Xcel Brands, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Financial statements are unaudited. Dollar amounts below are in millions unless otherwise stated.
Business context
Xcel is a brand-management and consumer-products company that licenses and supports apparel, jewelry, accessories, home goods and other products. Its portfolio includes Isaac Mizrahi, Judith Ripka, H Halston, C Wonder and Highline Collective. The company relies on licensees and distribution partners and outsources manufacturing and inventory ownership.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenue | $7.89 | $8.32 | $24.69 | $25.79 |
| Operating income | $1.26 | $0.84 | $2.81 | $1.41 |
| Operating margin | 15.9% | 10.0% | 11.4% | 5.5% |
| Net income (loss) | $0.25 | $0.12 | $0.07 | $(0.02) |
| Net margin | 3.2% | 1.4% | 0.3% | (0.1%) |
| Adjusted EBITDA (non-GAAP) | $2.36 | $2.34 | $6.56 | $7.08 |
Operating and net margins are approximate calculations from reported figures. Diluted GAAP EPS was $0.01 for each Q3 period and $0.00 for the 2017 nine-month period (versus a loss per share rounded to $(0.00) in 2016). Non-GAAP net income was $1.64 million in Q3 and $4.29 million year to date; non-GAAP diluted EPS was $0.09 and $0.22, respectively. These company-defined measures exclude specified items and are not substitutes for GAAP results.
- Cash flow: Nine-month operating cash flow was $2.33 million, down from $6.77 million. Investing used $0.19 million; financing used $8.00 million, including $5.75 million of senior-term-loan payments, $1.43 million on the IM Seller Note and $0.81 million for shares withheld for taxes. Cash, cash equivalents and restricted cash declined $5.85 million to $9.78 million.
- Liquidity: September 30 cash and cash equivalents were $8.27 million; restricted cash was $1.51 million. Working capital was $11.13 million, versus $11.53 million at December 31, 2016. Management expected existing cash and operating cash flows to cover operating needs, debt service and capital expenditures for at least 12 months after filing.
- Debt: Reported net carrying debt, including contingent obligations, was $24.90 million, down from $31.92 million at year-end 2016. The Xcel Term Loan balance was $19.50 million, with a 5.1% stated fixed rate and maturity in January 2021. The company reported compliance with applicable covenants at September 30.
- Tax: The effective tax rate was approximately 73% in Q3 and 96% for the nine-month period, materially reducing reported net income. Management cited recurring permanent differences and tax effects related to vesting restricted shares.
Changes versus prior periods
Q3 revenue decreased 5.2%; nine-month revenue decreased 4.3%. Management attributed the declines principally to the C Wonder QVC transition and the end of the Liz Claiborne New York management/design contract in July 2016. These were partly offset by growth in department-store business, including Dillard’s launches and expansion of the fast-to-market platform. Lower operating expenses and interest costs supported higher GAAP operating income and net income. However, nine-month Adjusted EBITDA fell about 7% to $6.56 million, and operating cash flow declined substantially, in part reflecting increased receivables and lower accrued liabilities.
Outlook, risks and notable items
- There is no quantified earnings or revenue guidance in the filing. Management described liquidity as adequate for at least the next 12 months, while noting dependence on licensees’ performance.
- QVC generated about 80% of Q3 revenue and 82% of nine-month revenue; QVC also represented 68% of receivables at September 30. This is a significant customer and collection concentration.
- The C Wonder QVC agreement was terminated effective May 1, 2017. QVC royalties continue through January 31, 2018, with specified interactive-TV exclusivity through May 1, 2018. Xcel said it was pursuing new channels and licensing partners.
- Term-loan covenants include minimum liquidity, net-worth, fixed-charge coverage, capital-expenditure and EBITDA requirements. The loan is secured by company and guarantor assets. The filing states the company was compliant at quarter-end.
- Other risks cited include fashion-trend and consumer-demand changes, retailer consolidation, supply-cost changes, and the ability to retain licensees and build brand awareness. Management said pending litigation was not expected to have a material adverse effect.
- Non-GAAP measures include substantial adjustments, including stock compensation and deferred tax provision; investors should assess them alongside GAAP results. A related-party consulting agreement with a director-controlled firm included cash fees and stock awards.
- After quarter-end, the company amended its charter to increase authorized common shares from 35 million to 50 million. The filing also reports a $2.85 million C Wonder contingent obligation and a $0.20 million Ripka earn-out liability.
Important facts for investors to verify
- QVC concentration, receivable collection and the revenue impact as C Wonder royalties and exclusivity expire.
- Whether new C Wonder partners and department-store expansion can offset terminated and discontinued brand-related revenue.
- Cash-flow conversion and working-capital trends, including accounts receivable growth and the company’s ability to maintain covenant liquidity.
- The basis and sustainability of the unusually high effective tax rate, and the reconciliation of GAAP earnings to company-defined non-GAAP measures.
- Debt amortization, covenant thresholds and contingent earn-out exposure, including the C Wonder obligation.
- Potential dilution from equity awards and the increase in authorized common shares; review the terms and disclosures for related-party compensation.