XCel Brands, Inc. 10-Q

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, 2019. 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 media and consumer products company engaged in the design, production, marketing, wholesale distribution, 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. Xcel was founded in 2011 with a vision to reimagine shopping, entertainment, and social media as one thing. The Company owns and manages the Isaac Mizrahi brand (the "Isaac Mizrahi Brand"), the Halston brand (the "Halston Brand"), the Judith Ripka brand (the "Ripka Brand"), the C Wonder brand (the "C Wonder Brand"), the LOGO by Lori Goldstein brand (the "Logo Lori Goldstein Brand"), and the Longaberger brand (the “Longaberger Brand”), pioneering a true omni-channel 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 be everywhere its customers shop. Our objective is to build a diversified portfolio of lifestyle consumer brands through organic growth and the strategic acquisition of new brands. To grow our brands, we are focused on 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 of 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 while leveraging our operating infrastructure and distribution relationships. We believe that Xcel offers 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; 21 Table of Contents ● our deep knowledge and expertise in live streaming; ● our design, production, sales, marketing, and supply chain and integrated technology platform that enables us to design and distribute trend-right product; and ● our operating strategy, significant media and internet presence, and distribution network. Our design, production and supply chain platform was developed to shorten the supply chain cycle by utilizing state-of-the-art supply chain management technology, trend analytics, and data science to actively monitor fashion trends and read and react to customer demands. Summary of Operating Results Three months ended March 31, 2021 (the “current quarter”) compared with the three months ended March 31, 2020 (the “prior year quarter”) Revenues Current quarter net revenue decreased approximately $1.7 million to $7.8 million from $9.5 million for the prior year quarter. Net licensing revenue decreased by approximately $1.3 million in the current quarter to $4.3 million, compared with $5.6 million in the prior year quarter. Approximately $1.1 million of this decline was attributable to the discontinuation of the licensing of the H Halston brand through QVC during the fourth quarter of 2020, and the Company’s transitioning of that brand to a wholesale supply model under arrangements with HSN and certain Qurate global affiliates, and other unrelated interactive television networks. The remainder of the decline in net licensing revenue was primarily driven by lower sales by our licensees as a result of the economic impacts related to the ongoing COVID-19 pandemic. Net product sales decreased by approximately $0.4 million in the current quarter to $3.5 million, compared with $3.9 million in the prior year quarter. Declines in wholesale apparel sales, primarily as the result of the economic impacts of the ongoing COVID-19 pandemic, were partially offset by significant growth in wholesale and e-commerce sales of fine jewelry as well as significant growth in e-commerce sales of Longaberger branded products. Cost of Goods Sold Current quarter cost of goods sold was $1.8 million, compared with $2.4 million for the prior year quarter due to lower volume of wholesale and e-commerce sales in the current quarter. Gross profit (net revenue less cost of goods sold) decreased approximately $1.1 million to $6.0 million from $7.1 million in the prior year quarter, primarily driven by the aforementioned decline in net licensing revenue. Total gross profit margin increased by approximately 1%, from 75% in the prior year quarter to 76% in the current quarter. Gross profit margin from product sales increased from 38% in the prior year quarter to 48% in the current quarter as a result of achieving greater efficiencies. Operating Costs and Expenses Operating costs and expenses increased approximately $0.3 million from $8.2 million in the prior year quarter to $8.5 million in the current quarter. This increase was mainly driven by higher salaries and benefits costs, and higher marketing expenses, partially offset by lower depreciation and amortization expense, resulting from the impairment and write-down of our Judith Ripka intangible assets in the fourth quarter of 2020, and the fact that the prior year quarter included expenses related a potential acquisition which ultimately was not consummated. 