UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 



 

For the quarterly period ended September 30, 2017



or





 

For the transition period from __________________ to ______________________.

 

Commission File Number 001-37656

 

SEQUENTIAL BRANDS GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

601 West 26th Street, 9th Floor
New York, New York 10001

(Address of principal executive offices) (Zip Code)

 

(646) 564-2577

(Registrant’s telephone number, including area code)

 

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, a 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 ☐ (Do not check if a smaller reporting company)   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 in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

As of November 2, 2017, the registrant had 63,151,870 shares of common stock, par value $0.01 per share, outstanding.

 

 

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SEQUENTIAL BRANDS GROUP, INC. AND SUBSIDIARIES

 

INDEX TO FORM 10-Q

 





 

 

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Forward-Looking Statements

 

This quarterly report on Form 10-Q (this “Quarterly Report”), including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We use words such as “future,” “seek,” “could,” “can,” “predict,” “believe,” “intend,” “expect,” “anticipate,” “plan,” “may,” “will,” “should,” “estimate,” “potential,” “project” and similar expressions to identify forward-looking statements. Such statements include, among others, those concerning our expected financial performance and strategic and operational plans, 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 that a number of risks and uncertainties could cause actual results to differ materially from those anticipated in the forward-looking statements.  Such risks and uncertainties include, but are not limited to the following: (i) risks and uncertainties discussed in the reports that the Company has filed with the Securities and Exchange Commission (the “SEC”); (ii) general economic, market or business conditions; (iii) the Company’s ability to identify suitable targets for acquisitions and to obtain financing for such acquisitions on commercially reasonable terms; (iv) the Company’s ability to timely achieve the anticipated results of recent acquisitions and any potential future acquisitions; (v) the Company’s ability to successfully integrate acquisitions into its ongoing business; (vi) the potential impact of the consummation of recent acquisitions or any potential future acquisitions on the Company’s relationships, including with employees, licensees, customers and competitors; (vii) the Company’s ability to achieve and/or manage growth and to meet target metrics associated with such growth; (viii) the Company’s ability to successfully attract new brands and to identify suitable licensees for its existing and newly acquired brands; (ix) the Company’s substantial level of indebtedness, including the possibility that such indebtedness and related restrictive covenants may adversely affect the Company’s future cash flows, results of operations and financial condition and decrease its operating flexibility; (x) the Company’s ability to achieve its guidance; (xi) continued market acceptance of the Company’s brands; (xii) changes in the Company’s competitive position or competitive actions by other companies; (xiii) licensees’ ability to fulfill their financial obligations to the Company; (xiv) concentrations of the Company’s licensing revenues with a limited number of licensees and retail partners; and (xv) other circumstances beyond the Company’s control. 

 

Forward-looking statements speak only as of the date they are made and are based on current expectation and assumptions.  You should not put undue reliance on any forward-looking statement.  We are not under any obligation, and we expressly disclaim any obligation, to update forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except to the extent required by applicable securities laws.  If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to such or other forward-looking statements.



Where You Can Find Other Information

 

Our corporate website address is www.sequentialbrandsgroup.com.  The information contained on our website is not part of this Quarterly Report.  We file our annual, quarterly and current reports and other information with the SEC.  These reports, and any amendments to these reports, are made available on our website and can be viewed and downloaded free of charge as soon as reasonably practicable after such reports are filed with or furnished to the SEC.  The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, D.C. 20549.  The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  In addition, the SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information regarding issuers that file electronically with the SEC, which is available at www.sec.gov.



Unless otherwise noted, references in this Quarterly Report to the “Sequential Brands Group,” “Company,” “our Company,” “we,” “us,” “our” or similar pronouns refer to Sequential Brands Group, Inc. and its subsidiaries.  References to other companies may include their trademarks, which are the property of their respective owners.



