Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-Looking Statements
This Quarterly Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of Exchange Act, which represent our management’s beliefs and assumptions concerning future events based on information currently available to us. When used in this Quarterly Report and in documents incorporated herein by reference, the words and phrases “may,” “will,” “expect,” “anticipate,” “intend,” “estimate,” “continue,” “believe,” “plan,” “project,” “will be,” “will continue,” “will likely result,” “indicates,” “forecast,” “guidance,” “outlook,” “targets” and similar expressions and the negatives of such words and phrases are intended to identify forward-looking statements. Similarly, statements that describe our future expectations, objectives and goals or contain projections of our future results of operations or financial condition are also forward-looking statements.
These statements are not guarantees of future performance and are subject to certain risks and uncertainties, which are difficult to predict and which could cause actual results to differ materially, including, without limitation: the risk that we incurred substantial indebtedness in connection with the acquisition of RG, and, to a lesser extent, SWIMS, and it may be necessary to refinance or extend our indebtedness, which may decrease our business flexibility and adversely affect our financial results; the risk that we may default on the indebtedness we incurred to finance the acquisition of RG; the risk that we will be unsuccessful in integrating Hudson, RG and SWIMS and achieving our intended results as a result of such acquisitions; the risk that our foreign sourcing of our products and the implementation of foreign production for Hudson’s products may adversely affect our business; the risk that we will be unsuccessful in gauging fashion trends and changing customer preferences; the risk that changes in general economic conditions, consumer confidence or consumer spending patterns, including consumer demand for denim and premium lifestyle apparel, will have a negative impact on our financial performance or strategies and our ability to generate cash flows from our operations to service our indebtedness; the risks associated with leasing retail space and operating our own retail stores; the highly competitive nature of our denim and premium lifestyle apparel businesses in the United States and internationally and our dependence on consumer spending patterns, which are influenced by numerous other factors; our ability to respond to the business environment and fashion trends; continued acceptance of our brands in the marketplace; our reliance on a small number of large customers; our ability to implement successfully any growth or strategic plans; our ability to manage our inventory effectively; the risk of cyber attacks and other system risks; our ability to continue to have access on favorable terms to sufficient sources of liquidity necessary to fund ongoing cash requirements of our operations or new acquisitions; competitive factors, including the possibility of major customers sourcing products overseas in competition with our products; the risk that acts or omissions by our third-party vendors, including those to whom we license our brands, could have a negative impact on our reputation; the effect of the RG Merger and the acquisition of SWIMS on our financial results, business performance and product offerings; the risk that our credit ratings or those of our subsidiaries may be different from what we expect; the risk that our existing stockholders may be diluted if we choose to settle our Modified Convertible Notes by issuing shares of our common stock;
risks associated with the restatement of our unaudited condensed consolidated financial statements as of and for the three months ended March 31, 2016, the identification of material weaknesses in our internal control over financial reporting and our ability to maintain effective internal control over financial reporting
and the risk factors contained in our reports filed with the SEC pursuant to the Exchange Act, including our annual report on Form 10-K for the year ended November 30, 2015 (the “
2015 Form 10-K
”), and in “Part II, Item 1A, Risk Factors” of this Quarterly Report.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Since we operate in a rapidly changing environment, new risk factors can arise and it is not possible for our management to predict all such risk factors, nor can our management assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Our future results, performance or achievements could differ materially from those expressed or implied in these forward-looking statements. We do not undertake any obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events, except as may be required by law.
Introduction
This management’s discussion and analysis summarizes the significant factors affecting our results of operations and financial condition during the quarterly periods ended June 30, 2016 and 2015. This discussion should be read in conjunction with our consolidated financial statements as of December 31, 2015 and 2014 and for the three-year period ended December 31, 2015 and the notes thereto (filed as Exhibit 99.1 to Amendment No. 1 to our Current Report on Form 8-K/A, filed with the SEC on March 30, 2016), as well as the unaudited condensed consolidated financial statements and notes thereto and information contained in this Quarterly Report.
Executive Overview
Our principal business activity is the design, development and worldwide marketing of apparel products, which include denim jeans, related casual wear and accessories bearing the brand Hudson®, the design, development, sales and licensing of apparel products and accessories bearing the brand name Robert Graham®, and as of July 18, 2016, the design, development, sales and licensing of shoes, accessories and apparel products bearing the brand name SWIMS®. Until the closing of the Joe’s Asset Sale in September 2015 and the transfer of the remaining Joe’s brand retail stores that we closed in February 2016 as part of our discontinued operations, we also sold apparel products bearing the Joe’s® brand name. Hudson® was established in 2002, and is similarly recognized as a premier designer and marketer of women’s and men’s premium branded denim apparel. Robert Graham® can be described as “American Eclectic” and received the 2014 “Menswear Brand of the Year” award from the American Apparel & Footwear Association. Since its launch in 2001, Robert Graham® was created based upon the premise of introducing sophisticated, eclectic style to the fashion market as an American-based company with an intention of inspiring a global movement. We completed the acquisition of our Robert Graham® business on January 28, 2016, when we acquired all of the outstanding equity interests of RG. SWIMS is a Scandinavian lifestyle brand best known for its range of fashion-forward, water-resistant footwear and sportswear that artfully balances performance, comfort and style. We completed the acquisition of SWIMS on July 18, 2016.
Our Hudson® product line includes women’s, men’s and children’s denim jeans, pants, jackets and other bottoms. We sell our products under our Hudson® brand through our website and to numerous retailers, which include major department stores, specialty stores and international customers around the world. We continue to evaluate offering a range of products under the Hudson® brand name.
Robert Graham® offers a cohesive lifestyle collection that includes premium priced men’s knits, polos, t-shirts, sweaters, sport coats, outerwear, jeans, pants, shorts, swimwear, sport shirts and accessories. We also offer a line of women’s apparel, mainly in our Robert Graham® brand retail stores. Additionally, under our Robert Graham® product line, men’s shoes, belts, small leather goods, dress shirts, neckwear, tailored clothing, headwear, eyeglasses and sunglasses, jewelry, hosiery, underwear, loungewear and fragrances are produced by third parties under various license agreements and we receive royalty payments based upon net sales from licensees. We sell our Robert Graham® brand in a limited manner in the international market.
SWIMS distributes its full range of footwear, swimwear, outerwear, ready-to-wear and accessories worldwide through high-end department stores, independent specialty stores and luxury resorts, and sells products through its own website and through ten licensed SWIMS-branded stores (the “
SWIMS Business
”). Because these businesses focus on design, development and marketing, we rely on third parties to manufacture our products for Hudson®, Robert Graham® and SWIMS®.
Asset Sale Relating to Joe’s Business and Merger with RG
During fiscal 2014 and 2015, we believed that our growth potential relied on the integration of the Hudson Business and Joe’s Business. However, we did not achieve the desired level of integration on our original timetable, and failed to meet certain financial covenants set forth in the Garrison Term Loan Credit Agreement. On November 6, 2014, we received a notice of default and demand for payment of default interest from Garrison under the Garrison Term Loan Credit Agreement, which resulted in our default under the terms of the CIT Revolving Credit Agreement and our separate factoring facility with CIT and prohibited us from making payments under other indebtedness. On February 10,
2015, we received additional notices of default and events of default for failure to comply with certain financial and other covenants and a demand for continued payment of default interest from both Garrison and CIT.
Additionally, during the first half of fiscal 2015, our business was impacted by a decrease in overall sales in both our wholesale and retail segments. During fiscal 2014, our business was impacted by a decline in our overall Joe’s Business, but offset by the addition of sales from the acquisition of Hudson. On a comparative basis, sales of our men’s and women’s denim bottoms were, and continue to be, impacted by a weakening in the overall denim market, as consumer preference shifts to non-denim bottoms. Our Hudson® brand has been focused on designing new products in a variety of fits and washes with new and innovative fabrics to give the customer a reason to purchase a new pair of jeans.
