Notes to Unaudited Condensed Consolidated Financial Statements
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
We are a leading designer, manufacturer and marketer of premium quality footwear and apparel marketed under a portfolio of well recognized brand names including Rocky, Georgia Boot, Durango and Lehigh. Our brands have a long history of representing high quality, comfortable, functional and durable footwear and our products are organized around six target markets: outdoor, work, duty, commercial military, western and lifestyle. In addition, as part of our strategy of outfitting consumers from head-to-toe, we market complementary branded apparel and accessories that we believe leverage the strength and positioning of each of our brands.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments that are necessary for a fair presentation of the financial results. All such adjustments reflected in the unaudited condensed consolidated financial statements are considered to be of a normal and recurring nature. The results of operations for the three months ended March 31, 2020 and 2019 are not necessarily indicative of the results to be expected for the whole year. The December 31, 2019 condensed consolidated balance sheet data was derived from the audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America ("GAAP"). This Quarterly Report on Form 10-Q should be read in connection with our Annual Report on Form 10-K for the year ended December 31, 2019, which includes all disclosures required by GAAP.
2. ACCOUNTING STANDARDS UPDATES
Recently Issued Accounting Pronouncements
Rocky Brands, Inc. is currently evaluating the impact of certain Accounting Standards Updates (“ASU”) on its Unaudited Condensed Consolidated Financial Statements or Notes to the Unaudited Condensed Consolidated Financial Statements:
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Standard
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Description
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Anticipated Adoption Period
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Effect on the financial statements or other significant matters
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ASU 2016-13, Measurement of Credit Losses on Financial Instruments
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The pronouncement seeks to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.
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Q1 2023 as long as we continue to qualify as a smaller reporting company
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The Company is evaluating the impacts of the new standard on its existing financial instruments, including trade receivables.
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ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes
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This pronouncement is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application.
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Q1 2021
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The Company is evaluating the impacts of the new standard on its Unaudited Condensed Consolidated Financial Statements.
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Accounting Standards Adopted in the Current Year
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Standard
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Description
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Effect on the financial statements or other significant matters
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ASU 2018-13 Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement
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This pronouncement changes the fair value measurement disclosure requirements of ASC 820. The amendments in this ASU are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting — Chapter 8: Notes to Financial Statements.
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The Company adopted the new standard in Q1 2020 and the standard did not have a significant impact on its Unaudited Condensed Consolidated Financial Statements.
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3. FAIR VALUE
Generally accepted accounting standards establish a framework for measuring fair value. The fair value accounting standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This standard clarifies how to measure fair value as permitted under other accounting pronouncements.
The fair value accounting standard defines fair value as the exchange price that would be received for 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 at the measurement date. This standard also establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
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Level 1 – Quoted prices in active markets for identical assets or liabilities.
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·
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Level 2 – Observable inputs other than quoted market prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
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·
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Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
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The fair values of cash and cash equivalents, receivables, and payables approximated their carrying values because of the short-term nature of these instruments. Receivables consist primarily of amounts due from our customers, net of allowances, amounts due from employees (sales persons’ advances in excess of commissions earned and employee travel advances); other customer receivables, net of allowances; and expected insurance recoveries. The carrying amounts of our long-term credit facility and other short-term financing obligations also approximate fair value, as they are comparable to the available financing in the marketplace during the year. The fair value of our revolving line of credit is categorized as Level 2.
Deferred Compensation Plan Assets and Liabilities
On December 14, 2018, our Board of Directors adopted the Rocky Brands, Inc. Executive Deferred Compensation Plan (the “Deferred Compensation Plan”), which became effective January 1, 2019. The Deferred Compensation Plan is an unfunded nonqualified deferred compensation plan in which certain executives are eligible to participate. The deferrals are held in a separate trust, which has been established for the administration of the Deferred Compensation Plan. The trust assets are recorded within prepaid expenses and other current assets in the accompanying consolidated balance sheets, with changes in the deferred compensation charged to operating expenses in the accompanying consolidated statements of operations. The fair value is based on unadjusted quoted market prices for the funds in active markets with sufficient volume and frequency (Level 1).
4. REVENUE
Nature of Performance Obligations
Our products are distributed through three distinct channels, which represent our business segments: Wholesale, Retail, and Military. In our Wholesale business, we distribute our products through a wide range of distribution channels representing over ten thousand retail store locations in the U.S., Canada, and internationally. Our Wholesale channels vary by product line and include sporting goods stores, outdoor specialty stores, online retailers, independent retailers, mass merchants, retail uniform stores, and specialty safety shoe stores. Our Retail business includes direct sales of our products to consumers through our e-commerce websites, our Rocky outlet store, and Lehigh business. We also sell footwear under the Rocky label to the U.S. Military.
