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, 2022 and 2021. 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, 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. 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. Currently, Xcel’s brand portfolio consists of the LOGO by Lori Goldstein Brand, the Halston Brand, the Ripka Brand, the C Wonder Brand, the Longaberger Brand, the Isaac Mizrahi Brand, and other proprietary brands.
● The Lori Goldstein Brand, Halston Brand, Ripka Brand, and C Wonder Brand are wholly owned by the Company.
● We manage the Longaberger Brand through our 50% ownership interest in Longaberger Licensing, LLC.
● We manage the Q Optix business through our 50% ownership interest in Q Optix, LLC.
● The Company wholly owned and managed the Isaac Mizrahi Brand through May 31, 2022. On May 31, 2022, we sold a majority interest in the brand to a third party, but retained a 30% noncontrolling interest in the brand and continue to participate in the operations of the business.
Xcel is 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 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, CJO, JTV, etc.);
● wholesale distribution through joint ventures or licensing 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.
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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;
● our deep knowledge, expertise, and proprietary technology 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 significant media and internet presence and distribution.
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 200 million homes worldwide and hundreds of millions of social media followers.
We believe our design, production, and joint venture 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, marketing, design, integrated technologies, production and joint venture 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.
Critical Accounting Policies and Estimates
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. Critical accounting estimates are those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. While our significant accounting policies and estimates are described in more detail in the notes to our consolidated financial statements, our most critical accounting policies and estimates, discussed below, pertain to revenue recognition, trademarks and other intangible assets, income taxes, and equity method investments. These include but are not limited to the estimation of the useful lives of our trademarks, the estimation of the future cash flows related to our trademarks, and the estimation of our incremental borrowing rate (for purposes of accounting for leases). 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.
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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 net licensing 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 royalties in excess of minimum guaranteed is applied and such sales-based royalties are recognized to the 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 within net sales in the accompanying consolidated statements of operations 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. Shipping to customers is accounted for as a fulfillment activity and is recorded within other selling, general and administrative expenses.
Direct to Consumer Sales
Our revenue associated with our e-commerce jewelry operations and the Longaberger brand is recognized within net sales in the accompanying consolidated statements of operations at the point in time when product is shipped to the customer. Shipping to customers is accounted for as a fulfillment activity and is recorded within other selling, general and administrative expenses. Revenue associated with our fine jewelry brick-and-mortar retail store is recognized within net sales in the accompanying consolidated statements of operations at the point of sale.
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 estimate the useful lives of our intangible assets based principally on our expected use and strategic plans for each asset, our own historical experience with similar assets, and our expectations related to demand, competition, and other economic factors.
Indefinite-Lived Intangible Asset
We tested our indefinite-lived intangible asset 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
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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.
We also re-evaluated on an annual basis whether events and circumstances continue to support an indefinite useful life.
We performed the annual impairment testing as described above for the year ended December 31, 2021, and concluded that there was no impairment of our indefinite-lived intangible asset. We subsequently sold our indefinite-lived intangible asset in May 2022 for a gain.
Finite-Lived Intangibles
Our 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.
With reference to our finite-lived intangible assets’ impairment process, we group 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.
There were no impairment charges recorded for finite-lived intangible assets for the years ended December 31, 2022 and 2021.
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. We consider forecasted earnings, future taxable income, and prudent and feasible tax planning strategies in determined the need for these valuation allowances.
With respect to any uncertainties in income taxes recognized in our financial statements, tax positions are initially 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 are initially and subsequently 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, 2019 through December 31, 2022.
Equity Method Investments
We account for our investments in entities over which we have the ability to exercise significant influence, but do not control the entity, under the equity method of accounting, and we recognize our proportionate share of income or losses from the entity within other income (expense) in the consolidated statement of operations.
We initially measure our investment in an equity method investee at cost. In cases where we retain a noncontrolling interest in an investee which we had previously consolidated, we initially measure such retained interest at fair value. In estimating fair value in such cases, we seek to maximize the use of observable inputs (market data obtained from independent sources)
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and to minimize the use of unobservable inputs (internal assumptions about how market participants would price assets and liabilities).
