* Reflects
the retroactive effect of the reverse stock split that became effective on September 11, 2012.
Consolidated Statements
of Cash Flows are continued on the following page.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND NATURE OF
OPERATIONS
Overview
Sequential Brands
Group, Inc., formerly known as People’s Liberation, Inc., (the “Company,” “we,” and/or “our”)
is a licensing and brand management company that promotes, markets and licenses a portfolio of consumer brands. Presently, the
Company’s brands include
William Rast
®,
People’s Liberation
®,
DVS®
,
Heelys
®,
Ellen Tracy
® and
Caribbean Joe
®. The Company intends to grow its portfolio of brands by acquiring rights
to additional brands. The Company has licensed and intends to license its brands in a variety of categories to retailers, wholesalers
and distributors in the United States and in certain international territories.
In the second half of 2011, the Company
changed its business model to focus on licensing and brand management. Prior to its change in business model and since 2005, the
Company designed, marketed and provided on a wholesale basis branded apparel and apparel accessories. Commencing in July 2008,
the Company implemented a retail strategy and opened retail stores to sell its branded products. In connection with the Company’s
change in business model, the Company discontinued its wholesale distribution of branded apparel and apparel accessories, liquidated
its existing inventory and closed its remaining retail stores. The Company’s wholesale and retail operations are referred
to as “Historical Operations” in these notes to the Company’s consolidated financial statements. To reflect
the Company’s business transition, in March 2012, the Company changed its corporate name from People’s Liberation,
Inc. to Sequential Brands Group, Inc.
Licensing and Brand Management Business
In the Company’s
licensing arrangements, the Company’s licensing partners are responsible for designing, manufacturing and distributing the
Company’s licensed products, subject to the Company’s continued oversight and marketing support. Including our
recently acquired Heelys®, Ellen Tracy® and Caribbean Joe® brands, we currently have more than 50 licensees. In our
direct-to-retail licenses, we grant the retailer the exclusive right to distribute branded apparel in a broad range of product
categories through stores, consumer-direct mail and consumer-direct e-commerce distribution channels. In our wholesale licenses,
we grant rights to a single or small group of related product categories to a wholesale supplier that is permitted to sell licensed
products to multiple stores within an approved channel of distribution.
Historical Operations
Wholesale Operations
Since the Company’s
inception in 2005, in the United States, the Company has distributed its William Rast branded merchandise and, through April 26,
2011, its J. Lindeberg branded merchandise to better specialty stores, boutiques and department stores, such as Nordstrom, Saks
Fifth Avenue and Neiman Marcus, as well as online at various websites including williamrast.com, jlindebergusa.com and zappos.com.
In 2012, the Company decided to discontinue its wholesale operations completely. For the remainder of 2012, the Company continued
to sell People’s Liberation branded apparel on a limited basis through its domestic wholesale operations in order to liquidate
its existing inventory.
As part of the Company’s
Historical Operations, the Company also sold its William Rast branded apparel products internationally in select countries directly
and through agents and distributors to better department stores and boutiques. The Company’s distributors purchased products
at wholesale prices for resale in their respective territories and marketed, sold, warehoused and shipped William Rast branded
apparel products at their expense. In 2012, the Company had a limited amount of sales of its William Rast and People’s Liberation
branded apparel from its international wholesale operations.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Retail Operations
The Company’s
Historical Operations also include the sale of William Rast branded apparel and accessories through its William Rast branded retail
stores and also through its William Rast branded outlet store. As part of the Company’s transition from a wholesale and
retail provider of apparel and apparel accessories to a brand management and licensing business, the Company closed its William
Rast retail stores located in Miami and San Jose in November 2011, its Century City store in June 2012 and its remaining William
Rast retail store December 2012. The Company had a limited amount of sales from these locations in 2012.
Through April 26,
2011, the Company’s J. Lindeberg branded apparel and accessories were sold through its three full-price J. Lindeberg branded
retail stores. The Company sold its interest in its J. Lindeberg business to the Company’s joint venture partner in April
2011, including its three retail stores.
Reverse Stock Split
On September 11, 2012,
the Company effected a 1-for-15 reverse stock split of its common stock. As a result of the reverse stock split, every fifteen
shares of common stock of the Company were combined into one share of common stock. Immediately after the September 11, 2012 effective
date, the Company had approximately 2.4 million shares of common stock issued and outstanding.
Fractional shares
resulting from the reverse stock split were canceled and the stockholders otherwise entitled to fractional shares received cash
payments in an amount equal to the product obtained by multiplying (i) the closing sale price of the Company’s common stock
on September 10, 2012 by (ii) the number of shares of the Company’s common stock held by the stockholder that would otherwise
have been exchanged for the fractional share interest.
All share and per
share amounts have been retroactively restated to reflect the reverse stock split.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying 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 the consolidation.
Discontinued Operations
The Company accounted
for the sale of its 50% member interest in J. Lindeberg USA and the decisions to close down its wholesale and retail operations
as discontinued operations in accordance with the guidance provided in Accounting Standards Codification (“ASC”) 360,
Accounting for Impairment or Disposal of Long-Lived Assets
, which requires that a component of an entity that has been
disposed of or is classified as held for sale and has operations and cash flows that can be clearly distinguished from the rest
of the entity be reported as assets held for sale and discontinued operations. In the period a component of an entity has been
disposed of or classified as held for sale, the results of operations for the periods presented are reclassified into separate
line items in the statements of operations. Assets and liabilities are also reclassified into separate line items on the related
balance sheets for the periods presented. The statements of cash flows for the periods presented are also reclassified to reflect
the results of discontinued operations as separate line items.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Use of Estimates
The preparation of consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates. The significant assets and liabilities that require management
to make estimates and assumptions that affect the reported amounts in the consolidated financial statements include the amounts
allocated to goodwill and intangible assets, the estimated useful lives for amortizable intangible assets, contingent liabilities,
the fair value of warrants granted in connection with various transactions, share-based payment arrangements, deferred taxes and
related valuation allowances.
Revenue Recognition
License Revenue
- The Company has entered into various trade name license agreements that provide revenues based on minimum royalties and
design fees and additional revenues based on a percentage of defined sales. Minimum royalty and design revenue is recognized on
a straight-line basis over the term of each contract year, as defined, in each license agreement. Royalties exceeding the defined
minimum amounts are recognized as income during the period corresponding to the licensee's sales. Payments received as consideration
of the grant of a license or advanced royalty payments are recorded as deferred revenue at the time payment is received and recognized
ratably as revenue over the term of the license agreement. Revenue is not recognized unless collectability is reasonably assured.
If licensing arrangements
are terminated prior to the original licensing period, the Company will recognize revenue for any contractual termination fees,
unless such amounts are deemed non-recoverable. In December 2012, the Company recognized approximately $400,000 of termination
fees related to the cancellation of a licensing agreement.
Wholesale Revenue
–
In its discontinued wholesale operations, the Company recognized wholesale revenue when merchandise was shipped to
a customer, at which point title transferred to the customer, and when collection was reasonably assured. Customers were not given
extended terms or dating or return rights without proper prior authorization. Revenue was recorded net of estimated returns, charge
backs and markdowns based upon management’s estimates and historical experience.
Website Revenue
– In its discontinued wholesale operations, the Company recognized website revenue when merchandise was shipped to a
customer and when collection was reasonably assured.
Retail Revenue
- In its discontinued wholesale operations, the Company recognized retail revenue on the date of purchase from the Company’s
retail stores.
Restricted Cash
As of December 31,
2012 and 2011, the Company had approximately $35,000 of restricted cash which was used to collateralize certain obligations.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Accounts Receivable
Accounts receivable are recorded net of
allowances for doubtful accounts, based on the Company’s ongoing discussions with its licensees, and its evaluation of each
licensee’s payment history and account aging. The Company did not deem it necessary to record an allowance for doubtful
accounts at December 31, 2012.
Property and Equipment
Property and equipment
are stated at cost. Maintenance and repairs are charged to expense as incurred. Upon retirement or other disposition of property
and equipment, applicable cost and accumulated depreciation and amortization are removed from the accounts and any gains or losses
are included in results of operations.
Depreciation of property
and equipment is computed using the straight-line method based on estimated useful lives of the assets as follows:
Furniture
and fixtures
|
5
years
|
Office
equipment
|
5
to 7 years
|
Machinery
and equipment
|
5
to 7 years
|
Leasehold
improvements
|
Term
of the lease or the estimated life of the related improvements, whichever is shorter.
|
Computer
Software
|
5
years
|
Impairment of Long-Lived Assets and
Intangibles
Long-lived assets,
representing trademarks related to the Company’s brands, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset.
If 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 fair value of the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
Goodwill
Goodwill
is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual
basis (December 31 for the Company) 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. The Company considers its market capitalization and
the carrying value of its assets and liabilities, including goodwill, when performing its goodwill impairment test. When conducting
its annual goodwill impairment assessment, the Company initially performs a qualitative evaluation of whether it is more likely
than not that goodwill is impaired. If it is determined by a qualitative evaluation that it is more likely than not that goodwill
is impaired, the Company then applies a two-step impairment test. The two-step impairment test first compares the fair value of
the Company's reporting unit to its carrying or book value. If the fair value of the reporting unit exceeds its carrying value,
goodwill is not impaired and the Company is not required to perform further testing. If the carrying value of the reporting unit
exceeds its fair value, the Company determines the implied fair value of the reporting unit's goodwill and if the carrying value
of the reporting unit's goodwill exceeds its implied fair value, then an impairment loss equal to the difference is recorded in
the consolidated statement
s
of
operations
.
The Company did not record an impairment of goodwill during the years ended December 31, 2012 and 2011.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Debt Financing Costs
Direct costs incurred
in connection with issuing debt securities or obtaining debt or other credit arrangements are recorded as debt financing costs
and are amortized as interest expense over the term of the related debt using the effective interest method.
