Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read together with our consolidated financial statements and the notes thereto, included in Item 8 of this Annual Report on Form 10-K. This discussion summarizes the significant factors affecting our consolidated operating results, financial condition and liquidity and cash flows for the years ended December 31, 2020 and 2019. Except for historical information, the matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements that involve risks and uncertainties and are based upon judgments concerning factors that are beyond our control.
Overview
Xcel Brands is a media and consumer products company engaged in the design, production, marketing, wholesale and direct-to-consumer sales of branded apparel, footwear, accessories, fine jewelry, home goods and other consumer products, and the acquisition of dynamic consumer lifestyle brands. The Company’s brands have generated over $3 billion in retail sales via live streaming in interactive television and digital channels alone.
Xcel was founded in 2011 with a vision to reimagine shopping, entertainment, and social media as one thing. Xcel owns the Isaac Mizrahi, Halston, Judith Ripka, C Wonder, and Longaberger brands, pioneering a ubiquitous sales strategy which includes the promotion and sale of products under its brands through interactive television, digital live-stream shopping, brick-and-mortar retail,wholesale and e-commerce channels.
To grow our brands, we are focused on the following primary strategies:
● expanding and leveraging our live-streaming platform. We recently launched our live-streaming platform through our Longaberger brand technology platform with the goal to build the world’s largest digital marketplace powered by live-streaming and micro-influencers for home and other related products, designed to create a better lifestyle. We plan to leverage this technology across our other brands.
● wholesale distribution of our brands to retailers that sell to the end consumer;
● wholesale sales and/or licensing our brands for sale through interactive television (i.e., QVC, HSN, The Shopping Channel, TVSN, etc.);
● licensing our brands to manufacturers and retailers for promotion and distribution through e-commerce, social commerce, and traditional brick-and-mortar retail channels whereby we provide certain design services;
● distribution of our brands through e-commerce directly to the end consumer; and
● acquiring additional consumer brands and integrating them into our operating platform and leveraging our operating infrastructure and distribution relationships.
We believe that we offer a unique value proposition to our retail and direct-to-consumer customers, and our licensees for the following reasons:
● our management team, including our officers’ and directors’ experience in, and relationships within, the industry;
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● our deep knowledge and expertise in live-streaming sales;
● our design, production, sales, marketing, and supply chain and integrated technology platform enables us to design, market, and distribute trend-right product; and
● our operating strategy, significant media and internet presence and distribution network.
Our vision is intended to reimagine shopping, entertainment, and social media as one thing. By leveraging live streaming, digital, and social media content across all distribution channels, we seek to drive consumer engagement and generate retail sales across our brands. Our strong relationships with leading retailers, interactive television companies, and streaming networks enable us to reach consumers in over 380 million homes worldwide and hundreds of millions of social media followers.
We believe our design, production, and supply chain platform provides significant competitive advantages compared with traditional wholesale consumer products companies that design, manufacture, and distribute products. We focus on our core competencies of live streaming, marking, design, integrated technologies, production and supply chain platform, and brand development. We believe that we offer a 360-degree solution to our retail partners that addresses many of the challenges facing the retail industry today. We believe our platform is highly scalable. Additionally, we believe we can acquire additional brands into our platform in order to leverage our operating infrastructure, marketing capabilities, and distribution network.
Summary of Critical Accounting Policies
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Critical accounting policies are those that are the most important to the portrayal of our financial condition and results of operations, and that require our most difficult, subjective, and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. While our significant accounting policies are described in more detail in the notes to our consolidated financial statements, our most critical accounting policies, discussed below, pertain to revenue recognition, trademarks and other intangible assets, stock-based compensation, fair value of contingent obligations, and income taxes. In applying such policies, we must use some amounts that are based upon our informed judgments and best estimates. Estimates, by their nature, are based upon judgments and available information. The estimates that we make are based upon historical factors, current circumstances, and the experience and judgment of management. We evaluate our assumptions and estimates on an ongoing basis.
Revenue Recognition
Licensing
In connection with our licensing model, we follow Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606-10-55-65, by which we recognize revenue at the later of when (1) the subsequent sale or usage occurs or (2) the performance obligation to which some or all of the sales- or usage-based royalty has been allocated is satisfied (in whole or in part). More specifically, we separately identify:
(i) Contracts for which, based on experience, royalties are expected to exceed any applicable minimum guaranteed payments, and to which an output-based measure of progress based on the “right to invoice” practical expedient is applied because the royalties due for each period correlate directly with the value to the customer of our performance in each period (this approach is identified as “View A” by the FASB Revenue Recognition Transition Resource Group, “TRG”); and
(ii) Contracts for which revenue is recognized based on minimum guaranteed payments using an appropriate measure of progress, in which minimum guaranteed payments are straight-lined over the term of the contract and recognized ratably based on the passage of time, and to which the royalty recognition constraint to the sales-based
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royalties in excess of minimum guaranteed is applied and such sales-based royalties are recognized to distinct period only when the minimum guaranteed is exceeded on a cumulative basis (this approach is identified as “View C” by the TRG).
Wholesale Sales
We generate revenue through sale of branded jewelry and apparel to both domestic and international customers who, in turn, sell the products to their consumers. We recognize revenue when performance obligations identified under the terms of contracts with our customers are satisfied, which occurs upon the transfer of control of the merchandise in accordance with the contractual terms and conditions of the sale.
Direct to Consumer Sales
Our revenue associated with our e-commerce jewelry operations and the Longaberger brand is recognized at a point in time when product is shipped to the customer.
