Xcel Brands
XCel Brands, Inc. (Form: 10-Q, Received: 08/10/2016 16:05:20)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2016

 

or

 

¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ___ to ___

 

Commission File Number: 0-31553

 

XCEL BRANDS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   76-0307819
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation or Organization)   Identification No.)

 

  1333 Broadway, 10th Floor, New York, NY 10018  
  (Address of Principal Executive Offices)  

 

(347) 727-2474

(Issuer's Telephone Number, Including Area Code)

 

  475 Tenth Avenue, 4th Floor, New York, NY 10018  
  (Former Name, Former Address and Former Fiscal Year, if changed
since last report)
 

 

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

 

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

 

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

 

Large accelerated filer  ¨ Accelerated filer  ¨
Non-accelerated filer  ¨ Smaller reporting company    x

 

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

 

As of August 4, 2016, there were 18,671,969 shares of common stock, $.001 par value per share, of the issuer outstanding.

 

 

 

 

XCEL BRANDS, INC.

 

INDEX

 

    Page
     
P ART I FINANCIAL INFORMATION  
     
Item 1. Financial Statements
     
  Unaudited Condensed Consolidated Balance Sheets 3
     
  Unaudited Condensed Consolidated Statements of Operations 4
     
  Unaudited Condensed Consolidated Statements of Cash Flows 5
     
  Notes to Unaudited Condensed Consolidated Financial Statements 6
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
     
Item 4. Controls and Procedures 29
     
PART II OTHER INFORMATION  30
     
Item 1. Legal Proceedings 30
     
Item 1A. Risk Factors 30
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
     
Item 3. Defaults Upon Senior Securities 30
     
Item 4. Mine Safety Disclosures 30
     
Item 5 Other information 30
     
Item 6 Exhibits 31
     
  Signatures 32

 

2  

 

 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Xcel Brands, Inc. and Subsidiaries

Unaudited Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

 

    June 30, 2016     December 31, 2015  
    (Unaudited)     (Note 1)  
Assets                
Current Assets:                
Cash and cash equivalents   $ 13,471     $ 16,860  
Accounts receivable, net     10,077       7,594  
Prepaid expenses and other current assets     567       655  
Total current assets     24,115       25,109  
Property and equipment, net     2,369       871  
Trademarks and other intangibles, net     111,759       112,323  
Goodwill     12,371       12,371  
Restricted cash     1,509       1,109  
Other assets     282       343  
Total non-current assets     128,290       127,017  
Total Assets   $ 152,405     $ 152,126  
                 
Liabilities and Stockholders' Equity                
Current Liabilities:                
Accounts payable, accrued expenses and other current liabilities   $ 3,822     $ 3,372  
Deferred revenue     39       597  
Current portion of long-term debt     8,058       8,918  
Current portion of long-term debt, contingent obligations     -       250  
Total current liabilities     11,919       13,137  
Long-Term Liabilities:                
Long-term debt, less current portion     29,843       31,860  
Deferred tax liabilities, net     6,490       6,749  
Other long-term liabilities     1,821       297  
Total long-term liabilities     38,154       38,906  
Total Liabilities     50,073       52,043  
                 
Commitments and Contingencies                
                 
Stockholders' Equity:                
Preferred stock, $.001 par value, 1,000,000 shares authorized, none issued and outstanding     -       -  
Common stock, $.001 par value, 35,000,000 shares authorized at June 30, 2016 and December 31, 2015, and 18,670,686 and 18,434,634 issued and outstanding at June 30, 2016 and December 31, 2015, respectively     19       18  
Paid-in capital     96,382       93,999  
Retained earnings     5,931       6,066  
Total Stockholders' Equity     102,332       100,083  
                 
Total Liabilities and Stockholders' Equity   $ 152,405     $ 152,126  

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

3  

 

  

Xcel Brands, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except share and per share data)

 

    For the Three Months
Ended June 30,
    For the Six Months
Ended June 30,
 
    2016     2015     2016     2015  
Revenues                                
Net licensing revenue   $ 9,092     $ 6,269     $ 17,437     $ 12,793  
Net e-commerce sales     24       52       71       119  
Total revenues     9,116       6,321       17,508       12,912  
Cost of goods sold     36       35       106       80  
Gross profit     9,080       6,286       17,402       12,832  
                                 
Operating expenses                                
Salaries, benefits and employment taxes     4,217       3,073       8,427       6,176  
Other design and marketing costs     831       808       1,660       1,092  
Other selling, general and administrative expenses     1,988       535       3,294       1,521  
Stock-based compensation     1,453       1,108       2,665       2,121  
Depreciation and amortization     359       318       785       580  
Total operating expenses     8,848       5,842       16,831       11,490  
                                 
Other expenses (income)                                
Gain on reduction of contingent obligation     -       (3,000 )     -       (3,000 )
Loss on extinguishment of debt     -       760       -       1,371  
Total other income, net     -       (2,240 )     -       (1,629 )
                                 
Operating income     232       2,684       571       2,971  
                                 
Interest and finance expense                                
Interest expense - term debt     352       309       663       621  
Other interest and finance charges     178       124       302       323  
Total interest and finance expense     530       433       965       944  
                                 
Income (loss) from continuing operations before income taxes     (298 )     2,251       (394 )     2,027  
                                 
Income tax (benefit) provision     (208 )     90       (259 )     (16 )
                                 
Income (loss) from continuing operations     (90 )     2,161       (135 )     2,043  
                                 
Loss from discontinued operations, net     -       (54 )     -       (267 )
                                 
Net income (loss)   $ (90 )   $ 2,107     $ (135 )   $ 1,776  
                                 
Basic and diluted net (loss) income per share:                                
Continuing operations   $ (0.00 )   $ 0.15     $ (0.01 )   $ 0.14  
Discontinued operations, net     -       (0.01 )     -       (0.02 )
Net (loss) income   $ (0.00 )   $ 0.14     $ (0.01 )   $ 0.12  
                                 
Diluted net (loss) income per share:                                
Continuing operations   $ (0.00 )   $ 0.14     $ (0.01 )   $ 0.13  
Discontinued operations, net     -       (0.01 )     -       (0.02 )
Net (loss) income   $ (0.00 )   $ 0.13     $ (0.01 )   $ 0.11  
                                 
Basic weighted average common shares outstanding     18,671,648       14,850,874       18,565,198       14,462,305  
Diluted weighted average common shares outstanding     18,671,648       15,963,975       18,565,198       15,575,406  

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

4  

 

  

Xcel Brands, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

    For the Six Months Ended June 30,  
    2016     2015  
             
Cash flows from operating activities                
Net (loss) income   $ (135 )   $ 1,776  
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:                
Loss from discontinued operations, net     -       267  
Depreciation and amortization expense     785       580  
Amortization of deferred finance costs     94       77  
Stock-based compensation     2,665       2,121  
Recovery of allowance for doubtful accounts     -       (21 )
Amortization of note discount     158       246  
Deferred income tax benefit     (259 )     (85 )
Tax benefit from vested stock grants and exercised options     -       (69 )
Non-cash property exit charge     648       -  
Gain on reduction of contingent obligation     -       (3,000 )
Loss on extinguishment of debt     -       1,371  
Changes in operating assets and liabilities:                
Accounts receivable     (2,484 )     (2,903 )
Prepaid expenses and other assets     92       (204 )
Accounts payable, accrued expenses and other current liabilities     449       (1,010 )
Deferred revenue     (558 )     (78 )
Other liabilities     875       (23 )
Net cash provided by (used in) operating activities from continuing operations     2,330       (955 )
Net cash provided by operating activities from discontinued operations, net     -       207  
Net cash provided by (used in) operating activities     2,330       (748 )
                 
Cash flows from investing activities                
Cash consideration for asset acquisition of the H Halston Brand     -       (14 )
Advance deposit for asset acquisition of the C Wonder Brand     -       (300 )
Purchase of property and equipment     (1,718 )     (47 )
Restricted cash for security deposits     (400 )     (1,109 )
Net cash used in investing activities     (2,118 )     (1,470 )
                 
Cash flows from financing activities                
Proceeds from exercise of stock options     20       -  
Tax benefit from vested stock grants and exercised options     -       69  
Shares repurchased including vested restricted stock in exchange for                
withholding taxes     (302 )     -  
Payment of deferred finance costs     (69 )     (10 )
Costs associated with equity offering     -       (316 )
Payment of long-term debt     (3,000 )     (1,256 )
Payment of QVC earnout obligation     (250 )     -  
Payment of installment obligations related to the acquisition of the Ripka Brand     -       (2,183 )
Net cash used in financing activities     (3,601 )     (3,696 )
                 
Net decrease in cash and cash equivalents     (3,389 )     (5,914 )
                 
Cash and cash equivalents, beginning of period     16,860       8,531  
                 
Cash and cash equivalents, end of period   $ 13,471     $ 2,617  
                 
Supplemental disclosure of non-cash activities:                
  Issuance of common stock as payment for a portion of the Ripka Seller Notes   $ -     $ 5,401  
                 
Supplemental disclosure of cash flow information:                
  Cash paid during the period for income taxes   $ 118     $ 437  
  Cash paid during the period for interest   $ 560     $ 610  

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

5  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

1. Nature of Operations, Background, and Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the United States Securities and Exchange Commission (“SEC”). Certain information or footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted, pursuant to the rules and regulations of the SEC for interim financial reporting. Accordingly, they do not include all the information and footnotes necessary for a comprehensive presentation of financial position, results of operations, or cash flows.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements were prepared following the same policies and procedures used in the preparation of the audited consolidated financial statements and reflect all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations, financial position, and cash flows of Xcel Brands, Inc. and its subsidiaries (the “Company”). The results of operations for the interim periods presented herein are not necessarily indicative of the results for the entire fiscal year or for any future interim periods. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC on March 17, 2016.  

