UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2014

 

or

 

[ ] Transition Report Pursuant Section 13 or 15(d) of the Securities Exchange Act of 1934

  For the transition period from              to               .

 

Commission file number 0-51536

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IRONCLAD PERFORMANCE WEAR CORPORATION

(Exact name of registrant as specified in its charter)

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Nevada		98-0434104
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

1920 Hutton Court, Suite 300

Farmers Branch, TX 75234

(Address of principal executive offices, zip code)

 

972-996-5664

(Registrant’s telephone number, including area code)

 

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	[ ]		Accelerated filer	[ ]
Non-accelerated filer	[ ] (Do not check if smaller reporting company)		Smaller reporting company	[x]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]

 

As of November 3, 2014, the registrant had 80,808,629 shares of common stock issued and outstanding.

TABLE OF CONTENTS

 

			Page
PART I	Financial Information		1
Item 1.	Financial Statements
	a.	Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2014 and December 31, 2013	1
	b.	Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2014 and September 30, 2013	2
	c.	Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2014 and September 30, 2013	3
	d.	Notes to Condensed Consolidated Financial Statements	4 – 17
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		24
Item 4.	Controls and Procedures		24
PART II	Other Information		26
Item 6.	Exhibits		26

PART I

ITEM 1. FINANCIAL STATEMENTS

 

IRONCLAD PERFORMANCE WEAR CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 30, 2014 (unaudited)				December 31, 2013
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	276,888			$	313,750
Accounts receivable net of allowance for doubtful accounts of $30,000 and $48,000			4,417,156				6,782,191
Inventory, net of reserve of $547,800 and $621,000			5,921,908				4,570,402
Deposits on inventory			1,325,644				868,662
Prepaid and other			714,264				407,619
Deferred tax assets – current			274,000				274,000
Total current assets			12,929,860				13,216,624
PROPERTY AND EQUIPMENT
Computer equipment and software			496,614				442,262
Vehicles			—				39,630
Office equipment and furniture			247,917				196,744
Leasehold improvements			158,322				90,441
Less: accumulated depreciation			(609,505	)			(577,759	)
Total property and equipment, net			293,348				191,318
Trademarks and patents, net of accumulated amortization of $56,171 and $49,064			137,453				138,260
Deposits			21,306				10,204
Deferred tax assets – long term			798,000				798,000
Total other assets			956,759				946,464
Total Assets		$	14,179,967			$	14,354,406
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses		$	3,150,729			$	2,129,905
Line of credit			1,152,114				2,169,411
Total current liabilities			4,302,843				4,299,316
Total Liabilities			4,302,843				4,299,316
STOCKHOLDERS’ EQUITY
Common stock, $.001 par value; 172,744,750 shares authorized; 80,808,629 shares issued and outstanding at September 30, 2014 and 76,704,275 shares issued and outstanding at December 31, 2013, respectively			80,809				76,704
Additional paid-in capital			20,202,032				19,208,255
Accumulated deficit			(10,405,717	)			(9,229,869	)
Total Stockholders’ Equity			9,877,124				10,055,090
Total Liabilities and Stockholders’ Equity		$	14,179,967			$	14,354,406

 

See Notes to Condensed Consolidated Financial Statements.

IRONCLAD PERFORMANCE WEAR CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

		Three Months  Ended September 30,				Three Months  Ended September 30,				Nine Months Ended September 30,				Nine Months  Ended September 30,
		2014				2013				2014				2013
REVENUES
Net sales		$	5,230,800			$	4,630,200			$	15,126,387			$	14,465,067
COST OF SALES
Cost of sales			3,379,628				3,166,746				10,148,412				9,463,514
GROSS PROFIT			1,851,172				1,463,454				4,977,975				5,001,553
OPERATING EXPENSES
General and administrative			1,057,775				506,707				2,592,865				1,925,176
Sales and marketing			690,613				812,216				2,053,095				2,384,090
Research and development			138,174				202,284				391,156				567,638
Purchasing, warehousing and distribution			336,191				283,294				1,020,287				861,775
Depreciation and amortization			30,264				44,376				88,759				129,692
Total operating expenses			2,253,017				1,848,877				6,146,162				5,868,371
LOSS FROM OPERATIONS			(401,845	)			(385,423	)			(1,168,187	)			(866,818	)
OTHER INCOME (EXPENSE)
Interest expense			(2,703	)			(26,996	)			(9,615	)			(58,355	)
Interest income			7				25				21				99
Other income, net			—				—				131				1
Gain on disposition of equipment			1,697				500				1,802				550
Total other income (expense)			(999	)			(26,471	)			(7,661	)			(57,705	)
NET LOSS BEFORE PROVISION FOR INCOME TAXES			(402,844	)			(411,894	)			(1,175,848	)			(924,523	)
BENEFIT FROM INCOME TAXES			—				—				—				(176,196	)
NET LOSS		$	(402,844	)		$	(411,894	)		$	(1,175,848	)		$	(748,327	)
NET LOSS PER COMMON SHARE
Basic		$	(0.01	)		$	(0.01	)		$	(0.02	)		$	(0.01	)
Diluted		$	(0.01	)		$	(0.01	)		$	(0.02	)		$	(0.01	)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic			79,072,089				76,704,275				77,639,852				76,673,821
Diluted			79,072,089				76,704,275				77,639,852				76,673,821

 

See Notes to Condensed Consolidated Financial Statements.

IRONCLAD PERFORMANCE WEAR CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Nine Months  Ended  September 30, 2014				Nine Months  Ended  September 30, 2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(1,175,848	)		$	(748,327	)
Adjustments to reconcile net loss provided (used) by operating activities:
Depreciation			81,652				123,069
Amortization			7,107				6,623
Stock option expense			245,644				208,731
Gain on disposition of property and equipment			(1,802	)			161
Changes in operating assets and liabilities:
Accounts receivable			2,365,035				3,394,512
Due from factor without recourse			—				915,492
Inventory			(1,351,506	)			(2,476,903	)
Deposits on inventory			(456,982	)			(505,478	)
Prepaid and other			(317,747	)			(290,752	)
Accounts payable and accrued expenses			1,020,825				(2,621,230	)
Net cash flows provided by (used in)  operating activities			416,378				(1,994,102	)
CASH FLOWS FROM INVESTING ACTIVITIES
Property and equipment purchased			(188,113	)			(97,740	)
Proceeds from sale of property and equipment			6,233				550
Investment in trademarks			(6,300	)			(12,119	)
Net cash flows used in investing activities			(188,180	)			(109,309	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock			752,238				23,102
Proceeds from bank line of credit			4,630,885				12,190,761
Payments to bank line of credit			(5,648,183	)			(10,542,734	)
Net cash flows provided by (used in) financing activities			(265,060	)			1,671,129
NET DECREASE IN CASH AND CASH EQUIVALENTS			(36,862	)			(432,282	)
CASH AND CASH EQUIVALENTS BEGINNING OF PERIOD			313,750				721,589
CASH AND CASH EQUIVALENTS END OF PERIOD		$	276,888			$	289,307
SUPPLEMENTAL DISCLOSURES
Interest paid in cash		$	9,616			$	58,355
Income taxes paid in cash		$	—			$	146,000

 

See Notes to Condensed Consolidated Financial Statements. 

IRONCLAD PERFORMANCE WEAR CORPORATION

Notes to Condensed Consolidated Financial Statements

 

1. Description of Business

 

Ironclad Performance Wear Corporation (“Ironclad,” the “Company,” “we,” “us” or “our”) was incorporated in Nevada on May 26, 2004 and engages in the business of design and manufacture of branded performance work wear including task-specific gloves and performance apparel designed to significantly improve the wearer’s ability to safely, efficiently and comfortably perform general to highly specific job functions. Its customers are primarily industrial distributors, hardware, lumber and automotive retailers, “Big Box” home centers and sporting goods retailers. The Company has received six U.S. patents, one international patent and four U.S. patents pending for design and technological innovations incorporated in its performance work gloves. The Company has 57 registered U.S. trademarks, 9 in-use U.S. trademarks, 4 U.S. trademarks pending registration, 21 registered international trademarks, 3 international trademarks pending and 7 copyright marks.

