Washington, D.C. 20549
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date.
Common Stock, $.001 Par Value – 57,794,880 shares as of August 6, 2008.
Item 1. Financial Statements
See Notes to Unaudited Condensed Consolidated Financial Statements.
See Notes to Unaudited Condensed Consolidated Financial Statements.
See Notes to Unaudited Condensed Consolidated Financial Statements.
See Notes to Unaudited Condensed Consolidated Financial Statements.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management of Iconix Brand Group, Inc. ("Company"), all adjustments (consisting primarily of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months (“Current Quarter”) and the six months (“Current Six Months”) ended June 30, 2008 are not necessarily indicative of the results that may be expected for a full fiscal year.
Certain prior period amounts have been reclassified to conform to the current period’s presentation.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007 (“Fiscal 2007”).
Statement of Financial Accounting Standards (“SFAS”) No. 157 “Fair Value Measurements” (“SFAS No. 157”), which the Company adopted on January 1, 2008, establishes a framework for measuring fair value and requires expanded disclosures about fair value measurement. While SFAS No.157 does not require any new fair value measurements in its application to other accounting pronouncements, it does emphasize that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS No. 157 established the following fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs):
Level 1: Observable inputs such as quoted prices for identical assets or liabilities in active markets
Level 2: Other inputs that are observable directly or indirectly, such as quoted prices for similar assets or liabilities or market-corroborated inputs
Level 3: Unobservable inputs for which there is little or no market data and which requires the owner of the assets or liabilities to develop its own assumptions about how market participants would price these assets or liabilities
The Company relies on a combination of Level 1 inputs generated by market transactions of identical instruments and Level 3 inputs using an income approach, to determine the fair value of certain financial instruments. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of financial assets and financial liabilities and their placement within the fair value hierarchy. The following table summarizes the instruments measured at fair value at June 30, 2008:
In accordance with the provisions of FSP No. FAS 157-2, Effective Date of FASB Statement No. 157, the Company has elected to defer implementation of SFAS 157 as it relates to its non-financial assets and non-financial liabilities until January 1, 2009 and is evaluating the impact, if any, this standard will have on its financial statements.
Marketable securities, which are accounted for as available-for-sale, are stated at fair value in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS No. 115”) and consist of auction rate securities. Temporary changes in fair market value are recorded as other comprehensive income or loss, whereas other than temporary markdowns will be realized through the Company’s income statement.
As of June 30, 2008, the Company held auction rate securities with a face value of $13.0 million and a fair value of $10.7 million. Although these auction rate securities continue to pay interest according to their stated terms, during the Current Six Months the Company recorded an unrealized pre-tax loss of $0.3 million in other comprehensive loss as a reduction to stockholders’ equity to reflect a temporary decline in the fair value of the marketable securities reflecting failed auctions due to sell orders exceeding buy orders. The Company believes the decrease in fair value is temporary due to general macroeconomic market conditions, as the underlying securities have maintained their investment grade rating. These funds will not be available to the Company until a successful auction occurs or a buyer is found outside the auction process. As these instruments have failed to auction and may not auction successfully in the near future, the Company has classified its marketable securities as non-current. The following table summarizes the activity for the period:
On July 26, 2007, the Company purchased a hedge instrument to mitigate the cash flow risk of rising interest rates on the Term Loan Facility (see Note 4). This hedge instrument caps the Company’s exposure to rising interest rates at 6.00% for LIBOR for 50% of the forecasted outstanding balance of the Term Loan Facility (“Interest Rate Cap”). Based on management’s assessment, the Interest Rate Cap qualifies for hedge accounting under SFAS 133 “Accounting for Derivative Instruments and Hedging Transactions”. On a quarterly basis, the value of the hedge is adjusted to reflect its current fair value, with any adjustment flowing through other comprehensive income. The fair value of this instrument is calculated based on Level 1 inputs. At June 30, 2008, the fair value of the Interest Rate Cap was $71,000, resulting in an other comprehensive gain of $16,000 for the Current Six Months, which is reflected in the Unaudited Condensed Consolidated Balance Sheet and Statement of Stockholders’ Equity, respectively.
Amortization expense for intangible assets for the Current Six Months and the six months ended June 30, 2007 (“Prior Year Six Months”) was $3.7 million and $2.4 million, respectively. The trademarks of Candies®, Bongo®, Joe Boxer®, Rampage®, Mudd®, London Fog®, Mossimo®, Ocean Pacific®, Danskin®, Rocawear®, Cannon®, Royal Velvet®, Fieldcrest®, Charisma®, and Starter® have been determined to have an indefinite useful life and accordingly, consistent with SFAS No. 142, no amortization has been recorded in the Company's consolidated income statements. Instead, each of these intangible assets will be tested for impairment at least annually as separate single units of accounting, with any related impairment charge recorded to the statement of operations at the time of determining such impairment.
On June 20, 2007, the Company completed the issuance of $287.5 million principal amount of the Company's 1.875% convertible senior subordinated notes due 2012 (the “Convertible Notes”) in a private offering to certain institutional investors. The net proceeds received by the Company from the offering were approximately $281.1 million.
The Convertible Notes bear interest at an annual rate of 1.875%, payable semi-annually in arrears on June 30 and December 31 of each year, beginning December 31, 2007. The Convertible Notes will be convertible into cash and, if applicable, shares of the Company's common stock based on a conversion rate of 36.2845 shares of the Company's common stock, subject to customary adjustments, per $1,000 principal amount of the Convertible Notes (which is equal to an initial conversion price of approximately $27.56 per share) only under the following circumstances: (1) during any fiscal quarter beginning after September 30, 2007 (and only during such fiscal quarter), if the closing price of the Company's common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is more than 130% of the conversion price per share, which is $1,000 divided by the then applicable conversion rate; (2) during the five business day period immediately following any five consecutive trading day period in which the trading price per $1,000 principal amount of the Convertible Notes for each day of that period was less than 98% of the product of (a) the closing price of the Company's common stock for each day in that period and (b) the conversion rate per $1,000 principal amount of the Convertible Notes; (3) if specified distributions to holders of the Company's common stock are made, as set forth in the indenture governing the Convertible Notes (“Indenture”); (4) if a “change of control” or other “fundamental change,” each as defined in the Indenture, occurs; (5) if the Company chooses to redeem the Convertible Notes upon the occurrence of a “specified accounting change,” as defined in the Indenture; and (6) during the last month prior to maturity of the Convertible Notes. If the holders of the Convertible Notes exercise the conversion provisions under the circumstances set forth, the Company will need to remit the lower of the principal balance of the Convertible Notes or their conversion value to the holders in cash. As such, the Company would be required to classify the entire amount outstanding of the Convertible Notes as a current liability in the following quarter. The evaluation of the classification of amounts outstanding associated with the Convertible Notes will occur every quarter.
Upon conversion, a holder will receive an amount in cash equal to the lesser of (a) the principal amount of the Convertible Note or (b) the conversion value, determined in the manner set forth in the Indenture. If the conversion value exceeds the principal amount of the Convertible Note on the conversion date, the Company will also deliver, at its election, cash or the Company's common stock or a combination of cash and the Company's common stock for the conversion value in excess of the principal amount. In the event of a change of control or other fundamental change, the holders of the Convertible Notes may require the Company to purchase all or a portion of their Convertible Notes at a purchase price equal to 100% of the principal amount of the Convertible Notes, plus accrued and unpaid interest, if any. If a specified accounting change occurs, the Company may, at its option, redeem the Convertible Notes in whole for cash, at a price equal to 102% of the principal amount of the Convertible Notes, plus accrued and unpaid interest, if any. Holders of the Convertible Notes who convert their Convertible Notes in connection with a fundamental change or in connection with a redemption upon the occurrence of a specified accounting change may be entitled to a make-whole premium in the form of an increase in the conversion rate.
Pursuant to Emerging Issues Task Force (“EITF”) 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion” (“EITF 90-19”), EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock” (“EITF 00-19”), and EITF 01-6, “The Meaning of Indexed to a Company's Own Stock” (“EITF 01-6”), the Convertible Notes are accounted for as convertible debt in the accompanying Condensed Consolidated Balance Sheet and the embedded conversion option in the Notes has not been accounted for as a separate derivative. For a discussion of the effects of the Convertible Notes and the convertible note hedge and warrants discussed below on earnings per share, see Note 6.
At June 30, 2008, the balance of the Convertible Notes was $282.4 million. The Convertible Notes do not provide for any financial covenants.
In connection with the sale of the Convertible Notes, the Company entered into hedges for the Convertible Notes (“Convertible Note Hedges”) with respect to its common stock with two entities (the “Counterparties”). Pursuant to the agreements governing these Convertible Note Hedges, the Company has purchased call options (the “Purchased Call Options”) from the Counterparties covering up to approximately 10.4 million shares of the Company's common stock. These Convertible Note Hedges are designed to offset the Company's exposure to potential dilution upon conversion of the Convertible Notes in the event that the market value per share of the Company's common stock at the time of exercise is greater than the strike price of the Purchased Call Options (which strike price corresponds to the initial conversion price of the Convertible Notes and is simultaneously subject to certain customary adjustments). On June 20, 2007, the Company paid an aggregate amount of approximately $76.3 million of the proceeds from the sale of the Convertible Notes for the Purchased Call Options, of which $26.7 million was included in the balance of deferred income tax assets at June 30, 2007 and is being recognized over the term of the Convertible Notes. As of June 30, 2008, the balance of deferred income tax assets related to this transaction was $21.4 million.
The Company also entered into separate warrant transactions with the Counterparties whereby the Company, pursuant to the agreements governing these warrant transactions, sold to the Counterparties warrants (the “Sold Warrants”) to acquire up to 3.6 million shares of the Company's common stock, at a strike price of $42.40 per share of the Company's common stock. The Sold Warrants will become exercisable on September 28, 2012 and will expire by the end of 2012. The Company received aggregate proceeds of approximately $37.5 million from the sale of the Sold Warrants on June 20, 2007.
