Item 2. Management’s Discussion and Analysis
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. Currently, the Company’s brand portfolio includes wholly owned brands – 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 other proprietary brands – and brands partially-owned through business ventures with third parties – the Longaberger brand (the “Longaberger Brand”) and the Isaac Mizrahi brand (the "Isaac Mizrahi Brand"). Xcel continues to pioneer 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 and related technology platforms;
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● 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 September 30, 2022 (the “current quarter”) compared with the three months ended September 30, 2021 (the “prior year quarter”)
Revenues
Current quarter net revenue decreased approximately $6.8 million to $4.5 million from $11.3 million for the prior year quarter.
Net licensing revenue decreased by approximately $4.7 million in the current quarter to $2.2 million, compared with $6.9 million in the prior year quarter. This decrease in licensing revenue was primarily attributable to the May 31, 2022 sale of a majority interest in the Isaac Mizrahi brand through the sale of a 70% interest in IM Topco, LLC to WHP. Since the closing of such sale, we no longer record Isaac Mizrahi brand licensing revenue as part of our revenues.
Net sales decreased by approximately $2.1 million in the current quarter to $2.3 million, compared with $4.4 million in the prior year quarter. This decrease in net sales was primarily attributable to declines in apparel wholesale revenue and, to a lesser extent, in wholesale jewelry sales, mainly driven by a combination of retailers pausing on purchases triggered by excess inventory levels, and the temporary closing of overseas factories due to COVID-19, causing delays in product delivery resulting in cancelled orders.
Cost of Goods Sold
Current quarter cost of goods sold was $1.5 million, compared with $2.9 million for the prior year quarter.
Gross profit margin from net product sales (net sales less cost of goods sold, divided by net sales) increased from approximately 35% in the prior year quarter to approximately 37% in the current quarter.
Gross profit (net revenue less cost of goods sold) decreased approximately $5.4 million to $3.0 million from $8.4 million in the prior year quarter, primarily driven by the aforementioned decrease in net licensing revenue, and also by the aforementioned decline in the wholesale business.
Operating Costs and Expenses
Operating costs and expenses decreased approximately $1.0 million from $9.7 million in the prior year quarter to $8.7 million in the current quarter. This decrease was primarily attributable to lower salaries, benefits and employment costs, driven by the May 31, 2022 sale of a majority interest in the Isaac Mizrahi brand, and the transfer of the employees associated with the Isaac Mizrahi brand to the IM Topco, LLC business venture.
Other (Expense) Income
We account for our interest in the ongoing operations of IM Topco, LLC using the equity method of accounting. We recognized an equity method loss of $0.28 million related to our investment for the current quarter, based on the distribution provisions set forth in the related business venture agreement.
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Interest and Finance (Income) Expense
Interest and finance (income) expense for the current quarter was $0.0 million, compared with $0.6 million for the prior year quarter. This decrease was primarily attributable to the May 31, 2022 repayment of all of our outstanding term loan debt.
Income Tax (Benefit) Provision
The estimated annual effective income tax rate for the current quarter and the prior year quarter was approximately 26% and 28%, respectively, resulting in an income tax benefit of $1.54 million and $0.54 million, respectively.
For the current quarter, the federal statutory rate differed from the effective tax rate primarily due to recurring permanent differences and state taxes, which increased the effective tax rate by approximately 5%.
For the prior year quarter, the federal statutory rate differed from the effective tax rate primarily due to recurring permanent differences and state taxes, which increased the effective tax rate by approximately 7%.
Net (Loss) Income Attributable to Xcel Brands, Inc. Stockholders
We had a net loss of $4.0 million for the current quarter, compared with a net loss of $1.1 million for the prior year quarter, due to the combination of the factors outlined above.
