| Summary of Significant Accounting Policies | 2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant areas requiring the use of estimates relate primarily to allowance for bad debts, returns, sales allowances, and customer chargebacks, inventory write-downs, valuation of goodwill, intangible and long-lived assets, and valuation of deferred income taxes. Actual results could differ from these estimates.
Revenue Recognition
Wholesale revenues are recorded when title transfers to the customer, collection of the relevant receivable is reasonably assured, persuasive evidence of an arrangement exists and the sales price is fixed or determinable, which is typically at the shipping point. Estimated reductions to revenue for customer programs, including co‑op advertising, other advertising programs or allowances are recorded based upon a percentage of sales. The Company allows for returns based upon pre‑approval or in the case of damaged goods. Such returns are estimated based on historical experience and an allowance is provided at the time of sale.
Retail store revenue is recognized at the time the customer takes possession of the related merchandise, net of estimated returns at the time of sale to consumers. Ecommerce sales of products ordered through our retail internet sites known as www.hudsonjeans.com , www.robertgraham.us and www.swims.com are recognized upon estimated delivery and receipt of the shipment by the customers. Ecommerce revenue is also reduced by an estimate of returns. Retail store revenue and ecommerce revenue exclude sales taxes.
Revenue from licensing arrangements is recognized when earned in accordance with the terms of the underlying agreements and deemed collectible, generally based upon the higher of (a) the contractually guaranteed minimum royalty or (b) actual net sales data received from licensees. Payments received in consideration of the grant of a license or advanced royalty payments is recognized ratably as revenue over the term of the license agreement. The unrecognized portion of upfront payments is included in accounts payable and accrued expenses within the accompanying consolidated balance sheets. The Company did not have deferred licensing revenue as of December 31, 2016 and 2015.
Amounts related to shipping and handling that are billed to customers are reflected in net sales, and the related costs are reflected in selling, general and administrative expenses within the accompanying consolidated statements of operations and comprehensive (loss) income. For the years ended December 31, 2016 and 2015, shipping and handling fee revenue included in net sales was $0.4 million and $0.2 million, respectively.
Cash Equivalents
All highly liquid investments that are both readily convertible into known amounts of cash and mature within 90 days from their date of purchase are considered to be cash equivalents.
Accounts Receivable, Factored Accounts Receivable and Allowance for Bad Debts, Sales Allowances, and Customer Chargebacks
The Company evaluates its ability to collect accounts receivable, factor accounts receivable with recourse and charge‑backs (disputes from the customer) based upon a combination of factors. Reserves for charge‑backs are recognized based on historical collection experience. A specific reserve for bad debts is taken against amounts due to reduce the net recognized receivable to the amount reasonably expected to be collected. Whether a receivable is past due is based on how recently payments have been received and in certain circumstances when the Company is aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filings, substantial downgrading of credit sources, etc.). Amounts are written off against the reserve once it is established that it is remote such amounts will be collected. The Company also reserves for potential sales returns and allowances based on historical trends.
Inventories
Inventory is valued at the lower of cost or net realizable value with cost determined by the first‑in, first‑out method. Inventory consists of finished goods, work‑in‑process and raw materials. The Company continually evaluates its inventory by assessing slow moving current product. Market value of non‑current inventory is estimated based on historical sales trends, the impact of market trends, an evaluation of economic conditions and the value of current orders relating to future sales. Inventory reserves establish a new cost basis for inventory. Such reserves are not reversed until the related inventory is sold or otherwise disposed. Costs capitalized in inventory include the purchase price of raw materials and contract labor, plus in‑bound transportation costs and import fees and duties.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation and amortization is calculated using the straight‑line method over the following estimated useful lives of the assets:
Leasehold improvements are amortized over the lessor of the term of the lease or the estimated useful life of the improvement. Maintenance and repairs are charged to expense as incurred. Upon sale or retirement, the asset cost and related accumulated depreciation or amortization is removed from the accounts, and any related gain or loss is included within selling, general and administrative expenses within the accompanying consolidated statements of operations and comprehensive (loss) income.
Impairment of Long‑Lived Assets, Intangible Assets and Goodwill
The Company assesses the impairment of long‑lived assets, identifiable intangible assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In addition, the Company assesses goodwill and indefinite lived intangible assets for impairment annually. Factors considered important that could trigger an impairment review other than on an annual basis include the following:
·
A significant underperformance relative to historical or projected future operating results;
·
A significant change in the manner of the use of the acquired asset or the strategy for the overall business; or
·
A significant negative industry or economic trend.