On January 19, 2015, our then-President and Chief Executive Officer, Marc B. Crossman, resigned. As a result of the defaults under the various credit agreements and the resignation of our Chief Executive Officer, our board of directors determined that it was in the best interests of the Company and our stockholders to explore strategic alternatives to remedy the defaults with our lenders and to find a new chief executive officer to lead us. On September 8, 2015, we entered into various definitive agreements intended to provide a total solution to resolving the Company’s operational, financial and management issues, pursuant to which we agreed to the following: (i) the Joe’s Asset Sale, later completed September 11, 2015, whereby we sold certain of our operating and intellectual property assets related to the Joe’s Business for a total of $80 million; (ii) the RG Merger Agreement, under which we agreed to combine our remaining business operated under the Hudson® brand with RG; (iii) the RG Stock Purchase Agreement, under which we agreed to issue and sell $50 million of our Series A Preferred Stock in a private placement to an affiliate of Tengram Capital Partners; (iv) the exchange of certain outstanding convertible notes for a combination of cash, shares of our common stock and certain Modified Convertible Notes; and (v) the appointment of a chief executive officer with public company experience.
On September 11, 2015, we completed the Joe’s Asset Sale of (i) certain of our intellectual property assets used or held for use in the Joe’s Business for an aggregate purchase price of $67 million pursuant to that certain asset purchase agreement, dated as of September 8, 2015, by and among us, Joe’s Holdings, and solely for the purpose of its related guarantee, Sequential Brands Group, Inc., a Delaware corporation (the “
Joe’s
IP Asset Purchase Agreement
”), and (ii) among other things, certain inventory and other assets and liabilities related to the Joe’s Business for an aggregate purchase price of $13 million pursuant to that certain asset purchase agreement, dated as of September 8, 2015, by and between us and GBG (the “
Joe’s
Operating Asset Purchase Agreement
”). The proceeds of the Joe’s Asset Sale were used to repay all of our indebtedness outstanding under the
Garrison Term Loan Credit Agreement
and a portion of our indebtedness outstanding under our revolving credit agreement. As a result, the Garrison Term Loan Credit Agreement was paid in full and terminated on September 11, 2015 and we entered into the
CIT Amended and Restated Revolving Credit Agreement,
which provided for a maximum credit availability of $7.5 million and waived certain defaults. On January 28, 2016, all outstanding loans under the CIT Amended and Restated Revolving Credit Agreement were repaid and it was terminated in connection with our entering into (i) the ABL Credit Agreement and security agreement with Wells Fargo Bank, National Association, as lender, and (ii) the Term Credit Agreement and security agreement with TCW Asset Management Company, as agent, and the lenders party thereto. The aggregate cash consideration received was reduced by $19.0 million to repay all of RG’s outstanding loans and indebtedness under its revolving credit agreement with J.P. Morgan Chase Bank, N.A.
On January 28, 2016, we completed the acquisition of all of the outstanding equity interests of RG, as contemplated by the RG
Merger Agreement
, by and among RG, RG Merger Sub and us, for an aggregate of $81.0 million in cash and 8,825,461 shares of our common stock (after giving effect to the Reverse Stock Split (as defined above and discussed below)). Pursuant to the RG Merger Agreement, among other things, our RG Merger Sub was merged with and into RG, so that RG, as the surviving entity, became our wholly-owned subsidiary.
Effective upon consummation of the RG Merger, we changed our name to “Differential Brands Group Inc.” and completed the Reverse Stock Split, such that each 30 shares of our issued and outstanding common stock were reclassified into one share of our issued and outstanding common stock. The Reverse Stock Split did not change the par value or the amount of authorized shares of our common stock. The primary purpose of the Reverse Stock Split was to increase the per-share market price of our common stock in order to maintain our listing on NASDAQ.
In connection with the RG Merger, on January 28, 2016, we completed the issuance and sale of an aggregate of 50,000 shares of our Series A Preferred Stock for an aggregate purchase price of $50 million in cash, as contemplated by our RG Stock Purchase Agreement with TCP Denim, LLC. We used the proceeds from the RG Stock Purchase Agreement and the debt financing provided by the credit facilities under the ABL Credit Agreement and Term Credit Agreement to, among other things, consummate the RG Merger and the transactions contemplated by the RG Merger Agreement.
After the closing of the Joe’s Operating Asset Purchase Agreement and the Joe’s IP Asset Purchase Agreement on September 11, 2015, we retained and opera
ted 32 Joe’s® brand retail stores, of which we transferred 18 retail stores to GBG on January 28, 2016 for no additional consideration. As of February 29, 2016, the remaining 14 Joe’s® brand retail stores were closed. GBG supplied Joe’s® branded merchandise to the retail stores for resale under a license from Joe’s Holdings. The Joe’s® retail stores which Differential retained after the RG Merger until their closure later in the first quarter of fiscal 2016 are reported as part of the discontinued operations of the post-RG Merger combined Company in this management’s discussion and analysis.
Reportable Segments
We view our business and measure performance based on three primary segments: Wholesale, Consumer Direct and Corporate and other. Before its Merger with RG, Differential operated its Hudson Business and Joe’s Business using Wholesale and Retail (which we have renamed Consumer Direct) as its two reportable segments. Because RG has been accounted for as the accounting acquirer as a result of the RG Merger, we have adopted RG’s three subdivisions as our reportable segments for all operations of our combined Company for periods after the RG Merger’s closing date. For periods before the RG Merger’s closing date, our discussion of reportable segments reflects only the operations of RG. Additionally, the below does not discuss the integration of the SWIMS® brand, as it was acquired on July 18, 2016, after the period covered by this Quarterly Report.
Wholesale
As of June 30, 2016 and 2015, our Wholesale segment was comprised of sales of Robert Graham® products to
leading nationwide premium department stores, specialty retailers and boutiques and select off-price retailers
(“
Off-
Price
”), and, following the closing of the RG Merger Agreement on January 28, 2016 and as of June 30, 2016, was also comprised of sales of Hudson® products to retailers, specialty stores and international and off-price customers.
Additionally, our Wholesale segment included expenses from our sales and customer service departments, trade shows, warehouse distribution and product samples associated with, as of June 30, 2015 and 2016, our Robert Graham® product line and, following the closing of the RG Merger Agreement on January 28, 2016 and as of June 30, 2016, our Hudson® product line. Domestically, we sell our Hudson® products through our own showrooms, as well as, in the case of our Robert Graham® products, with independent sales representatives who may have their own showrooms. At the showrooms, retailers review the latest collections offered and place orders. The showroom representatives provide us with purchase orders from the retailers and other specialty store buyers. Internationally, we sell our products to customers in various countries.
We measure performance of our Wholesale segment primarily based on the diversity of product classifications and number of retail “doors” that sell our products within existing accounts as well as our ability to selectively expand into new accounts having retail customers carrying similar premium-priced products. While growth in our Wholesale segment has been relatively flat since the beginning of 2013 as we have focused on growing our higher margin Consumer Direct segment, our go-forward strategy includes driving sales by improving productivity in existing accounts/doors within existing accounts, selectively expanding into new accounts and continued installation of shop-in-shops. International expansion largely through wholesale distributors and licensees is also a strategy that we are pursuing.
Consumer Direct
As of June 30, 2016 and 2015, our Consumer Direct segment was comprised of sales of our Robert Graham® products directly to consumers in the United States through full-price retail stores, outlet stores and through our retail internet site located at
www.robertgraham.us.
As this segment generates higher gross margins and provides us greater
control of our brand, product mix and distribution, we have grown from one Robert Graham® brand retail store in 2011 to 30 retail stores as of June 30, 2016, including 18 full price stores and 12 outlet stores. Additionally, during the second quarter of fiscal 2016, we opened one new Robert Graham® retail store and closed another retail store in New York. We have signed a lease for a store we expect to open in early 2017. We have expanded the ecommerce part of the Consumer Direct segment by creating a larger customer database and generating repeat customer sales through our Collector’s Club Loyalty Program. Additionally, following the closing of the RG Merger Agreement on January 28, 2016 and as of June 30, 2016, our Consumer Direct segment was comprised of sales of our Hudson® products to consumers through our online retail site at
www.hudsonjeans.com
. Revenues from the 14 Joe’s® brand retail stores which we owned and operated until they closed as of February 29, 2016 are reported as discontinued operations
.