Convertible Instruments
The Company reviews
all of its convertible instruments for the existence of an embedded conversion feature which may require bifurcation if certain
criteria are met. The criteria, if met, require companies to bifurcate conversion options from their host instruments and account
for them as freestanding derivative financial instruments. These three criteria include circumstances in which:
|
(a)
|
the economic characteristics and
risks of the embedded derivative instrument are not clearly and
closely related to the economic characteristics and risks of the
host contract,
|
|
(b)
|
the hybrid instrument that embodies
both the embedded derivative instrument and the host contract is
not remeasured at fair value under otherwise applicable generally
accepted accounting principles with changes in fair value reported
in earnings as they occur, and
|
|
(c)
|
a separate instrument with the
same terms as the embedded derivative instrument would be considered
a derivative instrument subject to certain requirements (except
for when the host instrument is deemed to be conventional).
|
The Company reviews
all of its convertible instruments for the existence of a beneficial conversion feature. Upon the determination that a beneficial
conversion feature exists, the beneficial conversion feature would be recorded as a discount from the face amount of the respective
debt instrument based upon the differences between the fair value of the underlying common stock at the commitment date of the
note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized
to interest expense over the term of the related debt. If the instrument is converted prior to the original maturity of the debt,
the remaining unamortized discount is charged to expense at the conversion date.
Preferred Stock
Preferred shares subject
to mandatory redemption (if any) are classified as liability instruments and are measured at fair value. The Company classifies
conditionally redeemable preferred shares (if any), which includes preferred shares that feature redemption rights that are either
within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s
control, as temporary equity. At all other times, the Company classifies preferred stock in stockholders’ equity.
The Company’s
preferred shares do not feature any redemption rights within the holders’ control or conditional redemption features not
solely within its control as of December 31, 2012. Accordingly, all issuances of preferred stock are presented as a component
of stockholders’ equity.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Common Stock Purchase Warrants and Derivative Financial
Instruments
The Company classifies
as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash
settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or
liabilities any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an
event occurs and if that event is outside the Company’s control) or (ii) gives the counterparty a choice of net-cash settlement
or settlement in shares (physical settlement or net-share settlement). The Company assesses classification of its common stock
purchase warrants and other freestanding derivatives, if any, at each reporting date to determine whether a change in classification
between assets and liabilities is required.
The Company determined that its outstanding common
stock purchase warrants satisfied the criteria for classification as equity instruments at December 31, 2012 and 2011.
Advertising
Advertising costs
are charged to expense as of the first date the advertisements take place. Advertising expenses included in operating expenses
approximated $604,000 and $942,000 for the years ended December 31, 2012 and 2011, respectively.
Stock-Based Compensation
The Company accounts
for stock options in accordance with ASC 718,
Compensation – Stock Compensation
. ASC 718 requires generally that
all equity awards be accounted for at their “fair value.” This fair value is measured on the grant date for stock-settled
awards, and at subsequent exercise or settlement for cash-settled awards. Fair value is equal to the underlying value of the stock
for “full-value” awards such as restricted stock and performance shares, and estimated using an option-pricing model
with traditional inputs for “appreciation” awards such as stock options and stock appreciation rights.
Costs equal to these
fair values are recognized ratably over the requisite service period based on the number of awards that are expected to vest for
awards that vest over time, and in the period of grant for awards that vest immediately. For awards that vest over time, cumulative
adjustments in later periods are recorded to the extent actual forfeitures differ from initial estimates: previously recognized
compensation cost is reversed if the service or performance conditions are not satisfied and the award is forfeited. The expense
resulting from share-based payments is recorded in operating expenses in the consolidated statements of operations.
Income Taxes
Current income taxes
are based on the respective periods’ taxable income for federal 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 enacted tax rates in effect for the year in which the differences are expected to reverse. 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 has adopted
the 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. Because of the Company’s historical losses, adoption of the guidance did not have a
significant effect on its accounting and disclosures for income taxes. At December 31, 2012 and 2011, the Company has no unrecognized
tax benefits and does not expect a material change in the next 12 months. 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, 2005 through 2012.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Earnings (Loss) Per Share
Basic earnings (loss)
per share (“EPS”) is computed by dividing income (loss) available to common stockholders by the weighted average number
of common shares outstanding during the year, excluding the effects of any potentially dilutive securities. Diluted EPS gives
effect to all potentially dilutive common shares outstanding during the period including stock options 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 effect of potentially dilutive securities was not significant to the 2011
diluted EPS computation.
The computation of
basic and diluted loss per share for the years ended December 31, 2012 and 2011 excludes the common stock equivalents of the following
potentially dilutive securities because their inclusion would be anti-dilutive:
|
|
For the Year Ended December 31,
|
|
|
|
2012
|
|
|
2011
|
|
Senior secured convertible debentures
|
|
|
5,523,810
|
|
|
|
-
|
|
Warrants
|
|
|
2,250,762
|
|
|
|
1,112,666
|
|
Unvested restricted stock
|
|
|
357,151
|
|
|
|
-
|
|
Stock options
|
|
|
404,800
|
|
|
|
451,467
|
|
|
|
|
8,356,523
|
|
|
|
1,564,133
|
|
Comprehensive Loss
Other comprehensive
loss includes all changes in stockholders’ equity (deficit) during a period from non-owner sources and is reported in the
consolidated statement of stockholders’ equity (deficit). There were no comprehensive income items for the years ended December
31, 2012 and 2011.
Concentration of Credit Risk
Financial instruments
which potentially expose the Company to credit risk consist primarily of cash and cash equivalents. Cash and cash equivalents
are held for use for working capital needs and/or future acquisitions. At times, our cash and cash equivalents may be uninsured
or in deposit accounts that exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limit.
Customer Concentrations
During the year ended
December 31, 2012, two customers comprised greater than 10% of the Company’s net revenue from continuing operations. Revenue
derived from these customers amounted to 63.0% and 13.9% of net revenue from continuing operations for the year ended December
31, 2012. During the year ended December 31, 2011, two customers comprised greater than 10% of the Company’s net revenue
from continuing operations. Revenue derived from these customers amounted to 52.2% and 40.7% of net revenue from continuing operations
for the year ended December 31, 2011. At December 31, 2012 and 2011, there was approximately $351,000 and $1.8 million due from
these major customers pursuant to the terms of the related license agreements.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Classification of Expenses
Operating
expenses primarily include compensation, royalty expenses paid under our agreement with Tennman WR-T, professional fees,
marketing and promotion, facility costs, travel and entertainment, depreciation and amortization expense, and other general
corporate expenses. For the year ended December 31, 2012, operating expenses also includes the impairment of fixed assets
(see Note 6), lease termination costs (Note 11), employee severance costs (Note 13) and transaction costs associated with the
acquisition of DVS (Note 4).
Noncontrolling Interest
Noncontrolling interest
from continuing operations recorded for the year ended December 31, 2012 represents loss allocations to Elan Polo, a member of
DVS LLC (see Note 4).
Noncontrolling interest
from continuing operations recorded for the year ended December 31, 2011 represents net loss allocations to Tennman WR-T, a member
of William Rast Sourcing and William Rast Licensing (see Note 14).
From July 1, 2008
through April 26, 2011, the operations of J. Lindeberg USA were included in the consolidated financial statements of the Company.
Profit and loss allocations to its non-controlling interest member, J. Lindeberg USA Corp., were recorded as increases and decreases
in noncontrolling interest in the consolidated financial statements of the Company. On April 26, 2011, the Company and its wholly
owned subsidiary, Bella Rose, LLC, completed the sale of Bella Rose’s 50% membership interest in J. Lindeberg USA, LLC to
J. Lindeberg USA Corp. (see Note 22).
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
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. Our chief operating decision maker, 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, we only have a single operating and reportable segment. In addition, we have no
foreign operations or any assets in foreign locations. All of our domestic operations are consisted of a single revenue stream
which is the licensing of our trademark portfolio.
Loss Contingencies
We recognize contingent
losses that are both probable and estimable. In this context, we define probability as circumstances under which events are likely
to occur. In regards to legal costs, we record such costs as incurred.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recently
Issued Accounting Standards
In July 2012, the
FASB issued ASU No. 2012-02,
Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for
Impairment
(ASU 2012-02)
,
allowing entities the option to first assess qualitative factors to determine whether
it is necessary to perform the quantitative impairment test. If the qualitative assessment indicates it is more-likely-than-not
that the fair value of an indefinite-lived intangible asset is less than its carrying amount, the quantitative impairment test
is required. Otherwise, no testing is required. ASU 2012-02 is effective for the Company in the period beginning January 1, 2013.
The Company does not expect the adoption of this update to have a material impact on the consolidated financial statements.
NOTE 3 –
Fair
Value of Financial Instruments
ASC 820-10,
Fair
Value Measurements and Disclosures
(“ASC 820-10”), defines fair value, establishes a framework for measuring fair
value in U.S. 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 flow.
Assets and liabilities typically recorded
at fair value on a non-recurring basis to which ASC 820-10 applies include:
|
·
|
Non-financial
assets and liabilities
initially measured
at fair value in
an acquisition or
business combination,
and
|
|
·
|
Long-lived
assets measured
at fair value due
to an impairment
assessment under
ASC 360-15.
|
ASC 820-10 requires
that assets and liabilities recorded at fair value be classified and disclosed in one of the following three categories:
|
·
|
Level
1 inputs utilize
quoted prices (unadjusted)
in active markets
for identical assets
or liabilities that
the Company has
the ability to access.
|
|
·
|
Level
2 inputs utilize
other-than-quoted
prices that are
observable, either
directly or indirectly.
Level 2 inputs include
quoted prices for
similar assets and
liabilities in active
markets, and inputs
such as interest
rates and yield
curves that are
observable at commonly
quoted intervals.
|
|
·
|
Level
3
inputs
are
unobservable
and
are
typically
based
on
the
Company’s
own
assumptions,
including
situations
where
there
is
little,
if
any,
market
activity.
Both
observable
and
unobservable
inputs
may
be
used
to
determine
the
fair
value
of
positions
that
are
classified
within
the
Level 3
classification.