 

2. Accounting Policies

 

Basis of Presentation

 

The accompanying interim condensed consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) including those for interim financial information and with the instructions for Form 10-Q and Article 8 of Regulation S-X issued by the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and note disclosures required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been reflected in these interim financial statements. These financial statements should be read in conjunction with the audited financial statements and notes for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 18, 2014.

 

Basis of Consolidation

 

The condensed consolidated financial statements include the accounts of Ironclad Performance Wear Corporation, a Nevada corporation and inactive parent company, and its wholly owned subsidiary Ironclad Performance Wear Corporation, a California corporation (“Ironclad California”). All significant inter-company transactions have been eliminated in consolidation.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. The Company places its cash with high quality credit institutions. The Federal Deposit Insurance Company (FDIC) insures cash amounts at each institution for up to $250,000 and the Securities Investor Protection Corporation (SIPC) also insures cash amounts at each institution up to $250,000. The Company maintains cash in excess of the FDIC and SIPC limits.

 

Accounts Receivable

 

The Company advances credit to most of its customers based on an initial analysis of their credit worthiness and an ongoing review of their payment history. Most accounts receivable are collected in 30 to 60 days from invoice, according to terms allowed, with a few exceptions. Customer payments are received directly into the Company’s lockbox at its bank by ACH transfer and wire transfer deposits, and customer checks.

 

The allowance for doubtful accounts is based on management’s regular evaluation of individual customer’s receivables and consideration of a customer’s financial condition and credit history. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received. Interest is not charged on past due accounts.

		September 30, 2014				December 31, 2013
Accounts receivable		$	4,447,156			$	6,830,191
Less - allowance for doubtful accounts			(30,000	)			(48,000	)
Net accounts receivable		$	4,417,156			$	6,782,191

 

Inventory

 

Inventory is stated at the lower of average cost (which approximates first in, first out) or market and consists primarily of finished goods. The Company regularly reviews its inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on management’s estimated forecast of product demand and production requirements.

   

Property and Equipment

 

Property and equipment are recorded at cost less accumulated depreciation. Depreciation is recorded using the straight-line method over the estimated useful lives of the related assets, which range from three to seven years. Leasehold improvements are depreciated over fifteen years or the lease term, whichever is shorter. Maintenance and repairs are charged to expense as incurred.

 

Trademarks

 

The costs incurred to acquire trademarks, which are active and relate to products with a definite life cycle, are amortized over the estimated useful life of fifteen years. Trademarks, which are active and relate to corporate identification, such as logos, are not amortized. Pending trademarks are capitalized and reviewed monthly for active status.

 

Long-Lived Asset Impairment

 

The Company periodically evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance may not be recoverable. When factors indicate that the asset should be evaluated for possible impairment, the Company uses an estimate of the undiscounted net cash flows over the remaining life of the asset in measuring whether the asset is recoverable. Based upon the anticipated future income and cash flow from operations and other factors, relevant in the opinion of the Company’s management, there has been no impairment.

 

Operating Segment Reporting

 

As previously discussed, the Company has two product lines, “gloves” and “apparel,” both of which have similar characteristics.  They each provide functional protection and comfort to workers in the form of work wear for various parts of the body; their production processes are similar; they are both sold to the same type of class of customers, typically on the same purchase order; and they are warehoused and distributed from the same warehouse facility.  In addition, the “apparel” segment currently comprises less than 1% of the Company’s revenues.  The Company believes that the aggregation criteria of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, paragraph 17 applies and will accordingly aggregate these two segments.

Revenue Recognition

 

A customer is obligated to pay for products sold to it within a specified number of days from the date that title to the products is transferred to the customer. The Company’s standard terms are typically net 30 days from the transfer of title to the products to the customer, however we have negotiated special terms with certain customers and industries. The Company typically collects payment from a customer within 30 to 45 days from the transfer of title to the products to a customer. Transfer of title occurs and risk of ownership generally passes to a customer at the time of shipment or delivery, depending on the terms of the agreement with a particular customer. The sale price of the Company’s products is substantially fixed or determinable at the date of sale based on purchase orders generated by a customer and accepted by the Company. A customer’s obligation to pay the Company for products sold to it is not contingent upon the resale of those products. The Company recognizes revenues when products are delivered, or shipped to customers, based on terms of agreement with the customers. All transactions are conducted in United States Dollars and therefore there are no transaction gains or losses incurred on transactions with foreign customers.

 

Revenue Disclosures

 

The Company’s revenues are derived from the sale of our core line of task specific work gloves plus our line of work wear apparel products, available to all of our customers, both domestically and internationally.  Below is a table outlining this breakdown for the comparative periods:

 

		Three Months Ended September 30, 2014												Three Months Ended September 30, 2013
Net Sales		Gloves				Apparel				Total				Gloves				Apparel				Total
Domestic		$	4,844,120			$	16,731			$	4,860,851			$	4,275,406			$	29,642			$	4,305,048
International			369,949				—				369,949				325,869				(717	)			325,152
Total		$	5,214,069			$	16,731			$	5,230,800			$	4,601,275			$	28,925			$	4,630,200
		Nine Months Ended September 30, 2014												Nine Months Ended September 30, 2013
Net Sales		Gloves				Apparel				Total				Gloves				Apparel				Total
Domestic		$	12,305,509			$	97,983			$	12,403,492			$	12,513,205			$	71,351			$	12,584,556
International			2,722,156				739				2,722,895				1,880,511				—				1,880,511
Total		$	15,027,665			$	98,722			$	15,126,387			$	14,393,716			$	71,351			$	14,465,067

 

Cost of Goods Sold

 

Cost of goods sold includes all of the costs associated with producing the product by independent, third party factories (FOB costs), plus the costs of transporting, inspecting and delivering the product to our distribution warehouse in California (landed costs). Landed costs consist primarily of ocean/air freight, transport insurance, import duties, administrative charges and local trucking charges from the port to our warehouse. Cost of goods sold for the three and nine months ended September 30, 2014 and 2013 were $3,379,628 and $10,148,412 and $3,166,746 and $9,463,514, respectively.

 

Purchasing, warehousing and distribution costs are reported in operating expenses on the line item entitled “Purchasing, warehousing and distribution” and, for the three and nine months ended September 30, 2014 and 2013 were $336,191 and $1,020,287 and $283,294 and $861,775, respectively.

 

Product Returns, Allowances and Adjustments

 

Product returns, allowances and adjustments is a broad term that encompasses a number of offsets to gross sales. Included herein are warranty returns of defective products, returns of saleable products and accounting adjustments.

Warranty Returns - the Company has a warranty policy that covers defects in workmanship. It allows customers to return defective products to us following a customary return merchandise authorization process.

 

Saleable Product Returns - the Company may allow from time to time, depending on the customer and existing circumstances, stock adjustment returns, whereby the customer is given the opportunity to ‘trade out’ of a style of product that does not sell well in their territory, usually in exchange for another product, again following the customary return merchandise authorization process. In addition the Company may allow from time to time other saleable product returns from customers for other business reasons, for example, in settlement of an outstanding accounts receivable, from a discontinued distributor customer or other customer service purpose.

 

For warranty returns the Company utilizes actual historical return rates to determine the allowance for returns in each period. For saleable product returns the Company also utilizes actual historical return rates, adjusted for large, non-recurring occurrences. The Company does not accrue for pricing and shipping corrections as they are unpredictable and generally de minimis. Gross sales are reduced by estimated returns. We record a corresponding accrual for the estimated liability associated with the estimated returns which is based on the historical gross sales of the products corresponding to the estimated returns. This accrual is offset each period by actual product returns.