 

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

SEQUENTIAL BRANDS GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)















SEQUENTIAL BRANDS GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

 

 











 

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SEQUENTIAL BRANDS GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(in thousands, except share data)

 

 









 

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SEQUENTIAL BRANDS GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)





  

 





 

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Overview

 

Sequential Brands Group, Inc. (the “Company”) owns a portfolio of consumer brands in the fashion, active and home categories.  The Company aims to maximize the strategic value of its brands by promoting, marketing and licensing its global brands through various distribution channels, including to retailers, wholesalers and distributors in the United States and in certain international territories.  The Company’s core strategy is to enhance and monetize the global reach of its existing brands, and to pursue additional strategic acquisitions to grow the scope of and diversify its portfolio of brands.  The Company licenses brands to both wholesale and direct-to-retail licensees.  In a wholesale license, a wholesale supplier is granted rights (typically on an exclusive basis) to a single or small group of related product categories for a particular brand for sale to multiple accounts within an approved channel of distribution and territory.  In a direct-to-retail license, a single retailer is granted the right (typically on an exclusive basis) to sell branded products in a broad range of product categories through its brick and mortar stores and e-commerce sites.  As of September 30, 2017, the Company had more than one-hundred fifty licensees, with wholesale licensees comprising a significant majority.





 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and pursuant to the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the United States Securities and Exchange Commission (the “SEC”).  Certain information or footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted, pursuant to the rules and regulations of the SEC for interim financial reporting.  Accordingly, they do not include all of the information and footnotes necessary for a comprehensive presentation of financial position, results of operations or cash flows.  It is the Company’s opinion, however, that the accompanying unaudited condensed consolidated financial statements include all adjustments, which are of a normal recurring nature, which are necessary for a fair presentation of the financial position, operating results and cash flows for the periods presented.

 

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on March 14, 2017, which contains the audited consolidated financial statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, for the years ended December 31, 2016, 2015 and 2014.  The financial information as of December 31, 2016 is derived from the audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.  The interim results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for the year ending December 31, 2017 or for any future interim periods.



Principles of Consolidation

 

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

 

Use of Estimates

 

The preparation of unaudited condensed consolidated financial statements in conformity with GAAP 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 unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.



Making estimates requires management to exercise significant judgment.  It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the unaudited condensed consolidated financial statements, which management considered in formulating its estimate, could change in the near term due to one or more future confirming events.  Accordingly, the actual results could differ significantly from estimates.

 

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Revenue Recognition

 

 The Company has entered into various license agreements that provide revenues based on guaranteed minimum royalty payments and advertising/marketing fees with additional royalty revenues based on a percentage of defined sales.  Guaranteed minimum royalty payments and advertising/marketing revenue are recognized on a straight-line basis over the term of each contract year, as defined in each license agreement.  Royalty payments exceeding the guaranteed minimum royalty payments are recognized as income during the period corresponding to the licensee’s sales.  Payments received as consideration for the grant of a license are recorded as deferred revenue at the time payment is received and recognized ratably as revenue over the term of the license agreement.  Advanced royalty payments are recorded as deferred revenue at the time payment is received and recognized as revenue when earned.  Revenue is not recognized unless collectability is reasonably assured.



If license agreements are terminated prior to the original licensing period, the Company recognizes revenue in the amount of any contractual termination fees, unless such amounts are deemed non-recoverable.

 

With respect to editorial content for books, the Company receives advance payments from the Company’s publishers and recognizes revenue when manuscripts are delivered to and accepted by the publishers.  Revenue is also earned from book publishing when sales on a unit basis exceed the advanced royalty.

 

Television sponsorship revenues are generally recorded ratably across the period when new episodes initially air.



The Company entered into a transaction with a media company for which it receives advertising credits as part of the consideration exchanged.  These transactions are recorded at the estimated fair value of the advertising credits received, as their fair value is deemed more readily determinable than the fair value of the trademark licensing right provided by the Company, in accordance with ASC 845, Nonmonetary Transactions. The fair value of the advertising credits are recorded as revenue and in other assets when earned, and expensed when the advertising credits are utilized.   The Company recorded revenue of $0.8 million for the three and nine months ended September 30, 2017 related to the advertising credits earned.  The Company did not record any expense related to the advertising credits as they have not yet been utilized.



