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
The COVID-19 pandemic and government steps to reduce the spread and address the impact of COVID-19 have had and continue to have an impact on the way people live, work, interact and shop. While the impact of COVID-19 on our business has largely abated at this time, uncertainties continue. We have also experienced certain disruptions to our supply chain due to COVID-19, which have impacted and may continue to impact sales of and consumer access to our products. In addition, we have experienced changes in the purchasing patterns of our customers, including a shift in many markets to purchasing our products online. COVID-19 may continue to impact consumers' behavior, shopping patterns and consumption preferences. While we currently expect to be able to continue operating our business as described above, uncertainty resulting from COVID-19 could result in unforeseen additional disruptions to our business, including our global supply chain and retailer network, and/or require us to incur additional operational costs.
Sale of Brands
OnDecember 15, 2022 , we sold the Prell® brand to a company that markets and distributes natural hair and skincare products. We have reflected the operations of Prell® as discontinued operations for all periods presented. 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 3 - "Discontinued Operations" in the Notes to Consolidated Financial Statements for further information on the sale of both brands.
OnJanuary 23, 2023 , we sold the Scott's Liquid Gold® brand, including the Wood Care and Floor Restore products, to a company that markets and distributes wood care products. Distribution toChina We terminated our exclusive distribution agreement of Alpha®Skin Care products with HK NFS onJuly 12, 2022 due to breaches of the distribution agreement by HK NFS, and are establishing a direct model to resume sales of our products to consumers inChina . The reestablishment of an effective business model inChina is dependent on deploying significant resources to marketing and advertising efforts and regulatory compliance, as well as the successful shutdown of our former distributor's storefronts on various e-commerce platforms. Throughout 2020 and early 2021, we obtained components and produced finished goods specifically designed and formulated for distribution in the PRC. Our exclusive distributor ultimately did not purchase these products in accordance with their minimum order requirements. Due to the difficulties we have encountered in establishing our own e-commerce storefronts, this has resulted in our accumulation of high amounts of finished goods inventories and raw materials specifically designed forChina . Due to uncertainties of future production requirements, raw materials that we have acquired is included in our impairment of inventories for the years endedDecember 31, 2022 and 2021, respectively. 11 --------------------------------------------------------------------------------
Distribution Agreement with Church & Dwight
Our distribution agreement with Church & Dwight Co., Inc. and our subsidiary,Neoteric Cosmetics, Inc. , was not extended beyondDecember 31, 2021 . As a result, the distribution agreement expired on its own terms as ofDecember 31, 2021 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 for the year endedDecember 31, 2021 . 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 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:
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Net sales (collectively and by operating segment);
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Profitability, focusing on gross margins and net income; and
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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.
During 2022, the Company achieved objectives focused on optimization, cost reduction, and modernization of our business. These included (but were not limited to) the following:
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Implementation of new, scalable enterprise resource planning software, replacing our prior software which had been in place for over 30 years;
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Sales of assets with low margins or limited future growth potential to optimize our product portfolio;
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Restructure and consolidation of business departments to facilitate greater cross-functional teamwork and workplace efficiency;
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Elimination of unprofitable sales arrangements with customers;
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Implementation of minimum order quantity thresholds on customer orders to reduce fulfillment costs; and
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Consolidation of third-party logistics and warehousing partners to achieve reduced costs and compliance fines.
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:
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Changes in national and international regulations;
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Changes in policies or practices of some of our key retail customers;
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Rapid growth of e-commerce and alternative retail channels; and
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Inflationary impacts to the costs of products, transportation, and labor associated with our logistics and warehousing partners.
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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 2023:
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Paydown of debt and improving cash flows from operations through growth of sales and optimization of cost structure;
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Pursuing growth opportunities, including distributing Alpha®
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Improving our processes and systems;
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Optimizing our inventories, supply chain, and operations, as well as further consolidation of third-party logistics partners; and
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Exploration of one or more of the following: the sale of additional brands; a sale, merger, or other strategic transaction involving the entire company; acquisitions of other brands or companies; issuance of additional debt or equity; and continuing to operate as a public, independent company.
