Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended May 31, 2014

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number:  0-18926

 

JOE’S JEANS INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

11-2928178

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

2340 South Eastern Avenue, Commerce, California

 

90040

(Address of principal executive offices)

 

(Zip Code)

 

(323) 837-3700

(Registrant’s telephone number, including area code)

 

NO CHANGE

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes          o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). x  Yes          o No

 

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

 

Large accelerated filer o

 

Accelerated filer x

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of shares of the registrant’s common stock outstanding as of July 10, 2014 was 69,186,577.

 

 

 



Table of Contents

 

JOE’S JEANS INC.

 

QUARTERLY REPORT ON FORM 10-Q

 

 

 

Page

 

 

 

PART I.

FINANCIAL INFORMATION

1

 

 

 

Item 1.

Financial Statements

1

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

24

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

42

 

 

 

Item 4.

Controls and Procedures

42

 

 

 

PART II.

OTHER INFORMATION

43

 

 

 

Item 1.

Legal Proceedings

43

 

 

 

Item 1A.

Risk Factors

43

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

Item 3.

Defaults upon Senior Securities

43

 

 

 

Item 4.

Mine Safety Disclosure

43

 

 

 

Item 5.

Other Information

44

 

 

 

Item 6.

Exhibits

45

 

 

 

 

SIGNATURES

46

 



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1.                   Financial Statements.

 

JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 

 

 

May 31, 2014

 

November 30, 2013

 

 

 

(unaudited)

 

 

 

ASSETS

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

424

 

$

785

 

Accounts receivable, net

 

4,829

 

4,621

 

Due from factor

 

26,838

 

31,434

 

Inventories, net

 

58,240

 

52,670

 

Deferred income taxes, net

 

3,114

 

3,114

 

Prepaid expenses and other current assets

 

2,708

 

2,178

 

Total current assets

 

96,153

 

94,802

 

 

 

 

 

 

 

Property and equipment, net

 

6,463

 

7,393

 

Goodwill

 

34,230

 

33,812

 

Intangible assets

 

81,943

 

83,110

 

Deferred financing costs

 

1,821

 

2,031

 

Other assets

 

1,817

 

1,875

 

 

 

 

 

 

 

Total assets

 

$

222,427

 

$

223,023

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities

 

 

 

 

 

Accounts payable and accrued expenses

 

$

23,086

 

$

26,436

 

Line of credit

 

23,741

 

17,673

 

Contingent consideration buy-out payable-short term

 

3,133

 

3,072

 

Promissory tax note issued

 

 

1,235

 

Total current liabilities

 

49,960

 

48,416

 

 

 

 

 

 

 

Long term debt

 

58,944

 

58,840

 

Convertible notes

 

23,449

 

27,912

 

Deferred income taxes, net

 

17,420

 

16,202

 

Contingent consideration buy-out payable-long term

 

1,629

 

3,230

 

Deferred rent

 

2,632

 

2,404

 

Other liabilities

 

250

 

250

 

Total liabilities

 

154,284

 

157,254

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Common stock, $0.10 par value: 100,000 shares authorized, 69,519 shares issued and 68,995 outstanding (2014) and 68,878 shares issued and 68,549 outstanding (2013)

 

6,954

 

6,890

 

Additional paid-in capital

 

110,309

 

107,933

 

Accumulated deficit

 

(45,802

)

(45,963

)

Treasury stock, 524 shares (2014), 329 shares (2013)

 

(3,318

)

(3,091

)

Total stockholders’ equity

 

68,143

 

65,769

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

222,427

 

$

223,023

 

 

The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

 

JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

 

 

 

Three months ended

 

Six months ended

 

 

 

May 31, 2014

 

May 31, 2013

 

May 31, 2014

 

May 31, 2013

 

 

 

(unaudited)

 

(unaudited)

 

Net sales

 

$

48,167

 

$

30,874

 

$

95,511

 

$

60,304

 

Cost of goods sold

 

25,594

 

17,369

 

51,453

 

32,484

 

Gross profit

 

22,573

 

13,505

 

44,058

 

27,820

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

18,125

 

10,840

 

37,077

 

22,327

 

Depreciation and amortization

 

1,160

 

542

 

2,387

 

1,034

 

Contingent consideration buy-out expense

 

 

 

 

8,732

 

 

 

19,285

 

11,382

 

39,464

 

32,093

 

Operating income (loss)

 

3,288

 

2,123

 

4,594

 

(4,273

)

Interest expense

 

3,355

 

127

 

6,676

 

197

 

Other income

 

(4,818

)

 

(2,268

)

 

Income (loss) before provision for taxes

 

4,751

 

1,996

 

186

 

(4,470

)

Income tax expense

 

2,412

 

823

 

25

 

745

 

Net income (loss) and comprehensive income (loss)

 

$

2,339

 

$

1,173

 

$

161

 

$

(5,215

)

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share - basic

 

$

0.03

 

$

0.02

 

$

0.00

 

$

(0.08

)

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share - diluted

 

$

0.01

 

$

0.02

 

$

0.00

 

$

(0.08

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

68,148

 

67,047

 

68,045

 

66,849

 

Diluted

 

87,096

 

68,411

 

87,212

 

66,849

 

 

The accompanying notes are an integral part of these financial statements.

 

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JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Six months ended

 

 

 

May 31, 2014

 

May 31, 2013

 

 

 

(unaudited)

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net cash (used in) provided by operating activities

 

$

(4,039

)

$

1,262

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Purchases of property and equipment

 

(290

)

(913

)

Purchase of Hudson Clothing, Inc., net of cash acquired

 

(418

)

 

Net cash used in investing activities

 

(708

)

(913

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from line of credit

 

6,068

 

 

Repayment of term loan

 

(15

)

 

Payment of promissory tax note

 

(1,235

)

 

 

Advances from factor, net

 

 

1,396

 

Proceeds from exercise of options

 

 

27

 

Purchase of restricted stock

 

(227

)

 

Payment of taxes on restricted stock units

 

(205

)

(255

)

Net cash provided by financing activities

 

4,386

 

1,168

 

 

 

 

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

(361

)

1,517

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, at beginning of period

 

785

 

13,426

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, at end of period

 

$

424

 

$

14,943

 

 

The accompanying notes are an integral part of these financial statements.

 

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JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

Common Stock

 

Additional

 

Accumulated

 

Treasury

 

Stockholders’

 

 

 

Shares

 

Par Value

 

Paid-In Capital

 

Deficit

 

Stock

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, November 30, 2012

 

67,294

 

$

6,732

 

$

106,747

 

$

(38,649

)

$

(3,091

)

71,739

 

Net loss and comprehensive loss (unaudited)

 

 

 

 

(5,215

)

 

(5,215

)

Exercise of stock options (unaudited)

 

20

 

2

 

25

 

 

 

 

 

27

 

Stock-based compensation, net of withholding taxes (unaudited)

 

 

 

649

 

 

 

649

 

Issuance of restricted stock (unaudited)

 

1,088

 

109

 

(109

)

 

 

 

Balance, May 31, 2013 (unaudited)

 

68,402

 

$

6,843

 

$

107,312

 

$

(43,864

)

$

(3,091

)

$

67,200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, November 30, 2013

 

68,878

 

$

6,890

 

$

107,933

 

$

(45,963

)

$

(3,091

)

$

65,769

 

Net income and comprehensive income (unaudited)

 

 

 

 

161

 

 

161

 

Embedded conversion feature, net of taxes (unaudited)

 

 

 

2,058

 

 

 

2,058

 

Stock repurchase (unaudited)

 

 

 

 

 

(227

)

(227

)

Stock-based compensation, net of withholding taxes (unaudited)

 

 

 

382

 

 

 

382

 

Issuance of restricted stock (unaudited)

 

641

 

64

 

(64

)

 

 

 

Balance, May 31, 2014 (unaudited)

 

69,519

 

$

6,954

 

$

110,309

 

$

(45,802

)

$

(3,318

)

$

68,143

 

 

The accompanying notes are an integral part of these financial statements.

 

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JOE’S JEANS INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - BASIS OF PRESENTATION

 

The unaudited condensed consolidated financial statements of Joe’s Jeans Inc., or Joe’s, we or us, which include the accounts of our wholly-owned subsidiaries, for the three and six months ended May 31, 2014 and 2013 and the related footnote information have been prepared on a basis consistent with our audited consolidated financial statements as of November 30, 2013 contained in our Annual Report on Form 10-K, or the Annual Report.  Our fiscal year end is November 30.

 

Our principal business activity involves the design, development and worldwide marketing of apparel products, which include denim jeans, related casual wear and accessories that bear the brands Joe’s® and Hudson®.  Our primary current operating subsidiaries are Joe’s Jeans Subsidiary Inc., or Joe’s Jeans Subsidiary and Hudson Clothing LLC, or Hudson.  In addition, we have other subsidiaries, including Joe’s Jeans Retail Subsidiary, Inc., Innovo West Sales Inc., Hudson Clothing Holdings, Inc. and HC Acquisition Inc.  All significant inter-company transactions have been eliminated.  We completed the acquisition of Hudson on September 30, 2013 and the information presented includes the results of operations of Hudson from the date of acquisition.

 

Our reportable business segments are Wholesale and Retail.  We manage, evaluate and aggregate our operating segments for segment reporting purposes primarily on the basis of business activity and operation.  Our Wholesale segment is comprised of sales of Joe’s® and Hudson® products to retailers, specialty stores and international distributors, includes revenue from licensing agreements and records expenses from sales, trade shows, distribution, product samples and customer service departments.  Our Retail segment is comprised of sales to consumers through full price retail stores, outlet stores and through our online retail sites at  www.joesjeans.com and www.hudsonjeans.com.  We opened our first full price retail store in October 2008 in Chicago, Illinois and we currently operate 13 full price retail stores and 20 outlet stores in outlet centers, malls and street locations around the country for our Joe’s® brand.  Our Corporate and other expense is comprised of expenses from corporate operations, which include the executive, finance, legal, human resources, design and production departments and general advertising expenses associated with our brands.

 

These unaudited condensed consolidated financial statements have been prepared in accordance with U.S. 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 of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in our Annual Report.  In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments), which management considers necessary to present fairly our financial position, results of operations and cash flows for the interim periods presented.  The results for the three and six months ended May 31, 2014 are not necessarily indicative of the results anticipated for the entire year ending November 30, 2014.  The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements.  Actual results may differ from those estimates.

 

NOTE 2 —ADOPTION OF ACCOUNTING PRINCIPLES

 

In February 2013, the Financial Accounting Standards Board, or FASB, issued a standard that revised the disclosure requirements for items reclassified out of accumulated other comprehensive income and requires entities to present information about significant items reclassified out of accumulated other comprehensive income by component either (1) on the face of the statement where net income is presented or (2) as a separate disclosure in the notes to the financial statements. This guidance is effective for annual reporting periods beginning after December 15, 2012. We adopted this guidance effective for our first quarter of fiscal 2014.  The adoption of this guidance did not have a material effect on our financial statements.

 

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Table of Contents

 

In March 2013, the FASB issued a standard which requires the release of a cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. This guidance is effective for annual reporting periods beginning after December 15, 2013. The adoption of this amendment will not have a material effect on our financial statements.

 

In July 2013, the FASB issued a standard clarify the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists as of the reporting date. This guidance is effective for annual reporting periods beginning after December 15, 2013. The adoption of this amendment will not have a material effect on our financial statements.

