dfbg_current_folio_10-Q

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2017

 

OR

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number:  0-18926

 

DIFFERENTIAL BRANDS GROUP INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

11-2928178

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

1231 South Gerhart Avenue, Commerce, California

 

90022

(Address of principal executive offices)

 

(Zip Code)

 

(323) 890-1800

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  ☒ Yes  ☐ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ☒  Yes  ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

 

Accelerated filer ☐

Non-accelerated filer ☐

 

Smaller reporting company ☒

(Do not check if a smaller reporting company)

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

The number of shares of the registrant’s common stock outstanding as of August 14, 2017 was 13,317,281.

 

 

 

 


 

Table of Contents

DIFFERENTIAL BRANDS GROUP INC.

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

 

 

 

 

 

 

Page

 

 

 

PART I. 

FINANCIAL INFORMATION

 

 

 

 

Item 1. 

Financial Statements

 

 

Condensed Consolidated Balance Sheets as of June 30, 2017, December 31, 2016 and June 30, 2016

3

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Six months ended June 30, 2017 and 2016 

4

 

Condensed Consolidated Statements of Equity for the Six months ended June 30, 2017 and 2016

5

 

Condensed Consolidated Statements of Cash Flows for the Six months ended June 30, 2017 and 2016

6

 

Notes to Condensed Consolidated Financial Statements

7

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

34

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

47

Item 4. 

Controls and Procedures

47

 

 

 

PART II. 

OTHER INFORMATION

 

 

 

 

Item 1. 

Legal Proceedings

48

Item 1A. 

Risk Factors

48

Item 6. 

Exhibits

48

 

 

 

SIGNATURES 

49

 

 

 

2


 

Table of Contents

PART I — FINANCIAL INFORMATION

Item 1.          Financial Statements

 

DIFFERENTIAL BRANDS GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

 

 

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

    

June 30, 

 

 

2017

 

2016

 

2016

 

 

(unaudited)

 

(Note 1)

 

(unaudited)

ASSETS

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,305

 

$

6,476

 

$

8,368

Accounts receivable, net

 

 

16,982

 

 

20,225

 

 

14,339

Inventories, net

 

 

30,623

 

 

23,977

 

 

26,759

Prepaid expenses and other current assets

 

 

5,465

 

 

4,249

 

 

1,976

Total current assets

 

 

59,375

 

 

54,927

 

 

51,442

Property and equipment, net

 

 

9,651

 

 

10,620

 

 

13,003

Goodwill

 

 

8,340

 

 

8,271

 

 

6,524

Intangible assets, net

 

 

90,669

 

 

91,886

 

 

84,965

Other assets

 

 

514

 

 

467

 

 

477

Total assets

 

$

168,549

 

$

166,171

 

$

156,411

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

20,206

 

$

19,930

 

$

20,838

Short-term convertible notes

 

 

13,436

 

 

13,137

 

 

 —

Current portion of long-term debt

 

 

1,875

 

 

1,250

 

 

875

Total current liabilities

 

 

35,517

 

 

34,317

 

 

21,713

Deferred rent

 

 

3,609

 

 

3,636

 

 

3,624

Line of credit

 

 

17,492

 

 

12,742

 

 

12,000

Convertible notes

 

 

13,242

 

 

12,660

 

 

12,251

Long-term debt, net of current portion

 

 

45,991

 

 

47,218

 

 

47,694

Deferred income taxes, net

 

 

13,416

 

 

11,074

 

 

9,723

Other liabilities

 

 

 —

 

 

 —

 

 

81

Total liabilities

 

 

129,267

 

 

121,647

 

 

107,086

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

 

 

Series A convertible preferred stock, $0.10 par value: 50,000 shares authorized, issued and outstanding at June 30, 2017, December 31, 2016 and June 30, 2016

 

 

 5

 

 

 5

 

 

 5

Common stock, $0.10 par value: 100,000,000 shares authorized, 13,317,281,  13,239,125 and 12,379,000 shares issued and outstanding at June 30, 2017, December 31, 2016 and June 30, 2016, respectively

 

 

1,332

 

 

1,324

 

 

1,239

Additional paid-in capital

 

 

59,962

 

 

59,154

 

 