Restricted Cash



Restricted cash consists of cash deposited with a financial institution required as collateral for the Company’s cash-collateralized letter of credit facilities.



Accounts Receivable

 

Accounts receivable are recorded net of allowances for doubtful accounts, based on the Company’s ongoing discussions with its licensees and other customers and its evaluation of their creditworthiness, payment history and account aging.  Accounts receivable balances deemed to be uncollectible are written off after all means of collection have been exhausted and the potential for recovery is considered remote.  The allowance for doubtful accounts was $0.3 million and $0.2 million as of September 30, 2017 and December 31, 2016.



The Company’s accounts receivable, net amounted to $50.6 million and $53.2 million as of September 30, 2017 and December 31, 2016, respectively.  Four licensees accounted for approximately 63% (25%, 14%, 13%, and 11%) of the Company’s total consolidated accounts receivable balance as of September 30, 2017 and four licensees accounted for approximately 49% (14%, 13%, 12% and 10%) of the Company’s total consolidated accounts receivable balance as of December 31, 2016.  The Company does not believe the accounts receivable balance from these licensees represents a significant collection risk based on past collection experience.



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Investments

 

The Company had marketable securities that were classified as available-for-sale securities under ASC 320, Investments – Debt and Equity Securities.  Such available-for-sale securities are reported at fair value in the condensed consolidated balance sheets and, at the time of purchase, were reported in the unaudited condensed consolidated statements of cash flows as an investing activity.  The Company reviews its available-for-sale securities at each reporting period to determine whether a decline in fair value is other-than-temporary.  Any decline in fair value that is determined to be other-than-temporary would result in an adjustment for an impairment charge in the accompanying unaudited condensed consolidated statements of operations.  The primary factors the Company considers in its determination are (i) the length of time that the fair value of the available-for-sale security is below the Company’s carrying value, (ii) the financial condition and operating performance of the available-for-sale security, (iii) the reason for decline in fair value and (iv) the Company’s intent and ability to hold the investment in available-for-sale security for a period of time sufficient to allow for a recovery in fair value.  Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific-identification basis. 



The unrealized gains and losses on the available-for-sale securities held by the Company as of December 31, 2016 is set forth below.





(1)  The cost basis is historical cost less other-than-temporary impairment.



During the second quarter of 2017, the Company sold its available-for-sale securities for $5.8 million.  The book cost basis of the available-for-sale securities was approximately $7.7 million, which was determined using the specific identification method.  The sale resulted in a net realized loss of $1.9 million, which is recorded in other (income) expense in the unaudited condensed consolidated statements of operations for the nine months ended September 30, 2017.  Included in the $1.9 million is $1.5 million that was reclassified from accumulated other comprehensive loss. 

 

Equity Method Investment



For investments in entities over which the Company exercises significant influence but which do not meet the requirements for consolidation, the Company uses the equity method of accounting.  On July 1, 2016, the Company acquired a 49.9% noncontrolling interest in Gaiam Pty. Ltd. in connection with its acquisition of Gaiam Brand Holdco, LLC, which is included in other assets in the condensed consolidated balance sheets.  The Company’s share of earnings from its equity method investee, which was not material for the three and nine months ended September 30, 2017, is included in other (income) expense in the unaudited condensed consolidated statements of operations.



The Company evaluates its equity method investment for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investment may not be recoverable.  The difference between the carrying value of the equity method investment and its estimated fair value is recognized as an impairment charge when the loss in value is deemed other-than-temporary.



Goodwill and Intangible Assets

 

Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.  In evaluating goodwill for impairment, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  Qualitative factors considered include, for example, macroeconomic and industry conditions, overall financial performance, and other relevant entity-specific events.  If the Company bypasses the qualitative assessment, or concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, it then performs a quantitative goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment to be recognized, if any.