 

In April 2014, the FASB issued authoritative guidance which raises the threshold for disposals to qualify as discontinued operations. Under this new guidance, a discontinued operation is (1) a component of an entity or group of components that have been disposed of or are classified as held for sale and represent a strategic shift that has or will have a major effect on an entity’s operations and financial results, or (2) an acquired business that is classified as held for sale on the acquisition date. This guidance also requires expanded or new disclosures for discontinued operations, individually material disposals that do not meet the definition of a discontinued operation, an entity’s continuing involvement with a discontinued operation following disposal and retained equity method investments in a discontinued operation. This guidance is effective for fiscal periods beginning after December 15, 2014. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

 

In May 2014, the FASB issued a comprehensive new revenue recognition standard which will supersede previous existing revenue recognition guidance. The standard creates a five-step model for revenue recognition that requires companies to exercise judgment when considering contract terms and relevant facts and circumstances. The five-step model includes (1) identifying the contract, (2) identifying the separate performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations and (5) recognizing revenue when each performance obligation has been satisfied. The standard also requires expanded disclosures surrounding revenue recognition. The standard is effective for fiscal periods beginning after December 15, 2016 and allows for either full retrospective or modified retrospective adoption. We are currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

NOTE 3 — ACCOUNTS RECEIVABLE, INVENTORY ADVANCES AND DUE FROM FACTOR

 

Historically, our primary method to obtain the cash necessary for operating needs has been through the sale of accounts receivable pursuant to factoring agreements and advances under inventory security agreements with our factor, CIT Commercial Services, a unit of CIT Group Inc., or CIT.

 

As a result of these agreements, amounts due from factor consist of the following (in thousands):

 

 

 

May 31, 2014

 

November 30, 2013

 

Non-recourse receivables assigned to factor

 

$

24,437

 

$

32,194

 

Client recourse receivables

 

6,479

 

3,220

 

Total receivables assigned to factor

 

30,916

 

35,414

 

 

 

 

 

 

 

Allowance for customer credits

 

(4,078

)

(3,980

)

Due from factor

 

$

26,838

 

$

31,434

 

 

 

 

 

 

 

Non-factored accounts receivable

 

$

5,834

 

$

5,396

 

Allowance for customer credits

 

(687

)

(478

)

Allowance for doubtful accounts

 

(318

)

(297

)

Accounts receivable, net of allowance

 

$

4,829

 

$

4,621

 

 

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Of the total amount of receivables sold by us as of May 31, 2014 and November 30, 2013, we hold the risk of payment of $6,479,000 and $3,220,000, respectively, in the event of non-payment by the customers.

 

CIT Commercial Services

 

Prior to our acquisition of Hudson on September 30, 2013, our Joe’s Jeans Subsidiary was a party to an accounts receivable factoring agreement and an inventory security agreement with CIT.  The agreements prior to September 30, 2013 were structured so that we had the ability to obtain cash by selling to CIT certain of our accounts receivable and advances for up to 50 percent of the value of certain eligible inventory.  The accounts receivables were sold for up to 85 percent of the face amount on either a recourse or non-recourse basis depending on the creditworthiness of the customer.  CIT permitted us to sell our accounts receivables at the maximum level of 85 percent and allowed advances of up to $6,000,000 for eligible inventory.  CIT had the ability, in its discretion at any time or from time to time, to adjust or revise any limits on the amount of loans or advances made to us pursuant to both of these agreements and to impose surcharges on our rates for certain of our customers.  In addition, cross guarantees were executed by and among us and all of our parent and subsidiaries to guarantee each entity’s obligations.  In connection with the agreements prior to September 30, 2013, certain assets were pledged to CIT, including our entire inventory, merchandise and/or goods, including raw materials through finished goods and receivables.  However, our trademarks were not encumbered under those agreements.

 

This accounts receivable agreement could be terminated by CIT upon 60 days’ written notice or immediately upon the occurrence of an event of default as defined in the agreement.  In June 2013, we entered into an amendment to the accounts receivable agreement that permitted us to terminate the accounts receivable agreement upon 30 days’ written notice prior to September 30, 2013, or thereafter upon 60 days’ written notice provided that the minimum factoring fees have been paid for the respective period or if CIT fails to fund us for five consecutive days.  The inventory agreement could be terminated once all obligations were paid under both agreements or if an event of default occurred as defined in the agreement.  On September 30, 2013, we entered into an amended and restated factoring agreement with CIT that amended and restated our existing factoring agreement and replaced all prior agreements relating to factoring and inventory security.

 

Under the agreements that terminated on September 30, 2013, we paid to CIT a factoring rate of 0.55 percent for accounts for which CIT had the credit risk, subject to discretionary surcharges, up to $40,000,000 of invoices factored, 0.50 percent over $40,000,000 of invoices factored and 0.35 percent for accounts for which we had the credit risk.  The interest rate associated with borrowings under the inventory lines and factoring facility was 0.25 percent plus the Chase prime rate, which was 3.25 percent prior to September 30, 2013.  In the event we needed additional funds, we also had a letter of credit facility with CIT to allow us to open letters of credit for a fee of 0.25 percent of the letter of credit face value with international and domestic suppliers, subject to our overall availability.

 

Amended and Restated Factoring Agreement

 

On September 30, 2013, we entered into an amended and restated factoring agreement, or the Amended and Restated Factoring Agreement, with CIT, which replaces all prior agreements relating to factoring and inventory security. The Amended and Restated Factoring Agreement provides that we sell and assign to CIT certain of our accounts receivable, including accounts arising from or related to sales of inventory and the rendition of services.  We will pay a factoring rate of 0.50 percent for accounts for which CIT bears the credit risk, subject to discretionary surcharges, and 0.35 percent for accounts for which we bear the credit risk, but in no event less than $3.50 per invoice.  The interest rate associated with borrowings under the factoring facility will be equal to the interest rate then in effect for “Revolving A Loans” pursuant to the revolving credit agreement. The Amended and Restated Factoring Agreement may be terminated by CIT upon 60 days’ written notice or immediately upon the occurrence of an event of default as defined in the agreement.  The accounts receivable agreement may be terminated by us upon 60 days’ written notice prior to September 30, 2018 or annually with 60 days’ written notice prior to September 30th of each year thereafter.  The Amended and Restated Factoring Agreement remains effective until it is terminated.

 

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As of May 31, 2014, our cash balance was $424,000 and our borrowing base cash availability with CIT was approximately $18,000,000.  This amount with CIT fluctuates on a daily basis based upon invoicing and collection related activity by CIT for the receivables sold.  See also “Note 12 — Debt” for a further discussion of our debt arrangements with CIT and other lenders.

 

NOTE 4 — INVENTORIES, NET

 

Inventories are valued at the lower of cost or market with cost determined by the first-in, first-out method.  Inventories consisted of the following (in thousands):

 

 

 

May 31, 2014

 

November 30, 2013

 

 

 

 

 

 

 

Finished goods

 

$

32,383

 

$

30,129

 

Finished goods consigned to others

 

1,383

 

1,066

 

Work in progress

 

5,098

 

5,057

 

Raw materials

 

21,470

 

18,406

 

 

 

60,334

 

54,658

 

Less allowance for obsolescence and slow moving items

 

(2,094

)

(1,988

)

 

 

$

58,240

 

$

52,670

 

 

We did not record any charges to our inventory reserve allowance for the three and six months ended May 31, 2014 or year ended November 30, 2013.

 

NOTE 5 —RELATED PARTY TRANSACTIONS

 

Joe Dahan

 

Since the acquisition of the Joe’s® brand as a result of a merger in October 2007 through February 18, 2013, Mr. Dahan was entitled to a certain percentage of our gross profit in any applicable fiscal year until October 2017.  At the time of the acquisition, pursuant to ASC 805 — Business Combinations, we assessed this original contingent consideration arrangement as compensatory and expensed such amounts over the term of the earn out period at the defined percentage amounts.  For the three and six months ended May 31, 2013, expense of $0 and $311,000, respectively, was recorded in the statement of net (loss) income and comprehensive (loss) income related to the contingent consideration expense made to Mr. Dahan under the original agreement.  For the three and six months ended May 31, 2014, we did not have any expense related to the contingent consideration expense made to Mr. Dahan under the original agreement since we entered into the new agreement with him as described below.

 

On February 18, 2013, we entered into a new agreement with Mr. Dahan that fixed the overall amount to be paid by us for the remaining months of year six through year 10 in the original merger agreement at $9,168,000 through weekly installment payments beginning on February 22, 2013 until November 27, 2015.  In the first quarter of fiscal 2013, we recorded a charge of $8,732,000 as contingent consideration buy-out expense in connection with this agreement.  This amount represented the net present value of the total fixed amount that Mr. Dahan would receive.  The entire amount was expensed during the first quarter of fiscal 2013 as the amount payable represented a present obligation due to Mr. Dahan.  On September 30, 2013, in connection with entry into new credit facilities relating to the acquisition of Hudson, Mr. Dahan, CIT, Garrison and all of our loan parties entered into an earn out subordination agreement, which provides, among other things, that any payment, whether in cash, in kind, securities or any other property, in connection with the our obligations to Mr. Dahan is expressly junior and subordinated in right of payment to all amounts due and owing upon any indebtedness outstanding under the revolving credit facility and the term loan facility.  We are permitted to make certain amount of weekly installment payments of our obligations in the absence of an insolvency proceeding or any event of default under the revolving credit agreement or the term loan credit agreement.

 

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See “Note 9 — Commitments and Contingencies - Contingent Consideration Payments, Buy Out Agreement and Earnout Subordination Agreement” for a further discussion on these agreements with Mr. Dahan.

 

Ambre Dahan

 

In January 2013, we entered in to a consulting arrangement with Ambre Dahan, the spouse of Mr. Joe Dahan, for design director services that pays her $175,000 per annum on a bi-weekly basis.  For the three months ended May 31, 2014 and 2013, we paid Ms. Dahan $40,000 and $40,000, respectively, under this arrangement.  For the six months ended May 31, 2014 and 2013, we paid Ms. Dahan $87,000 and $67,000, respectively, under this arrangement.  This arrangement may be terminated at any time by the parties.  Mr. Dahan is not a party to this arrangement, and we do not consider this arrangement material to us.

 

Albert Dahan

 

In April 2009, we entered into a commission-based sales agreement with Albert Dahan, brother of Joe Dahan, for the sale of our products into the off-price channels of distribution.  Under the agreement, Mr. Albert Dahan is entitled to a commission for purchase orders entered into by us where he acts as a sales person.  The agreement may be terminated at any time for any reason or no reason with or without notice.  For the three months ended May 31, 2014 and 2013, payments of $0 and $123,000, respectively, were made to Mr. Albert Dahan under this arrangement.  For the six months ended May 31, 2014 and 2013, payments of $0 and $243,000, respectively, were made to Mr. Albert Dahan under this arrangement.

 

In October 2011, we entered into an agreement with Ever Blue LLC, or Ever Blue, an entity for which Albert Dahan is the sole member, for the sale of children’s products.  Ever Blue has an exclusive right to produce, distribute and sell children’s products bearing the Joe’s® brand on a worldwide basis, subject to certain limitations on the channels of distribution.  In exchange for the license, Ever Blue pays to us a royalty on net sales with certain guaranteed minimum sales for each term.  In connection with this agreement, we provided initial funding to Ever Blue for inventory purchases, which such amount has been repaid in full.  For the three months ended May 31, 2014 and 2013, we recognized $60,000 and $154,000, respectively, in royalty income under the license agreement.  For the six months ended May 31, 2014 and 2013, we recognized $308,000 and $334,000, respectively, in royalty income under the license agreement.

 

Peter Kim

 

We have entered into several agreements, including a stock purchase agreement, a convertible note, a registration rights agreement, an employment agreement and a non-competition agreement with Peter Kim, CEO of our Hudson subsidiary and member of our Board of Directors, in connection with the acquisition of Hudson.  See “Note 11 — Acquisition of Hudson” and “Note 12 — Debt” for a further discussion of those agreements.