The estimated cash flows used for this nonrecurring fair value measurement are considered a Level 3 input as defined in Note 13.
Impairment of Long‑Lived Assets and Intangible Assets Subject to Amortization
When the Company determines that the carrying value of long‑lived assets, such as property and equipment, and intangible assets subject to amortization, may not be recoverable based upon the existence of one or more of the aforementioned factors and the carrying value exceeds the estimated undiscounted cash flows expected to be generated by the asset, impairment is measured based on a projected discounted cash flow method using a discount rate determined by management. These cash flows are calculated by netting future estimated sales against associated merchandise costs and other related expenses such as payroll, occupancy and marketing. The impairment loss calculations require management to apply judgment in estimating future cash flows and the discount rates that reflect the risk inherent in future cash flows.
Future expected cash flows for retail store assets are based on management’s estimates of future cash flows over the remaining lease period or expected life, if shorter. The Company considers historical trends, expected future business trends and other factors when estimating each store’s future cash flow. The Company also considers factors such as: the local environment for each store location, including mall traffic and competition; the ability to successfully implement strategic initiatives; and the ability to control variable costs such as cost of sales and payroll, and in some cases, renegotiate lease costs. If actual results are not consistent with the assumptions and judgments used in estimating future cash flows and asset fair values, there may be additional exposure to future impairment losses that could be material to the Company’s’ results of operations. Retail store impairment charges of $2.2 million were recorded during the year ended December 31, 2016. Based on the operating performance of these stores, the Company determined it could not recover the carrying value of property and equipment located at these stores. There was no impairment charge recorded related to the retail stores during the year ended December 31, 2015.
Intangible assets subject to amortization, such as customer relationships, are amortized over their estimated useful lives. There was no impairment charge recorded related to intangible assets subject to amortization during the years ended December 31, 2016 and 2015.
Goodwill and Indefinite Lived Intangible Assets
Goodwill and intangible assets with indefinite lives, such as trademarks, are not amortized but are tested at least annually for impairment on December 31 st of each year or when circumstances indicate their carrying value may not be recoverable. Goodwill is evaluated for impairment at least annually using a two-step process. The first step is to determine the fair value of each reporting unit and compare this value to its carrying value. If the fair value exceeds the carrying value, including goodwill, no further work is required and no impairment loss would be recognized. The second step is performed if the carrying value exceeds the fair value of the assets. The implied fair value of the reporting unit’s goodwill must be determined and compared to the carrying value of the goodwill. The Company reviews indefinite lived intangible assets for impairment on an annual basis, or when circumstances indicate their carrying value may not be recoverable. The Company calculates the value of the indefinite lived intangible assets using a discounted cash flow method, based on the relief from royalty method. There was no impairment charge recorded related to indefinite lived intangible assets or goodwill during the years ended December 31, 2016 and 2015.
Deferred Rent and Tenant Allowances
When a lease includes lease incentives (such as a rent holiday) or requires fixed escalations of the minimum lease payments, rental expense is recognized on a straight‑line basis over the term of the lease starting from the date of possession and the difference between the average rental amount charged to expense and amounts payable under the lease is included in deferred rent in the accompanying consolidated balance sheets. Deferred rent also includes tenant allowances received from landlords which are amortized as a reduction to rent expense on a straight-line basis over the term of the lease starting at the date of possession.
Deferred Financing Costs
Deferred financing costs are amortized using the effective interest rate method over the term of the related agreements and recorded as a component of interest expense in the accompanying consolidated statements of operations and comprehensive (loss) income. Amortization of deferred financing costs included in interest expense was approximately $0.4 million and $0 for the years ended December 31, 2016 and 2015. Deferred financing costs are presented on the consolidated balance sheets as a direct deduction of the related debt.
Preferred Share Dividend
Cumulative dividends on preferred stock are only accrued for when the board of directors declares a dividend. The board of directors has not declared a dividend through December 31, 2016.
