Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management ’ s Discussion and Analysis of Financial Condition and Results of Operations contains a discussion of our business, including a general overview of our segments, our results of operations, our liquidity and capital resources, and our quantitative and qualitative disclosures about market risk.
The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside of our control. Our actual results could differ materially from those discussed in these forward-looking statements. See “ Cautionary Remarks Regarding Forward Looking Statements ” in the front of this Annual Report on Form 10-K.
Management Summary
We are the owner and exclusive publisher of Kane Miller children’s books; Learning Wrap-Ups, maker of educational manipulatives; and SmartLab Toys, maker of STEAM-based toys and games. We are also the exclusive United States Multi-Level Marketing (“MLM”) distributor of Usborne Publishing Limited (“Usborne”) children’s books. Significant portions of our product offering, and inventory are concentrated with Usborne. Our distribution agreement with Usborne includes annual minimum purchase volumes along with specific payment terms, which, if not met or if payments are not received in a timely manner, offer Usborne the right to terminate the agreement. During fiscal 2023 and fiscal 2024, the Company did not meet the minimum purchase volumes and certain payments were not received timely. No notification of non-compliance or termination has been received from Usborne. Should termination of the agreement occur, the Company will be allowed, at a minimum, to sell through their remaining Usborne inventory over the twelve months following the termination date.
We sell our products through two separate divisions, PaperPie and Publishing. These two divisions each have their own customer base. The PaperPie division markets our complete line of products through a network of independent Brand Partners using a combination of home shows, internet party events and book fairs. The Publishing division markets Kane Miller, Learning Wrap-Ups and SmartLab Toys on a wholesale basis to various retail accounts. All other supporting administrative activities are recognized as other expenses outside of our two divisions. Other expenses consist primarily of the compensation for our office, warehouse, and sales support staff as well as the cost of operating and maintaining our corporate offices and distribution facility.
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PaperPie Division
Our PaperPie division uses a multi-level direct selling organizational structure to market our products using independent sales representatives (“Brand Partners”) located throughout the United States. The customer base of PaperPie consists of individual purchasers, as well as schools and public libraries. Revenues are primarily generated through book showings in individual homes, on social media collaboration platforms, through book fairs with school and public libraries and other in-person events.
An important factor in the growth of the PaperPie division is the addition of new Brand Partners and the retention of existing Brand Partners. Active Brand Partners (defined as those with sales during the past six months) are primarily responsible for recruiting new Brand Partners. PaperPie entices new recruits by providing joining incentives to new Brand Partners including discounted products and cash bonus awards based on exceeding certain sales criteria. In addition, our PaperPie division provides our Brand Partners with an extensive operational handbook, valuable training, and an individual website they can customize and use to generate sales. The Company also provides a “back-office” operations platform that allows Brand Partners to track their individual and team business results.
Brand Partners
FY 2024
FY 2023
New Brand Partners Added During Fiscal Year
10,800
16,500
Active Brand Partners at End of Fiscal Year
15,000
24,600
Our PaperPie division’s multi-level marketing organizational structure presently has eight levels of sales representatives, collectively known as Brand Partners:
●
Brand Partners
●
Team Leaders
●
Advanced Leaders
●
Senior Leaders
●
Executive Leaders
●
Senior Executive Leaders
●
Directors
●
Senior Directors
Upon signing up, sales representatives begin as “Brand Partners”. Brand Partners receive “weekly commissions” from each sale they make; the commission rate they receive on each sale is determined by the “order type” assigned to the sale. In addition, Brand Partners receive a monthly sales bonus once their total sales reach an established monthly goal and other awards (called “Level Perks”) for meeting other individual sales and recruiting goals for the month. Brand Partners who recruit a specified number of other Brand Partners into their downline become “Team Leaders”. These downline recruits are known as their "Central Group". Upon reaching this Team Leader level, Brand Partners become eligible to receive “monthly override payments” which are calculated on sales made by their Central Group and downlines up to two levels below their Central Group. Team Leaders that recruit and promote other Team Leaders, and meet other established criteria, are eligible to become “Advanced Leaders”.