We measure performance of our Consumer Direct segment primarily based on the profitability of our stores, as well as our ability to attract and retain customers in our ecommerce business and the conversion rates on our website. The opening of new stores requires significant capital investment prior to generating revenue. Given our plans to continue to expand our retail footprint, near-term operating results could be adversely affected and we will need to closely manage our liquidity and capital resources.
Corporate and other
As of June 30, 2016 and 2015, our Corporate and other segment was comprised of licenses to third parties for the right to use our various trademarks in connection with the manufacture and sale of designated Robert Graham® products in specified geographical areas for specified periods. Our licensing revenues for our Robert Graham® products stem primarily from the following product categories and geographical areas: men’s shoes, belts, small leather goods, dress shirts, neckwear, tailored clothing, headwear, eye and sun glasses, jewelry, hosiery, underwear, loungewear and fragrances, and distribution in Canada. Following the closing of the RG Merger on January 28, 2016, our Corporate and other segment also included licensing revenue from the sale by our licensee of our Hudson® children’s product line. Our Corporate and other segment also encompassed our corporate operations, including the design, production, general brand marketing and advertising, operations, information technology, accounting, executive, legal and human resources departments associated with, as of June 30, 2016 and June 30, 2015, our Robert Graham® product line and, following the closing of the RG Merger Agreement on January 28, 2016 and as of June 30, 2016, our Hudson® product line. Similar to our Wholesale segment, we measure performance of our Corporate and other segment primarily based on our licensees’ ability to sell our products in multiple categories to their existing wholesale customers and to add new licensees in brand relevant categories.
Seasonality
Our business is partly seasonal. For our Robert Graham® products, the fourth quarter is the strongest quarter for sales within our Consumer Direct segment, and the greatest volume of shipments are made in late summer through early fall and again in late winter and early spring. For our Hudson® products, historically, the majority of the marketing and sales orders have taken place from late fall to late spring, and the greatest volumes of shipments and actual sales have generally been made from summer through early fall. Accordingly, the cash flows of our Robert Graham Business and Hudson Businesses may be strongest in those respective periods. Due to the partial seasonality of our business, as well as the evolution and changes in our business and product mix,
including the sale of the Joe’s Business and the Company’s acquisition of the Robert Graham Business, our quarterly results are not necessarily indicative of the results for the next quarter or year.
Furthermore, because of the growing number of full-price retail and outlet stores opened at different points during the past few fiscal years, we continue to assess the seasonality of our business on our retail segment and the potential impact of our retail stores on our financial results. Since we have opened most of our Robert Graham® brand stores in the last three years, we are still evaluating their performance.
For the remainder of 2016, we believe that our growth drivers will be dependent upon successful integration of the Robert Graham Business with the Hudson Business as a result of the RG Merger, which includes reducing expenses and achieving synergies as a result of the RG Merger. In addition, we may face increased costs as we attempt to integrate the technology, personnel, customer base and business practices and to realize the anticipated efficiencies of our recently-acquired SWIMS Business. Overall, we see opportunities for continued margin enhancement if we are successful in growing our Wholesale, Consumer Direct and Corporate and other segments. In particular, we see opportunity to improve product sourcing through growing economies of scale and to further enhance gross margins as
we continue to increase the proportion of our business derived from our Consumer Direct segment. No assurances can be given that these or other actions will result in increased profitability.
Results of Operations
Comparison of Three Months Ended June 30, 2016 to Three Months Ended June 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
|
|
|
|
(in thousands, except percentages, unaudited )
|
|
|
|
June 30, 2016
|
|
June 30, 2015
|
|
$ Change
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
32,373
|
|
$
|
16,256
|
|
$
|
16,117
|
|
99
|
%
|
Cost of goods sold
|
|
|
15,274
|
|
|
6,310
|
|
|
8,964
|
|
142
|
%
|
Gross profit
|
|
|
17,099
|
|
|
9,946
|
|
|
7,153
|
|
72
|
%
|
Gross margin
|
|
|
53
|
%
|
|
61
|
%
|
|
44
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
18,718
|
|
|
9,259
|
|
|
9,459
|
|
102
|
%
|
Depreciation and amortization
|
|
|
1,501
|
|
|
936
|
|
|
565
|
|
60
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss from continuing operations
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|
|
(3,120)
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|
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(249)
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|
|
(2,871)
|
|
1,153
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
1,995
|
|
|
134
|
|
|
1,861
|
|
1,389
|
%
|
Loss from continuing operations, before income tax (benefit) provision
|
|
|
(5,115)
|
|
|
(383)
|
|
|
(4,732)
|
|
1,236
|
%
|
Income tax (benefit) provision
|
|
|
(1,510)
|
|
|
105
|
|
|
(1,615)
|
|
(1,538)
|
%
|
Loss from continuing operations
|
|
|
(3,605)
|
|
|
(488)
|
|
|
(3,117)
|
|
639
|
%
|
Income from discontinued operations, net of tax
|
|
|
—
|
|
|
—
|
|
|
—
|
|
N/A
|
|
Net loss
|
|
$
|
(3,605)
|
|
$
|
(488)
|
|
$
|
(3,117)
|
|
639
|
%
|
Three Months Ended June 30, 2016 and 2015 Overview
The following table sets forth certain statements of operations data by our reportable segments for the periods as indicated:
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|
|
Three months ended
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|
|
|
(in thousands, except percentages, unaudited )
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|
|
June 30, 2016
|
|
June 30, 2015
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|
$ Change
|
|
% Change
|
|
Net sales:
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|
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|
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|
|
|
|
|
|
Wholesale
|
|
$
|
22,755
|
|
$
|
8,483
|
|
$
|
14,272
|
|
168
|
%
|
Consumer Direct
|
|
|
9,097
|
|
|
7,245
|
|
|
1,852
|
|
26
|
%
|
Corporate and other
|
|
|
521
|
|
|
528
|
|
|
(7)
|
|
(1)
|
%
|
|
|
$
|
32,373
|
|
$
|
16,256
|
|
$
|
16,117
|
|
99
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
9,665
|
|
$
|
3,869
|
|
$
|
5,796
|
|
150
|
%
|
Consumer Direct
|
|
|
6,913
|
|
|
5,549
|
|
|
1,364
|
|
25
|
%
|
Corporate and other
|
|
|
521
|
|
|
528
|
|
|
(7)
|
|
(1)
|
%
|
|
|
$
|
17,099
|
|
$
|
9,946
|
|
$
|
7,153
|
|
72
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
5,108
|
|
$
|
3,455
|
|
$
|
1,653
|
|
48
|
%
|
Consumer Direct
|
|
|
501
|
|
|
913
|
|
|
(412)
|
|
(45)
|
%
|
Corporate and other
|
|
|
(8,729)
|
|
|
(4,617)
|
|
|
(4,112)
|
|
89
|
%
|
|
|
$
|
(3,120)
|
|
$
|
(249)
|
|
$
|
(2,871)
|
|
1,153
|
%
|
For the three months ended June 30, 2016, or the second quarter of fiscal 2016, our net sales increased to $32,373,000 from $16,256,000 for the three months ended June 30, 2015, or the second quarter fiscal 2015, a 99 percent increase. We had an operating loss from continuing operations of $3,120,000 compared to an operating loss from continuing operations of $249,000 for the second quarter of fiscal 2015.
Net Sales
Our overall net sales increased to $32,373,000 for the second quarter of fiscal 2016 from $16,256,000 for the second quarter of fiscal 2015, a 99 percent increase. This increase in our net sales was primarily attributed to the addition of $17,747,000 in sales from our Hudson® brand.
Wholesale net sales increased to $22,755,000 for the second quarter of fiscal 2016 from $8,483,000 for the second quarter of fiscal 2015, a 168 percent increase. This increase in our Wholesale net sales was primarily attributed to the addition of $16,765,000 in Wholesale sales from our Hudson® brand, which was offset by a decrease in Wholesale sales from Robert Graham during the comparative period.