Pursuant to Emerging Issues Task Force (EITF) Issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” (EITF 00-19), and EITF Issue No. 01-06, “The Meaning of Indexed to a Company’s Own Stock” (EITF 01-06), the convertible note hedge and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in additional paid-in capital in stockholders’ equity as separate equity transactions. As a result of these transactions, the Company recorded a net reduction to additional paid-in-capital of $12.1 million in June 2007.
As the Convertible Note Hedge transactions and the warrant transactions were separate transactions entered into by the Company with the Counterparties, they are not part of the terms of the Convertible Notes and will not affect the holders' rights under the Convertible Notes. In addition, holders of the Convertible Notes will not have any rights with respect to the Purchased Call Options or the Sold Warrants.
If the market value per share of the Company's common stock at the time of conversion of the Convertible Notes is above the strike price of the Purchased Call Options, the Purchased Call Options entitle the Company to receive from the Counterparties net shares of the Company's common stock, cash or a combination of shares of the Company's common stock and cash, depending on the consideration paid on the underlying Convertible Notes, based on the excess of the then current market price of the Company's common stock over the strike price of the Purchased Call Options. Additionally, if the market price of the Company's common stock at the time of exercise of the Sold Warrants exceeds the strike price of the Sold Warrants, the Company will owe the Counterparties net shares of the Company's common stock or cash, not offset by the Purchased Call Options, in an amount based on the excess of the then current market price of the Company's common stock over the strike price of the Sold Warrants.
These transactions will generally have the effect of increasing the conversion price of the Convertible Notes to $42.40 per share of the Company's common stock, representing a 100% percent premium based on the last reported sale price of the Company’s common stock of $21.20 per share on June 14, 2007.
In connection with the acquisition of the Rocawear brand, in March 2007, the Company entered into a $212.5 million credit agreement (the “Credit Agreement” or “Term Loan Facility”) with Lehman Brothers Inc. and Lehman Commercial Paper Inc. (“LCPI”). At the time, the Company pledged to LCPI 100% of the capital stock owned by the Company in its subsidiaries, OP Holdings and Management Corporation, a Delaware corporation (“OPHM”), and Studio Holdings and Management Corporation, a Delaware corporation (“SHM”). The Company's obligations under the Credit Agreement are guaranteed by each of OPHM and SHM, as well as by two of its other subsidiaries, OP Holdings LLC, a Delaware limited liability company (“OP Holdings”), and Studio IP Holdings LLC, a Delaware limited liability company ("Studio IP Holdings").
On October 3, 2007, in connection with the acquisition of Official-Pillowtex LLC, a Delaware limited liability company (“Official-Pillowtex”), with the proceeds of the Convertible Notes, the Company pledged to LCPI 100% of the capital stock owned by the Company in Mossimo, Inc., a Delaware corporation (“MI”), and Pillowtex Holdings and Management Corporation, a Delaware corporation (“PHM”), each of which guaranteed the Company’s obligations under the Credit Agreement. Simultaneously with the acquisition of Official-Pillowtex, each of Mossimo Holdings LLC, a Delaware limited liability company (“Mossimo Holdings”), and Official-Pillowtex guaranteed the Company’s obligations under the Credit Agreement.
On December 17, 2007, in connection with the acquisition of the Starter brand, the Company borrowed $63.2 million pursuant to the Term Loan Facility (the “Additional Borrowing”). The net proceeds received by the Company from the Additional Borrowing were $60 million.
The guarantees are secured by a pledge to LCPI of, among other things, the Ocean Pacific, Danskin, Rocawear, Mossimo, Cannon, Royal Velvet, Fieldcrest, Charisma, and Starter trademarks and related intellectual property assets, license agreements and proceeds therefrom. Amounts outstanding under the Term Loan Facility bear interest, at the Company’s option, at the Eurodollar rate or the prime rate, plus an applicable margin of 2.25% or 1.25%, as the case may be, per annum. The Credit Agreement provides that the Company is required to repay the outstanding term loan in equal quarterly installments in annual aggregate amounts equal to 1.00% of the aggregate principal amount of the loans outstanding, subject to adjustment for prepayments, in addition to an annual payment equal to 50% of the excess cash flow from the subsidiaries subject to the Term Loan Facility, as described in the Credit Agreement, with any remaining unpaid principal balance to be due on April 30, 2013. The Term Loan Facility can be prepaid, without penalty, at any time. On March 11, 2008, the Company paid to LCPI, for the benefit of the lenders under the Term Loan Facility, $15.6 million, representing 50% of the excess cash flow from the subsidiaries subject to the Term Loan Facility for Fiscal 2007. As a result of such payment, the Company is no longer required to pay the quarterly installments described above. The Term Loan Facility requires the Company to repay the principal amount of the term loan outstanding in an amount equal to 50% of the excess cash flow of the subsidiaries subject to the Term Loan Facility for the most recently completed fiscal year. If the Term Loan Facility had required the Company to repay the principal amount of the term loan outstanding based on the excess cash flow of such subsidiaries for the six months ended June 30, 2008 rather than based upon the fiscal year end results, the Company would have been required to pay approximately $20.5 million, representing 50% of the excess cash flow of such subsidiaries for that six-month period. However, in accordance with the terms of the Term Loan Facility as noted above, the next calculation for determining the actual excess cash flow payment the Company will be required to make under the Term Loan Facility will be based on the results of the subsidiaries subject to the Term Loan Facility for the 12 months ending December 31, 2008. The interest rate as of June 30, 2008 was 5.06%. At June 30, 2008, the balance of the Term Loan Facility was $255.1 million. As of June 30, 2008, the Company was in compliance with all material covenants set forth in the Credit Agreement. The $272.5 million in proceeds from the Term Loan Facility were used by the Company as follows: $204.0 million was used to pay the cash portion of the initial consideration for the acquisition of the Rocawear brand; $2.1 million was used to pay the costs associated with the Rocawear acquisition; $60 million was used to pay the consideration for the acquisition of the Starter brand; and $3.9 million was used to pay costs associated with the Term Loan Facility. The costs of $3.9 million relating to the Term Loan Facility have been deferred and are being amortized over the life of the loan, using the effective interest method.
The financing for certain of the Company's acquisitions has been accomplished through private placements by its subsidiary, IP Holdings LLC ("IP Holdings") of asset-backed notes ("Asset-Backed Notes") secured by intellectual property assets (trade names, trademarks, license agreements and payments and proceeds with respect thereto relating to the Candie’s, Bongo, Joe Boxer, Rampage, Mudd and London Fog brands) of IP Holdings. At June 30, 2008, the balance of the Asset-Backed Notes was $127.5 million.
Cash on hand in the bank account of IP Holdings is restricted at any point in time up to the amount of the next debt principal and interest payment required under the Asset-Backed Notes. Accordingly, $1.3 million and $5.2 million as of June 30, 2008 and December 31, 2007, respectively, have been disclosed as restricted cash within the Company's current assets. Further, in connection with IP Holdings' issuance of Asset-Backed Notes, a reserve account has been established and the funds on deposit in such account will be applied to the last principal payment with respect to the Asset-Backed Notes. Accordingly, $15.9 million and $15.2 million as of June 30, 2008 and December 31, 2007, respectively, have been disclosed as restricted cash within other assets on the Company's balance sheets.
Interest rates and terms on the outstanding principal amount of the Asset-Backed Notes as of June 30, 2008 are as follows: $44.5 million principal amount bears interest at a fixed interest rate of 8.45% with a six year term, $19.7 million principal amount bears interest at a fixed rate of 8.12% with a six year term, and $63.3 million principal amount bears interest at a fixed rate of 8.99% with a six and a half year term. The Asset-Backed Notes have no financial covenants by which the Company or its subsidiaries need comply. The aggregate principal amount of the Asset-Backed Notes will be fully paid by February 22, 2013.
Neither the Company nor any of its subsidiaries (other than IP Holdings) is obligated to make any payment with respect to the Asset-Backed Notes, and the assets of the Company and its subsidiaries (other than IP Holdings) are not available to IP Holdings' creditors. The assets of IP Holdings are not available to the creditors of the Company or its subsidiaries (other than IP Holdings).
On April 23, 2002, the Company acquired the remaining 50% interest in Unzipped (see Note 7) from Sweet Sportswear, LLC (“Sweet”) for a purchase price comprised of 3,000,000 shares of its common stock and $11.0 million in debt, which was evidenced by the Company’s issuance of the 8% Senior Subordinated Note due in 2012 (“Sweet Note”). Prior to August 5, 2004, Unzipped was managed by Sweet pursuant to the Management Agreement (as defined in Note 7), which obligated Sweet to manage the operations of Unzipped in return for, commencing in fiscal 2003, an annual management fee based upon certain specified percentages of net income achieved by Unzipped during the three- year term of the agreement. In addition, Sweet guaranteed that the net income, as defined in the agreement, of Unzipped would be no less than $1.7 million for each year during the term, commencing with fiscal 2003. In the event that the guarantee was not met for a particular year, Sweet was obligated under the Management Agreement to pay the Company the difference between the actual net income of Unzipped, as defined, for such year and the guaranteed $1.7 million. That payment, referred to as the shortfall payment, could be offset against the amounts due under the Sweet Note at the option of either the Company or Sweet. As a result of such offsets, the balance of the Sweet Note was reduced by the Company to $3.1 million as of December 31, 2006 and $3.0 million as of December 31, 2005 and was reflected in Long- term debt. This note bears interest, which was accrued for in the Current Six Months, at the rate of 8% per year and matures in April 2012.
In November 2007, the Company received a signed judgment related to the Sweet Sportswear/Unzipped litigation. See Note 9.
The judgment stated that the Sweet Note (originally $11.0 million when issued by the Company upon the acquisition of Unzipped from Sweet in 2002) should total approximately $12.2 million as of December 31, 2007. The recorded balance of the Sweet Note, prior to any adjustments related to the judgment was approximately $3.2 million. The Company increased the Sweet Note by approximately $6.2 million and recorded the expense as a special charge. The Company further increased the Sweet Note by approximately $2.8 million to record the related interest and included the charge in interest expense. The Sweet Note as of June 30, 2008 is approximately $12.2 million and included in the current portion of long-term debt.
