UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One) 

For the quarterly period ended: September 30, 2016

For the transition period from ____________ to _____________

Commission File Number: 333-193618

901 West Main Street, Suite A, Auburn, WA 98001

(Address of principal executive offices, Zip Code)

1-800-447-2993

(Registrant’s telephone number, including area code)

_____________________________________________________________

(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 x 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

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

The number of shares outstanding of each of the issuer’s classes of common stock, as of November 14, 2016 is as follows:

Peekay Boutiques, Inc.

Quarterly Report on Form 10-Q

 Period Ended September 30, 2016

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

PEEKAY BOUTIQUES, INC.

CONSOLIDATED BALANCE SHEETS

The accompanying condensed notes, together with the Notes to Consolidated Financial Statements contained in Form 10-K

for the fiscal year ended December 31, 2015, are an integral part of these financial statements.

PEEKAY BOUTIQUES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying condensed notes, together with the Notes to Consolidated Financial Statements contained in Form 10-K

for the fiscal year ended December 31, 2015, are an integral part of these financial statements.

PEEKAY BOUTIQUES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying condensed notes, together with the Notes to Consolidated Financial Statements contained in Form 10-K

for the fiscal year ended December 31, 2015, are an integral part of these financial statements.

PEEKAY BOUTIQUES, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

At the close of business on December 31, 2014, Christals Acquisition, LLC, a Delaware limited liability company (“Christals Acquisition”) and its members entered into a securities exchange agreement (“Exchange Agreement”) with Dico, Inc. a Nevada corporation (the “Company”), pursuant to which the Company acquired 100% of the issued and outstanding equity capital of Christals Acquisition in exchange for 420,812 shares of the Company’s common stock, par value $0.0001 per share, which constituted 70.5% of the issued and outstanding capital stock on a fully-diluted basis as of and immediately after the consummation of the transactions contemplated by the Exchange Agreement. In addition, at the closing of the share exchange, Christals paid the Company $350,000 in cash, which was immediately used for the following purposes (i) to pay down all of the Company’s outstanding liabilities, (ii) $308,436 of this cash was used as a partial payment toward the redemption of a total of 2,500,000 of the Company’s restricted shares from David Lazar, the former Chief Operating Officer and Secretary of the Company, pursuant to a redemption agreement entered into with Mr. Lazar on December 31, 2014, and (iii) to satisfy aggregate purchase price payable to holders of a total of 175,433 shares of the Company’s common stock, which shares were transferred to the members of Christals Acquisition as a condition to the closing of the exchange transaction. In addition to receiving the $308,436 payment for the redemption of his 2,500,000 shares of the Company’s common stock, the Company also transferred to Mr. Lazar the remaining inventory of loose diamonds pursuant to a bill of sale and assignment agreement as the balance of the consideration for the redemption of his shares. Immediately following the closing of the exchange transaction and the related transactions described above, the former members of Christals Acquisition and certain equity owners of such members who immediately received distributions of such securities, became the owners of 596,245 shares of the Company’s common stock, constituting 99.9% of the Company’s issued and outstanding common stock as of such closing. For accounting purposes, the exchange transaction with Christals Acquisition was treated as a reverse acquisition, with Christals Acquisition as the acquirer and the Company as the acquired party. In January 2015, Dico, Inc. changed its name to Peekay Boutiques, Inc. On October 28, 2015, the Company effected a one-for-six reverse split of its authorized and outstanding common stock, and all share and per share information has been adjusted to reflect this reverse split.

Christals Acquisition was formed in January 2012 to acquire existing limited liability companies operating retail stores in the sexual health and wellness category. The financial statements of the Company include the following fully owned subsidiaries: Christals Acquisition, Peekay Acquisition, LLC, Peekay SPA, LLC; ZJ Gift F-2, LLC, ZJ Gift F-3, LLC, ZJ Gifts F-4, LLC, ZJ Gifts F-5, LLC, ZJ Gifts F-6, LLC, ZJ Gifts I-1, LLC, ZJ Gifts M-1, LLC, ZJ Gifts M-2, LLC, and ZJ Gifts M- 3, LLC, which operate stores in Iowa, Texas and Tennessee under the Christals brand; and Peekay, Inc., ConRev, Inc., Condom Revolution, Inc. and Charter Smith Sanhueza Retail, Inc., which operate stores in Washington, Oregon and California under the Lovers, ConRev and A Touch of Romance brands.

Basis of Presentation – Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. During 2014 and 2015, the Company incurred net losses of $4,181,890 and $46,690,915 (including a $40,585,386 impairment charge), respectively, largely as a result of interest expense on its outstanding debt of almost $51 million, which exceeds the operating profits generated through the operations of its business. Approximately $38.2 million in senior secured debt matured on February 15, 2016, and the Company does not have the resources necessary to pay this debt and has not been able to raise the capital necessary or source refinancing to satisfy this obligation and is operating under a Forbearance Agreement.

The ability of the Company to continue its operations and execute its business plan is dependent on its ability to refinance this debt and/or to raise sufficient capital to pay this debt and other obligations as they come due (or are extended through a refinancing) and to provide sufficient capital to operate its business as contemplated. The Company continues to explore options to refinance or restructure the debt, to raise additional equity capital through a private or public placement of securities, or to complete a strategic transaction.

These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES

Information regarding significant accounting policies relating to the Company and its subsidiaries is contained in Note 2, “Significant Accounting Policies,” to the financial statements of the Company contained in the Annual Report on Form 10-K for the year ended December 31, 2015. Presented below in this and the following notes is supplemental information that should be read in conjunction with “Notes to Financial Statements” in the Annual Report on Form 10-K.

Basis of Presentation

The accompanying unaudited consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and the rules and regulations of the Securities and Exchange Commission (the “SEC”), for interim financial information and include the accounts of the Peekay Boutiques, Inc. and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, which are of a normal recurring nature, necessary to fairly state the financial position and results of operations and cash flows for the interim periods presented.

The Company’s business is subject to seasonal fluctuation. Significant portions of the Company’s net revenue and operating income are realized during the first and fourth quarters of the fiscal year, corresponding to the Valentine Day and Holiday shopping seasons, respectively. The results of the three and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2016, or for any other future interim period or for any future year.