Once Advanced Leaders promote a second level Brand Partner, add additional recruits, and meet other established criteria, they become “Senior Leaders”, “Executive Leaders”, “Senior Executive Leaders”, “Directors” or “Senior Directors”. One-time cash bonus payments are made to Advanced Leaders and higher at each promotion level. Executive Leaders and higher receive an additional monthly override payment based upon the sales of their executive group. Directors and higher receive an additional bonus payment if they promote a Team Leader from their Central Group. The maximum override payment a leader can receive is calculated on the sales of their Central Group and three levels below.
During fiscal year 2024, internet sales continued to be the largest sales channel within our PaperPie division. The use of social media and party plan platforms, such as those available on Facebook, continue to be popular sales tools. These platforms allow Brand Partners to “present” and customers to “attend” online purchasing events from any geographical location.
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Customers’ internet orders are primarily received via the Brand Partner’s customized website, which is hosted by the Company. Brand Partners contact hosts or hostesses (collectively “hostess”) who then provide a list of contacts to invite to an online party. During the online party, the Brand Partner answers attendees’ questions and provides product recommendations. These attendees then select desired products and place orders via the Brand Partner’s customized website. Internet orders are processed through a standard online “shopping cart checkout” and the Brand Partner receives sales credit and commission on the transaction. All internet orders are shipped directly to the end customer. The hostess earns discounted products based on the total sales from the attendees at the online party. Brand Partners use the list of contacts provided by the hostess as additional contacts for future hostess and recruiting opportunities.
In-person parties also occur when Brand Partners contact hostesses to hold book shows in their homes. The Brand Partner assists the hostess in setting up the details for the show, makes a presentation at the show and takes orders for the products. The hostess earns discounted products based on the total sales at the party, including internet orders for those customers who can only attend via online access. These orders are typically shipped to the hostess who then distributes the products to the end customer. Customer specials are also available when customers, or their party, order above a specified amount. As with online parties, home shows often provide an excellent opportunity for recruiting new Brand Partners.
PaperPie net revenues also include sales to schools and libraries through PaperPie Learning, a separate program for eligible Brand Partners which requires certain qualifications and the completion of additional training requirements. The PaperPie Learning program includes book fairs which are held with an organization as the sponsor. The Brand Partner provides promotional materials to introduce our products to parents, who then turn in their orders at a designated time. The book fair program generates discounted products for the sponsoring organization.
PaperPie also generates revenues through various fundraiser programs directed toward schools and community organizations. Reach for the Stars is a pledge-based reading incentive program that provides cash and products to the sponsoring organization and products for the participating children. An additional fundraising program, Cards for a Cause , offers Brand Partners the opportunity to help members of the community by sharing proceeds from the sale of specific items. Organizations sell a variety box of greeting-type cards and donate a portion of the proceeds to help support their related causes.
Publishing Division
Our Publishing division operates in a market that is highly fragmented, with many types of retail companies engaged in selling children’s books and toys. The Publishing division’s customer base includes national book chains, regional and local bookstores, toy and gift stores, school supply stores and museums. To reach these markets, the Publishing division utilizes a combination of commissioned sales representatives and an in-house sales group located at our headquarters.
The table below shows the percentage of net revenues from our Publishing division based on market type.
Publishing Division Net Revenues by Market Type
FY 2024
FY 2023
National chain bookstores
2
%
2
%
All other
98
%
98
%
Total net revenues
100
%
100
%
Publishing uses a variety of methods to attract potential new customers and maintain current customers. Our employees attend many of the national trade shows held by the book and toy selling industry each year, allowing us to contact potential buyers who may be unfamiliar with our products. Our marketing strategy targets toy and specialty stores, in addition to bookstores and museum gift shops, through print media advertising in trade publications. In some instances, our products are featured in promotions and catalogs by participation in co-ops with national chain retailers.
Publishing’s sales representatives actively target the smaller independent book and gift store customers. This market has seen continued growth due to a resurgence in the opening of local bookstores, toy stores, and specialty stores across the U.S., coupled with the efforts of both our in-house and outside sales representatives to increase sales to local and independent businesses. The Company shifted its focus toward independent stores as national chain stores saw a change in buying programs and purchasing slowed with COVID-19. Our annual catalogs are mailed to approximately 4,000 customers and potential customers. See Publishing Operating Results for discussion of our updated distribution agreement with Usborne.