Results of Operations For the Year Ended December 31, (in thousands) Increase / (Decrease) 2022 2021 $ % Net sales$ 16,570 $ 29,742 $ (13,172 ) (44.3 %) Cost of sales 9,024 16,805 (7,781 ) (46.3 %) Impairment of inventories 461 404 57 14.1 % Total cost of sales 9,485 17,209 (7,724 ) (44.9 %) Gross profit 7,085 12,533 (5,448 ) (43.5 %) Gross margin 42.8 % 42.1 % Operating expenses: Advertising 641 639 2 0.3 % Selling 6,477 8,956 (2,479 ) (27.7 %) General and administrative 2,786 4,611 (1,825 ) (39.6 %) Intangible asset amortization 325 802 (477 ) (59.5 %) Impairment of goodwill and intangible assets 5,172 4,050 1,122 27.7 % Total operating expenses 15,401 19,058 (3,657 ) (19.2 %) Loss from operations (8,316 ) (6,525 ) (1,791 ) (27.4 %) Interest expense (534 ) (341 ) (193 ) (56.6 %) Loss before income taxes and discontinued operations (8,850 ) (6,866 ) (1,984 ) (28.9 %) Income tax expense (63 ) (1,079 ) 1,016 94.2 % Loss from continuing operations (8,913 ) (7,945 ) (968 ) (12.2 %) Income (loss) from discontinued operations, net of taxes 62 (3,146 ) 3,208 102.0 % Net loss$ (8,851 ) $ (11,091 ) $ 2,240 20.2 %
Net loss changed primarily due to the following:
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Lower sales and gross profits from the conclusion of our distribution agreement with Church and Dwight for Batiste products, as well as reduced sales and gross profits from various product lines due to changes in our customers' purchasing strategies related to inventory and inflationary pressures. In addition, supply chain affected in-stock levels of certain products and impacted our sales to customers.
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Decrease in selling expenses caused by lower logistics and warehousing costs from lower sales, a transition to a different third-party logistics provider during the fourth quarter of 2022, and a reduction in personnel costs.
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Decrease in general and administrative costs due to changes in personnel and related costs as well as reductions in restructuring costs associated with separation of employees during 2021.
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Increase in interest expense associated with additional debt in 2022 and increases in variable interest rates.
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Decrease in intangible asset amortization from impairments of intangible assets in the fourth quarter of 2021 and second quarter of 2022.
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Impairment of goodwill and intangible assets.
Segment Results
The following tables show comparative net sales, gross margin, gross profit, loss 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) 2022 2021 $ % Net sales$ 11,763 $ 14,152 $ (2,389 ) (16.9 %) Gross profit$ 4,810 $ 5,583 $ (773 ) (13.8 %) Gross margin 40.9 % 39.5 % Loss from operations$ (6,574 ) $ (3,963 ) $ (2,611 ) (65.9 %) • Net sales and gross profit decreased due to changes in our customers' purchasing strategies related to inventory and inflationary pressures as well as supply chain disruptions.
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Loss from operations was reduced primarily related to less goodwill and intangible asset impairments and was partially offset by reductions in selling and general and administrative costs.
Health and beauty care products
For the Year Ended December 31, (in thousands) Increase / (Decrease) 2022 2021 $ % Health and beauty care net sales Net sales- distributed products $ -$ 7,123 $ (7,123 ) (100.0 %) Net sales- manufactured products 4,807 8,467 (3,660 ) (43.2 %) Total health and beauty care net sales$ 4,807 $ 15,590 $ (10,783 ) (69.2 %) Gross profit$ 2,275 $ 6,950 $ (4,675 ) (67.3 %) Gross margin 47.3 % 44.6 % Loss from operations$ (1,742 ) $ (2,562 ) $ 820 32.0 % •
Net sales of distributed health and beauty care products decreased due to the
termination of our Batiste distribution agreement with Church & Dwight in
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Net sales and gross profits from manufactured products decreased due to the elimination of sales to our exclusiveChina distributor of Alpha®Skin Care products as well as reduced sales of Alpha® from certain customers' changes in inventory management practices. During the first quarter of 2022 we also eliminated sales of our Denorex® brands to certain customers with minimal profitability.
