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 Factors section of our Form 10-K for the fiscal year ended December 31, 2021, as filed with the SEC on April 15, 2022. 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, live streaming, 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 LOGO by Lori Goldstein brand (the "Lori Goldstein Brand"), the Halston brand (the "Halston Brand"), the Judith Ripka brand (the "Ripka Brand"), the C Wonder brand (the "C Wonder 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 the following primary strategies: ● distribution and/or licensing of our brands for sale through interactive television (i.e., QVC, HSN, The Shopping Channel, TVSN, etc.); ● wholesale distribution of our brands to retailers that sell to the end consumer; ● direct-to-consumer distribution of our brands through e-commerce and live streaming; ● 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; and ● acquiring additional consumer brands and integrating them into our operating platform and 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; ● 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 19 Table of Contents ● 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, 2022 (the “current quarter”) compared with the three months ended March 31, 2021 (the “prior year quarter”) Revenues Current quarter net revenue increased approximately $0.9 million to $8.7 million from $7.8 million for the prior year quarter. Net licensing revenue increased by approximately $1.7 million in the current quarter to $6.0 million, compared with $4.3 million in the prior year quarter. This increase in licensing revenue was primarily attributable to the Lori Goldstein brand, which we acquired on April 1, 2021. Net sales decreased by approximately $0.7 million in the current quarter to $2.8 million, compared with $3.5 million in the prior year quarter. This decrease in net sales was primarily attributable to declines in apparel wholesale revenue, mainly driven by a change in our C Wonder brand distribution. Cost of Goods Sold Current quarter cost of goods sold was $1.7 million, compared with $1.8 million for the prior year quarter. Gross profit margin from net product sales (net sales less cost of goods sold, divided by net sales) declined from approximately 48% in the prior year quarter to approximately 40% in the current quarter, primarily due to the selling-off of seasoned apparel inventory during the current quarter, a portion of which was reserved for in previous periods. Gross profit (net revenue less cost of goods sold) increased approximately $1.1 million to $7.1 million from $6.0 million in the prior year quarter, primarily driven by the aforementioned increase in net licensing revenue. Operating Costs and Expenses Operating costs and expenses increased approximately $1.6 million from $8.5 million in the prior year quarter to $10.1 million in the current quarter. This increase was mainly driven by costs associated with the Lori Goldstein brand acquired on April 1, 2021 and, to a lesser extent, cost increases from service providers and vendors due to the current inflationary economic environment. Costs associated with the Lori Goldstein brand included a $0.6 million increase in salaries, benefits and employment taxes and $0.6 million of increased trademark amortization expense. The remainder of the increase in operating costs is largely attributable to higher shipping and logistics costs. Interest and Finance Expense Interest and finance expense for the current quarter was $0.7 million, compared with $0.3 million for the prior year quarter. This increase was attributable to the fact that the new term loan agreement entered into on December 30, 2021 resulted in a higher outstanding principal balance at a higher effective interest rate as compared with the previous term loan agreement. 20 Table of Contents Income Tax Benefit The estimated annual effective income tax benefit rate for the current quarter and the prior year quarter was approximately 0% and 5%, respectively, resulting in an income tax benefit of $0 and $0.14 million, respectively. For the current quarter, the federal statutory rate differed from the effective tax rate primarily due to the recording of a valuation allowance against the current period loss. Since it is not more likely than not that the current period loss will be utilized, the Company recorded the valuation allowance. For the prior year 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%. Net Loss Attributable to Xcel Brands, Inc. Stockholders We had a net loss of $3.5 million for the current quarter, compared with a net loss of $2.5 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 $1.9 million, or $0.10 per diluted share (“non-GAAP diluted EPS”), for the current quarter and a non-GAAP net loss of $1.5 million, or $0.08 per diluted share, for the prior year quarter. Non-GAAP net (loss) 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, 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 the provision 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 approximately $(0.9) million for both the current quarter and 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 the provision 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 our term loan agreement. 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. 