In addition, in November 2007 the Company was awarded a judgment of approximately $12.2 million for claims made by it against Hubert Guez and Apparel Distribution Services, Inc. As a result, the Company recorded a receivable of approximately $12.2 million and recorded the benefit in special charges in Fiscal 2007. This receivable is included in other assets - non-current and bears interest, which was accrued for in the Current Six Months, at the rate of 8% per year.
Debt Maturities
The Company's debt maturities are the following:
(000’s omitted) | | Total | | 2008 | | 2009 | | 2010 | | 2011 | | 2012 | | thereafter | |
| Convertible Notes | | $ | 282,361 | | $ | - | | $ | - | | $ | - | | $ | - | | $ | 282,361 | | $ | - | |
| Term Loan Facility | | | 255,144 | | | - | | | - | | | - | | | - | | | - | | | 255,144 | |
| Asset-Backed Notes | | | 127,519 | | | 21,300 | | | 23,202 | | | 25,275 | | | 27,533 | | | 30,209 | | | - | |
| Sweet Note | | | 12,186 | | | 12,186 | | | - | | | - | | | - | | | - | | | - | |
| Total Debt | | $ | 677,210 | | $ | 33,486 | | $ | 23,202 | | $ | 25,275 | | $ | 27,533 | | $ | 312,570 | | $ | 255,144 | |
5. Stockholders' Equity
Stock Options
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The fair value for these options and warrants was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:
| Expected Volatility | | | .30 - .50 | |
| Expected Dividend Yield | | | 0 | % |
| Expected Life (Term) | | | 3 - 7 years | |
| Risk-Free Interest Rate | | | 3.00 - 4.75 | % |
The options that were granted under the Plans expire at various times, either five, seven or ten years from the date of grant, depending on the particular grant.
Summaries of the Company's stock options, warrants and performance related options activity, and related information for the Current Quarter are as follows:
| | | Options | | Weighted- Average Exercise Price | |
| | | | | | |
| Outstanding January 1, 2008 | | | 5,106,543 | | $ | 4.23 | |
| Granted | | | - | | | - | |
| Canceled | | | - | | | - | |
| Exercised | | | 418,905 | | | 4.24 | |
| Expired | | | - | | | - | |
| Outstanding June 30, 2008 | | | 4,687,638 | | | 4.23 | |
| Exercisable at June 30, 2008 | | | 4,651,304 | | | 4.18 | |
| | | Warrants | | Weighted- Average Exercise Price | |
| | | | | | |
| Outstanding January 1, 2008 | | | 266,900 | | $ | 16.76 | |
| Granted | | | - | | | - | |
| Canceled | | | - | | | - | |
| Exercised | | | - | | | - | |
| Expired | | | - | | | - | |
| Outstanding June 30, 2008 | | | 266,900 | | $ | 16.76 | |
| Exercisable at June 30, 2008 | | | 266,900 | | $ | 16.76 | |
All warrants issued in connection with acquisitions are recorded at fair market value using the Black Scholes model and are recorded as part of purchase accounting. Certain warrants are exercised using the cashless method.
The Company values other warrants issued to non-employees at the commitment date at the fair market value of the instruments issued, a measure which is more readily available than the fair market value of services rendered, using the Black Scholes model. The fair market value of the instruments issued is expensed over the vesting period.
Restricted stock
Compensation cost for restricted stock is measured as the excess, if any, of the quoted market price of the Company’s stock at the date the common stock is issued over the amount the employee must pay to acquire the stock (which is generally zero). The compensation cost, net of projected forfeitures, is recognized over the period between the issue date and the date any restrictions lapse, with compensation cost for grants with a graded vesting schedule recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. The restrictions do not affect voting and dividend rights.
The Company has granted restricted stock-based awards to certain employees. The awards have restriction periods tied to employment and vest over a period of up to five years. The cost of the restricted stock-based awards, which is the fair market value on the date of grant net of estimated forfeitures, is expensed ratably over the vesting period. During the Current Six Months, the Company awarded an aggregate of 1,658,698 restricted stock-based awards, of which 315,116 are performance based. During the Prior Year Six Months, the Company awarded an aggregate of 68,383 restricted stock-based awards. The securities awarded during the Current Six Months and the Prior Year Six Months have a vesting period of up to five years and a fair market value of approximately $32.9 million and $1.4 million, respectively. As of June 30, 2008, 64,368 restricted stock-based awards had vested.
Unearned compensation expense related to restricted securities grants for the Current Six Months and the Prior Year Six Months was approximately $4.3 million and $0.4 million, respectively. An additional amount of $26.9 million is expected to be expensed evenly over a period of approximately three months to five years.
The following tables summarize information about unvested restricted securities transactions:
| | | Securities | | Weighted Average Grant Date Fair Value | |
| Non-vested, January 1, 2008 | | | 144,127 | | $ | 19.41 | |
| Granted | | | 1,658,698 | | | 19.86 | |
| Vested | | | (64,368 | ) | | 18.99 | |
| Forfeited | | | - | | | - | |
| Non-vested, June 30, 2008 | | | 1,738,457 | | $ | 19.85 | |
Stockholder Rights Plan
In January 2000, the Company's Board of Directors adopted a stockholder rights plan. Under the plan, each holder of common stock received a dividend of one right for each share of the Company's outstanding common stock, entitling the holder to purchase one thousandth of a share of Series A Junior Participating Preferred Stock, par value, $0.01 per share of the Company, at an initial exercise price of $6.00. The rights become exercisable and will trade separately from the common stock ten business days after any person or group acquires 15% or more of the common stock, or ten business days after any person or group announces a tender offer for 15% or more of the outstanding common stock.
Stock Repurchase Program
On September 15, 1998, the Company's Board of Directors authorized the repurchase of up to two million shares of the Company's common stock, which was replaced with a new agreement on December 21, 2000, authorizing the repurchase of up to three million shares of the Company's common stock. During the Current Quarter, no shares were repurchased in the open market.
Securities Available for Issuance
As of June 30, 2008, the number of securities remaining available for issuance under the Company’s 2001, 2002 and 2006 equity compensation plans, excluding securities to be issued upon exercise of outstanding options, warrants, and rights, is 51,750, 32,274, and 138,465, respectively.
6. Earnings Per Share
Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of restricted stock-based awards and common shares issuable upon exercise of stock options and warrants. The difference between basic and diluted weighted-average common shares results from the assumption that all dilutive stock options outstanding were exercised and all convertible notes have been converted into common stock.
As of June 30, 2008, of the total potentially dilutive shares related to restricted stock-based awards, stock options and warrants, 1.9 million were anti-dilutive. As of June 30 2007, 3.6 million warrants to purchase common stock shares were anti-dilutive, and no restricted stock-based awards or stock options were anti-dilutive.
As of June 30, 2008, of the performance related restricted stock-based awards issued in connection with the Company’s new employment agreement with its chairman, chief executive officer and president, 1.2 million of such awards (which is included in the total 1.9 million anti-dilutive stock-based awards described above) were anti-dilutive and therefore not included in this calculation.
Warrants issued in connection with the Company’s Convertible Notes financing were anti-dilutive and therefore not included in this calculation. Portions of the convertible note that would be subject to conversion to common stock were anti-dilutive as of June 30, 2008 and therefore not included in this calculation.
A reconciliation of shares used in calculating basic and diluted earnings per share follows:
| | | For the Three | | For the Six | |
| | | Months Ended | | Months Ended | |
| (000's omitted) | | June 30, | | June 30, | |
| | | 2008 | | 2007 | | 2008 | | 2007 | |
| Basic | | | 57,719 | | | 56,625 | | | 57,572 | | | 56,451 | |
| Effect of exercise of stock options | | | 3,416 | | | 4,589 | | | 3,585 | | | 4,715 | |
| Effect of contingent common stock issuance | | | 144 | | | - | | | 144 | | | - | |
| Effect of assumed vesting of restricted stock | | | - | | | 150 | | | 14 | | | 75 | |
| | | | - | | | - | | | - | | | - | |
| Diluted | | | 61,279 | | | 61,364 | | | 61,315 | | | 61,241 | |
7. Unzipped Apparel, LLC (“Unzipped”)
On October 7, 1998, the Company formed Unzipped with its then joint venture partner Sweet Sportswear, LLC (“Sweet”), the purpose of which was to market and distribute apparel under the Bongo label. The Company and Sweet each had a 50% interest in Unzipped. Pursuant to the terms of the joint venture, the Company licensed the Bongo trademark to Unzipped for use in the design, manufacture and sale of certain designated apparel products.
On April 23, 2002, the Company acquired the remaining 50% interest in Unzipped from Sweet for a purchase price of three million shares of the Company's common stock and $11 million in debt evidenced by the Sweet Note. See Note 4. In connection with the acquisition of Unzipped, the Company filed a registration statement with the Securities and Exchange Commission ("SEC") for the three million shares of the Company's common stock issued to Sweet, which was declared effective by the SEC on July 29, 2003.
Prior to August 5, 2004, Unzipped was managed by Sweet pursuant to a management agreement (the “Management Agreement”). Unzipped also had a supply agreement with Azteca Productions International, Inc. ("Azteca") and a distribution agreement with Apparel Distribution Services, LLC ("ADS"). All of these entities are owned or controlled by Hubert Guez.
On August 5, 2004, Unzipped terminated the Management Agreement with Sweet, the supply agreement with Azteca and the distribution agreement with ADS and commenced a lawsuit against Sweet, Azteca, ADS and Hubert Guez. See Note 9.
There were no transactions with these related parties during the Current Six Months and the Prior Year Six Months.
In November 2007, a judgment was entered in the Unzipped litigation, pursuant to which the $3.1 million in accounts payable to ADS/Azteca (previously shown as “accounts payable - subject to litigation”) was eliminated and recorded in the income statement as a benefit to the “expenses related to specific litigation”.
As a result of the judgment, in Fiscal 2007 the balance of the $11.0 million principal amount Sweet Note, originally issued by the Company upon the acquisition of Unzipped from Sweet in 2002, including interest, was increased from approximately $3.2 million to approximately $12.2 million as of December 31, 2007. Of this increase, approximately $6.2 million was attributed to the principal of the Sweet Note and the expense was recorded as an expense related to specific litigation. The remaining $2.8 million of the increase was attributed to related interest on the Sweet Note and recorded as interest expense. As of June 30, 2008, the full $12.2 million current balance of the Sweet Note and $0.7 million of accrued interest are included in the current portion of long term debt and accounts payable and accrued expenses, respectively.