 

NOTE 6— EARNINGS PER SHARE

 

Earnings per share are computed using weighted average common shares and dilutive common equivalent shares outstanding.  Potentially dilutive shares consist of outstanding options, shares issuable upon the assumed conversion of convertible notes, restricted stock and unvested RSUs.  A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share is as follows:

 

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Three months ended

 

Six months ended

 

 

 

(in thousands, except per share data)

 

(in thousands, except per share data)

 

 

 

May 31, 2014

 

May 31, 2013

 

May 31, 2014

 

May 31, 2013

 

Basic earnings (loss) per share computation:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net earnings (loss) and comprehensive earnings (loss)

 

$

2,339

 

$

1,173

 

$

161

 

$

(5,215

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

68,148

 

67,047

 

68,045

 

66,849

 

Earnings (loss) per common share - basic

 

 

 

 

 

 

 

 

 

Net earnings (loss) and comprehensive earnings (loss)

 

$

0.03

 

$

0.02

 

$

0.00

 

$

(0.08

)

 

 

 

 

 

 

 

 

 

 

Diluted earnings (loss) per share computation:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net earnings (loss) and comprehensive earnings (loss)

 

$

2,339

 

$

1,173

 

$

161

 

$

(5,215

)

Convertible notes interest expense, net of taxes

 

557

 

 

 

1,960

 

 

 

Other Income - Gain from change in fair value of conversion derivative, net of taxes

 

(2,371

)

 

 

(1,965

)

 

 

Numerator for dilutive earnings (loss) per share

 

$

525

 

$

1,173

 

$

156

 

$

(5,215

)

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

68,148

 

67,047

 

68,045

 

66,849

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Convertible note shares

 

18,430

 

 

18,369

 

 

Restricted shares, RSU’s and options

 

518

 

1,364

 

798

 

 

Dilutive potential common shares

 

87,096

 

68,411

 

87,212

 

66,849

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share - diluted

 

 

 

 

 

 

 

 

 

Net earnings (loss) and comprehensive earnings (loss)

 

$

0.01

 

$

0.02

 

$

0.00

 

$

(0.08

)

 

For the three months ended May 31, 2014, and 2013, currently exercisable options, convertible notes, unvested restricted shares and unvested RSUs in the aggregate of 21,510,929 and 450,000, respectively, have been excluded from the calculation of the diluted loss per share as their effect would have been anti-dilutive.  For the six months ended May 31, 2014, and 2013, currently exercisable options, convertible notes, unvested restricted shares and unvested RSUs in the aggregate of 21,510,929 and 4,164,822, respectively, have been excluded from the calculation of the diluted loss per share as their effect would have been anti-dilutive.

 

Shares Reserved for Future Issuance

 

As of May 31, 2014, shares reserved for future issuance include (i) 775,000 shares of common stock issuable upon the exercise of stock options granted under the incentive plans; (ii) 1,472,575 shares of common stock issuable upon the vesting of RSUs; and (iii) an aggregate of 2,988,654 shares of common stock available for future issuance under the Amended and Restated 2004 Stock Incentive Plan; and (iv) 18,471,051 shares of common stock issuable pursuant to the convertible notes.

 

NOTE 7 —INCOME TAXES

 

We utilize the liability method of accounting for income taxes in accordance with FASB Accounting Standards Codification, or ASC, 740.  Under the liability method, deferred taxes are determined based on the temporary differences between the financial statements and tax bases of assets and liabilities using enacted tax rates.

 

A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Quarterly, management reassesses the need for a valuation allowance. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on our assessment of these items for fiscal 2013, 2012 and 2011, we determined that the deferred tax assets were more likely than not to be realized with the exception of a valuation allowance of $342,000 that was recorded against a state net operating loss deferred tax asset during fiscal 2013.

 

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We are subject to U.S. federal income tax as well as income tax in multiple state jurisdictions.  To the extent allowed by law, the tax authorities may have the right to examine prior periods where net operating losses were generated and carried forward, and make adjustments up to the amount of the net operating loss carryforward amount.  We are no longer subject to U.S. federal and California income tax examinations by tax authorities for years prior to 2009.  We are currently not subject to any examinations, except for an examination by the State of Florida.  We do not expect the out come of this audit to have a significant impact on our financial results.

 

We had net operating loss carryforwards of $24,909,000 at the end of fiscal 2013 for federal tax purposes that will expire from fiscal 2019 through 2027.  We also had $22,467,000 of net operating loss carryforwards available for California which begin to expire from fiscal 2014 through fiscal 2020.

 

Certain limitations may be placed on net operating loss carryforwards as a result of “changes in control” as defined in Section 382 of the Internal Revenue Code.  In the event a change in control occurs, it will have the effect of limiting the annual usage of the carryforwards in future years.  Additional changes in control in future periods could result in further limitations of our ability to offset taxable income.  Management believes that certain changes in control have occurred which resulted in limitations on our net operating loss carryforwards.

 

NOTE 8 — STOCKHOLDERS’ EQUITY

 

Stock Incentive Plans

 

On June 3, 2004, we adopted the 2004 Stock Incentive Plan, or the 2004 Incentive Plan, and in October 2011, we adopted an Amended and Restated 2004 Stock Incentive Plan, or the Restated Plan, to update it with respect to certain provisions and changes in the tax code since its original adoption.  Under the Restated Plan, the number of shares authorized for issuance is 6,825,000 shares of common stock.  After the adoption of the Restated Plan in October 2011, we no longer grant awards pursuant to the 2004 Incentive Plan; however, it remains in effect for awards outstanding as of the adoption of the Restated Plan.  Under the Restated Plan, grants may be made to employees, officers, directors and consultants under a variety of awards based upon underlying equity, including, but not limited to, stock options, restricted common stock, restricted stock units or performance shares.  The Restated Plan limits the number of shares that can be awarded to any employee in one year to 1,250,000.  The exercise price for incentive options may not be less than the fair market value of our common stock on the date of grant and the exercise period may not exceed ten years.  Vesting periods, terms and types of awards are determined by the Board of Directors and/or our Compensation and Stock Option Committee, or Compensation Committee.  The Restated Plan includes a provision for the acceleration of vesting of all awards upon a change of control as well as a provision that allows forfeited or unexercised awards that have expired to be available again for future issuance. Since fiscal 2008, we have issued both restricted common stock and restricted common stock units, or RSUs, to our officers, directors and employees pursuant to our various plans.  The RSUs represent the right to receive one share of common stock for each unit on the vesting date provided that the employee continues to be employed by us.  On the vesting date of the RSUs, we expect to issue the shares of common stock to each participant upon vesting and expect to withhold an equivalent number of shares at fair market value on the vesting date to fulfill tax withholding obligations.  Any RSUs withheld or forfeited will be shares available for issuance in accordance with the terms of the Restated Plan.

 

The shares of common stock issued upon exercise of a previously granted stock option or a grant of restricted common stock or RSUs are considered new issuances from shares reserved for issuance in connection with the adoption of the various plans. We require that the option holder provide a written notice of exercise in accordance with the option agreement and plan to the stock plan administrator and full payment for the shares be made prior to issuance.  All issuances are made under the terms and conditions set forth in the applicable plan.  As of May 31, 2014, 2,988,654 shares remained available for issuance under the Restated Plan.

 

For all stock compensation awards that contain graded vesting with time-based service conditions, we have elected to apply a straight-line recognition method to account for all of these awards.  For existing grants that were not fully vested at November 30, 2013, there was a total of $352,000 and $455,000 of stock based compensation expense recognized during the three months ended May 31, 2014 and 2013, respectively, and $587,000 and $904,000 of stock based compensation expense recognized during the six months ended May 31, 2014 and 2013.

 

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The following summarizes option grants, restricted common stock and RSUs issued to members of the Board of Directors for the fiscal years 2002 through the second quarter of fiscal 2014 (in actual amounts) for service as a member:

 

 

 

May 31, 2014

 

 

 

Granted as of:

 

Number of options

 

Exercise price

 

2002

 

40,000

 

$

1.00

 

2002

 

31,496

 

$

1.27

 

2003

 

30,768

 

$

1.30

 

2004

 

320,000

 

$

1.58

 

2005

 

300,000

 

$

5.91

 

2006

 

450,000

 

$

1.02

 

 

 

 

 

 

 

 

 

 

 

Number of restricted

 

 

 

 

 

shares isssued

 

2007

 

 

 

320,000

 

2008

 

 

 

473,455

 

2009

 

 

 

371,436

 

2010

 

 

 

131,828

 

2011

 

 

 

 

2012

 

 

 

617,449

 

2013

 

 

 

 

2014

 

 

 

219,678

 

 

Exercise prices for all options outstanding as of May 31, 2014 were as follows:

 

 

 

Options Outstanding and Exercisable

 

Exercise Price

 

Number of shares

 

Weighted-Average
Remaining
Contractual Life

 

$1.00 - $1.02

 

100,000

 

1.8

 

$1.58 - $1.63

 

225,000

 

0.2

 

$5.91

 

450,000

 

1.0

 

 

 

 

 

 

 

 

 

775,000

 

0.9

 

 

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Table of Contents

 

The following table summarizes stock option activity by plan for the six months ended May 31, 2014 and 2013, (in actual amounts).  There are no stock options outstanding under our Restated Plan.

 

 

 

Total Number
of Shares

 

2004 Incentive
Plan

 

2000 Director
Plan

 

 

 

 

 

 

 

 

 

Outstanding at November 30, 2013

 

775,000

 

775,000

 

 

Granted

 

 

 

 

Exercised

 

 

 

 

Forfeited / Expired

 

 

 

 

Outstanding and exercisable at May 31, 2014

 

775,000

 

775,000

 

 

 

 

 

 

 

 

 

 

Outstanding at November 30, 2012

 

796,794

 

775,000

 

21,794

 

Granted

 

 

 

 

Exercised

 

(21,794

)

 

(21,794

)

Forfeited / Expired

 

 

 

 

Outstanding and exercisable at May 31, 2013

 

775,000

 

775,000

 

 

 

Stock option activity in the aggregate for the periods indicated are as follows (in actual amounts):

 

 

 

Options

 

Weighted
average
exercise price

 

Weighted average
remaining contractual
Life (Years)

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

 

 

 

 

Outstanding at November 30, 2013

 

775,000

 

$

4.03

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Expired

 

 

 

 

 

 

 

Forfeited

 

 

 

 

$

 

Outstanding and exercisable at May 31, 2014

 

775,000

 

$

4.03

 

0.9

 

$

 

 

 

 

 

 

 

 

 

 

 

Weighted average per option fair value of options granted during the year

 

 

 

N/A

 

 

 

 

 

 

 

 

Options

 

Weighted
average
exercise price

 

Weighted average
remaining contractual
Life (Years)

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

 

 

 

 

Outstanding at November 30, 2012

 

796,794

 

$

3.96

 

 

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

(21,794

)

1.30

 

 

 

 

 

Expired

 

 

 

 

 

 

 

Forfeited

 

 

 

 

 

Outstanding and exercisable at May 31, 2013

 

775,000

 

$

4.03

 

1.9

 

$

88,250

 

 

 

 

 

 

 

 

 

 

 

Weighted average per option fair value of options granted during the year

 

 

 

N/A

 

 

 

 

 

 

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As of May 31, 2014, there was $1,988,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 2004 Incentive Plan and the Restated Plan.  That unrecognized compensation cost is expected to be recognized over a weighted-average period of 2 years.