Non-GAAP Net (Loss) Income, Non-GAAP Diluted EPS, and Adjusted EBITDA
We had a non-GAAP net loss of approximately $3.3 million, or $0.17 per diluted share (“non-GAAP diluted EPS”), for the current quarter and non-GAAP net income of $0.01 million, or $0.00 per diluted share, for the prior year quarter. Non-GAAP net (loss) income is a non-GAAP unaudited term, which we define as net (loss) income attributable to Xcel Brands, Inc. stockholders, exclusive of amortization of trademarks, our proportional share of trademark amortization of equity method investees, 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 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 $(2.9) million for the current quarter, compared with approximately $1.0 million for the prior year quarter. Adjusted EBITDA is a non-GAAP unaudited measure, which we define as net (loss) income attributable to Xcel Brands, Inc. stockholders before depreciation and amortization, our proportional share of trademark amortization of equity method investees, 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, gain on sales of assets, 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.
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
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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 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 (loss) income:
Three Months Ended
September 30,
($ in thousands)
2022
2021
Net loss attributable to Xcel Brands, Inc. stockholders
$
(4,042)
$
(1,136)
Amortization of trademarks
1,520
1,519
Proportional share of trademark amortization of equity method investee
742
—
Stock-based compensation
51
163
Income tax benefit
(1,539)
(535)
Non-GAAP net (loss) income
$
(3,268)
$
11
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
September 30,
2022
2021
Diluted loss per share
$
(0.21)
$
(0.06)
Amortization of trademarks
0.08
0.08
Proportional share of trademark amortization of equity method investee
0.04
—
Stock-based compensation
0.00
0.01
Income tax provision (benefit)
(0.08)
(0.03)
Non-GAAP diluted EPS
$
(0.17)
$
0.00
Non-GAAP weighted average diluted shares
19,624,860
20,323,358
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
September 30,
($ in thousands)
2022
2021
Net loss attributable to Xcel Brands, Inc. stockholders
$
(4,042)
$
(1,136)
Depreciation and amortization
1,815
1,891
Proportional share of trademark amortization of equity method investee
742
—
Interest and finance (income) expense
(6)
588
Income tax benefit
(1,539)
(535)
State and local franchise taxes
85
33
Stock-based compensation
51
163
Adjusted EBITDA
$
(2,894)
$
1,004
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Nine months ended September 30, 2022 (the “current nine months”) compared with the nine months ended September 30, 2021 (the “prior year nine months”)
Revenues
Current nine months net revenue decreased approximately $8.1 million to $21.7 million from $29.8 million for the prior year nine months.
Net licensing revenue decreased by approximately $4.1 million in the current nine months to $13.3 million, compared with $17.4 million in the prior year nine months. This decrease in licensing revenue was primarily attributable to the May 31, 2022 sale of a majority interest in the Isaac Mizrahi brand through the sale of a 70% interest in IM Topco, LLC to WHP, partially offset by increased licensing revenue generated by the Lori Goldstein brand, which we acquired on April 1, 2021.
Net sales decreased by approximately $4.0 million in the current nine months to $8.4 million, compared with $12.4 million in the prior year nine months. This decrease in net sales was primarily attributable to declines in apparel wholesale revenue and, to a lesser extent, in wholesale jewelry sales, mainly driven by the previously mentioned retailer inventory levels and delays in product deliveries and canceled sales orders.
Cost of Goods Sold
Current nine months cost of goods sold was $5.7 million, compared with $7.8 million for the prior year nine months.
Gross profit margin from net product sales (net sales less cost of goods sold, divided by net sales) declined from approximately 38% in the prior year nine months to approximately 32% in the current nine months, primarily due to selling-off of seasoned apparel inventory during the earlier portion of 2022 and inventory write-downs related to cancelled sales orders.
Gross profit (net revenue less cost of goods sold) decreased approximately $4.1 million to $16.0 million from $22.1 million in the prior year nine months, primarily driven by the aforementioned decrease in net licensing revenue.