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Result of Operations
The following table shows our statements of operations data:
Twelve Months Ended
February 29 (28),
2024
2023
Net revenues
$
51,030,300
$
87,829,000
Cost of goods sold
18,045,400
31,759,200
Gross margin
32,984,900
56,069,800
Operating expenses
Operating and selling
8,789,200
15,780,600
Sales commissions
16,105,600
25,676,100
General and administrative
13,991,000
17,195,100
Total operating expenses
38,885,800
58,651,800
Other (income) expense
Interest expense
2,758,900
2,172,300
Other income
(9,394,300
)
(1,327,400
)
Earnings (loss) before income taxes
734,500
(3,426,900
)
Income taxes
188,100
(922,000
)
Net earnings (loss)
$
546,400
$
(2,504,900
)
See the detailed discussion of net revenues, gross margin and operating expenses by reportable segment below.
Non-Segment Operating Results
Total operating expenses not associated with a reporting segment were 11.3 million for the fiscal year ended February 29, 2024, compared to $14.9 million for the same period a year ago. Operating expenses decreased $3.6 million primarily as a result of a reduction in labor expenses of $2.6 million, with our warehouse payroll having the largest reduction, and a $0.7 million decrease in freight-handling costs, both associated with a decrease in gross sales, plus a $0.3 million decrease in depreciation expense due to the sale of the Company’s old headquarters and classification as assets held for sale of our current headquarters and warehouse , $0.2 million decrease in legal costs primarily related to the negotiation of our new Usborne distribution agreement which was executed in fiscal 2023, offset by a $0.2 million increase in personal property taxes due to the Company no longer qualifying for an exemption on long term inventory.
Interest expense increased $0.6 million, to $2.8 million for fiscal year ended February 29, 2024, compared to $2.2 million reported for fiscal year ended February 28, 2023, due primarily to increases in Secured Overnight Financing Rates (“SOFR”) interest rates, partially offset by reduced borrowings in fiscal 2024.
Other income increased $8.1 million, to $9.4 million for fiscal year ended February 29, 2024, compared to $1.3 million reported for fiscal year ended February 28, 2023, due to $3.8 million of other income related to the Employee Retention Credit, $4.0 million gain from the sale of the old headquarters building, $0.1 million gain from the sale of equipment, $0.1 million decrease in startup costs recognized from the acquisition of SmartLab Toys in 2023, and $0.1 million in other various changes.
Income taxes increased $1.1 million, to a tax expense of $0.2 million for fiscal year ended February 29, 2024, from a tax benefit of $0.9 million for the same period a year ago. This increase was primarily related to an increase in taxable income for the current fiscal year compared to the prior fiscal year. The effective tax rate decreased by 1.3%, to 25.6% for fiscal year ending February 29, 2024, as compared to 26.9% for fiscal year ended February 28, 2023, primarily due to sales mix fluctuations between states. Our tax rates are higher than the federal statutory rate of 21% due to the inclusion of state income and franchise taxes.
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PaperPie Operating Results
The following table summarizes the operating results of the PaperPie segment for the twelve months ended February 29 (28):
Twelve Months Ended
February 29 (28),
2024
2023
Gross sales
$
64,252,000
$
94,795,700
Less discounts and allowances
(20,981,500
)
(27,271,100
)
Transportation revenue
2,354,700
7,022,100
Net revenues
45,625,200
74,546,700
Cost of goods sold
15,745,500
24,639,000
Gross margin
29,879,700
49,907,700
Operating expenses
Operating and selling
7,151,300
12,501,100
Sales commissions
15,925,100
25,095,100
General and administrative
2,674,100
3,140,900
Total operating expenses
25,750,500
40,737,100
Operating income
$
4,129,200
$
9,170,600
Average number of active Brand Partners
18,300
28,000
PaperPie net revenues decreased $28.9 million, or 38.8%, to $45.6 million for fiscal year ended February 29, 2024, when compared with net revenues of $74.5 million reported for fiscal year ended February 28, 2023. The average number of active Brand Partners in fiscal year 2024 was 18,300, a decrease of 9,700, or 34.6%, from 28,000 in fiscal year 2023. The Company reports the average number of active Brand Partners as a key indicator for this division. We also saw new Brand Partner recruiting negatively impacted by the recent change in our distribution agreement with Usborne Publishing Limited. The new agreement created a level of uncertainty with our Brand Partners until we were able to effectively communicate the continuation of our relationship within the Direct Sales division. Further, sales were impacted beginning in the fourth quarter of fiscal 2023 and continuing through the first two quarters of fiscal 2024, associated with the rebranding of the direct sales division from Usborne Books & More (“UBAM”) to PaperPie. During this period, our Brand Partners were challenged with updating their individual marketing materials, training videos and personal business websites to the new brand. These efforts resulted in less sales and less new recruiting success. In addition, sales during fiscal 2024 continued to be negatively impacted by economic factors that include recent record inflation, resulting in high fuel costs and food price increases that continue to impact the disposable income of our customers. The reduced sales resulted in increased Brand Partner turnover and lower levels of new Brand Partner recruits. We expect this impact on sales to continue as inflationary pressures persist.