 

Reserve for Product Returns, Allowances and Adjustments
Reserve Balance 12/31/13		$	75,000
Payments For Returns Recorded During the Period			(90,968	)
			(15,968	)
Accrual for New Liabilities During the Period			90,968
Reserve Balance 3/31/14			75,000
Payments For Returns Recorded During the Period			(45,214	)
			29,786
Accrual for New Liabilities During the Period			45,214
Reserve Balance 6/30/14			75,000
Payments for Returns Recorded During the Period			(46,881	)
			28,119
Accrual for New Liabilities During the Reporting Period			46,881
Reserve Balance 9/30/14		$	75,000

 

Advertising and Marketing

 

Advertising and marketing costs are expensed as incurred. Advertising expenses for the three and nine months ended September 30, 2014 and 2013 were $109,405 and $319,334 and $73,558 and $398,468, respectively.

 

Shipping and Handling Costs

 

Freight billed to customers is recorded as sales revenue and the related freight costs as cost of sales. Freight billed to customers for the three and nine months ended September 30, 2014 and 2013 were $13,734 and $64,385 and $15,331 and $33,011, respectively. Freight out costs for the three and nine months ended September 30, 2014 and 2013 were $45,192 and $191,903 and $53,368 and $195,527, respectively. 

 

Customer Concentrations

 

Two customers accounted for approximately $2,159,682 or 41.2% of net sales for the quarter ended September 30, 2014 and two customers accounted for approximately $1,581,000 or 34.1% of net sales for the quarter ended September 30, 2013.  Two customers accounted for approximately $6,572,159 or 43.4% of net sales for the nine months ended September 30, 2014 and three customers accounted for approximately $7,204,000 or 49.8% of net sales for the nine months ended September 30, 2013.  No other customers accounted for more than 10% of net sales during the periods.

Supplier Concentrations

 

Two suppliers, who are located overseas, accounted for approximately 67% of total purchases for the three months ended September 30, 2014 and two suppliers, who are also located overseas, accounted for approximately 72% of total purchases for the three months ended September 30, 2013.  Two suppliers, who are located overseas, accounted for approximately 72% of total purchases for the nine months ended September 30, 2014 and two suppliers, who are also located overseas, accounted for approximately 72% of total purchases for the nine months ended September 30, 2013.  All transactions are conducted in United States Dollars and therefore there are no transaction gains or losses incurred on transactions with foreign suppliers.

 

Stock Based Compensation

 

The Company follows the provisions of FASB ASC 718, “Share-Based Payment.”  This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, as well as transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments.  ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements based on the fair value of the share-based payment.  ASC 718 establishes fair value as the measurement objective in accounting for share-based payment transactions with employees, such as the options issued under our stock incentive plans.

 

Earnings (Loss) Per Share

 

The Company utilizes FASB ASC 260, “Earnings per Share.” Basic earnings (loss) per share is computed by dividing earnings (loss) available to common shareholders by the weighted-average number of common shares outstanding. Diluted earnings (loss) per share is computed similar to basic earnings (loss) per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive.

 

As a result of the net loss for the three months and nine months ended September 30, 2014 and 2013, the Company calculated diluted earnings per share using weighted average basic shares outstanding only, as using diluted shares would be anti-dilutive to loss per share.

 

The following table sets forth the calculation of the numerators and denominators of the basic and pro forma diluted per share computations for the three months and nine months ended September 30, 2014 and 2013, if diluted shares were to be included:

 

		Three Months Ended				Three Months Ended				Nine Months Ended				Nine Months Ended
		September 30 2014				September 30 2013				September 30 2014				September 30 2013
Numerator: Net Loss		$	(402,844	)		$	(411,894	)		$	(1,175,848	)		$	(748,327	)
Denominator: Basic and Diluted EPS
Common shares outstanding, beginning of period			77,607,346				76,704,277				76,704,275				76,447,587
Weighted average common shares issued during the period			1,464,743				—				935,577				226,234
Denominator for basic earnings per common share			79,072,089				76,704,277				77,639,852				76,673,821

 

The following potential common shares have been excluded from the computation of diluted net income (loss) per share for the periods presented as the effect would have been anti-dilutive:

		Nine Months
		Ended September 30,
		2014				2013
Options outstanding under the Company’s stock option plans			13,745,671				3,131,625
Common Stock Warrants			43,146				—

 

Income Taxes

 

The Company adopted the provisions of FASB ASC 740-10 effective January 1, 2007. The implementation of FASB ASC 740-10 has not caused the Company to recognize any changes in its identified tax positions. Interest and penalties associated with unrecognized tax benefits would be classified as additional income taxes in the statement of operations.

 

Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to the difference between the basis of the allowance for doubtful accounts, accumulated depreciation and amortization, accrued payroll and net operating loss carryforwards for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.

 

Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized.

 

The components of the provision for income taxes for the three months and nine months ended September 30, 2014 were zero. The provision for income taxes for the three and nine months ended September 30, 2013 were $-0- and a $176,196 benefit, respectively.   Based on its history of losses, the Company provided a 100% valuation allowance against its deferred tax assets, as it was not more likely than not that any future benefit from deductible temporary differences and net operating loss carryforwards would be realized. For the year ended December 31, 2013, the Company evaluated its need for a valuation allowance against its deferred tax assets and determined that a 7% reduction in the valuation allowance was appropriate and recorded an additional deferred tax benefit of $214,500. These deferred tax benefits are recorded on the balance sheet as current deferred tax assets of $274,000 and long term deferred tax assets of $798,000 as of September 30, 2014 and December 31, 2013.

 

We will continue to evaluate if it is more likely than not that we will realize the benefits from future deferred taxes.

 

Use of Estimates

 

The preparation of financial statements requires management to make a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Significant estimates and assumptions made by management are used for, but not limited to, the allowance for doubtful accounts, inventory obsolescence, allowance for returns and the estimated useful lives of long-lived assets.

 

Fair Value of Financial Instruments

 

The fair value of the Company’s financial instruments is determined by using available market information and appropriate valuation methodologies. The Company’s principal financial instruments are cash, accounts receivable, accounts payable and short term line of credit debt. At September 30, 2014 and December 31, 2013, cash, accounts receivable, accounts payable and short term line of credit debt, due to their short maturities, and liquidity, are carried at amounts which reasonably approximate fair value.

The Company measures the fair value of its financial instruments using the procedures set forth below for all assets and liabilities measured at fair value that were previously carried at fair value pursuant to other accounting guidelines.

 

Under FASB ASC 820, “Fair Value Measurements” fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

 

FASB ASC 820 establishes a three-level hierarchy for disclosure to show the extent and level of judgment used to estimate fair value measurements.

 

Level 1 — Uses unadjusted quoted prices that are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2 — Uses inputs, other than Level 1, that are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data. Instruments in this category include non-exchange-traded derivatives, including interest rate swaps.

 

Level 3 — Uses inputs that are unobservable and are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

 

There were no financial assets or liabilities accounted for at fair value at September 30, 2014 or December 31, 2013. 

 

Recently Issued Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.

 

Subsequent Events

 

The Company evaluated its consolidated financial statements as of and for the nine months ended September 30, 2014 for subsequent events through the date the financial statements were issued. The Company is not aware of any subsequent event which would require recognition or disclosure in the financial statements.

3. Inventory

 

At September 30, 2014 and December 31, 2013 the Company had one class of inventory - finished goods.  Inventory is shown net of a provision of $547,800 at September 30, 2014 and $621,000 at December 31, 2013.