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During the quarter ended September 30, 2017, as a result of its qualitative assessment of the likelihood of goodwill impairment, the Company identified potential impairment indicators and determined that a quantitative assessment was necessary.  Fair value for the quantitative assessment was determined under an income approach using estimates of discounted future cash flows (the “DCF Method”).  The DCF Method relies on assumptions such as the Company’s projected future earnings and appropriate discount rates.   The Company corroborated the results of the DCF Method by reconciling to within a reasonable range of its market capitalization (calculated as total common shares outstanding multiplied by the common equity price per share, as adjusted for a control premium factor).  Reconciling items identified included the benefit of the Company’s fully reserved tax assets for which the market capitalization may not be giving full value.  Based on the results of the quantitative assessment, the Company determined goodwill was not impaired for the period ended September 30, 2017.



Intangible assets represent trademarks, customer agreements and patents related to the Company’s brands and a favorable lease.  Finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets.  Indefinite-lived intangible assets are not amortized, but instead are subject to impairment evaluation.  The carrying value of intangible assets and other finite-lived assets is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Indefinite-lived intangible assets are tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change that indicate that the carrying amount of the indefinite-lived intangible asset may not be recoverable.  When conducting its impairment assessment, the Company initially performs a qualitative evaluation of whether it is more likely than not that the asset is impaired.  If it is determined by a qualitative evaluation that it is more likely than not that the asset is impaired, the Company then tests the asset for recoverability.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to its future undiscounted net cash flows.  If the carrying amount of such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the recoverability of the assets.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.    During the quarter ended September 30, 2017, the Company recorded non-cash impairment charges of $36.5 million for indefinite-lived intangible assets related to the trademarks of five of the Company’s non-core brands: Caribbean Joe,  Revo,  Franklin Mint,  Nevados, and FUL.  Fair value for each trademark was determined based on estimates of future discounted cash flows.  The impairments arose due to reduced contractual minimums or reduced sales forecasts in key distribution channels for these brands.    This charge is included in impairment charges in the unaudited condensed consolidated statements of operations.  See Note 3 and Note 6 for further information.



Treasury Stock



Treasury stock is recorded at cost as a reduction of equity in the condensed consolidated balance sheets. 



Stock-Based Compensation



Compensation cost for restricted stock is measured using the quoted market price of the Company’s common stock at the date the common stock is granted.  For restricted stock and restricted stock units, for which restrictions lapse with the passage of time (“time-based restricted stock”), compensation cost is recognized on a straight-line basis over the period between the issue date and the date that restrictions lapse.  Time-based restricted stock is included in total shares of common stock outstanding upon the lapse of applicable restrictions.  For restricted stock, for which restrictions are based on performance measures (“performance stock units” or “PSUs”), restrictions lapse when those performance measures have been deemed achieved.  Compensation cost for PSUs is recognized on a straight-line basis during the period from the date on which the likelihood of the PSUs being earned is deemed probable and (x) the end of the fiscal year during which such PSUs are expected to vest or (y) the date on which awards of such PSUs may be approved by the compensation committee of the Company’s board of directors (the “Compensation Committee”) on a discretionary basis, as applicable.  PSUs are included in total shares of common stock outstanding upon the lapse of applicable restrictions.  PSUs are included in total diluted shares of common stock outstanding when the performance measures have been deemed achieved but the PSUs have not yet been issued.



Fair value cost for stock options and warrants is calculated using the Black-Scholes valuation model and is expensed on a straight-line basis over the requisite service period of the grant.  The Company elected to early adopt the provisions of ASU 2016-09 “Simplifying the Accounting for Share-Based Payments” (“ASU 2016-09”) and reduces compensation cost for actual forfeitures as they occur.  Prior to the adoption to ASU 2016-09, the Company’s estimated forfeiture rate utilized in calculating compensation cost was zero percent based on the Company’s limited historical forfeiture experience.  