PaperPie gross margin decreased $20.0 million, or 40.1%, to $29.9 million for fiscal year ended February 29, 2024, from $49.9 million reported for fiscal year ended February 28, 2023. Gross margin as a percentage of net revenues decreased 1.4% to 65.5% for fiscal year 2024 when compared to 66.9% for fiscal year 2023. The decrease in gross margin as a percentage of net revenues is primarily attributed to reduced freight revenues resulting from a discounted freight promotion that began in the third quarter of fiscal 2024 that continued through the fiscal fourth quarter impacting gross margins by $1.0 million, offset by increased margins on product mix of $0.4 million.
Total PaperPie operating expenses decreased $14.9 million, or 36.6%, to $25.8 million during the fiscal year ended February 29, 2024, when compared with $40.7 million reported for fiscal year ended February 28, 2023. Operating and selling expenses decreased $5.3 million, to $7.2 million for fiscal year ended February 29, 2024, from $12.5 million reported in the same period a year ago. These decreases were due to a $5.2 million decrease in shipping costs associated with the decrease in volume of orders shipped from lower sales, and a decrease of $0.2 million in accruals for Brand Partner incentive trip expenses, offset by a $0.1 million increase in accruals for Brand Partner meetings and convention expenses. Sales commissions decreased $9.2 million, to $15.9 million during the fiscal year ended February 29, 2024, when compared to $25.1 million reported in the same period a year ago primarily due to the decrease in net revenues. General and administrative expenses decreased $0.4 million, to $2.7 million during the fiscal year ended February 29, 2024, when compared with $3.1 million reported for fiscal year ended February 28, 2023. This decrease was due to $0.6 million of decreased credit card transaction fees associated with decreased sales volumes, a $0.2 million decrease in payroll and various other expenses, offset by $0.4 million increase in amortization and depreciation expenses related to the SmartLab Toys acquisition.
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Operating income of our PaperPie division decreased $5.1 million, or 55.4%, to $4.1 million for fiscal year ended February 29, 2024, as compared to $9.2 million reported for fiscal year ended February 28, 2023. Operating income for the PaperPie division as a percentage of net revenues for the year ended February 29, 2024, was 9.1%, compared to 12.3% for the year ended February 28, 2023, a change of 3.2%. Operating income as a percentage of net revenues changed from the prior year primarily due to the decrease in net revenues caused by higher discounts and lower transportation revenue, plus the increase in cost of goods sold resulting from higher inbound freight costs, and the increase in accrued expenses for the Company’s Brand Partners related to the annual incentive trip and convention.
Publishing Operating Results
The following table summarizes the operating results of the Publishing segment for the twelve months ended February 29 (28):
Twelve Months Ended
February 29 (28),
2024
2023
Gross sales
$
11,331,600
$
27,896,200
Less discounts and allowances
(5,947,900
)
(14,624,400
)
Transportation revenue
21,400
10,500
Net revenues
5,405,100
13,282,300
Cost of goods sold
2,299,800
7,120,200
Gross margin
3,105,300
6,162,100
Total operating expenses
1,882,000
2,975,300
Operating income
$
1,223,300
$
3,186,800
Our Publishing division’s net revenues decreased $7.9 million, or to $5.4 million for fiscal year ended February 29, 2024 from $13.3 million reported for fiscal year ended February 28, 2023. During fiscal year 2023, we entered into a new distribution agreement with Usborne. Under the contracted terms in our new distribution agreement, the Company no longer has the rights to distribute Usborne’s products to retail customers. The Company discontinued sales to retail customers in the first quarter of fiscal 2024 when Usborne introduced their new distribution vendor. Usborne’s products sold within the Publishing division decreased to 24.2%, or $2.7 million of net sales during the fiscal year ended February 29, 2024 from 83.4%, or $11.1 million, of net sales during the fiscal year ended February 28, 2023.
