Xcel Brands, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited. Xcel designs, licenses, markets and sells Isaac Mizrahi-branded products and licenses certain Liz Claiborne New York rights. It operates design and licensing and retail segments; its first retail store opened in June 2013.
Financial performance
| Metric | Three months ended Sept. 30, 2013 | Three months ended Sept. 30, 2012 | Nine months ended Sept. 30, 2013 | Nine months ended Sept. 30, 2012 |
|---|---|---|---|---|
| Revenue | $3.919 million | $3.725 million | $10.313 million | $9.429 million |
| Gross profit | $3.858 million | $3.725 million | $10.239 million | $9.429 million |
| Operating expenses | $4.950 million | $4.151 million | $12.255 million | $9.977 million |
| Income (loss) shown as operating income | $2.657 million | $(0.426) million | $1.733 million | $(0.548) million |
| Net income (loss) | $3.119 million | $(0.472) million | $1.936 million | $(1.664) million |
| Basic EPS | $0.31 | $(0.06) | $0.22 | $(0.25) |
| Interest and finance expense | $0.385 million | $0.548 million | $1.423 million | $1.636 million |
- Gross margin was approximately 98.4% in Q3 and 99.3% for the nine months, versus 100% in each 2012 comparison period. Retail gross margin was approximately 53% in Q3 and 54% for the nine months; retail segment operating losses were $0.140 million and $0.233 million, respectively.
- Revenue rose approximately 5.2% in Q3 and 9.4% year to date. Nine-month licensing revenue increased $1.048 million, while design and service fee income declined $0.326 million. Retail contributed $0.130 million in Q3 and $0.162 million year to date.
- Net cash provided by operating activities was $0.933 million, compared with $1.517 million in the prior-year period. Investing activities used $0.276 million; financing activities provided $3.281 million. Cash increased $3.938 million to $7.867 million.
- At September 30, cash was $7.867 million, current assets $13.045 million and current liabilities $7.561 million; the company reported a 1.68:1 working-capital ratio. Total debt and contingent obligations shown in Note 5 were $25.670 million, including $6.244 million classified as current.
Material changes and unusual items
- Q3 and nine-month results include a $5.1 million noncash gain from reducing the estimated fair value of seller earn-out obligations, partly offset by a $1.351 million loss on refinancing debt. The earn-out reduction reflected lower projected future Isaac Mizrahi royalties and reduced the recorded contingent obligation from $11.466 million at year-end 2012 to $6.366 million.
- On August 1, 2013, Xcel replaced its prior loan with a five-year, $13.0 million Bank of Hapoalim term loan at a fixed 4.44%, versus 8.5% on the prior loan. Principal payments begin in October 2014; the agreement also requires repayment of 20% of defined excess cash flow beginning with fiscal 2014. The company reported compliance with loan covenants at September 30.
- Operating expenses increased $0.799 million in Q3 and $2.278 million year to date, driven principally by higher salaries and stock-based compensation. Nine-month stock-based compensation was $4.652 million.
- In June, Xcel issued 1,428,573 common shares and warrants for 312,500 shares in a private offering that generated $5.0 million gross proceeds. Common shares outstanding rose from 7,339,979 at December 31, 2012 to 10,167,427 at September 30, 2013.
- Intangibles of $45.440 million and goodwill of $12.371 million are substantial portions of total assets. Management reported no impairment charge following its assessment.
Outlook, risks and other disclosures
- Management expected existing cash and operating cash flow to cover operating needs, debt service and capital expenditures for the next 12 months. It planned a second store in Atlanta in the first quarter/spring of 2014, with expected build-out spending similar to the first store. The lender limits annual capital expenditures to $1.0 million, subject to an increase tied to licensing revenue, and restricts additional store openings without consent.
- The company depends on licensees for most revenue and stated there is no assurance they will perform as projected. QVC generated 51% of Q3 revenue and 58% of nine-month revenue; QVC and Fifth & Pacific together accounted for 79% of receivables at September 30.
- Management identified fashion-trend shifts, consumer demand, economic conditions, supply costs and retail-industry consolidation as risks to licensee performance and future results. It also described plans to diversify product categories and distribution channels and pursue retail and international opportunities.
- No legal proceedings or defaults on senior securities were reported. Management concluded disclosure controls were effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Reconcile Q3 net income: the financial statements report $3.119 million, while MD&A states $3.15 million.
- Assess the sustainability of earnings excluding the $5.1 million earn-out remeasurement gain and the $1.351 million refinancing loss; the earn-out valuation depends on Level 3 assumptions about future royalties.
- Review QVC and other licensee concentration, receivable collection, and the assumptions behind management’s liquidity outlook and royalty projections.
- Review the seller note’s $6.244 million current classification and repayment/conversion options, the contingent obligations, and the new loan’s repayment, cash-flow recapture and covenant terms.
- Consider dilution from the offering, outstanding warrants and options, and restricted-stock awards; stock-based compensation materially increased operating expenses.