Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company's consolidated financial statements. This Item 7 contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risk, uncertainties, and other factors that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. Please refer to "Item 1A. Risk Factors" for a discussion of the uncertainties, risks and assumptions associated with these statements.
COVID-19 Pandemic
In 2020, the global economy began experiencing a downturn related to the impacts of the COVID-19 global pandemic. While many businesses resumed operations towards the end of the second quarter of 2020, the effects of the pandemic have continued into 2021 and the duration of the impact still remains uncertain. We expect to see continued volatility in the economic markets and government responses to the COVID-19 pandemic. These changing conditions and governmental responses could have impacts on our operating results for the remainder of the year or longer.
As a result of COVID-19, we have encountered various supply chain disruptions impacting the availability of certain raw materials for our finished goods products. We have been proactively identifying alternative sources for delayed raw materials. At times, our highest demand products were impacted by supply chain disruptions, but availability continues to improve primarily as a result of our actions to mitigate such disruptions. Our third-party logistics partners are facing challenges with availability of staffing and transportation sources, which could cause product shipments to be delayed. 9 --------------------------------------------------------------------------------
Health and Safety
We have taken proactive, aggressive action to protect the health and safety of our employees, customers, and partners. We monitor national, state, and local health recommendations and regulations, and will implement additional protective measures as appropriate. Customer Demand
At the onset of the pandemic, as a result of government-mandated stay-at-home orders, some of our customers were impacted and forced to cease operations. Customer closings primarily impacted revenue for our Batiste Dry Shampoo distributed products during 2020.
We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state, and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. Given the dynamic nature of this situation, we cannot reasonably estimate the impacts of COVID-19 on our financial condition, results of operations or cash flows in the future.
Distribution Agreement with Church & Dwight
Our distribution agreement with Church & Dwight Co., Inc. and our subsidiary,Neoteric Cosmetics, Inc. , was not extended beyond the Expiration Date. As a result, the distribution agreement expired on its own terms as of the Expiration Date and the Company ceased to distribute Batiste Dry Shampoo products. Unless offset by increased sales of our other products, the conclusion of this distribution agreement is expected to have a material impact on our net sales and result of operations. Net sales of Batiste were$7,155 and$5,299 for the years endedDecember 31, 2021 , and 2020, respectively.
Sale of Dryel® Brand
OnDecember 23, 2021 , we sold the Dryel® brand to a company that markets and distributes household cleaning products. We have reflected the operations of Dryel as discontinued operations for all periods presented. See Note 2 - "Discontinued Operations" in the Notes to Consolidated Financial Statements for further information. Executive Overview Our BusinessScott's Liquid Gold-Inc. exists to positively impact consumers' lives in the markets we serve and create shareholder value. We develop, market, and sell high-quality, high-value household and health and beauty care products nationally and internationally to mass merchandisers, drugstores, supermarkets, hardware stores, e-commerce retailers, other retail outlets, and to wholesale distributors. Our long history of selling household products has generated strong consumer and customer loyalty for our brands.
On an ongoing basis, management focuses on a variety of key indicators to monitor our business health and performance. These key indicators include (but are not limited to) the following:
• Net sales (collectively and by operating segment); • Profitability, focusing on gross margins and net income; and • Cash flow. To achieve our business and financial objectives, we focus on initiatives to drive the growth of the key indicators above. Our ability to drive and generate growth depends on consumer demand for our products and retail customers' willingness to carry our products in a competitive marketplace. In this environment, we intend to continue to focus on our key indicators to remain competitive, sustain our current level of operations, and drive further growth in future periods. 10 --------------------------------------------------------------------------------
Outlook
Looking forward, we are focused on both short- and long-term strategies that we believe will enhance our financial health and deliver shareholder value. While the marketplace in which we operate has always been highly competitive, we expect that the category challenges and the level of competition will continue to rise. We believe that some of the trends in our business and industry could adversely affect our profitability, including the following: • Changes in national and international regulations; • Changes in policies or practices of some of our key retail customers; • Rapid growth of e-commerce and alternative retail channels; and
• Volatility in the costs of products, transportation, and labor associated
with our logistics and warehousing partners.