Gross margin decreased $3.1 million, to $3.1 million for fiscal year ended February 29, 2024, from $6.2 million reported for fiscal year ended February 28, 2023. Gross margin as a percentage of net revenues increased 11.1%, to 57.5% for fiscal year 2024, compared to 46.4% reported the same period a year ago due to a change in customer order mix and the addition of SmartLab Toys.
Operating expenses decreased $1.1 million, to $1.9 million for fiscal year ended February 29, 2024, from $3.0 million reported for fiscal year ended February 28, 2023. The decrease in operating expenses resulted from the decrease in sales commissions of $0.4 million, a decrease in freight expense of $0.9 million, both due to decreased sales, offset by a $0.2 million increase in Learning Wrap Ups compensation expense resulting from earnout payments to sellers that reached their initial sales hurdle outlined in the purchase agreements of Learning Wrap-Ups in December 2021.
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Operating income for the segment decreased $2.0 million, or 62.5%, to $1.2 million for fiscal year ended February 29, 2024, from $3.2 million reported during the same period last year. The decrease in operating income resulted primarily from lower sales volumes compared to the previous fiscal year partially offset by the decrease in sales commissions and freight expenses.
Liquidity and Capital Resources
EDC has a history of profitability and positive cash flow. We typically fund our operations from the cash we generate. During periods of operating losses, EDC will reduce purchases and sell through inventory to generate cash flow. During fiscal 2024, the Company generated cash flows from reducing inventory that offset operating losses along with the receipt of $3.8 million in Employee Retention Credit and $4.9 million in proceeds from the sale of our old headquarters building. The Company expects to reduce current excess inventory levels and use the cash proceeds to offset any future operating losses, and to pay down the line of credit and portions of the term debt. Available cash has historically been used to pay down outstanding bank loan balances, for capital expenditures, to pay dividends and to acquire treasury stock. We utilize a bank credit facility and other term loan borrowings to meet our short-term cash needs, as well as fund capital expenditures, when necessary. As of the end of fiscal year 2024, our revolving bank credit facility loan balance was $5.5 million with $2.5 million in available capacity.
During fiscal year 2024, we experienced positive cash flows from operations of $8,750,600. These cash flows resulted from:
● net earnings of $546,400
Adjusted for:
● depreciation and amortization expense of $2,487,200
● share-based compensation expense, net of $212,000
● provision for credit losses of $33,300
● provision for inventory valuation allowance of $85,900
Offset by:
● net gain on sale of assets of $4,016,700
● deferred income taxes of $609,700
Positively impacted by:
● decrease in inventories, net of $8,130,000
● decrease in accounts receivable of $936,500
● increase in income taxes payable of $773,400
● decrease in prepaid expenses and other assets of $197,100
● increase in accounts payable of $46,300
Negatively impacted by:
● decrease in accrued salaries, commissions, and other liabilities of $51,900
● decrease in deferred revenues of $19,200
Cash provided by investing activities was $4,037,100 consisting of proceeds from the sale of assets of $4,858,900 offset by capital expenditures of $821,800 in software upgrades to our proprietary systems that our PaperPie Brand Partners use to monitor their business and place customer orders.
Cash used in financing activities was $12,199,400 which was comprised of net payments on the line of credit of $5,136,400, payments on term debt of $6,499,100 and cash paid in treasury stock transactions of $563,900.
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We continue to expect that cash generated from the sale of our owned real estate, along with cash generated from our operations, specifically from the reduction of excess inventory, and cash available through our line of credit with our Lender will provide us with the liquidity we need to support ongoing operations. Cash generated from the building sales and operations will be used to pay down existing debt and any excess may be used to purchase inventory to continue to expand our product offerings.
On August 9, 2022, the Company repaid in full all outstanding indebtedness and terminated all commitments and obligations under its Amended and Restated Loan Agreement dated February 15, 2021 (as amended), between the Company and MidFirst Bank and executed a new Credit Agreement (“Loan Agreement”) with BOKF, NA (“Bank of Oklahoma” or the “Lender”). The Loan Agreement established a fixed rate term loan in the principal amount of $15,000,000 (the “Fixed Rate Term Loan”), a floating rate term loan in the principal amount of $21,000,000 (the “Floating Rate Term Loan”; together with the Fixed Rate Term Loan, collectively, the “Term Loans”), and a revolving promissory note in the principal amount up to $15,000,000 (the “Revolving Loan” or “Line of Credit”).