 

The Company is a brand management and media company engaged in the design, production, licensing, marketing, and direct to consumer sales of branded apparel, footwear, accessories, jewelry, home goods, and other consumer products, and the acquisition of dynamic consumer lifestyle brands. Currently, the Company’s brand portfolio consists of the Isaac Mizrahi brand (the "Isaac Mizrahi Brand"), the Judith Ripka brand (the “Ripka Brand”), the H by Halston and H Halston brands (collectively, the “H Halston Brands”), the C Wonder brand (the “C Wonder Brand”), and the Highline Collective brand. The Company also managed and designed the Liz Claiborne New York brand (“LCNY Brand”) through July 31, 2016.

 

The Company licenses its brands to third parties, provides certain design, production, and marketing services, and generates royalty design and service fee revenues through licensing and other agreements with manufacturers and retailers. These activities include licensing its own brands for promotion and distribution through an omni-channel retail sales strategy, which encompasses distribution through interactive television, the internet, and traditional brick-and-mortar retail channels.

 

In December 2014, the Company decided to close its retail stores. Accordingly, the Company’s retail operations are treated and presented as discontinued operations (see Note 8).

 

Certain reclassifications have been made to the prior period condensed consolidated financial statements to conform to the current period presentation.

 

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Recent Accounting Pronouncements

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 requires that all excess tax benefits and tax deficiencies be recognized in the income statement as discrete tax items in the interim period in which they occur, clarifies that employee taxes paid when an employer withholds shares for tax purposes should be presented on the statement of cash flows as a financing activity, and changes the presentation of excess tax benefits on the statement of cash flows from a financing activity to an operating activity. ASU 2016-09 also provides for a policy election to either estimate the number of awards expected to vest (as per current GAAP) or account for forfeitures when they occur. This new accounting guidance is effective for public companies for fiscal years beginning after December 15, 2016 (i.e., calendar years beginning on January 1, 2017), including interim periods within those fiscal years. Early adoption is permitted in any interim or annual period. The Company is currently evaluating the impact that the adoption of ASU 2016-09 will have on the Company’s consolidated financial statements.

 

6  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

In April 2016, FASB issued Accounting Standards Update No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” (“ASU 2016-10”), and in May 2016, FASB issued Accounting Standards Update No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”). These Accounting Standards Updates contain amendments that provide additional guidance, clarification, and practical expedients related to ASU No. 2014-09 “Revenue from Contracts with Customers” (“ASU 2014-09”), which was issued by the FASB in May 2014. ASU 2016-10 amends certain aspects of the guidance in ASU 2014-09 related to identifying performance obligations and applying the new revenue guidance to licensing transactions. ASU 2016-12 addresses topics of collectability, presentation of sales tax collected from customers, non-cash consideration, contract modifications and completed contracts at transition, and transition disclosures. The Company will incorporate the guidance contained in ASU 2016-10 and ASU 2016-12 into its overall evaluation and adoption of ASU 2014-09, which collectively will be effective for fiscal years beginning after December 15, 2017 and interim periods therein.

 

In June 2016, FASB issued Accounting Standards Update No. 2016-13, “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). ASU 2016-13 changes the accounting guidance related to the measurement of credit losses on financial assets measured at amortized cost (including trade receivables) by eliminating the current “incurred loss” methodology, which requires a probable initial recognition threshold, and instead requiring that the valuation and presentation of financial assets reflect an entity’s current estimate of all expected credit losses. For public companies that are SEC filers, this new accounting guidance is effective for fiscal years beginning after December 15, 2019 (i.e. calendar years beginning on January 1, 2020), including interim periods within those fiscal years. The Company is currently evaluating the impact that the adoption of ASU 2016-13 will have on the Company’s consolidated financial statements.

 

2. Trademarks, Goodwill and Other Intangibles

 

Trademarks and other intangibles, net consist of the following:

 

          June 30, 2016  
($ in thousands)   Weighted-
Average
Amortization
Period
   

 

 

Gross Carrying
Amount

    Accumulated
Amortization
   

Net Carrying

Amount

 
Trademarks (indefinite-lived)     n/a     $ 96,676     $ -     $ 96,676  
Trademarks (definite-lived)     15 years       15,437       943       14,494  
Licensing agreements     4 years       2,000       2,000       -  
Non-compete agreement     7 years       562       120       442  
Copyrights and other intellectual property     10 years       190       43       147  
Total           $ 114,865     $ 3,106     $ 111,759  

 

          December 31, 2015  
($ in thousands)   Weighted-
Average
Amortization
 Period
   

 

 

Gross Carrying
Amount

   

Accumulated

Amortization

   

Net Carrying

Amount

 
Trademarks (indefinite-lived)     n/a     $ 96,676     $ -     $ 96,676  
Trademarks (definite-lived)     15 years       15,437       429       15,008  
Licensing agreements     4 years       2,000       2,000       -  
Non-compete agreement     7 years       562       80       482  
Copyrights and other intellectual property     10 years       190       33       157  
Total           $ 114,865     $ 2,542     $ 112,323  

 

7  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

Amortization expense for intangible assets for the quarter ended June 30, 2016 (the “Current Quarter”) and the quarter ended June 30, 2015 (the “Prior Year Quarter”) was $282,000 and $157,000, respectively. Amortization expense for intangible assets for the six months ended June 30, 2016 (“Current Six Months”) and the six months ended June 30, 2015 (the “Prior Year Six Months”) was $564,000 and $314,000, respectively.

 

The trademarks related to the Isaac Mizrahi Brand, the Ripka Brand, and the H Halston Brands have been determined to have indefinite useful lives, and accordingly no amortization has been recorded for these assets.

 

The Company has $12.371 million of goodwill related to the 2011 acquisition of the Isaac Mizrahi business. There was no change in goodwill during the Current Six Months.

 

3. Significant Contracts

 

QVC Agreements

 

Under the Company’s agreements with QVC, QVC is required to pay the Company fees based primarily on a percentage of its net sales of Isaac Mizrahi, Ripka, H Halston, and C Wonder branded merchandise. QVC royalty revenue represents a significant portion of the Company’s total revenues. Revenues from QVC totaled $7.83 million and $5.74 million for the Current Quarter and Prior Year Quarter, respectively, representing approximately 86% and 91% of the Company’s total revenues, respectively. Revenues from QVC totaled $15.14 million and $11.47 million for the Current Six Months and the Prior Year Six Months, respectively, representing approximately 87% and 89% of the Company’s total revenues, respectively. As of June 30, 2016 and December 31, 2015, the Company had receivables from QVC of $7.33 million and $6.40 million, respectively, representing approximately 73% and 84% of the Company’s total receivables, respectively.

 

4. Debt

 

The Company’s net carrying amount of debt is comprised of the following:

 

($ in thousands)   June 30,
2016
    December 31,
2015
 
Xcel Term Loan   $ 27,000     $ -  
IM Term Loan     -       11,375  
JR Term Loan     -       7,875  
H Term Loan     -       10,000  
Unamortized deferred finance costs related to term loans     (527 )     (493 )
IM Seller Note     4,308       4,918  
Ripka Seller Notes     486       469  
Contingent obligation - IM Seller     -       250  
Contingent obligation - JR Seller     3,784       3,784  
Contingent obligation - CW Seller     2,850       2,850  
Total     37,901       41,028  
Current portion (i)     8,058       9,168  
Long-term debt   $ 29,843     $ 31,860  

 

(i) The current portion of long-term debt as of June 30, 2016 consists of (a) $3.750 million related to the Xcel Term Loan and (b) $4.308 million related to the IM Seller Note, which is payable in stock or cash at the Company’s discretion.

 

8  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

Xcel Term Loan

 

On February 26, 2016, Xcel and its wholly owned subsidiaries, IM Brands, LLC, JR Licensing, LLC, H Licensing, LLC, C Wonder Licensing, LLC, Xcel Design Group, LLC, IMNY Retail Management, LLC, and IMNY E-Store, USA, LLC (each a “Guarantor” and collectively, the “Guarantors”), as Guarantors, entered into an Amended and Restated Loan and Security Agreement (the “Loan Agreement”) with Bank Hapoalim B.M. (“BHI”), as agent (the “Agent”), and the financial institutions party thereto as lenders (the “Lenders”). The Loan Agreement amended and restated the IM Term Loan, the JR Term Loan, and the H Term Loan. Pursuant to the Loan Agreement, Xcel assumed the obligations of each of IM Brands, LLC, JR Licensing, LLC, and H Licensing, LLC under the respective term loans with BHI in the aggregate principal amount of $27,875,000 (the loan under the Loan Agreement is referred to as the “Xcel Term Loan”).

 

The Xcel Term Loan matures on January 1, 2021. Principal on the Xcel Term Loan is payable in quarterly installments on each of January 1, April 1, July 1 and October 1. The aggregate remaining annual principal payments are as follows:

 

($ in thousands)

 

Year Ending December 31,

  Amount of
Principal
Payment
 
2016 (July 1 through December 31)   $ 1,750  
2017     4,000  
2018     4,000  
2019     4,000  
2020     4,000  
2021     9,250  
Total   $ 27,000  

 

Under the Loan Agreement, the Company has the right to prepay the Xcel Term Loan, provided that any prepayment of less than all of the outstanding balance shall be applied to the remaining amounts due in inverse order of maturity. If the Xcel Term Loan is prepaid on or prior to the third anniversary of the closing date (including as a result of an event of default), the Company shall pay an early termination fee as follows: an amount equal to the principal amount outstanding under the Term Loan on the date of prepayment, multiplied by: (i) two percent (2.00%) if the Xcel Term Loan is prepaid on or after the closing date and on or before the second anniversary of the closing date; and (ii) one percent (1.00%) if the Xcel Term Loan is prepaid after the second anniversary of the closing date and on or before the third anniversary of the closing date.