 

A summary of the status of restricted common stock and RSUs as of November 30, 2012 and November 30, 2013, and changes during the six months ended May 31, 2014 and 2013, are presented below (in actual amounts):

 

 

 

 

 

 

 

 

 

Weighted-Average Grant-Date
Fair Value

 

 

 

Restricted
Shares

 

Restricted
Stock Units

 

Total Shares

 

Restricted
Shares

 

Restricted
Stock Units

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at November 30, 2013

 

954,798

 

1,661,330

 

2,616,128

 

$

0.90

 

$

0.93

 

Granted

 

288,121

 

362,242

 

650,363

 

1.49

 

1.49

 

Issued

 

(450,616

)

(352,394

)

(803,010

)

0.95

 

1.06

 

Cancelled

 

 

(187,888

)

(187,888

)

 

0.98

 

Forfeited

 

 

(10,715

)

(10,715

)

 

0.70

 

Outstanding at May 31, 2014

 

792,303

 

1,472,575

 

2,264,878

 

$

1.08

 

$

1.04

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at November 30, 2012

 

844,236

 

2,713,605

 

3,557,841

 

$

0.85

 

$

0.89

 

Granted

 

420,882

 

631,059

 

1,051,941

 

1.02

 

1.02

 

Issued

 

(310,320

)

(667,598

)

(977,918

)

0.92

 

0.81

 

Cancelled

 

 

(239,011

)

(239,011

)

 

0.82

 

Forfeited

 

 

(3,031

)

(3,031

)

 

0.70

 

Outstanding at May 31, 2013

 

954,798

 

2,435,024

 

3,389,822

 

$

0.90

 

$

0.94

 

 

In the three months ended May 31, 2014, we did not grant any RSUs or shares of restricted stock.  In the six months ended May 31, 2014, we granted 362,242 RSUs and 288,121 shares of restricted stock.   In the three months ended May 31, 2013, we did not grant any RSUs or shares of restricted stock and in the six months ended May 31, 2013, we granted 631,059 RSUs and 420,882 shares of restricted stock. In the three months ended May 31, 2014, we (i) issued 58,914 shares of restricted stock and common stock to holders of RSUs, respectively, in connection with the granting of restricted stock or vesting of RSUs, and (ii) withheld, canceled or forfeited 13,837 RSUs.  In the six months ended May 31, 2014, we (i) issued 803,010 shares of restricted stock and common stock to holders of RSUs, respectively, in connection with the granting of restricted stock or vesting of RSUs, and (ii) withheld, canceled or forfeited 198,603 RSUs and retired into treasury 194,901 shares of restricted stock.  In the three months ended May 31, 2013, we (i) issued 87,247 shares of restricted stock and common stock to holders of RSUs, respectively in connection with the granting of restricted stock or vesting of RSUs, and (ii) withheld, canceled or forfeited 10,111 RSUs.  In the six months ended May 31, 2013, we (i) issued 977,918 shares of restricted stock and common stock to holders of RSUs, respectively in connection with the granting of restricted stock or vesting of RSUs, and (ii) withheld, canceled or forfeited 242,042 RSUs.

 

NOTE 9 — COMMITMENTS AND CONTINGENCIES

 

Contingent Consideration Payments, Buy-Out Agreement and Earnout Subordination Agreement

 

As part of the consideration paid in connection with the merger with JD Holdings in October of 2007 and without regard to continued employment, until February 12, 2013, Mr. Dahan was entitled to a certain percentage of the gross profit earned by us in any applicable fiscal year until October 2017.  Mr. Dahan was entitled to the following: (i) 11.33 percent of the gross profit from $11,251,000 to $22,500,000; (ii) three percent of the gross profit from $22,501,000 to $31,500,000; (iii) two percent of the gross profit from $31,501,000 to $40,500,000; and (iv) one percent of the gross profit above $40,501,000.  The payments were paid in advance on a monthly basis based upon estimates of gross profits after

 

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the assumption that the payments were likely to be paid.  At the end of each quarter, any overpayments were offset against future payments and any significant underpayments were made.  No payments were made if the gross profit was less than $11,250,000.  “Gross Profit” was defined as net sales of the Joe’s® brand less cost of goods sold.  We accounted for such payments as compensation expense.

 

On February 18, 2013, we entered into an agreement with Mr. Dahan that provided certainty of payments to him by removing the contingencies related to the contingent consideration payments to be made to Mr. Dahan as an earn out under the original merger agreement.  This agreement fixed the overall amount to be paid by us for the remaining months of year six through year 10 in the original merger agreement.  The payments are now made over an accelerated time period until November 2015 instead of October 2017.  Under the agreement, beginning on February 22, 2013 until November 27, 2015, Mr. Dahan is entitled to receive the total aggregate fixed amount of $9,168,000 through weekly installment payments.  In the first quarter of fiscal 2013, we recorded a charge of $8,732,000 as contingent consideration buy-out expense in connection with this agreement.  This amount represented the net present value of the total fixed amount that Mr. Dahan would receive.  The entire amount was expensed during the first quarter of fiscal 2013 as the amount payable represented a present obligation due to Mr. Dahan.  Mr. Dahan is not required to perform any services or remain employed to receive the fixed amount.  Mr. Dahan also agreed to an additional restrictive covenant relating to non-competition and non-solicitation until November 30, 2016 that added to the original restrictive covenant in the merger agreement.

 

Retail Leases

 

We lease retail store locations under operating lease agreements expiring on various dates through 2023 or 3 to 10 years from the rent commencement date and have one temporary space for a term of nine months.  Some of these leases require us to make periodic payments for property taxes, utilities and common area operating expenses. Certain retail store leases provide for rents based upon the minimum annual rental amount and a percentage of annual sales volume, generally ranging from 6 percent to 8 percent, when specific sales volumes are exceeded.  Some leases include lease incentives, rent abatements and fixed rent escalations, which are amortized and recorded over the initial lease term on a straight-line basis.

 

As of May 31, 2014, the future minimum rental payments under non-cancelable retail operating leases with lease terms in excess of one year were as follows (in thousands):

 

2014

Remainder of the year

 

$

3,977

 

2015

 

7,818

 

2016

 

7,737

 

2017

 

7,721

 

2018

 

7,551

 

Thereafter

 

16,741

 

 

 

$

51,545

 

 

Convertible Notes, Promissory Tax Notes, Revolving Credit Facility and Term Loan Credit Facility

 

See “Note 12 — Debt” for a further discussion on the commitments related to acquisition which included the issuance of the convertible notes, the promissory tax notes, the revolving credit facility and the term loan credit facility.

 

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NOTE 10 — SEGMENT INFORMATION

 

The following table contains summarized financial information concerning our reportable segments:

 

 

 

Three months ended

 

Six months ended

 

 

 

(dollar values in thousands)

 

 

 

May 31, 2014

 

May 31, 2013

 

May 31, 2014

 

May 31, 2013

 

 

 

 

 

 

 

 

 

 

 

Net sales:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

40,401

 

$

24,366

 

$

80,016

 

$

47,453

 

Retail

 

7,766

 

6,508

 

15,495

 

12,851

 

 

 

$

48,167

 

$

30,874

 

$

95,511

 

$

60,304

 

 

 

 

 

 

 

 

 

 

 

Gross profit:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

17,218

 

$

8,955

 

$

33,978

 

$

19,187

 

Retail

 

5,355

 

4,550

 

10,080

 

8,633

 

 

 

$

22,573

 

$

13,505

 

$

44,058

 

$

27,820

 

 

 

 

 

 

 

 

 

 

 

Operating (loss) income:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

11,560

 

$

5,716

 

$

21,931

 

$

12,420

 

Retail

 

103

 

132

 

(885

)

(194

)

Corporate and other

 

(8,375

)

(3,725

)

(16,452

)

(16,499

)

 

 

$

3,288

 

$

2,123

 

$

4,594

 

$

(4,273

)

 

 

 

 

 

 

Six months ended

 

 

 

May 31, 2014

 

May 31, 2013

 

Capital expenditures:

 

 

 

 

 

Wholesale

 

$

118

 

$

18

 

Retail

 

 

895

 

Corporate and other

 

172

 

 

 

 

$

290

 

$

913

 

 

 

 

 

 

 

 

 

May 31, 2014

 

November 30, 2013

 

Total assets:

 

 

 

 

 

Wholesale

 

$

92,784

 

$

91,312

 

Retail

 

11,037

 

12,117

 

Corporate and other

 

118,606

 

119,594

 

 

 

$

222,427

 

$

223,023

 

 

NOTE 11 - ACQUISITION OF HUDSON

 

On September 30, 2013, we completed the acquisition of Hudson and purchased all of the outstanding equity interests for an aggregate purchase price of approximately $94,102,000, consisting of $65,416,000 in cash, approximately $27,451,000 in convertible notes, net of discount, and $1,235,000 in aggregate principal amount of promissory notes bearing no interest to certain former option holders of Hudson that we subsequently paid on April 1, 2014.

 

In addition, in connection with the acquisition, we, along with all of our subsidiaries entered into: (i) a revolving credit agreement with CIT as administrative agent, collateral agent, documentation agent and syndication agent, CIT Finance LLC, as sole lead arranger and sole bookrunner, and the lenders party thereto, and (ii) a term loan credit agreement with Garrison Loan Agency Services LLC, as administrative agent, collateral agent, lead arranger, documentation agent and syndication agent, and the lenders party thereto, or Garrison.  In addition, we entered into an amended and restated factoring agreement with CIT that amends and restates our existing factoring agreement.  See “Note 12 — Debt” for a description of our debt arrangements.

 

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Management expects to complete the purchase price allocations during fiscal 2014.  We are in the process of completing the amounts assigned to assets and liabilities, acquired intangible assets and the related impact on goodwill for the acquisition.  More specifically, open items include finalizing the amounts associated with the tax refunds due to the sellers.  Adjustments in the second quarter of fiscal 2014 that were recorded against goodwill totaled $418,000 as a result of finalizing the working capital and certain deferred income tax balances.

 

The assets acquired in this acquisition consisted of tangible and intangible assets acquired and liabilities assumed.  The differences between the fair value of the consideration paid and the estimated fair value of the assets and liabilities has been recorded as goodwill.  We have determined that the useful life of the acquired trade name asset is indefinite, and therefore, no amortization expense will initially need to be recognized.  The useful life of the acquired customer relationships and design assets are finite and will be amortized over their useful lives.  However, we will test the assets for impairment annually and/or if events or changes in circumstances indicate that the assets might be impaired.  Additionally, a deferred tax liability has been established in the allocation of the purchase price with respect to the identified indefinite long lived intangible assets acquired.

 

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Under the purchase method of accounting, the total consideration as shown in the table below is allocated to the assets based on their estimated fair values as of the date of the completion of the acquisition. The consideration is allocated as follows:

 

Assets and liabilities assumed:

 

 

 

Cash and cash equivalents

 

$

198

 

Accounts receivable

 

1,263

 

Due from factor

 

13,806

 

Inventories

 

22,230

 

Prepaid expenses and other assets

 

2,183

 

Property and equipment

 

726

 

Other assets

 

239

 

Accounts payable and accrued expenses

 

(9,566

)

Other current liabilities

 

(3,132

)

Due to factor

 

(7,411

)

Deferred income taxes, net

 

(16,328

)

Intangible assets acquired:

 

 

 

Trade names

 

44,400

 

Customer relationships

 

2,700

 

Design

 

12,400

 

Net assets acquired

 

63,708

 

Goodwill created by the acquisition

 

30,394

 

 

 

 

 

Total consideration transferred

 

$

94,102

 

 

 

 

 

Total Purchase Price

 

 

 

Cash

 

$

65,416

 

Promissory notes

 

1,235

 

Convertible notes (Face value $32,445 less discount)

 

27,451

 

 

 

 

 

Total Purchase Price

 

$

94,102

 

 

NOTE 12 - DEBT

 

Convertible Notes

 

The convertible notes were issued with different interest rates and conversion features for Hudson’s management stockholders and Fireman, respectively.  Interest on the convertible notes is paid in a combination of cash and additional paid in kind notes, or PIK Notes.  Convertible notes in an aggregate principal amount of approximately $22,885,000 (face amount) were issued to Hudson’s management stockholders, are structurally and contractually subordinated to our senior debt and mature on March 31, 2019.  All of the notes are expressly junior and subordinated in right of payment to all amounts due and owing upon any indebtedness outstanding under the revolving credit facility and the term loan facility (as discussed below).

 

The management notes accrue interest quarterly on the outstanding principal amount (i) from September 30, 2013 until the earlier to occur of the date of conversion of the notes or November 30, 2014 at a rate of 10 percent per annum, which is payable 7.68 percent in cash and 2.32 percent in PIK Notes, (ii) from December 1, 2014 until the earlier to occur of the date of conversion of the notes or September 30, 2016 at a rate of 10 percent per annum payable in cash, and (iii) from October 1, 2016 until the earlier to occur of the date of conversion of the notes or the date such principal amount is paid in full at a rate of 10.928 percent per annum payable in cash.  Payment of interest at the cash pay rate under clause

 

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(ii) or (iii), as applicable, for any payment date will be subject to satisfaction of certain financial conditions for us.  The management notes become convertible by each of the holders beginning on September 30, 2015 until maturity on March 31, 2019 into shares of our common stock, cash, or a combination of cash and common stock, at our election, upon conversion by the holder or for cash at maturity.