Significant Accounting Policies and Judgements
Revenue is recognized when obligations under the terms of a contract with our customer are satisfied; this generally occurs upon shipment of our product to our customer, which is when the transfer of control of our products passes to the customer. The duration of our arrangements with our customers are typically one year or less. Revenue is measured as the amount of consideration we expect to receive in exchange for the transfer of our products at a point in time and consists of either fixed or variable consideration or a combination of both.
Revenues from sales are recorded at the net sales price, which includes estimates of variable consideration for which reserves are established. Components of variable consideration include prompt payment discounts, volume rebates, and product returns. These reserves, as detailed below, are based on the amounts earned, or to be claimed on the related sales, and are classified as reductions of accounts receivable (if the amount is payable to the customer) or a current liability (if the amount is payable to a party other than a customer).
The amount of variable consideration which is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized under the contract will not occur in a future period. Our analyses also contemplated application of the constraint in accordance with the guidance, under which it determined a material reversal of revenue would not occur in a future period for the estimates detailed below as of March 31, 2020. Actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our estimates, we will adjust these estimates, which would affect net revenue and earnings in the period such variances become known.
When a customer has a right to a prompt payment discount, we estimate the likelihood that the customer will earn the discount using historical data and adjust our estimate when the estimate of the likelihood that a customer will earn the discount changes or the consideration becomes fixed, whichever occurs earlier. The estimated amount of variable consideration is recognized as a credit to trade receivables and a reduction in revenue until the uncertainty of the variable consideration is alleviated. Because most of our customers have payment terms less than six months there is not a significant financing component in our contracts with customers.
When a customer is offered a rebate on purchases retroactively this is accounted for as variable consideration because the consideration for the current and past purchases is not fixed until it is known if the discount is earned. We estimate the expected discount the customer will earn at contract inception using historical data and projections and update our estimates when projections materially change or consideration becomes fixed. The estimated rebate is recognized as a credit to trade receivables and offset against revenue until the rebate is earned or the earning period has lapsed.
When a right of return is part of the arrangement with the customer, we estimate the expected returns based on an analysis using historical data. We adjust our estimate either when the most likely amount of consideration we expect to receive changes or when the consideration becomes fixed, whichever occurs earlier. Please see Notes 5 and 6 for additional information.
Trade receivables represent our right to unconditional payment that only relies on the passage of time.
Contract receivables represent contractual minimum payments required under non-cancellable contracts with the U.S. Military with a duration of one year or less.
Contract liabilities are performance obligations that we expect to satisfy or relieve within the next twelve months, advance consideration obtained prior to satisfying a performance obligation, or unconditional obligations to provide goods or services under non-cancellable contracts before the transfer of goods or services to the customer has occurred. Our contract liability represents unconditional obligations to provide goods under non-cancellable contracts with the U.S. Military.
Items considered immaterial within the context of the contract are recognized as an expense.
Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction, that are collected from customers, are excluded from revenue.
Costs associated with our manufacturer’s warranty continue to be recognized as expense when the products are sold in accordance with guidance surrounding product warranties.
Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are in included in operating expenses.
Costs associated with obtaining a contract are expensed as incurred in accordance with the practical expedient in ASC 340-40 in instances where the amortization period is one year or less. We anticipate substantially all of our costs incurred to obtain a contract would be subject to this practical expedient.
Contract Balances
The following table provides information about contract liabilities from contracts with our customers.
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March 31,
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December 31,
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March 31,
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($ in thousands)
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2020
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2019
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2019
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Contract liabilities
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$
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2,551
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$
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4,746
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$
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817
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Significant changes in the contract liabilities balance during the period are as follows:
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($ in thousands)
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Contract liabilities
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Balance, December 31, 2019
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$
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4,746
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Non-cancelable contracts with customers entered into during the period
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663
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Revenue recognized related to non-cancelable contracts with customers during the period
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(2,858)
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Balance, March 31, 2020
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$
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2,551
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Disaggregation of Revenue
All revenues are recognized at a point in time when control of our products pass to the customer at point of shipment. Because all revenues are recognized at a point in time and are disaggregated by channel, our segment disclosures are consistent with ASC 606 disaggregation requirements. See Note 12 for segment disclosures.