These interim consolidated financial statements and the related notes should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

Fiscal Year End

The Company has adopted a fiscal year end of December 31^st, and its quarters end on March 31^st, June 30^th, September 30^th and December 31^st.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

The Company’s most significant area of estimation and assumption is:

Recent Accounting Pronouncements and Account Changes

In February of 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements.

Our Company made no accounting changes during the three months ended September 30, 2016.

NOTE 3 – NOTES PAYABLE

Unsecured Subordinated Promissory Notes

Acquisition of the Christals Stores - On October 9, 2012, Christals Acquisition issued four promissory notes, two at $1,550,000 and two at $150,000 to the former owners of the Christals stores. These notes bear interest at a rate of 12% and are due at maturity on January 7, 2017. Interest is only payable prior to note maturity, if the stores sold as part of the agreement reach a certain quarterly EBITDA threshold. During 2014 and 2015, the stores reached that threshold for one quarter and $45,000 in interest was paid to the holders. These notes are subject to certain covenants that are defined in the purchase agreement.

Acquisition of the Peekay Stores - On December 31, 2012, Peekay Acquisition, LLC (“Peekay Acquisition”) and Peekay SPA, LLC, each a Delaware limited liability company, jointly and severally promised to pay to certain subordinated lenders the principal amount of $6,000,000 and $3,300,000 pursuant to a Common Stock Purchase Agreement, dated as of December 31, 2012, with interest at the rate of 9% and 12% per annum respectively. The notes mature on December 31, 2016. Subject to certain subordination provisions and all other rights of the Company’s senior creditors, all unpaid principal, together with any then unpaid and accrued interest and other amounts payable thereunder, will be due and payable in cash on the earlier of the maturity date, and the date when, upon the occurrence and during the continuance of an event of default, such amounts are declared due and payable in cash by a majority of the lenders or become automatically due and payable in cash thereunder, in each case, in accordance with the terms thereof. Accrued but unpaid interest shall be compounded quarterly on each March 1, June 1, September 1, and December 1, commencing on March 1, 2013 (each such date an “Interest Payment Date”). All such interest shall be paid by accretion thereof to the outstanding principal balance of the notes as PIK interest. Notwithstanding anything herein to the contrary, on each Interest Payment Date, 45% of the interest then accrued in respect to the three months then ending shall be due as cash interest, and if permitted by provisions of the subordination agreement, shall be payable as cash interest rather than PIK interest. By giving the subordinated lender five days written notice, the Company may prepay the debt, in whole or in part, without penalty or premium, with amounts paid applied to accrued, unpaid interest and then to principal. These notes contain certain covenants that restrict the amount of distributions and dividends that the Company can make.

On February 22, 2016, the Company entered into a Forbearance Agreement to the Financing Agreement, whereby all payments to the subordinated note holders are prohibited until the amounts due under the Financing Agreement have been paid in full or otherwise satisfied.

Financing Agreement

On December 31, 2012, Christals Acquisition, Peekay Acquisition and the subsidiaries of Christals Acquisition and Peekay Acquisition (the “Loan Parties”), as the borrowers and guarantors, entered into a financing agreement with Cortland Capital Marketing Services, LLC, as collateral agent for the several secured lenders.

The lenders made a term loan to the borrowers initially in the aggregate principal amount of $38,215,939, consisting of a tranche A term loan for the principal amount of $27,000,000, which matured on December 27, 2015, and bears interest at a rate of 12% per annum, and a tranche B term loan for the principal amount of $11,215,930, which matured on December 27, 2015, and bears interest at a rate of 15% per annum. The maturity date of the loans made under the financing agreement was extended to February 15, 2016 pursuant to the eighth amendment to the financing agreement, which is described below. The proceeds of the loans were used to repay then existing indebtedness, to finance a portion of the purchase price payable in connection with our acquisition of Peekay, Inc. (“Peekay”) and Conrev, Inc. (“Conrev”), to fund working capital requirements and to pay fees and expenses related to the Peekay and Conrev acquisition.

This debt matured on February 15, 2016 and we do not have the resources necessary to pay this debt and we have been unable to find replacement financing. We are currently operating under a forbearance agreement with our lenders, which is described below, but we may be forced to file for bankruptcy and/or liquidate our assets if we are unable to meet the terms of the forbearance agreement.

Our subsidiaries paid the following fees in connection with the financing agreement:

The financing agreement contains several financial covenants and other affirmative and negative covenants, including, without limitation, the following:

The obligations of the borrowers under the financing agreement are guaranteed by Christals Acquisition and all its subsidiaries as guarantors.

During 2014, we obtained three covenant waivers through amendments to our financing agreement with our secured lenders, dated March 31, 2014, September 30, 2014 and December 31, 2014. These waivers covered covenant requirements through April 30, 2015. We obtained a fourth covenant waiver on June 30, 2015, for the period ending September 30, 2015 and, a fifth covenant waiver on October 31, 2015 for the period ending November 30, 2015. We obtained a sixth covenant waiver on November 30, 2015 for the period ending December 27, 2015 and a seventh covenant waiver on December 16, 2015 for the period ending December 31, 2015.

At the same time, we entered into the fifth amendment to the financing agreement to obtain the fifth covenant waiver, we also entered into a sixth amendment to our financing agreement. The sixth amendment will only become effective if we close our proposed underwritten public offering as described in the Company’s registration statement on Form S-1 (Registration No. 333-203870) (the “Public Offering”) and satisfy the other conditions to the sixth amendment, which are described below. We refer to the date that the sixth amendment becomes effective as the sixth amendment effective date. On the sixth amendment effective date the financing agreement will be further modified as follows:

The conditions to the effectiveness of the sixth amendment to the financing agreement include, among others, the following:

On December 16, 2015, we entered into the eighth amendment to the financing agreement. The eighth amendment extended the final maturity date of the financing agreement to February 15, 2016, in order to allow for the completion of the Public Offering. The eighth amendment also waived, until February 15, 2016, any noncompliance due to (a) the payment to Christals Management, LLC of quarterly management fees in advance, rather than arrears from January 2013 through June 2015, and (b) failure to meet the required leverage ratio and minimum equity covenants set forth in the financing agreement.

An amendment fee equal to 0.50% of the aggregate principal amount of the outstanding loans will be payable on the earlier of the final maturity date and the date on which all the loan obligations are repaid or must be repaid, and the borrowers must pay a $150,000 legal expense advance. The eighth amendment also proscribed payment of accrued, unpaid management fees until the earlier of the final maturity date or the date on which all the loan obligations are repaid or must be repaid, except that upon the closing of a qualified public offering, including the Public Offering, we may pay management fees of $325,000 to CP IV SPV, LLC.