As
a
result,
the
unrealized
gains
and
losses
for
assets
within
the
Level 3
classification
may
include
changes
in
fair
value
that
were
attributable
to
both
observable
(e.g.,
changes
in
market
interest
rates)
and
unobservable
(e.g.,
changes
in
historical
company
data)
inputs.
|
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 asset or liability 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.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31,
2012 and 2011, there are no assets or liabilities that are required to be measured at fair value on a recurring basis. 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 December 31, 2012 and 2011:
|
|
|
|
|
Carrying
Value
|
|
|
Fair Value
|
|
Financial Instrument
|
|
|
Level
|
|
|
|
12/31/2012
|
|
|
|
12/31/11
|
|
|
|
12/31/2012
|
|
|
|
12/31/11
|
|
Cash and cash equivalents
|
|
|
1
|
|
|
$
|
2,624,243
|
|
|
$
|
242,791
|
|
|
$
|
2,624,243
|
|
|
$
|
242,791
|
|
Restricted cash
|
|
|
1
|
|
|
$
|
35,351
|
|
|
$
|
35,268
|
|
|
$
|
35,351
|
|
|
$
|
35,268
|
|
Accounts receivable
|
|
|
2
|
|
|
$
|
475,949
|
|
|
$
|
-
|
|
|
$
|
475,949
|
|
|
$
|
-
|
|
Accounts payable
|
|
|
2
|
|
|
$
|
3,719,504
|
|
|
$
|
1,618,374
|
|
|
$
|
3,719,504
|
|
|
$
|
1,618,374
|
|
Notes payable
|
|
|
3
|
|
|
$
|
-
|
|
|
$
|
1,000,000
|
|
|
$
|
-
|
|
|
$
|
1,000,000
|
|
Notes payable to related party
|
|
|
3
|
|
|
$
|
-
|
|
|
$
|
750,000
|
|
|
$
|
-
|
|
|
$
|
750,000
|
|
Senior secured subordinated debentures
|
|
|
3
|
|
|
$
|
3,502,267
|
|
|
$
|
-
|
|
|
$
|
12,594,000
|
|
|
$
|
-
|
|
The carrying amounts
of the Company’s cash and cash equivalents, restricted cash, accounts receivable and accounts payable approximate fair value
due to their short-term maturities. The remaining financial assets and liabilities are comprised of convertible debentures, notes
payable and notes payable to related parties. The Company estimated the fair value of its convertible debentures by performing
discounted cash flow analyses using an appropriate market discount rate. The Company calculated the market discount rate by obtaining
period-end treasury rates for fixed-rate debt, or LIBOR rates for variable-rate debt, for maturities that correspond to the maturities
of its debt adding appropriate credit spreads derived from information obtained from third-party financial institutions. These
credit spreads take into account factors such as the Company’s credit standing, the maturity of the debt, whether the debt
is secured or unsecured, and the loan-to-value ratios of the debt.
For purposes of this
fair value disclosure, the Company based its fair value estimate for notes payable and notes payable to related party on its internal
valuation whereby the Company applied the discounted cash flow method to its expected cash flow payments due under these debt
agreements based on market interest rate quotes as of December 31, 2012 and 2011 for debt with similar risk characteristics and
maturities.
NOTE 4 – DVS
ACQUISITION
In June 2012, the
Company completed a series of transactions which included (i) its acquisition of assets relating to the consumer product brands
“
DVS
®” and “
Matix
®”, (ii) its sale of all of its acquired assets relating to the
Matix
® brand and certain tangible assets related to the
DVS
® brand, but excluding its intellectual property
rights in the
DVS
® brand, (iii) the contribution of the trademarks relating to the
DVS
® brand into DVS LLC,
and (iv) the entry into a license agreement in relation to the
DVS
® brand, all as further described below. The DVS
acquisition was effected in order to develop and build the Company’s diversified portfolio of consumer brands.
Completion of DVS Acquisition
On June 26, 2012,
the Company acquired from DVS Shoe Co., Inc. (“DVS Shoe Co
.
”) substantially all of DVS Shoe Co.’s assets
relating to its consumer product brands “
DVS®
” and “
Matix®
” pursuant to the terms
of a Purchase and Sale Agreement entered into on June 20, 2012. In consideration for the assets, which primarily consisted of
inventory, accounts receivable, trademarks and other intellectual property rights, the Company paid $8.55 million in cash to DVS
Shoe Co. The acquisition of assets was treated as the acquisition of a business for accounting purposes.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Entry into Purchase and Sale Agreement with Westlife
Distribution USA, LLC.
Following the acquisition,
on June 28, 2012, the Company entered into a Purchase and Sale Agreement with Westlife Distribution USA, LLC (“Westlife”).
Pursuant to the agreement, the Company sold the assets relating to its acquired
Matix
® brand, including all trademarks
and other intellectual property relating to the
Matix
® brand, other intangibles, inventory of
Matix
® branded
products, prepaids and accounts receivable. On June 29, 2012, upon the closing of the transactions contemplated by the Purchase
and Sale Agreement, the Company received $2.95 million in cash from Westlife.
Entry into Collaboration with Elan
Polo International, Inc.
In connection with
the acquisition, the Company received a 65% economic interest in DVS Footwear International, LLC (“DVS LLC”). DVS
LLC is a collaboration between the Company and Elan Polo. The new company was formed for the purpose of licensing the
DVS
®
trademark to third parties primarily in connection with the manufacturing, distribution, marketing and sale of
DVS
®
branded footwear, apparel and apparel accessories. In exchange for its 65% economic interest in DVS LLC, the Company contributed
trademarks and other intellectual property rights relating to the
DVS
® brand to DVS LLC. In exchange for its 35% economic
interest in DVS LLC, Elan Polo contributed $2,124,000 in cash to the newly formed entity. The Company has included the accounts
of DVS LLC in its consolidated financial statements for the period ended December 31, 2012. Elan Polo’s minority member
interest in DVS LLC has been reflected as noncontrolling interest on the Company’s consolidated balance sheet as of December
31, 2012.
In connection with
the formation of DVS LLC, the Company and Elan Polo entered into a Limited Liability Company Operating Agreement of DVS Footwear
International LLC on June 29, 2012 (the “Operating Agreement”). Subject to certain exceptions, the Operating Agreement
provides that the Company has the right to manage, control and conduct the business affairs of DVS LLC. The Operating Agreement
provides that the Company will receive 65% of the distributions and allocation of net profits and losses of DVS LLC and 60% of
the distributable assets upon dissolution of DVS LLC.
Entry into License Agreement with Elan Polo International,
Inc.
On June 29, 2012,
DVS LLC entered into a license agreement with Elan Polo. Pursuant to the agreement, DVS LLC granted to Elan Polo an exclusive
license (subject to certain exceptions) to use the
DVS®
trademark in connection with the worldwide manufacture, distribution,
marketing and sale to approved customers of men’s, women’s and children’s footwear. Unless otherwise terminated
earlier pursuant to its terms, the agreement will continue through December 31, 2019. Subject to the satisfaction of certain conditions,
Elan Polo may elect to extend the term of the agreement for two additional renewal terms of five years each.
During the term of
the agreement, Elan Polo has agreed to pay DVS LLC royalties that are based on a percentage of net sales of DVS licensed products.
Royalties are payable on a quarterly basis, and Elan Polo has guaranteed the payment to DVS LLC of certain minimum royalties during
each contract year of the agreement.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with
the entry into the license agreement with Elan Polo, the Company also sold its DVS branded inventory, purchase orders, customer
lists and other intangible assets acquired from DVS Shoe Co. to Elan Polo for $640,000, its estimated fair market value.
Accounting for the DVS Transactions
The aggregate purchase
price of the acquisition amounted to $8.55 million. The preliminary allocation of the purchase price is summarized as follows:
Matix and DVS non-core assets
|
|
$
|
3,590,000
|
|
Accounts and other receivables
|
|
|
891,000
|
|
Trademarks
|
|
|
4,069,000
|
|
Total acquisition price
|
|
$
|
8,550,000
|
|
The DVS acquisition
was accounted for using the acquisition method. Accordingly, the net assets acquired were recorded at their estimated fair values
on the effective date of acquisition of June 26, 2012 and the consolidated financial statements include the results of operations
from June 26, 2012 through December 31, 2012. There was no excess of purchase price over the fair value of the assets acquired
and therefore no resulting goodwill upon the acquisition.
The DVS trademarks
will be amortized over their expected useful lives of 15 years. Legal and other fees related to the transaction of $710,417 were
included in operating expenses in the accompanying statement of operations for the year ended December 31, 2012.
DVS Shoe Co. had no
license revenues, therefore pro forma revenue would equal actual revenue from continuing operations for the years ended December
31, 2011 and 2012, if the transaction had occurred on January 1, 2011. The Company’s pro forma net loss attributable to
common stockholders (unaudited) would have been $8,201,000 and $10,300,000 for the years ended December 31, 2011 and 2012, respectively.
The Company immediately
sold the assets of the Matix brand to an unaffiliated company and its acquired DVS branded inventory to Elan Polo for an aggregate
amount of $3,590,000. The Company did not recognize a gain or loss on these transactions as it considered the purchase price of
the Matix assets and the DVS branded inventory to be equivalent to the fair value of the assets on the date of the transactions.
NOTE
5 – LICENSE AGREEMENTS
Exclusive License Agreement –
JC Penney
In November 2011,
the Company entered into an exclusive license agreement with JC Penney pursuant to which the Company granted JC Penney a license
to use its William Rast trademark in connection with the manufacture, sale and marketing of multiple product categories, including
men’s and women’s apparel and accessories. The product categories are subject to certain exceptions as outlined in
the license agreement. The Company will provide design, marketing and branding support for William Rast branded apparel and apparel
accessories to JC Penney under the terms of the contract.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Subject to certain
exceptions, the license granted to JC Penney is exclusive with respect to JC Penney’s right to sell and market William Rast
branded products through its stores in the United States and through its consumer-direct mail and consumer-direct ecommerce distribution
channels which are targeted to consumers in the United States. During the term of the agreement, the Company has agreed to refrain
from selling or authorizing any other party to sell, with certain exceptions described in the agreement, any line of William Rast
branded apparel products in the United States through any distribution channel; provided, however, that the Company continued
to have the right to sell William Rast branded products without restriction through June 30, 2012.
The agreement with
JC Penney will continue through January 30, 2016 and JC Penney may elect to extend the term of the agreement for one additional
renewal term of five years.
During each royalty
period during the term, JC Penney has agreed to pay the Company royalties based upon a percentage of JC Penney’s net sales
of William Rast branded products and has also agreed to pay the Company minimum annual royalties and design fees.
Product License Agreements
In addition to its
direct-to-retail license agreement with JC Penney, the Company has three other agreements for the license of its William Rast
branded products, two license agreements for its DVS branded products and one license for its People’s Liberation branded
products. The license agreements provide for the payment of royalties based on net sales at a negotiated rate and minimum royalty
amounts for each contract year.