In addition, in November 2007 the Company was awarded a judgment of approximately $12.2 million for claims made by it against Hubert Guez and ADS. As a result, the Company recorded a receivable of approximately $12.2 million and recorded the benefit in special charges for Fiscal 2007. As of June 30, 2008, this receivable and the associated accrued interest of $0.4 million for the Current Six Months are included in other assets - non-current.
8. Expenses Related to Specific Litigation
Expenses related to specific litigation consist of legal expenses and costs related to the Unzipped litigation. For the Current Six Months and Prior Year Six Months, the Company recorded expenses related to specific litigation of $0.4 million and $1.1 million, respectively. See Note 7 for information relating to Unzipped.
9. Commitments and Contingencies
Sweet Sportswear/Unzipped litigation
On August 5, 2004, the Company, along with its subsidiaries, Unzipped, Michael Caruso & Co., referred to as Caruso, and IP Holdings, collectively referred to as the plaintiffs, commenced a lawsuit in the Superior Court of California, Los Angeles County, against Unzipped's former manager, former supplier and former distributor, Sweet, Azteca and ADS, respectively, and a principal of these entities and former member of the Company's board of directors, Hubert Guez, collectively referred to as the Guez defendants. The Company pursued numerous causes of action against the Guez defendants, including breach of contract, breach of fiduciary duty, trademark infringement and others and sought damages in excess of $20 million. On March 10, 2005, Sweet, Azteca and ADS, collectively referred to as cross-complainants, filed a cross-complaint against the Company claiming damages resulting from a variety of alleged contractual breaches, among other things.
In January 2007, a jury trial was commenced, and on April 10, 2007, the jury returned a verdict of approximately $45 million in favor of the Company and its subsidiaries, finding in favor of the Company and its subsidiaries on every claim that they pursued, and against the Guez defendants on every counterclaim asserted. Additionally, the jury found that all of the Guez defendants acted with malice, fraud or oppression with regard to each of the tort claims asserted by the Company and its subsidiaries, and on April 16, 2007, awarded plaintiffs $5 million in punitive damages against Mr. Guez personally. The Guez defendants filed post-trial motions seeking, among other things, a new trial. Through a set of preliminary rulings dated September 27, 2007, the Court granted in part, and denied in part, the Guez defendants’ post trial motions, and denied plaintiffs’ request that the Court enhance the damages awarded against the Guez defendants arising from their infringement of plaintiffs’ trademarks. Through these rulings, the Court, among other things, reduced the amount of punitive damages assessed against Mr. Guez to $4 million, and reduced the total damages awarded against the Guez defendants by approximately 50%.
The Court adopted these preliminary rulings as final on November 16, 2007. On the same day, the Court entered judgment against Mr. Guez in the amount of $10,964,730 and ADS in the amount of $1,272,420, and against each of the Guez defendants with regard to each and every claim that they pursued in the litigation including, without limitation, ADS’s and Azteca’s unsuccessful efforts to recover against Unzipped any account balances claimed to be owed, totaling approximately $3.5 million including interest (collectively, the “Judgments”). In entering the Judgments, the Court upheld the jury’s verdict in favor of the Company relating to its write-down of the senior subordinated note due 2012, issued by the Company to Sweet in connection with the Company’s acquisition of Unzipped for Unzipped’s 2004 fiscal year. The monetary portion of the Judgments accrues interest at a rate of 10% per annum from the date of the Judgments’ entry. Also on November 16, 2007, the Court issued a Memorandum Order wherein it upheld an aggregate of approximately $7,000,000 of the jury’s verdicts against Sweet and Azteca, but declined to enter judgment against these entities since it had ordered a new trial with regard to certain other damage awards entered against these entities by the jury.
On March 7, 2008, the Court commenced a hearing with regard to plaintiffs’ petition seeking in excess of $15.0 million attorneys’ fees and costs, which hearing was concluded on April 18, 2008. By order dated May 6, 2008, the Court awarded plaintiffs certain statutory costs against the Guez defendants. The Court also determined that plaintiffs were entitled to pursue recovery of their non-statutory costs, comprised primarily of expert witness fees, incurred in connection with this action. The hearing with regard to plaintiffs’ recovery of non-statutory costs is scheduled to be conducted on August 7 and 8, 2008. The Company expects the Court to render a decision with regard to the pending requests for attorneys’ fees and non-statutory costs following the conclusion of this hearing.
On November 21, 2007, the Guez defendants filed a notice of appeal. They also filed a $49,090,491 undertaking with the Court, consisting primarily of a $43,380,491 personal surety given jointly by Gerard Guez and Jacqueline Rose Guez, bonding the monetary portions of the Judgments. By Order dated December 17, the Court determined that the undertaking was adequate absent changed circumstances. This determination serves to prevent the Company and its subsidiaries from pursuing collection of the monetary portions of the Judgments during the pendency of the appeal. The Company and its subsidiaries filed a notice of appeal on November 26, 2007, appealing, among other things, those parts of the jury’s verdicts vacated by the Court in connection with the Guez defendants’ post-trial motions. The Company and its subsidiaries intend to vigorously pursue their appeal, and vigorously defend against the Guez parties’ appeal.
Bader/Unzipped litigation
This lawsuit was settled and discontinued with prejudice on March 25, 2008. The lawsuit was commenced on November 5, 2004, when Unzipped filed a complaint in the Supreme Court of New York, New York County, against Unzipped's former president of sales, Gary Bader, alleging that Mr. Bader breached certain fiduciary duties owed to Unzipped as its president of sales, unfairly competed with Unzipped and tortiously interfered with Unzipped's contractual relationships with its employees. On October 5, 2005, Unzipped amended its complaint to assert identical claims against Bader's company, Sportswear Mercenaries, Ltd. On October 14, 2005, Bader and Sportswear Mercenaries filed an answer containing counterclaims to Unzipped's amended complaint, and a third-party complaint, which was dismissed in its entirety on June 9, 2006, except with respect to a single claim that it owed Bader and Sportswear Mercenaries $72,000.
Redwood Shoe litigation
This litigation, which was commenced in January 2002, by Redwood Shoe Corporation (“Redwood”), one of the Company's former buying agents of footwear, was dismissed with prejudice by the court on February 15, 2007, pursuant to an agreement in principle by the Company, Redwood, its affiliate, Mark Tucker, Inc. (“MTI”) and MTI's principal, Mark Tucker, to settle the matter. The proposed settlement agreement provides for the Company to pay a total of $1.9 million to Redwood. The stipulation and order dismissing the action may be reopened should the settlement agreement not be finalized and consummated by all of the parties. The Company is awaiting receipt of the signed Settlement Agreement from the other parties.
Bongo Apparel, Inc. litigation
On or about June 12, 2006, Bongo Apparel, Inc. (“BAI”), filed suit in the Supreme Court of the State of New York, County of New York, against the Company and IP Holdings alleging certain breaches of contract and other claims and seeks, among other things, damages of at least $25 million. The Company and IP Holdings believe that, in addition to other defenses that they asserted, the claims in the lawsuit are the subject of a release and settlement agreement that was entered into by the parties in August 2005, and based upon this belief, moved to dismiss most of BAI’s claims. In response to the motion to dismiss, BAI made a cross-motion for partial summary judgment on some of its claims. On April 25, 2007, the Court entered an order refusing to consider, and declining to accept BAI's summary judgment motion. On January 2, 2008, the Supreme Court granted the Company’s and IP Holdings’ motion to dismiss BAI’s lawsuit virtually in its entirety, holding that all but one claim against the Company and five claims against IP Holdings were barred by the parties’ August 2005 release and settlement agreement or otherwise failed to state a claim. As to the sole remaining claim against the Company, BAI has since withdrawn it against both the Company and IP Holdings and, as such, the Company is no longer a party to this action. BAI has appealed the Supreme Court’s January 2, 2008 rulings, and the Company and IP Holdings intend to vigorously defend against this appeal.
Additionally, on or about October 6, 2006, the Company and IP Holdings filed suit in the United States (“U.S.”) District Court for the Southern District of New York against BAI and its guarantor, TKO Apparel, Inc. (“TKO”). In that complaint, the Company and IP Holdings asserted various contract, tort and trademark claims that arose as a result of the failures of BAI with regard to the Bongo men's jeanswear business and its wrongful conduct with regard to the Bongo women's jeanswear business. The Company and IP Holdings sought monetary damages in an amount in excess of $10 million and a permanent injunction with respect to the use of the Bongo trademark. On January 4, 2007, the District Court denied the motion of BAI and TKO to dismiss the federal court action, and instead stayed the proceeding. On January 14, 2008, the Company and IP Holdings requested that the District Court lift the stay, and on March 1, 2008 the stay was lifted.
On March 7, 2008, the Company and IP Holdings filed an amended complaint, reiterating all of the claims that were asserted in the original complaint and seeking damages identical to those sought by the original complaint. Additionally, the amended complaint contains three fraudulent transfer claims predicated upon BAI’s and TKO’s dissipation of their assets, as well as claims for civil conspiracy and aiding and abetting arising from this conduct. On March 28, 2008, BAI and TKO filed a motion to dismiss the amended complaint in its entirety. By opinion and order dated July 8, 2008, the District Court granted BAI’s/TKO’s motion to the extent that it sought dismissal of the Company’s and IP Holding’s claim for breach of the duty of due care, and denied the motion in all other respects. The Company also voluntarily withdrew two trademark claims that it had asserted against BAI and TKO. IP Holdings is continuing to pursue these claims.
On July 14, 2008, the Company and IP Holdings filed a motion with the District Court seeking leave to file a second amended complaint. The contemplated second amended complaint seeks to join James Tate, Kenneth Tate, TKO-Evolution Apparel, Inc., TKO-Globetex Apparel, Inc., Tate Management, Inc., TKO Apparel Licensing, Inc. and TKO Evolution Licensing #1, Inc., as defendants in the action due to the involvement of these individuals and entities in the dissipation of BAI’s and TKO’s assets. The contemplated second amended complaint also seeks to add a claim for breach of fiduciary duty against James Tate and Kenneth Tate. This motion is currently pending. The Company and IP Holdings intend to vigorously pursue this litigation.
