Xcel Brands, Inc. annual report, FY2013

Xcel Brands, Inc. — FY2013 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2013, compared with fiscal 2012. This is an annual filing, not a standalone fourth-quarter report. The company manages consumer brands through design and licensing and, beginning in June 2013, a retail business. Its principal brands during 2013 were Isaac Mizrahi and Liz Claiborne New York (LCNY). The Judith Ripka acquisition closed after year-end, on April 3, 2014.

Financial performance and position

Metric	FY2013	FY2012
Total revenue	$13.368 million	$12.703 million
Net licensing revenue	$11.546 million	$10.432 million
Design and service fee revenue	$1.619 million	$2.271 million
Net income	$1.532 million	$4.284 million
Diluted earnings per share	$0.16	$0.57
Adjusted EBITDA, non-GAAP	$3.938 million	$4.501 million
Cash provided by operating activities	$2.383 million	$2.591 million

• Margins: Gross profit was $13.275 million, or approximately 99% of revenue, reflecting the licensing-heavy mix. The new retail segment generated $203,000 in sales, $110,000 in gross profit and a $339,000 operating loss. A consolidated operating margin is not presented here because reported operating income includes substantial other income from a contingent-obligation remeasurement.
• Profit drivers: Reported operating income was $1.856 million, down from $5.693 million. Other income included a $5.122 million gain from reducing contingent obligations, partly offset by a $1.351 million debt-extinguishment loss. The income tax benefit was $1.402 million, unusually large relative to $130,000 of pretax income, primarily because the contingent-obligation gain was not subject to federal income tax and other tax adjustments applied.
• Cash and liquidity: Cash and equivalents were $7.461 million at year-end, up from $3.929 million. Current assets were $11.549 million and current liabilities $2.411 million; the reported current ratio was 4.79, versus 2.45 in 2012. Investing activities used $509,000, while financing activities provided $1.658 million.
• Debt and obligations: Year-end debt and contingent obligations had a net carrying amount of $24.783 million, including a $13.0 million term loan, a $5.045 million seller note and $6.681 million of contingent obligations. The $13.0 million loan was refinanced in August 2013 at a fixed 4.44% rate and is secured by IM Brands assets and the company’s interest in that subsidiary. Management reported compliance with loan covenants at December 31, 2013.
• Revenue concentration: QVC accounted for 61% of revenue in both years; LCNY accounted for 12% in 2013 versus 13% in 2012. Together, those sources represented 73% of 2013 revenue. QVC also represented 55% of year-end receivables.

Material changes versus FY2012

• Revenue increased approximately 5%, as licensing revenue rose $1.114 million and retail added $203,000; design and service fees fell $652,000, largely due to lower non-recurring short-term service fees.
• Operating expenses rose $1.458 million to $15.190 million, driven chiefly by compensation and stock-based compensation. Stock-based compensation was $4.810 million.
• Net income declined 64% and Adjusted EBITDA declined approximately 13%. The year-over-year profit comparison was affected by the smaller contingent-obligation gain in 2013 and the debt-refinancing loss.
• The company raised $5.0 million gross in a June 2013 private stock offering and used a new $13.0 million loan to refinance its prior term debt.
• The first Isaac Mizrahi retail store opened in June 2013. The company opened a second store in March 2014 and planned an e-commerce launch later in 2014.

Outlook, risks and unusual items

• Management said existing cash and anticipated operating cash flow were expected to cover operating needs, debt service and capital expenditures for at least the next 12 months. This is not formal earnings guidance; the filing provides no clear numerical revenue or profit forecast for FY2014.
• Management planned to expand licensing, distribution channels, retail and e-commerce, and to integrate and grow the Ripka brand. It cautioned that results depend on licensee performance, consumer acceptance, fashion trends and retaining key personalities and partners.
• The Ripka acquisition was completed after year-end for $12.0 million cash, $6.0 million in interest-free notes and 571,429 shares. The company also agreed to further payments of $1.0 million in October 2014 and $1.2 million in April 2015, plus a potential earn-out of up to $5.0 million. It financed the acquisition in part with a separate $9.0 million, five-year Bank Hapoalim loan.
• The Ripka loan and amended existing loan impose financial covenants, including minimum EBITDA, minimum net worth of $31 million and minimum liquidity of $3 million, as well as cash-flow repayment provisions. These requirements and the new debt increase execution and liquidity risks.
• Other key risks include dependence on QVC, the concentration of revenue among a small number of partners, secured debt and covenant restrictions, possible share dilution from notes, earn-outs, warrants and equity awards, and the early-stage retail business. The company reported no pending legal proceedings and no material off-balance-sheet arrangements.
• Management concluded disclosure controls and internal control over financial reporting were effective at December 31, 2013. The auditor issued an unqualified opinion on the financial statements but did not attest to internal-control effectiveness.

Investor verification priorities

• Review the audited statements and debt notes to reconcile reported operating income, the contingent-obligation gains and the unusually large tax benefit.
• Assess the sustainability of licensing royalties, especially QVC dependence, customer receivables and guaranteed minimum royalty terms.
• Verify post-acquisition Ripka performance against the new loan’s EBITDA, liquidity and net-worth covenants, and track the scheduled cash payments and earn-out conditions.
• Evaluate retail-store losses, inventory and capital needs, and whether the planned e-commerce launch generated the expected returns.
• Quantify potential dilution from outstanding equity awards and the seller and Ripka notes, earn-outs and warrants; compare the reported share count with subsequent issuances.