At each subsequent reporting period prior to the lapse of restrictions on warrants, time-based restricted stock and PSUs granted to non-employees, the Company remeasures the aggregate compensation cost of such grants using the Company’s fair value at the end of such reporting period and revises the straight-line recognition of compensation cost in line with such remeasured amount.



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Leases



The Company leases certain properties for office and showroom.  Certain of the Company's lease agreements contain rent escalation clauses, free rent periods and tenant inducement payments.  Rent expense for noncancelable operating leases with scheduled rent increases is recognized on a straight-line basis over the expected lease term.  The difference between straight-line rent expense and the scheduled payment amounts is recorded as a deferred rent asset or liability.



Income Taxes

 

Current income taxes are based on the respective periods’ taxable income for federal, foreign and state income tax reporting purposes.  Deferred tax liabilities and assets are determined based on the difference between the financial statement and income tax bases of assets and liabilities, using statutory tax rates in effect for the year in which the differences are expected to reverse.  In accordance with ASU No. 2015-17 “Balance Sheet Classification of Deferred Taxes,” all deferred income taxes are reported and classified as non-current.  A valuation allowance is required if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.



The Company applies the Financial Accounting Standards Board (“FASB”) guidance on accounting for uncertainty in income taxes.  The guidance clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with other authoritative GAAP and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  The guidance also addresses derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  Interest and penalties related to uncertain tax positions, if any, are recorded in income tax expense.  Tax years that remain open for assessment for federal and state tax purposes include the years ended December 31, 2013 through December 31, 2016.



The benefit from income taxes for the three and nine months ended September 30, 2017 represents a non-cash deferred tax expense created by the amortization of certain acquired trademarks for tax but not book purposes and taxes for state, local and foreign jurisdictions offset by a tax benefit, discrete to the third quarter, representing a reduction in deferred tax liabilities resulting from the impairment of related to acquired trademarks.



Earnings Per Share

 

Basic earnings per share (“EPS”) is computed by dividing net (loss) income attributable to Sequential Brands Group, Inc. and Subsidiaries by the weighted-average number of common shares outstanding during the reporting period, excluding the effects of any potentially dilutive securities.  Diluted EPS gives effect to all potentially dilutive common shares outstanding during the reporting period, including stock options, PSUs and warrants, using the treasury stock method, and convertible debt, using the if-converted method.  Diluted EPS excludes all potentially dilutive shares of common stock if their effect is anti-dilutive.  The shares used to calculate basic and diluted EPS consist of the following:







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 The computation of diluted EPS for the three and nine months ended September 30, 2017 and 2016 excludes the common stock equivalents of the following potentially dilutive securities because their inclusion would be anti-dilutive:

 

 



Concentration of Credit Risk

 

Financial instruments which potentially expose the Company to credit risk consist primarily of cash, restricted cash, accounts receivable and available-for-sale securities.  Cash is held to meet working capital needs and future acquisitions.  Restricted cash is pledged as collateral for a comparable amount of irrevocable standby letters of credit for certain of the Company’s leased properties.  Substantially all of the Company’s cash, restricted cash and available-for-sale securities, prior to being sold, are deposited with high quality financial institutions.  At times, however, such cash, restricted cash and available-for-sale securities may be in deposit accounts that exceed the Federal Deposit Insurance Corporation insurance limit.  The Company has not experienced any losses in such accounts as of September 30, 2017.



Concentration of credit risk with respect to accounts receivable is minimal due to the collection history.  The Company performs periodic credit evaluations of its customers’ financial condition.  The allowance for doubtful accounts is based upon the expected collectability of all accounts receivable.



Customer Concentrations

 

The Company recorded net revenues of $39.0 million and $42.0 million during the three months ended September 30, 2017 and 2016, respectively.  During the three months ended September 30, 2017, three licensees represented at least 10% of net revenue, accounting for 12%, 11%, and 10% of the Company’s net revenue.  During the three months ended September 30, 2016, no licensees represented at least 10% of net revenue.