Since the Company was unable to repay the debt on the maturity date, the interest rate charged on both Term A and Term B debt was increased to 14% and 17% per annum, respectively, effective on the maturity date. On February 22, 2016, we and certain of the Company’s senior secured lenders (the “Consenting Term A Lenders”) entered into the forbearance and ninth amendment agreement. The forbearance and ninth amendment agreement further amends the financing agreement as described below.

The forbearance and ninth amendment agreement provides the Loan Parties with necessary forbearance from the enforcement by the secured lenders of default-related rights and remedies with respect to existing financing agreement defaults of the Loan Parties specified in the forbearance and ninth amendment agreement (the “Specified Defaults”) until July 31, 2016.

Under the forbearance and ninth amendment agreement, the Loan Parties have the following obligations, among others. As applicable, after each obligation identified below, we are disclosing our current compliance status.

On March 14, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed to a ten-day extension of the deadline to grant the Warrants and enter into a Step Two Restructuring Term Sheet (as defined in the forbearance and ninth amendment agreement) until March 24, 2016. This extension was conditioned on the agreement by the Company and the Loan Parties of the following conditions, which conditions were accepted by the Company and the other Loan Parties:

On March 24, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed to further extend the deadline to grant the warrants and enter into the Step Two Restructuring Term Sheet until March 30, 2016.

On March 31, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed to further extend the deadline to grant the warrants and enter into the Step Two Restructuring Term Sheet until April 11, 2016. After April 11, 2016, this extension will automatically renew unless the Company receives 24 hours’ notice from the Consenting Term A Lenders of the termination of the extension. In connection with this additional waiver, the Company agreed to the following conditions:

On June 1, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed not to enforce their rights to require the Company and the Loan Parties to perform their obligations under the forbearance and ninth amendment agreement and the financing agreement generally or to meet the deadlines specified therein, including without limitation, the obligations and deadlines itemized below, until 24 hours following the date that the Consenting Term A Lenders notify the Company in writing that they revoke such waiver (the “Revocation Notice”). This agreement was subject to the payment by the Company to counsel to the Consenting Term A Lenders of a $100,000 retainer which will be applied in the ordinary course to pay for legal services rendered and to be rendered by such firm on behalf of the Consenting Term A Lenders in connection with the restructuring efforts. The Company paid the $100,000 retainer on June 1, 2016.

The obligations under the forbearance and ninth amendment agreement that the Consenting Term A Lenders agreed not to enforce until 24 hours following receipt of the Revocation Notice by the Company include the following:

On July 25, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the requirement to complete a the Stock Turnover Transaction is also covered by the waiver obtained by the Company on June 1, 2016 so that the Company is not required to effectuate a Stock Turnover Transaction until 24 hours following the date that the Consenting Term A Lenders notify the Company in writing that they revoke such waiver.

None of the Consenting Term A Lenders waived any of its rights and remedies under the forbearance and ninth amendment agreement or the financing agreement generally. Instead, the Consenting Term A Lenders agreed to not enforce such rights until 24 hours following receipt by the Company of a Revocation Notice.

On September 30, 2016, the lenders agreed to waive compliance by the Loan Parties to use their best efforts to maintain with a responsible insurance company “key man” life insurance with respect to Lisa Berman (as successor officer to Barry Soosman) and the borrowers to pay to the Term A Agent (as defined in the financing agreement) for its own account, quarterly in arrears on the last day of each calendar quarter and on the date the obligations are paid in full, an administrative fee in the amount of $15,000 (or a pro rata portion in the case of the final payment of such fee).

There can be no assurance that we will be able to obtain additional waivers, or that we will continue to be in compliance with the terms and conditions of the agreements with our secured and other lenders. If we fail to obtain waivers or default on our secured debt, then our lenders may be able to accelerate such debt or take other action against us, which would have material adverse consequences on our financial condition and our ability to continue to operate.

NOTE 4 – FAIR VALUE MEASUREMENTS

The carrying value of cash and equivalents, deposit held in escrow and accounts payable approximates their estimated fair values due to the short maturities of these instruments.

Fair value is measured using inputs from the three levels of the fair value hierarchy, which are described as follows:

NOTE 5 – COMMITMENTS AND CONTINGENCIES

The Company maintains leases with numerous landlords for 47 retail stores, the corporate offices, distribution center and one closed store location. Store leases generally start with five year terms, and frequently contain renewal options for one or two additional five year terms.

Minimum lease payments under operating leases are as follows:

NOTE 6 – SUBSEQUENT EVENTS

We evaluated all events or transactions that occurred after December 31, 2015 through November 14, 2016, the date we issued these statements. During this period, except as described below, we did not have any material subsequent events that impacted our financial statements, which are not already disclosed herein.

On November 11, 2016, we entered into an investment banking engagement agreement, which we refer to as the engagement letter, with SSG Advisors, LLC and its affiliated broker-dealer SSG Capital Advisors, LLC, or SSG, and Lake Street Capital Markets, or Lake Street, who along with SSG, we refer to as the advisors. Pursuant to the engagement agreement, we engaged the advisors for advice and investment banking services on an exclusive basis in connection with the sale of our business or some part(s) of our business, which we refer to as a sale, and/or a restructuring of our balance sheet with existing stakeholders and lenders, which we refer to as a restructuring. In addition, upon our request the advisors will also provide certain financial advisory services as well as valuation services. We agreed to give the advisors exclusive authority to initiate and conduct discussions and assist and advise us regarding prospective purchasers. We also agreed to identify to the advisors all prospective purchasers and investors who had been in contact prior to the date of the engagement agreement, and all prospective purchasers who come in contact with us during the term of the engagement agreement. We may reject any proposed sale or restructuring regardless of the proposed terms.