We believe our history of providing high-quality, high-value products to consumers positions us to meet the challenges in our marketplace by continuing to focus on the following key priorities in 2022:
• Pursuing growth opportunities, including distributing Alpha®
Kids N Pets®, and other products to broader markets; • Improving our processes and systems, specifically through the implementation of a new ERP;
• Optimizing our inventories, supply chain, and third-party logistics
partners, and operations; and
• Paydown of debt and improving cash flows from operations through growth of sales and optimization of cost structure. 11
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Results of Operations For the Year Ended December 31, (in thousands) Increase / (Decrease) 2021 2020 $ % Net sales$ 33,081 $ 28,958 $ 4,123 14.2 % Cost of sales 19,082 16,433 2,649 16.1 % Impairment of inventories 404 876 (472 ) (53.9 %) Total cost of sales 19,486 17,309 2,177 12.6 % Gross profit 13,595 11,649 1,946 16.7 % Gross margin 41.1 % 40.2 % Operating expenses: Advertising 639 702 (63 ) (9.0 %) Selling 9,797 7,546 2,251 29.8 % General and administrative 4,611 4,724 (113 ) (2.4 %) Intangible asset amortization 1,111 1,005 106 10.5 % Impairment of goodwill and intangible assets 6,294 - 6,294 100.0 % Impairment of property and equipment - 107 (107 ) (100.0 %) Total operating expenses 22,452 14,084 8,368 59.4 % Loss from operations (8,857 ) (2,435 ) (6,422 ) (263.7 %) Interest expense (373 ) (216 ) (157 ) (72.7 %) Other income - 350 (350 ) (100.0 %) Loss before income taxes and discontinued operations (9,230 ) (2,301 ) (6,929 ) (301.1 %) Income tax (expense) benefit (1,008 ) 707 (1,715 ) (242.6 %) Loss from continuing operations (10,238 ) (1,594 ) (8,644 ) (542.3 %) (Loss) income from discontinued operations, net of taxes (853 ) 43 (896 ) (2,083.7 %) Net loss$ (11,091 ) $ (1,551 ) $ (9,540 ) (615.1 %)
Net loss increased primarily due to the following:
• Increase in gross profit due to the acquisition of BIZ in
additional foot traffic at our retail customers from eased restrictions
related to the COVID-19 pandemic in 2021. Additionally, net sales increased due to restored finished goods inventory of key products in 2021 in our household segment.
• Increase in selling expenses from the acquisition of BIZ and COVID-19
driven increases in costs in transportation and labor associated with our
logistics and warehousing partners.
• Decrease in general and administrative expenses is due to reduced
professional costs from acquisition-related expenses that were incurred
in 2020 and offset by restructuring costs associated with separation of
employees in 2021. • Increase in interest expense associated with our increased debt
facilities. The increased debt resulting from simultaneous supply chain
shortages and investment in building depleted finished goods inventories
has also increased our interest expense.
• Increase in income tax expense due to the establishment of a valuation
allowance against our deferred tax asset.
• Loss from discontinued operations due to the sale of our Dryel brand,
which resulted in the recognition of a loss on the sale of the business. • Impairment of goodwill and intangible assets of Detergent and Shampoo reporting units. 12 --------------------------------------------------------------------------------
Segment Results The following tables show comparative net sales, gross margin, gross profit, loss (income) from operations, volume and percentage changes for our household and health and beauty care products between periods: Household products For the Year Ended December 31, (in thousands) Increase / (Decrease) 2021 2020 $ % Net sales$ 14,152 $ 12,003 $ 2,149 17.9 % Gross profit$ 5,583 $ 5,830 $ (247 ) (4.2 %) Gross margin 39.5 % 48.6 %
(Loss) income from operations
(4,015 ) (7,721.2 %) • Household products increase in net sales was attributable to our
acquisition of BIZ. This was offset by a decrease in net sales from key
product shortages, including our Scott's Liquid GoldWood Care product. • Gross profit and gross margin decreased due to cost increases in our
manufacturing partners' raw materials and inventory impairment related to
slow moving and obsolete raw materials and finished goods.
• Loss from operations was related to increases in transportation and labor
associated with our logistics and warehousing partners, restructuring
costs, and impairment of goodwill and intangible assets in our Detergent
and All-Purpose reporting units.
Health and beauty care products
For the Year Ended December 31, (in thousands) Increase / (Decrease) 2021 2020 $ % Health and beauty care net sales Net sales- distributed products$ 7,123 $ 6,834 $ 289 4.2 % Net sales- manufactured products 11,806 10,121 1,685 16.6 %
Total health and beauty care net sales
$ 1,974 11.6 % Gross profit$ 8,012 $ 5,819 $ 2,193 37.7 % Gross margin 42.3 % 34.3 % Loss from operations$ (4,894 ) $ (2,487 ) $ (2,407 ) (96.8 %)
• Net sales of distributed health and beauty care products increased due to
additional foot traffic at our retail customers from eased restrictions
related to the COVID-19 pandemic in 2021. This increase is offset by the conclusion of our distribution arrangement withMontagne Jeunesse in the second quarter of 2020.
• Net sales of manufactured health and beauty care products increased
primarily due to higher sales of our
partners andChina as well as higher sales of our Denorex brand due to the restoration of consistent inventory levels in 2021.
• Increase in gross margin was due to increased sales of manufactured
products, improved margins from outsourced manufacturing operations, and
a reduction in impaired inventories in 2021.
• Loss from operations was primarily due to the impairment of goodwill and
intangible assets of our Shampoo reporting unit, inventory impairment
related to slow moving and obsolete raw materials and finished goods, and
increases in transportation and labor associated with our logistics and
warehousing partners.