 

Commencing with the fiscal year ending December 31, 2017, the Company is required to repay a portion of the Xcel Term Loan in an amount equal to 10% of the excess cash flow for the fiscal year; provided that no early termination fee shall be payable with respect to any such payment. Excess cash flow means, for any period, cash flow from operations (before certain permitted distributions) less (i) capital expenditures not made through the incurrence of indebtedness, (ii) all cash interest and principal and taxes paid or payable during such period, and (iii) all dividends declared and paid during such period to equity holders of any credit party treated as a disregarded entity for tax purposes.

 

Xcel’s obligations under the Loan Agreement are guaranteed by the Guarantors and secured by all of the assets of Xcel and the Guarantors (as well as any subsidiary formed or acquired that becomes a credit party to the Loan Agreement) and, subject to certain limitations contained in the Loan Agreement, equity interests of the Guarantors (as well as any subsidiary formed or acquired that becomes a credit party to the Loan Agreement).

 

Interest on the Xcel Term Loan accrues at a fixed rate of 5.1% per annum and is payable on each day on which the scheduled principal payments are required to be made.

 

9  

 

  

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

The Loan Agreement contains customary covenants, including reporting requirements, trademark preservation, and the following financial covenants of the Company (on a consolidated basis with the Guarantors and any subsidiaries subsequently formed or acquired that become a credit party under the Loan Agreement):

 

· net worth (as defined in the Loan Agreement) of at least $90,000,000 at the end of each fiscal quarter ending on June 30 and December 31 of each fiscal year;
· liquid assets of at least $5,000,000, until such time as the ratio of indebtedness to EBITDA (as defined in the Loan Agreement) is less than 1.00 to 1.00 and, in which event, liquid assets must be at least $3,000,000;
· a fixed charge ratio of at least 1.20 to 1.00 for each fiscal quarter ended June 30 and December 31 for the twelve fiscal month period ending on such date;
· capital expenditures shall not exceed (i) $2,650,000 for the year ending December 31, 2016 and (ii) $700,000 for any fiscal year thereafter; and
· EBITDA (as defined in the Loan Agreement) of $9,500,000 for the fiscal year ending December 31, 2016; and $9,000,000 for each fiscal year thereafter.

 

The Company was in compliance with all applicable covenants as of June 30, 2016.

 

In connection with the refinancing of its term loan debt, the Company paid $116,000 of fees to or on behalf of BHI. These fees, along with $466,000 of remaining unamortized deferred finance costs related to the previous term loan debt, have been deferred on the condensed consolidated balance sheet as a reduction to the carrying value of the Xcel Term Loan, and are being amortized into interest expense over the term of the Xcel Term Loan using the interest method.

 

IM Seller Note

 

On September 29, 2011, as part of the consideration for the purchase of the Isaac Mizrahi Business, the Company issued to IM Ready-Made, LLC (“IM Ready”) a promissory note in the principal amount of $7,377,000 (as amended, the “IM Seller Note”). The stated interest rate of the IM Seller Note is 0.25% per annum. Management determined that this rate was below the Company’s expected borrowing rate, which was then estimated at 9.25% per annum. Therefore, the Company discounted the IM Seller Note by $1,740,000 using a 9.0% imputed annual interest rate, resulting in an initial value of $5,637,000. In addition, on September 29, 2011, the Company prepaid $123,000 of interest on the IM Seller Note. The imputed interest amount is being amortized over the term of the IM Seller Note and recorded as other interest and finance expense on the Company’s condensed consolidated statements of operations.

 

On December 24, 2013, the IM Seller Note was amended to (1) revise the maturity date to September 30, 2016 (the “Amended Maturity Date”), (2) revise the date to which the maturity date may be extended to September 30, 2018, (3) provide the Company with a prepayment right with its common stock, subject to remitting in cash the required cash payments set forth below and a minimum common stock price of $4.50 per share, and (4) require interim scheduled payments.

 

The remaining scheduled principal payment (including amortization of imputed interest) of $4,377,000 is payable on September 30, 2016, and is payable in stock or cash at the Company’s sole discretion. The payment of this amount in cash requires BHI’s approval.

 

For the Current Quarter and Prior Year Quarter, the Company incurred interest expense of $69,000 and $78,000, respectively, which includes amortization of the discount on the IM Seller Note of $69,000 and $73,000, respectively. For the Current Six Months and the Prior Year Six Months, the Company incurred interest expense of $140,000 and $158,000, respectively, which includes amortization of the discount on the IM Seller Note of $140,000 and $149,000, respectively.

 

10  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

Ripka Seller Notes

 

On April 3, 2014, as part of the consideration for the purchase of the Ripka Brand, JR Licensing issued to Ripka promissory notes in the aggregate principal amount of $6,000,000 (the “Ripka Seller Notes”). The Ripka Seller Notes have a term of five years from the date of issuance, are payable in cash or shares of the Company’s common stock valued at the time of payment, at the Company’s option, and with a floor price of $7.00 per share if paid in stock, with Ripka having certain rights to extend the maturity of the Ripka Seller Notes in the event the Company’s stock is trading at a price of less than $7.00 per share. On February 20, 2015, a portion of the Ripka Seller Notes was amended and satisfied.

 

Management determined that the Company’s expected borrowing rate was estimated to be 7.33% per annum and, therefore, discounted the Ripka Seller Notes by $1,835,000 using a 7.33% imputed annual interest rate, resulting in an initial value of $4,165,000. The imputed interest amount is being amortized over the term of the Ripka Seller Notes and recorded as other interest and finance expense on the Company’s condensed consolidated statements of operations.

 

On February 20, 2015, the Company agreed to cancel Ripka Seller Notes in the principal amount of $3.0 million and execute in its place: (i) a $2.4 million principal amount promissory note issued in the name of Ripka (the “$2,400,000 Seller Note”) and (ii) a $600,000 principal amount promissory note issued in the name of Ripka (the “$600,000 Seller Note”), each with substantially the same terms as the Ripka Seller Notes; provided, however, that the Company and Ms. Ripka agreed that, upon Ripka’s assignment of the $600,000 Seller Note to a permitted assignee, the principal payments under the $600,000 Seller Note shall accelerate to be payable in eight equal quarterly installments of $75,000 with the first payment due on March 31, 2015 and with the final principal payment payable on December 31, 2016. As of the date of the filing of this Quarterly Report on Form 10-Q, the $600,000 Seller Note has not been assigned. The $2,400,000 Seller Note was assigned by Ripka to Judith Ripka Creations, Inc. and then assigned by Judith Ripka Creations, Inc. to Thai Jewelry Manufacturer Co. LTD. (“Thai Jewelry”).

 

On February 20, 2015, the Company entered into a release letter (the “Release Letter”) with Thai Jewelry, pursuant to which the Company agreed to issue to Thai Jewelry an aggregate of 266,667 shares of the Company’s common stock in exchange for the cancellation of the $2,400,000 Seller Note. On March 25, 2015, the Company issued the shares of common stock pursuant to the Release Letter. The carrying value, net of the discount at the time of the redemption of the $2.4 million Ripka Seller Notes was $1.79 million and, as a result, the Company recorded a loss on the early extinguishment of debt of $0.61 million during the Prior Year Six Months, which is included in the accompanying condensed consolidated statements of operations.

 

On April 21, 2015, the Company satisfied an additional $3.00 million principal amount of the Ripka Seller Notes by issuing 333,334 shares of the Company’s common stock. The carrying value, net of the discount at the time of the redemption of the $3.00 million Ripka Seller Notes was $2.24 million and, as a result, the Company recorded a loss on the early extinguishment of debt of $0.76 million during the Prior Year Quarter and Prior Year Six Months, which is included in the accompanying condensed consolidated statements of operations.

 

For both the Current Quarter and Prior Year Quarter, the Company incurred interest expense of $9,000, respectively, which consists solely of amortization of the discount on the Ripka Seller Notes. For the Current Six Months and the Prior Year Six Months, the Company incurred interest expense of $17,000 and $88,000, respectively, which consists solely of amortization of the discount on the Ripka Seller Notes.

 

Contingent Obligation – IM Seller (QVC Earn-Out)

 

The Company was obligated to pay IM Ready $2.76 million, payable in cash or common stock, at the Company’s option, contingent upon IM Brands receiving aggregate net royalty income of at least $2.5 million from QVC in the twelve-month period ended September 30, 2015 with the number of shares of such stock based upon the greater of (x) $4.50 per share, and (y) the average stock price for the last twenty business days prior to the time of such issuance. The $2.5 million in net royalty income from QVC for the twelve-month period ended September 30, 2015 was met and, therefore, the Company issued IM Ready 290,473 shares of common stock, valued at $2.51 million as of September 30, 2015 and made a $0.25 million payment in cash in January 2016 to satisfy this obligation.

 

11  

 

  

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

Contingent Obligation – JR Seller (Ripka Earn-Out)

 

In connection with the purchase of the Ripka Brand, the Company agreed to pay Ripka additional consideration of up to $5 million in aggregate (the “Ripka Earn-Out”), payable in cash or shares of the Company’s common stock based on the fair market value of the Company’s common stock at the time of payment, and with a floor of $7.00 per share, based on the Ripka Brand achieving in excess of $1 million of net royalty income during each of the 12-month periods ending on October 1, 2016, 2017 and 2018, less the sum of all earn-out payments for any prior earn-out period. Net royalty income does not include any revenues generated by interactive television sales or any revenue accelerated as a result of termination of any license agreement. The Ripka Earn-Out of $3.78 million is recorded in the accompanying condensed consolidated balance sheets based on the difference between the fair value of the acquired assets of the Ripka Brand at the acquisition date and the total consideration paid. In accordance with ASC Topic 480, the Ripka Earn-Out obligation is classified as a liability in the accompanying condensed consolidated balance sheets because of the variable number of shares payable under the agreement. 