 

		September 30, 2014				December 31,  2013
Finished goods, net		$	5,921,908			$	4,570,402

 

4. Property and Equipment

 

Property and equipment consisted of the following:

 

		September 30, 2014				December 31, 2013
Computer equipment and software		$	496,614			$	442,262
Vehicles			—				39,630
Office furniture and equipment			247,917				196,744
Leasehold improvements			158,322				90,441
			902,853				769,077
Less: Accumulated depreciation			(609,505	)			(577,759	)
Property and equipment, net		$	293,348			$	191,318

 

Depreciation expense for the three months ended September 30, 2014 and 2013 was $27,875 and $42,127, respectively. Depreciation expense for the nine months ended September 30, 2014 and 2013 was $81,652 and $123,069, respectively, and for the twelve months ended December 31, 2013 was $158,122.

 

5. Trademarks and Patents

 

Trademarks and patents consisted of the following:

 

		September 30,				December 31,
		2014				2013
Trademarks		$	168,789			$	162,489
Patents			24,835				24,835
Less: Accumulated amortization			(56,171	)			(49,064	)
Trademarks and Patents, net		$	137,453			$	138,260

 

Trademarks and patents consist of definite-lived trademarks and patents of $126,525 and $120,225 and indefinite-lived trademarks and patents of $67,099 and $67,099 at September 30, 2014 and December 31, 2013, respectively. All trademark and patent costs have been generated by the Company, and consist of legal and filing fees.

 

Amortization expense for the three months ended September 30, 2014 and 2013 was $2,389 and $2,249, respectively. Amortization expense for the nine months ended September 30, 2014 and 2013 was $7,107 and $6,623, respectively, and for the twelve months ended December 31, 2013 was $8,746.

6. Accounts Payable and Accrued Expenses

 

Accounts payable and accrued expenses consisted of the following at September 30, 2014 and December 31, 2013:

 

		September 30,  2014				December 31, 2013
Accounts payable		$	1,865,641			$	1,161,985
Accrued rebates and co-op			101,893				224,213
Accrued bonus			—				40,533
Customer deposits			570,894				260,717
Accrued returns reserve			75,000				75,000
Accrued expenses – other			537,301				367,457
Total accounts payable and accrued expenses		$	3,150,729			$	2,129,905

 

7. Bank Lines of Credit

   

Bank Revolving Loan

 

On November 30, 2012 the Company entered into a Business Loan Agreement with Union Bank, N.A. which provides a revolving loan of up to $6,000,000. The first $3,500,000 of advances under this facility are under an open line-of-credit. Advances in excess of $3,500,000, up to the line limit of $6,000,000, are subject to a Borrowing Base report. The term Borrowing Base means an amount equal to (a) 80% of the net amount of all eligible accounts receivable plus, (b) the lesser of (i) 50% of the value of eligible landed inventory and (ii) $2,750,000, plus (c) 35% of eligible in-transit inventory. In addition, during the months of April to October each calendar year, the outstanding principal amount of all advances against eligible inventory shall not exceed 150% of the aggregate outstanding principal amount of advances against eligible accounts receivable. The agreement includes covenants based on tangible net worth, the ratio of total liabilities to tangible net worth, trailing twelve month positive net profits and the ratio of current assets to current liabilities. At September 30, 2014 the Company is in compliance with the covenants. All of the Company’s assets secure amounts borrowed under the terms of this agreement. Interest on borrowed funds will accrue at Prime minus 0.25% unless the Company chooses to “fix” a portion of the indebtedness (minimum $150,000) at LIBOR plus 2% for fixed periods of time ranging from 30 days to 360 days. The Business Loan Agreement expires on November 30, 2014. The Company currently has a signed term sheet with a different bank to replace the Union Bank Business Loan Agreement. This transaction is expected to close and fund prior to the expiration of the Union Bank agreement.

 

As of September 30, 2014 and December 31, 2013, the total amounts due to Union Bank were $1,152,114 and $2,169,411, respectively.

 

8. Equity Transactions

 

Common Stock

  

On January 14, 2013 the Company issued 172,582 shares of common stock upon the exercise of a stock option at an exercise price of $0.09.

 

On February 5, 2013 the Company issued 35,513 shares of common stock upon the exercise of a stock option at an exercise price of $0.09.

 

On February 25, 2013 the Company issued 48,595 shares of common stock upon the exercise of a stock option at an exercise price of $0.09.

On May 14, 2014 the Company issued 144,959 shares of common stock upon the exercise of a stock option at an exercise price of $0.095.

 

On June 2, 2014 the Company issued 24,779 shares of common stock upon the exercise of a stock option at exercise prices between $0.09 and $0.095.

 

On June 19, 2014 the Company issued 733,333 shares of restricted common with a fair value of $0.23, vesting evenly on a quarterly basis over a period of one year.

 

On July 1, 2014 the Company issued 33,036 shares of common stock upon the exercise of a stock option at exercise prices between $0.09 and $0.095.

 

On July 1, 2014 the Company issued 171,096 shares of common stock upon the exercise of a stock option at an exercise price of $0.11.

 

On August 7, 2014 the Company issued 160,548 shares of common stock upon the exercise of a stock option at an exercise price of $0.095.

 

On August 11, 2014 the Company issued 255,100 shares of common stock upon the exercise of a stock option at exercise prices between $0.09 and $0.095.

 

On August 12, 2014 the Company issued 126,712 shares of common stock upon the exercise of a stock option at an exercise price of $0.095.

 

On August 22, 2014 the Company sold 2,124,691 shares of common stock at a per share purchase price of $0.2871.

 

On September 10, 2014 the Company issued 177,100 shares of common stock upon the exercise of a stock option at exercise prices between $0.09 and $0.095.

 

On September 16, 2014 the Company issued 153,000 shares of common stock upon the exercise of a stock option at an exercise price of $0.24.

 

There were 80,808,629 shares of common stock of the Company outstanding at September 30, 2014.

 

Warrants Activity

 

A summary of warrants activity is as follows:

 

		Number of Shares				Weighted Average Exercise Price
Warrants outstanding at December 31, 2013			43,146				0.19
Warrants exercised			—
Warrants outstanding at September 30, 2014			43,146				0.19

 

Stock Based Compensation

 

Ironclad California reserved 3,020,187 shares of its common stock for issuance to employees, directors and consultants under the 2000 Stock Incentive Plan, which the Company assumed in the merger pursuant to which Ironclad California became a wholly-owned subsidiary of the Company (the “2000 Plan”). Under the 2000 Plan, options may be granted at prices not less than the fair market value of the Company’s common stock at the grant date. Options generally have a ten-year term and are exercisable as determined by the Company’s board of directors.

Effective May 18, 2006, the Company reserved 4,250,000 shares of its common stock for issuance to employees, directors and consultants under its 2006 Stock Incentive Plan (the “2006 Plan”). In June, 2009, the shareholders of the Company approved an increase in the number of shares of common stock reserved under the 2006 Plan to 11,000,000 shares.  In April, 2011, the shareholders of the Company approved a further increase in the number of shares of common stock reserved under the 2006 Plan to 13,000,000 shares. In May, 2013, the shareholders of the Company approved a further increase in the number of shares of common stock reserved under the 2006 Plan to 16,000,000 shares. In May, 2014, the shareholders of the Company approved a further increase in the number of shares of common stock reserved under the 2006 Plan to 21,000,000 shares. Under the 2006 Plan, options may be granted at prices not less than the fair market value of the Company’s common stock at the grant date. Options generally have a ten-year term and are exercisable as determined by the Company’s board of directors.

 

The fair value of each stock option granted under either the 2000 Plan or 2006 Plan is estimated on the date of the grant using the Black-Scholes Model.  The Black-Scholes Model has assumptions for risk free interest rates, dividends, stock volatility and expected life of an option grant. The risk free interest rate is based on the U.S. Treasury Bill rate with a maturity based on the expected life of the options and on the closest day to an individual stock option grant. Dividend rates are based on the Company’s dividend history. The stock volatility factor is based on historical market prices of the Company’s common stock. The expected life of an option grant is based on management’s estimate. The fair value of each option grant is recognized as compensation expense over the vesting period of the option on a straight line basis.