On December 22, 2022, the Company executed the First Amendment to our Loan Agreement with the Lender. This amendment clarified the definition of the Fixed Charge Coverage Ratio to exclude dividends paid prior to November 30, 2022, and placed restrictions on acquisitions and cash dividends.
On May 10, 2023, the Company executed the Second Amendment to our Loan Agreement with the Lender. This amendment waived the fixed charge ratio default which occurred on February 28, 2023 and amended the financial covenant to not require the fixed charge ratio to be measured at May 31, 2023. The Second Amendment also added a cumulative maximum level of fiscal year to date inventory purchases through the expiration of the Revolving Loan Agreement, increased the borrowing rate on the Company’s Revolving Loan to Term SOFR Rate plus 3.5%, required certain swap agreement be executed within 30 days of the amendment, reduced the revolving commitment from $15,000,000 to $14,000,000, effective May 10, 2023, and further reduced the revolving commitment to $13,500,000, effective July 15, 2023, among other items.
On June 6, 2023, pursuant to its interest rate risk and risk management strategy, the Company entered into a swap transaction (the “Swap Transaction”) with the Lender, which converts a portion of the original $21,000,000 Floating Rate Term Loan from a floating interest rate to a fixed interest rate for the next two years. The Swap Transaction has a notional amount of $18,000,000 through fiscal quarter ending May 31, 2024, and then resets to $13,000,000 through May 30, 2025, while continuing to mirror the amortizing balance of the Floating Rate Term Loan. Under the terms of this agreement, the Company, in effect, has exchanged the floating interest rate of 30-Day Term SOFR Rate at the trade date of June 5, 2023, to a fixed rate of 4.73%. The Swap Transaction commenced on June 7, 2023, with a termination date of May 30, 2025.
On August 9, 2023, the Company executed the Third Amendment along with a Revised Credit Agreement (“Revised Loan Agreement”) with the Lender. This amendment extended the Revolving Loan maturity date to January 31, 2024 and introduced a stepdown to the Revolving Commitment from $13,500,000, through August 30, 2023; to $10,500,000 through October 30, 2023; to $9,000,000 through November 29, 2023; to $5,000,000 through December 30, 2023; to $4,500,000 through January 30, 2024; and to $4,000,000 on January 31, 2024. The amendment restricted the Company from entering into any new purchase orders and use its best efforts to cancel existing purchase orders. It also required the Company to list its real estate property located at 10302 East 55th Place, Tulsa, Oklahoma, for sale with a licensed commercial real estate broker satisfactory to the Lender on or before August 18, 2023, among other items. Contingent upon the occurrence of an Event of Default in the agreement, the Company shall within 15 days list the Hilti Complex with a licensed commercial real estate broker satisfactory to the Lender.
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Prior to the Third Amendment, executed on August 9, 2023, the Loan Agreement contained provisions that required the Company to maintain a minimum fixed charge ratio. The Company was in violation of the minimum fixed charge ratio covenant as of February 28, 2023, for which the Company obtained a written waiver of compliance from the Lender and was not required to measure the fixed charge ratio as of May 31, 2023. Concurrent with the execution of the Third Amendment to the Loan Agreement, the Loan Agreement was modified to incorporate the changes outlined in the Third Amendment and the fixed charge ratio covenant was removed, as well as the Lender’s right to accelerate the maturities of the Fixed Rate Term Loan and Floating Rate Term Loan due to the fixed charge ratio covenant. Should the Company fail to meet any of the remaining terms outlined in the Revised Credit Agreement or fail to meet the stepdown requirements of the Revolving Loan, the Company shall within 15 days list the Hilti Complex, with a licensed commercial real estate broker satisfactory to the Lender. Proceeds from the sale of the property would be used to pay off all the borrowings with the Lender. A third-party appraisal was completed on the Hilti Complex, consisting of the 400,000 square feet building complex on approximately 50 acres, along with approximately 15 acres of adjacent unused land, in July of 2023 with a market value of $41,970,000.