22 Table of Contents Interest and Finance Expense Interest and finance expense for the current quarter was $0.3 million, compared with $0.3 million for the prior year quarter. Income Tax Benefit The effective income tax rate for the current quarter and the prior year quarter was approximately 5% and 40%, respectively, resulting in an income tax benefit of $0.1 million and $0.6 million, respectively. For the current quarter, the federal statutory rate differed from the effective tax rate primarily due to recurring permanent differences, which decreased the effective tax rate by approximately 17%, partially offset by state taxes, which increased the effective tax rate by approximately 1%. For the prior year quarter, the federal statutory rate differed from the effective tax rate primarily due to state taxes and recurring permanent differences, which increased the effective tax rate by approximately 8% and 4%, respectively. The effective tax rate was also attributable to the tax impact of a potential federal net operating loss carryback due to the CARES Act. This item increased the effective rate by 7%. Net Loss attributable to Xcel Brands, Inc. stockholders We had a net loss of $2.5 million for the current quarter, compared with a net loss of $0.8 million for the prior year quarter, due to the combination of the factors outlined above. Non-GAAP Net Income, Non-GAAP Diluted EPS, and Adjusted EBITDA We had a non-GAAP net loss of approximately $1.5 million, or $(0.08) per diluted share (“non-GAAP diluted EPS”), for the current quarter and non-GAAP net income of $0.2 million, or $0.01 per diluted share, for the prior year quarter. 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 the bankruptcy of and economic impact on certain retail customers due to the COVID-19 pandemic, 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 negative $0.9 million for the current quarter, compared with Adjusted EBITDA of positive $0.7 million for the prior year quarter. 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 the bankruptcy of and economic impact on certain retail customers due to the COVID-19 pandemic. 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 supplemental information to assist investors in evaluating the Company’s financial results. Adjusted EBITDA is the measure used to calculate compliance with the EBITDA covenant under the Xcel Term Loan. 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 23 Table of Contents 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. 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 attributable to Xcel Brands, Inc. stockholders (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP net income: ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended ​ ​ March 31, ($ in thousands) 2021 2020 Net loss attributable to Xcel Brands, Inc. stockholders ​ $ (2,547) ​ $ (805) Amortization of trademarks ​ 876 ​ 1,108 Stock-based compensation ​ 160 ​ 243 Costs in connection with potential acquisition ​ ​ — ​ ​ 80 Certain adjustments to allowances for doubtful accounts ​ ​ 132 ​ ​ 114 Deferred income tax benefit ​ (138) ​ (552) Non-GAAP net (loss) income ​ $ (1,517) ​ $ 188 ​ The following table is a reconciliation of diluted loss per share (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP diluted EPS: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended ​ ​ March 31, ​ 2021 2020 Diluted loss per share ​ $ (0.13) ​ $ (0.04) Amortization of trademarks ​ 0.04 ​ 0.06 Stock-based compensation ​ 0.01 ​ 0.01 Costs in connection with potential acquisition ​ ​ — ​ ​ 0.00 Certain adjustments to allowances for doubtful accounts ​ ​ 0.01 ​ ​ 0.01 Deferred income tax benefit ​ (0.01) ​ (0.03) Non-GAAP diluted EPS ​ $ (0.08) ​ $ 0.01 Non-GAAP weighted average diluted shares ​ 19,261,436 ​ 18,871,020 ​ 24 Table of Contents The following table is a reconciliation of net loss attributable to Xcel Brands, Inc. stockholders (our most directly comparable financial measure presented in accordance with GAAP) to Adjusted EBITDA: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended ​ ​ March 31, ($ in thousands) 2021 2020 Net loss attributable to Xcel Brands, Inc. stockholders ​ $ (2,547) ​ $ (805) Depreciation and amortization ​ 1,210 ​ 1,303 Interest and finance expense ​ 280 ​ 294 Income tax benefit ​ (138) ​ (552) State and local franchise taxes ​ 39 ​ 38 Stock-based compensation ​ 160 ​ 243 Costs in connection with potential acquisition ​ ​ — ​ ​ 80 Certain adjustments to allowances for doubtful accounts ​ ​ 132 ​ ​ 114 Adjusted EBITDA ​ $ (864) ​ $ 715 ​ 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. As of March 31, 2021 and December 31, 2020, our cash and cash equivalents were approximately $3.0 million and $5.0 million, respectively. Restricted cash at March 31, 2021 and at December 31, 2020 consisted of $1.1 million of cash deposited with BHI as collateral for an irrevocable standby letter of credit associated with the lease of our current corporate office and operating facility. On April 14, 2021, we entered into a new loan and security agreement, which resulted in the extinguishment of the $16.8 million term loan debt which existed as of March 31, 2021, and increased our term loan debt obligations to $25.0 million. Under this agreement, our term loan debt obligation is 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 new term loan debt bears interest at a weighted average rate of LIBOR plus 6.2% per annum. In addition, the facility provides for up to $25.0 million of future acquisition financing, subject to lender approval on a deal-by-deal basis. 