WHLM Wilhelmina International Inc

Item 1. Consolidated Financial Statements

The accompanying notes are an integral part of these condensed consolidated financial statements

The accompanying notes are an integral part of these condensed consolidated financial statements

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements

WILHELMINA INTERNATIONAL, INC. AND SUBSIDIARIES

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Service Revenues

The Company’s service revenues fluctuate in response to its clients’ willingness to spend on advertising and the Company’s ability to have the desired talent available. The increases of 7.6% and 21.5% for the three and nine months ended September 30, 2022, when compared to the three and nine months ended September 30, 2021, were primarily due to increased bookings as the cities where Wilhelmina operates reopened and business activity increased as COVID-19 pandemic restrictions were moderated or rescinded.

License Fees and Other Income

License fees and other income include franchise revenues from independently owned model agencies that use the Wilhelmina trademark and various services provided by the Company. License fees decreased 11.5% for the nine months ended September 30, 2022, when compared to three and nine months ended September 30, 2021, primarily due to the timing of income from licensing agreements.

Gross Profit Margin

Gross profit margin decreased by 160 and 130 basis points for the three and nine months ended September 30, 2022, when compared to the three and nine months ended September 30, 2021, primarily due to a change in board revenue mix and a larger percentage of consolidated revenue from the Aperture division in 2022, which is lower margin than traditional core model bookings.

Salaries and Service Costs

Salaries and service costs consist of payroll related costs and travel and entertainment expenses required to deliver the Company’s services to its clients and talents. The 22.8% and 31.3% increases in salaries and service costs during the three and nine months ended September 30, 2022, when compared to the three and nine months ended September 30, 2021, were primarily due to personnel hires and payroll changes to better align Wilhelmina staffing with the needs of each office and geographical region.

Office and General Expenses

Office and general expenses consist of office and equipment rents, advertising and promotion, insurance expenses, administration and technology cost.  The increase in office and general expenses of 6.7% for the three months ended September 30, 2022, when compared to the three months ended September 30, 2021, was primarily due to increased marketing expense, legal expense, insurance, and bad debt expense. The decrease in office and general expenses of 5.2% for the nine months ended September 30, 2022, when compared to the nine months ended September 30, 2021, was primarily due to reduced rent expense, other office related expenses, and computer expenses, partially offset by an increase in bad debt expense and legal expense in 2022.

Amortization and Depreciation

Amortization and depreciation expense is incurred with respect to certain assets, including computer hardware, software, office equipment, furniture, and finance leases. Amortization and depreciation expense decreased by 81.8% and 80.0% for the three and nine months ended September 30, 2022 compared to the three and nine months ended September 30, 2021 primarily due to reduced depreciation of assets that became fully amortized in 2021. Fixed asset purchases (mostly related to technology and computer equipment) totaled approximately $78 thousand and $96 thousand during the three and nine months ended September 30, 2022, compared to $6 thousand and $16 thousand for the three and nine months ended September 30, 2021.

Corporate Overhead

Corporate overhead expenses include director and executive officer compensation, legal, audit and professional fees, corporate office rent and travel. Corporate overhead increased by 23.5% and 12.4% for the three and nine months ended September 30, 2022, compared to the three and nine months ended September 30, 2021, primarily due to increased securities compliance costs.

Operating Income and Loss and Operating Margin

Operating income was $0.7 million and $2.6 million for the three and nine months ended September 30, 2022 compared to $1.0 million and $2.0 million in the three and nine months ended September 30, 2021. Operating margin decreased to 4.1% for the three months ended September 30, 2022, compared to 6.7% for the three months ended September 30, 2021, due to the increase in operating expenses outpacing the increase in revenue net of model costs. Operating margin increased to 5.1% for the nine months ended September 30, 2022, compared to 4.8% for the nine months ended September 30, 2021, due to the increase in revenue net of model costs outpacing the increase in operating expenses.

Foreign Currency Exchange

The Company realized gains of $107 thousand and $211 thousand from foreign currency exchange during the three and nine months ended September 30, 2022, compared $4 thousand gain and $84 thousand loss from foreign currency exchange during the three and nine months ended September 30, 2021.  Foreign currency gain and loss is due to fluctuations in currencies from Great Britain, Europe, and Latin America.

Gain on Forgiveness of Loan

On March 27, 2021, the Company received notice from the SBA that $1.9 million of loans under the PPP were forgiven. On April 3, 2021, the Company received notice that an additional $0.1 million of loans were forgiven. The Company recorded these gains on forgiveness of loan during the first and second quarters of 2021, respectively.

Employee Retention Credit Income

During 2021, the Company was eligible for a one-time employee retention payroll tax credit as a refundable credit against certain employment taxes of up to $7,000 per employee. The Company recorded $0.5 million and $1.3 million of employee retention credit income during the three and nine months ended September 30, 2021.