Derivatives
Warrants and other derivative financial instruments are accounted for as either equity or liabilities based upon the characteristics and provisions of each instrument. During the year ended December 31, 2016, the warrants that were issued in conjunction with the acquisition of DFBG Swims (see “Note 3 – Acquisition of SWIMS”) were determined to be equity. Warrants classified as equity are recorded at fair value as of the date of issuance within the consolidated balance sheets and no further adjustments to their valuation is made. Management estimates the fair value of these warrants using option pricing models and assumptions that are based on the individual characteristics of the warrants or instruments on the valuation date, as well as assumptions for future financings, expected volatility, expected life, yield, and risk-free interest rate.
Costs of Goods Sold
Costs of goods sold includes product cost, freight in, inventory reserves, inventory markdowns and other various charges.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include salaries and benefits, travel and entertainment, professional fees, advertising, marketing, sample expenses, stock based compensation expense, facilities, fulfillment and distribution costs, bad debt expense and write down of other assets.
The Company charges all product design and development costs to selling, general and administrative expenses, when incurred. Product design and development costs aggregated were approximately $10.2 million and $5.3 million during the years ended December 31, 2016 and 2015, respectively.
The Company’s distribution network-related costs are included in selling, general and administrative expenses and are not allocated to specific segments. The expenses related to its distribution network, including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging of its product totaled $5.3 million and $1.6 million during the years ended December 31, 2016 and 2015, respectively.
Advertising Costs
Advertising costs are charged to expense as incurred. Advertising and tradeshow expenses included in selling, general and administrative expenses within the accompanying consolidated statements of operations and comprehensive (loss) income were $7.9 million and $2.8 million for the years ended December 31, 2016 and 2015, respectively. Prepaid advertising costs were $0.2 million at December 31, 2016 and 2015, respectively.
Shipping and Handling Costs
Shipping and handling costs for merchandise shipped to customers of $1.7 million and $0.2 million for the years ended December 31, 2016 and 2015, respectively, are included in selling, general and administrative expenses within the accompanying consolidated statements of operations and comprehensive (loss) income.
Stock‑Based Compensation
The cost of all employee stock‑based compensation awards is measured based on the grant date fair value of those awards and recorded as compensation expense over the period during which the employee is required to perform service in exchange for the award (generally over the vesting period of the award). The cost of all non-employee stock‑based compensation awards is measured based on the grant date fair value of those awards and revalued each reporting period, and is recorded as compensation expense over the service period. An entity may elect either an accelerated recognition method or a straight‑line recognition method for awards subject to graded vesting based on a service condition, regardless of how the fair value of the award is measured. For all stock based compensation awards that contain graded vesting based on service conditions, the Company has elected to apply a straight‑line recognition method to account for these awards.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Until the RG Merger on January 28, 2016, the Company was treated as a partnership for tax purposes. Pursuant to this status, taxable income or loss of the Company is included in the income tax returns of its owners. Consequently, no federal income tax provision is recorded through the RG Merger date. However, under state laws, certain taxes are imposed upon limited liability companies and are provided for through the RG Merger date.
Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The likelihood of a material change in the expected realization of these assets depends on the Company’s ability to generate sufficient future taxable income. The ability to generate enough taxable income to utilize the deferred tax assets depends on many factors, among which is the Company’s ability to deduct tax loss carry‑forwards against future taxable income, the effectiveness of tax planning strategies and reversing deferred tax liabilities.
The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based upon the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based upon the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. The Company’s policy is to recognize interest and penalties that would be assessed in relation to the settlement value of unrecognized tax benefits as a component of income tax expense within the accompanying consolidated statements of operations and comprehensive (loss) income.
Comprehensive (Loss) Income
Comprehensive (loss) income represents the change in equity resulting from transactions other than stockholder investments and distributions. Accumulated other comprehensive loss includes changes in equity that are excluded from net (loss) income, specifically, unrealized gains and losses on foreign currency translation adjustments and is presented within the consolidated statements of equity. The Company presents the components of comprehensive (loss) income within the consolidated statements of operations and comprehensive (loss) income.
Foreign Currency Translation
The Company’s wholly owned direct foreign operations present their financial reports in the currency used in the economic environment in which they mainly operate, known as the functional currency. The functional currency consists of the Norwegian Krone for operations in Norway. Assets and liabilities in foreign subsidiaries are translated into U.S. dollars at the exchange rate as of the balance sheet date, while revenues and expenses are translated using the average monthly exchange rate. Gains and losses from these foreign currency translation adjustments are recognized within accumulated other comprehensive loss within the accompanying consolidated statements of equity.