Trademarks and Other Intangible Assets
We follow ASC Topic 350, “Intangibles - Goodwill and Other.” Under this standard, goodwill and indefinite-lived intangible assets are not amortized, but are required to be assessed for impairment at least annually. Our finite-lived intangible assets are amortized over their estimated useful lives.
We perform our annual quantitative analysis of indefinite-lived intangible assets as of December 31 each year. As a result of performing our annual impairment testing of indefinite-lived intangible assets for the year ended December 31, 2019, we recorded a $6.2 million impairment charge related to the Ripka Brand trademarks, driven by the timing of the continued transition from a licensing model to a wholesale and direct-to-consumer model.
Effective January 1, 2020, we determined that the Ripka Brand, inclusive of all its trademarks, has a finite life of 15 years, and began to amortize these trademarks on a straight-line basis accordingly. During the year ended December 31, 2020, delays and uncertainty in implementing the brick-and-mortar retail store strategy for a portion of the Ripka Brand, primarily as a result of the novel coronavirus disease pandemic, indicated that the carrying value of the Ripka Brand trademarks may not be recoverable. Therefore, we performed an impairment test of finite-lived intangible assets, and as a result, recorded a $13.0 million impairment charge related to the Ripka Brand trademarks.
No other impairment charges were recorded for intangible assets for the years ended December 31, 2020 and 2019.
Indefinite-Lived Intangibles
The Company tests its indefinite-lived intangible assets for recovery in accordance with ASC 820-10-55-3F, which states that the income approach (“Income Approach”) converts future amounts (for example, cash flows) into a single current (that is, discounted) amount. When the Income Approach is used, fair value measurement reflects current market expectations about those future amounts. The Income Approach is based on the present value of future earnings expected to be generated by a business or asset. Income projections for a future period are discounted at a rate commensurate with the degree of risk associated with future proceeds. A residual or terminal value is also added to the present value of the income to quantify the value of the business beyond the projection period. As such, recoverability of such assets is measured by a comparison of the carrying amount of the asset to its expected future discounted net cash flows. If the carrying amount of such assets is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the recoverability of the assets.
Finite-Lived Intangibles
The Company’s finite-lived intangible assets, including Trademarks, are reviewed for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. An impairment loss is recognized if the carrying amount of a finite-lived intangible asset is not recoverable and its carrying amount exceeds its fair value.
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With reference to our finite-lived intangible assets’ impairment process, the Company groups assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities and evaluate the asset group against the sum of undiscounted future cash flows. If the undiscounted cash flows do not indicate the carrying amount of the asset is recoverable, an impairment charge is measured as the amount by which the carrying amount of the asset group exceeds its fair value based on discounted cash flows analysis or appraisals.
Leases
We determine if an arrangement is a lease at inception. At commencement of a lease, we recognize an operating lease right-of-use (“ROU”) asset, representing our right to use the underlying leased asset for the lease term, and a lease liability, representing our obligation to make future lease payments, based on the present value of the remaining lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We may use the implicit rate when readily determinable. Operating lease ROU assets also include scheduled lease payments made and initial direct costs, and exclude lease incentives and accrued rent. Lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for operating lease payments related to office leases is generally recognized on a straight-line basis over the lease term. Lease expense for operating lease payments related to retail leases is generally recognized on a straight-line basis over the period of operation, as this is representative of the pattern in which benefit is derived from the lease.
For real estate leases, we account for the lease and non-lease components as a single lease component. Variable lease payments that do not depend on an index or rate (such as real estate taxes and building insurance and lessee’s shares thereof), if any, are excluded from lease payments at lease commencement date for initial measurement. Subsequent to initial measurement, these variable payments are recognized when the event determining the amount of variable consideration to be paid occurs.
For leases with a term of 12 months or less, we do not recognize lease liabilities and ROU assets, but recognize the lease payments in net income on a straight-line basis over the respective lease terms.
We recognize income from subleases (in which we are the sublessor) on a straight-line basis over the term of the sublease, as a reduction to lease expense.
Income Taxes
Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities. Deferred income taxes are determined based on the temporary difference between the financial reporting and tax bases of assets and liabilities using enacted rates in effect during the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. ASC Topic 740, “Accounting for Income Taxes” clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. Tax positions shall initially be recognized in the financial statements when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that has a probability of fifty percent or greater of being realized upon ultimate settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Tax years that remain open for assessment for federal and state tax purposes include the years ended December 31, 2017 through December 31, 2020.
Recently Issued Accounting Pronouncements
In December 2019, the FASB issued Accounting Standards Update (“ASU”) No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” This ASU removes certain exceptions to the general principles in Topic 740, including, but not limited to, intraperiod tax allocations and interim period tax calculations. The ASU also provides additional clarification and guidance related to recognition of franchise taxes and changes in tax laws. This guidance is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15,
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2020, with early adoption permitted. The adoption of this new guidance in 2021 will not have any significant impact on our results of operations, cash flows, and financial condition.
In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which was subsequently amended in November 2018 through ASU No. 2018-19. This ASU will require entities to estimate lifetime expected credit losses for financial instruments, including trade and other receivables, which will result in earlier recognition of credit losses. In November 2019, the FASB issued ASU No. 2019-10, which, among other things, deferred the application of the new guidance on credit losses for smaller reporting companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We are currently evaluating the new guidance to determine the impact the adoption of this guidance will have on our results of operations, cash flows, and financial condition.
Recently Adopted Accounting Pronouncements
We adopted ASU No. 2018‑13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” effective January 1, 2020. This ASU adds, modifies, and removes several disclosure requirements relative to the three levels of inputs used to measure fair value in accordance with Topic 820, “Fair Value Measurement.” The adoption of this new guidance did not have any impact on our results of operations, cash flows, and financial condition.