Interest Expense

Interest expense of $2 thousand and $7 thousand for the three and nine months ended September 30, 2022 was primarily attributable to interest on finance leases. Interest expense of $7 thousand and $49 thousand for the three and nine months ended September 30, 2021 was primarily attributable to interest on finance leases and accrued interest on term loans drawn during 2018, which were fully repaid during the second half of 2021. See, “Liquidity and Capital Resources.”

Income before Income Taxes

Income before income taxes decreased to $0.8 million and $2.8 million for the three and nine months ended September 30, 2022, compared to $1.5 million and $5.2 million for the three and nine months ended September 30, 2021. The higher pre-tax income in 2021 was primarily due to the gain on forgiveness of PPP loans and employee retention credit income.

Income Taxes

Generally, the Company’s combined effective tax rate is high relative to reported net income as a result of certain valuation allowances on deferred tax assets, amortization expense, foreign taxes, and corporate overhead not being deductible and income being attributable to certain states in which it operates.  The Company operates in three states, which have relatively high tax rates: California, New York, and Florida. In addition, foreign taxes in the United Kingdom related to our London office are not deductible from U.S. federal taxes.  In 2021, the effective tax rate was lower due to PPP loan forgiveness, which was not subject to income tax.  The Company had income tax benefit of $1.1 million and $0.8 million for the three and nine months ended September 30, 2022 compared to $0.3 million and $0.7 million of income tax expense for the three and nine months ended September 30, 2021.

The income tax benefit for the three and nine months ended September 30, 2022, was primarily the result of the full release of a previous $1.5 million valuation allowance against deferred tax assets. As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of deferred tax assets. In connection with its assessment for the third quarter of 2022, management determined that there was sufficient evidence to conclude that it was more likely than not that all deferred tax assets were realizable. This evidence included three years of cumulative pretax income, excluding nonrecurring items. The Company will continue to assess the evidence used to determine the need for a valuation allowance and may reinstate the valuation allowance in future periods if warranted by changes in estimated future income and other factors.

Net Income

The Company had net income of $1.9 and $3.5 million for the three and nine months ended September 30, 2022, compared to $1.2 million and $4.5 million for the three and nine months ended September 30, 2021.  In 2022, the net income was significantly impacted by the release of the valuation allowance on the Company’s deferred tax assets.  In 2021, the net income was significantly impacted by the gain on forgiveness of PPP loans and employee retention payroll tax credits.

Liquidity and Capital Resources

The Company’s cash balance increased to $10.5 million at September 30, 2022 from $10.3 million at December 31, 2021. The cash balances increased as a result of $1.2 million net cash provided by operating activities, $0.1 million net cash used in investing activities, $45 thousand cash used in financing activities, and $0.8 million adverse effect of exchange rate on cash flow during the nine months ended September 30, 2022.

Net cash provided by operating activities of $1.2 million was primarily the result of net income, increases in amounts due to models and accounts payable and accrued expenses, partially offset by increases in accounts receivable, prepaid expenses, and other assets, and a decrease in deferred revenue.  The $0.1 million cash used in investing activities was attributable to purchases of property and equipment, including software and computer equipment.  The $45 thousand cash used in financing activities was attributable to payments on finance leases.

The Company’s primary liquidity needs are for working capital associated with performing services under its client contracts. Generally, the Company incurs significant operating expenses with payment terms shorter than its average collections on billings. Based on budgeted and year-to-date cash flow information, management believes that the Company has sufficient liquidity to meet its projected operational expenses and capital expenditure requirements for the next twelve months and beyond.

Amegy Bank Credit Agreement

As of September 30, 2022, the Company had a credit agreement with Amegy Bank which provided a $3.0 million revolving line of credit, subject to a borrowing base derived from 80% of eligible accounts receivable (as defined) and the Company’s minimum net worth covenant. The revolving line of credit bore interest at prime plus 0.50% payable monthly. The Company had borrowing capacity of $3.0 million at September 30, 2022. The Company was in compliance with its bank covenants as of September 30, 2022. The revolving line of credit expired on October 24, 2022.

On July 16, 2018, the Company amended its credit agreement with Amegy Bank to provide for a term loan of up to $1.0 million that could be drawn by the Company through July 12, 2019, for the purpose of repurchases of its common stock. On August 1, 2018, the Company drew $0.7 million of the additional term loan and used the proceeds to fund the purchase of 100,000 shares of its common stock in a private transaction. On December 12, 2018, the Company drew $0.3 million of the additional term loan and used the proceeds to partially fund a purchase of 50,000 shares of its common stock in a private transaction. On August 31, 2021, the Company prepaid, without penalty, the $0.6 million remaining balance of the additional term loan. As of September 30, 2022, there was no outstanding balance on the term loan.