The Company recorded net revenues of $120.6 million and $110.1 million during the nine months ended September 30, 2017 and 2016, respectively.  During the nine months ended September 30, 2017, three licensees represented at least 10% of net revenue, accounting for 11%, 11%, and 10% of the Company’s net revenue.  During the nine months ended September 30, 2016, two licensees represented at least 10% of net revenue, each accounting for 10% of the Company’s net revenue.



Loss Contingencies

 

The Company recognizes contingent losses that are both probable and estimable.  In this context, probable means circumstances under which events are likely to occur.  The Company records legal costs pertaining to contingencies as incurred.



Contingent Consideration



The Company recognizes the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree or assets of the acquiree in a business combination.  The contingent consideration is classified as either a liability or equity in accordance with ASC 480-10, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.  If classified as a liability, the liability is remeasured to fair value at each subsequent reporting date until the contingency is settled.  Increases in fair value are recorded as losses, while decreases are recorded as gains.  If classified as equity, contingent consideration is not remeasured and subsequent settlement is accounted for within equity.



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Noncontrolling Interest



Noncontrolling interest recorded for the three and nine months ended September 30, 2017 represents income allocations to Elan Polo International, Inc., a member of DVS Footwear International, LLC, With You, Inc., a member of With You LLC (the partnership between the Company and Jessica Simpson), and JALP, LLC (“JALP”), a member of FUL IP Holdings, LLC (“FUL IP”).  Noncontrolling interest recorded for the three and nine months ended September 30, 2016 represents income allocations to Elan Polo International, Inc., With You, Inc. and JALP.



Reportable Segment

 

An operating segment, in part, is a component of an enterprise whose operating results are regularly reviewed by the chief operating decision maker (the “CODM”) to make decisions about resources to be allocated to the segment and assess its performance.  Operating segments may be aggregated only to a limited extent.  The Company’s CODM, the Chief Executive Officer, reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues for purposes of making operating decisions and assessing financial performance.  Accordingly, the Company has determined that it has a single operating and reportable segment.  In addition, the Company has no foreign operations or any assets in foreign locations.  Nearly all of the Company’s operations consist of a single revenue stream, which is the licensing of its trademark portfolio, with an immaterial portion of revenues derived from television, book, café operations and certain commissions.



 



 

ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”), defines fair value, establishes a framework for measuring fair value in GAAP and provides for expanded disclosure about fair value measurements.  ASC 820-10 applies to all other accounting pronouncements that require or permit fair value measurements.



The Company determines or calculates the fair value of financial instruments using quoted market prices in active markets when such information is available or using appropriate present value or other valuation techniques, such as discounted cash flow analyses, incorporating available market discount rate information for similar types of instruments while estimating for non-performance and liquidity risk.  These techniques are significantly affected by the assumptions used, including the discount rate, credit spreads and estimates of future cash flows.



Assets and liabilities typically recorded at fair value on a non-recurring basis to which ASC 820-10 applies include:

 



This topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  ASC 820-10 requires that assets and liabilities recorded at fair value be classified and disclosed in one of the following three categories:







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In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  In such cases, the Company classifies such financial assets or liabilities based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.



During the quarter ended September 30, 2017, the Company recorded non-cash impairment charges of $36.5 million for indefinite-lived intangible assets related to the trademarks of five of the Company’s non-core brands: Caribbean Joe,  Revo,  Franklin Mint,  Nevados, and FUL.  Fair value for each trademark was determined based on estimates of future discounted cash flows, a Level 3 measure within the fair value hierarchy.  The impairments arose due to reduced contractual minimums or reduced sales forecasts in key distribution channels for these brands.    The following table shows the change in indefinite-lived assets for the nine months ended September 30, 2017:







As of September 30, 2017 and December 31, 2016, there were no assets or liabilities that are required to be measured at fair value on a recurring basis, except for available-for-sale securities, interest rate caps, contingent earn outs relating to the Linens ‘N Things brand (the “LNT Contingent Earn Out”) and Legacy Payments (as defined below) to Ms. Martha Stewart.  The following table sets forth the carrying value and the fair value of the Company’s financial assets and liabilities required to be disclosed at September 30, 2017 and December 31, 2016:







The carrying amounts of the Company’s cash, restricted cash, accounts receivable and accounts payable approximate fair value due to their short-term maturities.