NOTE 6 – PROPERTY AND EQUIPMENT
Property and equipment
is summarized as follows:
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Furniture and fixtures
|
|
$
|
-
|
|
|
$
|
257,304
|
|
Office equipment
|
|
|
-
|
|
|
|
72,715
|
|
Machinery and equipment
|
|
|
-
|
|
|
|
13,901
|
|
Auto
|
|
|
-
|
|
|
|
86,518
|
|
Leasehold improvements
|
|
|
-
|
|
|
|
47,623
|
|
Computer software
|
|
|
-
|
|
|
|
225,348
|
|
|
|
|
-
|
|
|
|
703,409
|
|
Less accumulated depreciation and amortization
|
|
|
-
|
|
|
|
(403,360
|
)
|
|
|
$
|
-
|
|
|
$
|
300,049
|
|
In December 2012,
in connection with the relocation the Company’s corporate headquarters, the Company wrote off approximately $178,000 of
fixed assets. This impairment of property and equipment is included in operating expenses on the accompanying consolidated statement
of operations for the year ended December 31, 2012. Depreciation and amortization expense amounted to $128,087 and $118,329 for
the years ended December 31, 2012 and 2011, respectively.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 – TRADEMARKS
Trademarks are summarized
as follows:
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Trademarks, at cost
|
|
$
|
4,568,790
|
|
|
$
|
499,298
|
|
Less accumulated amortization
|
|
|
(275,677
|
)
|
|
|
(107,723
|
)
|
|
|
$
|
4,293,113
|
|
|
$
|
391,575
|
|
Future annual estimated
amortization expense is summarized as follows:
Years Ending December 31,
|
|
|
|
2013
|
|
$
|
304,563
|
|
2014
|
|
|
304,563
|
|
2015
|
|
|
304,563
|
|
2016
|
|
|
304,563
|
|
2017
|
|
|
304,563
|
|
Thereafter
|
|
|
2,770,298
|
|
|
|
$
|
4,293,113
|
|
The Company’s
trademarks have a definite life and are amortized on a straight-line basis over their estimated useful lives of 15 years.
Trademark amortization
expense amounted to $167,954 and $50,657 for the years ended December 31, 2012 and 2011, respectively.
NOTE
8 - NOTE PAYABLE TO RELATED PARTIES AND ASSET PURCHASE AGREEMENT
On August 13, 2010,
the Company’s subsidiary, William Rast Licensing, entered into a promissory note in the amount of $750,000 with Mobility
Special Situations I, LLC (“Mobility”), an entity owned in part by Mark Dyne, the brother of the Company’s then
Chief Executive Officer, Colin Dyne, and New Media Retail Concepts, LLC, an entity owned by Gerard Guez, a significant beneficial
owner of the Company’s common stock. The promissory note had an interest rate of 8%, payable monthly in arrears, and was
due February 13, 2012. The promissory note was secured by the assets of William Rast Licensing and was guaranteed by the Company’s
other entities under common control, including Sequential Brands Group, Inc., William Rast Sourcing, LLC, William Rast Retail,
LLC, Bella Rose, LLC and Versatile Entertainment, Inc. The outstanding principal and interest balances of this promissory note
were paid in full in February 2012 with the proceeds received from the securities purchase agreement as further
described in Note 10.
In connection with
the promissory note discussed above, the Company also entered into an asset purchase agreement with New Media Retail Concepts,
LLC and ECA Holdings II, LLC on August 13, 2010. In exchange for $750,000 cash, the Company sold 50% of the net proceeds, after
legal fees and expenses, that may be received by the Company as a result of its on-going litigation with Charlotte Russe, as further
described in Note 12. The Company was not required to repay the $750,000 cash proceeds received from the asset purchase agreement
regardless of a favorable or unfavorable outcome of the Charlotte Russe litigation. New Media Retail Concepts, LLC and ECA Holdings
II, LLC received from Charlotte Russe, in respect to the interest they acquired in the litigation, a combined amount of $2.9 million
of the settlement amount paid by Charlotte Russe pursuant to the settlement agreement entered into by all parties to the litigation
on February 3, 2011.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - NOTE PAYABLE
On August 18, 2011,
the Company, through its subsidiary, William Rast Licensing, LLC, entered into a promissory note with Monto Holdings (Pty) Ltd.
(“Monto”). The promissory note in the amount of $1,000,000 was to be repaid as follows: (i) 40.0% of the
then outstanding principal amount on December 31, 2011, (ii) 20% of the then outstanding principal amount on February 29, 2012
and (iii) all of the remaining principal amount then outstanding on the maturity date, May 31, 2012. The promissory
note had an interest rate of 7% per annum, which was payable on the maturity date of the note unless the note was repaid earlier. The
promissory note was secured by the assets of William Rast Licensing and was guaranteed by the Company’s other entities under
common control, including Sequential Brands Group, Inc., William Rast Sourcing, LLC, William Rast Retail, LLC, Bella Rose, LLC
and Versatile Entertainment, Inc. The outstanding principal and interest balances of this promissory note were paid in full in
February 2012 with the proceeds received from the securities purchase agreement as further described in Note 10.
In connection with
the promissory note, Sequential Brands Group issued a fully-vested, five-year warrant to Monto to purchase 833,333 shares of the
Company’s common stock at an exercise price of $1.20 per share. The warrant was valued at $50,000 and was recorded
as interest expense during the year ended December 31, 2011.
NOTE 10 – SENIOR SECURED CONVERTIBLE DEBENTURES
Entry into Securities Purchase Agreement
On February 2, 2012,
the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with TCP WR Acquisition, LLC (“TCP”)
pursuant to which we issued Variable Rate Senior Secured Convertible Debentures (the “Debentures”) in the amount of
$14,500,000, warrants to purchase up to 1,104,762 shares of common stock (the “Warrants”) and 14,500 shares of Series
A Preferred Stock (as defined below). The Debentures were issued in two closings, the first of which closed on February 3, 2012
($3,000,000) and the second which closed on February 22, 2012 ($11,500,000). The Debentures have a three year term, with all principal
and interest being due and payable at the maturity date of January 31, 2015, and have an interest rate of LIBOR. Aggregate net
proceeds from this transaction amounted to approximately $13.7 million after the payment of legal and other fees.
The Debentures are
convertible at the option of TCP into 5,523,810 shares of the Company’s common stock at an initial conversion price of $2.625
per share (“Conversion Price”). The Conversion Price is subject to adjustment in the case of stock splits, stock dividends,
combinations of shares and similar recapitalization transactions. The Conversion Price is also subject to adjustment based on
the occurrence of certain events as further described in the Purchase Agreement.
Interest on the Debentures
is payable, at the Company’s option, in cash or in common stock upon conversion of a Debenture (with respect to the principal
amount then being converted) and on their maturity date.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 28, 2013,
TCP converted the aggregate principal amount outstanding under the Debentures into 5,523,810 shares of the Company’s common
stock. In connection with the conversion, the Company also redeemed all of the 14,500 issued and outstanding shares of Series
A Preferred Stock held by TCP for an aggregate redemption price of $14.50 (see Note 24).
In connection with
the Warrants, TCP has the right to purchase up to 1,104,762 shares of common stock at $2.625 per share exercisable for a period
of five years. The exercise price is subject to adjustment in the case of stock splits, stock dividends, combinations of shares
and similar recapitalization transactions. The fair value of the Warrants was determined to be approximately $4.2 million using
the Black-Scholes pricing model. The fair value of the warrants was recorded as a discount to the Debentures and a corresponding
increase to additional paid in capital. This amount is being accreted to interest expense over the contractual term of the Debentures.
The assumptions utilized to value the Warrants under the Black-Scholes pricing model included a dividend yield of zero, a risk-free
interest rate of 1.4%, expected term of five years and an expected volatility of 64%.
The Debentures were
deemed to have a beneficial conversion feature because the fair value of the stock exceeded the effective conversion price embedded
in the Debentures on the commitment date of the transaction. Accordingly, the Company recorded the value of the beneficial conversion
feature, which was determined to be approximately $7.3 million, as a discount to the Debentures and a corresponding increase to
additional paid in capital. This amount is being accreted to interest expense over the contractual term of the Debentures.
During the year ended
December 31, 2012, accretion of the discount amounted to approximately $534,000, which was recorded as a component of interest
expense in the accompanying statement of operations. Contractual interest expense under the Debentures amounted to approximately
$30,000 which was recorded as a component of interest expense and is also included in Debentures in the accompanying consolidated
balance sheet as of December 31, 2012.
The Company incurred
legal and other fees associated with this transaction of approximately $844,000. These amounts have been recorded as deferred
financing costs, included in other assets in the accompanying consolidated balance sheet, and are being amortized over the contractual
term of the Debentures. During the year ended December 31, 2012, amortization of these fees amounted to approximately $258,000
which is recorded as a component of interest expense in the accompanying consolidated statement of operations.
Also in connection
with the sale of the Debentures, the Company issued one share of Series A Preferred Stock, par value $0.001 per share (“Series
A Preferred Stock”), for every $1,000 of principal amount of Debentures issued to TCP. The Series A Preferred Stock is designed
to give holders of the Debentures certain voting rights while the Debentures remain outstanding and each share of Series A Preferred
Stock is entitled to vote 381 votes. The Series A Preferred Stock will be redeemed on the conversion or repayment of the Debentures
for a nominal amount.
The components of
the Debentures as of December 31, 2012 are as follows:
Face value of the Debentures
|
|
$
|
14,500,000
|
|
Unamortized discount
|
|
|
(11,028,086
|
)
|
Accrued interest
|
|
|
30,353
|
|
|
|
$
|
3,502,267
|
|
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Description of Subsidiary Guarantee and Security Agreement
In connection with the financing, the
Company’s subsidiaries, Versatile Entertainment, Bella Rose, William Rast Sourcing, William Rast Licensing and William Rast
Retail executed a Subsidiary Guarantee in favor of TCP pursuant to which such subsidiaries guarantee the Company’s obligations
under the Debentures (the “Subsidiary Guarantee”). In addition, the Company and the above mentioned subsidiaries entered
into a security agreement (the “Security Agreement”) with TCP pursuant to which such parties granted to TCP a first
priority security interest in all of their assets to secure the Company’s obligations under the Debentures and such subsidiaries’
obligations under the Subsidiary Guarantee.
Termination of Material Agreements
The proceeds received from the financing
were used in part to repay the following indebtedness of the Company and its subsidiaries: (a) all indebtedness owed by William
Rast Sourcing under its factoring facility with Rosenthal & Rosenthal; (b) all indebtedness owed by William Rast Licensing
to Mobility pursuant to a promissory note in the aggregate principal amount of $750,000; and (c) all indebtedness owed by William
Rast Licensing to Monto pursuant to a promissory note in the aggregate principal amount of $1,000,000. In connection with the
repayments, all security agreements, assignment agreements, and guarantee agreements were terminated.