On November 30, 2023, the Company executed the Fourth Amendment to the Credit Agreement (“Amendment”) with the Lender. The Amendment, effective December 1, 2023, increases the Revolving Loan commitment to $8,000,000 and extends the maturity date to May 31, 2024. The Amendment also requires the Company to list the Hilti Complex for sale, allows the Company to execute additional purchase orders, subject to the lender’s approval and conditions, not to exceed $2,100,000 between December 1, 2023 and March 31, 2024, among other items.
Available credit under the current $8,000,000 revolving line of credit with the Company’s Lender was approximately $2,501,900 at February 29, 2024.
Features of the Revised Loan Agreement include:
(i)
Two Term Loans on 20-year amortization with 5-year maturity date of August 9, 2027
(ii)
$15 Million Fixed Rate Term Loan bears interest at a fixed rate per annum equal to 4.26%
(iii)
$21 Million Floating Rate Term Loan bears interest at a rate per annum equal to Term SOFR Rate + 1.75%
(iv)
Stepdown Revolving Loan with maturity date of May 31, 2024. The Revolving Loan bears interest at a rate per annum equal to Term SOFR Rate + 4.50% (effective rate was 9.82% at February 29, 2024)
(v)
Revolving Loan allows for Letters of Credit up to $7,500,000 upon bank approval (none were outstanding at February 29, 2024)
The following table reflects aggregate current maturities of term debt, excluding the Revolving Loan, during the next fiscal year as follows:
Years ending February 28 (29),
2025
$
1,800,000
2026
1,800,000
2027
1,800,000
2028
23,200,900
Total
$
28,600,900
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Risks and Uncertainties
In accordance with ASC 205-40, Going Concern , the Company has evaluated whether there are conditions and events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the financial statements are issued.
The short-term duration of the Revolving Loan and uncertainty of the bank’s ongoing support beyond May 31, 2024, along with recurring operating losses and other items, raise substantial doubt over the Company's ability to continue as a going concern. Management has plans to sell the Hilti Complex and pay off the Term Loans and Revolving Loan. The proceeds from the sale are expected to generate sufficient cashflow to allow the Company to continue operations with limited borrowings. The Company expects these borrowings to be available through local banks or other financing sources. In addition, management’s plans include reducing inventory which will generate free cashflows and building the active PaperPie Brand Partners to pre-pandemic levels. Although there is no guarantee these plans will be successful, management believes these plans, if achieved, will alleviate the substantial doubt about continuing as a going concern and generate sufficient liquidity to meet our obligations as they become due over the next twelve months.
Contractual Obligations
We are a smaller reporting company and are not required to provide this information.
Off-Balance Sheet Arrangements
As of February 29, 2024, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Seasonality
The Company experiences increased sales in the Fall season. Historically, we have experienced an increase in inventory during the Summer in anticipation for the Fall increase in sales. In addition, new titles are typically released twice a year, in the Spring and Fall, which increases our inventory in the months preceding these scheduled releases. We do not expect inventory to increase in fiscal year 2025 as we continue to sell down excess inventory.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to our valuation of inventory, allowance for uncollectible accounts receivable, allowance for sales returns, long-lived assets, and deferred income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results may materially differ from these estimates under different assumptions or conditions. Historically, however, actual results have not differed materially from those determined using required estimates. Our significant accounting policies are described in the notes accompanying the financial statements included elsewhere in this report. However, we consider the following accounting policies to be significantly more dependent on the use of estimates and assumptions.
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Share-Based Compensation
We account for share-based compensation whereby share-based payment transactions with employees, such as stock options and restricted stock, are measured at estimated fair value at the date of grant. For awards subject to service conditions, compensation expense is recognized over the vesting period on a straight-line basis. Awards subject to performance conditions are attributed separately for each vesting tranche of the award and are recognized ratably from the service inception date to the vesting date for each tranche. Forfeitures are recognized when they occur. Any cash dividends declared after the restricted stock award is issued, but before the vesting period is completed, will be reinvested in Company shares at the opening trading price on the dividend payment date. Shares purchased with cash dividends will also retain the same restrictions until the completion of the original vesting period associated with the awarded shares.
The restricted share awards under the 2019 Long-Term Incentive Plan (“2019 LTI Plan”) and 2022 Long-Term Incentive Plan (“2022 LTI Plan”) contain both service and performance conditions. The Company recognizes share-based compensation expense only for the portion of the restricted share awards that are considered probable of vesting. Shares are considered granted, and the service inception date begins, when a mutual understanding of the key terms and conditions between the Company and the employees has been established. The fair value of these awards is determined based on the closing price of the shares on the grant date. The probability of restricted share awards granted with future performance conditions is evaluated at each reporting period and compensation expense is adjusted based on the probability assessment.