The engagement agreement requires us to pay to the advisors the following fees. A fee of $25,000, or the initial fee, which was due and payable to SSG upon the execution of the engagement agreement, and monthly fees of $25,000, or the monthly fees, which are due and payable each month beginning November 2016 and continuing during the term of the engagement agreement. The advisors will seek to identify an interested purchaser of our company and the fee payable to the advisors for the sale will be dependent upon whether there any other interested purchasers that make a bid higher than the initial purchaser’s bid, which we refer to as an overbid. The fees payable upon a sale range from $300,000 to $480,000 plus 5.0% of any overbid with credits for the initial fee and monthly fees. In the case of a restructuring with our lenders instead of a sale, SSG would be entitled to a fee equal to $300,000. We will not be required to pay both a sale fee and a restructuring fee. The initial fee and the monthly fees would also be credited against the restructuring fee. Finally, if we request financial advisory services, we would be required to pay an additional fee of $250,000 and if we request a valuation, we would be required to pay an additional fee of $50,000. In addition to the above fees, the advisors will be entitled to reimbursement for all reasonable out-of-pocket expenses incurred in connection with the subject matter of the engagement agreement.

The engagement agreement term will be six months and then may be terminated by either party upon 30 days’ written notice to the other, except that either party may terminate the engagement agreement immediately upon the closing of a sale or restructuring. If a sale or restructuring occurs within twelve months of the termination of the engagement agreement with a party with whom the Advisors had contact during the term of the engagement agreement, then we would remain obligated to pay a sale fee as calculated above.

Also on November 11, 2016, we entered into an engagement agreement, which we refer to as the Traverse engagement agreement, with Traverse LLC, or Traverse, for certain restructuring consulting services. These services will include Traverse making available to the Company a Chief Restructuring Officer, or CRO, and other employees of Traverse, who we refer to as the additional personnel, as required to assist the CRO in providing these services. The CRO and the additional personnel will report to and take direction from the Company’s board of directors to provide comprehensive support to the Company with respect to its pursuit of restructuring alternatives. The Company will pay a fixed monthly fee of $50,000 and a security retainer advance of $25,000. The Traverse engagement agreement will have a term of six months but may be terminated by either party upon thirty days’ prior written notice to the other.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; any statements about potential financing transactions, debt restructurings, or transactions with strategic partners, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A “Risk Factors” included in Exhibit 99.1 to our Annual Report on Form 10-K filed April 14, 2016, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of our company to differ materially from those expressed or implied by such forward-looking statements.

Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.

Use of Terms

Except as otherwise indicated by the context and for the purposes of this report only, references in this report to:

Overview

Based on our management’s belief and experience in the industry, we believe we are a leading retailer of lingerie, sexual health and wellness products. Our company was founded in 1981 in Auburn, WA by a mother and daughter team with a focus on creating a comfortable and inviting store environment catering to women and couples. We are dedicated to creating both a place and attitude of acceptance and education for our customers. Today, our company is a leader in changing the perception of sexual health and wellness throughout the United States with 47 locations across six states.

Our stores offer a broad selection of lingerie, sexual health and wellness products and accessories. We offer over 5,000 stock keeping units. We strive to create a visually inspiring environment at our stores and employ highly trained, knowledgeable sales staff, which ensures that our customers leave our stores enlightened by new information, great ideas and fun products.

Our mission is to provide a warm and welcoming retail environment for individuals and couples to explore sexual wellness.

Principal Factors Affecting our Financial Performance

Our operating results are primarily affected by the following factors:

Our business is also materially impacted by certain covenants contained in our senior financing agreements and our inability to repay our indebtedness under such agreements, which has already come due. We have sought and obtained several waivers of the leverage ratio and/or minimum liquidity covenants. We are currently in default under our financing agreement with our senior lenders and have entered into a forbearance agreement with our senior lenders. If we are unable to satisfy the demands of our senior lenders for the repayment of all amounts owed to them, raise capital to repay our indebtedness to our senior lenders or enter into a strategic transaction and related restructuring, we could be forced to file for bankruptcy protection. Our continued need to obtain waivers and forbearance from our lenders as needed, or to refinance our existing indebtedness, could have a material impact on our financial condition and operations.

Going Concern

Our auditor has raised substantial doubt about our ability to continue as a going concern. Our financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. During 2014 and 2015, we incurred net losses of $4.2 million and $46.7 million (including a $40.6 million goodwill impairment charge), respectively. Our net losses are largely a result of interest expense on the approximately $51 million of debt, which exceeds the operating profits generated through the operations of our business. Approximately $38.2 million in senior secured debt matured on February 15, 2016, and we do not have the resources necessary to pay this debt and we have been unable to find replacement financing. We are currently operating under a forbearance and ninth amendment agreement providing for certain forbearance treatment with our lenders (see “– Liquidity and Capital Resources – Financing Agreement; Amendments and Waivers”), but we may be forced to file for bankruptcy and/or liquidate our assets if we are unable to meet the terms of the agreement or otherwise find a restructuring arrangement that is satisfactory to all parties. Our ability to continue our operations and execute our business plan is dependent on our ability to refinance this debt and/or to raise sufficient capital to pay this debt and other obligations as they come due (or are extended through a refinancing) and to provide sufficient capital to operate our business as contemplated. If we are unable to refinance our existing senior debt or raise equity capital we may have to cease operations and liquidate our assets and the holders of our equity may lose all or a significant portion of the value of their equity.

Emerging Growth Company

We qualify as an “emerging growth company” under the JOBS Act. As a result, we are permitted to, and intend to, rely on exemptions from certain disclosure requirements. For so long as we are an emerging growth company, we will not be required to:

Results of Operations

Comparison of Three Months Ended September 30, 2016 and 2015

The following table sets forth key components of our results of operations for the three months ended September 30, 2016 and 2015.

Net revenue. For the three months ended September 30, 2016, net revenue decreased $0.1 million, or 1.4%, to $9.5 million, as compared to the same period in 2015. Our same store sales decreased $0.1 million, or 0.9%, to $9.4 million for the three months ended September 30, 2016 as compared to the same period in 2015. For the purpose of calculating our same store sales metrics, we compare the current period sales for stores open for 14 months or longer as of the last day of a month with the sales for these stores for the comparable period in the prior fiscal year. The decrease was primarily due to the discontinuation of DVD sales during the third quarter of 2015, during which our stores sold $0.1 million in DVDs before the products were removed from the assortment.

Gross profit. Gross profit for the three months ended September 30, 2016 was $6.1 million, a decrease of $0.2 million, or 2.8%, over the same period in 2015. Gross profit, expressed as a percentage of net revenue, was 63.4% for the three months ended September 30, 2016, as compared to 64.3% for the same period in 2015. Such decrease was primarily the result of an increase in promotional pricing on wellness products during the quarter, which lowered the overall margin recognized.