56,093

Accumulated other comprehensive income (loss)

 

 

125

 

 

(221)

 

 

 —

Accumulated deficit

 

 

(22,142)

 

 

(15,738)

 

 

(8,012)

Total equity

 

 

39,282

 

 

44,524

 

 

49,325

Total liabilities and equity

 

$

168,549

 

$

166,171

 

$

156,411

 

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

3


 

Table of Contents

DIFFERENTIAL BRANDS GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

    

2017

    

2016

    

2017

    

2016

 

 

 

 

 

 

(Note 2)

 

 

 

 

 

(Note 2)

Net sales

 

$

36,453

 

$

32,373

 

$

76,555

 

$

66,088

Cost of goods sold

 

 

20,234

 

 

19,862

 

 

41,733

 

 

37,240

Gross profit

 

 

16,219

 

 

12,511

 

 

34,822

 

 

28,848

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

14,915

 

 

14,130

 

 

32,319

 

 

30,593

Depreciation and amortization

 

 

1,527

 

 

1,501

 

 

3,032

 

 

2,863

Retail store impairment

 

 

 —

 

 

 —

 

 

 —

 

 

279

Total operating expenses

 

 

16,442

 

 

15,631

 

 

35,351

 

 

33,735

Operating loss from continuing operations

 

 

(223)

 

 

(3,120)

 

 

(529)

 

 

(4,887)

Interest expense

 

 

2,207

 

 

1,995

 

 

4,254

 

 

3,336

Other (income) expense, net

 

 

(12)

 

 

 —

 

 

11

 

 

 —

Loss from continuing operations before income taxes

 

 

(2,418)

 

 

(5,115)

 

 

(4,794)

 

 

(8,223)

Income tax provision (benefit)

 

 

1,636

 

 

(1,510)

 

 

1,610

 

 

577

Loss from continuing operations

 

 

(4,054)

 

 

(3,605)

 

 

(6,404)

 

 

(8,800)

Loss from discontinued operations, net of tax

 

 

 —

 

 

 —

 

 

 —

 

 

(1,286)

Net loss

 

$

(4,054)

 

$

(3,605)

 

$

(6,404)

 

$

(10,086)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(4,054)

 

$

(3,605)

 

$

(6,404)

 

$

(10,086)

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

283

 

 

 —

 

 

346

 

 

 —

Other comprehensive income

 

 

283

 

 

 —

 

 

346

 

 

 —

Comprehensive loss

 

$

(3,771)

 

$

(3,605)

 

$

(6,058)

 

$

(10,086)

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss per common share - basic

 

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.30)

 

$

(0.29)

 

$

(0.48)

 

$

(0.74)

Loss from discontinued operations

 

 

 —

 

 

 —

 

 

 —

 

 

(0.11)

Loss per common share - basic

 

$

(0.30)

 

$

(0.29)

 

$

(0.48)

 

$

(0.85)

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss per common share - diluted

 

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.30)

 

$

(0.29)

 

$

(0.48)

 

$

(0.74)

Loss from discontinued operations

 

 

 —

 

 

 —

 

 

 —

 

 

(0.11)

Loss per common share - diluted

 

$

(0.30)

 

$

(0.29)

 

$

(0.48)

 

$

(0.85)

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

13,309

 

 

12,380

 

 

13,298

 

 

11,852

Diluted

 

 

13,309

 

 

12,380

 

 

13,298

 

 

11,852

 

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

 

 

4


 

Table of Contents

DIFFERENTIAL BRANDS GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(in thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Preferred Series A

 

Additional

 

Comprehensive

 

Accumulated

 

Common Members

 

Preferred Members

 

Total

 

    

Shares

    

Par Value

    

Shares

    

Par Value

    

Paid-In Capital

    

Income (Loss)

    

Deficit

    

Units

    

Amount

    

Units

    

Amount

    

Equity

Balance, January 1, 2016

 

 —

 

$

 —

 

 

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

 

4,900

 

$

22,743

 

 

5,100

 

$

24,798

 

$

47,541

Net loss through RG Merger date

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(1,016)

 

 

 —

 

 

(1,058)

 

 

(2,074)

Redemption of Robert Graham unit holders

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(28,905)