We adopted ASU No. 2016-02, “Leases,” effective January 1, 2019, by applying the new guidance under the additional and alternative transition method allowed by ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements.” As of January 1, 2019, the adoption resulted in the recognition of operating lease right-of-use assets of approximately $10.4 million, lease liabilities of approximately $13.2 million, and a decrease of approximately $2.8 million in accrued rent. The adoption of the new lease accounting guidance did not have an impact on our consolidated statement of operations, and had no impact on cash provided by or used in operating, financing, or investing activities in our consolidated statement of cash flows. We elected the available practical expedients under ASC 842-10-15-37 (thereby not separating lease components from non-lease components and instead accounting for all components as a single lease component) and ASC 842-10-65-1 (thereby, among other things, not reassessing lease classification), and implemented changes to our processes and methodologies related to leases to enable the preparation of financial information upon adoption and to allow for the correct identification, classification, and measurement of leases in accordance with the new guidance going forward.
Summary of Operating Results
The consolidated financial statements and related notes included elsewhere in this Form 10-K are as of or for the year ended December 31, 2020 (the “Current Year”), and the year ended December 31, 2019 (the “Prior Year”).
Revenues
Current Year net revenue decreased approximately $12.3 million to $29.4 million from $41.7 million for the Prior Year.
Net licensing revenue decreased by $6.2 million in the Current Year to approximately $20.2 million, compared with $26.4 million in the Prior Year. This decline was primarily driven by a combination of (i) lower customer sales by our licensees as a result of government-ordered retail store closures as well as an overall slowdown in economic activity related to the COVID-19 pandemic, (ii) a $3.0 million reduction in guaranteed minimum revenues from one of our existing licensing arrangements upon renewal effective January 1, 2020, and (iii) a $1.7 million reduction in revenues from another one of our existing licensing arrangements changing from guaranteed minimum amounts to sales-based royalties effective April 1, 2019.
Net product sales decreased by approximately $6.1 million in the Current Year to $9.2 million, compared with approximately $15.3 million in the Prior Year. The decline in net product sales was primarily driven by lower sales as a result of government-ordered retail store closures as well as an overall slowdown in economic activity related to the COVID-19 pandemic following the outbreak of the pandemic, partially offset by volume growth in our apparel wholesale business in the first quarter of 2020.
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Cost of Goods Sold
Current Year cost of goods sold was $5.5 million, compared with $10.3 million for the Prior Year. This decrease was due to lower overall volume of wholesale and e-commerce sales in the Current Year. Gross profit (net revenue less cost of goods sold) decreased approximately $7.4 million to $24.1 million from $31.5 million in the Prior Year, primarily driven by the aforementioned decline in net licensing revenue.
Gross profit margin from product sales increased from 33% in the Prior Year to 41% in the Current Year as a result of achieving greater efficiencies in our wholesale business operations. Total gross profit margin was 75% in the Prior Year and 81% in the Current Year; this increase was the result of the aforementioned increase in gross profit margins for product sales as well as the proportional shift of revenue mix towards licensing revenues in the Current Year.
Operating Costs and Expenses
Operating costs and expenses increased approximately $3.5 million from $36.9 million in the Prior Year to $40.4 million in the Current Year.
This increase was primarily due to a $13.0 million non-cash impairment charge recorded in the Current Year related to the Ripka Brand trademarks, driven by delays and uncertainty in implementing the brick-and-mortar retail store strategy for a portion of the brand, primarily as a result of the COVID-19 pandemic, compared with a similar $6.2 million non-cash impairment charge recorded in the Prior Year related to the Ripka Brand trademarks, which was driven by the timing of the transition from a licensing model to a wholesale and direct-to-consumer model. Also contributing to the increase was a $1.6 million increase in depreciation and amortization expense, primarily due to the change in estimated life for the Judith Ripka trademarks as of January 1, 2020, and $1.0 million of bad debt expense recognized in the Current Year related to the bankruptcy of several retail customers due to the COVID-19 pandemic.
These increases in operating costs and expenses were partially offset by various cost reduction actions taken by management during the Current Year in response to the COVID-19 pandemic, including temporary reductions of employee compensation from April to December of 2020 and cutting non-essential costs, as well as government assistance received through the Paycheck Protection Program under the CARES Act, for which the Company recognized $1.8 million as a reduction to Current Year operating costs and expenses. Additionally, there were $1.3 million of costs incurred in the Prior Year in connection with a potential acquisition, which ultimately was not consummated; approximately $0.2 million of these costs were recovered or reimbursed in the Current Year.
Other Income
During the Current Year, we recognized a $0.05 million net gain on the sale of certain assets related to the Longaberger brand.
During the Prior Year, we recognized a $2.85 million gain on the reduction of contingent obligations related to the 2015 acquisition of the C Wonder Brand. As part of that acquisition, the seller was eligible to earn additional consideration based on future royalties related to the C Wonder Brand exceeding certain thresholds, and we recorded a liability for the potential future payment of such consideration. The final earn-out period ended on June 30, 2019, and the seller ultimately did not earn any additional consideration under the terms of the purchase agreement.
Interest and Finance Expense
Interest and finance expense for the Current Year was $1.2 million, compared with $1.5 million for the Prior Year. This decrease is primarily attributable to the fact that the Prior Year includes a $0.2 million loss on extinguishment of debt as a result of the February 11, 2019 term loan amendment, with no such comparable extinguishment loss in the current Year. The remainder of the decrease is largely due to a lower outstanding principal balance on our term loan resulting from regular debt service payments.