Consumer Direct net sales increased to $9,097,000 for the second quarter of fiscal 2016 from $7,245,000 for the second quarter of fiscal 2015, a 26 percent increase. This increase in our Consumer Direct net sales was attributed to the addition of $846,000 in sales from our Hudson® ecommerce business. Our Robert Graham Consumer Direct net sales also increased for the second quarter of fiscal 2016 due to the opening of nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016.
Our net sales also include $521,000 of licensing revenue in our Corporate and other segment for the second quarter of fiscal 2016 compared to $528,000 for the second quarter of fiscal 2015, representing a one percent decrease, which was due to lower revenues from existing licensees.
Gross Profit
Our gross profit increased to $17,099,000 for the second quarter of fiscal 2016 from $9,946,000 for the second quarter of fiscal 2015, a 72 percent increase. This increase in our gross profit was primarily attributed to the addition of $7,768,000 in gross profit from our Hudson® brand.
Our overall gross margin was 53 percent for the second quarter of fiscal 2016, compared to 61 percent for the second quarter of fiscal 2015, which was due to the addition of Hudson’s wholesale business, which generated a lower gross margin than Robert Graham.
Our Wholesale gross profit increased to $9,665,000 for the second quarter of fiscal 2016 from $3,869,000 for the second quarter of fiscal 2015, a 150 percent increase. This increase was primarily driven by an additional $6,987,000 in gross profit from the Hudson wholesale business.
Our Consumer Direct gross profit increased to $6,913,000 for the second quarter of fiscal 2016, compared to $5,549,000 for the second quarter of fiscal 2015, a 25 percent increase, driven primarily by the increase in sales as a result of opening nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016 and the addition of $645,000 from our Hudson® ecommerce business.
Our Corporate and other gross profit decreased to $521,000 for the second quarter of fiscal 2016, compared to $528,000 for the second quarter of fiscal 2015, a one percent decrease, due to lower revenues from existing licensees.
Selling, General and Administrative Expense, including Depreciation and Amortization
Selling, general and administrative, or SG&A, expenses increased to $20,219,000 for the second quarter of fiscal 2016 from $10,195,000 for the second quarter of fiscal 2015, a 98 percent increase. Our SG&A expense increase was mainly attributable to the addition of the Hudson® brand as a result of the RG Merger. In addition, we incurred $1,660,000
of transaction expenses related to the RG Merger
and the acquisition of SWIMS in July 2016.
Our SG&A expense includes expenses related to employee and employee related benefits, sales commissions, warehousing and freight, advertising, sample production, facilities and distribution related costs, professional fees, stock-based compensation, factor and bank fees, depreciation and amortization and retail store impairment.
Our Wholesale SG&A expense increased to
$4,557
,000 for the second quarter of fiscal 2016 from
$414
,000 for the second quarter of fiscal 2015, or a 1,001 percent increase. Our Wholesale SG&A expense increase was mainly attributable to the addition of
$3,565
,000 in SG&A expense stemming from Hudson’s Wholesale operations.
Our Consumer Direct SG&A expense increased to
$6,412
,000 for the second quarter of fiscal 2016 from
$4,636
,000 for the second quarter of fiscal 2015, a 38 percent increase. Our Consumer Direct SG&A expense increased mostly due to costs associated with the opening of nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016, as well as $448,000 of expenses from Hudson’s ecommerce business.
Our Corporate and other SG&A expense increased to
$9,250
,000 for the second quarter of fiscal 2016 from
$5,145
,000 for the second quarter of fiscal 2015, an 80 percent increase. Our Corporate and other SG&A expense includes general overhead associated with our operations as well as professional advisor fees incurred in connection with the RG Merger. Our increase in SG&A expense was attributable to the addition of
$3,232
,000 in Hudson’s corporate operating expenses and
$1,660
,000 of transaction expenses related to the RG Merger
and the acquisition of SWIMS in July 2016.
Operating Loss from Continuing Operations
We had operating loss from continuing operations of
$3,120
,000 for the second quarter of fiscal 2016, compared to operating loss from continuing operations of
$249
,000 for the second quarter of fiscal 2015. This was primarily due to operating losses in our Corporate and other segment described below.
Our Wholesale operating income increased to
$5,108
,000 in the second quarter of fiscal 2016 from
$3,455
,000 for the second quarter of fiscal 2015, a 48 percent increase, primarily due to the addition of operating income of
$3,422
,000 attributable to the Hudson Business.
Our Consumer Direct segment had operating income of
$501,
000 for the second quarter of fiscal 2016, compared to operating income of
$913
,000 for the second quarter of fiscal 2015, a 45 percent decrease, primarily due to costs associated with the opening of nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016.
Corporate and other operating loss increased to
$8,729
,000 for the second quarter of fiscal 2016 from
$4,617
,000 for the second quarter of fiscal 2015, an 89 percent increase, mainly due to the additional costs related to Corporate and other SG&A expense described above.
Interest Expense
Our interest expense increased to
$1,995
,000 for the second quarter of fiscal 2016 from $134,000 for the second quarter of fiscal 2015. Our interest expense for the second quarter of fiscal 2016 is primarily associated with interest expense from our credit facilities and Modified Convertible Notes, paid-in-kind interest from our Modified Convertible Notes and amortization of debt discounts and deferred financing costs.
Income Tax (Benefit) Provision
Our effective tax rate from operations was a benefit of 30 percent for the second quarter of fiscal 2016 compared to an expense of 27 percent for the second quarter of fiscal 2015. The decreased tax expense for the second quarter of fiscal 2016 was primarily due to adjustments to the projected tax loss for the year, which reduced the allocation of the projected tax expense for the year to this quarter. The projected tax expense for the year predominately consists of current tax expenses and deferred taxes associated with our deferred tax liability for indefinite lived intangible assets.
As our subsidiary RG is a limited liability company, until the RG Merger on January 28, 2016, it paid taxes only in some jurisdictions, since income was generally taxed directly to its members and most taxes were paid directly by its members on the income of RG. However, since some jurisdictions do not recognize the limited liability company status, they required taxes to be paid by RG. After the transaction, all of our entities are subject to corporate entity level taxes as the transaction resulted in a status change.
Loss (Income) from Discontinued Operations
We did not have any discontinued operations in the second quarter of fiscal 2016 or 2015.
Net Loss
We generated a net loss of
$3,605
,000 for the second quarter of fiscal 2016, compared to
$488
,000 for the second quarter of fiscal 2015. The primary reason for the increase in our net loss for the second quarter of fiscal 2016 was due to the increase in Corporate and other expenses as a result of the RG Merger,
transaction expenses associated with the RG Merger and transaction expenses incurred during the second quarter in preparation for the July 2016 with the acquisition of SWIMS.