 

 

 —

 

 

(29,313)

 

 

(58,218)

Contribution of Robert Graham in exchange for common shares

 

8,825

 

 

883

 

 

 —

 

 

 —

 

 

(13,634)

 

 

 —

 

 

 —

 

 

(4,900)

 

 

7,178

 

 

(5,100)

 

 

5,573

 

 

 —

Reverse acquisition with Robert Graham

 

3,509

 

 

351

 

 

 —

 

 

 —

 

 

19,649

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

20,000

Issuance of Series A convertible preferred stock, net of offering costs of $931

 

 —

 

 

 —

 

 

50

 

 

 5

 

 

49,064

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

49,069

Stock-based compensation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

516

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

516

Issuance of restricted common stock, net of taxes withheld

 

45

 

 

 5

 

 

 —

 

 

 —

 

 

498

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

503

Net loss post RG Merger date

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,012)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,012)

Balance, June 30, 2016

 

12,379

 

$

1,239

 

 

50

 

$

 5

 

$

56,093

 

$

 —

 

$

(8,012)

 

 

 —

 

$

 —

 

 

 —

 

$

 —

 

$

49,325

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2017

 

13,239

 

$

1,324

 

 

50

 

$

 5

 

$

59,154

 

$

(221)

 

$

(15,738)

 

 

 —

 

$

 —

 

 

 —

 

$

 —

 

$

44,524

Stock-based compensation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

900

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

900

Issuance of restricted common stock, net of taxes withheld

 

78

 

 

 8

 

 

 —

 

 

 —

 

 

(92)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(84)

Foreign currency translation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

346

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

346

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(6,404)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(6,404)

Balance, June 30, 2017

 

13,317

 

$

1,332

 

 

50

 

$

 5

 

$

59,962

 

$

125

 

$

(22,142)

 

 

 —

 

$

 —

 

 

 —

 

$

 —

 

$

39,282

 

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

 

 

5


 

Table of Contents

DIFFERENTIAL BRANDS GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

 

 

 

 

 

 

 

 

 

Six months ended June 30, 

 

    

2017

    

2016

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

Loss from continuing operations

 

$

(6,404)

 

$

(8,800)

Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

3,032

 

 

2,863

Retail store impairment

 

 

 —

 

 

279

Amortization of deferred financing costs

 

 

215

 

 

162

Amortization of convertible notes discount

 

 

350

 

 

359

Paid-in-kind interest

 

 

770

 

 

92

Stock-based compensation

 

 

900

 

 

1,019

Provision for bad debts

 

 

194

 

 

31

Amortization of inventory step up

 

 

 —

 

 

383

Deferred taxes

 

 

2,289

 

 

270

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

3,081

 

 

(1,339)

Inventories

 

 

(6,591)

 

 

(411)

Prepaid expenses and other assets

 

 

(1,253)

 

 

217

Accounts payable and accrued expenses

 

 

2,220

 

 

(8,264)

Deferred rent

 

 

(20)

 

 

56

Net cash used in continuing operating activities

 

 

(1,217)

 

 

(13,083)

Net cash used in discontinued operating activities

 

 

 —

 

 

(1,384)

Net cash used in operating activities

 

 

(1,217)

 

 

(14,467)

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

Cash paid in reverse acquisition with Robert Graham, net of cash acquired

 

 

 —

 

 

(6,538)

Refund of security deposit

 

 

 7

 

 

 —

Purchases of property and equipment

 

 

(601)

 

 

(1,125)

Net cash used in investing activities

 

 

(594)

 

 

(7,663)

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

Proceeds from issuance of Series A convertible preferred stock, net of offering costs

 

 

 —

 

 

49,881

Proceeds from term debt

 

 

 —

 

 

50,000

Repayment of long-term debt

 

 

(625)

 

 

(250)

Proceeds from line of credit, net

 

 

4,350

 

 

12,587

Repayment of terminated line of credit and loan payable

 

 

 —

 

 

(23,349)

Payment of deferred financing costs

 

 

(124)

 

 

(1,584)

Redemption of unit holders

 

 

 —

 

 

(58,218)

(Repayment of) proceeds from customer cash advances

 

 

(1,707)

 

 