Normal Course litigation
From time to time, the Company is also made a party to litigation incurred in the normal course of business. While any litigation has an element of uncertainty, the Company believes that the final outcome of any of these routine matters will not have a material effect on the Company’s financial position or future liquidity.
10. Related Party Transactions
On May 1, 2003, the Company granted Kenneth Cole Productions, Inc. the exclusive worldwide license to design, manufacture, sell, distribute and market footwear under its Bongo brand. The chief executive officer and chairman of Kenneth Cole Productions is Kenneth Cole, who is the brother of Neil Cole, the Company's chairman, chief executive officer and president. During the Current Six Months and Prior Year Six Months, the Company earned $0.6 million and $0.5 million, respectively, in royalties from Kenneth Cole Productions.
The Candie's Foundation, a charitable foundation founded by Neil Cole for the purpose of raising national awareness about the consequences of teenage pregnancy, owed the Company $0.5 million and $0.4 million at June 30, 2008 and December 31, 2007, respectively, which is included in prepaid advertising and other on the unaudited condensed consolidated balance sheet. The Candie's Foundation intends to pay-off the entire borrowing from the Company during 2008, although additional advances will be made as and when necessary. Mr. Cole’s wife, Elizabeth Cole, performs services for the foundation but receives no compensation.
The Company recorded expenses of approximately $199,000 for the Current Six Months for the hire and use of aircraft owned by a company in which the Company’s chairman, chief executive officer and president is the sole owner. There were no such expenses in the Prior Year Six Months. Management believes that all transactions were made on terms and conditions similar to those available in the marketplace from unrelated parties.
11. Segment Data
The Company has one reportable segment, licensing revenue generated from its brands. The geographic regions consist of the United States and Other (which principally represents Canada, Japan and Europe). Long lived assets are substantially all located in the United States. Revenues attributed to each region are based on the location in which licensees are located.
The revenues by type of license and information by geographic region are as follows:
| | | For the three months ended | | For the six months ended | |
| (000's omitted) | | June 30, | | June 30, | |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| Revenues by product line: | | | | | | | | | | | | | |
| Direct-to-retail license | | $ | 13,902 | | $ | 12,341 | | $ | 29,774 | | $ | 26,516 | |
| Wholesale license | | | 37,191 | | | 26,201 | | | 76,411 | | | 42,389 | |
| Other | | | 607 | | | 529 | | | 1,182 | | | 1,007 | |
| | | $ | 51,700 | | $ | 39,071 | | $ | 107,367 | | $ | 69,912 | |
| | | | | | | | | | | | | | |
| Revenues by geographic region: | | | | | | | | | | | | | |
| United States | | $ | 47,956 | | $ | 36,594 | | $ | 100,792 | | $ | 65,586 | |
| Other | | | 3,744 | | | 2,477 | | | 6,575 | | | 4,326 | |
| | | $ | 51,700 | | $ | 39,071 | | $ | 107,367 | | $ | 69,912 | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. The statements that are not historical facts contained in this report are forward looking statements that involve a number of known and unknown risks, uncertainties and other factors, all of which are difficult or impossible to predict and many of which are beyond the control of the Company, which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. These risks are detailed in the Company’s Form 10-K for the fiscal year ended December 31, 2007 and other SEC filings. The words “believe”, “anticipate,” “expect”, “confident”, “project”, provide “guidance” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date the statement was made.
Executive Summary. The Company is a brand management company engaged in licensing, marketing and providing trend direction for a diversified and growing portfolio of consumer brands. The Company’s brands are sold across every major segment of retail distribution, from luxury to mass. As of June 30, 2008, the Company owned 16 iconic consumer brands: Candie’s, Bongo, Badgley Mischka, Joe Boxer, Rampage, Mudd, London Fog, Mossimo, Ocean Pacific/OP, Danskin, Rocawear, Cannon, Royal Velvet, Fieldcrest, Charisma, and Starter. The Company licenses its brands worldwide through approximately 220 direct-to-retail and traditional wholesale licenses for use in connection with a broad variety of product categories, including footwear, fashion accessories, sportswear, home products and décor, and beauty and fragrance. The Company’s business model allows it to focus on its core competencies of marketing and managing brands without many of the risks and investment requirements associated with a more traditional operating company. Its licensing agreements with leading retail and wholesale partners throughout the world provide the Company with a predictable stream of guaranteed minimum royalties.
The Company’s growth strategy is focused on increasing licensing revenue from its existing portfolio of brands through the addition of new product categories, expanding its brands’ retail penetration and optimizing the sales of its licensees. The Company will also seek to continue the international expansion of its brands by partnering with leading licensees throughout the world. Finally, the Company believes it will continue to acquire iconic consumer brands with applicability to a wide range of merchandise categories and an ability to further diversify its brand portfolio.
Results of Operations
For the three months ended June 30, 2008
Revenue. Revenue for the Current Quarter increased to $51.7 million from $39.1 million during the Prior Year Quarter. The primary driver of this growth of $12.6 million was a full quarter of revenue generated from the acquisitions of the Official-Pillowtex brands (i.e. Cannon, Royal Velvet, Fieldcrest, Charisma) and Starter made during the fourth quarter of Fiscal 2007, which had no comparable revenue in the Prior Year Quarter.
Operating Expenses. Selling, general and administrative (“SG&A”) expenses totaled $18.3 million in the Current Quarter compared to $9.0 million in the Prior Year Quarter. The increase of $9.3 million was primarily related to: (i) an increase of approximately $3.3 million in advertising mainly driven by increased advertising related to brands acquired in the fourth quarter of Fiscal 2007, with no comparable advertising expense in the Prior Year Quarter; (ii) an increase of approximately $3.5 million in payroll costs, primarily due to an increase of $1.6 million in non-cash stock compensation expense, from $0.5 million in the Prior Year Quarter to $2.1 million in the Current Quarter, of which $1.3 million of the increase related to the new employment contract with our chairman, chief executive officer and president, with the balance of the aggregate increase in payroll costs attributable to the increase in employee headcount mainly related to our 2007 acquisitions; and (iii) amortization of intangible assets (mainly contracts and non-competes) as a direct result of the Mossimo, Ocean Pacific, Danskin, Rocawear and the Official-Pillowtex brands acquisitions accounted for $2.0 million in the Current Quarter and $1.5 million in the Prior Year Quarter. The remaining increase in SG&A of $2.0 million is primarily attributed to an increase in other general and administrative expenses associated with the Danskin, Rocawear, Official-Pillowtex, and Starter acquisitions.
For the Current Quarter and Prior Year Quarter, the Company’s expenses related to specific litigation (formerly called special charges), included an expense for professional fees of $0.2 million and $0.3 million, respectively, relating to litigation involving Unzipped. See Notes 7 and 8 of Notes to Unaudited Condensed Consolidated Financial Statements.
Operating Income. Operating income for the Current Quarter increased to $33.2 million, or approximately 64% of total revenue, compared to $29.7 million or approximately 76% of total revenue in the Prior Year Quarter. The decrease in our operating margin percentage is primarily the result of the increase in operating expenses for the reasons detailed above.
Interest Expense - Net - Interest expense increased by $0.6 million in the Current Quarter to $8.5 million, compared to interest expense of $7.9 million in the Prior Year Quarter. This increase was due primarily to an increase in the Company’s debt financing arrangements in connection with the acquisitions of Official-Pillowtex and Starter, as well as interest related to the Sweet Note, offset by a decrease in the interest rate for our variable rate debt (i.e. our Term Loan Facility) and interest income related to our judgment against Herbert Guez and ADS. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements. Deferred financing costs increased by $0.5 million in the Current Quarter to $0.8 million from $0.3 million in the Prior Year Quarter due to additional financing obtained in Fiscal 2007.
Provision for Income Taxes. The effective income tax rate for the Current Quarter is approximately 35.6% resulting in the $9.1 million income tax expense, as compared to an effective income tax rate of 35.2% in the Prior Year Quarter which resulted in the $8.0 million income tax expense.
Net Income. The Company’s net income was $16.5 million in the Current Quarter, compared to net income of $14.8 million in the Prior Year Quarter, as a result of the factors discussed above.
For the six months ended June 30, 2008
Revenue. Revenue for the Current Six Months increased to $107.4 million from $70.0 million during the Prior Year Six Months. The driver of this growth of $37.4 million was two full quarters of revenue generated from the acquisitions of Rocawear and Danskin, as compared to only one quarter of revenue from these brands in the Prior Year Six Months, and two full quarters of revenue generated from the acquisitions of the Official-Pillowtex brands and Starter made during the fourth quarter of 2007, which had no comparable revenue in the Prior Year Six Months.
Operating Expenses. SG&A expenses totaled $37.0 million in the Current Six Months compared to $16.7 million in the Prior Year Six Months. The increase of $20.3 million was primarily related to: (i) an increase of approximately $6.9 million in advertising mainly driven by increased advertising related to brands acquired in Fiscal 2007, with no comparable advertising expense in the Prior Year Six Months; (ii) an increase of approximately $7.5 million in payroll costs, primarily due to an increase of $3.4 million in non-cash stock compensation expense, from $0.8 million in the Prior Year Six Months to $4.2 million in the Current Six Months, of which $2.7 million of the increase related to the new employment contract with our chairman, chief executive officer and president, with the balance of the aggregate increase in payroll costs attributable to the increase in employee headcount mainly related to our 2007 acquisitions; and (iii) amortization of intangible assets (mainly contracts and non-competes) as a direct result of the Mossimo, Ocean Pacific, Danskin, Rocawear and the Official-Pillowtex brands acquisitions accounted for $3.7 million in the Current Six Months and $2.4 million in the Prior Year Six Months. The remaining increase in SG&A of $5.3 million is primarily attributed to an increase in other general and administrative expenses associated with the Danskin, Rocawear, Official-Pillowtex, and Starter acquisitions.
For the Current Six Months and Prior Year Six Months, the Company’s expenses related to specific litigation, formerly known as special charges, included an expense for professional fees of $0.4 million and $1.1 million, respectively, relating to litigation involving Unzipped. See Notes 7 and 8 of Notes to Unaudited Condensed Consolidated Financial Statements.