Earnings per Share
Basic earnings per share, or EPS, is computed using the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period except for periods of net loss for which no common share equivalents are included because their effect would be anti‑dilutive. Dilutive common equivalent shares consist of common stock issuable upon exercise of stock options, restricted stock and restricted stock units using the treasury stock method. Dilutive common stock equivalent shares issuable upon conversion of the convertible notes are calculated using the if‑converted method. EPS has been adjusted to reflect the Reverse Stock Split.
The Company calculates basic and diluted earnings per common share using the two-class method. Under the two-class method, net earnings are allocated to each class of common stock and participating security as if all of the net earnings for the period had been distributed. Our participating securities consist of convertible preferred shares that contain a nonforfeitable right to receive dividends and therefore are considered to participate in undistributed earnings with common stockholders.
Concentration of Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents, accounts receivable and factor accounts receivable. The Company maintains cash and cash equivalents with various financial institutions. The policy is designed to limit exposure to any one institution. Periodic evaluations are performed of the relative credit rating of those financial institutions that are considered in the Company’s investment strategy.
The Company does not require collateral for trade accounts receivable. However, the Company sells a portion of accounts receivable to CIT on a non‑recourse basis (see “Note 7 – Factored Accounts and Receivables”). In that instance, the Company is no longer at risk if the customer fails to pay. For accounts receivable that are not sold to CIT or are sold on a recourse basis, the Company continues to be at risk if these customers fail to pay. The Company provides an allowance for estimated losses to be incurred in the collection of accounts receivable based upon the aging of outstanding balances and other account monitoring analysis. The net carrying value approximates the fair value for these assets. Such losses have historically been within management’s expectations. Uncollectible accounts are written off once collection efforts are deemed by management to have been exhausted.
For the years ended December 31, 2016 and 2015, sales to customers or customer groups representing 10 percent or greater of net sales are as follows:
Year ended December 31,
2016
2015
Customer A
%
%
International sales were $9.4 million and $0.5 million for the years ended December 31, 2016 and 2015, respectively.
As of December 31, 2016 and 2015, customers representing 10 percent or greater of accounts receivable and factored accounts receivable are as follows:
As of December 31,
2016
2015
Customer A
%
%
Customer B
%
*
%
* Represents less than 10%
In addition, the Company primarily utilizes three manufacturing contractors in Mexico, the United States and India. Purchases from these three manufacturing contractors in the aggregate accounted for approximately 50% and 47% percent of our purchases for fiscal 2016 and 2015, respectively.
Fair Value of Financial Instruments
The fair value of financial instruments held (which consist of cash and cash equivalents, accounts receivable, factored accounts receivable, royalties receivable, accounts payable, and accrued expenses) do not differ materially from their recorded amounts because of the relatively short period of time between origination of the instruments and their expected realization. The carrying amounts of the line of credit and term loan approximate fair value because of the variable interest rates. The fair value of the convertible notes is based on the amount of future cash flows associated with the instrument discounted using the incremental borrowing rate, which are considered Level 2 liabilities.
The Company does not hold or have any obligations under financial instruments that possess off‑balance sheet credit or market risk.
Discontinued Operations
In accordance with the Financial Accounting Standards Board (“ FASB ”), Accounting Standards Codification (“ ASC ”), ASC 205-20, Presentation of Financial Statements – Discontinued Operations , the results of operations of a component of an entity or a group or component of an entity that represents a strategic shift that has, or will have, a major effect on the reporting company’s operations that has either been disposed of or is classified as held for sale are required to be reported as discontinued operations in a company’s consolidated financial statements. In order to be considered a discontinued operation, both the operations and cash flows of the discontinued component must have been (or will be) eliminated from the ongoing operations of the company and the company will not have any significant continuing involvement in the operations of the discontinued component after the disposal transaction. The accompanying consolidated financial statements reflect the results of operations of the Joe's Business as discontinued operations.
Financial Accounting Standards Recently Adopted
In August 2014, the FASB issued Accounting Standards Update (“ ASU ”) No. 2014-15 to communicate amendments to FASB Accounting Standards Codification Subtopic 205-40, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, or ASC amendments. The ASC amendments establish new requirements for management to evaluate a company's ability to continue as a going concern and to provide certain related disclosures. The ASC amendments are effective for the annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter. We adopted this standard as of December 31, 2016 and there was no material impact on our consolidated financial statements and related disclosures.