 

The approximately $9,560,000 (face amount) in aggregate principal amount of convertible notes issued to Fireman are structurally and contractually subordinated to our senior debt and mature on March 31, 2019.  The Fireman note accrues interest quarterly on the outstanding principal amount (i) from September 30, 2013 until the earlier to occur of the date of conversion of the notes or November 30, 2014 at a rate of 6.5 percent per annum, which is payable 3 percent in cash and 3.5 percent in PIK Notes, (ii) from December 1, 2014 until the earlier to occur of the date of conversion of the notes or September 30, 2016 at a rate of 6.5 percent per annum payable in cash, and (iii) from October 1, 2016 until the earlier to occur of the date of conversion of the notes or the date such principal amount is paid in full at a rate of 7 percent per annum payable in cash. Payment of interest at the cash pay rate under clause (ii) or (iii), as applicable, for any payment date will be subject to satisfaction of certain financial conditions for us.  The Fireman note becomes convertible by the holder on October 14, 2014 until maturity on March 31, 2019 into shares of common stock, cash, or a combination of cash and common stock, at our election, upon conversion by the holder or for cash at maturity.

 

Each of the notes are convertible, in whole but not in part, at a conversion price of $1.78 per share, subject to certain adjustments, into approximately 18,200,000 shares of our common stock.  The Fireman note may be converted at its sole election and the management notes may be converted at either a majority of the holders’ election or individually, depending on the holder.  If the we elect to pay cash with respect to a conversion of the notes, the amount of cash to be paid per share will be equal to (a) the number of shares of common stock issuable upon such conversion multiplied by (b) the average of the closing prices for the common stock over the 20 trading day period immediately preceding the notice of conversion.  We will have the right to prepay all or any portion of the principal amount of the notes at any time by paying 103 percent of the principal amount of the portion of any management note subject to prepayment or 100 percent of the principal amount of the portion of the Fireman note subject to prepayment.  At our Annual Meeting of Stockholders on May 8, 2014, our stockholders approved our ability to issue shares above a 13,600,000 cap that was in place at the time the original notes were issued.

 

In connection with the quarterly interest payments on January 1, 2014 and April 1, 2014, we issued a total of approximately $218,000 and $215,000, respectively, in the aggregate principal amount of convertible notes as PIK notes to the holders of the convertible notes.

 

The holders of the convertible notes also have demand and piggyback registration rights associated  with their notes in a separate agreement pursuant to which they have the right to require us to prepare and file a registration statement on Form S-1 or S-3 or any similar form or successor to such forms under the Securities Act, or any other appropriate form under the Securities Act or the Exchange Act, for the resale of all or part of their shares that may be issued under the convertible notes.

 

Embedded Conversion Derivative

 

FASB Accounting Standards Codification (ASC) Topic 470 (ASC 470), Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement) requires the issuer of convertible debt that may be settled in shares or cash upon conversion at their option, such as our convertible notes, to account for their liability and equity components separately by bifurcating the embedded conversion derivative, or the derivative, from the host debt instrument. Although ASC 470 has no impact on our actual past or future cash flows, it requires us to record non-cash interest expense as the debt discount is amortized.

 

As a result of the issuance of convertible notes in September 2013, the total potential shares of common stock that could be issued exceeded the amount of shares we were eligible to issue under NASDAQ rules as of that date.  Therefore, we were required to value the derivative and recognize the fair value as a long-term liability. The fair value of this derivative at the time of issuance of the convertible notes was $5,496,000 and was recorded as the original debt discount for the purposes of accounting for the debt component of the convertible notes.  This debt discount on the Fireman and management notes are being amortized as interest expense using an effective interest rate of 8.32 percent and 4.31 percent, respectively, over the 5.5 year life of the convertible notes.

 

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On May 8, 2014, we obtained stockholder approval for our ability to issue the common stock underlying the convertible notes in compliance with NASDAQ rules.  The derivative liability has been reassessed and it was determined that it should be reclassified to stockholders’ equity as of May 8, 2014.  We determined the fair value of the derivative using a binomial lattice model at that date. The key assumptions for determining the fair value at May 8, 2014 included the remaining time to maturity of approximately four years and ten months, volatility of 60 percent, and the risk-free interest rate of 1.63 percent.  The fair value of the embedded conversion derivative was $5,700,000 and $3,430,000 at November 30, 2013 and May 8, 2014, respectively.  The decrease in the fair value of the embedded conversion derivative from November 30, 2013 to May 8, 2014 resulted in a gain of $4,820,000, which has been recorded as other income.  The primary reason for the decrease in fair value was due to the change in our stock price as compared to the conversion price.

 

The following table (in thousands) is a summary of the recorded value of the convertible note as of May 31, 2014.  The value of the convertible note reflects the present value of the contractual cash flows from the convertible notes and resulted in an original issue discount of $10,490,000 including the additional original discount attributed to the embedded conversion derivative of $5,496,000, that were recorded on September 30, 2013, the issuance date.

 

 

 

Balance

 

 

 

May 31, 2014

 

Convertible notes - Face value

 

$

32,445

 

Less: Original issue discount

 

(4,994

)

Less: Debt discount related to the embedded derivative liability

 

(5,496

)

Convertible notes recorded value on issue date

 

21,955

 

Add: PIK notes issued

 

433

 

Accretion of debt discounts

 

1,062

 

Convertible notes value

 

23,450

 

Plus: Embedded derivative liability - fair market value

 

 

Debt as of May 31, 2014

 

$

23,450

 

 

The following table (in thousands) is a summary of our total interest expense as follow:

 

 

 

Three monthes ended

 

Six monthes ended

 

 

 

May 31, 2014

 

May 31, 2013

 

May 31, 2014

 

May 31, 2013

 

Contractual coupon interest

 

$

2,791

 

$

127

 

$

5,543

 

$

197

 

Amortization of discount and deferred financing costs

 

564

 

 

1,133

 

 

Total interest expense

 

$

3,355

 

$

127

 

$

6,676

 

$

197

 

 

Promissory Notes

 

In connection with the acquisition, we issued approximately $1,235,000 in aggregate principal amount of promissory notes bearing no interest to certain option holders of Hudson that we subsequently paid on April 1, 2014.

 

Revolving Credit Agreement

 

The revolving credit agreement with CIT provides us with a revolving credit facility up to $50,000,000 comprised of a revolving A-1 commitment of up to $1,000,000 and a revolving A commitment of up to $50,000,000 minus the revolving A-1 commitment.  Our actual maximum credit availability under the revolving facility varies from time to time and is determined by calculating a borrowing base, which is based on the value of the eligible accounts and eligible inventory minus reserves imposed by CIT.  The revolving facility also provides for swingline loans, up to $5,000,000 sublimit, and letters of credit, up to $1,000,000 sublimit.  Proceeds from advances under the revolving facility may be used for working capital needs and general corporate purposes and were initially used to pay a portion of the consideration for the acquisition and fees and expenses associated with the acquisition and to repay our existing factor loans.  As of May 31, 2014, $23,741,000 was outstanding under our revolving credit facility and approximately $18,000,000 was available to us.

 

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All unpaid loans under the revolving facility mature on September 30, 2018.  We have the right at any time and from time to time to terminate the commitments under the revolving facility by paying in full or prepay any borrowings, in whole or in part, without terminating or reducing the commitment.  If we terminate the revolving facility in full prior to the second anniversary of the date, we are required to pay a prepayment fee of one percent or 0.5 percent of the commitments terminated depending on when we make the prepayment.

 

The revolving facility is guaranteed by us and all of our subsidiaries, and secured by liens on substantially all assets owned by us, including a first-priority lien on certain property, including principally trade accounts, inventory, certain related assets and proceeds of the foregoing, subject to permitted liens and exceptions, and a second-priority lien on all other assets, including intellectual property owned by us, which secures the term loan facility on a first-priority basis.

 

Advances under the revolving facility are in the form of either base rate loans or LIBOR rate loans.  The interest rate for base rate loans under the revolving A commitment fluctuates and is equal to (x) the Alternate Base Rate, which is the greatest of (a) the JPMorgan Chase Bank prime rate; (b) the Federal funds rate plus 0.50 percent; and (c) the 90-Day LIBO Rate, which is the rate per annum equal to the 90 day LIBOR published in the New York City edition of the Wall Street Journal under “Money Rates,” plus 1 percent, in each case, plus (y) 1.5 percent.  The interest rate for LIBOR rate loans under the revolving A commitment is equal to the 90-Day LIBO Rate per annum plus 2.5 percent.  The interest rate for base rate loans and LIBOR rate loans under the revolving A-1 commitment is equal to (i) Alternate Base Rate plus 2.5 percent and (ii) the 90-Day LIBO Rate plus 3.5 percent, respectively.  Interest on the Revolving Facility is payable on the first day of each calendar month and the maturity date.  Among other fees, we pay a commitment fee of 0.25 percent per annum (due quarterly) on the average daily amount of the unused revolving commitment under the revolving facility.  We also pay fees with respect to any letters of credit.

 

The revolving facility contains usual and customary negative covenants for transactions of this type, including, but not limited to, restrictions on our ability and our subsidiaries’ ability, to create or incur indebtedness; create liens; consolidate, merge, liquidate or dissolve; sell, lease or otherwise transfer any of its assets; substantially change the nature of its business; make investments or acquisitions; pay dividends; enter into transactions with affiliates; amend material documents, prepay certain indebtedness and make capital expenditures.  The negative covenants are subject to certain exceptions as specified in the revolving credit agreement.

 

In addition, the revolving credit agreement requires us to (a) maintain (i) at all times availability under the revolving facility of not less than $5,000,000 and (ii) at all times the sum of availability under the revolving facility plus up to $2,500,000 of unrestricted cash of not less than $7,500,000; and (b) maintain a minimum fixed charge coverage ratio calculated for each four fiscal quarter period at levels set forth in the revolving facility.

 

As of May 31, 2014, we were in compliance with the covenants under the revolving credit agreement.

 

Term Loan Credit Agreement

 

The term loan credit agreement entered into with Garrison provided for term loans of up to $60,000,000 and was fully funded to us as of September 30, 2013.  The term loan proceeds were used to finance a portion of the consideration for the acquisition, to pay fees and expenses associated with the acquisition and for working capital needs and other general corporate purposes.

 

The term loan matures on September 30, 2018.  We are allowed to prepay the term loan at any time, in whole or in part, subject to the payment of a prepayment fee if we prepay prior to September 30, 2016.  The prepayment fee is 3 percent if we prepay prior to September 30, 2014 and reduces by 1 percent per year until September 30, 2016.  In addition, we are required to make prepayments out of extraordinary receipts, certain percentage of the excess cash flow and certain net proceeds of certain asset sales or equity issuances, in each case (other than a prepayment in connection with excess cash flow), subject to the payment of the prepayment fee as set forth above.

 

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The term loan facility is guaranteed by us and all of our subsidiaries and is secured by liens on substantially all assets owned by us, including a first-priority lien on intellectual property owned by us and a second-priority lien on the revolving credit priority collateral.

 

The interest rate for the term loan fluctuates and is equal to the rate per annum equal to the British Banker Association Interest Settlement Rate for deposits in Dollars with a term of three months, as appears on the Bloomberg BBAM Screen, plus 10.75 percent.  Interest is payable on the first day of each calendar month and the maturity date.

 

The term loan credit agreement contains usual and customary negative covenants for transactions of this type, including, but not limited to, restrictions on our ability and our subsidiaries’ ability to create or incur indebtedness; create liens; consolidate, merge, liquidate or dissolve; sell, lease or otherwise transfer any of its assets; substantially change the nature of its business; make investments or acquisitions; pay dividends; enter into transactions with affiliates; amend material documents, prepay certain indebtedness and make capital expenditures.  The negative covenants are subject to certain exceptions as specified in the term loan credit agreement.

 

In addition, the term loan credit agreement also requires us to maintain (a) (i) at all times, availability under the revolving credit facility of not less than $5,000,000 and (ii) at all times as tested on each date that a borrowing certificate is delivered, the sum of availability under the revolving credit facility plus up to $2,500,000 of unrestricted cash of not less than $7,500,000; (b) a minimum fixed charge coverage ratio, (c) a minimum EBITDA, and (d) a leverage ratio not more than the maximum leverage coverage ratio as set forth in the term loan credit agreement.