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Income Tax (Benefit) Provision
The effective income tax rate for the Current Year was approximately 25.9% resulting in a $4.5 million income tax benefit. During the Current Year, the effective tax rate was impacted by the vesting of restricted shares of common stock. The excess tax deficiencies were treated as a discrete item in the determination of the tax provision as required by ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” decreasing the effective rate by approximately 1.9%. The effective tax rate was also impacted by recurring permanent differences, which, based on the amount of income before income taxes compared to the permanent differences, increased the effective rate in 2020 by approximately 4.0%. The largest such recurring permanent differences were state and local tax provisions, which increased the effective rate in 2020 by approximately 4.5%, and disallowed excess compensation, which decreased the effective rate in 2020 by approximately 0.5%. Also impacting the effective rate for 2020 was the addback impact of the Paycheck Protection Program, which increased the effective rate by approximately 2.2%.
The effective income tax rate for the Prior Year was approximately 15.8% resulting in a $0.6 million income tax benefit. During the Prior Year, the effective tax rate was impacted by the vesting of restricted shares of common stock. The excess tax deficiencies were treated as a discrete item in the determination of the tax provision as required by ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” decreasing the effective rate by approximately 7.0%. The effective tax rate was also impacted by recurring permanent differences, which, based on the amount of income before income taxes compared to the permanent differences, increased the effective rate in 2019 by approximately 1.8%. The largest such recurring permanent differences were state and local tax provisions, which increased the effective rate in 2019 by approximately 7.4%, and was largely offset by the effect of disallowed excess compensation, which decreased the effective rate in 2019 by approximately 5.1%.
Net Loss
We had a net loss of approximately $13.1 million for the Current Year, compared with a net loss of approximately $3.4 million for the Prior Year, as a result of the factors discussed above.
Non-GAAP Net Income, Non-GAAP Diluted EPS and Adjusted EBITDA
We had non-GAAP net income of $1.8 million or $0.10 per share (“non-GAAP diluted EPS”) based on 19,152,569 weighted average shares outstanding for the Current Year, compared with non-GAAP net income of $4.8 million, or $0.25 per share based on 18,858,379 weighted average shares outstanding for the Prior Year. Non-GAAP net income is a non-GAAP unaudited term, which we define as net income (loss) attributable to Xcel Brands, Inc. stockholders, exclusive of amortization of trademarks, stock-based compensation, non-cash interest and finance expense from discounted debt related to acquired assets, loss on extinguishment of debt, gain on sales of assets, gain on reduction of contingent obligations, costs (recoveries) in connection with potential acquisitions, certain adjustments to allowances for doubtful accounts related to debtors that have filed for bankruptcy protection triggered by the impact of COVID-19, asset impairments, and deferred income taxes. 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.
We had Adjusted EBITDA of $4.1 million for the Current Year, compared with Adjusted EBITDA of approximately $7.1 million for the Prior Year. Adjusted EBITDA is a non-GAAP unaudited measure, which we define as net income (loss) attributable to Xcel Brands, Inc. stockholders before depreciation and amortization, interest and finance expenses (including loss on extinguishment of debt, if any), income taxes, other state and local franchise taxes, stock-based compensation, gain on reduction of contingent obligations, gain on sale of assets, costs (recoveries) in connection with potential acquisitions, asset impairments, and certain adjustments to allowances for doubtful accounts related to debtors that have filed for bankruptcy protection triggered by the impact of COVID-19.
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 these measures adjust for certain costs and other events that management believes are not representative of our core business operating results, and thus these non-GAAP measures provide
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supplemental information to assist investors in evaluating the Company’s financial results. The Company has incurred certain costs which it could have eliminated but elected not to do so in light of government assistance received through the Paycheck Protection Program under the CARES Act (the “PPP Benefit”), which represents a cash benefit directly related to the Company’s operating expenses incurred. Accordingly, the PPP Benefit is not considered a reconciling item for purposes of the computation of non-GAAP net income and Adjusted EBITDA. Adjusted EBITDA is the measure used to calculate compliance with the EBITDA covenant under our term loan agreement with BHI.
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 these measures in a different manner than we do.