In July 2015, FASB issued ASU No. 2015-11, Inventory (Topic 330) - Simplifying the Measurement of Inventory , which will require an entity to measure inventory at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. We adopted this standard in the first quarter of fiscal 2016 and there was no material impact on our consolidated financial statements and related disclosures.
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes , which will require entities to present deferred tax assets (“ DTAs ”) and deferred tax liabilities (“ DTLs ”) as noncurrent in a classified balance sheet. ASU No. 2015-17 simplifies the current guidance, which requires entities to separately present DTAs and DTLs as current and noncurrent in a classified balance sheet. We adopted this standard in the first quarter of fiscal 2016 and there was no material impact on our consolidated financial statements and related disclosures.
In April 2015, the FASB issued ASU No. 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs , which changes the presentation of debt issuance costs in financial statements. ASU No. 2015-03 requires an entity to present such costs on the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. The standard’s core principle is debt issuance costs related to a note shall be reported in the balance sheet as a direct deduction from the face amount of that note and that amortization of debt issuance costs also shall be reported as interest expense. We adopted this standard in the first quarter of fiscal 2016 and there was no material impact on our consolidated financial statements and related disclosures.
Recently Issued Financial Accounting Standards
In January 2017, the FASB issued ASU No. 2017-04, Intangibles —Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. Topic 350, Intangibles—Goodwill and Other (Topic 350) , currently requires an entity to perform a two-step test to determine the amount, if any, of goodwill impairment. ASU No. 2017-04 removes the second step of the test. An entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. The ASC amendments are effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) , which affects the accounting for leases. The guidance requires lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The amendment also will require qualitative and quantitative disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for fiscal years beginning after December 15, 2018 and interim periods within that reporting period. Early application is permitted. The Company is currently assessing the impact of the new standard on its consolidated financial statements, but anticipates an increase in assets and liabilities due to the recognition of the required right-of-use asset and corresponding liability for all lease obligations that are currently classified as operating leases, such as real estate leases for corporate headquarters, administrative offices, retail stores, and showrooms as well as additional disclosure on all our lease obligations. The income statement recognition of lease expense is not expected to significantly change from the current methodology.
In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements To Employee Share-Based Payment Accounting , which amends ASC Topic 718, relating to employee share-based payment accounting. This guidance simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within that reporting period. Early application is permitted. We have not yet adopted this ASU and are currently evaluating the impact it may have on our consolidated financial statements and related disclosures.
In April and March 2016, the FASB issued ASU No. 2016-10, Identifying Performance Obligations and Licensing , and ASU No. 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net) , respectively. ASU No. 2016-10 clarifies the implementation guidance on licensing and the identification of performance obligations considerations included in ASU No. 2014-09. ASU No. 2016-08 provides amendments to clarify the implementation guidance on principal versus agent considerations included in ASU No. 2014-09. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of ASU No. 2014-09. ASU No. 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The effective date of this pronouncement is for fiscal years beginning after December 15, 2017 with early adoption permitted as of the original effective date. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Customers with Contracts (Topic 606) Narrow-Scope Improvements and Practical Expedients . ASU No. 2016-12 amends certain aspects of ASU No. 2014-09, Revenue from Customers with Contracts (Topic 606) . The amendments include the following:
·
Collectibility – ASU No. 2016-12 clarifies the objective of the entity’s collectibility assessment and contains new guidance on when an entity would recognize as revenue consideration it receives if the entity concludes that collectibility is not probable.
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Presentation of sales tax and other similar taxes collected from customers – Entities are permitted to present revenue net of sales taxes collected on behalf of governmental authorities (i.e., to exclude from the transaction price sales taxes that meet certain criteria).
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Noncash consideration – An entity’s calculation of the transaction price for contracts containing noncash consideration would include the fair value of the noncash consideration to be received as of the contract inception date. Further, subsequent changes in the fair value of noncash consideration after contract inception would be subject to the variable consideration constraint only if the fair value varies for reasons other than its form.
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Contract modifications and completed contracts at transition – The ASU establishes a practical expedient for contract modifications at transition and defines completed contract |