Other terms
The Purchase Agreement
provides TCP with piggyback registration rights with respect to TCP’s shares of common stock, requires the Company to seek
approval from its stockholders to amend the Company’s certificate of incorporation to increase its common stock available
for issuance, required the Company to pay TCP a fee of $362,500 plus all legal and other fees and expenses incurred by TCP in
connection with the Purchase Agreement, and requires the Company to pay TCP an annual monitoring fee of $250,000 so long as certain
conditions are satisfied.
In addition, the Purchase
Agreement contains negative covenants that prohibit the Company and its subsidiaries from taking certain actions without TCP’s
prior consent until the later of February 3, 2014 and the date that TCP’s beneficial ownership of common stock is less than
40% of the Company’s fully diluted common stock. The negative covenants apply to, with certain exceptions, issuing debt
or equity securities; acquiring assets or equity interests of third parties, disposing of assets or equity interests of subsidiaries,
entering into joint ventures, or engaging in other types of mergers and acquisitions transactions; paying or declaring dividends;
settling litigation; entering into transactions with affiliates; dissolving or commencing bankruptcy proceedings; or changing
the Company’s principal lines of business.
NOTE 11 – LEASES
The Company leases
approximately 10,000 square feet of office and showroom space, as well as office equipment, for its new corporate headquarters
under a temporary agreement that expires on December 31, 2013. The Company plans to enter into a long term agreement with the
landlord for this space prior to the expiration of the term of the current agreement.
The Company is also
party to a lease agreement for 3,000 square feet of office space for its prior corporate headquarters. The Company relocated its
corporate headquarter in December 2012 and recorded a charge of $142,000 for the remaining lease obligation, net of estimated
sublease rentals. The accrual of $142,000 is included in accounts payable and accrued expenses in the accompanying consolidated
balance sheet as of December 31, 2012. The lease obligation is expected to paid through 2014.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Total rent expense
for the years ended December 31, 2012 and 2011 amounted to approximately $855,000 and $1.7 million, respectively.
Future annual minimum
payments due under the leases are summarized as follows:
Years Ending December 31,
|
|
|
|
2012
|
|
$
|
136,838
|
|
2013
|
|
|
140,940
|
|
2014
|
|
|
96,203
|
|
|
|
$
|
373,981
|
|
NOTE 12 – COMMITMENTS AND CONTINGENCIES
Charlotte Russe Litigation
On February 3, 2011,
the Company (along with the other parties to the litigation) settled its litigation with Charlotte Russe related to an exclusive
distribution agreement between the parties. Pursuant to the settlement agreement, the Company received $3.5 million, after the
distribution of amounts owed under the terms of an asset purchase agreement entered into by the Company with two related parties.
The Company sold 50% of the net proceeds, after contingent legal fees and expenses, that may be received by the Company as a result
of the litigation in connection with the asset purchase agreement. The settlement included the dismissal with prejudice of all
claims pending between the parties as well as mutual releases, without any admission of liability or wrongdoing by any of the
parties to the actions. The settlement amount of $3.5 million is included in loss from discontinued operations of wholesale business
in the Company’s statement of operations for the year ended December 31, 2011.
Shareholder Derivative
Complaint
On January 17, 2012,
RP Capital, LLC (“plaintiff”) filed a shareholders’ derivative complaint in the Superior Court of the State
of California, County of Los Angeles, against the Company and former directors Colin Dyne, Kenneth Wengrod, Susan White and Dean
Oakey. The case alleges that the defendants (i) breached their fiduciary duties to the Company for failing to properly oversee
and manage the Company, (ii) certain defendants were unjustly enriched, (iii) abused their control, (iv) grossly mismanaged the
Company, (v) wasted corporate assets, (vi) engaged in self-dealing, and (vii) breached their fiduciary duties by disseminating
false and misleading information. The plaintiffs seek (i) judgment against the defendants in favor of the Company for the
amount of damages sustained by the Company as a result of the defendants’ alleged breaches of their fiduciary duties; (ii)
judgment directing the Company to take all necessary actions to reform and improve its corporate governance and internal procedures
to comply with applicable laws; (iii) an award to the Company of restitution from the defendants and an order from the court to
disgorge all profits, benefits and other compensation obtained by the defendants from their alleged wrongful conduct and alleged
fiduciary breaches and (iv) an award of costs and disbursements of the action, including reasonable fees for professional services.
The parties have agreed upon a settlement in the action. The court granted final approval of the settlement on March 12, 2013
and dismissed the case on the same day. Pursuant to the settlement, the Company is required, subject to certain exceptions, to
implement and maintain in effect for a period of three years certain corporate governance initiatives, many of which the Company
implemented in early 2012. The settlement did not include any cash payment for damages.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
General Legal Matters
From time to time,
we are involved in legal matters arising in the ordinary course of business. While we believe that such matters are currently
not material, there can be no assurance that matters arising in the ordinary course of business for which we are, or could be,
involved in litigation, will not have a material adverse effect on our business, financial condition or results of operations.
Contingent liabilities arising from potential litigation are assessed by management based on the individual analysis of these
proceedings and on the opinion of the Company’s lawyers and legal consultants. At December 31, 2012, the Company is a defendant
in litigation involving former vendors of the Company’s discontinued wholesale operations. These vendors’ claims relate
primarily to amounts owed for goods sold and delivered to the Company. Based on the information received from our legal consultants
and on the analysis of potential demands, we have recorded an estimated liability for the probable loss as a component of liabilities
of discontinued operations in the accompanying consolidated balance sheet at December 31, 2012.
NOTE 13 – OFFICER
COMPENSATION
Yehuda Shmidman Employment Agreement
On November 19, 2012,
the Board appointed Yehuda Shmidman as the Company’s Chief Executive Officer and a Class I Director of the Board. Mr. Shmidman
will serve on the Board for a term expiring at the 2015 annual meeting of stockholders, or until his successor has been elected
and qualified. In connection with his appointment as the Company’s Chief Executive Officer, the Company entered into an
employment agreement with Mr. Shmidman. Pursuant to the agreement, Mr. Shmidman will serve as the Company’s Chief Executive
Officer for a term of three years. During the term of the agreement, Mr. Shmidman will receive a base salary of $600,000 per annum,
which is subject to increase, and he will be eligible to receive an annual cash performance bonus of up to 100% of his base salary
based on the attainment of the EBITDA target to be agreed upon by the compensation committee and Mr. Shmidman. Mr. Shmidman also
purchased 396,196 shares of restricted stock at a purchase price of $0.001 per share, of which 99,049 shares, or 25%, vested on
the date of grant, with the remaining shares vesting in equal installments on each of the first, second and third anniversaries
of the grant date. In the event of a change of control of the Company, all unvested shares of restricted stock will immediately
vest.
In the event Mr. Shmidman’s
employment is terminated by the Company without cause or by Mr. Shmidman for good reason, Mr. Shmidman will receive all earned
but unpaid base salary and payment for all accrued but unused vacation time through the date of termination, as well as any benefits
to which Mr. Shmidman may be entitled under employee benefit plans (collectively, the “accrued obligations”). Mr.
Shmidman will also receive a severance amount equal to the greater of (i) 1.5 times his base salary then in effect and (ii) an
amount equal to the base salary that Mr. Shmidman would have received for the remainder of the term of the agreement had Mr. Shmidman’s
employment continued until the end of the employment period. In addition, Mr. Shmidman will receive earned bonuses that have not
been paid for prior fiscal years and, in the event such resignation or termination occurs following the Company’s first
fiscal quarter of any year, a pro-rated annual bonus for the year in which his employment was terminated (the “pro-rated
bonus”). In the event Mr. Shmidman’s employment is terminated by the Company without cause or by Mr. Shmidman for
good reason, all unvested restricted stock will accelerate and become fully vested on the date of his termination.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Gary Klein Employment Agreement
On November 29, 2012,
the Board of Directors appointed Gary Klein as the Company’s Chief Financial Officer for a term of three years. During the
term of his employment, Mr. Klein will receive a base salary of $250,000 per annum, which is subject to increase, and he will
be eligible to receive an annual cash performance bonus of up to 50% of his base salary based on the attainment of the EBITDA
target to be agreed upon by the Company and Mr. Klein. Mr. Klein received a signing bonus of $20,000 and on November 29, 2012,
purchased 80,000 shares of restricted stock at a purchase price of $0.001 per share, of which 20,000 shares, or 25%, vested upon
Mr. Klein’s employment commencement date, with the remaining shares vesting in equal installments on each of the first,
second and third anniversaries of Mr. Klein’s start date. In the event of a change of control of the Company, all unvested
shares of restricted stock will immediately vest.
Colin Dyne
On November 15, 2012,
Colin Dyne resigned from his positions as the Company’s Chief Executive Officer, Chief Financial Officer and Director of
the Board. In connection with Mr. Dyne’s resignation, the Company and Mr. Dyne entered into a separation and release agreement
which provides for an aggregate payment to Mr. Dyne of $2.35 million, which has been included in operating expenses in the consolidated
statement of operations for the year ended December 31, 2012. The agreement also provides that, subject to certain exceptions,
other than the payment of accrued wages and unpaid vacation time, Mr. Dyne will not be entitled to any other payments or benefits
in connection with the termination of his employment, including those provided for in Mr. Dyne’s employment agreement with
the Company. Subject to certain exceptions, the agreement also provides a release of all claims that each party may have against
the other and for the continued right for Mr. Dyne to exercise his outstanding stock options for a period of three years.
NOTE 14 – WILLIAM RAST OWNERSHIP
RECAPITALIZATION
Effective as of October
1, 2011, the Company recapitalized the ownership of its William Rast branded apparel business. The recapitalization increased
the ownership of Bella Rose in each of William Rast Sourcing and William Rast Licensing in exchange for certain royalties to be
paid to Tennman WR-T as well as other consideration.