Results of Operations
Comparison of Six Months Ended June 30, 2016 to Six Months Ended June 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended
|
|
|
|
(in thousands, except percentages, unaudited )
|
|
|
|
June 30, 2016
|
|
June 30, 2015
|
|
$ Change
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
66,088
|
|
$
|
35,204
|
|
$
|
30,884
|
|
88
|
%
|
Cost of goods sold
|
|
|
28,686
|
|
|
13,367
|
|
|
15,319
|
|
115
|
%
|
Gross profit
|
|
|
37,402
|
|
|
21,837
|
|
|
15,565
|
|
71
|
%
|
Gross margin
|
|
|
57
|
%
|
|
62
|
%
|
|
50
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
39,147
|
|
|
19,551
|
|
|
19,596
|
|
100
|
%
|
Depreciation and amortization
|
|
|
2,863
|
|
|
1,833
|
|
|
1,030
|
|
56
|
%
|
Retail store impairment
|
|
|
279
|
|
|
—
|
|
|
279
|
|
N/A
|
|
Operating (loss) income from continuing operations
|
|
|
(4,887)
|
|
|
453
|
|
|
(5,340)
|
|
(1,179)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
3,336
|
|
|
268
|
|
|
3,068
|
|
1,145
|
%
|
(Loss) income from continuing operations, before income tax provision
|
|
|
(8,223)
|
|
|
185
|
|
|
(8,408)
|
|
(4,545)
|
%
|
Income tax provision
|
|
|
577
|
|
|
116
|
|
|
461
|
|
397
|
%
|
(Loss) income from continuing operations
|
|
|
(8,800)
|
|
|
69
|
|
|
(8,869)
|
|
(12,854)
|
%
|
Loss from discontinued operations, net of tax
|
|
|
(1,286)
|
|
|
-
|
|
|
(1,286)
|
|
N/A
|
|
Net (loss) income
|
|
$
|
(10,086)
|
|
$
|
69
|
|
$
|
(10,155)
|
|
(14,717)
|
%
|
Six Months Ended June 30, 2016 and 2015 Overview
The following table sets forth certain statements of operations data by our reportable segments for the periods as indicated and excludes results from discontinued operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended
|
|
|
|
(in thousands, except percentages, unaudited )
|
|
|
|
June 30, 2016
|
|
June 30, 2015
|
|
$ Change
|
|
% Change
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
48,332
|
|
$
|
20,299
|
|
$
|
28,033
|
|
138
|
%
|
Consumer Direct
|
|
|
16,736
|
|
|
13,763
|
|
|
2,973
|
|
22
|
%
|
Corporate and other
|
|
|
1,020
|
|
|
1,142
|
|
|
(122)
|
|
(11)
|
%
|
|
|
$
|
66,088
|
|
$
|
35,204
|
|
$
|
30,884
|
|
88
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
23,696
|
|
$
|
10,132
|
|
$
|
13,564
|
|
134
|
%
|
Consumer Direct
|
|
|
12,686
|
|
|
10,563
|
|
|
2,123
|
|
20
|
%
|
Corporate and other
|
|
|
1,020
|
|
|
1,142
|
|
|
(122)
|
|
(11)
|
%
|
|
|
$
|
37,402
|
|
$
|
21,837
|
|
$
|
15,565
|
|
71
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
14,753
|
|
$
|
8,285
|
|
$
|
6,468
|
|
78
|
%
|
Consumer Direct
|
|
|
(1,024)
|
|
|
1,150
|
|
|
(2,174)
|
|
(189)
|
%
|
Corporate and other
|
|
|
(18,616)
|
|
|
(8,982)
|
|
|
(9,634)
|
|
107
|
%
|
|
|
$
|
(4,887)
|
|
$
|
453
|
|
$
|
(5,340)
|
|
(1,179)
|
%
|
For the six months ended June 30, 2016, our net sales increased to $66,088,000 from $35,204,000 for the six months ended June 30, 2015, an 88 percent increase. We had an operating loss from continuing operations of $4,887,000 for the six months ended June 30, 2016, compared to operating income from continuing operations of $453,000 for the six months ended June 30, 2015.
Net Sales
Our overall net sales increased to $66,088,000 for the six months ended June 30, 2016 from $35,204,000 for the six months ended June 30, 2015, an 88 percent increase. This increase in our net sales was primarily attributed to the addition of $34,681,000 in sales from our Hudson® brand.
Wholesale net sales increased to $48,332,000 for the six months ended June 30, 2016 from $20,299,000 for the six months ended June 30, 2015, a 138 percent increase. This increase in our Wholesale net sales was primarily attributed to the addition of $33,166,000 in Wholesale sales from our Hudson® brand, which was offset by a decrease in Wholesale sales from our Robert Graham Business relative to the comparative period.
Consumer Direct net sales increased to $16,736,000 for the six months ended June 30, 2016 from $13,763,000 for the six months ended June 30, 2015, a 22 percent increase. This increase in our Consumer Direct net sales was primarily attributed to the addition of $1,379,000 from our Hudson® ecommerce business. Our Robert Graham Consumer Direct net sales also increased for the six months ended June 30, 2016 due to the opening of nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016.
Our net sales also include $1,020,000 of licensing revenue in our Corporate and other segment for the six months ended June 30, 2016, compared to $1,142,000 for the six months ended June 30, 2015, an 11 percent decrease, due to lower revenues from existing licensees.
Gross Profit
Our gross profit increased to $37,402,000 for the six months ended June 30, 2016 from $21,837,000 for the six months ended June 30, 2015, a 71 percent increase. This increase in our gross profit was primarily attributed to the addition of $16,982,000 in gross profit from our Hudson® brand.
Our overall gross margin was 57 percent for the six months ended June 30, 2016 compared to 62 percent for the six months ended June 30, 2015, which was due to the addition of Hudson’s Wholesale business, which generated a lower gross margin than our Robert Graham Business.
Our Wholesale gross profit increased to $23,696,000 for the six months ended June 30, 2016 from $10,132,000 for the six months ended June 30, 2015, a 134 percent increase. This increase was primarily driven by an additional $15,793,000 in gross profit from the Hudson Wholesale business.
Our Consumer Direct gross profit increased to $12,686,000 for the six months ended June 30, 2016 compared to $10,563,000 for the six months ended June 30, 2015, a 20 percent increase, driven primarily by the increase in sales as a result of our opening nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016 and the addition of $1,053,000 from our Hudson® ecommerce business.
Our Corporate and other gross profit decreased to $1,020,000 for the six months ended June 30, 2016 compared to $1,142,000 for the six months ended June 30, 2015, an 11 percent decrease, which was due to lower revenues from existing licensees.
Selling, General and Administrative Expense, including Depreciation and Amortization and Retail Store Impairment
Our SG&A expense increased to $42,289,000 for the six months ended June 30, 2016 from $21,384,000 for the six months ended June 30, 2015, a 98 percent increase. Our SG&A expense increase was mainly attributable to the
addition of the Hudson® brand as a result of the RG Merger. In addition, we incurred $4,940,000 of
transaction expenses related to the RG Merger
and the acquisition of SWIMS in July 2016.
Our SG&A includes expenses related to employee and employee related benefits, sales commissions, warehousing and freight, advertising, sample production, facilities and distribution related costs, professional fees, stock-based compensation, factor and bank fees, depreciation and amortization and retail store impairment.
Our Wholesale SG&A expense increased to
$8,943
,000 for the
six months ended June 30,
2016 from
$1,847
,000 for the
six months ended June 30,
2015, or a 384 percent increase. Our Wholesale SG&A expense increase was mainly attributable to the addition of
$6,474
,000 in SG&A expense stemming from Hudson’s wholesale operations.
Our Consumer Direct SG&A expense increased to
$13,710
,000 for the
six months ended June 30,
2016 from
$9,413
,000 for the
six months ended June 30,
2015, a 46 percent increase. Our Consumer Direct SG&A expense increased mostly due to costs associated with the opening of nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016.
Our Corporate and other SG&A expense increased to
$19,636
,000 for the
six months ended June 30,
2016 from
$10,124
,000 for the
six months ended June 30,
2015, a 94 percent increase. Our Corporate and other SG&A expense includes general overhead associated with our operations as well as professional advisor fees incurred in connection with the RG Merger. Our increase in SG&A expense was attributable to the addition of
$5,300
,000 in Hudson’s corporate operating expenses and
$4,940
,000
of
transaction expenses related to the RG Merger
and
in preparation for the July 2016 the acquisition of SWIMS
.
Operating (Loss) Income from Continuing Operations
We had operating loss from continuing operations of
$4,887
,000 for the
six months ended June 30,
2016, compared to operating income from continuing operations of
$453
,000 for the
six months ended June 30,
2015.
Our Wholesale operating income increased to
$14,753
,000 in the
six months ended June 30,
2016, from
$8,285
,000 for the
six months ended June 30,
2015, a 78 percent increase, primarily due to the addition of operating income of
$9,319
,000 attributable to the Hudson Business.
Our Consumer Direct segment had operating loss of
$1,024
,000 for the
six months ended June 30,
2016, compared to operating income of
$1,150
,000 for
six months ended June 30,
2015, a 189 percent decrease, primarily due to costs related to the termination of a lease for one Robert Graham® brand retail store during the quarter, costs associated with the opening of nine new Robert Graham® brand retail stores during fiscal 2015 and one new store as of June 30, 2016 and lower traffic and sales at Robert Graham® brand retail stores during the six month period.
Our Corporate and other operating loss increased to
$18,616
,000 for the
six months ended June 30,
2016 from
$8,982
,000 for the
six months ended June 30,
2015, a 107 percent increase, mainly due to the additional costs related to Corporate and other SG&A expenses described above.
