Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Factors Affecting Forward-Looking Statements
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 our control. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, number of our success in recruiting and retaining new consultants, our ability to locate and procure desired books, our ability to ship the volume of orders that are received without creating backlogs, our ability to obtain adequate financing for working capital and capital expenditures, economic and competitive conditions, regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in our Annual Report on Form 10-K for the year ended February 28, 2018 and this Quarterly Report on Form 10-Q, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may or may not occur. See “Cautionary Remarks Regarding Forward-Looking Statements” in the front of this Quarterly Report on Form 10-Q.
Overview
We are the exclusive United States trade co-publisher of Usborne children’s books and the owner of Kane Miller. We operate two separate segments: UBAM and Publishing, to sell our Usborne and Kane Miller children’s books. These two segments each have their own customer base. The Publishing segment markets its products on a wholesale basis to various retail accounts. The UBAM segment markets its products through a network of independent sales consultants using a combination of home shows, internet party plan events and book fairs. All other supporting administrative activities are recognized as other expenses outside of our two segments. Other expenses are primarily compensation of our office, warehouse and sales support staff as well as the cost of operating and maintaining our corporate office and distribution facility.
The following table shows our condensed statements of earnings data:
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|
For the Three Months Ended
May 31,
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|
|
|
2018
|
|
|
2017
|
|
Net revenues
|
|
$
|
30,022,300
|
|
|
$
|
26,941,200
|
|
Cost of goods sold
|
|
|
9,669,700
|
|
|
|
8,598,800
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|
Gross margin
|
|
|
20,352,600
|
|
|
|
18,342,400
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
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|
|
|
|
|
|
|
|
Operating and selling
|
|
|
4,752,200
|
|
|
|
4,226,800
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|
Sales commissions
|
|
|
9,373,100
|
|
|
|
8,509,200
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|
General and administrative
|
|
|
3,892,500
|
|
|
|
3,713,900
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|
Total operating expenses
|
|
|
18,017,800
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|
|
|
16,449,900
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|
|
|
|
|
|
|
|
|
|
Other (income) expense
|
|
|
|
|
|
|
|
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Interest expense
|
|
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213,400
|
|
|
|
281,500
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|
Other income
|
|
|
(374,400
|
)
|
|
|
(371,200
|
)
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Earnings before income taxes
|
|
|
2,495,800
|
|
|
|
1,982,200
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
|
679,200
|
|
|
|
756,900
|
|
Net earnings
|
|
$
|
1,816,600
|
|
|
$
|
1,225,300
|
|
See the detailed discussion of revenues, costs of services, gross margin, general and administrative expenses by reportable segment below. The following is a discussion of significant changes in the non-segment related general and administrative expenses, other income and expenses and income taxes during the respective periods.
Total operating expenses
not associated with a reporting segment remained consistent totaling $3,270,500 for the three-month period ending May 31, 2018, compared to $3,056,100 for the same quarterly period a year ago. Operating expenses increased primarily associated with additional warehouse labor associated with increased sales.
Interest expense
decreased $68,100 to $213,400 for the three months ended May 31, 2018, from $281,500 for the same quarterly period a year ago. Interest expense decreased primarily as a result of $0 in borrowings against the line of credit in the first quarter of fiscal 2019 as compared to $5.6 million in the first quarter of fiscal 2018.
Income taxes
decreased $77,700 to $679,200 for the three months ended May 31, 2018, from $756,900 for the same quarterly period a year ago. Our effective tax rate was 27.2% for the quarter ended May 31, 2018, and 38.2% for the quarter ended May 31, 2017. These rates are higher than the federal statutory rate due to the inclusion of state income and franchise taxes.