831

Payment of accrued distribution to members

 

 

 —

 

 

(1,366)

Taxes paid in lieu of shares issued for stock-based compensation

 

 

(251)

 

 

 —

Net cash provided by financing activities

 

 

1,643

 

 

28,532

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(3)

 

 

 —

 

 

 

 

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

 

(171)

 

 

6,402

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, at beginning of period

 

 

6,476

 

 

1,966

CASH AND CASH EQUIVALENTS, at end of period

 

$

6,305

 

$

8,368

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

Interest paid

 

$

2,797

 

$

1,563

Income taxes paid

 

$

116

 

$

507

 

 

 

 

 

 

 

Supplemental disclosures of non-cash investing and financing activities:

 

 

 

 

 

 

Common stock issued in reverse acquisition with Robert Graham

 

$

 —

 

$

20,000

Issuance of convertible notes

 

$

 —

 

$

16,473

Debt discount recorded in connection with convertible notes

 

$

 —

 

$

4,673

Contribution of Robert Graham in exchange for common shares

 

$

 —

 

$

12,751

Reclassification of other assets to offering costs

 

$

 —

 

$

812

Reclassification of other assets to deferred financing costs

 

$

 —

 

$

349

Non-cash investing activities: accrued capital expenditures

 

$

79

 

$

 —

 

 

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

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DIFFERENTIAL BRANDS GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands except share and per share data)

(unaudited)

 

1.    Business Description and Basis of Presentation

 

The condensed consolidated balance sheet as of December 31, 2016 has been derived from audited financial statements. The condensed consolidated financial statements as of and for the three and six months ended June 30, 2017 and 2016 and the related footnote information have been prepared on a basis consistent with the consolidated financial statements as of and for the years ended December 31, 2016 and 2015. In addition, these condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements and thus should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments (consisting of normal recurring adjustments), which management considers necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results for the three and six months ended June 30, 2017 are not necessarily indicative of the results anticipated for the entire year ending December 31, 2017. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results may differ from those estimates.

 

Differential Brands Group Inc. and subsidiaries (we,” “us,” the “Company” or “Differential”) began operations in 1987 as Innovo, Inc. Since the Company’s founding, the Company has evolved from producing craft and accessory products to designing and selling apparel products bearing the Hudson®, Robert Graham® and SWIMS® brand names.

 

The Company’s principal business activity involves the design, development and worldwide marketing of: apparel products, which include denim jeans, related casual wear and accessories bearing the brand name Hudson®; apparel products and accessories bearing the brand name Robert Graham®; footwear, apparel and accessories bearing the brand name SWIMS®. Our primary operating subsidiaries are Hudson Clothing, LLC (“Hudson”), Robert Graham Designs, LLC and Robert Graham Retail, LLC (collectively “Robert Graham”), and DFBG Swims, LLC (“Swims”). In addition, we have other non-operating subsidiaries.

 

The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

As previously reported, on September 11, 2015, the Company completed the sale of certain operating and intellectual property assets related to the business operated under the brand names “Joe’s Jeans,” “Joe’s,” “Joe’s JD” and “else” (the “Joe’s Business”) to GBG USA Inc., a Delaware corporation (“GBG”), and the sale of certain intellectual property assets related to the Joe’s Business to Joe’s Holdings LLC, a Delaware limited liability company (“Joe’s Holdings”), for an aggregate purchase price of $80.0 million (the “Joe’s Asset Sale”). The Company also entered into the amended and restated revolving credit agreement (the “CIT Amended and Restated Revolving Credit Agreement”), dated September 11, 2015, which provided for a maximum credit availability of $7.5 million.

 

On January 28, 2016, the Company completed the acquisition (the “RG Merger”) of all of the outstanding equity interests of RG Parent LLC and its subsidiaries (“Robert Graham” or “RG”), for an aggregate of $81.0 million in cash and 8,825,461 shares of the Company’s common stock, par value $0.10 per share (after giving effect to the Reverse Stock Split, as defined below).  The aggregate cash consideration was used to repay $19.0 million of RG’s outstanding loans and indebtedness under its revolving credit agreement with J.P. Morgan Chase Bank, N.A.  On the RG Merger’s closing date, all outstanding loans under the CIT Amended and Restated Revolving Credit Agreement were repaid and it was terminated in connection with entering into (i) a new credit and security agreement (as later amended, the

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ABL Credit Agreement”) with Wells Fargo Bank, National Association, as lender, (ii) a new credit and security agreement with TCW Asset Management Company, as agent, and the lenders party thereto (as later amended, the “Term Credit Agreement”), and (iii) an amended and restated deferred purchase factoring agreement with CIT (the “A&R Factoring Agreement”). 