Subsequent recognition of an investor’s proportionate share of income or losses of an equity method investee is generally determined based on the investor’s proportional ownership interest. However, in cases where contractual agreements specify allocation ratios for profits and losses, specified costs and expenses, and/or distributions of cash from operations, that differ from our ownership interest, we use such specified allocation ratios for purposes of determining our share of income or losses from the investee if the agreement is considered substantive.
Recently Issued Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update (“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. Subsequently, the FASB issued additional guidance in ASU No. 2019-05 in May 2019, ASU No. 2019-10 and 2019-11 in November 2019, ASU No. 2020-02 in February 2020, and ASU No. 2022-02 in March 2022. Among other things, the additional guidance 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 when it is adopted during the first quarter of 2023.
Recently Adopted Accounting Pronouncements
We adopted ASU No. 2021-10, “Government Assistance (Topic 823): Disclosures by Business Entities about Government Assistance” effective January 1, 2022. This ASU requires certain financial statement disclosures about transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy. As this ASU only affects financial statement disclosures, the adoption of this guidance did not have any impact on our results of operations, cash flows, or financial condition.
We adopted ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” effective January 1, 2021. 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. The adoption of this new guidance did not have any impact on our results of operations, cash flows, or financial condition.
Summary of Operating Results
The consolidated financial statements and related notes included elsewhere in this Form 10-K are as of or for the years ended December 31, 2022 (the “Current Year”), and December 31, 2021 (the “Prior Year”).
Revenues
Current Year net revenue decreased approximately $12.1 million to $25.8 million from $37.9 million for the Prior Year.
Net licensing revenue decreased by $7.1 million in the Current Year to approximately $14.7 million, compared with approximately $21.8 million in the Prior Year. 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 $5.0 million in the Current Year to approximately $11.1 million, compared with approximately $16.1 million in the Prior Year. 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
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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 and Gross Profit
Current Year cost of goods sold was $8.0 million, compared with $10.7 million for the Prior Year, due to the lower volumes of product sales in the Current Year. Gross profit (net revenue less cost of goods sold) decreased approximately $9.5 million to $17.8 million from $27.3 million in the Prior Year, primarily driven by the aforementioned decrease in net licensing revenue.
Gross profit margin from product sales (net sales less cost of goods sold, divided by net sales) declined from approximately 34% in the Prior Year to approximately 28% in the Current Year, primarily due to the selling-off of seasoned apparel inventory during the earlier portion of 2022, and inventory write-downs related to cancelled sales orders for the reasons outlined above in the discussion of revenues.
Operating Costs and Expenses
Operating costs and expenses increased approximately $0.5 million, or approximately 1%, from $39.8 million in the Prior Year to $40.3 million in the Current Year. This slight increase was primarily driven by the combination of (i) higher shipping and logistics costs, as well as cost increases from other service providers and vendors due to the current inflationary economic environment, and (ii) increased trademark amortization expense, related to the acquisition of the Lori Goldstein brand on April 1, 2021, largely offset by (iii) lower asset impairment charges in the Current Year, and (iv) the elimination of salary and other expenses associated with the Isaac Mizrahi brand after the sale of a majority interest in that brand on May 31, 2022.
Other Income (Expense)
We recognized a gain on the sale of a majority interest in the Isaac Mizrahi brand in the Current Year 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 approximately $1.2 million related to our investment for Current Year, based on the distribution provisions and preferences set forth in the related business venture agreement.
Other income (expense) for the Current Year also includes a $0.9 million gain on the reduction of contingent obligations. In connection with our 2019 purchase of the Halston Heritage trademarks, we agreed to pay the seller additional consideration of up to an aggregate of $6.0 million, based on royalties earned from 2019 through December 31, 2022. This potential earn-out was initially recorded as a liability of $0.9 million, based on the difference at the date of acquisition between the fair value of the acquired assets of the Halston Heritage trademarks and the total consideration paid. The final royalty target year ended on December 31, 2022, and the seller ultimately did not earn any additional consideration based on the formula set forth in the related asset purchase agreement.
Interest and Finance Expense
Interest and finance expense for the Current Year was $3.5 million, compared with $3.6 million for the Prior Year.