UBAM Operating Results for the Three Months Ended May 31, 2018
The following table summarizes the operating results of the UBAM segment for the three months ended May 31, 2018 and 2017:
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|
For the Three Months Ended
May 31,
|
|
|
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2018
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|
|
2017
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|
Gross sales
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|
$
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34,158,600
|
|
|
$
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29,986,300
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|
Less discounts and allowances
|
|
|
(9,283,800
|
)
|
|
|
(7,860,700
|
)
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Transportation revenue
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|
|
2,841,300
|
|
|
|
2,693,500
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Net revenues
|
|
|
27,716,100
|
|
|
|
24,819,100
|
|
|
|
|
|
|
|
|
|
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Cost of goods sold
|
|
|
8,424,500
|
|
|
|
7,473,700
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Gross margin
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|
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19,291,600
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|
|
|
17,345,400
|
|
|
|
|
|
|
|
|
|
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Operating expenses
|
|
|
|
|
|
|
|
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Operating and selling
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|
|
3,949,300
|
|
|
|
3,165,200
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|
Sales commissions
|
|
|
9,286,800
|
|
|
|
8,423,700
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|
General and administrative
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|
|
956,500
|
|
|
|
1,377,000
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|
Total operating expenses
|
|
|
14,192,600
|
|
|
|
12,965,900
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|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
5,099,000
|
|
|
$
|
4,379,500
|
|
|
|
|
|
|
|
|
|
|
Average number of active consultants
|
|
|
35,100
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|
|
|
25,600
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|
Net revenues increased $2,897,000, or 11.7%, during the three-month period ending May 31, 2018, when compared with the same quarter a year ago. The sales increase primarily resulted from an increase in the number of active consultants. The average number of active sales consultants increased 9,500, or 37.1% from 25,600 in the first quarter of fiscal year 2018 to 35,100 in the first quarter of fiscal 2019. Our consultant growth is driven by existing active consultants recruiting and retaining new consultants.
Gross margin increased $1,946,200, or 11.2%, during the three-month period ending May 31, 2018, when compared to the same quarter a year ago, due primarily to an increase in sales. Gross margin, as a percentage of net revenues, remained consistent at 69.6% for the three-month period ending May 31, 2018 when compared to 69.9% the same period a year ago.
UBAM operating expenses consists of operating and selling expenses, sales commissions and general and administrative expenses. Operating and selling expenses primarily consists of freight expenses and materials and supplies. Sales commissions include amounts paid to consultants for new sales and promotions. These operating expenses are directly tied to the sales volumes of the UBAM segment. General and administrative expenses include payroll, travel and entertainment expenses, outside services, inventory reserves and other expenses directly associated with the UBAM segment. Operating expenses increased 1,226,700, or 9.5%, during the three-month period ending May 31, 2018, when compared with the same quarter a year ago, due primarily to the growth in sales.
Operating income of the UBAM segment increased $719,500, or 16.4%, during the three-month period ending May 31, 2018, when compared to the same quarter a year ago, due primarily to growth in sales.
Publishing Operating Results for the Three Months Ended May 31, 2018
The following table summarizes the operating results of the Publishing segment for the three months ended May 31, 2018 and 2017:
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|
For the Three Months Ended
May 31,
|
|
|
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2018
|
|
|
2017
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|
Gross sales
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|
$
|
4,916,200
|
|
|
$
|
4,524,800
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|
Less discounts and allowances
|
|
|
(2,617,600
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)
|
|
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(2,409,800
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)
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Transportation revenue
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|
|
7,600
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|
|
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7,100
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Net revenues
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2,306,200
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|
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2,122,100
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|
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Cost of goods sold
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1,245,200
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|
|
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1,125,100
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Gross margin
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|
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1,061,000
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|
|
|
997,000
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|
|
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|
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Total operating expenses
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554,700
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427,900
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Operating income
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$
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506,300
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|
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$
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569,100
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Our Publishing division’s net revenues increased $184,100, or 8.7%, to $2,306,200 for the three months ended May 31, 2018, when compared to net revenues of $2,122,100 reported for the three months ended May 31, 2017. This increase is primarily related to an increase in orders from our smaller customers.
Gross margin increased $64,000, or 6.4%, to $1,061,000 for the three months ended May 31, 2018, when compared to gross margin of $997,000 reported for the three months ended May 31, 2017. This increase is primarily related to the growth in sales.
Total operating expenses and operating income of the Publishing segment remained consistent between the two periods.
Liquidity and Capital Resources
EDC has a history of profitability and positive cash flow. We typically fund our operations from the cash we generate. We also use available cash primarily to pay down outstanding bank loan balances, for capital expenditures, to pay dividends, and to acquire treasury stock. We have utilized a bank credit facility and other term loan borrowings to meet our short-term cash needs when necessary. Our revolving bank credit facility loan balance was $0 with $10,448,800 in available capacity at May 31, 2018.
During the first quarter of fiscal 2019, we experienced cash inflow from our operations of $2,767,500. Cash flows resulted from the following items:
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net earnings of $1,816,600,
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•
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depreciation expense of $352,800,
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•
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an increase in the provision for inventory valuation allowance of $92,100,
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•
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a decrease in accounts receivable of $56,400,
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•
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an increase in deferred income tax liability of $188,100,
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•
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an increase in accounts payable of $1,366,700,
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•
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a decrease in prepaid expenses and other assets of $299,800,
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•
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an increase in net income tax payable of $486,400, and
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•
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an increase in the provision for doubtful accounts $85,000.