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Liquidity and Capital Resources
Financing Agreements
Please see Note 7 to our Consolidated Financial Statements for information on
our debt facilities with
Liquidity and Changes in Cash Flows
AtDecember 31, 2021 , we had$5,467 available on our revolving credit facility with UMB, and approximately$770 in cash on hand, an increase of$765 fromDecember 31, 2020 due to our sale of Dryel and paydown of our revolving credit facility. The following is a summary of cash provided by or used in each of the indicated types of activities: For the Year Ended December 31, (in thousands) Increase / (Decrease) 2021 2020 $ % Operating activities$ (322 ) $ 3,582 $ (3,904 ) (109.0 %) Investing activities 4,381 (10,097 ) 14,478 143.4 % Financing activities (2,794 ) 5,426 (8,220 ) (151.5 %)
• Net cash used by operating activities decreased primarily related
increases in costs related to supply chain and third party logistics
impacted as well as investments in finished goods inventories.
• Net cash provided by investing activities was primarily attributable to
our sale of Dryel. • Net cash used in financing activities was primarily attributable to repayments of the UMB revolving credit facility and term loan and was offset by proceeds from La Plata term loan. The uncertainty related to the COVID-19 outbreak has impacted our operations and could affect our future results. While we believe that our business model will allow us to generate sufficient operating cash flows, our liquidity has been affected by the timing of our build of depleted finished goods inventories, while our net sales have been delayed due to supply chain shortages. We expect that our current cash reserves and availability under our UMB Loan Agreement and La Plata Loan Agreement will be sufficient to meet operational cash needs during the next twelve months, but further supply chain disruptions in the short-term could limit our liquidity.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted inthe United States of America requires management to use judgment and make estimates. The level of uncertainty in estimates and assumptions increases with the length of time until the underlying transactions are completed. Actual results could ultimately differ from those estimates. The accounting policies that are most critical in the preparation of the Company's Consolidated Financial Statements are those that are both important to the presentation of the Consolidated Financial Statements and require significant or complex judgments and estimates on the part of management.
Revenue Recognition
Our revenue recognition policy is significant because the amount and timing of revenue is a key component of our results of operations. See Note 1(m), "Revenue Recognition" in our Consolidated Financial Statements in Item 8 for additional discussion.
Intangible Assets and
For fiscal year 2021, the Company's reporting units for goodwill impairment testing purposes were its individual components, which are differentiated by their product categories. These reporting units are the level at which discrete financial information is available and reviewed by management. 14 -------------------------------------------------------------------------------- Determining the fair value of the Company's reporting units for goodwill and the fair value of its intangible assets requires significant estimates and judgments by management. When a quantitative analysis is performed, the Company generally uses the income approach, which requires several estimates, including future cash flows consistent with management's strategic plans, sales growth rates, and the selection of royalty rates and a discount rate. Estimating sales growth rates requires significant judgment by management in areas such as future economic conditions, category growth rates, product pricing, consumer tastes and preferences and future expansion expectations. In selecting an appropriate royalty rate, the Company considers recent market transactions for similar brands and products. In determining an appropriate discount rate, the Company considers the current interest rate environment and its estimated cost of capital. Other qualitative factors the Company considers, in addition to those quantitative measures discussed above, include assessments of general macroeconomic conditions, industry-specific considerations and historical financial performance. The Company generally engages a third-party valuation firm to assist it in determining the fair value of intangible assets acquired in business combinations. In determining the fair value of the Company's reporting units, fair value is also determined using the market approach, which is generally derived from metrics of comparable publicly traded companies. As multiple valuation methodologies are used, the Company also performs a qualitative analysis comparing the fair value of a reporting unit under each method to assess its reasonableness and ensure consistency of results. Determining the expected life of a brand requires management judgment and is based on an evaluation of several factors including market share, brand history, future expansion expectations, the level of in-market support anticipated by management, legal or regulatory restrictions and the economic environment where the products are sold. We made revisions to the internal forecasts relating to all reporting units during the fourth quarter of 2021 due primarily to the sale of our Dryel brand and the impact of rising costs associated with the manufacture and distribution of our products. Through our annual assessments conducted onDecember 31, 2021 , we concluded that the changes in circumstances in these reporting units triggered the need for a quantitative review of the carrying values of goodwill and certain intangible assets and resulted in impairment charges to each of our Detergent, All-Purpose, and Shampoo reporting units during the year endedDecember 31,2021 , and resulted in the following impairment charges: Intangible Assets Goodwill Total Detergent $ 1,085$ 593 $ 1,678 Shampoo 2,966 1,520 4,486 All-Purpose 130 - 130 $ 4,181$ 2,113 $ 6,294 Inventories Valuation Our inventory valuation policy is significant because the costs and valuation of slow-moving or obsolete inventories are key components of our results of operations. See Note 1(f), "Inventories Valuation" in our Consolidated Financial Statements in Item 8 for additional discussion.
During the year ended
Income Taxes
Our income taxes policy is significant because our estimate for taxes is a key component of our results of operations. See Note 1(l), "Income Taxes" in our Consolidated Financial Statements in Item 8 for additional discussion.
Recently Issued Accounting Standards
For information on recently issued accounting standards, see Note 1(q), "Recently Issued Accounting Standards," to our Consolidated Financial Statements.
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