During fiscal years 2024 and 2023, the Company recognized $0.2 million and $0.9 million, respectively, of compensation expense associated with the shares granted.
Revenue Recognition
Sales associated with product orders are recognized and recorded when products are shipped. Products are shipped FOB-Shipping Point. PaperPie’s sales are generally paid at the time the product is ordered. Sales which have been paid for but not shipped are classified as deferred revenue on the balance sheet. Sales associated with consignment inventory are recognized when reported and payment associated with the sale has been remitted. Transportation revenue represents the amount billed to the customer for shipping the product and is recorded when the product is shipped.
Estimated allowances for sales returns are recorded as sales are recognized. Management uses a moving average calculation to estimate the allowance for sales returns. We are not responsible for a product damaged in transit. Damaged returns are primarily received from the retail customers of our Publishing division. This damage occurs in the stores, not in shipping to the stores, and we typically do not offer credit for damaged returns. It is industry practice to accept non-damaged returns from retail customers. Management has estimated and included a reserve for sales returns of $0.2 million for the fiscal years ended February 29, 2024 and February 28, 2023.
Allowance for Credit Losses
We maintain an allowance for estimated losses resulting from the inability of our customers to make required payments and a reserve for vendor share markdowns, when applicable (collectively “credit losses”). An estimate of uncollectible amounts is made by management based upon historical bad debts, current customer receivable balances, age of customer receivable balances, customers’ financial conditions and current economic trends. Management has estimated and included an allowance for credit losses of $0.1 million and $0.2 million for the fiscal years ended February 29, 2024 and February 28, 2023, respectively.
Inventory
Our inventory contains approximately 2,000 titles, each with different rates of sale depending upon the nature and popularity of the title. Almost all of our product line is saleable as the products are not topical in nature and remain current in content today as well as in the future. Most of our products are printed in China, Europe, Singapore, India, Malaysia, and Dubai typically resulting in a four to eight-month lead-time to have a title printed and delivered to us.
Certain inventory is maintained in a noncurrent classification. Management continually estimates and calculates the amount of noncurrent inventory. Noncurrent inventory arises due to occasional purchases of titles in quantities in excess of what will be sold within the normal operating cycle, due to the minimum order requirements of our suppliers. Noncurrent inventory is estimated by management using an anticipated turnover ratio by title, based primarily on historical trends. Inventory in excess of 2½ years of anticipated sales is classified as noncurrent inventory. These inventory quantities have additional exposure for storage damages, aging of topical related content and associated issues, and therefore have higher obsolescence reserves. Noncurrent inventory balances prior to valuation allowances were $12.3 million and $5.1 million at February 29, 2024 and February 28, 2023, respectively. Noncurrent inventory valuation allowances were $0.6 million at February 29, 2024 and $0.4 million at February 28, 2023.
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Brand Partners that meet certain eligibility requirements may request and receive inventory on consignment. We believe allowing our Brand Partners to have consignment inventory greatly increases their ability to be successful in making effective presentations at home shows, book fairs and other events; in summary, having consignment inventory leads to additional sales opportunities. Approximately 11.6% of our active Brand Partners maintained consignment inventory at the end of fiscal year 2024. Consignment inventory is stated at cost, less an estimated reserve for consignment inventory that is not expected to be sold or returned to the Company. The total cost of inventory on consignment with Brand Partners was $1.4 million and $1.5 million at February 29, 2024 and February 28, 2023, respectively.
Inventories are presented net of a valuation allowance, which includes reserves for inventory obsolescence and reserves for consigned inventory that is not expected to be sold or returned to the Company. Management estimates the inventory obsolescence allowance for both current and noncurrent inventory, which is based on management’s identification of slow-moving inventory. Management has estimated a valuation allowance for both current and noncurrent inventory, including the reserve for consigned inventory, of $1.0 million at February 29, 2024, and $0.9 February 28, 2023.
New Accounting Pronouncements
See the New Accounting Pronouncements section of Note 1 to our financial statements, included in Part IV, Item 15 of this report, for further details of recent accounting pronouncements.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are a smaller reporting company and are not required to provide this information.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 begins at page 28.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
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