 

Contingent Obligations – CW Seller (C Wonder Earn-Out)

 

In connection with the purchase of the C Wonder Brand, the Company agreed to pay the seller additional consideration (the “C Wonder Earn-Out”), which would be payable, if at all, in cash or shares of common stock of the Company, at the Company’s sole discretion, after June 30, 2019, with a value based on the royalties related directly to the assets the Company acquired pursuant to the purchase agreement. The value of the earn-out shall be calculated as the positive amount, if any, of (i) two times (A) the maximum net royalties as calculated for any single twelve month period commencing on July 1 and ending on June 30 between the closing date and June 30, 2019 (each, a “Royalty Target Year”) less (B) $4,000,000, plus (ii) two times the maximum royalty determined based on a percentage of retail and wholesale sales of C Wonder branded products by the Company as calculated for any single Royalty Target Year. The C Wonder Earn-Out of $2.85 million is recorded in the accompanying condensed consolidated balance sheets based on the probability of the C Wonder Brand achieving certain net royalty income targets within the earn-out periods and then calculating the present value of the weighted average payment amount. In accordance with ASC Topic 480, the C Wonder Earn-Out obligation is classified as a liability in the accompanying condensed consolidated balance sheets because of the variable number of shares payable under the agreement.

 

As of June 30, 2016 and December 31, 2015, total contingent obligations were $6.63 million and $6.88 million, respectively.

 

5. Stockholders’ Equity

 

2011 Equity Incentive Plan

 

The Company’s 2011 Equity Incentive Plan, as amended and restated (the “Plan”), is designed and utilized to enable the Company to provide its employees, officers, directors, consultants and others whose past, present and/or potential contributions to the Company have been, are or will be important to the success of the Company, an opportunity to acquire a proprietary interest in the Company. A total of 8,000,000 shares of common stock are eligible for issuance under the Plan. The Plan provides for the grant of any or all of the following types of awards: stock options, restricted stock, deferred stock, stock appreciation rights and other stock-based awards. The Plan is administered by the Company’s Board of Directors, or, at the Board’s discretion, a committee of the Board.

 

The fair value of options and warrants is estimated on the date of grant using the Black-Scholes option pricing model. The valuation determined by the Black-Scholes option pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The risk-free rate is based on the U.S. Treasury rate for the expected life at the time of grant, volatility is based on the average long-term implied volatilities of peer companies, the expected life is based on the estimated average of the life of options and warrants using the simplified method, and forfeitures are estimated on the date of grant based on certain historical data. The Company utilizes the simplified method to determine the expected life of the options and warrants due to insufficient exercise activity during recent years as a basis from which to estimate future exercise patterns. The expected dividend assumption is based on the Company’s history and expectation of dividend payouts. 

 

12  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

For stock option awards for which vesting is contingent upon the achievement of certain performance targets, the timing and amount of compensation expense recognized is based upon the Company’s projections and estimates of the relevant performance metric(s).

 

Stock Options

 

Options granted under the Plan expire at various times, either five, seven or ten years from the date of grant, depending on the particular grant.

 

On March 1, 2016, the Company granted options to purchase an aggregate of 100,000 shares of common stock to a member of management. The exercise price of the options is $7.00 per share, and one-third of the options will vest on each of December 31, 2016, December 31, 2017, and March 31, 2018.

 

On March 31, 2016, the Company granted options to purchase an aggregate of 1,671,500 shares of common stock to certain executives, non-executive management, and employees. The exercise price of the options is $5.80 per share, and one-third of the options will vest on each of March 31, 2017, March 31, 2018, and March 31, 2019.

 

On March 31, 2016, the Company granted options to purchase an aggregate of 500,000 shares of common stock to certain key employees. The exercise price for 100,000 of these options is $5.80 per share, and such options will vest on January 1, 2017. The exercise price of the remaining 400,000 options is $7.50 per share, and the vesting of such options is dependent upon the achievement of certain royalty income targets.

 

On March 31, 2016, the Company granted options to purchase an aggregate of 150,000 shares of common stock to non-management directors. The exercise price of the options is $5.80 per share, and 50% of the options will vest on each of March 31, 2017 and March 31, 2018.

 

The fair values of the options granted during the Current Six Months were estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions:

 

Expected Volatility     33.25 – 33.88 %  
Expected Dividend Yield     0 %  
Expected Life (Term)     3.25 – 5.32 years    
Risk-Free Interest Rate     0.91 – 1.21 %  

 

13  

 

  

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

A summary of the Company’s stock options activity for the Current Six Months is as follows:

 

    Number of
Options
    Weighted
Average
Exercise
Price
    Weighted
Average
Remaining
Contractual
Life
(in Years)
    Aggregate
Intrinsic
Value
 
Outstanding at January 1, 2016     379,500     $ 5.50       1.71     $ 1,174,000  
Granted     2,421,500       6.13                  
Canceled     -       -                  
Exercised     (10,000     (3.10                
Expired/Forfeited     (18,500 )     (4.82 )                
Outstanding at June 30, 2016, and expected to vest     2,772,500     $ 6.06       4.58     $ -    
Exercisable at June 30, 2016     340,500     $ 5.45       1.01     $ -   

  

Compensation expense related to stock options for the Current Quarter and the Prior Year Quarter was approximately $329,000 and $16,000, respectively. Compensation expense related to stock option grants for the Current Six Months and the Prior Year Six Months was $349,000 and $33,000, respectively. Total unrecognized compensation expense related to unvested stock options at June 30, 2016 amounts to $3,183,000 and is expected to be recognized over a weighted average period of 3.05 years.

 

The following table summarizes the Company’s stock option activity for non-vested options for the Current Six Months:

 

    Number of
Options
    Weighted
Average
Grant Date
Fair Value
 
Balance at January 1, 2016     47,500     $ 1.43  
Granted     2,421,500       1.45  
Vested     (25,000 )     1.41  
Forfeited or Canceled     (12,000 )     1.49  
Balance at June 30, 2016     2,432,000     $ 1.45  

 

Warrants

 

Warrants granted under the Plan expire at various times, either five, seven or ten years from the date of grant, depending on the particular grant.

 

14  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

A summary of the Company’s warrants activity for the Current Six Months is as follows:

 

    Number of
Warrants
    Weighted
Average
Exercise
Price
    Weighted
Average
Remaining
Contractual
Life
(in Years)
    Aggregate
Intrinsic
Value
 
Outstanding and exercisable at January 1, 2016     2,219,543     $ 6.07       3.23     $ 3,168,000  
Granted     -       -                  
Canceled     -       -                  
Exercised     (26,000 )     (0.01 )                
Expired/Forfeited     -       -                  
Outstanding and exercisable at June 30, 2016     2,193,543     $ 6.14       2.77     $ -  

 

No compensation expense was recognized in the Current Six Months or Prior Year Six Months related to warrants.

 

Restricted Stock

 

On March 31, 2016, the Company issued to a key employee 17,242 shares of restricted stock. The shares of restricted stock vest over six months.

 

On March 31, 2016, the Company issued to a member of management 50,000 shares of restricted stock. The shares of restricted stock vest evenly over 4 years, whereby 25% shall vest on each of March 31, 2017, March 31, 2018, March 31, 2019, and March 31, 2020.

 

On March 31, 2016, the Company issued to certain executives an aggregate of 150,001 shares of restricted stock. The shares of restricted stock vest evenly over three years, whereby one-third shall vest on each of March 31, 2017, March 31, 2018, and March 31, 2019.

 

On March 31, 2016, the Company issued to non-management directors an aggregate of 48,000 shares of restricted stock. The shares of restricted stock will vest evenly over two years, whereby 50% shall vest on March 31, 2017 and 50% shall vest on March 31, 2018.

 

Notwithstanding the foregoing, each grantee may extend the first anniversary of all or a portion of the restricted stock by six months and, thereafter one or more times may further extend such date with respect to all or a portion of the restricted stock until the next following September 30th or March 31st, as the case may be, by providing written notice of such election to extend such date with respect to all or a portion of the restricted stock prior to such date.

 

A summary of the Company’s restricted stock activity for the Current Six Months is as follows:

 

    Number of
Restricted
Shares
    Weighted
Average
Grant Date
Fair Value
 
Outstanding at January 1, 2016     3,530,485     $ 4.95  
Granted     265,243       5.80  
Canceled     -       -  
Vested     (189,900 )     5.05  
Expired/Forfeited     (11,275 )     8.63  
Outstanding at June 30, 2016     3,594,553     $ 5.00  

 

15  

 

 

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

Compensation expense related to restricted stock grants for the Current Quarter and Prior Year Quarter was $1,124,000 and $1,092,000, respectively. Compensation expense related to restricted stock grants for the Current Six Months and Prior Year Six Months was $2,316,000 and $2,088,000, respectively.

 

Total unrecognized compensation expense related to unvested restricted stock grants at June 30, 2016 amounts to $3,629,000 and is expected to be recognized over a weighted average period of 1.64 years.

 

Shares Available Under the Company’s 2011 Equity Incentive Plan

 

At June 30, 2016, there were 590,663 shares of common stock available for issuance under the Plan.

 

Shares Reserved for Issuance

 

At June 30, 2016, there were 5,556,706 shares of common stock reserved for issuance pursuant to unexercised warrants and stock options, or available for issuance under the Plan.

 

Dividends

 

The Company has not paid any dividends to date.

 

6. Earnings Per Share

 

Basic earnings per share (“EPS”) is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS gives effect to all potentially dilutive common shares outstanding during the period, including stock options and warrants, using the treasury stock method. Diluted EPS excludes all potentially dilutive shares of common stock if their effect is anti-dilutive.

 

Shares used in calculating basic and diluted income (loss) per share are as follows:

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
    2016     2015     2016     2015  
Basic     18,671,648       14,850,874       18,565,198       14,462,305  
Effect of exercise of warrants     -       971,873       -       971,873  
Effect of exercise of stock options     -       141,228       -       141,228  
Diluted     18,671,648       15,963,975       18,565,198       15,575,406  

 

As a result of the net loss from continuing operations presented for the three and six months ended June 30, 2016, the Company calculated diluted earnings per share using basic weighted-average shares outstanding for those periods, as utilizing diluted shares would be anti-dilutive to loss per share.