21 Table of Contents 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 other 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) 2022 2021 Net loss attributable to Xcel Brands, Inc. stockholders ​ $ (3,487) ​ $ (2,547) Amortization of trademarks ​ 1,514 ​ 876 Stock-based compensation ​ 32 ​ 160 Certain adjustments to provision for doubtful accounts ​ ​ — ​ ​ 132 Deferred income tax benefit ​ — ​ (138) Non-GAAP net (loss) income ​ $ (1,941) ​ $ (1,517) ​ 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, ​ 2022 2021 Diluted loss per share ​ $ (0.18) ​ $ (0.13) Amortization of trademarks ​ 0.08 ​ 0.04 Stock-based compensation ​ 0.00 ​ 0.01 Certain adjustments to provision for doubtful accounts ​ ​ — ​ ​ 0.01 Deferred income tax benefit ​ — ​ (0.01) Non-GAAP diluted EPS ​ $ (0.10) ​ $ (0.08) Non-GAAP weighted average diluted shares ​ 19,571,119 ​ 19,261,436 ​ 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) 2022 2021 Net loss attributable to Xcel Brands, Inc. ​ $ (3,487) ​ $ (2,547) Depreciation and amortization ​ 1,820 ​ 1,210 Interest and finance expense ​ 709 ​ 280 Income tax benefit ​ — ​ (138) State and local franchise taxes ​ 36 ​ 39 Stock-based compensation ​ 32 ​ 160 Certain adjustments to provision for doubtful accounts ​ ​ — ​ ​ 132 Adjusted EBITDA ​ $ (890) ​ $ (864) ​ 22 Table of Contents 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, 2022 and December 31, 2021, our cash and cash equivalents were approximately $3.1 million and $4.5 million, respectively. Restricted cash at March 31, 2022 and December 31, 2021 was approximately $0.6 million and $0.7 million, respectively, and consisted of cash deposited as collateral for an irrevocable standby letter of credit associated with the lease of our corporate office and operating facility. 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 $5.2 million and $7.9 million as of March 31, 2022 and December 31, 2021, respectively. This decrease in working capital was primarily attributable to the use of cash in operations, as well as scheduled debt interest payments, and the timing of payments to vendors and service providers. 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 $0.89 million in the current quarter, compared with approximately $1.69 million in the prior year quarter. The current quarter cash used in operating activities was primarily attributable to the combination of the net loss of $(3.74) million plus non-cash expenses of approximately $1.94 million and the net change in operating assets and liabilities of approximately $0.91 million. Non-cash net expenses were primarily comprised of $1.82 million of depreciation and amortization and $0.09 million of amortization of deferred finance costs. The net change in operating assets and liabilities was primarily comprised of an increase in accounts payable, accrued expenses, and other liabilities of $2.62 million, partially offset by an increase in accounts receivable of $(1.04) million and an increase in inventory of $(0.57) million. The changes in these operating assets and liabilities were primarily related to the timing and volume of sales and collections, and the timing of payments to vendors and service providers. The prior year 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 changes in lease-related assets and liabilities 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. 23 Table of Contents Investing Activities Net cash used in investing activities for the current quarter was approximately $0.04 million, related to minor capital expenditures. Net cash used in investing activities for the prior year quarter was approximately $0.30 million, primarily attributable to capital expenditures relating to the fit-out and furnishing of our planned Judith Ripka fine jewelry retail store (which opened in the second quarter of 2021 and was subsequently closed in the first quarter of 2022). Financing Activities Net cash used in financing activities for the current quarter consisted of $0.63 million of scheduled payments on our term loan debt. There was no cash provided by or used in financing activities for the prior year quarter. Other Factors We continue to seek to expand and diversify the types of products being produced and licensed under our brands. We plan to continue to diversify the distribution channels within which 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, Lori Goldstein 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. 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 April 2021, we acquired the Lori Goldstein brand, which is currently available and sold to consumers through Qurate’s QVC channel. However, the impacts of the ongoing 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 approximately $1.4 million of accounts receivable due at March 31, 2022. As a result, we continue to recognize an allowance for doubtful accounts of approximately $1.1 million as of March 31, 2022, 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 our lenders 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, 24 Table of Contents makes it difficult to forecast any effects on our 2022 results. However, as of the date of this filing, we expect our results for some portion of 2022 to be affected. In addition, the global shipping industry continues to face challenges related to port delays and tight availability for carriers and containers. This situation has negatively impacted our supply chain partners, including third party manufacturers, logistics providers, and other vendors, as well as the supply chains of our licensees, and has resulted in increased cost of supply and freight costs for us and our licensees. Such higher costs are currently expected to continue for at least some portion of 2022. Our long-term 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 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. Critical Accounting Policies and Estimates 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, 2021, filed with the SEC on April 15, 2022, for a discussion of our critical accounting policies and estimates. During the three months ended March 31, 2022, there were no material changes to our accounting policies. ​ ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable to smaller reporting companies. ​ ​ 25 Table of Contents