 

As of May 31, 2014, we were in compliance with the covenants under the term loan credit agreement.

 

Amended and Restated Factoring Agreement

 

See “Note 3 — Accounts Receivable, Inventory Advances and Due To Factor” for a discussion of our Amended and Restated Factoring Agreement.

 

NOTE 13 - FAIR VALUE DISCLOSURES

 

Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. Accounting guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:

 

Level 1-Quoted prices in active markets for identical assets or liabilities.

 

Level 2-Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

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Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. We review the fair value hierarchy classification on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.

 

The following table presents our fair value hierarchy for liabilities measured at fair value on a recurring basis as of May 31, 2014 and November 30, 2013 (in thousands):

 

 

 

As of May 31, 2014

 

As of November 30, 2013

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Embedded conversion derivative

 

$

 

$

 

$

 

$

 

$

5,700

 

$

 

$

 

$

5,700

 

 

A reconciliation of the changes in Level 3 fair value measurements is as follows as of May 31, 2014 (in thousands):

 

 

 

Convertible Notes

 

 

 

Embedded Derivative

 

 

 

 

 

Balance at November 30, 2013

 

$

5,700

 

Purchases, issuances and settlements

 

 

Total gain included in other expense

 

(2,270

)

Reclassification to stockholder equity

 

(3,430

)

Balance at May 31, 2014

 

$

 

 

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Item 2.                                                         Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward-Looking Statements

 

When used in this Quarterly Report on Form 10-Q, or Quarterly Report, the words “may,” “will,” “expect,” “anticipate,” “intend,” “estimate,” “continue,” “believe,” “plan,” “project,” “will be,” “will continue,” “will likely result,” and similar expressions are intended to identify forward-looking statements.  Similarly, statements that describe our future expectations, objectives and goals or contain projections of our future results of operations or financial condition are also forward-looking statements.  Statements looking forward in time are included in this Quarterly Report pursuant to the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995.  Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially, including, without limitation, the risk that we incurred substantial indebtedness to finance the acquisition of Hudson Clothing Holdings, Inc. and its subsidiaries, or collectively, Hudson, which may decrease our business flexibility and adversely affect our financial results; the risk that we may not be able to remain in compliance with the financial covenants under our financing agreements and that we pledged all our tangible and intangible assets as collateral under these agreements; the risk that we incurred and will continue to incur significant transaction and acquisition related costs in connection with the acquisition and integration of Hudson into our business plan; the risk that our existing stockholders may be diluted if we choose to settle the convertible notes by issuing shares of our common stock; the risk that we will be unsuccessful in integrating Hudson and achieving our intended results as a result of the acquisition of Hudson; the risk that we will be unsuccessful in gauging fashion trends and changing customer preferences; the risk that changes in general economic conditions, consumer confidence or consumer spending patterns will have a negative impact on our financial performance or strategies; the risks associated with leasing retail space and operating our own retail stores; the highly competitive nature of our business in the United States and internationally and our dependence on consumer spending patterns, which are influenced by numerous other factors; our ability to respond to the business environment and fashion trends; continued acceptance of our brands in the marketplace; our ability to meet and maintain requirements for listing on Nasdaq; successful implementation of any growth or strategic plans; effective inventory management; the risk of cyber attacks and other system risks; our ability to continue to have access on favorable terms to sufficient sources of liquidity necessary to fund ongoing cash requirements of our operations, which access may be adversely impacted by a number of factors, including the reduced availability of credit, generally, and the substantial tightening of the credit markets, including lending by financial institutions, who are sources of credit for us, the recent increase in the cost of capital, the level of our cash flows, which will be impacted by the level of consumer spending and retailer and consumer acceptance of its products; our ability to generate positive cash flow from operations; competitive factors, including the possibility of major customers sourcing product overseas in competition with our products; the risk that acts or omissions by our third party vendors could have a negative impact on our reputation; a possible oversupply of denim in the marketplace; and the risk factors contained in our reports filed with the Securities and Exchange Commission, or SEC, pursuant to the Securities Exchange Act of 1934, as amended, or Exchange Act, including our Annual Report on Form 10-K for the year ended November 30, 2013, or Annual Report, and in Part II, Item 1A of this Quarterly Report on Form 10-Q under the heading “Risk Factors.”  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  Our future results, performance or achievements could differ materially from those expressed or implied in these forward-looking statements.  We do not undertake any obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events, except as required by law.

 

Introduction

 

This discussion and analysis summarizes the significant factors affecting our results of operations and financial conditions during the three and six month periods ended May 31, 2014 and 2013.  This discussion should be read in conjunction with our Audited Consolidated Financial Statements and the related notes thereto contained in our Annual Report and our Condensed Consolidated Financial Statements, Notes to Unaudited Condensed Consolidated Financial Statements and supplemental information contained in this Quarterly Report.

 

Executive Overview

 

Our principal business activity is the design, development and worldwide marketing of apparel products, which include denim jeans, related casual wear and accessories that bear the brand Joe’s® and Hudson®.  Joe’s® was

 

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established in 2001 and the brand is recognized in the premium denim industry, an industry term for denim jeans with price points generally of $120 or more, for its quality, fit and fashion-forward designs.  Hudson was established in 2002, and is similarly recognized as a premier designer and marketer of women’s and men’s premium branded denim apparel with similar price points to Joe’s®.  Because we focus on design, development and marketing, we rely on third parties to manufacture our apparel products.  We sell our products through our own retail stores for our Joe’s® brand, and to numerous retailers, which include major department stores, specialty stores and distributors around the world.

 

On September 30, 2013, we acquired all of the outstanding equity interests in Hudson, a designer and marketer of women’s and men’s premium branded denim apparel, for an aggregate purchase price consisting of approximately $65,416,000 in cash and approximately $27,451,000 in convertible notes, net of discount. We also issued promissory notes, bearing no interest, for approximately $1,235,000 in aggregate principal amount to certain option holders of Hudson that we subsequently paid on April 1, 2014. This acquisition provides us with an additional proven premium denim brand, enhances our prospects for growth across wholesale, retail and e-commerce, both domestically and overseas, and creates the potential for improved purchasing authority with current and future vendors and other operational efficiencies. The acquired business represented approximately 40 percent of our consolidated total assets at November 30, 2013 and approximately 11 percent of consolidated net sales for the year ended November 30, 2013.

 

Our Joe’s® product line includes women’s and men’s denim jeans, pants, shirts, sweaters, jackets and other apparel products.  We also offer women’s handbags and clutches, children’s products, shoes, belts and leather goods produced by us or under various license agreements and we receive royalty payments based upon net sales from licensees.  Our Hudson® product line includes women’s, men’s and children’s denim jeans, pants, jackets and other bottoms.  Similar to the evolution of Joe’s®, we expect to look into offering a range of additional products under the Hudson® brand name.

 

In the first quarter of fiscal 2012, we launched a new brand, else™, which was initially sold primarily at Macy’s.  The brand has price points starting at $68 and was created to reach young women who are looking for a premium denim-like product at a more affordable price.  We have created a unique product that incorporates staple denim fits such as skinny, boot cut, cropped, and boyfriend, in a variety of styles, as well as shorts and denim jackets.  We believe that the future of the else™ brand as we move beyond our distribution arrangement with Macy’s is limited and we are evaluating its marketability internationally versus domestically.

 

Through May 31, 2014, we recognized growth through increases in our retail sales, and the addition of sales from our acquisition of Hudson.  We acquired Hudson on September 30, 2013 and our results of operations reflect the consolidation of Hudson as one of our wholly owned subsidiaries from that date.  Hudson’s financial results are included in each of the two reportable segments in a manner consistent with our reporting structure.  Therefore, our results of operations through May 31, 2014 are not necessarily indicative of future results.

 

For the remainder of 2014, we believe that our growth drivers will be dependent upon the integration and addition of sales from our acquisition of Hudson, cost savings resulting from operational benefits or synergies of the two brands, the performance of our retail stores, continued increases from our international and men’s sales, performance of our licensee’s under their respective agreements for children’s products and shoes and enhancement of products available to our customers.  Since our retail expansion commenced in 2008, we currently operate 33 retail stores, 13 of which are full price retail stores and 20 of which are outlet stores.  During fiscal 2013, we opened an additional six stores, consisting of five full price retail stores and one outlet store.  We continue to look for additional leases for further expansion, but we currently do not any signed leases for store openings in 2014 or beyond.  We believe that through our retail stores, we are able to enhance our net sales and gross profit and sell overstock or slow moving items at higher profit margins.  In addition, we selectively license our Joe’s® and Hudson® brands for other product categories.  By licensing certain product categories, we do not incur significant capital investments or incremental operating expenses and at the same time, we receive royalty payments on net sales, which contribute to our overall growth.  In addition, on September 30, 2013, we acquired Hudson, a designer and marketer of women’s and men’s premium branded denim apparel.  Hudson operates as a wholly owned subsidiary and we expect Hudson will enhance our sales and operating income as we integrate their operations into ours to realize cost savings and other operational benefits or synergies. We funded the acquisition through a combination of the convertible notes, a revolving credit facility and term loan.  In connection with these agreements, we have certain restrictions on our ability and our subsidiaries’ ability, to create or incur indebtedness; create

 

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Table of Contents

 

liens; consolidate, merge, liquidate or dissolve; sell, lease or otherwise transfer any of its assets; substantially change the nature of its business; make investments or acquisitions; pay dividends; enter into transactions with affiliates; amend material documents, prepay certain indebtedness and make capital expenditures with certain exceptions.  In addition, all of our assets, including our trademarks, are pledged as collateral under the loans.  Hudson will continue to operate its brand separately, as a wholly owned subsidiary; however, we expect to integrate some of the non-design and marketing functions into ours.

 

Our business is seasonal.  The majority of the marketing and sales orders take place from late fall to late spring.  The greatest volume of shipments and actual sales are generally made from summer through early fall, which coincides with our third and fourth fiscal quarters, and accordingly, our cash flow is strongest in those quarters.  Due to the seasonality of our business, as well as the evolution and changes in our business and product mix, including our acquisition of Hudson, our quarterly or yearly results are not necessarily indicative of the results for the next quarter or year.  Furthermore, because of the growing number of full-price retail and outlet stores opened at different points during the past few fiscal years, we continue to assess the seasonality of our business on our retail segment and its potential impact on our financial results.

 

Our reportable business segments are Wholesale and Retail.  We manage, evaluate and aggregate our operating segments for segment reporting purposes primarily on the basis of business activity and operation.  Our Wholesale segment is comprised of sales of Joe’s® and Hudson® products to retailers, specialty stores and international distributors, revenue from licensing agreements and includes expenses from sales, trade shows, distribution, product samples and customer service departments.  Our Retail segment is comprised of sales to consumers through full-price retail stores, outlet stores and through our online retail sites at www.joesjeans.com and www.hudsonjeans.com.  Our Corporate and other is comprised of expenses from corporate operations, which include the executive, finance, legal, human resources, design and production departments and general advertising expenses associated with our products.