 

The computation of diluted EPS excludes the common stock equivalents of the following potentially dilutive securities because their inclusion would be anti-dilutive:

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
    2016     2015     2016     2015  
Stock options and warrants     4,966,043       750,000       4,966,043       750,000  

 

16  

 

  

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

7. Income Tax

 

The effective income tax rate for the Current Quarter and the Prior Year Quarter from continuing operations was approximately 70% and 4%, respectively, resulting in a $208,000 income tax benefit and $90,000 income tax provision, respectively.

 

The effective income tax rate for the Current Six Months and the Prior Year Six Months was approximately 66% and (1)%, respectively, resulting in a $259,000 income tax benefit and $16,000 income tax benefit, respectively.

 

During the Current Quarter and the Current Six Months, the respective effective tax rates were attributable to recurring permanent differences. Based on the amount of loss from continuing operations before income taxes compared to the permanent differences, the effective rate increased by 29% and 25% for the Current Quarter and the Current Six Months, respectively. 

 

For the Prior Year Quarter and the Prior Year Six Months, the Company recorded a $3.00 million gain on the reduction of contingent obligations related to the acquisition of the Isaac Mizrahi Brand, partially offset by recurring permanent differences. This gain was not subject to tax and was therefore treated as a discrete item (permanent difference) occurring in the Prior Year Quarter and the Prior Year Six Months. Based on the amount of income from continuing operations before income taxes compared to the permanent differences, the effective rate decreased by 37% and 42% for the Prior Year Quarter and the Prior Year Six Months, respectively. 

 

8. Discontinued Operations

 

Discontinued operations represent the net sales and expenses related to the Company’s retail operations, which were discontinued in December 2014. A summary of the results of discontinued operations for the Current Quarter, Prior Year Quarter, Current Six Months, and Prior Year Six Months is as follows (in thousands, except share and per share data):

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
    2016     2015     2016     2015  
Net sales   $ -     $ 181     $ -     $ 287  
Cost of sales     -       (101 )     -       (221 )
Operating expenses     -       (91 )     -       (266 )
Loss from disposal of discontinued operations     -       (77 )     -       (241 )
Income tax benefit     -       34       -       174  
Loss from discontinued operations, net   $ -     $ (54 )   $ -     $ (267 )
                                 
Loss per share from discontinued operations, net:                                
Basic   $ -     $ (0.01 )   $ -     $ (0.02 )
Diluted   $ -     $ (0.01 )   $ -     $ (0.02 )
                                 
Weighted average shares outstanding:                                
Basic     18,671,648       14,850,874       18,565,198       14,462,305  
Diluted     18,671,648       15,963,975       18,565,198       15,575,406  

 

Assets and liabilities of discontinued operations were not material as of June 30, 2016 and December 31, 2015.

 

17  

 

  

XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

9. Related Party Transactions

 

Licensing Agent Agreement

 

On August 2, 2011, the Company entered into a licensing agent agreement with Adam Dweck, son of Jack Dweck, a former director of the Company, pursuant to which he is entitled to a five percent commission on any royalties the Company receives under any new license agreements that he procures for the Company for the initial term of such license agreements. Adam Dweck earned approximately $1,000 and $7,000 in fees for the Current Quarter and Prior Year Quarter, respectively, and earned approximately $2,000 and $14,000 in fees for the Current Six Months and Prior Year Six Months, respectively.

 

Todd Slater

 

On September 29, 2011, the Company entered into an agreement, which was amended on October 4, 2011 and on July 10, 2012, with Todd Slater, who is a director of the Company, for services related to the Company’s licensing strategy and introduction to potential licensees. In July 2012, the Company made a one-time payment to Mr. Slater of $163,000 in connection with the amendment. The Company incurred direct licensing costs with Mr. Slater from amortization of the one-time payment for the Prior Year Quarter and Prior Year Six Months of $8,000 and $16,000, respectively.

 

Benjamin Malka

 

The Company entered into a license agreement with The H Company IP, LLC (“HIP”) on December 22, 2014, which was amended September 1, 2015. Benjamin Malka, a director of the Company, is a 25% equity holder of HIP’s parent company, House of Halston LLC (“HOH”), and Chief Executive Officer of HOH. The HIP license agreement provides for royalty payments including guaranteed minimum royalties to be paid to the Company during the initial term that expires on December 31, 2019.

 

On September 1, 2015 the Company entered into a license agreement with Lord and Taylor, LLC (the “L&T License”) and simultaneously amended the H Halston License Agreement eliminating HIP’s minimum guaranteed royalty obligations, provided the L&T License is in effect. In addition, the Company entered into a sublicense agreement with HIP obligating the Company to pay HIP a royalty participation fee on an annual basis the greater of (i) 50% of royalties received under the L&T License or (ii) guaranteed minimum royalties. Guaranteed minimum royalties are equal to $0.25 million for the seventeen months ending January 31, 2017, and $0.75 million, $0.75 million, $1.5 million, and $1.75 million for the twelve months ending January 31, 2018, 2019, 2020, and 2021, respectively.

 

The Company incurred a $28,000 and $62,000 royalty participation fee with HIP for the Current Quarter and Current Six Months, respectively.

 

HOH has also entered into an arrangement with another licensee of the Company to supply Halston-branded apparel for the subsequent sale of such product to end customers. Under the Company’s separate pre-existing licensing agreements in place with the aforementioned other licensee and with HIP as described above, the Company earns royalties on the sales of such Halston-branded products.

 

Edward Jones, III

 

On May 14, 2015, and amended on June 24, 2015, the Company entered into a consulting agreement with Jones Texas, Inc., ("JT Inc.") whose controlling shareholder is Edward Jones, a director of the Company. The agreement, as amended, provided for fees payable to JT Inc. up to $75,000 for consulting services related to due diligence on the C Wonder brand prior to acquisition. The Company paid fees to JT Inc. of $12,500 during the Prior Year Quarter and Prior Year Six Months. An additional $62,500 of fees was paid to Jones Texas in August 2015.

 

During the six months ended June 30, 2016, Edward Jones performed consulting services for and received compensation from a certain licensee of the Company (the “Licensee”). Under the terms of the Company’s agreement with the Licensee, the Licensee may supply the Company’s branded products to our other licensees. Under the terms of the Company’s separate pre-existing agreements with other licensees, the Company would earn royalties on the sales of such branded products sold to end customers. To date, the Company has not earned or received any fees or revenues related to the Company’s agreement with the Licensee, but may earn or receive such amounts in the future.

 

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XCEL BRANDS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(Unaudited)

 

10. Facility Exit Costs

 

In June 2016, the Company relocated its corporate offices and operations from 475 Tenth Avenue in New York City to 1333 Broadway in New York City. In connection with the exit from its former office location, the Company recognized a liability at the exit and cease-use date for the remaining lease obligation associated with 475 Tenth Avenue, based on the remaining contractual lease payments less estimated sublease rentals, discounted to present value using a credit-adjusted risk-free rate.

 

The Company recorded a net non-cash charge of approximately $648,000 associated with the recognition of this liability. The Company also incurred certain cash costs of approximately $15,000 related to the exit from its former office space, and incurred a loss of approximately $7,000 associated with the sale of certain equipment. These amounts, totaling approximately $670,000, have been recorded as other selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations for the three and six months ended June 30, 2016.

 

The remaining balance of the exit cost liability related to the former office space was approximately $940,000 as of June 30, 2016, of which $229,000 was recorded as an other current liability and $711,000 was recorded as an other long-term liability in the accompanying unaudited condensed consolidated balance sheets.

 

A summary of the activity related to the exit cost liability for the Current Six Months is as follows:

 

($ in thousands)      
Balance as of January 1, 2016   $ -  
Non-cash costs incurred and charged to expense     648  
Transfers of previously-recognized deferred balance sheet amounts related to lease     333  
Cash payments     (41 )
Balance as of June 30, 2016   $ 940  

 

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

 

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. The statements that are not historical facts contained in this report are forward-looking statements that involve a number of known and unknown risks, uncertainties and other factors, all of which are difficult or impossible to predict and many of which are beyond our control, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These risks are detailed in the Risk Section of our Form 10-K for the fiscal year ended December 31, 2015. The words “believe,” “anticipate,” “expect,” “continue,” “estimate,” “appear,” “suggest,” “goal,” “potential,” “predicts,” “seek,” “will,” “confident,” “project,” “provide,” “plan,” “likely,” “future,” “ongoing,” “intend,” “may,” “should,” “would,” “could,” “guidance,” and similar expressions identify forward-looking statements.

 

Overview

 

Xcel Brands, Inc. (“Xcel,” the “Company,” “we,” “us” or “our”) is a brand management and media company engaged in the design, production, licensing, marketing, and direct to consumer sales of branded apparel, footwear, accessories, jewelry, home goods, and other consumer products, and the acquisition of dynamic consumer lifestyle brands. Currently, our brand portfolio consists of the Isaac Mizrahi, Judith Ripka, H Halston, C Wonder, and Highline Collective brands. We also managed and designed the Liz Claiborne New York brand (“LCNY Brand”) through July 31, 2016. Going forward, our focus shall be on our wholly owned brands.

 

Our objective is to build a diversified portfolio of lifestyle consumer brands through organic growth and the strategic acquisition of new brands. To achieve growth under our brands, we are focused on two primary licensing and design activities:

· licensing our brands for distribution through interactive television (i.e. QVC and The Shopping Channel); and
· licensing our brands to manufacturers and retailers for promotion and distribution through e-commerce, social commerce, and traditional brick-and-mortar retail channels.

 

We believe that Xcel offers a unique value proposition to its licensees and customers for the following reasons:

· our management team, including our officers’ and directors’ historical track records and relationships within the industry;
· our brand management platform, which has a strong focus on design, production, marketing, and social media; and
· our operating strategy of licensing brands with significant media presence and driving sales through our omni-channel retail sales strategy across interactive television, internet and traditional retail channels.