 

For stock options issued during the three months ended September 30, 2014 and 2013 and nine months ended September 30, 2014 and 2013, the fair value of these options was estimated at the date of the grant using a Black-Scholes option pricing model with the following range of assumptions:

 

Three Months Ended

Three Months Ended

Nine Months Ended

Nine Months Ended

September 30, 2014

September 30, 2013

September 30, 2014

September 30, 2013

Risk free interest rate

1.68%

0.12%

0.05% to 2.66%

0.12% to 1.33%

Dividends

—

—

—

—

Volatility factor

192.25%

64.80%

80.9% to 192.25%

64.8% to 88.3%

Expected life

6.26 years

5.5 years

5.5 to 6.26 years

5.5 to 6.25 years

 

A summary of stock option activity is as follows:

		Number of Shares				Weighted Average Exercise Price
Outstanding at December 31, 2013			10,143,765			$	0.140
Granted			3,238,250			$	0.172
Exercised			—
Cancelled/Expired			(225,041	)		$	0.198
Outstanding at March 31, 2014			13,156,974			$	0.147
Granted - Options			1,200,000			$	0.188
Exercised			(169,738	)		$	0.094
Cancelled/Expired			(161,332	)		$	0.097
Outstanding at June 30, 2014			14,025,904			$	0.153
Granted - Options			700,000			$	0.197
Exercised			(1,076,592	)		$	0.119
Cancelled/Expired			(636,974	)		$	0.148
Outstanding at September 30, 2014			13,012,338			$	0.158

The following table summarizes information about stock options outstanding at September 30, 2014:

 

Range of Exercise  Price				Number Outstanding				Weighted Average Remaining Contractual Life (Years)				Weighted Average Exercise Price				Intrinsic Value Outstanding Shares
$	0.09 - $0.27				13,012,338				6.95			$	0.158			$	878,832

 

The following table summarizes information about stock options exercisable at September 30, 2014:

 

Range of Exercise Price				Number Exercisable				Weighted Average Remaining Contractual Life (Years)				Weighted Average Exercise Price				Intrinsic Value Exercisable Shares
$	0.09 - $0.27				7,396,138				5.12			$	0.139			$	695,109

 

The following table summarizes information about non-vested stock options at September 30, 2014:

 

				Number of Shares				Weighted Average Grant Date Fair Value
	Non-Vested at December 31, 2013				2,333,932			$	0.20
	Granted				3,238,250			$	0.17
	Vested				(543,151	)		$	0.11
	Forfeited				(225,041	)		$	0.13
	Non-Vested at March 31, 2014				4,803,990			$	0.12
	Granted				1,200,000			$	0.19
	Vested				(451,042	)		$	0.12
	Forfeited				(139,761	)		$	0.10
	Non-Vested at June 30, 2014				5,413,187			$	0.13
	Granted				700,000			$	0.20
	Vested				(134,846	)		$	0.11
	Forfeited				(362,141	)		$	0.18
	Non-Vested at June 30, 2014				5,616,200			$	0.14

 

In accordance with ASC 718, the Company recorded $88,528 and $59,553 of compensation expense for employee stock options during the three months ended September 30, 2014 and 2013. The Company recorded $245,644 and $208,731 of compensation expense for employee stock options during the nine months ended September 30, 2014 and 2013. There was a total of $664,994 of unrecognized compensation costs related to non-vested share-based compensation arrangements under the Plan outstanding at September 30, 2014. This cost is expected to be recognized over a weighted average period of 3.3 years. The total fair value of shares vested during the nine months ended September 30, 2014 was $133,069.

 

9. Income Taxes

 

The Company adopted FASB ASC 740-10, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109” as of January 1, 2007. FASB ASC 740-10 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax position taken or expected to be taken on a tax return. Additionally, FASB ASC 740-10 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. No adjustments were required upon adoption of FASB ASC 740-10.

  The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the fiscal years 2010 through 2013. The Company’s state tax returns are open to audit under the statute of limitations for the fiscal years 2010 through 2013. 

 

The provision for income taxes differs from the amount that would result from applying the federal statutory rate for the periods ended September 30, 2014 and 2013 as follows:  

 

		September 30,  2014				September 30,  2013
Statutory regular federal income benefit rate			34.0	%			34.0	%
State income taxes, net of federal benefit			5.3	%			(16.4	%)
Change in valuation allowance			(39.3	%)			(17.6	%)
Total			—	%			—	%

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of sufficient future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize some portion or all of the benefits of these deductible differences. 

 

As of September 30, 2014, the Company had unused federal and states net operating loss carryforwards available to offset future taxable income of approximately $5,629,000 and $6,708,000, respectively, that expire between 2015 and 2025.

 

10. Commitments and Contingencies

  

On June 11, 2014 the Company entered into a 42 month lease for a new corporate office facility in Farmers Branch, Texas, commencing in the third quarter of 2014. The Company relocated its corporate headquarters to Texas in the third quarter. This new facility is approximately 13,026 square feet and the Company has negotiated six months of rent abatement. The monthly base rent is $7,653 plus $3,449 for common area operating expenses. A security deposit of one month’s rent has been made in the amount of $11,102.

 

The Company entered into a five-year lease with one option to renew for an additional five years for a corporate office and warehouse lease commencing in July 2006.  The Company exercised its five year option to renew this lease commencing in July 2011.  The facility is located in El Segundo, California.   As part of this renewal process we reduced our square footage by approximately 1,700 square feet of unneeded warehouse space in exchange for six months of rent concessions and approximately $40,000 of tenant improvements.  Rent expense for this facility for the three and nine months ended September 30, 2014 was $40,716 and $127,778, respectively. The Company has sublet this facility for the remainder of its lease.

 

The Company has various non-cancelable operating leases for office equipment expiring through August 2018.  Equipment lease expense charged to operations under these leases for the nine months ended September 30, 2014 was $10,200.

 

Future minimum rental commitments under these non-cancelable operating leases for years ending December 31 are as follows:

Year		Facility				Equipment				Total
2014			69,428				2,695				72,123
2015			263,491				10,781				274,272
2016			178,437				10,138				188,575
2017			93,878				9,240				103,118
2018			15,646				5,775				21,421
Thereafter			-				-				-
		$	620,880			$	38,629			$	659,509

 

Ironclad California executed a Separation Agreement with Eduard Jaeger effective in April 2004, which was subsequently amended on November 26, 2008. Pursuant to the terms of the Separation Agreement, if Ironclad terminated Mr. Jaeger’s employment with Ironclad California at any time other than for Cause, then: (a) Ironclad California was required to pay Mr. Jaeger all accrued and unpaid salary and other compensation payable by the Company for services rendered through the termination date, payable in a lump sum payment on the termination date;  (b) Ironclad California was required to pay a cash amount equal to Two Hundred Thousand Dollars ($200,000), payable in installments throughout the one (1) year period following the termination date in the same manner as Ironclad California pays salaries to its other executive officers; and (c) all outstanding options issued to Mr. Jaeger under the Company’s 2006 Stock Incentive Plan, or any other plan or agreement approved by the Company’s board of directors would become immediately vested and exercisable. Further, the Separation Agreement, as amended, also provided that the Company’s board of directors could not remove Mr. Jaeger during his then current board term, except for Cause (as defined in the Separation Agreement).  Finally, the Separation Agreement required Mr. Jaeger to sign a general release and non-competition agreement in order to receive the lump sum payment. For the purposes of the Separation Agreement, termination for “Cause” meant termination by reason of: (i) any act or omission knowingly undertaken or omitted by Mr. Jaeger with the intent of causing damage to Ironclad California, its properties, assets or business or its stockholders, officers, directors or employees; (ii) any improper act of Mr. Jaeger involving a material personal profit to him, including, without limitation, any fraud, misappropriation or embezzlement, involving properties, assets or funds of Ironclad California or any of its subsidiaries; (iii) any consistent failure by Mr. Jaeger to perform his normal duties as directed by the Chairman of the Board, in the sole discretion of the board of directors; (iv) any conviction of, or pleading nolo contendere to, (A) any crime or offense involving monies or other property of Ironclad; (B) any felony offense; or (C) any crime of moral turpitude; or (v) the chronic or habitual use or consumption of drugs or alcoholic beverages. This Separation Agreement was cancelled, effective February 18, 2014, in conjunction with a Consulting Agreement of same date, as described in Note 11.