Liquidity and Capital Resources
Financing Agreements
Please see Note 7 to our Consolidated Financial Statements for information on our debt facilities withUMB Bank, N.A . ("UMB") andLa Plata Capital, LLC ("La Plata").
Liquidity and Changes in Cash Flows
At
14 -------------------------------------------------------------------------------- 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) 2022 2021 $ % Operating activities$ (1,849 ) $ (322 ) $ (1,527 ) (474.2 %) Investing activities 338 4,381 (4,043 ) (92.3 %) Financing activities 290 (2,794 ) 3,084 110.4 % • Net cash used in operating activities was primarily related to our net loss and partially offset by conversion of working capital from accounts receivable and reduction in finished goods inventories.
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Net cash provided by investing activities was due to purchases relating to our internal use software offset by the sale of our Prell® brand.
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Net cash provided by financing activities was from proceeds of our various debt facilities which is used for working capital.
The accompanying Consolidated Financial Statements have been prepared assuming that the Company will continue as a going concern, which contemplates the continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business. However, substantial doubt about the Company's ability to continue as a going concern exists. Primarily due to a decline in net sales, disruption of our international sales toChina , and increases in costs associated with the manufacture and distribution of our products, the Company used net cash in operating activities of$1,849 during the year endedDecember 31, 2022 . All proceeds from the sale of our Scott's Liquid Gold® brand inJanuary 2023 were used to reduce outstanding debt. InFebruary 2023 , the Company terminated its Loan and Security Agreement withUMB Bank, N.A . and repaid its revolving credit facility in full. The Company's debt agreement withLa Plata Capital, LLC matures onNovember 9, 2023 , which will require repayments of all principal amounts outstanding during 2023. Management's assessment of cash flow forecasts indicate that, absent any other action, the Company likely will require additional liquidity to continue its operations over the next 12 months. Management has implemented actions to reduce the Company's operating expenses and has restructured debt facilities through the adjustments to the timing of required principal payments and covenant compliance periods. Management is considering additional various strategic actions including asset sales, obtaining additional debt or equity financing (potentially in conjunction with acquisitions), workforce reduction, deferring or eliminating certain capital expenditures, and further reduction of other operating expenses to ensure alignment with customer demand in order to address liquidity needs and pursue its business plan. The Company expects that these strategic actions will reduce expenses and outstanding debt balances and provide required liquidity for ongoing operations. However, given the impact of the economic downturn on theU.S. , the Company may be unable to sell assets or access further equity or debt financing when needed. As such, there can be no assurance that the Company will be able to obtain additional liquidity when needed or under acceptable terms, if at all. The Consolidated Financial Statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of these uncertainties.
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(l), "Revenue Recognition" in our Consolidated Financial Statements in Item 8 for additional discussion. 15 --------------------------------------------------------------------------------
Intangible Assets and
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 second quarter of 2022 due to changes in the economic outlook of our All-Purpose reporting unit, and during the fourth quarter of 2022 related to our annual assessment of all reporting units. Through our assessments, 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 reporting units during the year endedDecember 31, 2022 , and resulted in the following impairment charges: 2022 2021 Intangible Intangible Assets Goodwill Total Assets Goodwill Total All-Purpose$ 2,717 $ 1,710 $ 4,427 $ 1,084 $ 593 $ 1,677 Shampoo 194 - 194 1,483 760 2,243 Detergent 551 - 551 130 - 130$ 3,462 $ 1,710 $ 5,172 $ 2,697 $ 1,353 $ 4,050 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 years endedDecember 31, 2022 and 2021, we specifically identified slow moving and obsolete inventories, resulting in an impairment of$461 and$404 , respectively. 16 --------------------------------------------------------------------------------
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(k), "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(p), "Recently Issued Accounting Standards," to our Consolidated Financial Statements.
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