 

We license our brands to third parties, provide certain design, production, and marketing services, and generate royalty design and service fee revenues through licensing and other agreements with manufacturers and retailers. This includes licensing our own brands for promotion and distribution through an omni-channel retail sales strategy, which includes distribution through interactive television, the internet, and traditional brick-and-mortar retail channels. We believe that this strategy distinguishes us from other brand management companies that rely primarily on their licensees for design, production and distribution, and enables us to leverage the media reach of our interactive television partners, including through television, digital and social media, to drive sales of products under our brands across distribution channels. 

 

Our vision is intended to reimagine shopping, entertainment, and social as one. By leveraging digital and social media content across all distribution channels, we seek to drive customer (follower) engagement and generate retail sales across our brands. Our strong relationships with leading retailers and interactive television companies, such as QVC and The Shopping Channel, enable us to reach consumers in over 350 million homes worldwide.

 

We believe our “virtual vertical” business model provides significant competitive advantages compared with traditional wholesale apparel companies that design, manufacture, and distribute products. We remain focused on our core competencies of licensing, production, design, marketing and brand development, while outsourcing manufacturing and the related inventory ownership to best-in-class partners. We believe that we provide 360 degrees of service for a comprehensive solution for our retail partners that addresses many of the challenges facing the retail industry today. We believe our platform is highly scalable due to our business model’s low overhead and working capital requirements, coupled with minimum guaranteed income levels through our multi-year licensing contracts. Additionally, we believe we can quickly integrate additional brands into our platform in order to leverage our design, production oversight, and marketing capabilities and retail and licensee relationships. 

 

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We opened a full-price store and an outlet store under the Isaac Mizrahi brand in 2013 and 2014, respectively. In December 2014, we decided to close our retail stores. Accordingly, our retail operations have been classified as discontinued operations for all periods presented. Our e-commerce operations, which were previously reported as a component of retail operations, are reported as a component of our licensing business.

 

Summary of Operating Results

 

The three months ended June 30, 2016 (the “Current Quarter”) compared with the three months ended June 30, 2015 (the “Prior Year Quarter”)

 

Total Revenues

Current Quarter total revenues increased approximately $2.80 million to $9.12 million from $6.32 million in the Prior Year Quarter. This increase was attributable to increases in net licensing revenues of approximately $2.82 million, partially offset by declines in net e-commerce sales of $0.03 million.

 

The increase in net licensing revenues for the Current Quarter as compared with the Prior Year Quarter was primarily due to (i) higher revenues from our interactive television business of approximately $2.46 million, largely driven by acquisitions made in late 2014 and 2015, and (ii) approximately $0.68 million of revenues recognized from new license agreements entered into in 2015. These increases were partially offset by a decrease in revenue of approximately $0.40 associated with the management and design of the LCNY brand, for which our contract subsequently ended in July 2016.

 

The decline in net e-commerce sales from the Prior Year Quarter is the result of management’s decision to phase out of e-commerce during 2016.

 

Gross Profit

Gross profit for the Current Quarter was $9.08 million, compared with $6.29 million for the Prior Year Quarter. The increase in gross profit was primarily attributable to the increase in net licensing revenues described above.

 

Operating Expenses

Operating expenses totaled $8.85 million for the Current Quarter, compared with $5.84 million for the Prior Year Quarter. The increase of approximately $3.01 million was primarily due to an increase in compensation-related expenses (including stock-based compensation) of approximately $1.49 million and an increase in other selling, general and administrative expenses of approximately $1.45 million, which included non-recurring charges of $0.67 million incurred in the Current Quarter in connection with the exit from our former leased office facilities. The increase in compensation-related costs was largely driven by increased staffing to support (i) the C Wonder Brand, which we acquired in July 2015 and which began selling on QVC in March 2016, (ii) the development and operation of our quick-time-response or short lead time “virtual vertical” production platform, and (iii) the launch of the IMNYC Isaac Mizrahi, H Halston, and Highline Collective brands at Lord & Taylor and Hudson’s Bay department stores in April 2016. The increase in other selling, general and administrative expenses was mainly attributable to the scaling of our operations and infrastructure to support the ongoing growth of our business.

 

Other Expenses (Income)

Total other income, net of $2.24 million for the Prior Year Quarter was comprised of a $3.00 million gain on the reduction of contingent obligations, partially offset by a $0.76 million loss on extinguishment of debt.

 

The gain on the reduction of contingent obligations was a result of the Company reducing the fair value of its contingent obligation on its earn-out obligation to the seller of the Isaac Mizrahi Brand, based on a revision of the timing of projected future net royalty income related to the Isaac Mizrahi business.

 

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The loss on extinguishment of debt was a result of the Company satisfying $3.00 million principal amount of Ripka Seller Notes by issuing 333,334 shares of our common stock in April 2015. The carrying value, net of the discount, of the Ripka Seller Notes at the redemption date was $2.24 million, resulting in a loss of $0.76 million.

 

Interest and Finance Expense

Interest and finance expense for the Current Quarter increased by approximately $0.10 million to $0.53 million, compared with $0.43 million in the Prior Year Quarter. This increase was primarily due to the higher interest rate (the term debt interest rate was converted from a variable rate to a fixed rate) on our term debt following the February 2016 refinancing.

  

Income Tax (Benefit) Provision

The effective income tax rate for the Current Quarter was approximately 70% resulting in a $0.21 million income tax benefit. During the Current Quarter, the effective tax rate was attributable to recurring permanent differences. Based on the amount of loss from continuing operations before income taxes compared to the permanent differences, the effective rate increased by 29%.

 

The effective income tax rate for the Prior Year Quarter was approximately 4% which resulted in a $0.09 million income tax provision. For the Prior Year Quarter, the Company recorded a $3.00 million gain on the reduction of contingent obligations related to the acquisition of the Isaac Mizrahi Brand, partially offset by recurring permanent differences. This gain was not subject to tax and was therefore treated as a discrete item (permanent difference) occurring in the Prior Year Quarter. Based on the amount of income from continuing operations before income taxes compared to the permanent differences, the effective rate decreased by 37%.

 

Discontinued Operations

The loss from discontinued operations, net of $0.05 million in the Prior Year Quarter was related to our retail operations and was primarily attributable to compensation expense, other general and administrative expenses, and wind down costs associated with the closing of our retail stores, partially offset by an income tax benefit of $0.03 million. As these wind down and closure activities were essentially completed by the end of 2015, we had no such costs reported as discontinued operations in the Current Quarter.

 

Net (Loss) Income

The Company had a net loss of $0.09 million for the Current Quarter, compared with net income of $2.11 million for the Prior Year Quarter.

 

Non-GAAP Net Income, Non-GAAP Diluted EPS, and Adjusted EBITDA

The Company had non-GAAP net income of $2.11 million, or $0.11 per diluted share (“non-GAAP diluted EPS”) for the Current Quarter, compared with non-GAAP net income of $1.12 million, or non-GAAP diluted EPS of $0.07 for the Prior Year Quarter. Non-GAAP net income is a non-GAAP unaudited term, which we define as net income (loss), exclusive of stock-based compensation, non-cash interest expense from discounted debt related to acquired assets, gain on the reduction of contingent obligations (if any), loss on extinguishment of debt, non-recurring facility exit charges, and net loss from discontinued operations. Non-GAAP net income and non-GAAP diluted EPS measures do not include the tax effect of the aforementioned adjusting items, due to the nature of these items and the Company’s tax strategy.

 

The Company had Adjusted EBITDA of $2.74 million for the Current Quarter, compared with Adjusted EBITDA of $1.90 million for the Prior Year Quarter. Adjusted EBITDA is a non-GAAP unaudited measure, which we define as net income (loss) before stock-based compensation, interest expense and other financing costs (including gain (loss) on extinguishment of debt), income taxes, other state and local franchise taxes, depreciation and amortization, gain on the reduction of contingent obligations, non-recurring facility exit charges, and net loss from discontinued operations.

 

Management uses non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA as measures of operating performance to assist in comparing performance from period to period on a consistent basis and to identify business trends relating to the Company's results of operations. Management believes Non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA are also useful because they provide supplemental information to assist investors in evaluating the Company’s financial results.

 

Non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA should not be considered in isolation or as alternatives to net income, earnings per share, or any other measure of financial performance calculated and presented in accordance with GAAP. Given that non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA are financial measures not deemed to be in accordance with GAAP and are susceptible to varying calculations, our non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA may not be comparable to similarly titled measures of other companies, including companies in our industry, because other companies may calculate non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA in a different manner than we calculate these measures.

 

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In evaluating non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA, you should be aware that in the future we may or may not incur expenses similar to some of the adjustments in this report. Our presentation of non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA does not imply that our future results will be unaffected by these expenses or any unusual or non-recurring items. When evaluating our performance, you should consider non-GAAP net income, non-GAAP diluted EPS, and Adjusted EBITDA alongside other financial performance measures, including our net income and other GAAP results, and not rely on any single financial measure.