Paycheck Protection Program Loans

On April 15, 2020, Wilhelmina International, Ltd. (the “Borrower”), a wholly-owned subsidiary of the Company, executed a Business Loan Agreement and a Promissory Note each dated April 13, 2020 (collectively, the “Sub PPP Loan Documents”), with respect to a loan in the amount of $1.8 million (the “Sub PPP Loan”) from Amegy Bank. The Sub PPP Loan was obtained pursuant to the federal Paycheck Protection Program (the “PPP”). The Sub PPP Loan originally matured on April 13, 2022 and bore interest at a rate of 1.00% per annum. As allowed under the Paycheck Protection Flexibility Act, the Sub PPP Loan was extended to mature on April 13, 2025. On March 27, 2021, the Company received notice from the SBA that the Sub PPP loan, including $17 thousand accrued interest, had been fully forgiven, resulting in $1.9 million of gain on forgiveness of loan recorded within other (income) expenses during the quarter ended March 31, 2021.

On April 18, 2020, the Company executed a Business Loan Agreement and a Promissory Note each dated April 17, 2020 (collectively, the “Parent PPP Loan Documents”), with respect to a loan in the amount of $128 thousand (the “Parent PPP Loan”) from Amegy Bank. The Parent PPP Loan was also obtained pursuant to the PPP. The Parent PPP Loan originally matured on April 17, 2022 and bore interest at a rate of 1.00% per annum. As allowed under the Paycheck Protection Flexibility Act, the Parent PPP Loan was extended to mature on April 17, 2025. On April 3, 2021, the Company received notice from the SBA that the Parent PPP Loan, including $1 thousand accrued interest, had been fully forgiven, resulting in $0.1 million of gain on forgiveness of loan recorded within other (income) expense during the quarter ended June 30, 2021. Under the PPP, the SBA reserves the right to audit any PPP loan forgiveness application for a period of six years from the date of loan forgiveness.

Critical Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Wilhelmina and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Revenue Recognition

The Company has adopted the requirements of Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”). ASC 606 establishes a principle for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services.

Our revenues are derived primarily from fashion model bookings, and representation of social media influencers and actors for commercials, film, and television. Our performance obligations are primarily satisfied at a point in time when the talent has completed the contractual requirements.

Service revenues are recognized, and talent costs are accrued, when the customer obtains control of the product or service, which typically occurs when the talent has completed the contractual requirement. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The performance obligations for most of the Company’s core modeling bookings are satisfied on the day of the event, and the “day rate” total fee is agreed in advance, when the customer books the model for a particular date. For contracts with multiple performance obligations (which are typically all satisfied within 1 to 3 days), the contract’s transaction price is allocated to each performance obligation based on the estimated relative standalone selling price. The Company expenses incremental costs of obtaining a contract as and when incurred because the expected amortization period of the asset that would have been recognized is one year or less or the amount is immaterial.

Model Costs

Model costs include amounts owed to talent, including taxes required to be withheld and remitted directly to taxing authorities, commissions owed to other agencies, and related costs such as those paid for photography. Costs are accrued in the period in which the event takes place consistent with when the revenue is recognized. The Company typically enters into contractual agreements with models under which the Company is obligated to pay talent upon collection of fees from the customer.

Share Based Compensation

Share-based compensation expense is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes option pricing model and is recognized on a straight line basis as an expense over the requisite service period, which is generally the vesting period. The determination of the fair value of share-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the estimated volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates, estimated forfeitures and expected dividends.

Income Taxes

We are subject to income taxes in the United States, the United Kingdom, and numerous local jurisdictions.

Deferred tax assets are recognized for unused tax losses, unused tax credits, and deductible temporary differences to the extent that it is probable that future taxable profits will be available against which they can be used. Unused tax loss carry-forwards are reviewed at each reporting date and a valuation allowance is established if it is doubtful we will generate sufficient future taxable income to utilize the loss carry-forwards.

In determining the amount of current and deferred income tax, we take into account whether additional taxes, interest, or penalties may be due. Although we believe that we have adequately reserved for our income taxes, we can provide no assurance that the final tax outcome will not be materially different. To the extent that the final tax outcome is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are accounted for at net realizable value, do not bear interest and are short-term in nature. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability to collect on accounts receivable. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to the allowance.  Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the allowance and a credit to accounts receivable.  The Company generally does not require collateral.

Goodwill and Intangible Asset Impairment Testing

The Company performs impairment testing at least annually and more frequently if events and circumstances indicate that an asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the reporting unit’s fair value. The Company sometimes utilizes an independent valuation specialist to assist with the determination of fair value. In accordance with ASU 2017-03, effective January 1, 2020, only a one-step quantitative impairment test is performed, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value. If the carrying amount of the reporting unit’s goodwill exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount over the reporting unit’s goodwill.

Whenever events or circumstances change, entities have the option to first make a qualitative evaluation about the likelihood of goodwill impairment. If impairment is deemed more likely than not, management would perform the goodwill impairment test. Otherwise, the goodwill impairment test is not required. In assessing the qualitative factors, the Company assesses relevant events and circumstances that may impact the fair value and the carrying amount of the reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve significant judgments and assumptions. The judgment and assumptions include the identification of macroeconomic conditions, industry and market considerations, overall financial performance, Company specific events and share price trends, an assessment of whether each relevant factor will impact the impairment test positively or negatively, and the magnitude of any such impact.