5. TRADE RECEIVABLES
Trade receivables are presented net of the related allowance for uncollectible accounts of approximately $262,000, $952,000 and $1,313,000 for the periods ending March 31, 2020, December 31, 2019 and March 31, 2019, respectively. We record the allowance based on historical experience, the age of the receivables, and identification of customer accounts that are likely to prove difficult to collect due to various criteria including pending bankruptcy. However, estimates of the allowance in any future period are inherently uncertain and actual allowances may differ from these estimates. If actual or expected future allowances were significantly greater or less than established reserves, a reduction or increase to bad debt expense would be recorded in the period this determination was made. Our credit policy generally provides that trade receivables will be deemed uncollectible and written-off once we have pursued all reasonable efforts to collect on the account.
In accordance with ASC 606, the return reserve liability netted against trade receivables was approximately $838,000, $1,050,000 and $950,000 for the periods ending March 31, 2020, December 31, 2019 and March 31, 2019, respectively.
6. INVENTORY
Inventories are comprised of the following:
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March 31,
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December 31,
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March 31,
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($ in thousands)
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2020
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2019
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2019
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Raw materials
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$
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12,634
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$
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12,466
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$
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13,103
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Work-in-process
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960
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856
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1,129
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Finished goods
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63,620
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63,409
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55,673
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Total
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$
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77,214
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$
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76,731
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$
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69,905
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In accordance with ASC 606, the return reserve asset included within inventories was approximately $492,000, $613,000 and $572,000 for the periods ending March 31, 2020, December 31, 2019 and March 31, 2019, respectively.
7. IDENTIFIED INTANGIBLE ASSETS
A schedule of identified intangible assets is as follows:
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Gross
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Accumulated
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Carrying
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($ in thousands)
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Amount
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Amortization
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Amount
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March 31, 2020
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Trademarks
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Wholesale
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$
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27,192
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-
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$
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27,192
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Retail
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2,900
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-
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2,900
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Patents
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895
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$
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755
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140
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Total Intangibles
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$
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30,987
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$
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755
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$
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30,232
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Gross
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Accumulated
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Carrying
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December 31, 2019
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Amount
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Amortization
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Amount
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Trademarks
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Wholesale
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$
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27,192
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-
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$
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27,192
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Retail
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2,900
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-
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2,900
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Patents
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895
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$
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747
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148
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Total Intangibles
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$
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30,987
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$
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747
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$
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30,240
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Gross
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Accumulated
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Carrying
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March 31, 2019
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Amount
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Amortization
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Amount
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Trademarks
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Wholesale
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$
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27,192
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-
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$
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27,192
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Retail
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2,900
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-
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2,900
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Patents
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895
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$
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723
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172
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Customer Relationships
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|
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-
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-
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-
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Total Intangibles
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$
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30,987
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$
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723
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$
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30,264
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The weighted average life for our patents is 3.6 years.
A schedule of approximate amortization expense related to finite-lived intangible assets for the three months ended March 31, 2020 and 2019 is as follows:
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Three Months Ended
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March 31,
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($ in thousands)
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2020
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2019
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Amortization expense
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$
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8
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$
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9
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A schedule of approximate expected amortization expense related to finite-lived intangible assets for the years ending December 31, is as follows:
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Amortization
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($ in thousands)
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Expense
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2020
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$
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31
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2021
|
|
26
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2022
|
|
22
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2023
|
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20
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2024
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17
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2025
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12
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2026+
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20
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8. LONG-TERM DEBT
On February 13, 2019, we entered into a Revolving Credit, Guaranty, and Security Agreement (“Credit Agreement”) with the Huntington National Bank (“Huntington”) as administrative agent. The Credit Agreement provides for a new senior secured asset-based revolving credit facility up to a principal amount of $75 million, which includes a sublimit for the issuance of letters of credit up to $7.5 million (the “Credit Facility”). The Credit Facility may be increased up to an additional $25 million at our request and the lenders’ option, subject to customary conditions. The Credit Agreement matures on February 13, 2024.
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Revolver Pricing Level
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Average Excess Revolver Availability for Previous Quarter
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Applicable Spread Rates for Eurodollar Rate Revolving Advances
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Applicable Spread Rates for Domestic Rate Revolving Advances
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I
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$
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25,000,000+
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1.00
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%
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(0.50)
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%
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II
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$
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17,500,000 to < 25,000,000
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1.25
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%
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(0.50)
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%
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III
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$
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10,000,000 to < 17,500,000
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1.50
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%
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(0.25)
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%
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IV
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$
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< 10,000,000
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|
1.75
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%
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0.00
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%
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The total amount available under our Credit Facility is subject to a borrowing base calculation based on various percentages of accounts receivable and inventory. As of March 31, 2020, we had total capacity of $60.3 million.