Operating Income. Operating income for the Current Six Months increased to $70.0 million, or approximately 65% of total revenue, compared to $52.1 million or approximately 75% of total revenue in the Prior Year Six Months. The decrease in our operating margin percentage is primarily the result of the increase in operating expenses for the reasons detailed above.
Interest Expense - Net - Interest expense increased by $7.2 million in the Current Six Months to $18.6 million, compared to interest expense of $11.4 million in the Prior Year Six Months. This increase was due primarily to an increase in the Company’s debt financing arrangements in connection with the acquisitions of Rocawear, Official-Pillowtex and Starter, as well as interest related to the Sweet Note, offset by a decrease in interest rates for our variable rate debt (i.e. our Term Loan Facility) and interest income related to our judgment against Herbert Guez and ADS. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements. Specifically, for the Current Six Months, there was a total interest expense relating to the Term Loan Facility, Convertible Notes and the Sweet Note of approximately $8.2 million, $2.7 million and $0.5 million respectively with no comparable interest expense in the Prior Year Six Months. Deferred financing costs increased by $1.0 million in the Current Six Months to $1.5 million from $0.5 million in the Prior Year Six Months due to additional financing obtained in Fiscal 2007.
Provision for Income Taxes. The effective income tax rate for the Current Six Months is approximately 35.5% resulting in the $19.1 million income tax expense, as compared to an effective income tax rate of 35.3% in the Prior Year Six Months which resulted in the $15.0 million income tax expense.
Net Income. The Company’s net income was $34.7 million in the Current Six Months, compared to net income of $27.5 million in the Prior Year Six Months, as a result of the factors discussed above.
Liquidity and Capital Resources
Liquidity
The Company’s principal capital requirements have been to fund acquisitions, working capital needs, and to a lesser extent capital expenditures. The Company has historically relied on internally generated funds to finance its operations and its primary source of capital needs for acquisition have been the issuance of debt and equity securities. At June 30, 2008 and December 31, 2007, the Company’s cash totaled $67.3 million and $53.3 million, respectively, including short-term restricted cash of $1.3 million and $5.2 million, respectively.
The Term Loan Facility requires the Company to repay the principal amount of the term loan outstanding in an amount equal to 50% of the excess cash flow of the subsidiaries subject to the Term Loan Facility for the most recently completed fiscal year. If the Term Loan Facility had required the Company to repay the principal amount of the term loan outstanding based on the excess cash flow of such subsidiaries for the six months ended June 30, 2008 rather than based upon the fiscal year end results, the Company would have been required to pay approximately $20.5 million, representing 50% of the excess cash flow of such subsidiaries for that six-month period. However, in accordance with the terms of the Term Loan Facility as noted above, the next calculation for determining the actual excess cash flow payment the Company will be required to make under the Term Loan Facility will be based on the results of the subsidiaries subject to the Term Loan Facility for the 12 months ending December 31, 2008.
The Company believes that cash from future operations as well as currently available cash will be sufficient to satisfy its anticipated working capital requirements for the foreseeable future. The Company intends to continue financing its brand acquisitions through a combination of cash from operations, bank financing and the issuance of additional equity and/or debt securities. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements for a description of certain prior financings consummated by the Company and its subsidiaries.
As of June 30, 2008, the Company’s marketable securities consist of investment grade auction rate securities. During Fiscal 2007, the Company invested $196.4 million in auction rate securities and the majority of these securities ($183.4 million) had successful auctions. However, beginning in the third quarter of Fiscal 2007, $13.0 million of the auction rate securities had failed auctions due to sell orders exceeding buy orders. These funds will not be available to the Company until a successful auction occurs or a buyer is found outside the auction process. As a result, $13.0 million of auction rate securities were written down to $10.7 million, using Level 3 inputs with present value techniques as described by the fair value hierarchy and the income approach outlined in SFAS 157, as an unrealized pre-tax loss of $2.3 million to reflect a temporary decrease in fair value. As the write-down of $2.3 million has been identified as a temporary decrease in fair value, the write-down has not impacted the Company’s earnings and is reflected as an other comprehensive loss in the consolidated statement of stockholders’ equity. The Company believes this decrease in fair value is temporary due to general macroeconomic market conditions, as the underlying securities have maintained their investment grade rating. Furthermore, the Company believes its cash flow from future operations and its cash will be sufficient to satisfy its anticipated working capital requirements for the foreseeable future, regardless of the timeliness of the auction process.
Changes in Working Capital
At June 30, 2008 and December 31, 2007 the working capital ratio (current assets to current liabilities) was 2.32 to 1 and 1.25 to 1, respectively. This increase was driven by an increase in cash as well as the factors set forth below:
Operating Activities
Net cash provided by operating activities totaled $37.6 million in the Current Six Months, as compared to $36.4 million of net cash provided by operating activities in the Prior Year Six Months. Cash provided by operating activities in the Current Six Months increased primarily due to net income of $34.7 million, stock-based compensation expense of $4.4 million, amortization of intangibles of $3.7 million, and a net increase of $11.3 million in deferred income taxes primarily related to the provision for income taxes for the Current Six Months, offset primarily by increases of $8.7 million in prepaid advertising and other and $6.9 million in accounts receivable, and a decrease of $4.0 million in deferred revenue. The Company continues to rely upon cash generated from licensing operations to finance its operations.
Investing Activities
Net cash used in investing activities in the Current Six Months totaled $5.1 million, as compared to $473.1 million used in the Prior Year Six Months. In the Prior Year Six Months, the Company paid $71.0 million in cash for certain assets related to the Danskin brand, $205.5 million in cash for certain assets related to the Rocawear brand, and $196.4 million for the purchase of certain marketable securities. Capital expenditures for the Current Six Months were $4.1 million, compared to less than $0.1 million in capital expenditures in the Prior Year Six Months, primarily relating to the purchase of fixtures for certain brands.
Financing Activities
Net cash used in financing activities was $14.6 million in the Current Six Months, compared with $443.0 million of net cash provided by financing activities in the Prior Year Six Months. Of the $14.6 million in net cash used in financing activities, $25.6 million was used for principal payments related to the Asset-Backed Notes and the Term Loan Facility. This was offset by $1.1 million from net proceeds in connection with the exercise of stock options and warrants, $6.8 million from excess tax benefit from share-based payment arrangements, and a net decrease of $3.2 million in total restricted cash.
Other Matters
Summary of Critical Accounting Policies.
Several of the Company's accounting policies involve management judgments and estimates that could be significant. The policies with the greatest potential effect on the Company's consolidated results of operations and financial position include the estimate of reserves to provide for collectability of accounts receivable. The Company estimates the collectability considering historical, current and anticipated trends related to deductions taken by customers and markdowns provided to retail customers to effectively flow goods through the retail channels, and the possibility of non-collection due to the financial position of its licensees' customers. Due to the licensing model, the Company has eliminated its inventory risk and reduced its operating risks, and can now reasonably forecast revenues and plan expenditures based upon guaranteed royalty minimums.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. 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. The Company reviews all significant estimates affecting the financial statements on a recurring basis and records the effect of any adjustments when necessary.
In connection with its licensing model, the Company has entered into various trademark license agreements that provide revenues based on minimum royalties and additional revenues based on a percentage of defined sales. Minimum royalty revenue is recognized on a straight-line basis over each period, 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.
In June 2001, the Financial Accounting Standards Board, or FASB, issued SFAS No. 142, "Goodwill and Other Intangible Assets," (“SFAS No. 142”) which changed the accounting for goodwill from an amortization method to an impairment-only approach. Upon the Company's adoption of SFAS No. 142 on February 1, 2002, the Company ceased amortizing goodwill. As prescribed under SFAS No. 142, the Company had goodwill tested for impairment during the years ended December 31, 2007, 2006 and 2005, and no impairments were necessary.
Impairment losses are recognized for long-lived assets, including certain intangibles, used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are not sufficient to recover the assets carrying amount. Impairment losses are measured by comparing the fair value of the assets to their carrying amount.
Effective January 1, 2006, we adopted SFAS No. 123(R), “Accounting for share-based payment,” which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. Under SFAS No. 123(R), using the modified prospective method, compensation expense is recognized for all share-based payments granted prior to, but not yet vested as of, January 1, 2006. Prior to the adoption of SFAS No.123 (R), we accounted for our stock-based compensation plans under the recognition and measurement principles of accounting principles board, or APB, Opinion No. 25, “Accounting for stock issued to employees,” and related interpretations. Accordingly, the compensation cost for stock options had been measured as the excess, if any, of the quoted market price of our common stock at the date of the grant over the amount the employee must pay to acquire the stock. In accordance with the modified prospective transition method, our consolidated financial statements have not been restated to reflect the impact of SFAS No.123(R). The impact on our financial condition and results of operations from the adoption of SFAS No. 123(R) will depend on the number and terms of stock options granted in future years under the modified prospective method, the amount of which we cannot currently estimate.
The Company accounts for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes” (“SFAS No. 109”). Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. In determining the need for a valuation allowance, management reviews both positive and negative evidence pursuant to the requirements of SFAS No. 109, including current and historical results of operations, the annual limitation on utilization of net operating loss carry forwards pursuant to Internal Revenue Code section 382, future income projections and the overall prospects of the Company's business. Based upon management's assessment of all available evidence, including the Company's completed transition into a licensing business, estimates of future profitability based on projected royalty revenues from its licensees, and the overall prospects of the Company's business, management concluded in Fiscal 2007 that it is more likely than not that the net deferred income tax asset recorded as of December 31, 2006 will be realized.
The Company adopted FIN 48 beginning January 1, 2007. The implementation of FIN 48 did not have a significant impact on the Company’s financial position or results of operations. The total unrecognized tax benefit was $1.1 million at the date of adoption. At June 30, 2008, the total unrecognized tax benefit was $1.1 million. However, the liability is not recognized for accounting purposes because the related deferred tax asset has been fully reserved in prior years. The Company is continuing its practice of recognizing interest and penalties related to income tax matters in income tax expense. There was no accrual for interest and penalties related to uncertain tax positions for the Current Six Months. The Company files federal and state tax returns and is generally no longer subject to tax examinations for fiscal years prior to 2003.