Selling, general and administrative expense. For the three months ended September 30, 2016, selling, general and administrative expenses totaled $4.9 million, a decrease of $0.6 million over the same period in 2015. The decrease in operating expenses resulted, in part, from a reduction of $0.2 million in marketing and advertising costs, from the third quarter of 2015 to comparable period in 2016, as the company tested various advertising and marketing programs during the Fifty Shades of Grey movie and DVD release in 2015. The Company also reduced management and administrative fees for the three months ended September 30, 2016 by $0.2 million, as compared to the third quarter of 2015.

Depreciation and amortization. Depreciation and amortization for the three months ended September 30, 2016 was $0.7 million, a reduction of 50% from the $1.4 million recorded in the third quarter of 2015. The Company continues to incur $0.6 million in amortized loan costs associated with its Financing Agreement each quarter the debt remains outstanding.

Operating income (loss). For the three months ended September 30, 2016, the Company reported $0.5 million in operating income, an improvement of $1.1 million from the $0.6 million operating loss realized during the third quarter of 2015, primary as a result of lower operating and amortization expenses.

Interest, other and tax expense. Interest and other expense for the three months ended September 30, 2016 and 2015 was $2.1 million, an increase of $0.4 million over the comparable 2015 period, primarily due to an increase in interest expense associated with the incursion of default interest on the senior debt, and non-operating legal and restructuring costs incurred. No material income tax expense was recognized for the three months ended September 30, 2016 or 2015.

Net loss. As a result of the foregoing, the net loss for the three months ended September 30, 2016 was $1.6 million as compared to a loss $2.3 million for the same period in 2015.

Comparison of Nine Months Ended September 30, 2016 and 2015

The following table sets forth key components of our results of operations for the nine months ended September 30, 2016 and 2015.

Net revenue. For the nine months ended September 30, 2016, net revenue decreased $0.8 million, or 2.8%, to $30 million, as compared to the same period in 2015. Our same store sales decreased $0.8 million, or 2.5%, to $29.5 million for the nine months ended September 30, 2016 as compared to the same period in 2015. For the purpose of calculating our same store sales metrics, we compare the current period sales for stores open for 14 months or longer as of the last day of a month with the sales for these stores for the comparable period in the prior fiscal year. Sales of our private label products declined by $0.7 million for the nine months ended September 30, 2016, as compared to the comparable period in 2015, as we finish selling through the remaining products imported in 2013 and early 2014, while DVD sales were $0.4 million lower than 2015, as we discontinued distribution of DVDs in the third quarter of 2015.

Gross profit. Gross profit for the nine months ended September 30, 2016 was $19.2 million, a decrease of $0.6 million, or 3.2%, over the same period in 2015. Gross profit, expressed as a percentage of net revenue, declined 30 basis points from 64.2% for the nine months ended September 30, 2015 to 63.9% for the nine months ended September 30, 2016, due to changes in product assortment associated with our revised media strategy, and a reduction in the number of products in our private label program.

Selling, general and administrative expense. For the nine months ended September 30, 2016, selling, general and administrative expenses totaled $15.2 million, a decrease of $1.3 million over the same period in 2015. The decrease in operating expenses resulted from a reduction of $0.4 million in marketing and advertising costs from the nine months ended September 30, 2015 to the comparable period in 2016, as the Company tested theater advertisement and other marketing programs during the Fifty Shades of Grey movie and DVD release in 2015. The Company also reduced certain management and administrative fees and expenses during the first nine months of 2016 that resulted in savings of approximately $0.5 million.

Depreciation and amortization. Depreciation and amortization for the nine months ended September 30, 2016 was $2.4 million, $0.5 million lower than for the same period in 2015, primarily due to a decrease in the amortization of fees associated with our senior credit facility.

Operating income. Despite a decrease in revenue of $0.8 million for the first nine months of 2016, as compared to the comparable prior year period, operating income increased $1.1million, or 232%, to $1.6 million for the nine months ended September 30, 2016.

Interest, other and tax expense. Interest and other expense for the nine months ended September 30, 2016 and 2015 was $6 million, an increase of $1.1 million over the comparable 2015 period, due primarily to the incurrence of default interest on the senior notes and non-operating legal and restructuring costs incurred during the first half of 2016. No measurable income tax expense was recognized for the nine months ended September 30, 2016 or 2015.

Net loss. As a result of the foregoing, the net loss for the nine months ended September 30, 2016 increased less than twenty thousand dollars to $4.6 million as compared to a loss $4.5 million for the same period in 2015.

Liquidity and Capital Resources

Cash Flow

As of September 30, 2016, we had cash and cash equivalents of $2.3 million. The following table provides a summary of our net cash flows from operating, investing, and financing activities.

Cash Flow

(In Thousands)

Operating activities. Operating activities consist of net income, adjusted for certain non-cash items, including depreciation and amortization, and the effect of changes in working capital. Net cash provided by operating activities was $1.4 million in the nine months ended September 30, 2016, as compared with $0.7 million net cash provided by operating activities in the same period in 2015. The increase in net cash provided by operating activities was primarily due to the increase in accrued liabilities associated with the deferral of cash interest payments on the senior debt commencing June 1, 2016.

Investing activities. Historically, we have used cash primarily to make acquisitions, and to remodel and build new stores. We used no cash for investing activities during the nine months ended September 30, 2016, as compared with the usage of $0.1 million in the same period in 2015. The net cash used during the first nine months of 2015 was for leasehold improvements and equipment for our new store in Valencia, California.

Financing activities. No cash was used or provided by financing activities during the nine months ended September 30, 2016, as compared to the $0.7 million used in financing activities during the same period in 2015 for the payment of covenant waiver fees incurred under the senior debt facility.

Loan Commitments

As of September 30, 2016, the amount, maturity date and term of each of our notes payable are as follows:

Financing Agreement; Amendments and Waivers

On December 31, 2012, our subsidiaries, Christals Acquisition, Peekay Acquisition and the subsidiaries of Christals Acquisition and Peekay Acquisition, which we refer to as the Loan Parties, as the borrowers and guarantors, entered into a financing agreement with Cortland Capital Marketing Services, LLC, as collateral agent for the several secured lenders.