As of March 31, 2020, we had $20.0 million in outstanding borrowings against the Credit Facility with an effective rate of 1.92%. As of December 31, 2019 and March 31, 2019, respectively, we had no outstanding borrowings against our Credit Facility.
Credit Facility Covenants
Our Credit Facility contains restrictive covenants which require us to maintain a fixed charge coverage ratio. These restrictive covenants are only in effect upon a triggering event taking place. Our Credit Facility contains restrictions on the amount of dividends that may be paid. During the three months ended March 31, 2020 and 2019, there were no triggering events and the covenant was not in effect.
9. TAXES
We are subject to tax examinations in various taxing jurisdictions. The earliest years open for examination are as follows:
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Earliest Exam Year
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Taxing Authority Jurisdiction:
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U.S. Federal
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2016
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Various U.S. States
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2015
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Puerto Rico (U.S. Territory)
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2014
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Canada
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2014
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Our policy is to accrue interest and penalties on any uncertain tax position as a component of income tax expense. No such expenses were recognized during the three months ended March 31, 2020 and 2019. We do not believe there will be any material changes in our uncertain tax positions over the next 12 months.
Accounting for uncertainty in income taxes requires financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements. Under this guidance, income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of the standard. We did not have any unrecognized tax benefits and there was no effect on our financial condition or results of operations.
Our estimated effective tax rate was 21.0% for the three months ended March 31, 2020 and 2019, respectively.
10. EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed by dividing net income applicable to common shareholders by the weighted average number of common shares outstanding during each period. The diluted earnings per share computation includes common share equivalents, when dilutive.
A reconciliation of the shares used in the basic and diluted income per common share computation for the three months ended March 31, 2020 and 2019 is as follows:
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Three Months Ended
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|
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March 31,
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(shares in thousands)
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2020
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2019
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Basic - weighted average shares outstanding
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|
7,351
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|
7,382
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Dilutive restricted share units
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-
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|
3
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Dilutive stock options
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|
35
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|
49
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Diluted - weighted average shares outstanding
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|
7,386
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|
7,434
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Anti-dilutive securities
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|
151
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|
75
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11. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental cash flow information for the three months ended March 31, 2020 and 2019 was as follows:
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Three Months Ended
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|
|
March 31,
|
($ in thousands)
|
|
2020
|
|
2019
|
|
|
|
|
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Interest paid
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$
|
19
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$
|
72
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|
|
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|
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Federal, state, and local income taxes paid, net
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$
|
-
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$
|
3,476
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|
|
|
|
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Change in contract receivables, net
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$
|
2,195
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$
|
817
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|
|
|
|
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Change in contract liabilities, net
|
$
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(2,195)
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$
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(817)
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|
|
|
|
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Property, plant, and equipment purchases in accounts payable
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$
|
1,308
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$
|
520
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12. SEGMENT INFORMATION
We have identified three reportable segments: Wholesale, Retail and Military. Wholesale includes sales of footwear and accessories to several classifications of retailers, including sporting goods stores, outdoor specialty stores, online retailers, independent retailers, mass merchants, retail uniform stores, and specialty safety shoe stores. Our Retail business includes direct sales of our products to consumers through our e-commerce websites, our Rocky outlet store, and Lehigh business. Military includes sales to the U.S. Military. The following is a summary of segment results for the Wholesale, Retail, and Military segments for the three months ended March 31, 2020 and 2019.
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|
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Three Months Ended
|
|
|
March 31,
|
($ in thousands)
|
|
2020
|
|
2019
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NET SALES:
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|
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|
Wholesale
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$
|
34,986
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$
|
42,389
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Retail
|
|
16,890
|
|
15,439
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Military
|
|
3,844
|
|
8,101
|
Total Net Sales
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$
|
55,720
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$
|
65,929
|
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|
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|
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GROSS MARGIN:
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|
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Wholesale
|
$
|
11,241
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$
|
14,375
|
Retail
|
|
7,454
|
|
6,675
|
Military
|
|
625
|
|
1,928
|
Total Gross Margin
|
$
|
19,320
|
$
|
22,978
|