Operating Costs and Expenses
Operating costs and expenses increased approximately $2.6 million from $27.6 million in the prior year nine months to $30.2 million in the current nine months. This increase was primarily driven by the combination of (i) costs associated with the Lori Goldstein brand acquired on April 1, 2021 (including salaries, benefits and employment taxes as well as increased trademark amortization expense), (ii) $1.0 million of bonuses awarded to senior management related to the May 31, 2022 sale of a majority interest in the Isaac Mizrahi brand, and (iii) higher shipping and logistics costs, as well as cost increases from other service providers and vendors due to the current inflationary economic environment.
Other (Expense) Income
We recognized a gain on the sale of a majority interest in the Isaac Mizrahi brand in the current nine months of approximately $20.6 million, which was comprised of $46.2 million of cash proceeds plus the recognition of the fair value of our retained interest in the brand of $19.8 million, less $0.9 million of fees and expenses directly related to the transaction and the derecognition of the brand trademarks previously recorded on our balance sheet of $44.5 million.
We account for our interest in the ongoing operations of IM Topco, LLC using the equity method of accounting. We recognized an equity method loss of $0.28 million related to our investment for the current nine months, based on the distribution provisions set forth in the related business venture agreement.
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Interest and Finance (Income) Expense
Interest and finance expense for the current nine months was $3.5 million, compared with $2.3 million for the prior year nine months. This increase was primarily attributable to a higher loss on early extinguishment of debt as a result of the May 31, 2022 repayment of all of our outstanding term loan debt in the current nine months compared with a smaller loss on early extinguishment of debt incurred in the prior year nine months as a result of the April 14, 2021 term loan debt refinancing. This was partially offset by the fact that we had no interest expense in the current quarter, as all of our outstanding term loan was repaid on May 31, 2022 and we have not incurred any new debt.
Income Tax (Benefit) Provision
The estimated annual effective income tax rate for the current nine months and the prior year nine months was approximately 62% and 26%, respectively, resulting in an income tax provision (benefit) of $1.64 million and $(2.02) million, respectively.
For the current nine months, the federal statutory rate differed from the effective tax rate primarily due to recurring permanent differences, state taxes, and the discrete treatment of stock compensation shortfall, which increased the effective tax rate by approximately 41%.
For the prior year nine months, the federal statutory rate differed from the effective tax rate primarily due to recurring permanent differences and state taxes, which increased the effective tax rate by approximately 5%.
Net (loss) Income Attributable to Xcel Brands, Inc. Stockholders
We had net income of $2.0 million for the current nine months, compared with a net loss of $5.2 million for the prior year nine months, due to the combination of the factors outlined above.
Non-GAAP Net (Loss) Income, Non-GAAP Diluted EPS, and Adjusted EBITDA
We had a non-GAAP net loss of approximately $8.8 million, or $0.45 per diluted share, for the current nine months and a non-GAAP net loss of $1.6 million, or $0.08 per diluted share, for the prior year nine months.
We had Adjusted EBITDA of approximately $(6.6) million for the current nine months, compared with approximately $1.0 million for the prior year nine months.