As a result of the
recapitalization, both William Rast Sourcing and William Rast Licensing are now owned 82% by Bella Rose and 18% by Tennman WR-T,
and Bella Rose is entitled to all of the distributable cash from operations and all of the distributable cash from a sale of William
Rast Sourcing or William Rast Licensing that is not paid to Tennman WR-T. In connection with the ownership recapitalization, Tennman
WR-T, William Rast Sourcing and William Rast Licensing entered into a Royalty Agreement effective as of October 1, 2011 (the “Royalty
Agreement”). Pursuant to the Royalty Agreement, William Rast Sourcing is obligated to pay Tennman WR-T royalties that are
based on a percentage of net sales and sublicensee considerations it receives. Additionally, during the term of the agreement,
William Rast Sourcing is obligated to pay Tennman WR-T guaranteed minimum royalties. The Royalty Agreement also provides that
William Rast Licensing shall pay to Tennman WR-T a percentage of all gross receipts of William Rast Licensing in respect of royalties
or other compensation earned with respect to the license by William Rast Licensing of rights to the William Rast mark, subject
to certain offsets. The amounts to be paid by both William Rast Licensing and William Rast Sourcing commence July 1, 2011 and
continue until the earlier of (i) the date that William Rast Licensing or William Rast Sourcing, as applicable, pays a liquidating
payment to Tennman WR-T or (ii) the date that Tennman WR-T or any of its affiliates no longer owns Class B membership interests
in William Rast Licensing or William Rast Sourcing, as applicable.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the years ended
December 31, 2012 and 2011, the Company recorded approximately $930,000 and $200,000, respectively, in royalty expense, of which
approximately $872,000 and $0, respectively, are included in operating expenses from continuing operations and $58,000 and $200,000,
respectively, are included in discontinued operations.
NOTE 15 - PREFERRED STOCK
On February 3, 2012,
the Company amended its certificate of incorporation by creating a new series of preferred stock designated Series A Preferred
Stock, by filing with the Delaware Secretary of State a Certificate of Designation of Preferences, Rights and Limitations of Series
A Preferred Stock. The Certificate of Designation sets forth the rights, preferences, privileges and restrictions of the Series
A Preferred Stock, which include the following:
|
·
|
The
authorized number
of shares of Series
A Preferred Stock
is 19,400, having
a par value $0.001
per share and a
stated value of
$1,000 per share
(“Stated Value”).
|
|
·
|
Holders
of Series A Preferred
Stock are not entitled
to dividends or
any liquidation
preference.
|
|
·
|
Series
A Preferred Stock
may only be transferred
by a holder of such
stock to a transferee
if such transfer
also includes a
transfer to the
transferee of $1,000
in principal amount
of Debentures for
each one share of
transferred Series
A Preferred Stock.
|
|
·
|
The
holders of Series
A Preferred Stock
vote together as
a single class with
the holders of common
stock on all matters
requiring approval
of the holders of
common stock, except
that each share
of Preferred Stock
is entitled to 381
votes per share
(which is the number
of shares of common
stock a Debenture
holder would receive
if it converted
$1,000 in principal
amount of Debentures
into common stock
at a conversion
price of $2.625),
which number of
votes per share
is subject to adjustment
in the case of stock
splits, stock dividends,
combinations of
shares and similar
recapitalization
transactions relating
to the Company’s
common stock.
|
|
·
|
As
long as any shares
of Series A Preferred
Stock are outstanding,
the Company will
not, without the
affirmative vote
of the holders of
a majority of the
then outstanding
shares of the Series
A Preferred Stock,
(a) alter or change
adversely the powers,
preferences or rights
given to the Series
A Preferred Stock
or alter or amend
the Certificate
of Designation,
(b) amend the Company’s
certificate of incorporation
or other charter
documents in any
manner that adversely
affects any rights
of such holders,
(c) increase the
number of authorized
shares of Series
A Preferred Stock,
or (d) enter into
any agreement with
respect to any of
the foregoing.
|
|
·
|
Upon
conversion of the
principal amount
of a Debenture,
in whole or in part,
into shares of common
stock or upon the
repayment of the
principal amount
of a Debenture,
in whole or in part,
by the Company,
the Company has
the right to and
will redeem from
the Debenture holder
at a price of $0.001
per share, a number
of shares of Series
A Preferred Stock
determined by dividing
(i) the outstanding
principal amount
of the Debenture
that has been repaid
or converted into
common stock, as
applicable by (ii)
the Stated Value.
|
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - STOCK INCENTIVE PLAN, OPTIONS
AND WARRANTS
Stock Options
On January 5, 2006,
the Company adopted its 2005 Stock Incentive Plan (the “Plan”), which authorized the granting of a variety of stock-based
incentive awards. The Plan is administered by the Company’s Board of Directors, or a committee appointed by the Board of
Directors, which determines the recipients and terms of the awards granted. The Plan provides for the issuance of both incentive
stock options (“ISO’s”) and non-qualified stock options (“NQO’s”). ISO’s may only be
granted to employees and NQO’s may be granted to directors, officers, employees, consultants, independent contractors and
advisors. The Plan provides for a total of 366,667 shares of common stock to be reserved for issuance under the Plan.
Options granted under
the Plan generally vest over various periods, ranging from immediate vesting to vesting over four years. The vesting period is
generally determined by the number of past years employed with the Company. The options expire no later than ten years from the
date of grant. Compensation cost arising from share-based awards is recognized as compensation expense using the straight-line
method over the vesting period and is included in operating expenses in the consolidated statements of operations.
During the year ended
December 31, 2012, the Company did not grant any options. During the year ended December 31, 2011, the Company granted 152,000
options to employees and officers within the Plan at an exercise prices ranging from $2.25 to $3.00 and 333,333 options to two
employees and an officer outside the Plan, at an exercise price of $2.25.
The fair value of
options is estimated on the date of grant using the Black-Scholes option pricing model. The valuation determined by the Black-Scholes
pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective
variables. These variables include, but are not limited to, expected stock price volatility over the term of the awards, and actual
and projected employee stock option exercise behaviors. Stock price volatility is estimated based on a peer group of public companies
and expected term is estimated using the “safe harbor” provisions provided in accordance with U.S. GAAP. The safe
harbor provisions were extended beyond December 31, 2007 for companies that did not have sufficient historical data to calculate
the expected term of their related options. The Company did not have sufficient historical data to calculate expected term and
the safe harbor provisions were used to calculate expected term for options granted during the periods. The risk-free interest
rate assumption is based on the U.S. Treasury instruments whose term was consistent with the expected term of our stock options.
The expected dividend assumption is based on our history and expectation of dividend payouts. The weighted-average assumptions
the Company used as inputs to the Black-Scholes pricing model for options granted during the year ended December 31, 2011 included
a dividend yield of zero, a risk-free interest rate of 2.2%, expected term of 6.1 years and an expected volatility of 64%.
Forfeitures are required
to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates. For the year ended December 31, 2011, the Company used historical data to calculate the expected forfeiture rate.
Total compensation
expense related to stock options for years ended December 31, 2012 and 2011 was approximately $4,000 and $76,000, respectively.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Options awarded to
non-employees are charged to expense when the services are performed and benefit is received.
The following table
summarizes our stock option activity for the year ended December 31, 2012:
|
|
Number of
Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining
Contractual
Life
(in Years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding - December 31, 2011
|
|
|
451,467
|
|
|
$
|
4.51
|
|
|
|
8.1
|
|
|
$
|
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited or Canceled
|
|
|
(46,667
|
)
|
|
|
(8.19
|
)
|
|
|
|
|
|
|
|
|
Outstanding - December 31, 2012
|
|
|
404,800
|
|
|
$
|
4.09
|
|
|
|
7.3
|
|
|
$
|
807,733
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable - December 31, 2012
|
|
|
358,560
|
|
|
$
|
4.26
|
|
|
|
7.2
|
|
|
$
|
705,917
|
|
A summary of the changes
in the Company’s unvested stock options within the Plan is as follows:
|
|
Number of
Shares
|
|
|
Weighted
Average Grant
Date Fair Value
|
|
Unvested stock options – January 1, 2012
|
|
|
85,139
|
|
|
|
0.01
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Vested
|
|
|
(38,899
|
)
|
|
|
0.01
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Unvested stock options – December 31, 2012
|
|
|
46,240
|
|
|
$
|
0.01
|
|
As of December 31,
2012, there were 158,560 of vested stock options within the Plan and 200,000 of vested options outside the Plan. As of December
31, 2012, there was approximately $3,000 of total unrecognized compensation expense related to stock options which is expected
to be recognized over a weighted-average period of two years.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants
The following table
summarizes the Company’s outstanding warrants:
|
|
Number of
Warrants
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining
Contractual Life
(in Years)
|
|
|
Aggregate
Intrinsic Value
|
|
Outstanding - December 31, 2011
|
|
|
1,112,666
|
|
|
$
|
1.76
|
|
|
|
4.5
|
|
|
$
|
-
|
|
Granted
|
|
|
1,164,762
|
|
|
|
2.79
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited or Canceled
|
|
|
(26,666
|
)
|
|
|
(6.94
|
)
|
|
|
|
|
|
|
|
|
Outstanding - December 31, 2012
|
|
|
2,250,762
|
|
|
$
|
2.23
|
|
|
|
4.0
|
|
|
$
|
6,290,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable - December 31, 2012
|
|
|
2,205,762
|
|
|
$
|
2.16
|
|
|
|
3.9
|
|
|
$
|
6,290,476
|
|
A summary of the changes
in the Company’s unvested warrants is as follows:
|
|
Number of
Shares
|
|
|
Weighted
Average Grant
Date Fair Value
|
|
Unvested warrants – January 1, 2012
|
|
|
-
|
|
|
|
-
|
|
Granted
|
|
|
1,164,762
|
|
|
|
3.36
|
|
Vested
|
|
|
(1,119,762
|
)
|
|
|
(3.37
|
)
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Unvested warrants – December 31, 2012
|
|
|
45,000
|
|
|
$
|
3.05
|
|
Restricted Stock
As more fully described
in Note 13, on November 19, 2012, the Company issued 396,196 shares of restricted stock to the Company’s Chief Executive
Officer, Yehuda Shmidman, in accordance with the terms of his employment agreement. Total compensation related to the restricted
stock grant amounted to approximately $2.3 million, $570,000 of which was recorded in operating expenses in the Company’s
consolidated statement of operations for the year ended December 31, 2012.