Interest Expense
Our interest expense increased to
$3,336
,000 for the
six months ended June 30,
2016 from $268,000 for the
six months ended June 30,
2015. Our interest expense for the
six months ended June 30,
2016 is primarily associated with interest expense from our credit facilities and Modified Convertible Notes, paid in kind interest from our Modified Convertible Notes and amortization of debt discounts and deferred financing costs.
Income Tax Provision
Our effective tax rate from operations was an expense of seven percent for the six months ended June 30, 2016 compared to an expense of 63 percent for the six months ended June 30, 2015. The difference in effective tax rate for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015 was primarily due to us
becoming subject to entity level income tax during the six months ended June 30, 2016 as a consequence of the RG Merger, increased estimated current year taxes, an increase to our deferred tax liabilities associated with indefinite lived intangible assets and the loss from operations incurred during the six months ended June 30, 2016. This tax expense consisted of current tax expenses and deferred taxes associated with our deferred tax liability for indefinite lived intangible assets.
As our subsidiary RG is a limited liability company, until the RG Merger on January 28, 2016, it paid taxes only in some jurisdictions, since income was generally taxed directly to its members and most taxes were paid directly by its members on the income of RG. However, since some jurisdictions do not recognize the limited liability company status, they required taxes to be paid by RG. After the transaction, all of our entities are subject to corporate entity level taxes as the transaction resulted in a status change.
Loss from Discontinued Operations
We had a loss from discontinued operations of $1,286,000 in the six months ended June 30, 2016 due to the operation of the 14 Joe’s® brand retail stores, which we operated until their assignment in January 2016 or closure in February 2016.
Net (Loss) Income
We generated a net loss of
$10,086
,000 for the
six months ended June 30,
2016, compared to net income of
$69
,000 for the
six months ended June 30,
2015. The primary reason for our net loss for the
six months ended June 30,
2016 was
transaction expenses associated with the RG Merger
and the acquisition of SWIMS in July 2016
, expenses related to certain Joe’s® branded retail stores until their closure on February 29, 2016 as part of our discontinued operations and expenses related to the lease termination for one Robert Graham retail store that we closed in June 2016.
Liquidity and Capital Resources
Sources of Liquidity and Outlook
Our primary sources of liquidity are: (i) cash from the collection of Wholesale accounts receivable, both factored and non-factored; (ii) collections from sales through our Consumer Direct segment by payment either in cash or credit; (iii) licensee fees collected from licensees; and (iv) the proceeds of our various credit facilities described below. Cash is used to make payments on our credit facilities, pay interest on our Modified Convertible Notes and pay for inventories, all other cash expenses of the Company’s business and the purchase of property and equipment.
For the remainder of fiscal 2016, our primary capital needs are for: (i) operating expenses; (ii) payments, including interest required to be made under our existing credit facilities, our Modified Convertible Notes and the SWIMS Convertible Note; (iii) working capital necessary to fund inventory purchases; (iv) integration and other costs associated with the RG Merger and the acquisition of SWIMS; and (v) financing extensions of trade credit to our customers. We anticipate funding our operations through working capital by: (i) generating cash flows from sales of our products from the combined companies; (ii) managing our operating expenses and inventory levels; (iii) maximizing trade payables with our domestic and international suppliers; (iv) increasing collection efforts on existing accounts receivables; and (v) utilizing the proceeds from our existing credit facilities.
At June 30, 2016 and December 31, 2015, our cash and cash equivalent balances were $8,368,000 and $1,966,000, respectively. Based on our cash on hand, cash flows from operations, the expected borrowing availability under our existing credit facilities and other financing arrangements, and sales forecasts, we believe that we have the working capital resources necessary to meet our projected operational needs for the next 12 months. However, if we require more capital for growth and integration or if we experience a decline in sales and/or operating losses, we believe that it will be necessary to obtain additional working capital through additional credit arrangements.
We believe that the rate of inflation over the past few years has not had a significant adverse impact on our net sales or income from continuing operations. Significant changes in the rate of inflation in the future may, however, affect
certain expenses, including employee compensation, and we may not be able to successfully recover such increased costs from customers.
Subsequent Liquidity Event
On July 18, 2016, we completed the acquisition of all of the outstanding share capital of Norwegian private limited company (
aksjeselskap
) SWIMS. We purchased SWIMS for aggregate consideration of (i) approximately $12.3 million in cash, (ii) 702,943 shares of our common stock and (iii) warrants to purchase an aggregate of 150,000 shares of our common stock with an exercise price of $5.47 per share, which we refer to as the
SWIMS Seller Warrants
. Pursuant to the SWIMS Purchase Agreement, DFBG Swims deposited approximately $325,000 of the cash consideration into an escrow account for certain indemnification obligations of the SWIMS Sellers. The SWIMS Purchase Agreement contains customary representations, warranties and covenants of the SWIMS Sellers and us, along with customary post-closing indemnification rights of DFBG Swims.
To finance the acquisition, we issued the following to our major stockholder Tengram Capital Partners Fund II, L.P.: (i) a warrant for the purchase of 500,000 shares of our common stock at an exercise price of $3.00 per share, referred to as the Tengram Warrant; and (ii) a convertible promissory note with principal of $13.0 million, referred to as the
SWIMS Convertible Note
. The SWIMS Convertible Note accrues interest at a rate of 3.75% per annum, compounding on the first day of each month starting August 1, 2016, and will convert, at Tengram II’s option or on the maturity date of January 18, 2017 if not already repaid in cash on or prior to that date, into up to 4,500,000 newly issued shares of our Class A-1 Preferred Stock at a conversion price of $3.00 per share. Additionally, the Class A-1 Preferred Stock will itself be convertible into shares of our common stock at an initial price of $3.00 per share (subject to adjustment), will be entitled to dividends at a rate of 10% per annum payable quarterly in arrears, will be senior to the common stock upon liquidation and will have voting rights on an as-converted basis alongside our common stock. To permit the acquisition, on July 18, 2016, we also entered into (i) a Consent and Amendment No. 1 to our ABL Credit Agreement and accompanying security agreement with Wells Fargo Bank, National Association, as lender, and (ii) a Consent and Amendment No. 1 to our Term Credit Agreement and accompanying security agreement with TCW Asset Management Company, as agent for the lenders and the lenders party thereto.
Unless otherwise noted, the effect of the acquisition of SWIMS, the payment of the various forms of consideration therefor, and the issuance of the Tengram Warrant and SWIMS Convertible Note on our financial condition and results of operations are not reflected in these unaudited condensed consolidated financial statements or elsewhere in the notes to those financial statements, as the transactions occurred after June 30, 2016, the period covered by this Quarterly Report.
Cash Flows for the Six Months Ended June 30, 2016 and June 30, 2015
For the six months ended June 30, 2016, we used $14,467,000 of cash flows from operating activities to fund our working capital, pay for costs related to the RG Merger that were incurred through June 30, 2016 and fund our discontinued operations. Cash flows from financing activities during the six months ended June 30, 2016 totaled $28,532,000, net of financing costs. These cash flows consisted of $50,000,000 from the issuance of Series A Preferred Stock and $61,003,000 in funds from our credit facilities, net of the following financing costs: (i) $23,349,000 for the repayment in full of our CIT Amended and Restated Revolving Credit Agreement and the JPM Loan Agreement; (ii) $58,218,000 for the redemption of the units held by our RG members; (iii) $1,366,000 as a distribution to RG members, which was accrued at the prior year end; and (iv) $250,000 of principal payments under our Term Loan Credit Agreement. Additionally, in investing activities, we used cash flows of $1,125,000 for the purchase of property and equipment and $8,630,000 to pay the existing holders of convertible notes pursuant to the Rollover Agreement, net of cash on hand as of the date of the RG Merger of $2,092,000. At June 30, 2016, the JPM Loan Agreement and the CIT Amended and Restated Revolving Credit Agreement were each fully repaid using the proceeds of the cash consideration given to RG in the Merger in January 2016.