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 (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP net income:
Year Ended December 31,
($ in thousands)
2020
2019
Net loss attributable to Xcel Brands, Inc. stockholders
$
(12,936)
$
(3,426)
Intangible asset impairments
13,000
6,200
Amortization of trademarks
4,432
3,105
Non-cash interest and finance expense
—
16
Stock-based compensation
850
976
Loss on extinguishment of debt
—
189
(Recovery of) costs in connection with potential acquisition
(158)
1,290
Certain adjustments to allowances for doubtful accounts
971
—
Property and equipment impairment
113
—
Gain on sale of assets
(46)
—
Gain on reduction of contingent obligation
—
(2,850)
Deferred income tax benefit
(4,382)
(705)
Non-GAAP net income
$
1,844
$
4,795
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The following table is a reconciliation of diluted (loss) earnings per share to non-GAAP diluted EPS:
Year Ended December 31,
2020
2019
Diluted loss per share attributable to Xcel Brands, Inc. stockholders
$
(0.68)
$
(0.18)
Intangible asset impairments
0.68
0.33
Amortization of trademarks
0.23
0.16
Non-cash interest and finance expense
—
0.00
Stock-based compensation
0.04
0.05
Loss on extinguishment of debt
—
0.01
(Recovery of) costs in connection with potential acquisitions
(0.01)
0.07
Certain adjustments to allowances for doubtful accounts
0.05
—
Property and equipment impairment
0.01
—
Gain on sale of assets
0.00
—
Gain on reduction of contingent obligation
—
(0.15)
Deferred income tax (benefit) provision
(0.22)
(0.04)
Non-GAAP diluted EPS
$
0.10
$
0.25
Diluted weighted average shares outstanding
19,152,569
18,858,379
The following table is a reconciliation of basic weighted average shares outstanding to non-GAAP diluted weighted average shares outstanding:
Year Ended December 31,
2020
2019
Basic weighted average shares
19,117,460
18,857,657
Effect of exercising warrants
490
722
Effect of exercising stock options
34,619
—
Non-GAAP diluted weighted average shares outstanding
19,152,569
18,858,379
The following table is a reconciliation of net loss (our most directly comparable financial measure presented in accordance with GAAP) to Adjusted EBITDA:
Year Ended December 31,
($ in thousands)
2020
2019
Net loss attributable to Xcel Brands, Inc. stockholders
$
(12,936)
$
(3,426)
Intangible asset impairments
13,000
6,200
Depreciation and amortization
5,497
3,902
Interest and finance expense
1,193
1,474
Income tax benefit
(4,518)
(642)
State and local franchise taxes
145
197
Stock-based compensation
850
976
(Recovery of) costs in connection with potential acquisition
(158)
1,290
Certain adjustments to allowances for doubtful accounts
971
—
Property and equipment impairment
113
—
Gain on sale of assets
(46)
—
Gain on reduction of contingent obligation
—
(2,850)
Adjusted EBITDA
$
4,111
$
7,121
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Liquidity and Capital Resources
General
As of December 31, 2020 and 2019, our cash and cash equivalents were $5.0 million and $4.6 million, respectively. Restricted cash at December 31, 2020 and 2019 consisted of $1.1 million of cash deposited with Bank Hapoalim B.M. (“BHI”) as collateral for an irrevocable standby letter of credit associated with the lease of our current corporate office and operating facility.
Our principal capital requirements have been to fund working capital needs, acquire new brands, and to a lesser extent, capital expenditures. Notwithstanding our recent investments in our ERP system, our business operating model generally does not require material capital expenditures, and as of December 31, 2020, we have no significant commitments for future capital expenditures. Material cash requirements from known contractual and other obligations are discussed under “Obligations and Commitments” below.
We expect that existing cash and operating cash flows will be adequate to meet our operating needs, term debt service obligations, and capital expenditure needs, for at least the twelve months subsequent to the filing date of this Annual Report on Form 10-K. We believe that cash from future operations, including growth opportunities and future business development, as well as currently available cash, will be sufficient to satisfy our anticipated long-term operating needs, including our debt service requirements and making necessary investments in our infrastructure and technology, for the foreseeable future beyond the next twelve months.
Changes in Working Capital
Our working capital (current assets less current liabilities, excluding the current portion of lease obligations and any contingent liabilities payable in common stock) was $7.9 million and $9.5 million as of December 31, 2020 and 2019, respectively. This decrease in working capital was primarily due to lower accounts receivable at December 31, 2020 as a result of the combination of lower sales during the Current Year and increased allowances for doubtful accounts. Commentary on components of our cash flows for the Current Year compared with the Prior Year is set forth below. Working capital as of December 31, 2020 included $8.9 million of accounts receivable; substantially all of this balance was collected subsequent to year-end.
Operating Activities
Net cash provided by operating activities was approximately $3.2 million and $3.5 million in the Current Year and Prior Year, respectively.
The Current Year’s cash provided by operating activities was primarily attributable to the combination of the net loss of $(13.1) million plus non-cash expenses of approximately $16.2 million, and a net change in operating assets and liabilities of approximately $0.1 million. The net loss of $(13.1) million includes $1.8 million of government assistance received through the PPP under the CARES Act, which was recognized as a reduction to Current Year expenses for which the program was intended to compensate. Non-cash net expenses were primarily comprised of a $13.0 million intangible asset impairment charge, $5.5 million of depreciation and amortization, $1.0 million of bad debt expense, $0.9 million of stock-based compensation, and $(4.4) million of deferred income tax benefit. The net change in operating assets and liabilities includes a decrease in accounts receivable of $0.7 million, an increase in inventory of $(0.3) million, a decrease in prepaid expenses and other assets of $0.6 million, and a decrease in accounts payable, accrued expenses and other current liabilities of $(0.5) million, all of which are primarily due to timing of collections and payments, and cash paid in excess of rent expense of $(0.4) million.
The Prior Year’s cash provided by operating activities was primarily attributable to the combination of the net loss of $(3.4) million plus non-cash expenses of approximately $7.8 million, partially offset by a net change in operating assets and liabilities of approximately $(0.9) million. Non-cash net expenses mainly consisted of a $6.2 million intangible asset impairment charge, $3.9 million of depreciation and amortization, $1.0 million of stock-based compensation, $(0.7) million of deferred income tax benefit, $(2.9) million of gain on reduction of contingent obligations, and $0.2 million of
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loss on extinguishment of debt. The net change in operating assets and liabilities includes a decrease in accounts receivable of $0.4 million, a decrease in inventory of $1.1 million, and a decrease in accounts payable, accrued expenses and other current liabilities of $(1.7) million, all of which are primarily due to timing of collections and payments, and cash paid in excess of rent expense of $(0.4) million.
Investing Activities
Net cash used in investing activities for the Current Year was approximately $0.7 million, compared with $10.3 million in the Prior Year. Cash used in investing activities for the Current Year was primarily attributable to capital expenditures, a substantial portion of which relates to the implementation of our ERP system. Cash used in investing activities in the Prior Year was primarily related to $8.8 million in cash consideration paid to acquire the Halston Heritage Brands, as well as capital expenditures of $1.1 million predominantly related to implementation of our ERP system.