The Company recorded its available-for-sale securities on the condensed consolidated balance sheets at fair value using Level 1 inputs at December 31, 2016.  The fair value of the Company’s available-for-sale securities was based upon quoted market prices for identical assets in active markets.



During 2016, the Company entered into interest rate cap agreements related to its 1-month London Interbank Offered Rate (“LIBOR”) rates related to the Company’s loan agreements (the “2016 Cap Agreements”) with certain financial institutions.  The 2016 Cap Agreements have a $500 million notional value, strike rate of 1.50% and mature on November 23, 2018.  The Company recorded its interest rate caps on the condensed consolidated balance sheets at fair value using Level 2 inputs.  The valuation technique used to determine the fair value of the 2016 Cap Agreements approximated the net present value of future cash flows, taking into account current interest rates.

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The Company’s risk management objective and strategy with respect to the 2016 Cap Agreements is to reduce its exposure to variability in expected future cash outflows (forecasted interest payments) attributable to changes in 1-month LIBOR rates, the designated benchmark interest rate being hedged, relating to a portion of its outstanding floating-rate debt.  The 2016 Cap Agreements protect the Company from increases in hedged cash flows on its floating-rate debt attributable to changes in 1-month LIBOR rates above the strike rate.  Should 1-month LIBOR rates exceed 1.50% on a rate reset date during the terms of the 2016 Cap Agreements, the financial institutions will pay the Company for an amount equivalent to the excess interest over the strike rate.  To the extent the hedging relationship is perfectly effective, changes in the fair value of the hedging instrument each period will be deferred in accumulated other comprehensive loss in the statement of changes in equity, and the upfront hedging instrument purchase price will be reclassified to interest expense, net in the unaudited condensed consolidated statements of operations according to its caplet values.  If hedge ineffectiveness exists, accumulated other comprehensive loss will be adjusted to a balance that reflects the lesser of either the cumulative change in the fair value of the hedging or the cumulative change in the fair value of the hypothetically “perfect” derivative.  The amount of ineffectiveness, if any, recorded in earnings would be equal to the excess of the cumulative change in the fair value of the hedging instrument over the cumulative change in the fair value of the hypothetical derivative.



The components of the 2016 Cap Agreements as of September 30, 2017 are as follows:







For purposes of this fair value disclosure, the Company based its fair value estimate for the 2016 Term Loans and 2016 Revolving Loan (each, as defined in Note 7) on its internal valuation whereby the Company applied the discounted cash flow method to its expected cash flow payments due under the loan agreements based on interest rates as of September 30, 2017 and December 31, 2016 for debt with similar risk characteristics and maturities.



On the date of the acquisition of Galaxy Brand Holdings, Inc., no value was assigned to the LNT Contingent Earn Out based on the remote probability that the Linens ‘N Things brand will achieve the performance measurements.  At September 30, 2017 and December 31, 2016, the LNT Contingent Earn Out had no value.  The Company continues to evaluate these performance measurements at each reporting period and determines their fair values if/when the achievement of the performance measurements becomes probable.