The lenders made a term loan to the borrowers initially in the aggregate principal amount of $38,215,939, consisting of a tranche A term loan for the principal amount of $27,000,000, which matured on December 27, 2015, and bears interest at a rate of 12% per annum, and a tranche B term loan for the principal amount of $11,215,930, which matured on December 27, 2015, and bears interest at a rate of 15% per annum. The maturity date of the loans made under the financing agreement was extended to February 15, 2016 pursuant to the eighth amendment to the financing agreement, which is described below. The proceeds of the loans were used to repay then existing indebtedness, to finance a portion of the purchase price payable in connection with our acquisition of Peekay and Conrev, to fund working capital requirements and to pay fees and expenses related to the Peekay and Conrev acquisition.

This debt matured on February 15, 2016 and we do not have the resources necessary to pay this debt and we have been unable to find replacement financing. We are currently operating under a forbearance agreement with our lenders, which is described below, but we may be forced to file for bankruptcy and/or liquidate our assets if we are unable to meet the terms of the forbearance agreement or otherwise agree upon a restructuring arrangement with our lenders.

Our subsidiaries paid the following fees in connection with the financing agreement:

The financing agreement contains several financial covenants and other affirmative and negative covenants, including, without limitation, the following:

The obligations of the borrowers under the financing agreement are guaranteed by Christals Acquisition and all its subsidiaries as guarantors.

Although our company, Peekay Boutiques, Inc., is not a party to the financing agreement, since we are a holding company and do not have any material assets or operations other than ownership of equity interests of our subsidiaries, who are all parties to the financing agreement as either borrowers or guarantors, as a practical matter, we are restricted by the terms of the financing agreement. Our operations are conducted almost entirely through our subsidiaries, and our ability to generate cash to meet our obligations or to pay dividends to our shareholders is highly dependent on the earnings of, and receipt of funds from, our subsidiaries through dividends or intercompany loans. The financing agreement restricts the circumstances under which our subsidiaries may pay dividends to us or make intercompany loans to us.

During 2014, we obtained three covenant waivers through amendments to our financing agreement with our secured lenders, dated March 31, 2014, September 30, 2014 and December 31, 2014. These waivers covered covenant requirements through April 30, 2015. We obtained a fourth covenant waiver on June 30, 2015, for the period ending September 30, 2015 and, a fifth covenant waiver on October 31, 2015 for the period ending November 30, 2015. We obtained a sixth covenant waiver on November 30, 2015 for the period ending December 27, 2015 and a seventh covenant waiver on December 16, 2015 for the period ending December 31, 2015.

At the same time, we entered into the fifth amendment to the financing agreement to obtain the fifth covenant waiver, we also entered into a sixth amendment to our financing agreement. The sixth amendment will only become effective if we close our proposed underwritten public offering as described in the Company's registration statement on Form S-1 (Registration No. 333-203870), or the Public Offering, and satisfy the other conditions to the sixth amendment, which are described below. We refer to the date that the sixth amendment becomes effective as the sixth amendment effective date. On the sixth amendment effective date the financing agreement will be further modified as follows:

The conditions to the effectiveness of the sixth amendment to the financing agreement include, among others, the following:

On December 16, 2015, we entered into the eighth amendment to the financing agreement. The eighth amendment extended the final maturity date of the financing agreement to February 15, 2016, in order to allow for the completion of the Public Offering. The eighth amendment also waived, until February 15, 2016, any noncompliance due to (a) the payment to Christals Management, LLC of quarterly management fees in advance, rather than arrears from January 2013 through June 2015, and (b) failure to meet the required leverage ratio and minimum equity covenants set forth in the financing agreement.

An amendment fee equal to 0.50% of the aggregate principal amount of the outstanding loans will be payable on the earlier of the final maturity date and the date on which all the loan obligations are repaid or must be repaid, and the borrowers must pay a $150,000 legal expense advance. The eighth amendment also proscribed payment of accrued, unpaid management fees until the earlier of the final maturity date or the date on which all the loan obligations are repaid or must be repaid, except that upon the closing of a qualified public offering, including the Public Offering, we may pay management fees of $325,000 to CP IV SPV, LLC.

Since the Company was unable to repay the debt on the maturity date, the interest rate charged on both Term A and Term B debt was increased to 14% and 17% per annum, respectively, effective on the maturity date. On February 22, 2016, we and certain of the Company’s senior secured lenders, who we refer to as the Consenting Term A Lenders, entered into the forbearance and ninth amendment agreement. The forbearance and ninth amendment agreement further amends the financing agreement as described below.

The forbearance and ninth amendment agreement provides the Loan Parties with necessary forbearance from the enforcement by the secured lenders of default-related rights and remedies with respect to existing financing agreement defaults of the Loan Parties specified in the forbearance and ninth amendment agreement, or the Specified Defaults, until July 31, 2016.

Under the forbearance and ninth amendment agreement, the Loan Parties have the following obligations, among others. As applicable, after each obligation identified below, we are disclosing our current compliance status.

The foregoing is a summary description of certain terms of the forbearance and ninth amendment agreement, and by its nature is incomplete. A copy of the Forbearance and Ninth Amendment Agreement was filed on April 14, 2016, as Exhibit 10.31 to the Company’s report on Form 10-K for the fiscal year ended December 31, 2015, and is incorporated into this report by reference. All readers are encouraged to read the entire text of the Forbearance and Ninth Amendment Agreement.

On March 14, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed to a ten-day extension of the deadline to grant the Warrants and enter into a Step Two Restructuring Term Sheet (as defined in the forbearance and ninth amendment agreement) until March 24, 2016. This extension was conditioned on the agreement by the Company and the Loan Parties of the following conditions, which conditions were accepted by the Company and the other Loan Parties:

On March 24, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed to further extend the deadline to grant the warrants and enter into the Step Two Restructuring Term Sheet until March 30, 2016.