Financing Activities
Net cash used in financing activities for the Current Year was approximately $(2.2) million, and was primarily attributable to payments made on long-term debt obligations of $(2.3) million, cash contributions received from the non-controlling interest holder in Longaberger Licensing, LLC of $0.3 million, and $(0.2) million of shares repurchased related to vested restricted stock in exchange for withholding taxes.
Net cash provided by financing activities for the Prior Year was approximately $2.3 million, and was primarily attributable to proceeds received from long-term debt of $7.5 million, partially offset by payments made on our senior term debt obligation of $(4.0) million, the final payment on the IM Seller Note obligation of $(0.7) million, and payment of $(0.3) million of deferred finance costs.
Obligations and Commitments
Term Loan Debt
On February 26, 2016, the Company 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 with Bank Hapoalim B.M. as agent, and the financial institutions party thereto as lenders.
On February 11, 2019, concurrent with the Closing Date of the acquisition of the Halston Heritage Brands (see Note 3 to the notes to financial statements), the Company entered into an amended loan agreement with BHI (the “Loan Agreement”), which amended and restated the prior term loan. Immediately prior to February 11, 2019, the aggregate principal amount of the prior term loan was $14.5 million. Pursuant to the Loan Agreement, the Lenders have extended to Xcel an additional term loan in the amount of $7.5 million, such that, as of February 11, 2019, the aggregate outstanding balance of all the term loans extended by BHI to Xcel was $22.0 million, which amount has been divided under the Loan Agreement into two term loans: (1) a term loan in the amount of $7.3 million (“Term Loan A”) and (2) a term loan in the amount of $14.7 million (“Term Loan B” and, together with Term Loan A, the “Term Loans”). The proceeds of the additional term loan were used to finance the Halston Heritage Brands acquisition.
The terms and conditions of the Loan Agreement resulted in significantly different debt service payment requirements, compared with the prior term loan, including an increase of $7.5 million in the principal balance, and related changes to the timing and amount of principal payments, as well as changes in the interest rate. Management assessed and determined that this amendment resulted in an extinguishment of debt and recognized a loss of $0.2 million (consisting of unamortized deferred finance costs) during the year ended December 31, 2019.
The Loan Agreement also allows that BHI and any other lender party to the Loan Agreement (collectively, the “Lenders”) can provide to Xcel a revolving loan facility and a letter of credit facility, the terms of each of which shall be agreed to by Xcel and the Lenders. Amounts advanced under the revolving loan facility (the “Revolving Loans”) will be used for the purpose of consummating acquisitions by Xcel or its subsidiaries that are or become parties to the Loan Agreement. Xcel
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will have the right to convert Revolving Loans to incremental term loans (the “Incremental Term Loans”) in minimum amounts of $5.0 million. The Company has not drawn down any funds under either the revolving loan facility or letter of credit facility.
On April 13, 2020, the Company and BHI amended the Loan Agreement. Under this amendment, the quarterly installment payment due March 31, 2020 was deferred, and the amounts of the quarterly installment payments due throughout the remainder of 2020 were reduced, while the amount of principal to be repaid through variable payments based on excess cash flow was increased. In addition, there were multiple changes and waivers to the various financial covenants. Further, this amendment permitted Xcel to incur unsecured debt through the Paycheck Protection Program (“PPP”) under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), and excludes any associated PPP debt and debt service from the covenant calculations. There were no changes to the total principal balance, interest rate, or maturity date.
On August 18, 2020, the Company and BHI further amended the Loan Agreement. Under this amendment, the amounts of the quarterly installment payments due throughout 2021 were reduced, and the amount of principal to be repaid through variable payments based on excess cash flow was increased. In addition, there were multiple changes and waivers to the various financial covenants. There were no changes to the total principal balance, interest rate, or maturity date.
The Term Loans mature on December 31, 2023, Incremental Term Loans shall mature on the date set forth in the applicable term note, and Revolving Loans and the letter of credit facility shall mature on such date as agreed upon by Xcel and the Lenders. Any letter of credit issued under Loan Agreement shall terminate no later than one year following the date of issuance thereof.
The remaining principal balance of the Term Loans, as amended, outstanding at December 31, 2020 is payable in fixed installments as set forth in the following table, plus the variable payments as described below:
($ in thousands)
Installment Payment Dates
Amount
March 31, 2021, June 30, 2021, September 30, 2021, and December 31, 2021
$
700
March 31, 2022, June 30, 2022, September 30, 2022, and December 31, 2022
$
1,125
March 31, 2023, June 30, 2023, September 30, 2023, and December 31, 2023
$
1,250
In addition to the fixed installments outlined above, commencing with the fiscal quarter ending March 31, 2021, the Company is required to repay a portion of the Term Loans in an amount equal to 50% of the excess cash flow for the fiscal quarter, 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 principal paid or payable during such period, and (iii) all dividends declared and paid (or which could have been declared and paid) during such period to equity holders of any credit party treated as a disregarded entity for tax purposes. To the extent that the cumulative amount of such variable repayments made is less than $4.45 million as of March 31, 2022, any such shortfall must be repaid at that date.