Marketable securities, which are accounted for as available-for-sale, are stated at fair value in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and consist of auction rate securities. Temporary changes in fair market value are recorded as other comprehensive income or loss, whereas other than temporary markdowns will be realized through the Company’s statement of operations. On January 1, 2008, the Company adopted SFAS No. 157, which establishes a framework for measuring fair value and requires expanded disclosures about fair value measurement. While SFAS No.157 does not require any new fair value measurements in its application to other accounting pronouncements, it does emphasize that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation.
In May 2008 the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) APB 14-1 “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlements)” (previously FSP APB 14-a), which will change the accounting treatment for convertible securities that the issuer may settle fully or partially in cash. Under the final FSP, cash-settled convertible securities will be separated into their debt and equity components. The value assigned to the debt component will be the estimated fair value, as of the issuance date, of a similar debt instrument without the conversion feature. As a result, the debt will be recorded at a discount to adjust its below-market coupon interest rate to the market coupon interest rate for the similar debt instrument without the conversion feature. The difference between the proceeds for the convertible debt and the amount reflected as the debt component represents the value of the conversion feature and will be recorded as additional paid-in capital. The debt will subsequently be accreted to its par value over its expected life, with an offsetting increase in interest expense on the income statement to reflect the market rate for the debt component at the date of issuance.
Beginning with fiscal 2009, and applied retrospectively to all past periods presented, the Company will be required to adopt the provisions of FSP APB 14-1 as they relate to the Convertible Notes. As compared to the current accounting for the Convertible Notes, adoption of the proposal will reduce long-term debt, increase stockholders’ equity, and reduce net income and earnings per share. Adoption of the proposal would not affect the Company's cash flows. The Company is currently evaluating the impact of the adoption of FSP APB 14-1 on its financial statements.
Seasonal and Quarterly Fluctuations.
The majority of the products manufactured and sold under the Company’s brands and licenses are for apparel, accessories, footwear and home products and decor, for which sales may vary as a result of holidays, weather, and the timing of product shipments. Accordingly, a portion of the Company’s revenue from its licensees, particularly from those mature licensees that are performing and actual sales royalties exceed minimum royalties, may be subject to seasonal fluctuations. The results of operations in any quarter therefore will not necessarily be indicative of the results that may be achieved for a full fiscal year or any future quarter.
Other Factors
We continue to seek to expand and diversify the types of licensed products being produced under our various brands, as well as diversify the distribution channels within which licensed products are sold, in an effort to reduce dependence on any particular retailer, consumer or market sector. The success of the Company, however, will still remain largely dependent on our ability to build and maintain brand awareness and contract with and retain key licensees and on our licensees’ ability to accurately predict upcoming fashion trends within their respective customer bases and fulfill the product requirements of their particular retail channels within the global marketplace. Unanticipated changes in consumer fashion preferences, slowdowns in the U.S. economy, changes in the prices of supplies, consolidation of retail establishments, and other factors noted in “Part II - Item 1A-Risk Factors,” could adversely affect our licensees’ ability to meet and/or exceed their contractual commitments to us and thereby adversely affect our future operating results
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company limits exposure to foreign currency fluctuations by requiring substantially all of its revenue to be paid in U.S. dollars.
The Company is exposed to potential loss due to changes in interest rates. Investments with interest rate risk include marketable securities. Debt with interest rate risk includes the fixed and variable rate debt. As of June 30, 2008, the Company had approximately $255.1 million in variable interest debt under its Term Loan Facility. See Note 4 of the Notes to Unaudited Condensed Consolidated Financial Statements for further explanation. To mitigate interest rate risks, the Company is utilizing derivative financial instruments such as interest rate hedges to convert certain portions of the Company’s variable rate debt to fixed interest rates.
The Company invested in certain investment grade auction rate securities. During the Current Six Months, our balance of auction rate securities failed to auction due to sell orders exceeding buy orders. These funds will not be available to us until a successful auction occurs or a buyer is found outside the auction process. As a result, $10.9 million of auction rate securities were written down to $10.7 million as an unrealized pre-tax loss of $0.2 million to reflect a temporary decrease in fair value. The Company believes this decrease in fair value is temporary due to general macroeconomic market conditions, as the underlying securities have maintained their investment grade rating. As the write-down of approximately $0.2 million has been identified as a temporary decrease in fair value, the write-down did not impact our earnings and is reflected as an other comprehensive loss in the consolidated statement of stockholders’ equity. The cumulative effect of the failure to auction since the third quarter of Fiscal 2007 has resulted in an accumulated other comprehensive loss of $2.3 million which is reflected in the Stockholders’ equity section of the Unaudited Condensed Consolidated Balance Sheet.
In connection with the initial sale of convertible notes, the Company entered into convertible note hedge transactions with affiliates of Merrill Lynch and Lehman Brothers, which hedging transactions are expected, but are not guaranteed, to eliminate the potential dilution upon conversion of the convertible notes. At the same time, the Company entered into sold warrant transactions with the hedge counterparties. In connection with such transactions, the hedge counterparties entered into various over-the-counter derivative transactions with respect to the Company’s common stock and purchased the Company’s common stock; and they may enter into or unwind various over-the-counter derivatives and/or purchase or sell the Company’s common stock in secondary market transactions in the future. Such activities could have the effect of increasing, or preventing a decline in, the price of our common stock. Such effect is expected to be greater in the event we elect to settle converted notes entirely in cash. The hedge counterparties are likely to modify their hedge positions from time to time prior to conversion or maturity of the convertible notes or termination of the transactions by purchasing and selling shares of our common stock, other of our securities, or other instruments they may wish to use in connection with such hedging. In particular, such hedging modification may occur during any conversion reference period for a conversion of notes. In addition, we intend to exercise options we hold under the convertible note hedge transactions whenever notes are converted and we have elected, with respect to such conversion, to pay a portion of the consideration then due by us to the noteholder in shares of our common stock. In order to unwind their hedge positions with respect to those exercised options, the hedge counterparties will likely sell shares of our common stock in secondary market transactions or unwind various over-the-counter derivative transactions with respect to our common stock during the conversion reference period for the converted notes. The effect, if any, of any of these transactions and activities on the trading price of our common stock will depend in part on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the value of our common stock. Also, the sold warrant transaction could have a dilutive effect on our earnings per share to the extent that the price of our common stock exceeds the strike price of the warrants.
Item 4. Controls and Procedures
The Company, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. The purpose of disclosure controls is to ensure that information required to be disclosed in our reports filed with or submitted to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to ensure that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC filings and ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms.
The principal executive officer and principal financial officer also conducted an evaluation of internal control over financial reporting (“Internal Control”) to determine whether any changes in Internal Control occurred during the quarter ended June 30, 2008 that may have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no change in the Company’s Internal Control during the quarter ended June 30, 2008 that has materially affected, or is reasonably likely to affect, the Company’s Internal Control.
PART II. Other Information
Item 1. Legal Proceedings
See Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements.
Item 1A. Risk Factors.
In addition to the risk factors disclosed in Part 1, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2007, set forth below are certain factors that have affected, and in the future could affect, our operations or financial condition. We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could impact our operations. The risks described below and in our Annual Report on Form 10-K for the year ended December 31, 2007 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our financial condition and/or operating results.
Our existing and future debt obligations could impair our liquidity and financial condition, and in the event we are unable to meet our debt obligations we could lose title to our trademarks.
As of June 30, 2008, we had consolidated debt of approximately $677.2 million, including secured debt of $382.6 million ($255.1 million under our Term Loan Facility and $127.5 million under Asset-Backed Notes issued by our subsidiary, IP Holdings), primarily all of which was incurred in connection with our acquisition activities. We may also assume or incur additional debt, including secured debt, in the future in connection with, or to fund, future acquisitions. Our debt obligations:
| · | could impair our liquidity; |
| · | could make it more difficult for us to satisfy our other obligations; |
| · | require us to dedicate a substantial portion of our cash flow to payments on our debt obligations, which reduces the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements; |
| · | could impede us from obtaining additional financing in the future for working capital, capital expenditures, acquisitions and general corporate purposes; |
| · | impose restrictions on us with respect to future acquisitions; |
| · | make us more vulnerable in the event of a downturn in our business prospects and could limit our flexibility to plan for, or react to, changes in our licensing markets; and |
| · | place us at a competitive disadvantage when compared to our competitors who have less debt. |
While we believe that by virtue of the guaranteed minimum royalty payments due to us under our licenses we will generate sufficient revenues from our licensing operations to satisfy our obligations for the foreseeable future, in the event that we were to fail in the future to make any required payment under agreements governing our indebtedness or fail to comply with the financial and operating covenants contained in those agreements, we would be in default regarding that indebtedness. A debt default could significantly diminish the market value and marketability of our common stock and could result in the acceleration of the payment obligations under all or a portion of our consolidated indebtedness. In the case of our Term Loan Facility, it would enable the lenders to foreclose on the assets securing such debt, including the Ocean Pacific/OP, Danskin, Rocawear, Starter and Mossimo trademarks, as well as the trademarks acquired by us in connection with the Official-Pillowtex acquisition, and, in the case of IP Holdings’ Asset-Backed Notes, it would enable the holders of such notes to foreclose on the assets securing such notes, including the Candie’s, Bongo, Joe Boxer, Rampage, Mudd and London Fog trademarks.
A substantial portion of our licensing revenue is concentrated with a limited number of licensees such that the loss of any of such licensees could decrease our revenue and impair our cash flows.