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Offset by:
•
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an increase in inventories of $1,243,600,
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•
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a decrease in accrued salaries and commissions, and other liabilities of $482,200, and
|
•
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a decrease in deferred revenue of $250,600.
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Cash used in investing activities was $804,100 for capital expenditures, which was primarily comprised of improvements to our warehouse picking and inventory management systems and various other improvements to the warehouse and facility.
Cash used in financing activities was $255,800, which was primarily comprised of payments on long-term debt of $251,300 and $4,500 net cash used in treasury stock transactions.
During fiscal year 2019, we continue to expect our cash from operations, along with our expanded line of credit with our Bank, will provide us the ability to meet our liquidity requirements. Cash generated from operations will be used to increase inventory in anticipation of continued sales growth, to liquidate existing debt, and any excess cash is expected to be distributed to our shareholders.
We have a Loan Agreement with the Bank including Term Loan #1 comprised of Tranche A of $13.4 million and Tranche B of $5.0 million both with the maturity date of December 1, 2025. Tranche A has a fixed interest rate of 4.23% and interest is payable monthly. The Loan Agreement also includes Term Loan #2 in the amount of $4.0 million, which is secured by a warehouse and land with the maturity date of June 28, 2021, and a $15.0 million revolving loan (“line of credit”) through June 15, 2018.
Effective March 10, 2016, we signed a First Amendment Loan Agreement with the Bank which provided an increase to $6.0 million from our original $4.0 million line of credit through June 15, 2016. Effective June 15, 2016, we signed a Second Amendment Loan Agreement with the Bank which provided a further increase to $7.0 million from our previous $6.0 million line of credit and extended it through June 15, 2017. Effective June 28, 2016, we signed a Third Amendment Loan Agreement with the Bank which included Term Loan #2 in the amount of $4.0 million. Effective February 7, 2017, we signed a Fourth Amendment Loan Agreement with the Bank which modified certain debt covenant calculations and waived an existing default that occurred in the fourth quarter of fiscal year 2017.
Effective, June 15, 2017, the Company executed the Fifth Amendment Loan Agreement with the Bank which modified the Loan Agreement to increase the maximum revolving principal amount from $7.0 million to $10.0 million and extended the termination date of the Loan Agreement to June 15, 2018. The Fifth Amendment also modified the Loan Agreement to include an Advancing Term Loan of $3.0 million which the Company used to cover the cost of the fiscal 2018 capital improvements to increase our daily shipping capacity. The Advancing Term loan accrued interest between June 15, 2017 and December 1, 2017, at which time the balance was converted to a term loan and set to amortize over a thirty-six-month period. The Advancing Term Loan was repaid early, without penalty, in February 2018.
Effective September 1, 2017, we signed a Sixth Amendment Loan Agreement with the Bank which further increased the maximum revolving principal amount from $10.0 million to $15.0 million, subject to certain collateral restrictions.
Effective February 15, 2018, we signed a Seventh Amendment Loan Agreement with the Bank which modified the limitation on dividends as well as modified and removed other financial covenant calculations.
Subsequent to quarter end, on June 15, 2018, we signed an Eighth Amendment Loan Agreement with the Bank which extended the termination date until August 15, 2019, reduced the interest rate pricing grid for all floating rate borrowings, established a new $3.0 million advancing term loan to be used for capital expansions to increase daily shipping capacity, released the personal Guaranty of Randall W. White and Carol White, along with other covenant restrictions being lessened. The amendment also included an adjustment to the Adjusted Funded Debt to EBITDA Ratio for covenant compliance.
We had no borrowings outstanding on our revolving credit agreement at May 31, 2018 and $5.6 million in borrowings at May 31, 2017. Available credit under the revolving credit agreement was $10,448,800 at May 31, 2018.
Tranche B of Term Loan #1, Term Loan #2 and the line of credit accrue interest monthly, at the bank adjusted LIBOR Index plus a tiered pricing rate based on the Company’s Adjusted Funded Debt to EBITDA Ratio (5.03% at May 31, 2018).
The Loan Agreement also contains a provision for our use of the Bank’s letters of credit. The Bank agrees to issue, or obtain issuance of commercial or stand-by letters of credit provided that the sum of the line of credit plus the letters of credit issued would not exceed the borrowing base in effect at the time. For the three months ended May 31, 2018, we had no letters of credit outstanding. The agreement contains provisions that require us to maintain specified financial ratios, restrict transactions with related parties, prohibit mergers or consolidation, disallow additional debt, and limit the amounts of dividends declared, compensation, salaries, investments, capital expenditures, and leasing transactions.