Thus, the aggregate remaining annual principal payments under the Term Loans at December 31, 2020 were as follows:
Amount of
($ in thousands)
Principal
Year Ending December 31,
Payment
2021
$
2,800
2022
8,950
2023
5,000
Total
$
16,750
Xcel has the right to prepay the Term Loans, Incremental Term Loans, Revolving Loans, and obligations with respect to letters of credit and accrued and unpaid interest thereon and to terminate the Lenders’ obligations to make Revolving
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Loans and issue letters of credit; provided that any prepayment of less than all of the outstanding balances of the Term Loans and Incremental Term Loans shall be applied to the remaining amounts due in inverse order of maturity.
If any Term Loan or any Incremental Term Loan is prepaid on or prior to the third anniversary of the Closing Date (including as a result of an event of default), Xcel shall pay an early termination fee as follows: an amount equal to the principal amount of the Term Loan or Incremental Term Loan, as applicable, being prepaid, multiplied by: (i) two percent (2.00%) if any of Term Loan B or any Incremental Term Loan is prepaid on or before the second anniversary of the later of the Closing Date or the date such Incremental Term Loan was made, as applicable; (ii) one percent (1.00%) if any of Term Loan A is prepaid on or before the second anniversary of the Closing Date; (iii) one percent (1.00%) if any of Term Loan B or any Incremental Term Loan is prepaid after the second anniversary of the later of the Closing Date or such Incremental Term Loan was made, as applicable, but on or before the third anniversary of such date; (iv) one-half of one percent (0.50%) if any of Term Loan A is prepaid after the second anniversary of the Closing Date, but on or before the third anniversary of such date; or (v) zero percent (0.00%) if any Term Loan or any Incremental Term Loan is prepaid after the third anniversary of the later of the Closing Date or the date such Incremental Term Loan was made, as applicable.
Notwithstanding the above, Xcel may make a voluntary prepayment of up to $0.75 million without any early termination fees, and any such prepayment would be excluded from the computation of excess cash flows.
Xcel’s obligations under the Loan Agreement are guaranteed by and secured by all of the assets of Xcel and its wholly owned subsidiaries, as well as any subsidiary formed or acquired that becomes a credit party to the Loan Agreement (the “Guarantors”) and, subject to certain limitations contained in Term Loans, equity interests of the Guarantors. Xcel also granted the Lenders a right of first offer to finance any acquisition for which the consideration will be paid other than by cash of Xcel or by the issuance of equity interest of Xcel.
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 under the Loan Agreement):
● net worth of at least $90.0 million at the end of each fiscal quarter;
● liquid assets of at least $3.0 million through December 31, 2020, at least $2.5 million for the fiscal quarters ending March 31, 2021 through September 30, 2021, at least $3.0 million for the fiscal quarter ending December 31, 2021, and at least $5.0 million thereafter;
● the fixed charge coverage ratio for the twelve fiscal month period ending at the end of each fiscal quarter shall not be less than the ratio set forth below:
Fiscal Quarter End
Fixed Charge Coverage Ratio
December 31, 2020, March 31, 2021, June 30, 2021, September 30, 2021, and December 31, 2021
1.25 to 1.00
March 31, 2022, and thereafter
1.10 to 1.00
● capital expenditures (excluding any capitalized compensation costs) shall not exceed $1.6 million for the fiscal year ending December 31, 2020, and $0.7 million for any fiscal year beginning after December 31, 2020; and
● the leverage ratio for the twelve fiscal month period ending at the end of each fiscal period set forth below shall not exceed the ratio set forth below:
Fiscal Period
Maximum Leverage Ratio
December 31, 2020
3.50 to 1.00
March 31, 2021
3.15 to 1.00
June 30, 2021
3.00 to 1.00
September 30, 2021
2.75 to 1.00
December 31, 2021
2.50 to 1.00
March 31, 2022 and each Fiscal Quarter end thereafter
1.50 to 1.00
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The Company was in compliance with all applicable covenants under the Loan Agreement as of and for the fiscal year ended December 31, 2020.
In connection with the February 11, 2019 refinancing transaction and subsequent amendments, the Company incurred fees to or on behalf of BHI of approximately $0.3 million during the Prior Year and $0.03 million during the Current Year. These fees have been deferred on the consolidated balance sheets as a reduction to the carrying value of the Term Loans, and are being amortized to interest expense over the term of the Term Loans using the effective interest method. The effective interest rate on the Loan Agreement was approximately 6.6% and 6.7% for the Current Year and Prior Year, respectively.
Interest on Term Loan A accrues at a fixed rate of 5.1% per annum and is payable on each day on which the scheduled principal payments on Term Loans are required to be made. Interest on Term Loan B accrues at a fixed rate of 6.25% per annum and is payable on each day on which the scheduled principal payments on Term Loans are required to be made. Interest on the Revolving Loans will accrue at either the Base Rate or LIBOR, as elected by Xcel, plus a margin to be agreed to by Xcel and the Lenders and will be payable on the first day of each month. Base Rate is defined in the Loan Agreement as the greater of (a) BHI’s stated prime rate or (b) 2.00% per annum plus the overnight federal funds rate published by the Federal Reserve Bank of New York. Interest on the Incremental Term Loans will accrue at rates to be agreed to by Xcel and the Lenders and will be payable on each day on which the scheduled principal payments under the applicable note are required to be made.
For the Current Year and Prior Year, the Company incurred interest expense of approximately $1.1 million and $1.2 million, respectively, related to term loan debt.