This slight decrease was primarily attributable to the fact that we had no interest expense from June 1, 2022 through December 31, 2022, as all of our outstanding term loan was repaid on May 31, 2022 and we have not incurred any new debt. The decrease was partially offset by the higher loss on early extinguishment of debt as a result of the aforementioned May 31, 2022 repayment in the Current Year, compared with losses on extinguishment in the Prior Year.
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Income Tax Benefit
The effective income tax benefit rate for the Current Year was approximately 10.0% resulting in a $0.4 million income tax benefit. During the Current Year, the effective tax rate was primarily attributable to the impacts of stock-based compensation, which decreased the effective rate by approximately 6.1%, and federal tax true-ups, which decreased the effective tax rate by approximately 5.1%. The effective tax rate was also impacted by recurring permanent differences; the largest such recurring permanent differences were state and local tax provisions, which increased the effective rate in 2022 by approximately 6.1%, and disallowed excess compensation, which decreased the effective rate in 2022 by approximately 5.3%.
The effective income tax benefit rate for the Prior Year was approximately 19.3% resulting in a $3.1 million income tax benefit. During the Prior Year, the effective tax rate was impacted by the impact of stock-based compensation, which decreased the effective rate by approximately 5.6%. The effective tax rate was also impacted by recurring permanent differences; the largest such recurring permanent differences were state and local tax provisions, which increased the effective rate in 2021 by approximately 4.6%, and disallowed excess compensation, which decreased the effective rate in 2021 by approximately 0.7%.
Net Loss
We had a net loss of approximately $5.4 million for the Current Year, compared with a net loss of approximately $13.0 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 a non-GAAP net loss of $15.0 million or $(0.77) per share (“non-GAAP diluted EPS”) based on 19,624,669 weighted average shares outstanding for the Current Year, compared with a non-GAAP net loss of $6.2 million, or $(0.32) per share based on 19,455,987 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 asset impairments, amortization of trademarks, our proportional share of trademark amortization of equity method investees, stock-based compensation, loss on early extinguishment of debt, 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, gain on sale of assets, gain on reduction of contingent obligations, 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 $(12.5) million for the Current Year, compared with Adjusted EBITDA of approximately $(2.5) 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 asset impairments, depreciation and amortization, our proportional share of trademark amortization of equity method investees, interest and finance expenses (including loss on early extinguishment of debt, if any), income taxes, other state and local franchise taxes, stock-based compensation, 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, gain on sale of assets, and gain on reduction of contingent obligation.
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 measures not deemed to be in accordance with GAAP and are susceptible to varying calculations, our non-GAAP net
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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 attributable to Xcel Brands, Inc. stockholders (our most directly comparable financial measure presented in accordance with GAAP) to non-GAAP net loss:
Year Ended December 31,
($ in thousands)
2022
2021
Net loss attributable to Xcel Brands, Inc. stockholders
$
(4,018)
$
(12,184)
Asset impairments
274
1,372
Amortization of trademarks
6,079
5,435
Proportional share of trademark amortization of equity method investee
1,202
—
Stock-based compensation
620
720
Loss on early extinguishment of debt
2,324
1,516
Certain adjustments to provision for doubtful accounts
413
132
Gain on sale of assets
(20,586)
—
Gain on reduction of contingent obligation
(900)
—
Income tax benefit
(431)
(3,192)
Non-GAAP net loss
$
(15,023)
$
(6,201)
The following table is a reconciliation of diluted loss per share to non-GAAP diluted EPS:
Year Ended December 31,
2022
2021
Diluted loss per share attributable to Xcel Brands, Inc. stockholders
$
(0.20)
$
(0.63)
Asset impairments
0.01
0.07
Amortization of trademarks
0.31
0.28
Proportional share of trademark amortization of equity method investee
0.06
—
Stock-based compensation
0.03
0.04
Loss on early extinguishment of debt
0.12
0.08
Certain adjustments to provision for doubtful accounts
0.02
0.01
Gain on sale of assets
(1.05)
—
Gain on reduction of contingent obligation
(0.05)
—
Income tax benefit
(0.02)
(0.17)
Non-GAAP diluted EPS
$
(0.77)
$
(0.32)
Diluted weighted average shares outstanding
19,624,669
19,455,987
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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:
Year Ended December 31,
($ in thousands)
2022
2021
Net loss attributable to Xcel Brands, Inc. stockholders
$
(4,018)
$
(12,184)
Asset impairments
274
1,372
Depreciation and amortization
7,263
6,830
Proportional share of trademark amortization of equity method investee
1,202
—
Interest and finance expense
3,527
3,579
Income tax benefit
(431)
(3,106)
State and local franchise taxes
102
142
Stock-based compensation
620
720
Certain adjustments to provision for doubtful accounts
413
132
Gain on sale of assets
(20,586)
—
Gain on reduction of contingent obligation
(900)
—
Adjusted EBITDA
$
(12,534)
$
(2,515)
Liquidity and Capital Resources
General
As of December 31, 2022 and 2021, our cash and cash equivalents were $4.6 million and $4.5 million, respectively.