The following table is a reconciliation of net income (loss) attributable to Xcel Brands, Inc. stockholders (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP net income:
Nine Months Ended
September 30,
($ in thousands)
2022
2021
Net income (loss) attributable to Xcel Brands, Inc. stockholders
$
1,961
$
(5,241)
Amortization of trademarks
4,559
3,915
Proportional share of trademark amortization of equity method investee
742
—
Stock-based compensation
568
754
Loss on extinguishment of debt
2,324
821
Certain adjustments to provision for doubtful accounts
—
132
Gain on sale of assets
(20,608)
—
Income tax provision (benefit)
1,639
(2,019)
Non-GAAP net (loss) income
$
(8,815)
$
(1,638)
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The following table is a reconciliation of diluted earnings (loss) per share (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP diluted EPS:
Nine Months Ended
September 30,
2022
2021
Diluted earnings (loss) per share
$
0.10
$
(0.27)
Amortization of trademarks
0.23
0.20
Proportional share of trademark amortization of equity method investee
0.04
—
Stock-based compensation
0.03
0.04
Loss on extinguishment of debt
0.12
0.04
Certain adjustments to provision for doubtful accounts
—
0.01
Gain on sale of assets
(1.05)
—
Income tax provision (benefit)
0.08
(0.10)
Non-GAAP diluted EPS
$
(0.45)
$
(0.08)
Non-GAAP weighted average diluted shares
19,624,604
19,418,469
The following table is a reconciliation of net income (loss) attributable to Xcel Brands, Inc. stockholders (our most directly comparable financial measure presented in accordance with GAAP) to Adjusted EBITDA:
Nine Months Ended
September 30,
($ in thousands)
2022
2021
Net income (loss) attributable to Xcel Brands, Inc. stockholders
$
1,961
$
(5,241)
Depreciation and amortization
5,447
4,949
Proportional share of trademark amortization of equity method investee
742
—
Interest and finance expense
3,505
2,311
Income tax provision (benefit)
1,639
(2,019)
State and local franchise taxes
121
105
Stock-based compensation
568
754
Certain adjustments to provision for doubtful accounts
—
132
Gain on sale of assets
(20,608)
—
Adjusted EBITDA
$
(6,625)
$
991
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 September 30, 2022 and December 31, 2021, our cash and cash equivalents were approximately $8.4 million and $4.5 million, respectively.
Restricted cash at December 31, 2021 was approximately $0.7 million, 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. There was no restricted cash at September 30, 2022, as the aforementioned letter of credit had expired and was not renewed.
We expect that existing cash and operating cash flows will be adequate to meet our operating 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 $13.7 million and $7.9 million as of September 30, 2022 and
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December 31, 2021, respectively. This increase in working capital was primarily attributable to the net proceeds received from the May 31, 2022 sale of a majority interest in the Isaac Mizrahi brand to WHP, partially offset by the full repayment of all of our term loan debt in the second quarter of 2022, and operating costs paid during the third quarter of 2022.
Commentary on the components of our cash flows for the current nine months as compared with the prior year nine months is set forth below.
Operating Activities
Net cash used in operating activities was approximately $11.03 million in the current nine months, compared with approximately $5.53 million in the prior year nine months.
The current nine months cash used in operating activities was primarily attributable to the combination of the net income of $1.02 million plus non-cash items of approximately $(11.30) million and the net change in operating assets and liabilities of approximately $(0.75) million. Non-cash items were primarily comprised of a $(20.61) million net gain on the sale of the assets of the Isaac Mizrahi brand, $5.45 million of depreciation and amortization, $0.57 million of stock-based compensation, a $2.32 million loss on extinguishment of debt, and $0.36 million of deferred taxes. The net change in operating assets and liabilities was primarily comprised of an increase in inventory of $(0.51) million, decreases in various operating liabilities of $(0.80) million, and changes in lease-related assets and liabilities of $(0.20) million, partially offset by a decrease in accounts receivable of $0.75 million.
The prior year nine months cash used in operating activities was primarily attributable to the combination of the net loss of $(5.80) million plus non-cash expenses of approximately $4.85 million and the net change in operating assets and liabilities of approximately $(4.58) million. Non-cash net expenses were primarily comprised of $4.95 million of depreciation and amortization, $0.75 million of stock-based compensation, $0.13 million of bad debt expense, $0.21 million of amortization of deferred finance costs, a $0.82 million loss on extinguishment of debt, and a deferred income tax benefit of $(2.02) million. The net change in operating assets and liabilities was primarily comprised of an increase in inventory of $(2.21) million and an increase in accounts receivable of $(2.19) million.