On April 14, 2021, we entered into a loan and security agreement with BHI, FEAC Agent LLC, and the financial institutions party thereto (the “2021 Loan Agreement”). We used a portion of the proceeds from the 2021 Loan Agreement to repay the $16.75 million outstanding balance under the previous Loan Agreement, resulting in the extinguishment of the term loan debt that existed as of December 31, 2020. Under 2021 Loan Agreement, the Company’s debt obligations increased to $25.0 million, payable in 16 equal quarterly installments of $625,000, commencing June 30, 2021 and ending on March 31, 2025, with a final payment of $15.0 million payable on the maturity date of April 14, 2025. The debt under the 2021 Loan Agreement bears interest at a weighted average rate of LIBOR plus 6.2% per annum. In addition, the 2021 Loan Agreement provides for up to $25 million of future acquisition financing, subject to lender approval on a deal-by-deal basis.
Contingent Obligations – HH Seller (Halston Heritage Earn-Out)
In connection with the February 11, 2019 purchase of the Halston Heritage Trademarks from HIP, the Company agreed to pay HIP additional consideration (the “Halston Heritage Earn-Out”) of up to $6.0 million, based on royalties earned through December 31, 2022. The Halston Heritage Earn-Out of $0.9 million is recorded as a long-term liability as of December 31, 2020 and 2019 in the accompanying consolidated balance sheets, based on the difference between the fair value of the acquired assets of the Halston Heritage Trademarks and the total consideration paid. In accordance with ASC Topic 480, the Halston Heritage Earn-Out obligation is treated as a liability in the accompanying consolidated balance sheets because of the variable number of shares payable under the agreement.
The Halston Heritage Earn-Out is generally required to be paid in shares of our common stock, subject to certain limitations. Payment of this obligation in stock would not affect our liquidity.
Real Estate Leases
As described in Item 2 of this Annual Report on Form 10-K, we have real estate leases for our current office, former office, and a planned retail store location, with remaining lease terms between approximately one year to eight years. Future payments under these leases are expected to be approximately $2.7 million for the year ending December 31, 2021, $1.7 million for each year ending December 31, 2022 – 2025, and $3.3 million thereafter.
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Employment Contracts
We have entered into contracts with certain executives and key employees. The future minimum payments under these contracts are expected to be approximately $6.7 million, of which approximately $4.6 million is expected to be paid in 2021 and approximately $2.1 million is expected to be paid in 2022.
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, Halston brand, and C Wonder brand have a core business in fashion apparel and accessories. The Ripka brand is a fine jewelry business, and the Longaberger brand focuses on home good products, which we believe helps diversify our industry focus while at the same time complements our business operations and relationships.
We continue to work towards expanding our wholesale and e-commerce businesses, and complement these operations with our licensing business, including interactive television, and leveraging our wholesale customers with our brick-and-mortar licensees. Our current strategy is to manage our working capital needs by minimizing inventory risk.
In addition, we continue to seek new opportunities, including expansion through interactive television, our design, production and supply chain platform, additional domestic and international licensing arrangements, and acquiring additional brands. In November 2019, we acquired an ownership interest in the Longaberger brand through a joint venture, and launched the brand on the QVC channel that same month. We are also actively pursuing the potential acquisition of other brands and business operations which we believe are synergistic to our existing portfolio of brands and our operating platform, and are complementary to our overall strategy.
However, the impacts of the current COVID-19 pandemic are broad reaching and are having an impact on our licensing and wholesale businesses. This global pandemic is impacting our supply chain, and temporary factory closures and the pace of workers returning to work have impacted our contract manufacturers’ ability to source certain raw materials and to produce finished goods in a timely manner. The pandemic is also impacting distribution and logistics providers' ability to operate in the normal course of business. In addition, COVID-19 has resulted in a sudden and continuing decrease in sales for many of our products, resulting in order cancellations. Further, the global pandemic has affected the financial health of certain of our customers, and the bankruptcy of certain other customers, including Lord & Taylor and Le Tote, Stein Mart, and Century 21, from which we had an aggregate of $1.21 million of accounts receivable due at December 31, 2020. As a result, we have recognized an allowance for doubtful accounts of $0.97 million for the year ended December 31, 2020, and may be required to make additional adjustments for doubtful accounts which would increase our operating expenses in future periods and negatively impact our operating results, and could result in our failure to meet financial covenants under our credit facility. Financial impacts associated with the COVID-19 pandemic include, but are not limited to, lower net sales, adjustments to allowances for doubtful accounts due to customer bankruptcy or other inability to pay their amounts due to vendors, the delay of inventory production and fulfillment, potentially further impacting net sales, and potential incremental costs associated with mitigating the effects of the pandemic, including increased freight and logistics costs and other expenses. The impact of the COVID-19 pandemic is expected to continue to have an adverse effect on our operating results, which could result in our inability to comply with certain debt covenants and require BHI to waive compliance with, or agree to amend, any such covenant to avoid a default. The COVID-19 global pandemic is ongoing, and its dynamic nature, including uncertainties relating to the severity and duration of the pandemic, as well as actions that would be taken by governmental authorities to contain the pandemic or to treat its impact, makes it difficult to forecast any effects on our 2021 results. However, as of the date of this filing, we expect our results for some portion of 2021 to be significantly affected.
Our success, however, will still remain largely dependent on our ability to build and maintain our brands’ awareness and continue to attract wholesale and direct-to-consumer customers, and contract with and retain key licensees, as well as our and our licensees’ ability to accurately predict upcoming fashion and design trends within their respective customer bases and fulfill the product requirements of the particular retail channels within the global marketplace. Unanticipated changes in consumer fashion preferences and purchasing patterns, slowdowns in the U.S. economy, changes in the prices of
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supplies, consolidation of retail establishments, and other factors noted in “Risk Factors” could adversely affect our licensees’ ability to meet and/or exceed their contractual commitments to us and thereby adversely affect our future operating results.
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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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