 

Comparison of Three Months Ended May 31, 2014 to Three Months Ended May 31, 2013

 

 

 

Three months ended

 

 

 

( dollar values in thousands )

 

 

 

May 31, 2014

 

May 31, 2013

 

$ Change

 

%  Change

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

48,167

 

$

30,874

 

$

17,293

 

56

%

Cost of goods sold

 

25,594

 

17,369

 

8,225

 

47

%

Gross profit

 

22,573

 

13,505

 

9,068

 

67

%

Gross margin

 

47

%

44

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general & administrative

 

18,125

 

10,840

 

7,285

 

67

%

Depreciation & amortization

 

1,160

 

542

 

618

 

114

%

Operating income

 

3,288

 

2,123

 

1,165

 

55

%

 

 

 

 

 

 

 

 

 

 

Interest expense

 

3,355

 

127

 

3,228

 

2,542

%

Other income

 

(4,818

)

 

(4,818

)

N/A

 

Income before provision for taxes

 

4,751

 

1,996

 

2,755

 

138

%

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

2,412

 

823

 

1,589

 

193

%

 

 

 

 

 

 

 

 

 

 

Net income and comprehensive income

 

$

2,339

 

$

1,173

 

$

1,166

 

99

%

 

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Three Months Ended May 31, 2014 Overview

 

The following table sets forth certain statements of operations data by our reportable segments for the periods as indicated:

 

 

 

Three months ended

 

 

 

( dollar values in thousands )

 

 

 

May 31, 2014

 

May 31, 2013

 

$ Change

 

% Change

 

 

 

 

 

 

 

 

 

 

 

Net sales:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

40,401

 

$

24,366

 

$

16,035

 

66

%

Retail

 

7,766

 

6,508

 

1,258

 

19

%

 

 

$

48,167

 

$

30,874

 

$

17,293

 

56

%

 

 

 

 

 

 

 

 

 

 

Gross profit:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

17,218

 

$

8,955

 

$

8,263

 

92

%

Retail

 

5,355

 

4,550

 

805

 

18

%

 

 

$

22,573

 

$

13,505

 

$

9,068

 

67

%

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

Wholesale

 

$

11,560

 

$

5,716

 

$

5,844

 

102

%

Retail

 

103

 

132

 

(29

)

(22

)%

Corporate and other

 

(8,375

)

(3,725

)

(4,650

)

125

%

 

 

$

3,288

 

$

2,123

 

$

1,165

 

55

%

 

For the three months ended May 31, 2014, or the second quarter of fiscal 2014, our net sales increased to $48,167,000 from $30,874,000 for the three months ended May 31, 2013, or the second quarter fiscal 2013, a 56 percent increase.  We had an operating income of $3,288,000 compared to $2,123,000 for the second quarter of fiscal 2013, a 55 percent increase.

 

Net Sales

 

Our overall net sales increased to $48,167,000 for the second quarter of fiscal 2014 from $30,874,000 for the second quarter of fiscal 2013, a 56 percent increase.

 

More specifically, our wholesale net sales increased to $40,401,000 for the second quarter of fiscal 2014 from $24,366,000 for the second quarter of fiscal 2013, a 66 percent increase.  This increase in our wholesale sales is primarily attributed to the addition of $17,911,000 in wholesale sales from Hudson®.  The increases were partially offset by a $1,282,000, or a 103 percent, decline in sales from our else™ brand and a $594,000, or a three percent, decline in wholesale sales from Joe’s®.  We believe that the future of the else™ brand as we move beyond our distribution arrangement with Macy’s is limited and we are evaluating its marketability internationally versus domestically.  As a result, sales from our else™ brand were negatively impacted by not having an exclusive distribution partner in the second quarter of fiscal 2014 as compared to the second quarter of fiscal 2013.

 

Our retail net sales increased to $7,766,000 for the second quarter of fiscal 2014 from $6,508,000 for the second quarter of fiscal 2013, a 19 percent increase.  The primary reason for this increase was the addition of $837,000 in retail sales from Hudson’s® e-shop, as well as the opening of three additional retail stores since the end of the second quarter of fiscal 2013 that contributed to the overall sales increase for this segment.  Same store sales, which includes Joe’s® stores opened at least 12 months and our Joe’s® e-shop, increased by one percent.  Same store sales for our brick and mortar Joe’s® stores decreased by one percent.  Same store sales for our Joe’s® e-shop increased by 22 percent.

 

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Table of Contents

 

Gross Profit

 

Our gross profit increased to $22,573,000 for the second quarter of fiscal 2014 from $13,505,000 for the second quarter of fiscal 2013, a 67 percent increase, as a result of the increase in our net sales.  Our overall gross margin percentage increased to 47 percent for the second quarter of fiscal 2014 from 44 percent for the second quarter of fiscal 2013.  Our overall gross margin percentage for the second quarter of fiscal 2014 was positively impacted by the addition of $7,902,000 in gross profit from Hudson®.  Our Hudson® brand carries a higher average wholesale price than our Joe’s® brand and contributed to the increase in our gross margin percentage.

 

Our wholesale gross profit increased to $17,218,000 for the second quarter of fiscal 2014 from $8,955,000 for the second quarter of fiscal 2013, a 92 percent increase.  Our wholesale gross profit increased for the second quarter of fiscal 2014 compared to the second quarter of fiscal 2013 due to the addition of sales from Hudson®.  Gross profit attributable to Hudson totaled $7,902,000 for the period.  Our wholesale gross margin percentage for the second quarter of fiscal 2014 increased to 43 percent compared to 37 percent for the prior year comparable period.  The increase in gross margin percentage is mostly attributed to the addition of $7,902,000 in gross profit from Hudson®, which has a higher average wholesale price than our Joe’s® brand.

 

Our retail gross profit increased to $5,355,000 for the second quarter of fiscal 2014 from $4,550,000 for the second quarter of fiscal 2013, an 18 percent increase, due to the addition of $837,000 in sales from Hudson’s® e-shop and a $421,000 increase in Joe’s® sales from the addition of three new stores and growth in Joe’s® e-shop sales.  Our gross margin percentage was 69 percent for the second quarter of fiscal 2014 compared to 70 percent for the second quarter of fiscal 2013, and decreased slightly due to more promotional activity in our outlet stores.

 

Selling, General and Administrative Expense, including Depreciation and Amortization

 

Selling, general and administrative, or SG&A, expenses increased to $19,285,000 for the second quarter of fiscal 2014 from $11,382,000 for the second quarter of fiscal 2013, a 69 percent increase.  Our SG&A expenses attributable to additional expenses related to the operation of our Hudson subsidiary was $7,014,000 for the second quarter of fiscal 2014.  Our SG&A includes expenses related to employee and employee related benefits, sales commissions, contingent consideration expense, advertising, sample production, facilities and distribution related costs, professional fees, stock-based compensation, factor and bank fees, transaction expense in connection with the Hudson acquisition, expenses related to Hudson’s operation as our subsidiary and also includes depreciation and amortization.

 

Our wholesale SG&A expense increased to $5,658,000 for the second quarter of fiscal 2014 from $3,239,000 for the second quarter of fiscal 2013, or a 75 percent increase.  Our wholesale SG&A expense was higher in the second quarter of fiscal 2014 mostly due to the additional SG&A expense of $2,381,000 associated with Hudson’s operations.  Our Joe’s wholesale SG&A expense increased slightly by $38,000 to $3,277,000 from $3,239,000, or one percent, on a comparative basis.

 

Our retail SG&A expense increased to $5,252,000 for the second quarter of fiscal 2014 from $4,418,000 for the second quarter of fiscal 2013, a 19 percent increase.  Our retail SG&A expense increased mostly due to additional retail expense of $403,000 associated with Hudson’s e-commerce operations and the addition of costs associated with opening and operating three additional stores between the end of the second quarter of fiscal 2013 and the end of our second quarter of fiscal 2014, which included additional store payroll, store rents and depreciation expense.

 

Our corporate and other SG&A expense increased to $8,375,000 for the second quarter of fiscal 2014 from $3,725,000 for the second quarter of fiscal 2013, a 125 percent increase.  Our corporate and other SG&A expense includes general overhead associated with our operations, including Hudson, and professional fees and other transaction expenses associated with the acquisition of Hudson.  Our corporate and other SG&A expense was higher in the second quarter of fiscal 2014 mostly due to additional legal fees associated with the securities filings related to our proxy statement and conflict mineral report.  We also incurred expenses for Hudson’s corporate operations of $4,230,000 in the second quarter of fiscal 2014 that we did not have in the second quarter of fiscal 2013.

 

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Table of Contents

 

Operating (Loss) Income

 

We had operating income of $3,288,000 for the second quarter of fiscal 2014 compared to $2,123,000 for the second quarter of fiscal 2013.  Our increase in operating income was primarily due to the positive impact of the addition of net sales and gross profits from our Hudson subsidiary that we did not have in the second quarter of fiscal 2013.

 

Due to the addition of Hudson’s net sales and gross profits, our wholesale operating income increased to $11,560,000 in the second quarter of fiscal 2014 from $5,716,000 for the second quarter of fiscal 2013, a 102 percent increase.  As a result of the addition of gross profit from Hudson’s® e-shop, we generated a retail operating income of $103,000 in the second quarter of fiscal 2014 compared to $132,000 in the second quarter of fiscal 2013.  Corporate operating loss increased to $8,375,000 for the second quarter of fiscal 2014 from $3,725,000 for the second quarter of fiscal 2013, mostly due to the addition of expenses for Hudson’s corporate operations of $4,229,000 in the second quarter of fiscal 2014 that we did not have in the second quarter of fiscal 2013.

 

Interest Expense

 

Our interest expense increased to $3,355,000 for the second quarter of fiscal 2014 from $127,000 for the second quarter of fiscal 2013.  Our interest expense is primarily associated with interest expense from our revolving and term loan credit agreements with CIT Commercial Services, a unit of CIT Group Inc., or CIT, and Garrison Loan Agency Services LLC, or Garrison, interest expense and PIK interest from our convertible notes and amortization of debt discounts and deferred financing costs associated with the finance arrangements resulting from the Hudson acquisition, which we did not have in the second quarter of fiscal 2013.

 

Other Income

 

Other income represents the benefit due to the change in fair value of the embedded conversion derivative from February 28, 2014 to May 8, 2014 of $4,818,000.

 

Income Tax

 

Our effective tax rate was 51 percent for the second quarter of fiscal 2014 compared to 41 percent for the second quarter of fiscal 2013.  The increased effective tax rate for the second quarter of fiscal 2014 resulted from the effect that income associated with the derivative liability valuation applicable to the second quarter of fiscal 2014 had on the annual income forecast.  The increase to the forecasted income reduced the projected effective tax rate applied to our second quarter of fiscal 2014 income, whereas the projected effective tax rate used for the first quarter of fiscal 2014 was higher and produced a tax benefit due to the loss generated for the first quarter of fiscal 2014.  Differences between our effective tax rate and statutory tax rate are primarily due to state taxes and permanent book/tax differences related to the financing expense for the Hudson acquisition.

 

Net Income and Comprehensive Income

 

We generated a net income of $2,339,000 for the second quarter of fiscal 2014 compared to $1,173,000 for the second quarter of fiscal 2013.  Our increase in net income in the second quarter of fiscal 2014 was primarily due to the addition of Hudson’s net sales and gross profit of $18,748,000 and $8,512,000, respectively, in the second quarter of fiscal 2014 that we did not have in the second quarter of fiscal 2013 and the benefit due to the change in fair value of the embedded conversion derivative from February 28, 2014 to May 8, 2014 of $4,818,000 for the second quarter of fiscal 2014.

