Xcel Brands, Inc. — Q2 2018 Form 10-Q
Business context and period. This unaudited report covers the three and six months ended June 30, 2018. Xcel designs, licenses, markets and sells consumer brands, including Isaac Mizrahi, Judith Ripka, H Halston, C Wonder and Highline Collective. Licensing is its primary revenue source; the company also began separately reporting jewelry wholesale and e-commerce sales in 2018.
Financial performance
| Metric ($ millions, except per-share amounts) | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | 8.49 | 8.37 | 17.25 | 16.80 |
| Net licensing revenue | 8.14 | 8.37 | 16.62 | 16.80 |
| Net revenue after sales cost of goods | 8.26 | 8.37 | 16.84 | 16.80 |
| Operating income | 1.29 | 1.12 | 2.50 | 1.55 |
| Interest and finance expense | 0.27 | 0.35 | 0.55 | 0.73 |
| Income before taxes | 1.02 | 0.77 | 1.95 | 0.83 |
| Income tax provision | 1.13 | 0.56 | 1.56 | 1.01 |
| Net income (loss) | (0.11) | 0.21 | 0.39 | (0.19) |
| Adjusted EBITDA (non-GAAP) | 2.22 | 2.26 | 4.38 | 4.20 |
| Non-GAAP net income | 1.49 | 1.50 | 2.93 | 2.65 |
| GAAP diluted EPS | (0.01) | 0.01 | 0.02 | (0.01) |
Q2 net revenue was approximately 97% of total revenue; operating income was approximately 15% of total revenue. Both are simple calculations from reported figures. The filing cautions that its non-GAAP measures are supplemental and may not be comparable with similarly titled measures at other companies.
Balance sheet, cash flow and debt
- At June 30, 2018, cash and cash equivalents were $7.64 million, with another $1.51 million restricted. Current assets were $20.01 million and current liabilities $9.88 million; working capital was $10.13 million.
- Total debt carrying value, including seller notes and contingent obligations, was $22.22 million, down from $24.95 million at December 31, 2017. The Xcel term loan was $17.50 million, at a stated fixed rate of 5.1%, and matures January 1, 2021. Scheduled principal payments include $2.0 million in the second half of 2018 and $4.0 million in 2019.
- For the first six months, operating cash flow was $1.96 million, investing cash use was $1.08 million (principally capital expenditures), and financing cash use was $3.43 million. Cash, cash equivalents and restricted cash declined $2.54 million to $9.15 million.
- Management said existing cash and operating cash flows were expected to cover operating needs, debt service and capital expenditures for at least 12 months after the filing date. The company reported compliance with all applicable loan covenants at June 30, 2018. Covenant requirements include minimum liquidity, net worth and fixed-charge coverage, as well as EBITDA and capital-expenditure limits.
Changes, outlook and risks
- Q2 total revenue rose $0.12 million year over year, while licensing revenue fell $0.23 million. Jewelry wholesale and e-commerce added $0.35 million of sales, but contributed only $0.12 million of net revenue after cost of goods. For the first half, total revenue increased $0.45 million; reported sales were $0.63 million and net licensing revenue declined $0.18 million.
- Management attributed lower licensing revenue in part to the C Wonder QVC transition: the sell-off period ended in January 2018. It cited higher ongoing interactive licensing as a partial offset. QVC accounted for about 81% of Q2 net revenue and 80% of first-half net revenue; QVC receivables were $6.73 million, about 67% of total receivables, at quarter-end.
- Operating expenses declined year over year, primarily because compensation and stock-based compensation were lower. First-half operating income improved, but Q2 GAAP net income turned to a loss because the $1.13 million tax provision exceeded pretax income. The filing cites restricted-stock vesting, state taxes and permanent differences as contributors to unusually high effective tax rates. Certain Tax Cuts and Jobs Act accounting remained provisional.
- No specific revenue or earnings guidance was provided. Management described plans to diversify brands and distribution channels, pursue new domestic and international licensing opportunities, expand C Wonder distribution, and seek additional brand acquisitions. It noted that results depend on licensee performance, brand awareness, fashion trends and retail demand. The filing also identifies consumer preference changes, economic weakness, supply costs and retail consolidation as potential risks.
- Potentially significant items include a $2.85 million C Wonder earn-out liability, payable after June 30, 2019 in cash or stock at the company’s discretion; a $0.57 million facility-exit liability scheduled through February 2022; and related-party H Halston arrangements involving a director-affiliated entity. The company reported $0.7 million of Q2 revenue from HOC, a related party, and stated that proposed arrangements were being negotiated while operating under at-will terms.
- The company adopted ASC 606 in January 2018 and reported no material effect on revenue or results. Management said disclosure controls were effective at June 30, 2018 and reported no significant quarterly change in internal control over financial reporting.
Investor verification priorities
- Review QVC concentration, receivable collection and the effect of the C Wonder QVC exit on future royalties.
- Check debt amortization, covenant headroom and the assumptions behind management’s 12-month liquidity assessment.
- Assess recurring earnings and cash generation separately from stock compensation, deferred taxes and other non-GAAP adjustments.
- Verify the status and economics of the H Halston related-party agreements, including design fees, royalty participation and any final contracts.
- Monitor C Wonder earn-out valuation and payment form, and the company’s new jewelry wholesale and e-commerce inventory and margins.