In connection with the acquisition of Martha Stewart Living Omnimedia (“MSLO”), beginning with calendar years commencing on or after January 1, 2026, the Company will pay Ms. Stewart three and one-half percent (3.5%) of Gross Licensing Revenues (as defined in Ms. Stewart’s employment agreement) for each such calendar year for the remainder of Ms. Stewart’s life (with a minimum of five (5) years of payments, to be made to Ms. Stewart’s estate if Ms. Stewart dies before December 31, 2030) (the “Legacy Payments”).  The Company recorded $0.1 million of accretion during each of the three months ended September 30, 2017 and 2016 and $0.2 million of accretion during each of the nine months ended September 30, 2017 and 2016 related to the Legacy Payments and recorded the expense within interest expense, net in the unaudited condensed consolidated statements of operations.    





Acquisition of Gaiam Brand Holdco, LLC



On July 1, 2016, the Company, together with its wholly-owned subsidiary, SBG-Gaiam Holdings LLC (formerly known as Stretch & Bend Holdings LLC), a Delaware limited liability company (“SBG-Gaiam” or the “Purchaser”) completed the acquisition pursuant to the terms of the Membership Interest Purchase Agreement (the “MIPA”) with GAIAM, Inc., a Colorado corporation (“Seller”) pursuant to which Purchaser agreed to acquire the branded consumer business of Seller for a total purchase price of $145.7 million in cash.  As part of the transaction, SBG-Gaiam acquired Seller’s yoga, fitness and wellness product business, which include the GAIAM and SPRI brands.  In tandem with the transaction, the Company signed long-term licensing agreements for the brands’ core categories, which became effective upon closing.



As part of the MIPA, the Company paid $1.9 million to Seller for severance related charges to employees of GAIAM, Inc.  Also as part of the MIPA, the Company acquired a 49.9% noncontrolling interest in Gaiam Pty. Ltd, which is recorded under the equity method of accounting.  The acquisition was accounted for under the acquisition method of accounting.  Accordingly, the acquired assets were recorded at their estimated fair values, and operating results for the GAIAM and SPRI brands are included in the Company’s condensed consolidated financial statements from the effective date of the acquisition, July 1, 2016.

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The Company made the following updates to the purchase price during the nine months ended September 30, 2017 in connection with finalizing the valuation of the Gaiam Brand Holdco, LLC acquisition (in thousands):









The final allocation of the purchase price is summarized as follows (in thousands):







The Company and Gaiam Brand Holdco, LLC elected to treat the acquisition as an asset acquisition under section 338(h)(10) of the United States Internal Revenue Service tax code.  As such, the Company is not required to record a deferred tax liability in connection with the acquisition.



Goodwill arising from the acquisition mainly consists of the synergies of an ongoing licensing and brand management business.  Trademarks have been determined by management to have an indefinite useful life and, accordingly, no amortization is recorded in the Company’s unaudited condensed consolidated statements of operations.  Goodwill and trademarks are tested for impairment on an annual basis or sooner if an event occurs or circumstances change that indicate that the carrying amount of the goodwill or trademarks may not be recoverable.





  

The changes in goodwill are summarized as follows:







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Goodwill represents the excess of the purchase price over the fair value of net assets acquired under the acquisition method of accounting.  Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.  In evaluating goodwill for impairment, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  Qualitative factors considered include, for example, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events.  If the Company bypasses the qualitative assessment, or concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, it then performs a quantitative goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment to be recognized, if any.

 

During the quarter ended September 30, 2017, as a result of its qualitative assessment of the likelihood of goodwill impairment, the Company identified potential impairment indicators and determined that a quantitative assessment was necessary.  Fair value for the quantitative assessment was determined under an income approach using estimates of discounted future cash flows (the “DCF Method”).  The DCF Method relies on assumptions such as the Company’s projected future earnings and appropriate discount rates.   The Company corroborated the results of the DCF Method by reconciling to within a reasonable range of its market capitalization (calculated as total common shares outstanding multiplied by the common equity price per share, as adjusted for a control premium factor).  Reconciling items identified included the benefit of the Company’s fully reserved tax assets for which the market capitalization may not be giving full value.  Based on the results of the quantitative assessment, the Company determined goodwill was not impaired for the period ended September 30, 2017.





 

Intangible assets are summarized as follows: