 30, 2020 and 2019 were $6.78 million and $5.49 million, respectively, or 47% and 48% of revenues respectively. Our neck brace products continue to generate a higher gross profit margin than other product categories. Neck brace revenues accounted for 16% and 24% of our revenues for the six months ended June 30, 2020 and 2019, 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, 2020 and 2019 were $4,659 and $15,696, respectively. The 70% decrease in product royalty income is due to a decrease in the sale of licensed products by licensees in the 2020 period.

Salaries and Wages - Salaries and wages for the six-month periods ended June 30, 2020 and 2019 were $1,467,452 and $1,590,640, respectively. Although the Company employed additional in-house professional sales personnel in the United States and sales and marketing staff that are based in Europe during the six months ended June 30, 2020, the 8% decrease in salaries and wages during the 2020 period was primarily due to temporary staff cost reduction measures implemented by the Company at all levels globally during the second quarter of 2020, in an effort to partially mitigate the potential effects of the COVID-19 pandemic.

Commissions and Consulting Expense - During the six-month periods ended June 30, 2020 and 2019, commissions and consulting expenses were $187,342 and $158,560, respectively. This 18% increase in commissions and consulting expenses during the 2020 period is primarily the result of an increase in commissions paid to internal and external sales personnel in the United States, as a result of increased dealer demand and selling activity that commenced in the phased opening period instituted in various states in the United States during the period.

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, 2020 and 2019 were $534,905 and $384,537, respectively. This 39% increase in professional fees is primarily due to increased expenditures on product liability litigation during the 2020 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, 2020 and 2019 were $981,231 and $1,035,882, respectively. The 5% decrease in advertising and marketing expenditures during the 2020 period is primarily due to a decrease in costs associated with race attendance and the timing of the production of marketing content material as a result of race series cancellation and travel restrictions imposed to curb the spread of the COVID-19 pandemic during the 2020 period.

Office Lease and Expenses - Office lease and expenses for the six-month periods ended June 30, 2020 and 2019 were $146,200 and $138,538, respectively. The 6% increase in office lease and expenses during the 2020 period was primarily due to an increase in warehouse lease expenditures in the United States in line with additional storage space required to accommodate the Company's rapidly growing assortment of exceptional protective gear.

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, 2020 and 2019, increased to $724,812, from $706,315, during the same 2019 period. The 3% increase in research and development costs during the 2020 period is due to increased development costs as the Company continues to expand its product offering with exceptional protective gear across multiple product categories and continues to develop a pipeline of innovative products that appeal to wider consumer groups.

Bad Debt Expense - Bad Debt Expense for the six-month periods ended June 30, 2020 and 2019 were $26,920 and $9,499, respectively. This increase in Bad Debt Expense during the 2020 period is primarily the result of an increase in the provision for doubtful accounts in line with an increase in the accounts receivable balances.

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, 2020 and 2019 were $930,243 and $988,654, respectively. The 6% decrease in general and administrative expenses during the 2020 period is primarily as a result of a decrease in travel expenditures incurred as a result of the worldwide travel restrictions imposed to curtail the spread of the COVID-19 pandemic, that were partially offset by an increase in product liability insurance premiums incurred during the 2020 period.

Depreciation Expense - Depreciation Expense for the six-month periods ended June 30, 2020 and 2019 were $382,801 and $377,995, respectively. This 1% increase in depreciation during the 2020 period is primarily due to the addition of molds and tooling utilized in the production of the Company's widening product range.

Total Operating Expenses - Total operating expenses decreased by $8,714 to $5.38 million in the six-month periods ended June 30, 2020, or 0%, compared to $5.39 million in the 2019 period. This decrease in total operating expenses during the 2020 period is primarily due to decreased general and administrative costs, salaries and wages and advertising and marketing expenditure that were partially offset by an increase in professional fees incurred during the 2020 period.

Net income - Net income after income taxes for the six-month period ended June 30, 2020 was $1,036,955, as opposed to a net income after income taxes of $82,938 for the six-month period ended June 30, 2019.  This increase in net income during the 2020 period is primarily due to the increase in revenue and gross profit and decrease in operating expenses discussed above.

Cash increased by $554,574, or 27%, for the six months ended June 30, 2020, when compared to cash on hand at December 31, 2019. The primary sources of cash for the six months ended June 30, 2020 were net income of $1,036,955 and a decrease in inventory of $3,025,131. The primary uses of cash for the six months ended June 30, 2020 were decreased accounts payables of $2,998,745 and an increase in prepaid expenses and other current assets of $895,254.

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 in the U.S. and abroad.

Obligations under Material Contracts

Pursuant to our Licensing Agreement with Xceed Holdings, a company owned and controlled by Dr. Christopher Leatt, our founder, chairman and head of research and development, 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.  During the quarters ended June 30, 2020 and 2019, the Company paid an aggregate of $61,215 and $65,589, in licensing fees to Xceed Holdings. 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. During the quarters ended June 30, 2020 and 2019, the Company paid an aggregate of $15,285 and $16,397, in licensing fees to Mr. De Villiers.

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, as amended, Innovate has agreed to serve as the Company's exclusive research, development and marketing consultant, in exchange for a monthly fee of $38,062; 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 six 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. Effective January 1, 2019, the Company and Innovate amended the Consulting Agreement to increase the monthly fee payable to Innovate under the agreement to $40,435, in accordance with the parties' prior agreement that Innovate may increase its monthly fees by no greater than the lesser of: (a) two and one-half percent (2.5%) of the prior year's annualized fee; or (b) a percentage equal to then-applicable annual percentage increase in the Consumer Price Index published by the United States Department of Labor's bureau of labor statistics, plus one-half percent (0.5%).  Accordingly, effective January 1, 2020, the Company's monthly fee to Innovate, increased to $41,446. During the quarters ended June 30, 2020 and 2019, the Company paid an aggregate of $103,615 and $121,305 in consulting fees to Innovate.

Pursuant to a Premium Finance Agreement, dated May 27, 2020, between the Company and AFCO, the Company is obligated to pay AFCO an aggregate sum of $133,821 in ten payments of $11,634, at a 4.950% annual interest rate, commencing on June 1, 2020 and ending on March 1, 2020. 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, 2020, the Company had not defaulted on its payment obligations under this agreement.

The Company entered into a Premium Finance Agreement with AFCO Acceptance Corporation "AFCO" dated October 10, 2019, to finance its U.S. short-term insurance over the period of coverage. The Company is obligated to pay AFCO an aggregate sum of $753,360 in eleven payments of $70,468, at an annual interest rate of 5.740% commencing on November 1, 2019 and ending on September 1, 2020. 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 on June 30, 2020, the Company had not defaulted on its payment obligations under this agreement.

On November 19, 2018, the Company entered into a $1,000,000 revolving line of credit agreement with a bank. Payments for the advances under the line bear interest at the LIBOR Daily Floating Rate plus 2.5 percentage points commencing January 1, 2019. The line of credit matures on November 19, 2020, at which time the unpaid principal, interest, or other charges outstanding under the agreement are due and payable. Obligations under the line of credit are secured by equipment and fixtures in the United States of America, accounts receivable and inventory of Leatt Corporation and Two-Eleven Distribution, LLC. The revolving line of credit was fully repaid on May 4, 2020 and the balance of $1,000,000 is available.

On May 4, 2020, the Company received proceeds of $210,732, under the Paycheck Protection Program or PPP established under the CARES Act. The Company will be able to submit an application seeking forgiveness of up to 100% of the entire PPP loan balance at the end of the  24-week period from the Company's first receipt of PPP loan funds; so long as the Company  uses the funds for specific expenses as outlined in the CARES Act incurred and paid within the 24-week period.  The Company may use up to 40% of the loan for specific non-payroll related expenses.  Any amount of the loan that is not forgiven is repayable at a 1% interest rate over a 2-year period following receipt of the loan.

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, leases and accounting for income taxes.

Revenue and Cost Recognition - The Company recognizes revenue in accordance with ASC 606 "Revenues from Contracts with Customers".  As such the Company has and will continue to review its performance obligations in terms of material customer contractual arrangements in order to verify that revenue is recognized when performance obligations are satisfied on a periodic basis.

All manufacturing of Leatt products is performed by third party subcontractors that are predominately based 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 or where consumers choose to purchase directly via the Company's e-commerce website (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 where no exchange of product is possible. Revenues are recognized when our performance obligations are satisfied as evidenced by transfer of control of promised goods to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Product royalty income, representing less than 1% of total revenues, is recorded as the underlying product sales occur, in accordance with the related licensing arrangements.

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 or the consumer chooses to purchase directly from the Company's e-commerce website 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.

The Company's standard terms and conditions of sale for non-consumer direct or web-based sales do not allow for product returns other than under warranty.

International sales (other than in the United States and South Africa) are generally drop-shipped directly from the third-party manufacturer to the international distributors. 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 and exchanged 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.

The Company reviews the reserves for customer returns at each reporting period and adjusts them to reflect data available at that time. To estimate reserves for returns, the Company estimates the expected returns and claims based on historical rates as well as events and circumstances that indicate changes to historical rates of product returns and claims. Historically, returns due to product quality issues have not been material and there have been no distributor terminations that resulted in product returns. The provision for estimated returns at June 30, 2020 and 2019 were $0 and $0, respectively.

Sales commissions are expensed when incurred, which is generally at the time of sale or cash received from customers, because the amortization period would have been one year or less. These costs are recorded in commissions and consulting expenses within operating expense in the accompanying consolidated statements of operations and comprehensive income.

Shipping and handling activities associated with outbound freight, after control over a product has transferred to a customer, are accounted for as a fulfilment cost and are included in revenues and cost of revenues in the accompanying consolidated statements of operations and comprehensive income.

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Revenue recognized from contracts with customers is recorded net of sales taxes, value added taxes, or similar taxes that are collected on behalf of local taxing authorities.

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. The allowance for doubtful accounts at June 30, 2020 was $129,679 and at December 31, 2019 was $104,704.

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 at June 30, 2020 was $91,398 and at December 31, 2019 was $109,127.

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 were no impairment charges during the quarters ended June 30, 2020 and 2019.

Operating Leases - The Company determines if an arrangement is a lease at contract inception. Operating leases are included in the right-of-use assets ("ROU''), and lease liability obligations are included in the Company's consolidated balance sheets. ROU assets represent the Company's right to use an underlying asset of the lease term and lease liability obligations represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at the commencement date, based on the present value of lease payments over the lease term. As the Company's leases typically do not provide an implicit rate, the Company estimates its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Company uses the implicit rate when readily determinable. The ROU asset also includes any lease payments made, and excludes lease incentives and lease direct costs. The Company's lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense is recognized on a straight-line basis over the lease term.

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 11, "Recent Accounting Pronouncements" 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 on 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. 

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