 

11. Management Changes

 

On February 18, 2014 the board of directors of the Company appointed Mr. Jeffrey Cordes as Chief Executive Officer with a compensation of $300,000 per year, along with an incentive bonus of $125,000 for over-achievement of corporate objectives. Mr. Cordes was also appointed to the Company’s board of directors. In addition, Mr. Cordes was awarded 2,700,000 options to purchase the Company’s common stock at $0.17, the stock closing price on the date of the award.

 

Concurrent with the above appointment, Mr. Eduard Jaeger tendered his resignation as Head of Business Development and as a member of the board of directors. Mr. Jaeger will remain affiliated with the Company for two years as a Brand Ambassador and Evangelist for the Company’s products pursuant to a consulting contract.

 

Also concurrent with the above appointment, Mr. Scott Jarus resigned from the board of directors.

 

On May 5, 2014, the Company’s board of directors appointed Mr. William Aisenberg as the Company’s Executive Vice President, Chief Financial Officer and Secretary, with a compensation of $225,000 per year; he is also eligible to receive an annual incentive bonus of up to 30% of his salary based on the Company achieving certain revenue and operating income targets, and based upon Mr. Aisenberg and/or the Company achieving certain corporate objectives. In addition, Mr. Aisenberg was awarded 1,000,000 options to purchase the Company’s common stock at $0.19, the stock closing price on the date of the award.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This discussion summarizes the significant factors affecting our operating results, financial condition and liquidity and cash flows for the nine months ended September 30, 2014 and 2013. The following discussion of our results of operations and financial condition should be read together with the condensed consolidated financial statements and the notes to those statements included elsewhere in this report. Except for historical information, the matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond our control. Our actual results could differ materially from the results anticipated in any forward-looking statements as a result of a variety of factors, including those discussed in “Risk Factors.”

 

Overview

 

We are a leading designer and manufacturer of branded performance work wear. Founded in 1998, we have grown and leveraged our proprietary technologies to produce task-specific gloves and performance apparel that are designed to significantly improve the wearer’s ability to safely, efficiently and comfortably perform general to highly specific job functions. We have built and continue to augment our reputation among professionals in the construction and industrial service markets, and do-it-yourself and sporting goods consumers with products specifically designed for individual tasks or task types. We believe that our dedication to quality and durability and focus on our client needs has created a high level of brand loyalty and has solidified substantial brand equity.

 

We plan to increase our domestic revenues by leveraging our relationships with existing retailers and industrial distributors, including “Big Box,” automotive and sporting goods retailers, increasing our product offerings in new and existing locations, and introducing new products, developed and targeted for specific customers and/or industries.

 

We believe that our products have international appeal. In 2005, we began selling products in Australia and Japan through independent distributors, which accounted for approximately 4% of total sales.  From 2006 through 2013, we entered the Canadian and European markets through distributors and international sales have represented approximately 7% - 19% of total sales. We plan to continue to pursue sales internationally by expanding our distribution into Europe and other international markets in ensuing years. 

 

General

 

Net sales are comprised of gross sales less returns and discounts. Our operating results are seasonal, with a greater percentage of net sales being earned in the third and fourth quarters of our fiscal year due to the fall and winter selling seasons.

 

Our cost of goods sold includes the free on board (“FOB”) cost of the product plus landed costs and a reserve for slow-moving inventory. Landed costs include freight-in, insurance, duties and administrative costs to deliver the finished goods to our distribution warehouse. Cost of goods sold does not include purchasing, warehousing or distribution costs. These costs are captured as incurred on a separate line in operating expenses. Our gross margins may not be comparable to other entities that may include some or all of these costs in the calculation of gross margin.

 

Our operating expenses consist primarily of payroll and related costs, marketing costs, corporate infrastructure costs and our purchasing, warehousing and distribution costs. We expect that our operating expenses will decrease as a percentage of net sales if we are able to increase our net sales through expansion and growth. We expect this reduction in operating expenses to be offset by investment in sales and marketing to achieve brand growth, the development of new product lines, and the increased costs of operating as a public company.

Historically, we have funded our working capital needs through a combination of our existing asset-based credit facility along with subordinated debt and equity financing transactions. On November 30, 2012 we entered into a Business Loan Agreement with Union Bank, N.A. which provides a revolving loan of up to $6,000,000. The first $3,500,000 of advances under this facility are under an open line-of-credit. Advances in excess of $3,500,000, up to the line limit of $6,000,000, are subject to a Borrowing Base report. The term Borrowing Base means an amount equal to (a) 80% of the net amount of all eligible accounts receivable plus, (b) the lesser of (i) 50% of the value of eligible landed inventory and (ii) $2,750,000, plus (c) 35% of eligible in-transit inventory. In addition, during the months of April to October each calendar year, the outstanding principal amount of all advances against eligible inventory shall not exceed 150% of the aggregate outstanding principal amount of advances against eligible accounts receivable. All of our assets secure amounts borrowed under the terms of this agreement. Interest on borrowed funds accrue at Prime minus 0.25% unless we choose to “fix” a portion of the indebtedness (minimum $150,000) at LIBOR plus 2% for fixed periods of time ranging from 30 days to 360 days.

 

Critical Accounting Policies, Judgments and Estimates

 

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations section discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. To prepare these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities. These estimates also affect our reported revenues and expenses. On an ongoing basis, management evaluates its estimates and judgment, including those related to revenue recognition, accrued expenses, financing operations and contingencies and litigation. Management bases its estimates and judgment on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

 

Revenue Recognition

 

Under our sales model, a customer is obligated to pay us for products sold to it within a specified number of days from the date that title to the products is transferred to the customer. Our standard terms are typically net 30 days from the transfer of title to the products to a customer, however we have negotiated special terms with certain customers and industries. We typically collect payment from a customer within 30 to 60 days from the transfer of title to the products to a customer. Transfer of title occurs and risk of ownership passes to a customer at the time of shipment or delivery, depending on the terms of our agreement with a particular customer. The sale price of our products is substantially fixed or determinable at the date of sale based on purchase orders generated by a customer and accepted by us. A customer’s obligation to pay us for products sold to it is not contingent upon the resale of those products. We recognize revenue at the time title is transferred to a customer.

 

Revenue Disclosures

 

Our revenues are derived from the sale of our core line of task specific work gloves plus our line of work wear apparel products, available to all of our customers, both domestically and internationally.  Below is a table outlining this breakdown for the comparative periods:

 

		Nine Months Ended September 30, 2014												Nine Months Ended September 30, 2013
Net Sales		Gloves				Apparel				Total				Gloves				Apparel				Total
Domestic		$	12,305,509			$	97,983			$	12,403,492			$	12,513,205			$	71,351			$	12,584,556
International			2,722,156				739				2,722,895				1,880,511				—				1,880,511
Total		$	15,027,665			$	98,722			$	15,126,387			$	14,393,716			$	71,351			$	14,465,067

Inventory Obsolescence Allowance

 

We review the inventory level of all products quarterly. For most products that have been in the market for one year or greater, we consider inventory levels of greater than one year’s sales to be excess.  Products that are no longer part of the current product offering are considered obsolete. The potential for re-sale of slow-moving and obsolete inventories is based upon our assumptions about future demand and market conditions. The recorded cost of obsolete inventories is then reduced to zero and a reserve is established for slow moving products. Both the write down and reserve adjustments are recorded as charges to cost of goods sold. As of September 30, 2014 and December 31, 2013, our inventory reserve was $547,800 and $621,000, respectively. All adjustments for obsolete inventory establish a new cost basis for that inventory as we believe such reductions are permanent declines in the market price of our products. Generally, obsolete inventory is sold to companies that specialize in the liquidation of these items or contributed to charities, while we continue to market slow-moving inventories until they are sold or become obsolete. As obsolete or slow-moving inventory is sold or disposed of, we reduce the reserve. In the first nine months of 2014, the Company sold some of its slow-moving inventory and reduced its inventory reserve by $73,200.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our current customers consist primarily of large national, regional and smaller independent customers with good payment histories with us. We perform periodic credit evaluations of our customers and maintain allowances for potential credit losses based on management’s evaluation of historical experience and current industry trends. If the financial condition of our customers were to deteriorate, resulting in the impairment of their ability to make payments, additional allowances may be required. New customers are evaluated for credit worthiness before terms are established. Although we expect to collect all amounts due, actual collections may differ.  The allowance for doubtful accounts was $30,000 at September 30, 2014 and $48,000 at December 31, 2013.