For the six months ended June 30, 2015, we generated $175,000 of cash flows from operating activities to fund our working capital needs. Cash flows generated from financing activities totaled $643,000, net of financing costs, and consisted of $1,558,000 of proceeds from our line of credit, which was offset by $584,000 of payments against our loan
payable and $331,000 of accrued distributions to our members. During the six months ended June 30, 2015, we used $1,278,000 in investing activities primarily for the purchase of property and equipment.
Credit Agreements and Other Financing Arrangements
JPM Credit Facility and Capex Loan of RG
On December 23, 2013, our subsidiary RG entered into the JPM Loan Agreement), which was later
amended
such that $3.5 million of the revolving credit facility was reclassified to the
Capex Loan
, a term loan
.
Interest on the amounts borrowed pursuant to the JPM Loan Agreement was charged based on RG’s average balance and, at our management’s election, at the bank’s prevailing prime rate plus 0.75% or at LIBOR plus 2.25%, which was 2.6% at December 31, 2015. As a result of the Capex Loan, the maximum amount available under the JPM Loan Agreement’s revolving credit facility was reduced to $26.5 million. The remaining revolving credit facility under the JPM Loan Agreement provided for borrowings based on an amount not to exceed the sum of (i) 85% of eligible accounts receivable, (ii) 90% of eligible credit card receivables, (iii) 70% of eligible wholesale inventory, (iv) 75% of eligible retail inventory and (v) the trademark component, as defined in the JPM Loan Agreement, minus outstanding principal amount of Capex Loan, and minus reserves. In January 2016, RG used the aggregate cash consideration received in the RG Merger to repay all of RG’s outstanding loans and indebtedness under the JPM Loan Agreement, including the Capex Loan.
Hudson Convertible Notes
On September 8, 2015, the Company entered into the Rollover Agreement with the holders of convertible notes originally issued in connection with the acquisition of the Hudson Business, pursuant to which, on January 28, 2016, the holders of the notes contributed the notes to the Company in exchange for the following:
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1,167,317 shares of common stock;
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a cash payment of approximately $8.6 million, before expenses; and
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an aggregate principal amount of approximately $16.5 million of Modified Convertible Notes.
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The Modified Convertible Notes are structurally and contractually subordinated to our senior debt and will mature on July 28, 2021. The Modified Convertible Notes accrue interest quarterly on the outstanding principal amount at a rate of 6.5% per annum (to be increased to 7% as of October 1, 2016 with respect to the Modified Convertible Notes issued to Fireman), which is payable 50% in cash and 50% in additional paid-in-kind notes; provided, however, that the Company may, in its sole discretion, elect to pay 100% of such interest in cash. Beginning
on January 28, 2016, the Modified Convertible Notes are convertible by each of the holders into shares of our common stock, cash, or a combination of cash and common stock, at our election.
If we elect to issue only shares of common stock upon conversion of the Modified Convertible Notes, each of the Modified Convertible Notes would be convertible, in whole but not in part, into a number of shares equal to the conversion amount divided by the market price. The conversion amount is (a) the product of (i) the market price, multiplied by (ii) the quotient of (A) the principal amount, divided by (B) the conversion price, minus (b) the aggregate optional prepayment amounts paid to the holder. The market price is the average of the closing prices for our common stock over the 20 trading day period immediately preceding the notice of conversion. If we elect to pay cash with respect to a conversion of the Modified Convertible Notes, the amount of cash to be paid per share will be equal to the conversion amount. We will have the right to prepay all or any portion of the principal amount of the Modified Convertible Notes at any time so long as we make a pro rata prepayment on all of the Modified Convertible Notes.
RG’s Former Factoring Agreement with CIT
In December 2013, our subsidiary RG entered into a deferred purchase factoring arrangement and loan agreement with CIT. Under the agreement, RG assigned trade accounts receivable to a commercial factor with recourse,
while retaining ownership of the assigned accounts receivable until the occurrence of a specified triggering event. RG paid fees ranging from 0.20% to 0.50% of the gross amount of the accounts receivable assigned, with an annual floor amount of $100,000. In January 2016, in connection with the RG Merger, we terminated our deferred purchase factoring arrangement and loan agreement and entered into our A&R Factoring Agreement pursuant to which we sell or assign to CIT certain of our accounts receivable, including accounts arising from or related to sales of inventory and the rendition of services. Under the A&R Factoring Agreement, we pay a factoring rate of (i) 0.20 percent for certain major department store accounts, (ii) 0.40 percent for all other accounts for which CIT bears the credit risk, subject to discretionary surcharges, and (iii) 0.35 percent for accounts for which we bear the credit risk, but in no event less than $3.50 per invoice. The A&R Factoring Agreement may be terminated by CIT upon 60 days’ written notice or immediately upon the occurrence of an event of default as defined in the agreement. The A&R Factoring Agreement may be terminated by us upon 60 days’ written notice prior to December 31, 2020 or annually with 60 days’ written notice prior to December 31 of each year thereafter.
ABL Credit Agreement and Term Credit Agreement
On January 28, 2016, in connection with the closing of the RG Merger Agreement, we and certain of our subsidiaries entered into (i) the ABL Credit Agreement and accompanying security agreement with Wells Fargo Bank, National Association, as lender, and (ii) the Term Credit Agreement and accompanying security agreement with TCW Asset Management Company, as agent, and the lenders party thereto.
The ABL Credit Agreement provides for the Revolving Facility with commitments in an aggregate principal amount of $40 million. The Term Credit Agreement provides for the Term Facility in an aggregate principal amount of $50 million. The Term Facility matures on January 28, 2021. The Revolving Facility matures on October 30, 2020. The amount available to be drawn under the Revolving Facility will be based on the borrowing base values attributed to eligible accounts receivable and eligible inventory.
Certain domestic subsidiaries of the Company are co-borrowers under the ABL Credit Agreement and the Term Credit Agreement. The obligations under the ABL Credit Agreement and Term Credit Agreement are guaranteed by all of our domestic subsidiaries and are secured by substantially all of our assets, including the assets of our domestic subsidiaries. For additional information on the ABL Credit Agreement and Term Credit Agreement, see
“Note 15 – Debt and Preferred Stock” to our unaudited condensed consolidated financial statements in “Part I, Item 1” of this Quarterly Report.
As of June 30, 2016, we were in compliance with the financial and non-financial covenants in our ABL Credit Agreement and our Term Credit Agreement.
Contractual Obligations
As a “smaller reporting company” as defined in Item 10 of Regulation S-K, we are not required to provide this information.
Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
We believe that the accounting policies discussed below are important to an understanding of our condensed consolidated financial statements because they require management to exercise judgment and estimate the effects of uncertain matters in the preparation and reporting of financial results. Accordingly, we caution that these policies and the judgments and estimates they involve are subject to revision and adjustment in the future. While they involve less judgment, management believes that the accounting policies discussed in Note 3 to our audited consolidated financial statements as of December 31, 2015 and 2014 and for the three-year period ended December 31, 2015 (filed as Exhibit 99.1 to Amendment No. 1 to our Current Report on Form 8-K/A, filed with the SEC on March 30, 2016) and in
“Note 2 – Accounting Policies” to our unaudited condensed consolidated financial statements above are also important to an understanding of our financial statements. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements.
Revenue Recognition
Sales from our wholesale operations are recorded when the title to the goods is transferred to the customer, which is generally when we ship products to our customers. Provisions for product returns, allowances and other adjustments are recorded in the period the related sales are recognized.
Sales from our retail operations are recognized at the time the customer takes possession of the related merchandise. Sales from our ecommerce business are recognized when the merchandise is received by the customer. We record retail sales net of sales taxes collected from retail customers and estimates for future returns.
We earn royalties on the licensing of the use of our intellectual property in connection with certain products produced and sold by outside vendors. Royalties from licensing, including those pursuant to guaranteed minimum royalty obligations, are recognized when earned and deemed collectible, and are included in net sales.
Accounts Receivable, and Allowance for Doubtful Accounts and Reserves
Accounts receivable, including royalties, are stated at the amount we expect to collect. We maintain reserves for customer returns and markdowns and estimated losses resulting from the inability of our customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer creditworthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. If the financial conditions of our customers deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, we provide for an allowance for doubtful accounts. Balances that remain outstanding after we have made reasonable collection efforts are written off.