Restricted cash at December 31, 2021 consisted of $0.7 million of cash deposited as collateral for an irrevocable standby letter of credit associated with the lease of our current corporate office and operating facility. There was no restricted cash at December 31, 2022, as the aforementioned letter of credit had expired and was not renewed.
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 and our brick-and-mortal retail store in 2020 and 2021, respectively, our business operating model generally does not require material capital expenditures, and as of December 31, 2022, 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.
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 $8.8 million and $7.9 million as of December 31, 2022 and 2021, respectively. Commentary on components of our cash flows for the Current Year compared with the Prior Year is set forth below.
Liquidity and Management’s Plans
The Company incurred net losses of approximately $5.4 million ($25.9 million excluding the gain on sale of a majority interest in the Isaac Mizrahi brand) and $13.0 million during the years ended December 31, 2022 and 2021, respectively, and had an accumulated deficit of approximately $32.8 million and $28.8 million as of December 31, 2022 and 2021, respectively. Included in the net losses were non-cash expenses of approximately $8.2 million and $7.5 million for the years ended December 31, 2022 and 2021, respectively. Net cash used in operating activities was $14.2 million in 2022 and $6.6 million in 2021. These factors raise uncertainties about the Company’s ability to continue as a going concern.
Management plans to mitigate an expected shortfall of capital and to support future operations by shifting the business from a wholesale/licensing hybrid model into a licensing plus business model and to divest or restructure the Longaberger brand. In the first quarter of 2023, we began to restructure our business operations by entering into new licensing agreements and joint venture arrangements with best-in-class business partners. We entered into a new interactive
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television licensing agreement with America’s Collectibles Network, Inc. d/b/a JTV (“JTV”) for the Ripka Brand, and a separate license with JTV for the Ripka Brand’s e-commerce business. For apparel, similar transactions have recently been executed. In conjunction with the launch of the C Wonder Brand on HSN, we licensed the wholesale production operations related to the brand to One Jeanswear Group, LLC (“OJG”); this new license with OJG also includes other new celebrity brands that we plan to launch in 2023 and beyond. For the Halston Brand, we plan on entering into a joint venture related to the brand’s wholesale apparel business with another leading manufacturer (the “Halston JV”). The Halston JV will develop an apparel business under the H Halston brand through department stores, e-commerce, and other retailers. The Halston JV will include a wholesale license to Xcel. We expect the transition of these operating businesses to be completed by the second quarter of 2023. We believe that this evolution of our operating model will provide us with significant cost savings and allow us to reduce and better manage our exposure to operating risks. As of March 31, 2023, steps have been taken to reduce payroll by $6 million and operating cost by approximately $7 million over the next twelve months. Further, the Company intends to obtain a line of credit to provide additional capital resources. However, there is no assurance that this line of credit or any other external financing will be obtained.
Based on these recent changes in our business model, management expects to generate adequate cash flows to meet the Company’s operating and capital expenditure needs, for at least the twelve months subsequent to the filing date of this Annual Report on Form 10-K, and therefore, such conditions and uncertainties with respect to the Company’s ability to continue as a going concern as of December 31, 2022, have subsequently been alleviated.
Operating Activities
Net cash (used in) provided by operating activities was approximately $(14.2) million and $(6.6) million in the Current Year and Prior Year, respectively.
The Current Year’s cash used in operating activities was primarily attributable to the combination of the net loss of $(5.4) million plus non-cash items of approximately $(10.2) million, partially offset by a net change in operating assets and liabilities of approximately $1.4 million. Non-cash items were primarily comprised of, but not limited to, the net gain on sale of assets of $(20.6) million, $7.3 million of depreciation and amortization, a $2.3 million loss on extinguishment of debt, and the $1.2 million undistributed proportional share of net income of equity method investee. The net change in operating assets and liabilities notably included a decrease in accounts receivable of $2.1 million, a decrease in inventory of $0.5 million, a decrease in prepaid expenses and other assets of $0.6 million, and decreases in various operating liabilities of $(1.4) million. The decrease in accounts receivable was primarily related to the Current Year sale of a majority interest in the Isaac Mizrahi brand, resulting in lower licensing revenues and thus lower receivable balances. The decreases in inventory and other operating assets and liabilities were primarily reflective of the declines in our wholesale business due to retailers pausing or canceling orders during the Current Year.
The Prior Year’s cash used in operating activities was primarily attributable to the combination of the net loss of $(13.0) million plus non-cash expenses of approximately $7.7 million, and a net change in operating assets and liabilities of approximately $(1.2) million. Non-cash net expenses were primarily comprised of $6.8 million of depreciation and amortization, $1.4 million of asset impairment charges, $0.3 million of amortization of deferred finance costs, a $1.5 million loss on extinguishment of debt, $0.7 million of stock-based compensation, and $(3.2) million of deferred income tax benefit. The net change in operating assets and liabilities notably included a decrease in accounts receivable of $1.1 million, an increase in inventory of $(2.2) million, an increase in prepaid expenses and other assets of $(0.8) million, and an increase in accounts payable, accrued expenses and other current liabilities of $1.2 million. The changes in accounts receivable and payable were primarily related to the timing of collections and payments, while the change in inventory is primarily related to expected increases in wholesales, including our drop-ship programs, and an increase in our direct-to-consumer businesses.
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Investing Activities
Net cash provided by investing activities for the Current Year was approximately $44.5 million, and was attributable to $45.4 million of net proceeds from the sale of a majority interest in the Isaac Mizrahi brand to WHP, partially offset by $0.6 million of capital contributions to our equity method investee and approximately $0.3 million of capital expenditures.
Net cash used in investing activities for the Prior Year was approximately $4.8 million, which was primarily attributable to the acquisition of the Lori Goldstein brand on April 1, 2021, and, to a lesser extent, to 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 Year was approximately $31.0 million, which mainly consisted of $29.0 million of repayments of our term loan debt, and, to a lesser extent, $1.5 million of prepayment and other fees associated with the early extinguishment of debt, as well as $0.4 million of shares repurchased related to withholding taxes on vested restricted stock.
Net cash provided by financing activities for the Prior Year was approximately $10.5 million, and was primarily attributable to a net increase in debt obligations of $13.5 million, due to debt refinancing transactions entered into on April 14, 2021 and December 30, 2021, as well as cash contributions received from the noncontrolling interest holder in Longaberger Licensing, LLC of $1.0 million. These sources of cash were partially offset by deferred finance costs and other fees paid in connection with the aforementioned debt refinancing transactions of $(2.7) million, and principal payments made on term loan debt of $(1.3) million during the year.
Obligations and Commitments
Contingent Obligation – Lori Goldstein Earn-Out
In connection with the April 1, 2021 purchase of the Lori Goldstein trademarks (see Note 3 of the consolidated financial statements for additional information), we agreed to pay the seller additional cash consideration of up to $12.5 million, based on royalties earned during the six calendar year period commencing in 2021. The Lori Goldstein Earn-Out of $6.6 million is recorded as a liability in the accompanying consolidated balance sheets, based on the difference at the date of acquisition between the fair value of the acquired assets of the Lori Goldstein brand and the total consideration paid. Based on the performance of the Lori Goldstein brand through December 31, 2022, approximately $0.2 million of additional consideration has been earned and is payable to the Seller in 2023. At December 31, 2022, $0.2 million of the balance is recorded as a current liability and $6.4 million is recorded as a long-term liability; at December 31, 2021, the entire balance was recorded as a long-term liability.
Contingent Obligation – Isaac Mizrahi Transaction
In connection with the May 31, 2022 transaction related to the sale of a majority interest in the Isaac Mizrahi brand, we agreed with WHP (the buyer) that, in the event that IM Topco, LLC receives less than $13.3 million in aggregate royalties for any four consecutive calendar quarters over a three-year period ending on May 31, 2025, WHP will be entitled to receive from us up to $16 million, less all amounts of net cash flow distributed to WHP on an accumulated basis, as an adjustment to the purchase price previously paid by WHP. Such amount would be payable by us in either cash or equity interests in IM Topco, LLC held by us. Based on IM Topco’s earnings from May 31, 2022 through December 31, 2022 and the applicable distribution provisions, WHP earned $4.32 million in cash flow, which reduces the potential purchase price adjustment to $11.68 million. No amount has been recorded in the accompanying consolidated balance sheets related to this contingent obligation, and management believes the likelihood of any such payment is remote.
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Contingent Obligation – Halston Heritage Earn-Out
In connection with the February 11, 2019 purchase of the Halston Heritage trademarks from the H Company IP, LLC (“HIP”), we agreed to pay HIP additional consideration (the “Halston Heritage Earn-Out”) of up to an aggregate of $6.0 million, based on royalties earned from 2019 through December 31, 2022. This additional consideration would have been payable in shares of our common stock. The Halston Heritage Earn-Out of $0.9 million was recorded as a long-term liability on February 11, 2019 and as of December 31, 2021, based on the difference at the date of acquisition between the fair value of the acquired assets of the Halston Heritage Trademarks and the total consideration paid.
The final royalty target year ended on December 31, 2022, and HIP ultimately did not earn any additional consideration based on the formula set forth in the related asset purchase agreement. As such, during the year ended December 31, 2022, we recorded a $0.9 million gain on the reduction of contingent obligations in the accompanying consolidated statement of operations. As of December 31, 2022, there were no amounts remaining under the Halston Heritage Earn-Out.
Real Estate Leases
As described in Item 2 of this Annual Report on Form 10-K, as of December 31, 2022 we had real estate leases for our current office and a retail store location, with remaining lease terms between approximately five to seven years. We recorded an impairment charge related to the right-of-use asset for the retail store as of December 31, 2021, subsequently closed the retail store in 2022, and are currently in the process of negotiating the termination of the retail store lease; however, the lease liability for the retail store remains on our consolidated balance sheet as a liability and is included in the future payment obligations set forth below.
Future payments under our real estate leases are expected to be approximately $1.7 million for each of the years ending December 31, 2023 – 2026, $1.5 million for the year ending December 31, 2027, and $0.2 million thereafter.
Employment Contracts
We have entered into contracts with certain executives and key employees. The future minimum payments under these contracts is expected to be approximately $19.9 million, of which, approximately $4.3 million is expected to be paid in 2023, approximately $2.1 million is expected to be paid for each of the years ending December 31, 2024 – 2030, and approximately $0.5 million is expected to be paid in 2031.
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.
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 Lori Goldstein 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.
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 future cash flows from our retained interest in the Isaac Mizrahi brand, are expected to position us to fund various strategic initiatives as we concentrate our resources on growing our brands, new brand launches, and investing in live streaming technology and new business partnerships.
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We continue to work towards expanding and developing more efficient ways to operate 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, including recent launches of our Victor Glemaud and C Wonder by Christian Sirano businesses on HSN.
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 recognized bad debt expense of approximately $0.4 million and $0.1 million in the Current Year and Prior Year, respectively, 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 is currently experiencing 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 2023.
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 at least some portion of 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.
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 and potential business partners, 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 Item 1A of this Annual Report on Form 10-K could adversely affect our licensees’ ability to meet and/or exceed their contractual commitments to us and thereby adversely affect our future operating results.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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