 

The following table is a reconciliation of net (loss) income (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP net income:

 

    Three Months Ended June 30,  
($ in thousands)   2016     2015  
Net (loss) income   $ (90 )   $ 2,107  
Non-cash interest and finance expense     80       86  
Stock-based compensation     1,453       1,108  
Loss on extinguishment of debt     -       760  
Gain on reduction of contingent obligations     -       (3,000 )
Non-recurring facility exit charges     670       -  
Loss from discontinued operations, net     -       54  
Non-GAAP net income   $ 2,113     $ 1,115  

  

The following table is a reconciliation of diluted (loss) earnings per share to non-GAAP diluted EPS:

 

    Three Months Ended June 30,  
    2016     2015  
Diluted (loss) earnings per share   $ (0.00 )   $ 0.13  
Non-cash interest and finance expense     -       -  
Stock-based compensation     0.08       0.07  
Loss on extinguishment of debt     -       0.05  
Gain on reduction of contingent obligations     -       (0.19 )
Non-recurring facility exit charges     0.03       -  
Loss from discontinued operations, net     -       0.01  
Non-GAAP diluted EPS   $ 0.11     $ 0.07  
Non-GAAP weighted average diluted shares     19,388,557       15,963,975  

  

The following table is a reconciliation of basic weighted average shares to non-GAAP weighted average diluted shares:

 

    Three Months Ended June 30,  
    2016     2015  
Basic weighted average shares     18,671,648       14,850,874  
Effect of exercising warrants     673,995       971,873  
Effect of exercising stock options     42,914       141,228  
Non-GAAP weighted average diluted shares     19,388,557       15,963,975  

 

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The following table is a reconciliation of net (loss) income (our most directly comparable financial measure presented in accordance with GAAP) to Adjusted EBITDA:

 

    Three Months Ended June 30,  
($ in thousands)   2016     2015  
Net (loss) income   $ (90 )   $ 2,107  
Depreciation and amortization     359       318  
Interest and finance expense     530       433  
Income tax (benefit) provision     (208 )     90  
State and local franchise taxes     24       27  
Stock-based compensation     1,453       1,108  
Loss on extinguishment of debt     -       760  
Gain on reduction of contingent obligations     -       (3,000 )
Non-recurring facility exit charges     670       -  
Loss from discontinued operations, net     -       54  
Adjusted EBITDA   $ 2,738     $ 1,897  

 

The six months ended June 30, 2016 (the “Current Six Months”) compared with the six months ended June 30, 2015 (the “Prior Year Six Months”)

 

Total Revenues

Current Six Months total revenues increased approximately $4.60 million to $17.51 million from $12.91 million in the Prior Year Six Months. This increase was attributable to increases in net licensing revenues of approximately $4.64 million, partially offset by declines in net e-commerce sales of $0.05 million.

 

The increase in net licensing revenues for the Current Six Months as compared with the Prior Year Six Months was primarily due to (i) higher revenues from our interactive television business of approximately $4.07 million, largely driven by acquisitions made in late 2014 and 2015, and (ii) approximately $1.34 million of revenues recognized from new license agreements entered into in 2015. These increases were partially offset by a decrease in revenue of approximately $0.46 associated with the management and design of the LCNY brand, for which our contract subsequently ended in July 2016.

 

The decline in net e-commerce sales from the Prior Year Six Months is the result of management’s decision to phase out of e-commerce during 2016.

 

Gross Profit

Gross profit for the Current Six Months was $17.40 million, compared with $12.83 million for the Prior Year Six Months. The increase in gross profit was primarily attributable to the increase in net licensing revenues described above.

 

Operating Expenses

Operating expenses totaled $16.83 million for the Current Six Months, compared with $11.49 million for the Prior Year Six Months. The increase of approximately $5.34 million was primarily related to an increase in compensation-related expenses (including stock-based compensation) of approximately $2.80 million, an increase in design and marketing costs of approximately $0.57 million, and an increase in other selling, general and administrative expenses of approximately $1.77 million, which included non-recurring charges of $0.67 million incurred in the Current Six Months in connection with the exit from our former leased office facilities. These increases in expenses were the result of increased staffing and scaling of our operations and infrastructure in order to support (i) the C Wonder Brand, which we acquired in July 2015 and which began selling on QVC in March 2016, (ii) the development and operation of our quick-time-response or short lead time “virtual vertical” production platform, and (iii) launch and related ramp-up of the IMNYC Isaac Mizrahi, H Halston, and Highline Collective brands at Lord & Taylor and Hudson’s Bay department stores in April 2016.

 

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The increase in depreciation and amortization expense of approximately $0.20 million was primarily related to the amortization of the C Wonder trademarks acquired in July 2015, partially offset by certain other intangible assets becoming fully amortized in 2015 (see Note 2 in the Unaudited Condensed Consolidated Financial Statements).

 

Other Expenses (Income)

Total other income, net of $1.63 million for the Prior Year Six Months was comprised of a $3.00 million gain on the reduction of contingent obligations, partially offset by a $1.37 million loss on extinguishment of debt.

 

The gain on the reduction of contingent obligations was a result of the Company reducing the fair value of its contingent obligation on its earn-out obligation to the seller of the Isaac Mizrahi Brand, based on a revision of the timing of projected future net royalty income related to the Isaac Mizrahi business.

 

The loss on extinguishment of debt was a result of the Company satisfying $5.40 million principal amount of Ripka Seller Notes by issuing 600,001 shares of our common stock in March and April 2015. The carrying value, net of the discount, of the Ripka Seller Notes at the redemption date was $4.03 million, resulting in a loss of $1.37 million.

 

Interest and Finance Expense

Interest and finance expense for the Current Six Months increased by approximately $0.02 million to $0.96 million, compared with $0.94 million in the Prior Year Quarter. This increase was primarily due to the higher interest rate (the term debt interest rate was converted from a variable rate to a fixed rate) on our term debt following the February 2016 refinancing and fees associated with the refinancing, largely offset by lower interest expense following the satisfaction of $5.40 million principal amount of the Ripka Seller Notes in March 2015 and April 2015.

 

Income Tax (Benefit) Provision

The effective income tax rate for the Current Six Months was approximately 66% resulting in a $0.26 million income tax benefit. During the Current Six Months, the effective tax rate was attributable to recurring permanent differences. Based on the amount of loss from continuing operations before income taxes compared to the permanent differences, the effective rate increased by 25%.

 

The effective income tax rate for the Prior Year Six Months was approximately (1)% which resulted in a $0.02 million income tax benefit. For the Prior Year Six Months, the Company recorded a $3.00 million gain on the reduction of contingent obligations related to the acquisition of the Isaac Mizrahi Brand, partially offset by recurring permanent differences. This gain was not subject to tax and was therefore treated as a discrete item (permanent difference) occurring in the Prior Year Six Months. Based on the amount of income from continuing operations before income taxes compared to the permanent differences, the effective rate decreased by 42%.

 

Discontinued Operations

The loss from discontinued operations, net of $0.27 million in the Prior Year Six Months was related to our retail operations and was primarily attributable to compensation expense, other general and administrative expenses, and wind down costs associated with the closing of our retail stores, partially offset by an income tax benefit of $0.17 million. As these wind down and closure activities were essentially completed by the end of 2015, we had no such costs reported as discontinued operations in the Current Six Months.

 

Net (Loss) Income

The Company had a net loss of $0.14 million for the Current Six Months, compared with net income of $1.78 million for the Prior Year Six Months.

 

Non-GAAP Net Income, Non-GAAP Diluted EPS, and Adjusted EBITDA

The Company had non-GAAP net income of $3.36 million, or $0.17 per diluted share for the Current Six Months, compared with non-GAAP net income of $2.78 million, or non-GAAP diluted EPS of $0.18 for the Prior Year Six Months. The Company had Adjusted EBITDA of $4.74 million for the Current Six Months, compared with Adjusted EBITDA of $4.10 million for the Prior Year Six Months.

 

The following table is a reconciliation of net (loss) income (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP net income:

 

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    Six Months Ended June 30,  
($ in thousands)   2016     2015  
Net (loss) income   $ (135 )   $ 1,776  
Non-cash interest and finance expense     158       246  
Stock-based compensation     2,665       2,121  
Loss on extinguishment of debt     -       1,371  
Gain on reduction of contingent obligations     -       (3,000 )
Non-recurring facility exit charges     670       -  
Loss from discontinued operations, net     -       267  
Non-GAAP net income   $ 3,358     $ 2,781  

 

The following table is a reconciliation of diluted (loss) earnings per share to non-GAAP diluted EPS:

 

    Six Months Ended June 30,  
    2016     2015  
Diluted (loss) earnings per share   $ (0.01 )   $ 0.11  
Non-cash interest and finance expense     0.01       0.01  
Stock-based compensation     0.14       0.14  
Loss on extinguishment of debt     -       0.09  
Gain on reduction of contingent obligations             (0.19 )
Non-recurring facility exit charges     0.03       -  
Loss from discontinued operations, net     -       0.02  
Non-GAAP diluted EPS   $ 0.17     $ 0.18  
Non-GAAP weighted average diluted shares     19,268,245       15,575,406  

  

The following table is a reconciliation of basic weighted average shares to non-GAAP weighted average diluted shares:

 

    Six Months Ended June 30,  
    2016     2015  
Basic weighted average shares     18,565,198       14,462,305  
Effect of exercising warrants     663,270       971,873  
Effect of exercising stock options     39,777       141,228  
Non-GAAP weighted average diluted shares     19,268,245       15,575,406  

 

The following table is a reconciliation of net (loss) income (our most directly comparable financial measure presented in accordance with GAAP) to Adjusted EBITDA:

 

    Six Months Ended June 30,  
($ in thousands)   2016     2015  
Net (loss) income   $ (135 )   $ 1,776  
Depreciation and amortization     785       580  
Interest and finance expense     965       944  
Income tax benefit     (259 )     (16 )
State and local franchise taxes     49       56  
Stock-based compensation     2,665       2,121  
Loss on extinguishment of debt     -       1,371  
Gain on reduction of contingent obligations     -       (3,000 )
Non-recurring facility exit charges     670       -  
Loss from discontinued operations, net     -       267  
Adjusted EBITDA   $ 4,740     $ 4,099  

 

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Liquidity and Capital Resources

 

Liquidity

 

Our principal capital requirements have been to fund working capital needs, acquire new brands, and to a lesser extent, capital expenditures. At June 30, 2016 and December 31, 2015, our unrestricted cash and cash equivalents were $13.47 million and $16.86 million, respectively.

 

We expect that existing cash and operating cash flows will be adequate to meet our operating needs, debt service obligations (including debt service under the Loan Agreement), and capital expenditure needs, for at least the twelve months subsequent to June 30, 2016. We are dependent on our licensees for most of our revenues, and there is no assurance that the licensees will perform as projected.

 

Our business operating model generally does not require significant capital expenditures.