 

Product Returns, Allowances and Adjustments

 

Product returns, allowances and adjustments is a broad term that encompasses a number of offsets to gross sales. Included herein are warranty returns of defective products, returns of saleable products and accounting adjustments.

 

Warranty Returns - We have a warranty policy that covers defects in workmanship. It allows customers to return damaged or defective products to us following a customary return merchandise authorization process.

 

Saleable Product Returns - We may allow from time to time, depending on the customer and existing circumstances, stock adjustment returns, whereby the customer is given the opportunity to ‘trade out’ of a style of product that does not sell well in their territory, usually in exchange for another product, again following the customary return merchandise authorization process. In addition we may allow from time to time other saleable product returns from customers for other business reasons, for example, in settlement of an outstanding accounts receivable, from a discontinued distributor customer or other customer service purpose.

 

Accounting Adjustments - These adjustments include pricing and shipping corrections and periodic adjustments to the product returns reserve.

 

For both warranty and saleable product returns we utilize actual historical return rates to determine our allowance for returns in each period, adjusted for unique, one-time events. Gross sales is reduced by estimated returns. We record a corresponding accrual for the estimated liability associated with the estimated returns which is based on the historical gross sales of the products corresponding to the estimated returns. This accrual is offset each period by actual product returns.

Our current estimated future warranty product return rate is approximately 1.5% of Net Sales and our current estimated future stock adjustment return rate is approximately 0.5% of Net Sales. As noted above, our return rate is based upon our past history of actual returns and we estimate amounts for product returns for a given period by applying this historical return rate and reducing actual gross sales for that period by a corresponding amount. We believe that using a trailing 12-month return rate provides us with a sufficient period of time to establish recent historical trends in product returns for two primary reasons:  (i) our products’ useful life is approximately 3-4 months and (ii) we are able to quickly correct any significant quality issues as we learn about them. If an unusual circumstance exists, such as a product that has begun to show materially different actual return rates as compared to our average 12-month return rates, we will make appropriate adjustments to our estimated return rates. Factors that could cause materially different actual return rates as compared to the 12-month return rates include a new product line, a change in materials or product being supplied by a new factory. Although we have no specific statistical data on this matter, we believe that our practices are reasonable and consistent with those of our industry. Our warranty terms under our arrangements with our suppliers do not provide for individual products returned by retailers or retail customers to be returned to the vendor.

 

Reserve for Product Returns, Allowances and Adjustments      

Reserve Balance 12/31/13		$	75,000
Payments For Returns Recorded During the Period			(90,968	)
			(15,968	)
Accrual for New Liabilities During the Reporting Period			90,968
Reserve Balance 3/31/14			75,000
Payments For Returns Recorded During the Period			(45,214	)
			29,786
Accrual for New Liabilities During the Reporting Period			45,214
Reserve Balance 6/30/14			75,000
Payments for Returns Recorded During the Period			(46,881	)
			28,119
Accrual for New Liabilities During the Reporting Period			46,881
Reserve Balance 9/30/14		$	75,000

 

Stock Based Compensation

 

We follow the provisions of FASB ASC 718, “Share-Based Payment.”  This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, as well as transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments.  ASC 718 requires that the cost resulting from all share-based payment transactions be recognized in the financial statements based on the fair value of the share-based payment.  ASC 718 establishes fair value as the measurement objective in accounting for share-based payment transactions with employees, such as the options issued under our stock incentive plans.

 

Income Taxes

 

Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates as of the date of enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be effectively sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution of appeals or litigation, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.   In the past we have fully reserved our deferred tax assets, however, we have now had several years in a row of sustained profits and believe it would now be appropriate to reduce this valuation allowance. Accordingly the Company reversed approximately 30% of its valuation allowance for its current deferred tax assets and recorded a deferred tax benefit of $857,500 in 2012. At December 31, 2013 we once again reviewed our current profitability and forecasted future results and concluded that it is more likely than not that we would be able to realize some more of our deferred tax assets. At December 31, 2013 we reversed approximately 7% of our valuation allowance for our current deferred tax assets and recorded an additional deferred tax benefit of $214,500. At September 30, 2014 and December 31, 2013, these deferred tax benefits are recorded on the balance sheet as current deferred tax assets of $274,000 and long term deferred tax assets of $798,000.

 

Interest and penalties associated with unrecognized tax benefits would be classified as additional income taxes in the statement of operations.

 

Results of Operations

 

Comparison of Three and Nine Months Ended September 30, 2014 and 2013

 

Net Sales increased $600,600 or 13.0%, to $5,230,800 in the quarter ended September 30, 2014 from $4,630,200 for the corresponding period in 2013. Two customers accounted for 41.2% of Net Sales during the quarter ended September 30, 2014 and two customers accounted for 34.1% of Net Sales during the quarter ended September 30, 2013. Net Sales increased $661,320 or 4.6%, to $15,126,387 in the nine months ended September 30, 2014 from $14,465,067 for the corresponding period in 2013. Two customers accounted for 43.4% of Net Sales during the nine months ended September 30, 2014 and three customers accounted for 49.8% of Net Sales for the nine months ended September 30, 2013. The Net Sales increase for the quarter is due to increased sales in our industrial/safety segments, offset in part by decreases in the automotive and private label segments.  The Net Sales increase for the nine month period is due to increased sales in our industrial/safety and private label segments, offset in part by decreases in the retail automotive, co-op and independent hardware segments. We continue to focus our sales efforts on those areas where we see growth opportunities, the industrial and safety markets and job specific and specialty glove styles.

 

Gross Profit increased $387,718 to $1,851,172 for the quarter ended September 30, 2014 from $1,463,454 for the corresponding period in 2013. Gross Profit, as a percentage of net sales, or gross margin, increased to 35.4% in the third quarter of 2014 from 31.6% in the same quarter of 2013.  The increase in Gross Profit of 3.8% for the third quarter was primarily due to customer and product mix. Gross Profit decreased $23,578 to $4,977,975 for the nine months ended September 30, 2014 from $5,001,553 in the prior year period. Gross Profit, as a percentage of net sales, or gross margin, decreased to 32.9% on a year-to-date basis from 34.6% for the same period of 2013. The decrease in Gross Profit of 1.7% for the nine months was primarily due to a decrease in higher margin sales plus several large promotional incentives incurred earlier in the year.

Operating Expenses increased $404,138 to $ 2,253,017 for the quarter ended September 30, 2014 from $1,848,877 for the corresponding period in 2013. As a percentage of net sales, Operating Expenses represented 43.1% for the three months ended September 30, 2014, compared to 39.9% of net sales for the same period in 2013. Operating Expenses were $6,146,162 for the nine months ended September 30, 2014, compared to $5,868,371 for the corresponding period in 2013. As a percentage of net sales, Operating Expenses for the nine month period in 2014 was consistent the nine month period in 2013 at 40.6%. The expense increase in actual dollars for the nine month period is primarily driven by the costs associated with the Company’s move from California to Texas, including severance and move related costs. Our number of employees was 22 at September 30, 2014 and 27 at September 30, 2013.