Investing Activities
Net cash provided by investing activities for the current nine months was approximately $45.17 million, and was predominantly attributable to $45.41 million of net proceeds from the sale of a majority interest in the Isaac Mizrahi brand to WHP, partially offset by approximately $0.24 million of capital expenditures.
Net cash used in investing activities for the prior year nine months was approximately $4.75 million, which was primarily attributable to the acquisition of the Lori Goldstein brand on April 1, 2021, and, to a lesser extent, capital expenditures relating to the fit-out and furnishing of our 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 nine months was approximately $30.95 million, which mainly consisted of $29.00 million of repayments of our term loan debt, and, to a lesser extent, $1.51 million of prepayment and other fees associated with the extinguishment of debt, as well as $0.44 million of shares repurchased related to withholding taxes on vested restricted stock.
Net cash provided by financing activities for the prior year nine months was approximately $8.93 million, and was primarily attributable to $25.0 million of proceeds from term loan debt entered into on April 14, 2021, as well as $2.5 million of proceeds drawn from a revolving loan facility. Also contributing to cash inflows from financing activities was a $1.0 million capital contribution in Longaberger Licensing, LLC by the non-controlling interest holder. Partially offsetting these proceeds were $(16.75) million paid on the balance of previous term loan debt, $(0.37) million of fees paid to the previous debtholders in connection with the extinguishment of previous term loan debt, $(1.20) million of deferred
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finance costs paid in connection with the April 14, 2021 term loan, and $(1.25) million of scheduled principal payments made under the April 14, 2021 term loan.
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 Lori Goldstein brand, Halston brand, C Wonder brand, and Isaac Mizrahi 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.
While the recent sale of a majority interest in the Isaac Mizrahi brand is expected to result in a short-term decrease in our revenues, as that brand represented a significant portion of our historical revenues, we will seek to replace those revenues in the long-term with new strategic business initiatives. The proceeds from the sale, as well as the continuing cash flows from our retained interest in the Isaac Mizrahi brand, are expected to help fuel various strategic initiatives as we concentrate our resources on growing our brands, new brand launches, and investing in livestreaming technology platforms and partnerships.
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, live streaming, our design, production and supply chain platform, additional domestic and international licensing arrangements, and acquiring additional brands.
However, the impacts of the ongoing COVID-19 pandemic (including actions taken by national, state, and local governments in response to COVID-19) has negatively impacted the U.S. and global economy, disrupted consumer spending and global supply chains, and created significant volatility and disruption of financial markets. More specifically, COVID-19 has had, and continues to have, a significant negative impact on our business. The initial onset of the pandemic in 2020 resulted in a sudden decrease in sales for many of the Company’s products, from which we have yet to fully recover. The global pandemic has affected the financial health of certain of our customers, and the bankruptcy of certain other customers; as a result, we continue to recognize an allowance for doubtful accounts of approximately $1.3 million as of September 30, 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. Due to the ongoing COVID-19 pandemic, there is significant uncertainty surrounding the Company’s future results of operations and cash flows. Continued impacts of the pandemic could materially adversely affect the Company’s near-term and long-term revenues, earnings, liquidity, and cash flows.
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 the remainder of 2022, if not longer.
Further, the cost of raw materials, labor, manufacturing, energy, fuel, shipping and logistics, and other inputs related to the production and distribution of our products have increased and may continue to increase unexpectedly. Beginning in the first quarter of 2022, input costs increased significantly. We expect the pressures of input cost inflation to continue for the remainder of 2022, if not through 2023. We may not be able to mitigate the impact of inflation and cost increases or pass these costs along to our customers.
Also, poor economic and market conditions, including a potential recession, may negatively impact market sentiment, decreasing the demand for apparel, footwear, accessories, fine jewelry, home goods, and other consumer products, which would adversely affect our operating income and results of operations. If we are unable to take effective measures in a timely manner to mitigate the impact of the inflation as well as a potential recession, our business, financial condition, and results of operations could be adversely affected.
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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 and nine months ended September 30, 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.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.