 

Our contingent obligations (see Note 4, Debt in the Unaudited Condensed Consolidated Financial Statements) are payable in stock or cash, at the Company’s discretion. Payment of these obligations in stock would not affect our liquidity.

 

Changes in Working Capital

 

At June 30, 2016 and December 31, 2015, our adjusted working capital (current assets less current liabilities, excluding current contingent obligations and seller notes payable in stock (see Note 4, Debt in the Unaudited Condensed Consolidated Financial Statements)) was $16.50 million and $16.14 million, respectively. Commentary on the components of our cash flows used in continuing operations for the Current Six Months as compared with the Prior Year Six Months is set forth below.

 

Operating Activities

 

Net cash provided by operating activities from continuing operations was approximately $2.33 million in the Current Six Months, compared with net cash used in operating activities from continuing operations of approximately $0.96 million in the Prior Year Six Months.

 

The Current Six Months’ cash provided by operating activities was due to the combination of a net loss of $(0.14) million and the net change in operating assets and liabilities of $(1.63) million, partially offset by non-cash expenses of $4.10 million. Non-cash expenses mainly consist of $2.67 million of stock-based compensation, $0.79 million of depreciation and amortization, $0.25 million of amortization of debt discount and deferred finance costs, and a non-cash charge of $0.65 million related to the exit from our former leased office facilities, partially offset by $(0.26) million of deferred income tax benefit. The net change in operating assets and liabilities includes an increase in accounts receivable of $2.48 million primarily attributable to increase in revenues.

 

The Prior Year Six Months’ cash used in operating activities from continuing operations was primarily comprised of the net change in operating assets and liabilities of $(4.22) million, partially offset by net income of $1.78 million, non-cash expenses of $1.22 million, and a net loss from discontinued operations of $0.27 million. Non-cash expenses mainly consisted of $2.12 million of stock-based compensation, $1.37 million of loss from the extinguishment of debt, $0.58 million of depreciation and amortization, $(3.0) million of gain from the reduction of contingent obligations, $0.32 million of amortization of debt discount and deferred finance costs, and $(0.15) million of tax benefits. The $(4.22) million change in operating assets and liabilities includes an increase of $2.90 million of accounts receivable primarily attributable to increase in revenues. Net cash provided by operating activities from discontinued operations was $0.21 million.

  

27  

 

 

Investing Activities

 

Net cash used in investing activities for the Current Six Months was approximately $2.12 million, compared with approximately $1.47 million in the Prior Year Six Months.

 

The Current Six Months’ net cash used in investing activities was attributable to $1.72 million of capital expenditures associated with leasehold improvements, furniture and fixtures, and equipment for our new corporate offices and operations facility, and $0.40 million of restricted cash related to the security deposit of the subtenant at our former office facilities.

 

The Prior Year Six Months’ net cash used in investing activities was primarily attributable to restricted cash of $1.11 million for a security deposit on the lease for our new office space, an advance deposit of $0.30 million made in connection with the C Wonder acquisition, and capital expenditures of $0.05 million.

 

Financing Activities

 

Net cash used in financing activities for the Current Six Months was approximately $3.60 million, primarily attributable to payments on our term debt obligations of $2.25 million, payment on our IM Seller Note obligation of $0.75 million, payment of the QVC Earn-Out obligation of $0.25 million, shares repurchased including vested restricted stock in exchange for withholding taxes of $0.30 million, and payment of deferred finance costs of $0.07 million.

 

Net cash used in financing activities for the Prior Year Six Months was approximately $3.70 million, primarily attributable to payment on our installment obligation related to the Ripka Brand of $2.18 million, repayments on our long-term debt of $1.26 million, and $0.32 million of costs associated with our July 2015 public equity offering.

 

Other Factors

 

We continue to seek to expand and diversify the types of licensed products being produced under our brands. We plan to continue to diversify the distribution channels within which licensed products are sold, in an effort to reduce dependence on any particular retailer, consumer, or market sector within each of our brands. The Mizrahi brand, H Halston brand, and C Wonder brand have a core business in fashion apparel and accessories. The Ripka brand historically has been focused on fine jewelry, which we believe helps diversify our industry focus while at the same time complements, expands on, and grows our overall business relationship with QVC. As of July 31, 2016, we no longer manage and design the Liz Claiborne New York brand. In April 2016, we brought the IMNYC Isaac Mizrahi, H Halston, and Highline Collective brands to Lord & Taylor and The Bay department stores through our quick-time-response direct-to-retail “virtual vertical” platform, and plan to do the same with the C Wonder Limited brand later this year. We also intend to seek new opportunities, including expansion through interactive television business and additional domestic and international licensing arrangements, and acquiring additional brands. Our success, however, will still remain largely dependent on our ability to build and maintain our brands’ awareness and contract with and retain key licensees, as well as our licensees’ ability to accurately predict upcoming fashion and design trends within their respective customer bases and fulfill the product requirements of their particular retail channels within the global marketplace. Unanticipated changes in consumer fashion preferences, slowdowns in the U.S. economy, changes in the prices of supplies, consolidation of retail establishments, and other factors noted in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015 as filed with the SEC could adversely affect our licensees’ ability to meet and/or exceed their contractual commitments to us and thereby adversely affect our future operating results.

 

Effects of Inflation

 

We do not believe that the relatively moderate rates of inflation experienced over the past two years in the United States, where we primarily compete, have had a significant effect on revenues or profitability. If there were an adverse change in the rate of inflation by less than 10%, the expected effect on net income and cash flows would be immaterial. 

 

28  

 

 

Off-Balance Sheet Arrangements

 

We do not have any 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, or liquidity.  

 

Critical Accounting Policies

 

The preparation of our unaudited condensed consolidated financial statements in conformity with GAAP requires management to exercise judgment. We exercise considerable judgment with respect to establishing sound accounting policies and in making estimates and assumptions that affect the reported amounts of our assets and liabilities, our recognition of revenues and expenses, and disclosure of commitments and contingencies at the date of the financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates and judgments on a variety of factors, including our historical experience, knowledge of our business and industry and current and expected economic conditions 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. We periodically re-evaluate our estimates and assumptions with respect to these judgments and modify our approach when circumstances indicate that modifications are necessary. While we believe that the factors we evaluate provide us with a meaningful basis for establishing and applying sound accounting policies, we cannot guarantee that the results will always be accurate. Because the determination of these estimates requires the exercise of judgment, actual results could differ from such estimates. 

 

Please refer to our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 17, 2016, for a discussion of our critical accounting policies. During the three and six months ended June 30, 2016, there were no material changes to these policies.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable to smaller reporting companies.

 

ITEM 4. CONTROLS AND PROCEDURES

 

A. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES:

 

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2016, the end of the period covered by this report. Based on, and as of the date of such evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of June 30, 2016 such that the information required to be disclosed in our SEC reports is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

B. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:

 

There have not been any significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

29  

 

  

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

In the ordinary course of business, from time to time we become involved in legal claims and litigation. In the opinion of management, based on consultations with legal counsel, the disposition of litigation currently pending against us is unlikely to have, individually or in the aggregate, a materially adverse effect on our business, financial position or results of operations.

  

ITEM 1A. RISK FACTORS

 

We operate in a highly competitive industry that involves numerous known and unknown risks and uncertainties that could impact our operations. The risks described in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2015 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our financial condition and/or operating results.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

There were no sales of unregistered or registered securities during the six months ended June 30, 2016.

 

The following table provides information with respect to shares of common stock we repurchased during the six months ended June 30, 2016:

 

Period   Total Number of
Shares
Purchased
    Average
Price per
Share
    Total Number of Shares
Purchased as
Part of a Publicly Announced
Plan or Program
 
March 1, 2016 to March 31, 2016 (i)     52,000       5.80       -  
Total     52,000     $ 5.80       -  

 

(i) The shares were exchanged from employees in connection with the income tax withholding obligations on behalf of such employees from the vesting of restricted stock.

   

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

30  

 

 

ITEM 6. EXHIBITS

 

The following exhibits are filed herewith:

 

31.1 Rule 13a-14(a)/15d-14(a) Certification (CEO)

31.2 Rule 13a-14(a)/15d-14(a) Certification (CFO)

32.1 Section 1350 Certification (CEO)

32.2 Section 1350 Certification (CFO)

101.INS XBRL Instance Document

101.SCH XBRL Taxonomy Extension Schema Document

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF XBRL Taxonomy Extension Definitions Linkbase Document

101.LAB XBRL Taxonomy Extension Label Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

 

31  

 

  

SIGNATURES

 

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

 

Date: August 10, 2016 By: /s/ Robert W. D’Loren
    Name: Robert W. D’Loren
    Title: Chairman and Chief Executive Officer
     
  By: /s/ James Haran
    Name: James Haran
    Title: Chief Financial Officer and Vice President

 

32  

 

EXHIBIT 31.1

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, Robert W. D’Loren certify that:

 

1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 of Xcel Brands, Inc. (the “Company”).

 

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

August 10, 2016 By: /s/ Robert W. D’Loren
    Name: Robert W. D’Loren
    Title: Chairman and Chief Executive Officer

 

 

 

EXHIBIT 31.2

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, James Haran certify that:

 

1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 of Xcel Brands, Inc. (the “Company”).

 

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

 

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the Company's board of directors (or persons performing the equivalent functions):

 

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

August 10, 2016 By: /s/ James Haran
    Name: James Haran
    Title: Chief Financial Officer  and Vice President

 

 

 

EXHIBIT 32.1

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of Xcel Brands, Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2016 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert W. D’Loren certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

 

August 10, 2016 By: /s/ Robert W. D’Loren
    Name: Robert W. D’Loren
    Title: Chairman and Chief Executive Officer

  

 

 

EXHIBIT 32.2

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of Xcel Brands, Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2016 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James Haran, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

 

August 10, 2016 By: /s/ James Haran
    Name: James Haran
    Title: Chief Financial Officer and Vice President