Inventories
Inventories are stated at the lower of cost or net realizable value, with cost determined by the first-in, first-out method. Inventory cost components consist of purchase price of finished product plus duties, freight, purchase commissions, brokerage and cartage. Inventory reserves have been established for excess and obsolete items, if necessary.
Valuation of Goodwill and Other Finite-lived and Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including intangible assets. Indefinite-lived intangible assets consist of trademarks. Goodwill and trademarks are not being amortized in accordance with the provisions of theFASB’s guidance, which requires these assets to be tested for impairment annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our annual impairment testing date is December 31.
We assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying basis for determining whether it is necessary to perform goodwill impairment testing.
The quantitative goodwill impairment test, if necessary, is a two-step process. Under the first of two steps, we compare the fair value of a reporting unit to its carrying amount, including goodwill, to identify a potential impairment. If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for such reporting unit and the enterprise must perform step two of the impairment test to measure the impairment, if any. Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of
the reporting unit in a manner similar to a purchase price allocation: the fair value of the reporting unit is allocated to all assets and liabilities of that unit (including any unrecognized intangible assets) and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill.
We primarily use discounted expected future cash flows (“
DCF
”) (Level 3 input), to test goodwill. Indefinite-lived intangible assets are tested for impairment through an income approach known as the relief from royalty method. A discounted cash flow analysis calculates the fair value by estimating the after-tax cash flows attributable to a reporting unit or asset and then discounting the after-tax cash flows to a present value using a risk-adjusted discount rate. Assumptions used in DCF and the relief from royalty method require the exercise of significant judgment including judgment about appropriate royalty rates, discount rates and terminal values, growth rates and the amount and timing of expected future cash flows. Although we believe the historical assumptions and estimates made are reasonable and appropriate, different assumptions and estimates could materially impact its reported financial results.
We review our other indefinite-lived intangible assets for impairment on an annual basis, or when circumstances indicate their carrying value may not be recoverable. We calculate the value of the indefinite-lived intangible assets using a discounted cash flow method, based on the relief from royalty method. Amortization of our customer relationships is computed using the straight-line method over an estimated useful life of 15 years.
Income Taxes
As part of the process of preparing our consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which we operate. The process involves estimating actual current tax expense along with assessing temporary differences resulting from differing treatment of items for book and tax purposes. These timing differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. Management records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Management has considered future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. Increases in the valuation allowance result in additional expense to be reflected within the tax provision in the consolidated statement of income. Reserves are also estimated for ongoing audits regarding federal and state issues that are currently unresolved. We routinely monitor the potential impact of these situations.
Recent Accounting Pronouncements
See “Note 5 – Adoption of Accounting Principles” to our unaudited condensed consolidated financial statements above regarding new accounting pronouncements.
Where You Can Find Other Information
Our corporate website is
www.differentialbrandsgroup.com
. Information contained on our website is not incorporated into this Quarterly Report. We make available on or through our website, without charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after such reports are electronically submitted to the SEC. Our SEC filings, including exhibits filed or furnished therewith, are also available for at the SEC’s website at
www.sec.gov
. In addition, any materials filed with, or furnished to, the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 or viewed online at www.sec.gov. Information regarding the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. You may request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at its principal office at 100 F Street, NE, Room 1580, Washington, D.C. 20549.
Item 3.
Quantitative and Qualitative Disclosure About Market Risk.
As a “smaller reporting company” as defined in Item 10 of Regulation S-K, we are not required to provide this information.
Item 4.
Controls and Procedures.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act. Disclosure controls and procedures are those controls and procedures designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. In addition, disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed by us in our reports under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
As of the end of the period covered by this quarterly report, our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. In making this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013). Based on that evaluation, due to the material weakness in internal control described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of June 30, 2016 based on those criteria.
Material Weaknesses in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
Management determined that as of June 30, 2016, the Company did not have adequately designed and documented management review controls to properly detect or prevent errors and omissions of required disclosures within the Company’s previously issued unaudited condensed consolidated financial statements, financial data and related disclosures for the quarterly period ended March 31, 2016 (the “
Q1 2016 Financial Statements
”). These errors and omissions related to the following: (i) the classification and accounting treatment of the closure of 14 Joe’s® brand retail stores as of February 29, 2016 as discontinued operations; (ii) the accounting treatment for the dividend payable on the Company’s Series A Preferred Stock; (iii) the effect of modified convertible notes on the calculation of basic and diluted weighted average shares outstanding; and (iv) the financial statement disclosures did not include disclosures for the calculation of earnings per share under the two-class method, non-cash supplemental cash flow information, certain accounting policies, pro forma financial information, certain related party disclosures and information relating to goodwill and intangible assets and the fair value of financial instruments.
Management determined that these errors and omissions resulted in two material weaknesses in the Company’s internal control over financial reporting.
Material Weakness #1 - The Company did not have adequately designed internal controls and technical expertise to ensure the timely identification, preparation and review of its accounting for certain complex, non-routine transactions, which was necessary to provide reasonable assurance that the Company’s financial statements and related disclosures would be prepared in accordance with U.S. GAAP.
Material Weakness #2 - The Company did not have adequately designed and documented management review controls to ensure that all relevant required disclosures under U.S. GAAP were identified and properly reflected in the notes to the Company’s financial statements.
These material weaknesses in the Company’s internal control over financial reporting led to errors being identified on the balance sheet as of March 31, 2016, the statements of operations, equity and cash flows for the three months ended March 31, 2016 and the related footnotes thereto.
As
a result of the identification of such errors, as
reported in the Company’s Current Report on Form 8-K and Amendment No. 1 to Quarterly Report on Form 10-Q filed with the SEC on August 16, 2016, the Company’s board of directors (the “
Board
”), in consultation with management, concluded that: (i)
the Company’s previously issued Q1 2016 Financial Statements should no longer be relied upon due to the errors identified therein; and (ii) such financial statements required restatement. On August 16, 2016, the Company filed Amendment No. 1 to its Quarterly Report on Form 10-Q for the period ended March 31, 2016 containing such amended and restated Q1 2016 Financial Statements.
Notwithstanding the material weakness and the restatement discussed above, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the financial statements included in this Quarterly Report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP.
Remediating the Material Weakness
We are in the process of improving our controls to remediate the material weaknesses that existed as of June 30, 2016. Our management team is dedicated to evaluating, designing and implementing, with the support of external advisors and oversight of the audit committee of the Company’s Board (the “
Audit Committee
”), the appropriate remedial actions to address the material weaknesses and strengthen the Company’s internal control environment. Remediation actions include the following:
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We will engage a third-party expert in accounting and financial reporting to assist management with the review of the accounting treatment and the financial reporting and disclosure of complex and non-recurring transactions. We expect that this expert will provide an additional layer of review and expertise to ensure the application of U.S. GAAP to complex and significant transactions;
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We will form a disclosure committee composed of a member of our Audit Committee and members of management and finance, whose role will be the review of our financial reporting and disclosure of recurring and routine transactions on a quarterly basis and to oversee our evaluation of the accounting treatment and financial statement disclosure of such transactions. Our disclosure committee will report to our senior management, including our Chief Executive Officer and/or our Chief Financial Officer; and
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We plan to enhance our reliance on our existing financial reporting checklists so as to develop a more robust
financial statement close process
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We will test the ongoing operating effectiveness of the new and existing controls in future periods. The material weaknesses cannot be considered to be completely addressed until the applicable additional controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.
The foregoing has been approved by management, including our Chief Executive Officer and Chief Financial Officer, who have been involved with the reassessment and analysis of our internal control over financial reporting. Additionally, as part of its evaluation of disclosure controls and procedures as of June 30, 2016, management reviewed the results of the above-described assessment of the Company’s internal control over financial reporting with the Audit Committee, and the Audit Committee agreed with the conclusions. The Audit Committee will continue to meet regularly with management and our independent registered accounting firm to review accounting, reporting, auditing, disclosure control and internal control matters.
Changes in Internal Control Over Financial Reporting
Except for the matters discussed above, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the second quarter of fiscal 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.