 

Loss from Operations increased by $16,422, to a loss of $401,845 in the third quarter of 2014, from a loss of $385,423 in the third quarter of 2013. Loss from operations as a percentage of net sales decreased to 7.7% in the third quarter of 2014 from 8.3% in the third quarter of 2013.  The dollar increase in loss from operations in the third quarter was primarily due to increased sales offset by increased operating expenses. Loss from Operations increased by $301,999 to a loss of $1,168,187 for the nine months ended September 30, 2014, from a loss of $866,818 in the corresponding period of 2013. The increase in loss from operations in the nine month period was primarily due to higher cost of goods sold and increased operating expenses, as discussed above.

 

Interest Expense decreased $24,293 to $2,703 in the third quarter of 2014 from $26,996 in the same period of 2013. This decrease is due to reduced borrowings during the quarter under our bank line of credit agreement, the outstanding balance under which was reduced to $-0- during the first quarter of 2014. Interest expense decreased $48,740 in the first nine months of 2014 from $58,355 in the same period of 2013. 

 

Net Loss decreased $9,050 to a loss of $402,844 in the third quarter of 2014 from a loss of $411,894 in the third quarter of 2013.  Net Loss increased $427,521 to a loss of $1,175,848 for the nine months ended September 30, 2014 from a loss of $748,327 in the prior year period. This increased loss was primarily the result of lower margin sales due to customer and product mix early in the year and the cost of the management restructure and move to Texas.

 

Seasonality and Quarterly Results

 

Our glove business generally shows an increase in sales during the third and fourth quarters due primarily to an increase in the sale of our winter glove line during this period and fall promotions.  We typically generate 55% - 65% of our glove net sales during these months.  The first and second quarters of the year are generally considered our slower season.  Even though the overall economy continues to exhibit moderate and uneven growth, which affects some of our channels, we have been experiencing some mixed growth in certain channels - international and private label - which helps offset declines in other areas.

 

Our working capital, at any particular time, reflects the seasonality of our glove business and plans to expand product lines and enter new markets.  We expect inventory and current liabilities to be higher in the third and fourth quarters for these reasons.

 

Liquidity and Capital Resources

 

Our cash requirements are principally for working capital. Our need for working capital is seasonal, with the greatest requirements from June through the end of October each year as a result of our inventory build-up during this period for the fall and winter selling seasons. Historically, our main sources of liquidity have been borrowings under our existing revolving credit facility, the issuance of subordinated debt and the sale of equity.  In the short term we monitor our credit issuances and cash collections to maximize cash flows and investigate opportunities to reduce our current inventories to convert these assets into cash.  Over the past several years, and continuing in the near and longer term we are focused on controlling our operating costs, managing margins and improving operating procedures to generate sustained profitability.

On November 30, 2012 we entered into a Business Loan Agreement with Union Bank, N.A. which provides a revolving loan of up to $6,000,000. The first $3,500,000 of advances under this facility are under an open line-of-credit. Advances in excess of $3,500,000, up to the line limit of $6,000,000, are subject to a Borrowing Base report. The term Borrowing Base means an amount equal to (a) 80% of the net amount of all eligible accounts receivable plus, (b) the lesser of (i) 50% of the value of eligible landed inventory and (ii) $2,750,000, plus (c) 35% of eligible in-transit inventory. In addition, during the months of April to October each calendar year, the outstanding principal amount of all advances against eligible inventory shall not exceed 150% of the aggregate outstanding principal amount of advances against eligible accounts receivable. All of our assets secure amounts borrowed under the terms of this agreement. Interest on borrowed funds will accrue at Prime minus 0.25% unless we choose to “fix” a portion of the indebtedness (minimum $150,000) at LIBOR plus 2% for fixed periods of time ranging from 30 days to 360 days.  This Business Loan Agreement expires on November 30, 2014. The Company currently has a signed term sheet with a different bank to replace the Union Bank Business Loan Agreement. This transaction is expected to close and fund prior to the expiration of the Union Bank agreement.

 

On August 22, 2014, we entered into Subscription Agreements with certain of our directors and officers pursuant to which we agreed to sell in a private placement (the “Private Placement”) an aggregate of 2,124,691 shares of our common stock at a purchase price of $0.2871 per share, a 10% premium to the trailing ten-day average closing price. The Private Placement resulted in aggregate proceeds to us of approximately $610,000.

 

At September 30, 2014 and December 31, 2013 we had available, but unused credit under this facility of approximately $4,546,000 and $3,831,000, respectively.  

 

Off Balance Sheet Arrangements

 

At September 30, 2014, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 Not applicable.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Controls and Procedures

 

As of September 30, 2014, the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934 Act, as amended. Based on this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are effective.  In making this assessment, our management used the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission under the 1992 Framework (COSO). The COSO Commission has recently adopted a revision of the Internal Control-Integrated Framework which will become effective for us in December 2014. We expect to be in full compliance later this year.

Our disclosure controls and procedures, and internal controls over financial reporting, provide reasonable, but not absolute, assurance that all deficiencies in design and or operation of those control systems, or all instances of errors or fraud, will be prevented or detected.  Those control systems are designed to provide reasonable assurance of achieving the goals of those systems in light of our resources and nature of our business operations.  Our disclosure controls and procedures, and internal control over financial reporting, remain subject to risks of human error and the risk that controls can be circumvented for wrongful purposes by one or more individuals in management or non-management positions.

 

During the quarter, we completed our review of the facts and circumstances surrounding the lawsuit filed in the District Court of Dallas, Texas against our current CEO Jeff Cordes and CFO William Aisenberg, as well as several other defendants, in connection with the sale of their former company, Walls Holding Company, Inc., to Williamson-Dickie Holding Company.  The lawsuit does not involve nor contain any allegations against our Company.

 

After reviewing all available information concerning the matter, we have concluded that the lawsuit represents a dispute surrounding a business transaction between Walls Holding Company, Inc. and Williamson-Dickie Holding Company.  Our board of directors does not believe that the unsubstantiated allegations contained in the lawsuit create any concern over the performance of Mr. Cordes and Mr. Aisenberg at Ironclad, and our board of directors continues to have complete confidence in the integrity and performance of our management team.  As part of its review, our board of directors evaluated and made certain clarifications to our Code of Ethical Conduct.  In connection with the appointment of BDO USA, LLP as our independent registered public accounting firm, and to improve our overall corporate governance, we have engaged BDO to evaluate certain of our internal control and review procedures, and have made BDO specifically aware of the allegations contained in the lawsuit.

 

Internal Control Over Financial Reporting

 

During the last fiscal quarter, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II:  OTHER INFORMATION

 

ITEM 6. EXHIBITS

 

Exhibit Index

 

Exhibit Number	Exhibit Title
10.1	Form of Subscription Agreement.  Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K (File No. 000-51365), filed August 25, 2014.
10.2	Form of Lock-Up Agreement.  Incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K (File No. 000-51365), filed August 25, 2014.
31.1	Certification by Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended.
31.2	Certification by Principal Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended.
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**	XBRL Instance.
101.SCH**	XBRL Taxonomy Extension Schema.
101.CAL**	XBRL Taxonomy Extension Calculation.
101.DEF**	XBRL Taxonomy Extension Definition.
101.LAB**	XBRL Taxonomy Extension Labels.
101.PRE**	XBRL Taxonomy Extension Presentation.

 

** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	IRONCLAD PERFORMANCE WEAR CORPORATION
Date: November 11 , 2014	By:	/s/ William Aisenberg
		William Aisenberg, EVP, Chief Financial Officer