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 12 months subsequent to the filing date of this Quarterly Report on Form 10-Q. Changes in Working Capital Our working capital (current assets less current liabilities, excluding the current portion of operating lease obligations and any contingent obligations payable in common stock) was $6.5 million and $7.9 million as of March 31, 2021 and December 31, 2020, respectively. This working capital decrease was primarily attributable to cash used in operating activities during the first three months of 2021. Commentary on the components of our cash flows for the current quarter as compared with the prior year quarter is set forth below. Operating Activities Net cash used in operating activities was approximately $(1.69) million in the current quarter, compared with net cash provided by operating activities of approximately $0.31 million in the prior year quarter. 25 Table of Contents The current quarter cash used in operating activities was primarily attributable to the combination of the net loss of $(2.63) million plus non-cash expenses of approximately $1.38 million and the net change in operating assets and liabilities of approximately $(0.45) million. Non-cash net expenses were primarily comprised of $1.21 million of depreciation and amortization, $0.16 million of stock-based compensation, $0.13 million of bad debt expense, and a deferred income tax benefit of $(0.14) million. The net change in operating assets and liabilities includes an increase in inventory of $(1.57) million, an increase in accounts receivable of $(0.38) million, an increase in accounts payable, accrued expenses and other current liabilities of $1.82 million, an increase in prepaid expenses and other assets of $(0.22) million, and cash paid in excess of rent expense of $(0.10) million. The changes in inventory and accounts payable, which largely offset each other, are related and are mainly due to the timing of certain inventory purchases. The change in accounts receivable is primarily related to the timing of sales and collections. The prior year quarter cash provided by operating activities was primarily attributable to the combination of the net loss of $(0.84) million plus non-cash expenses of approximately $1.23 million, partially offset by a net change in operating assets and liabilities of approximately $(0.08) million. Non-cash net expenses were primarily comprised of $1.30 million of depreciation and amortization, $0.24 million of stock-based compensation, $0.21 million of bad debt expense, and deferred income tax benefit of $(0.55) million. The net change from operating assets and liabilities includes a decrease in accounts receivable of $1.57 million, a decrease in inventory of approximately $0.11 million, and a decrease in accounts payable, accrued expenses and other current liabilities of $(1.67) million, all of which were primarily due to timing of collections and payments, and cash paid in excess of rent expense of $(0.09) million. Investing Activities Net cash used in investing activities for the current quarter was approximately $0.3 million, primarily attributable to capital expenditures relating to the fit-out and furnishing of our planned Judith Ripka fine jewelry retail store. Net cash used in investing activities for the prior year quarter was approximately $0.6 million and was attributable to capital expenditures, a substantial portion of which related to the implementation of our ERP system. Financing Activities There was no cash provided by or used in financing activities for the current quarter. Net cash used in financing activities for the prior year quarter was approximately $0.1 million, and was attributable to shares repurchased related to vested restricted stock in exchange for withholding taxes. 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 QVC that same month. In April 2021, we acquired the Lori Goldstein brand trademarks, which are currently available and sold to consumers through QVC. 26 Table of Contents 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, from which we had an aggregate of approximately $1.5 million of accounts receivable due at March 31, 2021. As a result, we have recognized an allowance for doubtful accounts of approximately $1.1 million as of March 31, 2021, 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. 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, 2020, filed with the SEC on April 23, 2021, for a discussion of our critical accounting policies. During the three months ended March 31, 2021, there were no material changes to our accounting policies. ​ ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable to smaller reporting companies. ​ 27 Table of Contents