 

Effective upon consummation of the RG Merger, the Company effected a reverse stock split (the “Reverse Stock Split”) of the Company’s issued and outstanding common stock such that each 30 shares of issued and outstanding common stock were reclassified into one share of issued and outstanding common stock, which Reverse Stock Split did not change the par value or the amount of authorized shares of common stock. The primary purpose of the Reverse Stock Split was to increase the per-share market price of the Company’s common stock in order to maintain its listing on The Nasdaq Capital Market maintained by The Nasdaq Stock Market LLC. Unless otherwise indicated, all share amounts in this Quarterly Report on Form 10-Q (this “Quarterly Report”) have been adjusted to reflect the Reverse Stock Split.

 

After the closing of the Joe’s Asset Sale on September 11, 2015, the Company retained and operated 32 Joe’s® brand retail stores, of which the Company 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 and as a result are reported in this Quarterly Report as discontinued operations for the six months ended June 30, 2016.  

 

On July 18, 2016, the Company completed the acquisition of all of the outstanding share capital of Norwegian private limited company SWIMS AS (“SWIMS”) for an aggregate consideration of (i) $12.0 million in cash, (ii) 702,943 shares of common stock and (iii) warrants to purchase an aggregate of 150,000 shares of common stock with an exercise price of $5.47 per share.

 

The RG Merger has been accounted for as a reverse merger and recapitalization and as a result of the RG Merger, the former RG members own a majority of the Company’s issued and outstanding equity. Under the acquisition method, RG is deemed the accounting acquirer for financial reporting purposes, with the Company, as the legal acquirer, being viewed as the accounting acquiree. As a result, the assets, liabilities and operations reflected in the historical condensed consolidated financial statements and elsewhere in this Quarterly Report prior to the RG Merger are those of RG and are recorded at the historical cost basis and reflect RG’s historical financial condition and results of operations for comparative purposes. The Company’s condensed consolidated financial statements include: (i) from January 1, 2016 up to the day prior to the closing of the RG Merger on January 28, 2016, the results of operations and cash flows of RG; (ii) from and after the RG Merger’s closing date on January 28, 2016, the results of continuing operations, cash flows and, as applicable, the assets and liabilities of the combined company, comprising the Company’s Hudson business and RG; (iii) from and after the RG Merger’s closing date on January 28, 2016, the results of the discontinued operations from the Joe’s® brand retail stores that were not transferred to GBG but that closed as of February 29, 2016 ; and (iv) from and after the acquisition of SWIMS on July 18, 2016, the results of continuing operations and cash flows and, as applicable, the assets and liabilities of SWIMS.    

 

Prior to the RG Merger, RG and the Company had different fiscal year ends, with RG’s fiscal year ending on December 31 and the Company’s fiscal year ending on November 30. In connection with the RG Merger, the Company changed its fiscal year end to December 31.

 

The Company’s reportable business segments are Wholesale, Consumer Direct and Corporate and other. For periods before the RG Merger’s closing date, the discussion of reportable segments reflects only the operations of RG.  The Company manages, evaluates and aggregates its operating segments for segment reporting purposes primarily on the basis of business activity and operation. The Wholesale segment is comprised of sales of products to premium nationwide department stores, boutiques, specialty retailers, and select off-price and international customers. The Wholesale segment also includes expenses from sales and customer service departments, trade shows, warehouse distribution, design and production, and product samples. The Consumer Direct segment is comprised of sales to consumers through the Robert Graham® brand full-price retail stores and outlet stores, through the SWIMS® brand outlet stores and through the online e-commerce sites at www.hudsonjeans.com,  www.robertgraham.us and www.swims.com. The information contained on, or that can be accessed through, these websites is not a part of this Quarterly Report and is not incorporated by reference herein. The Corporate and other segment is comprised of revenue from trademark licensing agreements and expenses from corporate operations, which include the executive, finance,

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legal, information technology and human resources departments and general brand marketing and advertising expenses associated with the Company’s brands.