The following table reflects aggregate future maturities of long-term debt during the next five fiscal years and thereafter as follows:
Year Ending February 28 (29)
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|
|
|
|
|
|
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2019
|
|
$
|
735,800
|
|
2020
|
|
|
926,300
|
|
2021
|
|
|
968,100
|
|
2022
|
|
|
1,016,800
|
|
2023
|
|
|
1,065,300
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|
Thereafter
|
|
|
15,742,700
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|
Total Maturities
|
|
$
|
20,455,000
|
|
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 more significantly dependent on the use of estimates and assumptions.
Revenue Recognition
Sales are generally recognized and recorded when products are shipped. Products are shipped FOB shipping point. The UBAM segment’s sales are typically paid at the time the product is ordered. These sales accounted for 92.3% of net revenues for the three-month period ended May 31, 2018, and 92.1% for the three-month period ended May 31, 2017. Sales that 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 recognized when the product is shipped.
Estimated allowances for sales returns, which reduce net sales and costs of goods sold, are recorded as sales are recognized and recorded. Management uses a moving average calculation to estimate the allowance for sales returns. We are not responsible for product damaged in transit. Damaged returns are primarily from retail stores. These returns primarily result from damage that occurs in the stores, not in shipping to the stores. It is industry practice to accept non-damaged returns from retail customers. Management has estimated sales returns of approximately $217,000 as of May 31, 2018, and February 28, 2018, which is included in other current liabilities on the Company’s balance sheet as of May 31, 2018 and 2017, respectively. In addition, Management has recorded an asset for the expected value of non-damaged inventories to be returned. The estimated value of returned products of $100,000 is included in other current assets on the Company’s balance sheet as of May 31, 2018 and 2017, respectively.
Allowance for Doubtful Accounts
We maintain an allowance for estimated losses resulting from the inability of our customers to make required payments. An estimate of uncollectable amounts is made by management based upon historical bad debts, current customer receivable balances, age of customer receivable balances, the customer's financial condition and current economic trends. Management has estimated and included an allowance for doubtful accounts of $347,200 at May 31, 2018, and $297,100 at February 28, 2018.
Inventory
Our inventory contains over 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 books are not topical in nature and remain current in content today as well as in the future. Most of our products are printed in Europe, China, Singapore, India, Malaysia and Dubai resulting in a three to six-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 minimum order requirements of our suppliers. Noncurrent inventory was estimated by management using the current year turnover ratio by title. All inventory in excess of 2 ½ years of anticipated sales is classified as noncurrent inventory. Noncurrent inventory balances prior to valuation allowances were $838,800 and $707,700 at May 31, 2018 and February 28, 2018, respectively.
Consultants that meet certain eligibility requirements are allowed to receive inventory on consignment. We believe allowing our consultants to have consignment inventory greatly increases their ability to be successful in making effective presentations at home shows, book fairs and other events; and having consignment inventory leads to additional sales opportunities. Approximately 11% of our active consultants maintained consignment inventory at May 31, 2018 and February 28, 2018. 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 value of inventory on consignment with active consultants was $1,372,900 and $1,270,700 at May 31, 2018 and February 28, 2018, respectively. Inventory related to inactive consultants amounted to $288,500 and $278,500 as of May 31, 2018 and February 28, 2018, respectively.
Inventories are presented net of a valuation allowance, which includes reserves for inventory obsolescence and active and inactive consultant consignment inventory that is not expected to be sold or returned. Management estimates the allowance for both current and noncurrent inventory. Management has estimated a valuation allowance for both current and noncurrent inventory as well as consignment inventory held by active and inactive consultants of $810,000 and $731,800 as of May 31, 2018 and February 28, 2018, respectively.
Our principal supplier, Usborne, generally requires a minimum reorder of 6,500 or more of a title in order to get a solo print run. Smaller orders require a shared print run with the supplier’s other customers, which can result in lengthy delays to receive the ordered title. Anticipating customer preferences and purchasing habits requires historical analysis of similar titles in the same series. We place our initial order or re-orders based upon this analysis.
These factors and historical analysis have led our management to determine that 2 ½ years represents a reasonable estimate of the normal operating cycle for our products.
Stock-Based Compensation
We account for stock-based compensation whereby share-based payment transactions with employees, such as stock options and restricted stock, are measured at estimated fair value at date of grant and recognized as compensation expense over the vesting period, net of estimated forfeitures.