Additionally, as more
fully described in Note 13, on November 29, 2012, the Company issued 80,000 shares of restricted stock to the Company’s
Chief Financial Officer, Gary Klein, in accordance with the terms of his employment offer letter. Total compensation related to
the restricted stock grant amounted to approximately $400,000, $100,000 of which was recorded in operating expenses in the Company’s
consolidated statement of operations for the year ended December 31, 2012.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the restricted
stock activity for the year ended December 31, 2012 is as follows:
|
|
Number
of
Shares
|
|
|
Weighted
Average Grant
Date Fair Value
|
|
|
Weighted
Average
Contractual
Term
|
|
|
Aggregate
Intrinsic Value
|
|
Unvested Outstanding at January 1, 2011
|
|
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
|
$
|
—
|
|
Granted
|
|
|
476,196
|
|
|
|
5.62
|
|
|
|
4.0
|
|
|
|
|
|
Vested
|
|
|
(119,049
|
)
|
|
|
5.62
|
|
|
|
4.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested Outstanding at December 31, 2012
|
|
|
357,147
|
|
|
$
|
5.62
|
|
|
|
3.9
|
|
|
$
|
—
|
|
NOTE 17 - INCOME
TAXES
The Company and its
subsidiaries are consolidated and taxes are reported by the parent, Sequential Brands Group, Inc. Taxes are calculated on a consolidated
basis at C-Corporation tax rates.
Deferred income taxes
arise principally from net operating loss (“NOL”) carryforwards. In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be
realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during
the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred income
tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on consideration
of these items, management has determined that enough uncertainty exists relative to the realization of the deferred income tax
asset balances to warrant the application of a full valuation allowance as of December 31, 2012.
The Company has federal
and state net operating losses available to carryforward to future periods of approximately
$17.6
million as of December 31, 2012 which expire beginning in 2017 for state purposes and 2027 for federal purposes. As a result of
TCP’s investment in February 2012, we experienced an “ownership change” under Section 382 of the Internal Revenue
Code, limiting our utilization of any NOLs accrued up to February 2012 based upon a formula provided under Section 382 of the
Code that is based on the fair market value of the Company and prevailing interest rates at the time of the ownership change.
An “ownership change” is generally a 50% increase in ownership over a three-year period by stockholders who directly
or indirectly own at least five percent of a company’s stock. The limitations on the use of NOLs as a result of TCP’s
investment could affect our ability to offset future taxable income.
The Company currently
files U.S. federal tax returns, California and New York state tax returns and previously filed Georgia, Florida, New Jersey and
Texas franchise tax returns. We are subject to examination by federal and state taxing authorities for the 2008 and subsequent
tax years. The Federal income tax return for the year ended December 31, 2010 is currently under examination by the Internal Revenue
Service, for which results are not expected to be material. The Company is not currently under examination in any other jurisdiction.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The provision (benefit)
for income taxes from continuing operations for the years ended December 31, 2012 and 2011 consists of the following:
|
|
2012
|
|
|
2011
|
|
Federal:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current provision
|
|
$
|
-
|
|
|
$
|
-
|
|
Deferred benefit
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
State:
|
|
|
|
|
|
|
|
|
Current provision (benefit)
|
|
|
26,998
|
|
|
|
(800
|
)
|
Deferred benefit
|
|
|
-
|
|
|
|
-
|
|
|
|
|
26,998
|
|
|
|
-
|
|
|
|
$
|
26,998
|
|
|
$
|
(800
|
)
|
The difference between
the provision (benefit) for income taxes and the expected income tax provision determined by applying the statutory federal and
state income tax rates to pre-tax accounting loss from continuing operations for the years ended December 31, 2012 and 2011 are
as follows:
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Federal statutory rate
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
State taxes net of Federal benefit
|
|
|
6.0
|
|
|
|
6.0
|
|
Non-deductible transaction costs
|
|
|
(11.0
|
)
|
|
|
-
|
|
Valuation allowance
|
|
|
(29.0
|
)
|
|
|
(56.9
|
)
|
Gross receipts tax and minimum statutory state income
taxes
|
|
|
0.3
|
|
|
|
(0.3
|
)
|
Other
|
|
|
0.1
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.4
|
%
|
|
|
(0.3
|
)%
|
The components of
the Company’s consolidated deferred income tax balances as of December 31, 2012 and 2011 are as follows:
|
|
December 31,
2012
|
|
|
December 31,
2011
|
|
|
|
|
|
|
|
|
Deferred income tax assets – current
|
|
|
|
|
|
|
|
|
Bad debt reserve
|
|
$
|
-
|
|
|
$
|
42,000
|
|
Accruals and other reserves
|
|
|
386,000
|
|
|
|
428,000
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax asset – long-term:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
6,854,000
|
|
|
|
3,888,000
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax liability – long-term:
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
-
|
|
|
|
(195,000
|
)
|
|
|
|
7,240,000
|
|
|
|
4,163,000
|
|
Less: Valuation allowance
|
|
|
(7,240,000
|
)
|
|
|
(4,163,000
|
)
|
Net deferred income tax asset – long-term
|
|
$
|
-
|
|
|
$
|
-
|
|
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 –
RELATED PARTY TRANSACTIONS
Agreement
and Plan of Merger Relating to Heelys, Inc.
On
December 7, 2012, in connection with the Company’s entry into an agreement and plan of merger with Heelys, Inc. (see Note
24), the Company entered into an equity commitment letter with Tengram Capital Partners Gen2 Fund, L.P., pursuant to which such
entity agreed to provide up to $8,100,000 of equity financing to the Company, subject to the terms and conditions set forth in
the commitment letter, if needed, for the Company to satisfy its obligations under the agreement and plan of merger. The commitment
letter automatically terminated upon the consummation of the transactions contemplated by the merger agreement on January 24,
2013 without an equity financing by Tengram Capital Partners Gen2 Fund, L.P.
Change of Control
Transaction with TCP
William Sweedler,
Matthew Eby and Richard Gersten are each directors of the Company, and are the controlling members of Tengram Capital Associates,
LLC which has the sole voting control over TCP. As further described in Note 10, on February 2, 2012, we entered into a Securities
Purchase Agreement with TCP pursuant to which we sold debentures, warrants and Series A Preferred Stock to TCP.
Fees paid to TCP,
including the annual monitoring fee (see Note 10), and legal and other fees included in deferred financing costs, amounted to
approximately $689,000 for the year ended December 31, 2012.
Loan Received from
Colin Dyne
During the year ended
December 31, 2011, the Company’s former Chief Executive Officer/Chief Financial Officer and director, Colin Dyne, loaned
the Company $230,000 in the form of unsecured, non-interest bearing advances. There were no formal terms of repayment, however,
the entire balance was repaid to Mr. Dyne in 2011.
Transactions with
Justin Timberlake
In May 2010, the Company’s
subsidiary, William Rast Sourcing, entered into a design and licensing agreement with the Target Corporation. During the year
ended December 31, 2011, Target made a direct payment of $250,000 to Justin Timberlake, an affiliate of the minority interest
holder of William Rast Sourcing, on our behalf for his services related to the Target agreement. During the year ended December
31, 2012, the Company paid $400,000 in royalties to Justin Timberlake.
NOTE 19 – PROFIT
SHARING PLAN
The Company has established
a 401(k) profit-sharing plan for the benefit of eligible employees. The Company may make contributions to the plan as determined
by the Board of Directors. There were no contributions made during the years ended December 31, 2012 and 2011.
NOTE 20 – DISCONTINUED OPERATIONS
OF WHOLESALE BUSINESS
In 2012, the Company’s
Board of Directors decided to discontinue the Company’s wholesale business completely and as a result, no longer sells its
People’s Liberation and William Rast branded products to wholesale and retail customers through its historical distribution
channels.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The discontinuation
of the Company’s wholesale business has been accounted for as a discontinued operation and, accordingly, all prior periods
presented in the accompanying consolidated balance sheets, statements of operations and cash flows have been adjusted to conform
to this presentation.
The following table
summarizes certain selected components of the discontinued operations of the Company’s wholesale business as of and for the
years ended December 31, 2012 and 2011:
|
|
Year Ended
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Net Revenue
|
|
$
|
943,149
|
|
|
$
|
6,330,129
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(985,126
|
)
|
|
$
|
(6,550,550
|
)
|
Noncontrolling interest
|
|
|
-
|
|
|
|
3,117,623
|
|
Net loss attributable to discontinued operations
|
|
$
|
(985,126
|
)
|
|
$
|
(3,432,927
|
)
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share from discontinued operations
|
|
$
|
(0.41
|
)
|
|
$
|
(1.43
|
)
|
|
|
December 31,
2012
|
|
|
December 31,
2011
|
|
Current assets
|
|
$
|
-
|
|
|
$
|
339,184
|
|
Long-term assets
|
|
$
|
3,950
|
|
|
$
|
54,160
|
|
Current liabilities
|
|
$
|
956,920
|
|
|
$
|
1,762,552
|
|
NOTE 21 – DISCONTINUED OPERATIONS
OF RETAIL SUBSIDIARY
In the second half
of 2011, the Company’s Board of Directors decided to transition the Company’s business from a wholesale and retail
provider of branded apparel and apparel accessories to a brand management and licensing business. As a result, the Company’s
retail operations conducted by its subsidiary, William Rast Retail, which consisted of four retail stores, were discontinued. The
Company closed its William Rast branded stores during 2011 and 2012.
The closing of the
Company’s retail stores has been accounted for as a discontinued operation and, accordingly, all prior periods presented
in the accompanying consolidated balance sheets, statements of operations and cash flows have been adjusted to conform to this
presentation.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table
summarizes certain selected components of the discontinued operations of William Rast Retail as of and for the years ended December
31, 2012 and 2011:
|
|
Year Ended
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
Net Revenue
|
|
$
|
706,926
|
|
|
$
|
1,850,723
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(795,181
|
)
|
|
$
|
(1,554,672
|
)
|
Noncontrolling interest
|
|
|
-
|
|
|
|
439,883
|
|
Net loss attributable to discontinued operations
|
|
$
|
(795,181
|
)
|
|
$
|
(1,114,789
|
)
|
|
|
|
|
|
|
|
|
|
Basic and diluted loss per share from discontinued operations
|
|
$
|
(0.33
|
)
|
|
$
|
(0.46
|
)
|
|
|
December 31,
2012
|
|
|
December 31,
2011
|
|
Current assets
|
|
$
|
-
|
|
|
$
|
60,883
|
|
Long-term assets
|
|
$
|
-
|
|
|
$
|
260,825
|
|
Current liabilities
|
|
$
|
393,729
|
|
|
$
|
403,805
|
|
Long-term liabilities
|
|
$
|
-
|
|
|
$
|
288,765
|
|
The Company does not
expect any significant costs to be incurred in future periods related to the closing down of its retail stores and the winding
down of William Rast Retail’s operations. The Company recognized costs incurred to close its retail stores upon the “cease
use date” of the retail store.