 

2.    Summary of Significant Accounting Policies

 

Information regarding significant accounting policies is contained in Note 2, “Summary of Significant Accounting Policies” of the consolidated financial statements in the Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

 

Inventory and Reclassification

 

During the three months ended March 31, 2017, the Company modified its capitalization of overhead costs allocated to inventory to include certain production costs that were previously excluded. These production expenses were previously included in cost of goods sold and selling, general and administrative expenses. These costs are now included in production overhead capitalized to inventory to better reflect the costs incurred to bring the Company’s inventory to a saleable condition after the recent change in the Company’s processes of sourcing inventory. This modification resulted in additional capitalization of $1.4 million of production overhead to the standard cost of inventory from production expenses. This modification has been accounted for on a prospective basis from January 1, 2017.

 

The increase in inventories resulted in a $1.4 million non-cash benefit (or $0.11 per diluted share), which was comprised of a $0.3 million decrease in cost of goods sold and a $1.1 million decrease in selling, general and administrative expenses.

 

In addition, the Company has reclassified delivery expenses, design costs, warehousing and handling costs and other inventory acquisition related costs to cost of goods sold, which were previously included in selling, general and administrative expenses. The classification of these costs in cost of goods sold more accurately reflects the cost of producing and distributing products. Additionally, this presentation enhances the comparability of the Company’s financial statements with industry peers. The change has been reflected in the condensed consolidated statements of operations in the prior periods to conform to the presentation in the current period. The impact of the reclassification resulted in an increase to cost of goods sold and a decrease to selling, general and administrative expenses in the amount of $4.6 million and $8.6 million for the three and six months ended June 30, 2016, respectively.

 

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Following is a reconciliation of the reclassification of costs from selling, general and administrative to cost of goods sold discussed above for the three and six months ended June 30, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2016

 

Six months ended June 30, 2016

 

Before

 

 

 

After

 

As Previously

 

 

 

After

 

Reclass

    

Reclass

    

Reclass

    

Reported

    

Reclass

    

Reclass

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

$

32,373

 

$

 —

 

$

32,373

 

$

66,088

 

$

 —

 

$

66,088

Cost of goods sold

 

15,274

 

 

4,588

 

 

19,862

 

 

28,686

 

 

8,554

 

 

37,240

Gross profit

 

17,099

 

 

(4,588)

 

 

12,511

 

 

37,402

 

 

(8,554)

 

 

28,848

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

18,718

 

 

(4,588)

 

 

14,130

 

 

39,147

 

 

(8,554)

 

 

30,593

Depreciation and amortization

 

1,501

 

 

 —

 

 

1,501

 

 

2,863

 

 

 —

 

 

2,863

Retail store impairment

 

 —

 

 

 —

 

 

 —

 

 

279

 

 

 —

 

 

279

Total operating expenses

 

20,219

 

 

(4,588)

 

 

15,631

 

 

42,289

 

 

(8,554)

 

 

33,735

Operating loss from continuing operations

 

(3,120)

 

 

 —

 

 

(3,120)

 

 

(4,887)

 

 

 —

 

 

(4,887)

Interest expense

 

1,995

 

 

 —

 

 

1,995

 

 

3,336

 

 

 —

 

 

3,336

Other (income) expense, net

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Loss from continuing operations before income taxes

 

(5,115)

 

 

 —

 

 

(5,115)

 

 

(8,223)

 

 

 —

 

 

(8,223)

Income tax provision (benefit)

 

(1,510)

 

 

 —

 

 

(1,510)

 

 

577

 

 

 —

 

 

577

Loss from continuing operations

 

(3,605)

 

 

 —

 

 

(3,605)

 

 

(8,800)

 

 

 —

 

 

(8,800)

Loss from discontinued operations, net of tax

 

 —

 

 

 —

 

 

 —

 

 

(1,286)

 

 

 —

 

 

(1,286)

Net loss

$

(3,605)

 

$

 —

 

$

(3,605)

 

$

(10,086)

 

$

 —

 

$

(10,086)

 

 

Cost of Goods Sold

 

Cost of goods sold includes the following: the cost of merchandise; customs related taxes and duties; production costs; delivery expense; in-bound and outbound freight; obsolescence and shrink provisions; design costs; warehousing and handling costs and other inventory acquisition related costs.