On March 31, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed to further extend the deadline to grant the warrants and enter into the Step Two Restructuring Term Sheet until April 11, 2016. After April 11, 2016, this extension will automatically renew unless the Company receives 24 hours’ notice from the Consenting Term A Lenders of the termination of the extension. In connection with this additional waiver, the Company agreed to the following conditions:

On June 1, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the Consenting Term A Lenders agreed not to enforce their rights to require the Company and the Loan Parties to perform their obligations under the forbearance and ninth amendment agreement and the financing agreement generally or to meet the deadlines specified therein, including without limitation, the obligations and deadlines itemized below, until 24 hours following the date that the Consenting Term A Lenders notify the Company in writing that they revoke such waiver, which we refer to as the Revocation Notice. This agreement was subject to the payment by the Company to counsel to the Consenting Term A Lenders of a $100,000 retainer which will be applied in the ordinary course to pay for legal services rendered and to be rendered by such firm on behalf of the Consenting Term A Lenders in connection with the restructuring efforts. The Company paid the $100,000 retainer on June 1, 2016.

The obligations under the forbearance and ninth amendment agreement that the Consenting Term A Lenders agreed not to enforce until 24 hours following receipt of the Revocation Notice by the Company include the following:

On July 25, 2016, counsel to the Consenting Term A Lenders confirmed by email correspondence on behalf of the Consenting Term A Lenders that the requirement to complete a the Stock Turnover Transaction is also covered by the waiver obtained by the Company on June 1, 2016 so that the Company is not required to effectuate a Stock Turnover Transaction until 24 hours following the date that the Consenting Term A Lenders notify the Company in writing that they revoke such waiver.

None of the Consenting Term A Lenders waived any of its rights and remedies under the forbearance and ninth amendment agreement or the financing agreement generally. Instead, the Consenting Term A Lenders agreed to not enforce such rights until 24 hours following receipt by the Company of a Revocation Notice.

On September 30, 2016, the lenders agreed to waive compliance by the Loan Parties to use their best efforts to maintain with a responsible insurance company “key man” life insurance with respect to Lisa Berman (as successor officer to Barry Soosman) and the borrowers to pay to the Term A Agent (as defined in the financing agreement) for its own account, quarterly in arrears on the last day of each calendar quarter and on the date the obligations are paid in full, an administrative fee in the amount of $15,000 (or a pro rata portion in the case of the final payment of such fee).

The foregoing is a summary description of certain terms of this waiver, and, by its nature, is incomplete. A copy of the waiver was filed as Exhibit 10.5 to our report on Form 8-K filed on October 6, 2016 and is incorporated into this report by reference. All readers are encouraged to read the entire text of the waiver.

There can be no assurance that we will be able to obtain additional waivers, or that we will continue to be in compliance with the terms and conditions of the agreements with our secured and other lenders. If we fail to obtain waivers or default on our secured debt, then our lenders may be able to accelerate such debt or take other action against us, which would have material adverse consequences on our financial condition and our ability to continue to operate.

Obligations Under Material Contracts

Except with respect to the loan obligations disclosed above, and the minimum amounts due under various lease arrangements for our stores, corporate headquarters and warehouse (which are more fully described in Note 5 of the Notes to the Consolidated Financial Statements contained herein), we have no material obligations to pay cash or deliver cash to any other party.

Impact of Inflation and Changing Prices

Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future could have an adverse effect on our ability to maintain current levels of gross profit and could result in an increase in operating expenses, as a percentage of revenue, if we cannot increase our retail prices to cover these increased costs. In addition, inflation could materially increase the interest rates that we are able to obtain, if we were to refinance our debt or increase our borrowings.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.

Seasonality

Our business is subject to seasonal fluctuation. Significant portions of our net sales and profits are realized during the fourth quarter of the fiscal year due to the holiday selling season. To a lesser extent, our business is also affected by Valentine’s Day. Any decrease in sales during these higher sales volume periods could have an adverse effect on our business, financial condition, or operating results for the entire fiscal year. Our quarterly results of operations have varied in the past and are likely to do so again in the future. As such, we believe that period-to-period comparisons of our results of operations should not be relied upon as an indication of our future performance.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operation. Critical accounting policies are those that are most important to the portrayal of our financial conditions and results of operations and require management’s difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments. We believe the following critical accounting policies involve the most significant estimates and judgments used in the preparation of our financial statements:

Inventory. Inventory consists of merchandise acquired for resale and is valued at the lower of cost or market, with cost determined on a FIFO basis, and includes costs to purchase and distribute the goods, net of any markdowns or volume discounts. We maintain reserves for potential obsolescence and shrinkage.

Vendor Allowances. We receive allowances from vendors in the normal course of business, including markdown allowances, purchase volume discounts and rebates, and other merchandise credits. Vendor allowances are recorded as a reduction of the vendor’s product cost and are recognized in cost of sales as the product is sold.

Fair Value of Financial Instruments. Our management believes the carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses approximate fair value due to their short maturity.

Long-Lived Assets. Property and equipment are stated at cost. Maintenance and repair costs are charged to expense as incurred. Depreciation is provided using the straight-line method with estimated useful lives as indicate below:

Leasehold improvements are amortized using the straight-line method over the lesser of the estimated useful lives of the related assets or the leases term, and this amortization is included in depreciation.

Impairment of Long-Lived Assets. We review long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on undiscounted cash flows. If long-lived assets are impaired, an impairment loss is recognized and is measured as the amount by which the carrying value exceeds the estimated fair value of the assets. The estimation of future undiscounted cash flows from operating activities requires significant estimates of factors that include future sales growth and gross margin performance. Management believes they have appropriately determined future cash flows and operating performance; however, should actual results differ from those expected, additional impairment may be required. No significant impairment charges have been recognized in fiscal 2016 or 2015.

Goodwill. Goodwill represents the excess of cost over the fair value of net assets acquired using acquisition accounting and is not amortized. Under FASB ASC 350, Intangibles - Goodwill and Other, goodwill and indefinite-lived intangible assets are reviewed at least annually for impairment. Acquired intangible assets with definite lives are amortized over their individual useful lives. On at least an annual basis, management assesses whether there has been any impairment in the value of goodwill by first comparing the fair value to the net carrying value. If the carrying value exceeds its estimated fair value, a second step is performed to compute the amount of the impairment. An impairment loss is recognized if the implied fair value of the asset being tested is less than its carrying value. In this event, the asset is written down accordingly. The fair values of goodwill impairment testing are determined using valuation techniques based on estimates, judgments and assumptions management believes are appropriate in the circumstances. At December 31, 2015, we took a $40.6 million goodwill impairment charge.

Finance Costs, Net. We are a party to debt agreements that contain non-interest fees and expenses, such as underwriting and covenant waiver fees. These fees are accrued as incurred and amortized over the life of the financing agreement.