NOTE 22 – DISCONTINUED OPERATIONS
OF J. LINDEBERG USA, LLC SUBSIDIARIES
On April 26, 2011,
the Company and its wholly owned subsidiary, Bella Rose, completed the sale of Bella Rose’s 50% membership interest in J.
Lindeberg USA to J. Lindeberg USA Corp. (“Buyer”) pursuant to the terms of a Unit Purchase Agreement entered into by
the parties on April 7, 2011. Prior to the closing of the transaction and since July 1, 2008, J. Lindeberg USA was owned
50% by Bella Rose and 50% by Buyer.
In consideration for
Bella Rose’s 50% membership interest in J. Lindeberg USA, Buyer agreed to pay to the Company an aggregate of $1,650,000,
of which $900,000 was paid upon the closing of the transaction and $750,000 was received in the form of a receivable that was non-interest
bearing and to be paid on the six month anniversary of the closing of the transaction. On June 24, 2011, the Company and Bella
Rose entered into an asset purchase agreement with Monto. Pursuant to the agreement, the Company sold to Monto without recourse
the $750,000 receivable owed to the Company under the terms of the Unit Purchase Agreement discussed above. The receivable balance
was paid by Buyer to Monto in October 2011.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The divestiture of
the Company’s membership interest in J. Lindeberg USA has been accounted for as a discontinued operation and, accordingly,
all prior periods presented in the accompanying consolidated balance sheets, statements of operations and cash flows have been
adjusted to conform to this presentation.
The Company recorded
a gain in the second quarter of 2011 related to this divestiture as follows:
Carrying value of net assets of J. Lindeberg USA
|
|
$
|
(1,501,404
|
)
|
Noncontrolling interest on date of divestiture
|
|
|
1,863,727
|
|
Carrying value of net assets attributable to J. Lindeberg USA
|
|
|
362,323
|
|
Cash proceeds received at closing
|
|
|
900,000
|
|
Receivable from Buyer
|
|
|
750,000
|
|
Gain on sale of member interest in subsidiary
|
|
$
|
2,012,323
|
|
The following table summarizes certain selected
components of the discontinued operations of J. Lindeberg USA for the year ended December 31, 2011:
Net Revenue
|
|
$
|
3,374,624
|
|
|
|
|
|
|
Net loss
|
|
$
|
(125,771
|
)
|
Noncontrolling interest
|
|
|
62,885
|
|
Net loss attributable to discontinued operations
|
|
$
|
(62,886
|
)
|
|
|
|
|
|
Income per share from discontinued operations, basic and diluted
|
|
$
|
0.81
|
|
During the year ended
December 31, 2011, the Company purchased all of its J. Lindeberg brand products from J. Lindeberg AB in Sweden, the beneficial
owner of 50% of the Company’s former subsidiary, J. Lindeberg USA. Total purchases from J. Lindeberg AB for the year ended
December 31, 2011 amounted to approximately $1.8 million.
NOTE 23 – SECURITIES
PURCHASE AGREEMENT
On
December 21, 2012, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with a select
group of accredited investors (the “Investors”), pursuant to which the Company agreed to sell to the Investors an aggregate
of 4,966,667 shares of the Company’s common stock, par value $0.001 (the “Securities”), at a purchase price of
$4.50 per share, for a total offering amount of approximately $22.4 million (the “Offering”). Net proceeds, after the
payment of legal and other expenses, amounted to approximately
$21.3 million
.
The
Offering was consummated on January 9, 2013. Affiliates of the Company purchased 744,444 shares, with the Company’s Chief
Executive Officer, Mr. Shmidman, purchasing 11,111 shares and TCP SQBG Acquisition, LLC, a fund affiliated with TCP, purchasing
733,333 shares. The Company’s directors, William Sweedler, Matthew Eby and Richard Gersten, are co-managing members
of Tengram Capital Associates, LLC, which is the managing member of TCP. As contemplated by the Purchase Agreement, the Company
also entered into a registration rights agreement with the Investors on January 9, 2013 (the “Registration Rights Agreement”).
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Registration Rights
Agreement requires the Company to file a resale shelf registration statement (the “Resale Shelf”) for the Securities
purchased by each Investor in the Offering within 120 days of the Closing Date (the “Filing Deadline”) and must use
its commercially reasonable efforts to cause the Resale Shelf to become effective as promptly thereafter as practicable but in
any event not later than 90 days after the Filing Deadline if the Company receives comments from the Securities and Exchange Commission
(the “SEC”), or 30 days after the Filing Deadline, if the Company does not receive comments from the SEC (such applicable
date, the “Effectiveness Deadline”). If the Company fails to meet the Filing Deadline or the Effectiveness Deadline,
subject to certain grace periods provided for in the Registration Rights Agreement, the Company will be required to pay certain
liquidated damages to the Investors. The Registration Rights Agreement also provides for customary indemnification and contribution
provisions, as well as customary restrictions such as blackout periods. In the event the Investors no longer hold “Registrable
Securities,” as defined in the Registration Rights Agreement, notwithstanding the foregoing, the Company may not be obligated
to put up the Resale Shelf.
NOTE 24 –SUBSEQUENT
EVENTS
Heelys
Acquisition
On
January 24, 2013, the Company completed its acquisition of Heelys, Inc. (“Heelys”) pursuant to the Agreement and Plan
of Merger (“Merger Agreement”) dated December 7, 2012. In accordance with the Merger Agreement, the Company acquired
all of the outstanding shares of common stock of Heelys at a purchase price of $2.25 per share in cash, for an aggregate consideration
of approximately $62.9 million. In connection with the acquisition, the Company incurred legal and other costs related to the transaction
of approximately $1.4 million. The Heelys acquisition was effected in order to develop and build the Company’s diversified
portfolio of consumer brands.
In connection with
the acquisition of Heelys, the Company entered into a multi-country exclusive license agreement (the “Heelys License Agreement”)
with BBC International LLC (“BBC”) to license the trademark “Heelys” and all existing derivative brands,
including (i) Heelys, (ii) Sidewalk Sports, (iii) Nano, and (iv) Soap (collectively, the “Marks”). The Heelys License
Agreement grants an exclusive, nontransferable, non-assignable license, without the right to sub-license, to use the Marks and
certain proprietary rights, including patents, in connection with the manufacturing, distribution, advertising and sale of wheeled
footwear and footwear without wheels (the “Licensed Products”) subject to the terms and conditions stated in the Heelys
License Agreement.
The term of the Heelys
License Agreement expires on June 30, 2019 and,subject to certain conditions, may be renewed by BBC for two renewal periods of
five years each in years five and ten, respectively, provided that BBC is not in default of the terms and conditions of the Heelys
License Agreement and in compliance with the aggregate guaranteed minimum royalties requirements set forth therein.
SEQUENTIAL
BRANDS GROUP, INC.
(FORMERLY PEOPLE’S LIBERATION,
INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Brand Matter Acquisition
On March 28,
2013, the Company acquired all of the outstanding shares of Brand Matter, LLC (“Brand Matter”) for an aggregate
purchase price consisting of (i) $62.3 million of cash and (ii) 2.8 million shares of the Company’s common stock. In connection with the acquisition, the Company entered into a (i) first lien term loan agreement (“First Lien
Loan Agreement”), which provides for term loans of up to $45 million and (ii) a second lien term loan (“Second
Lien Loan Agreement”) which provides for term loans of up to $20 million. The proceeds from each term loan were used to
fund the acquisition of Brand Matter, repay existing debt, pay fees and expenses in connection with the foregoing, finance
capital expenditures and for general corporate purposes. In connection with the Second Lien Loan Agreement, the Company
issued 5-year warrants to purchase up to an aggregate of 285,160 shares of the Company’s common stock at an exercise
price of $4.50 per share. The Brand Matter acquisition was effected to complete the Company’s base platform through
acquiring two strong brands with a proven team.
The term loans were
drawn in full on March 28, 2013 and are required to be repaid on March 28, 2018. The Company is required to make quarterly scheduled
amortization payments of $2 million during the term of the loan. The First Lien Term Loan bears interest, at the Company’s
option, at either (a) 4% per annum plus adjusted LIBOR or (b) 3% per annum plus the Base Rate, as defined in the loan agreement.
The Second Lien Term Loan bears interest at 12.75% per annum plus LIBOR.
The Loan Agreements
include customary representations and warranties and include representations relating to the intellectual property owned by the
Company and its subsidiaries and the status of the Company’s material license agreements. In addition, the Loan Agreements
include covenants and events of default including requirements that the Company satisfy a minimum positive net income test, maintain
a minimum loan to value ratio (as calculated pursuant to the First Lien Loan Agreement or the Second Lien Loan Agreement, as applicable)
and, in the case of the Second Lien Loan Agreement, maintain a minimum cash balance in accounts subject to control agreements,
as well as limitations on liens on the assets of the Company and its subsidiaries, indebtedness, consummation of acquisitions (subject
to certain exceptions and consent rights as set forth in the Loan Agreements) and fundamental changes (including mergers and consolidations
of the Company and its subsidiaries), dispositions of assets of the Company and its subsidiaries, investments, loans, advances
and guarantees by the Company and its subsidiaries, and restrictions on issuing dividends and other restricted payments, prepayments
and amendments of certain indebtedness and material licenses, affiliate transactions and issuance of equity interests.
The purchase price
allocation for these acquisitions has not been completed as of the date of this filing. The Company does not believe there is a
bargain purchase option associated with these acquisitions.
Due to the timing of
these transactions, the Company’s pro forma revenue and net loss attributable to common stockholders has not been presented
because the purchase price allocation for these acquisitions has not been completed.
Conversion of Debentures
In connection with
the Brand Matter acquisition discussed above, on March 28, 2013, TCP converted the aggregate principal amount outstanding under
the Debentures into 5,523,810 shares of the Company’s common stock at a conversion rate of $2.625 per share. At the time
of the conversion, the aggregate principal amount outstanding under the Debentures was $14.5 million, plus accrued and unpaid interest.
In connection with the conversion, the Company also redeemed all of the 14,500 issued and outstanding shares of Series A Preferred
Stock held by TCP for an aggregate redemption price of $14.50. Additionally, in connection with the conversion of the Debentures,
the Subsidiary Guarantee and Security Agreement were terminated (see Note 10). As a result of the conversion of the Debentures,
the Company charged the remaining unamortized debt discount and deferred financing costs of approximately $11,614,000 to non-cash
interest expense in the three month period ended March 31, 2013.