Our licensees Target, Kohl's, Kmart were our four largest direct-to-retail licensees during the Current Six Months, representing approximately 15%, 5%,and 5%, respectively, of our total revenue for such periods. Our license agreement with Target grants it the exclusive U.S. license with respect to the Mossimo trademark for substantially all Mossimo-branded products for an initial term expiring in January 2010, and our other license agreement with Target grants it the exclusive U.S. license with respect to our Fieldcrest trademark for substantially all Fieldcrest-branded products for an initial term expiring in July 2010; our license agreement with Kohl's grants it the exclusive U.S. license with respect to the Candie's trademark for a wide variety of product categories for a term expiring in January 2011; and, our license agreement with Kmart grants it the exclusive U.S. license with respect to the Joe Boxer trademark for a wide variety of product categories for a term expiring in December 2010. Because we are dependent on these licensees for a significant portion of our licensing revenue, if any of them were to have financial difficulties affecting its ability to make guaranteed payments, or if any of these licensees decides not to renew or extend its existing agreement with us, our revenue and cash flows could be reduced substantially. For example, as of September 2006, Kmart had not approached the sales levels of Joe Boxer products needed to trigger royalty payments in excess of its guaranteed minimums since 2004, and, as a result, when we entered into the current license agreement with Kmart in September 2006 expanding its scope to include Sears stores and extending its term from December 2007 to December 2010, we agreed to reduce the guaranteed annual royalty minimums by approximately half, as a result of which our revenues from this license were substantially reduced.
We have a material amount of goodwill and other intangible assets, including our trademarks, recorded on our balance sheet. As a result of changes in market conditions and declines in the estimated fair value of these assets, we may, in the future, be required to write down a portion of this goodwill and other intangible assets and such write-down would, as applicable, either decrease our net income or increase our net loss.
As of June 30, 2008, goodwill represented approximately $130.6 million, or approximately 10% of our total assets, and trademarks and other intangible assets represented approximately $1,034.9 million, or approximately 76.% of our total assets. Under SFAS No. 142, goodwill and indefinite life intangible assets, including some of our trademarks, are no longer amortized, but instead are subject to impairment evaluation based on related estimated fair values, with such testing to be done at least annually. While, to date, no impairment write-downs have been necessary, any write-down of goodwill or intangible assets resulting from future periodic evaluations would, as applicable, either decrease our net income or increase our net loss and those decreases or increases could be material.
Changes in the accounting method for convertible debt securities will, when adopted by us, have an adverse impact on our reported or future financial results.
For the purpose of calculating diluted earnings per share, a convertible debt security providing for net share settlement of the excess of the conversion value over the principal amount, if any, and meeting specified requirements under Emerging Issues Task Force, or EITF, Issue No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion,” such as our convertible notes, is accounted for similar to non-convertible debt, with the stated coupon constituting interest expense and any shares issuable upon conversion of the security being accounted for under the treasury stock method. The effect of the treasury stock method in relation to our Convertible Notes is that the shares potentially issuable upon conversion of the Convertible Notes are not included in the calculation of our diluted earnings per share until the conversion price is “in the money,” at which time we are assumed to have issued the number of shares of common stock necessary to settle.
In May 2008 the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) APB 14-1 “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlements)” (previously FSP APB 14-a), which will change the accounting treatment for convertible securities that the issuer may settle fully or partially in cash. Under the final FSP, cash-settled convertible securities will be separated into their debt and equity components. The value assigned to the debt component will be the estimated fair value, as of the issuance date, of a similar debt instrument without the conversion feature. As a result, the debt will be recorded at a discount to adjust its below-market coupon interest rate to the market coupon interest rate for the similar debt instrument without the conversion feature. The difference between the proceeds for the convertible debt and the amount reflected as the debt component represents the value of the conversion feature and will be recorded as additional paid-in capital. The debt will subsequently be accreted to its par value over its expected life, with an offsetting increase in interest expense on the income statement to reflect the market rate for the debt component at the date of issuance.
Beginning with fiscal 2009, and applied retrospectively to all past periods presented, we will be required to adopt the provisions of FSP APB 14-1 as they relate to our Convertible Notes. As compared to our current accounting for our Convertible Notes, adoption of the proposal will reduce long-term debt, increase stockholders’ equity, and reduce net income and earnings per share. Adoption of the proposal would not affect our cash flows. We are currently evaluating the impact of the adoption of FSP APB 14-1 on our financial statements.
At the time FSP APB 14-1 is implemented we will, pursuant to the terms of the indenture governing our outstanding Convertible Notes, have the right for a period of 90 days thereafter, at our option, to call the Convertible Notes for redemption. However, although we will have such redemption right, we may not have sufficient cash to pay, or may not be permitted to pay, the required cash portion of the consideration that would be due to holders of the convertible notes in the event we elected to exercise such right or the ability to raise funds through debt or equity financing within the time period required for us to make such an election.
Due to the recent downturn in the market, certain of the marketable securities we own may take longer to auction than initially anticipated, if at all.
Marketable securities consist of investment grade auction rate securities. From the third quarter of 2007 to the present, our balance of auction rate securities failed to auction due to sell orders exceeding buy orders. These funds will not be available to us until a successful auction occurs or a buyer is found outside the auction process. As a result, $13.0 million of auction rate securities were written down to $10.7 million, based on our analysis, as an unrealized pre-tax loss to reflect a temporary decrease in fair value, reflected as an accumulated other comprehensive loss of $2.3 million in the stockholders’ equity section of our unaudited condensed consolidated balance sheet. We believe this decrease in fair value is temporary due to general macroeconomic market conditions, as the underlying securities have maintained their investment grade rating. There are no assurances that a successful auction will occur, or that we can find a buyer outside the auction process.
A decline in general economic conditions resulting in a decrease in consumer-spending levels and an inability to access capital may adversely affect our business.
Many economic factors beyond our control may impact our forecasts and actual performance. These factors include consumer confidence, consumer spending levels, employment levels, availability of consumer credit, recession, deflation, inflation, a general slowdown of the U.S. economy or an uncertain economic outlook. Furthermore, changes in the credit and capital markets, including market disruptions, limited liquidity and interest rate fluctuations, may increase the cost of financing or restrict our access to potential sources of capital for future acquisitions.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The following table represents information with respect to purchases of common stock made by the Company during the three months ended June 30, 2008:
Month of purchase | | Total number of shares purchased(1) | | Average price paid per share | | Total number of shares purchased as part of publicly announced plans or programs | | Maximum dollar value of shares that may yet be purchased under the plans or programs | |
| April 1 - April 30, 2008 | | | 6,908 | | $ | 19.10 | | $ | - | | $ | - | |
| May 1 – May 31, 2008 | | | 1,267 | | $ | 20.52 | | $ | - | | $ | - | |
| June 1 - June 30, 2008 | | | - | | $ | - | | $ | - | | $ | - | |
| Total | | | 8,175 | | $ | 19.32 | | $ | — | | $ | — | |
(1) | | Represents shares of common stock surrendered to the Company to pay employee withholding taxes due upon the vesting of restricted stock. |
Item 4. Submission of Matters to a Vote of Security Holders
At the Company’s Annual Meeting of Stockholders held on May 15, 2008, the stockholders of the Company voted on proposals to: (i) elect the seven individuals named below to serve as Directors of the Company, (ii) approve an amendment to the Company’s 2006 Equity Incentive Plan to increase the number of shares of common stock that the Company has authority to issue under the plan by 1.5 million shares, (iii) approve the Company’s Executive Incentive Bonus Plan and to (iv) ratify the appointment of BDO Seidman, LLP as the Company’s independent registered public accountants for the fiscal year ending December 31, 2008.
1) The votes cast by stockholders with respect to the election of Directors (all of whom were elected) were as follows:
| Director | | Votes Cast "For" | | Votes Withheld | |
| Neil Cole | | | 50,159,030 | | | 2,615,754 | |
| Barry Emmanuel | | | 49,871,564 | | | 2,903,220 | |
| Steven Mendelow | | | 50,091,256 | | | 2,683,528 | |
| Drew Cohen | | | 48,269,295 | | | 4,505,489 | |
| F. Peter Cuneo | | | 50,092,566 | | | 2,682,218 | |
| Mark Freidman | | | 50,081,164 | | | 2,693,620 | |
| James A. Marcum | | | 50,251,641 | | | 2,523,143 | |
2) The votes cast by stockholders with respect to the amendment to the Company’s 2006 Equity Incentive Plan (which was not approved) were as follows:
Votes Cast "For" | | Votes Cast Against | | Votes "Abstaining" | |
| | 23,113,514 | | | 24,587,951 | | | 125,437 | |
In addition, there were 4,947,882 “broker non-votes” with respect to this proposal.
3) The votes cast by stockholders with respect to the approval of the Company’s Executive Incentive Bonus Plan (which was approved) were as follows:
Votes Cast "For" | | Votes Cast Against | | Votes "Abstaining" | |
| | 42,627,527 | | | 5,058,200 | | | 141,175 | |
In addition, there were 4,947,882 “broker non-votes” with respect to this proposal .
4) The votes cast by stockholders with respect to the ratification of the appointment of BDO Seidman, LLP were as follows:
Votes Cast "For" | | Votes Cast Against | | Votes "Abstaining" | |
| | 52,618,602 | | | 136,298 | | | 19,884 | |
Item 6. Exhibits
| EXHIBIT NO. | | DESCRIPTION OF EXHIBIT |
| | | |
| Exhibit 10.1 | | Iconix Brand Group, Inc. Executive Incentive Bonus Plan (1)* |
| | | |
| Exhibit 10.2 | | Agreement dated May 2008 between the Company and Neil Cole* |
| | | |
| Exhibit 31.1 | | Certification of Chief Executive Officer Pursuant To Rule 13a-14 or 15d-14 of The Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 Of The Sarbanes-Oxley Act of 2002 |
| | | |
| Exhibit 31.2 | | Certification of Chief Financial Officer Pursuant To Rule 13a-14 or 15d-14 of The Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 Of The Sarbanes-Oxley Act of 2002 |
| | | |
| Exhibit 32.1 | | Certification of Chief Executive Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002 |
| | | |
| Exhibit 32.2 | | Certification of Chief Financial Officer Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002 |
| (1) Incorporated by reference to Annex B to the Company’s Definitive Proxy Statement on Schedule 14A filed with the SEC on April 7, 2008. |
| * Denotes management compensation plan or arrangement. |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | Iconix Brand Group, Inc. (Registrant) |
| | |
| Date: August 6, 2008 | /s/ Neil Cole |
| | Neil Cole Chairman of the Board, President and Chief Executive Officer (on Behalf of the Registrant) |
| Date: August 6, 2008 | /s/ Warren Clamen |
| | Warren Clamen Chief Financial Officer |