Revenue Recognition. We derive revenues from sale of merchandise and upon the following: (1) there is persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered, (3) the seller’s price to the buyer is fixed or determinable, and (4) collectability is reasonably assured.

Cost of Goods Sold. Cost of goods sold consists primarily of the merchandise cost of products sold, including inbound freight, duties and packaging.

Recent Accounting Pronouncements

See Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this report.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Rule 13a-15(e) of the Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Ms. Lisa Berman, and Chief Financial Officer, Ms. Janet Mathews, of the effectiveness of the design and operation of our disclosure controls and procedures, as of September 30, 2016. Based upon, and as of the date of this evaluation, Mmes. Berman and Mathews determined that, because of the material weaknesses described in Item 9A “Controls and Procedures” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, which we are still in the process of remediating as of September 30, 2016, our disclosure controls and procedures were not effective. Investors are directed to Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 for the description of these weaknesses.

Changes in Internal Control Over Financial Reporting

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.

During its evaluation of the effectiveness of internal control over financial reporting as of September 30, 2016, our management identified material weaknesses associated with separation of duties, software and system process documentation and testing, and other internal control testing. As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, our management has identified the steps necessary to address the material weaknesses and will continue with the design and implementation of remedial procedures to address these weaknesses, and the replacement and upgrade of its computer systems as resourced become available. Certain changes associated with the lack of separation of duties will not be implemented until we have restructured our debt and are able to hire the additional staff necessary to bring our Company into compliance.

Other than in connection with the implementation of the remedial measures described above, there were no changes in our internal controls over financial reporting during the third quarter of fiscal 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II 

OTHER INFORMATION 

ITEM 1. LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.

ITEM 1A.RISK FACTORS.

Not applicable as we are a smaller reporting company. See, however, the risk factors contained in Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2015. Please also see the risk factors contained in our Form S-1/A, dated October 30, 2015.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

We did not sell any equity securities during the third quarter of fiscal year 2016 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the quarter.

During the three-month period ended September 30, 2016, we did not repurchase any shares of our common stock.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5. OTHER INFORMATION.

On November 11, 2016, we entered into an investment banking engagement agreement, which we refer to as the engagement letter, with SSG Advisors, LLC and its affiliated broker-dealer SSG Capital Advisors, LLC, or SSG, and Lake Street Capital Markets, or Lake Street, who along with SSG, we refer to as the advisors. Pursuant to the engagement agreement, we engaged the advisors for advice and investment banking services on an exclusive basis in connection with the sale of our business or some part(s) of our business, which we refer to as a sale, and/or a restructuring of our balance sheet with existing stakeholders and lenders, which we refer to as a restructuring. In addition, upon our request the advisors will also provide certain financial advisory services as well as valuation services. We agreed to give the advisors exclusive authority to initiate and conduct discussions and assist and advise us regarding prospective purchasers. We also agreed to identify to the advisors all prospective purchasers and investors who had been in contact prior to the date of the engagement agreement, and all prospective purchasers who come in contact with us during the term of the engagement agreement. We may reject any proposed sale or restructuring regardless of the proposed terms.

The engagement agreement requires us to pay to the advisors the following fees. A fee of $25,000, or the initial fee, which was due and payable to SSG upon the execution of the engagement agreement, and monthly fees of $25,000, or the monthly fees, which are due and payable each month beginning November 2016 and continuing during the term of the engagement agreement. The advisors will seek to identify an interested purchaser of our company and the fee payable to the advisors for the sale will be dependent upon whether there any other interested purchasers that make a bid higher than the initial purchaser’s bid, which we refer to as an overbid. The fees payable upon a sale range from $300,000 to $480,000 plus 5.0% of any overbid with credits for the initial fee and monthly fees. In the case of a restructuring with our lenders instead of a sale, SSG would be entitled to a fee equal to $300,000. We will not be required to pay both a sale fee and a restructuring fee. The initial fee and the monthly fees would also be credited against the restructuring fee. Finally, if we request financial advisory services, we would be required to pay an additional fee of $250,000 and if we request a valuation, we would be required to pay an additional fee of $50,000. In addition to the above fees, the advisors will be entitled to reimbursement for all reasonable out-of-pocket expenses incurred in connection with the subject matter of the engagement agreement.

The engagement agreement term will be six months and then may be terminated by either party upon 30 days’ written notice to the other, except that either party may terminate the engagement agreement immediately upon the closing of a sale or restructuring. If a sale or restructuring occurs within twelve months of the termination of the engagement agreement with a party with whom the Advisors had contact during the term of the engagement agreement, then we would remain obligated to pay a sale fee as calculated above.

The foregoing is a summary description of certain terms of the engagement agreement, and, by its nature, is incomplete. A copy of the engagement agreement is filed as Exhibit 10.3 to this report and is incorporated into this report by reference. All readers are encouraged to read the entire text of the agreement.

Also on November 11, 2016, we entered into an engagement agreement, which we refer to as the Traverse engagement agreement, with Traverse LLC, or Traverse, for certain restructuring consulting services. These services will include Traverse making available to the Company a Chief Restructuring Officer, or CRO, and other employees of Traverse, who we refer to as the additional personnel, as required to assist the CRO in providing these services. The CRO and the additional personnel will report to and take direction from the Company’s board of directors to provide comprehensive support to the Company with respect to its pursuit of restructuring alternatives. The Company will pay a fixed monthly fee of $50,000 and a security retainer advance of $25,000. The Traverse engagement agreement will have a term of six months but may be terminated by either party upon thirty days’ prior written notice to the other.

The foregoing is a summary description of certain terms of the Traverse Engagement Agreement, and, by its nature, is incomplete. A copy of the Traverse Engagement Agreement is filed as Exhibit 10.4 to this report and is incorporated into this report by reference. All readers are encouraged to read the entire text of the agreement.

Except as specified above, we have no information to disclose that was required to be in a report on Form 8-K during the third quarter of fiscal year 2016, but was not reported. There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors.

ITEM 6. EXHIBITS.

The following exhibits are filed with this report, except those indicated as having previously been filed with the SEC and are incorporated by reference to another report, registration statement or form. As to any stockholder of record requesting a copy of this report, we will furnish any exhibit indicated in the list below as filed with this report upon payment to us of our expenses in furnishing the information.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBIT INDEX