 

Financial Accounting Standards Recently Adopted

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements To Employee Share-Based Payment Accounting, which amends ASC Topic 718, relating to employee share-based payment accounting. This guidance simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within that reporting period.  The Company adopted this standard in the first quarter of 2017 and there was no material impact on the condensed consolidated financial statements.

 

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In January 2017, the FASB issued ASU No. 2017-04, Intangibles —Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. Topic 350, Intangibles—Goodwill and Other (Topic 350), currently requires an entity to perform a two-step test to determine the amount, if any, of goodwill impairment. ASU No. 2017-04 removes the second step of the test. An entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. The ASC amendments are effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 with early adoption permitted. The Company adopted this standard in the first quarter of 2017 and there was no impact on the condensed consolidated financial statements.

 

Recently Issued Financial Accounting Standards

 

In April and March 2016, the FASB issued ASU No. 2016-10, Identifying Performance Obligations and Licensing, and ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), respectively. ASU No. 2016-10 clarifies the implementation guidance on licensing and the identification of performance obligations considerations included in ASU No. 2014-09. ASU No. 2016-08 provides amendments to clarify the implementation guidance on principal versus agent considerations included in ASU No. 2014-09. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU No. 2014-09. ASU No. 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The effective date of this pronouncement is for fiscal years beginning after December 15, 2017 with early adoption permitted as of the original effective date. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Customers with Contracts (Topic 606) Narrow-Scope Improvements and Practical Expedients. ASU No. 2016-12 amends certain aspects of ASU No. 2014-09, Revenue from Customers with Contracts (Topic 606). The amendments include the following:

 

·

Collectibility – ASU No. 2016-12 clarifies the objective of the entity’s collectibility assessment and contains new guidance on when an entity would recognize as revenue consideration it receives if the entity concludes that collectibility is not probable.

·

Presentation of sales tax and other similar taxes collected from customers – Entities are permitted to present revenue net of sales taxes collected on behalf of governmental authorities (i.e., to exclude from the transaction price sales taxes that meet certain criteria).

·

Noncash consideration – An entity’s calculation of the transaction price for contracts containing noncash consideration would include the fair value of the noncash consideration to be received as of the contract inception date. Further, subsequent changes in the fair value of noncash consideration after contract inception would be subject to the variable consideration constraint only if the fair value varies for reasons other than its form.

·

Contract modifications and completed contracts at transition – The ASU establishes a practical expedient for contract modifications at transition and defines completed contracts as those for which all (or substantially all) revenue was recognized under the applicable revenue guidance before the new revenue standard was initially adopted.

·

Transition technical correction – Entities that elect to use the full retrospective transition method to adopt the new revenue standard would no longer be required to disclose the effect of the change in accounting principle on the period of adoption (as is currently required by ASC No. 250-10-50-1(b)(2)); however, entities would still be required to disclose the effects on preadoption periods that were retrospectively adjusted.

 

ASU No. 2016-12 is effective for annual and interim periods beginning on or after December 15, 2017, and early adoption is permitted as of the original effective date of December 31, 2016. The Company will adopt the new revenue standards in the first quarter of 2018. The Company has not selected a transition model. The Company is still completing the assessment of the impact these ASUs will have on its condensed consolidated financial statements; however at the current time the Company does not expect that the adoption of these ASUs will have a material impact on its consolidated financial condition or results of operations. The adoption of these ASUs will require enhanced disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which affects the accounting for leases. The guidance requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations

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created by all leases with terms of more than 12 months. The amendment also will require qualitative and quantitative disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for fiscal years beginning after December 15, 2018 and interim periods within that reporting period. Early application is permitted. The Company is currently assessing the impact of the new standard on its condensed consolidated financial statements, but anticipates an increase in assets and liabilities due to the recognition of the required right-of-use asset and corresponding liability for