 

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Table of Contents

 

Comparison of Six Months Ended May 31, 2014 to Six Months Ended May 31, 2013

 

 

 

Six months ended

 

 

 

( dollar values in thousands )

 

 

 

May 31, 2014

 

May 31, 2013

 

$ Change

 

% Change

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

95,511

 

$

60,304

 

$

35,207

 

58

%

Cost of goods sold

 

51,453

 

32,484

 

18,969

 

58

%

Gross profit

 

44,058

 

27,820

 

16,238

 

58

%

Gross margin

 

46

%

46

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general & administrative

 

37,077

 

22,327

 

14,750

 

66

%

Depreciation & amortization

 

2,387

 

1,034

 

1,353

 

131

%

Contingent consideration buy-out expense

 

 

8,732

 

(8,732

)

 

Operating income (loss)

 

4,594

 

(4,273

)

8,867

 

208

%

 

 

 

 

 

 

 

 

 

 

Interest expense

 

6,676

 

197

 

6,479

 

3,289

%

Other income

 

(2,268

)

 

(2,268

)

N/A

 

Income (loss) before provision for taxes

 

186

 

(4,470

)

4,656

 

104

%

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

25

 

745

 

(720

)

97

%

 

 

 

 

 

 

 

 

 

 

Net income (loss) and comprehensive income (loss)

 

$

161

 

$

(5,215

)

$

5,376

 

103

%

 

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Table of Contents

 

Six Months Ended May 31, 2014 Overview

 

The following table sets forth certain statements of operations data by our reportable segments for the periods as indicated:

 

 

 

Six months ended

 

 

 

( dollar values in thousands )

 

 

 

May 31, 2014

 

May 31, 2013

 

$ Change

 

% Change

 

 

 

 

 

 

 

 

 

 

 

Net sales:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

80,016

 

$

47,453

 

$

32,563

 

69

%

Retail

 

15,495

 

12,851

 

2,644

 

21

%

 

 

$

95,511

 

$

60,304

 

$

35,207

 

58

%

 

 

 

 

 

 

 

 

 

 

Gross profit:

 

 

 

 

 

 

 

 

 

Wholesale

 

$

33,978

 

$

19,187

 

$

14,791

 

77

%

Retail

 

10,080

 

8,633

 

1,447

 

17

%

 

 

$

44,058

 

$

27,820

 

$

16,238

 

58

%

 

 

 

 

 

 

 

 

 

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

Wholesale

 

$

21,931

 

$

12,420

 

$

9,511

 

77

%

Retail

 

(885

)

(194

)

(691

)

356

%

Corporate and other

 

(16,452

)

(16,499

)

47

 

(0

)%

 

 

$

4,594

 

$

(4,273

)

$

8,867

 

(208

)%

 

For the six months ended May 31, 2014, our net sales increased to $95,511,000 from $60,304,000 for the six months ended May 31, 2013, a 58 percent increase.  We had operating income in the amount of $4,594,000 for the six months ended May 31, 2014 compared to an operating loss of $4,273,000 for the six months ended May 31, 2013.

 

Net Sales

 

Our net sales increased to $95,511,000 for the six months ended May 31, 2014 compared to $60,304,000 for the six months ended May 31, 2013, a 58 percent increase.

 

More specifically, our wholesale net sales increased to $80,016,000 for the six months ended May 31, 2014 compared to $47,453,000 for the six months ended May 31, 2013, an 69 percent increase.  This increase in our wholesale sales is primarily attributed to the addition of $35,196,000 in wholesale sales from Hudson® and a slight increase in Joe’s® international sales.  The increases were partially offset by a $3,185,000 decline in sales from our else™ brand.  We believe that the future of the else™ brand as we move beyond our distribution arrangement with Macy’s is limited and we are evaluating its marketability internationally versus domestically.  As a result, sales from our else™ brand were negatively impacted by not having an exclusive distribution partner in the six months ended May 31, 2014 as compared to the six months ended May 31, 2013.

 

Our retail net sales increased to $15,495,000 for the six months ended May 31, 2014 compared to $12,851,000 for the six months ended May 31, 2013, a 21 percent increase.  The primary reason for this increase was the addition of $1,897,000 in retail sales from Hudson’s® e-shop, as well as the opening of five additional retail stores since the end of the second quarter of fiscal 2013 that contributed to the overall sales increase for this segment.  Same store sales, which includes Joe’s® stores opened at least 12 months and our Joe’s® e-shop, decreased by two percent.  Same store sales for our brick and mortar Joe’s® stores decreased by six percent.  Same store sales for our Joe’s® e-shop increased by 37 percent.

 

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Table of Contents

 

Gross Profit

 

Our gross profit increased to $44,058,000 for the six months ended May 31, 2014 compared to $27,820,000 for the six months ended May 31, 2013, a 58 percent increase.  Our overall gross margin was comparable at 46 percent for the six months ended May 31, 2014 and 2013.

 

Our wholesale gross profit increased to $33,978,000 for the six months ended May 31, 2014 compared to $19,187,000 for the six months ended May 31, 2013, a 77 percent increase.  Our wholesale gross profit increased for the six months ended May 31, 2014 compared to the six months ended May 31, 2013 due to the addition of sales from Hudson®.  Gross profit attributable to Hudson totaled $14,784,000 for the period.  Our wholesale gross margin percentage for the six months ended May 31, 2014 increased to 43 percent compared to 40 percent for the prior year comparable period.  The increase in gross margin percentage is mostly attributed to higher margin wholesale sales from Hudson®.  Our gross profit includes an amortization charge of approximately $1,000,000 related to a fair value step up of Hudson® inventory acquired from the acquisition and sold during the six months ended May 31, 2014.

 

Our retail gross profit increased to $10,080,000 for the six months ended May 31, 2014 compared to $8,633,000 for the six months ended May 31, 2013, a 13 percent increase, due to the addition of $1,897,000 in net sales and $1,324,000 in gross profit from Hudson’s® e-shop and a $747,000 increase in overall sales from the addition of five new stores since the end of the six months ended May 31, 2013.  Our gross margin percentage was 65 percent for the six months ended May 31, 2014 compared to 67 percent for the six months ended May 31, 2013, and decreased primarily due to more promotional activity in our retail stores than during the prior year comparative period.

 

Selling, General and Administrative Expense, including Depreciation and Amortization and Contingent Consideration Buy-out Expense

 

SG&A expenses increased to $39,464,000 for the six months ended May 31, 2014 compared to $32,093,000 for the six months ended May 31, 2013, a 23 percent increase.  Excluding the contingent consideration buy out expense in the first quarter of fiscal 2013, our SG&A expenses increased by $16,103,000, or 69 percent, primarily due to the additional expenses related to the operation of our Hudson subsidiary.  Our SG&A includes expenses related to employee and employee related benefits, sales commissions, contingent consideration expense, advertising, sample production, facilities and distribution related costs, professional fees, stock-based compensation, factor and bank fees, transaction expense in connection with the Hudson acquisition and also includes depreciation and amortization.

 

Our wholesale SG&A expense increased to $12,047,000 for the six months ended May 31, 2014 compared to $6,767,000 for the six months ended May 31, 2013, a 78 percent increase.  Our wholesale SG&A expense was higher in the six months ended May 31, 2014 mostly due to the additional SG&A expense of $5,200,000 associated with Hudson’s operations.  Our Joe’s wholesale SG&A expense increased slightly by $80,000 to $6,847,000 from $6,767,000, an increase of one percent, on a comparative basis.

 

Our retail SG&A expense increased to $10,965,000 for the six months ended May 31, 2014 compared to $8,827,000 for the six months ended May 31, 2013, a 24 percent increase.  Our retail SG&A expense increased mostly due to additional retail expense of $977,000 associated with Hudson’s e-commerce operations and the addition of costs associated with opening and operating five additional stores between the end of the six months ended May 31, 2013 and the end of six months ended May 31, 2014, which included additional store payroll, store rents and depreciation expense.

 

Our corporate and other SG&A expense decreased to $16,452,000 for the six months ended May 31, 2014 compared to $16,499,000 for the six months ended May 31, 2013, a less than one percent decrease.  Our corporate and other SG&A expense includes general overhead associated with our operations, including Hudson, and professional fees and other transaction expenses associated with the acquisition of Hudson.  In addition, in the first quarter of fiscal 2013, we recorded a contingent consideration buy out expense of $8,732,000 in connection with the new agreement entered into with Mr. Dahan that fixed the overall amount to be paid by us for the remainder of his contingent consideration agreement in connection with the acquisition of the Joe’s® brand in October 2007.  We also incurred $165,000 of professional fees and other transaction expenses in connection with the purchase of Hudson and the addition of expenses for Hudson’s corporate operations of $8,244,000 in the six months ended May 31, 2014 that we did not have in the six months ended May 31, 2013.

 

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Table of Contents

 

Operating (Loss) Income

 

We had operating income of $4,594,000 for the six months ended May 31, 2014 compared to an operating loss of $4,273,000 for the six months ended May 31, 2013.  Our shift to operating income from an operating loss was primarily due to a first quarter of fiscal 2013 contingent consideration buy out expense of $8,732,000 in connection with the new agreement entered into with Mr. Dahan that we did not have in the first quarter of fiscal 2014.

 

Due to the addition of Hudson’s operations, our wholesale operating income increased to $21,931,000 in the six months ended May 31, 2014 from $12,420,000 for the six months ended May 31, 2013, a 77 percent increase.  As a result of lower gross margins and higher expenses associated with opening and operating new stores, we generated a retail operating loss of $885,000 in the six months ended May 31, 2014 compared to $194,000 in the six months ended May 31, 2013.  Corporate operating loss decreased slightly to $16,452,000 for the six months ended May 31, 2014 from $16,499,000 for the six months ended May 31, 2013 mostly due to the contingent consideration buy out expense of $8,732,000 recorded in the first quarter of fiscal 2013 that we did not have in the first quarter of fiscal 2014.  This expense was comparable to the addition of expenses for Hudson’s corporate operations of $8,244,000 in the six months ended May 31, 2014 that we did not have in the six months ended May 31, 2013.

 

Interest Expense

 

Our interest expense increased to $6,676,000 for the six months ended May 31, 2014 from $197,000 for the six months ended May 31, 2013.  Our interest expense is primarily associated with interest expense from our revolving and term loan credit agreements with CIT Commercial Services, a unit of CIT Group Inc., or CIT, and Garrison Loan Agency Services LLC, or Garrison, interest expense and PIK interest from our convertible notes and amortization of debt discounts and deferred financing costs associated the finance arrangements resulting from the Hudson acquisition, which we did not have in the second quarter of fiscal 2013.

 

Other Income

 

Other income represents the income due to the change in fair value of the embedded conversion derivative from November 30, 2014 to May 31, 2014 of $2,268,000 for the six months ended May 31, 2014.

 

Income Tax

 

Our effective tax rate was 14 percent for the six months ended May 31, 2014 compared to negative 17 percent for the six months ended May 31, 2013.  The increased effective tax rate for the six months ended May 31, 2014 resulted from losses recorded during the first quarter of fiscal 2013 from the contingent consideration buy out expense (associated with acquiring the trademark in October 2007) and the associated unfavorable permanent book/tax difference.  Differences between our effective tax rate and statutory tax rate are primarily due to state taxes, permanent book/tax differences related to the financing expense for the Hudson acquisition and certain discrete items.

 

Net (Loss) Income and Comprehensive (Loss) Income

 

Our net income was $161,000 for the six months ended May 31, 2014 compared to a net loss of $5,215,000 for the six months ended May 31, 2013.  Our shift from a net loss in the six months ended May 31, 2013 to net income in the six months ended May 31, 2014 was primarily due to the contingent consideration buy out expense of $8,732,000 recorded in the first quarter of fiscal 2013 that we did not have in the first quarter of fiscal 2014.  This amount was offset by interest costs associated with the debt incurred in connection with the purchase of Hudson and the loss related to the change in value of the embedded conversion derivative from November 30, 2013 to May 31, 2014.

 

Liquidity and Capital Resources

 

Until the acquisition of Hudson on September 30, 2013, our primary sources of liquidity were: (i) cash from sales of our products; (ii) sales from accounts receivable factoring facilities and advances against inventory; and (iii) utilizing existing cash balances.  Beginning September 30, 2013, in connection with the acquisition of Hudson, we entered into an

 

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amended and restated accounts receivable factoring facility and revolving credit agreement with CIT that provided advances to us for eligible accounts receivable and eligible inventory up to $50,000,000, based upon the value of the eligible accounts receivable and inventory less any reserves imposed by CIT.  The initial proceeds from the advances under this revolving credit facility, which included accounts receivable and inventory borrowing, were used to pay a portion of the consideration for the acquisition and fees and expenses associated with the acquisition and the remainder was used to repay our existing factor loans and for working capital and other general corporate purposes.  The revolving credit facility matures on September 30, 2018 unless terminated by payment in full earlier.  In addition, we entered into a term loan credit agreement for $60,000,000 with Garrison to finance the remainder of the purchase price required for the acquisition.  Under the term loan credit agreement, we pay interest to Garrison and are required to make prepayments under certain circumstances.  The term loan matures on September 30, 2018.  Both of these agreements, along with the convertible notes issued in connection with the acquisition are discussed in more detail below under “Financing Arrangements Related to the Acquisition of Hudson.”

 

For the six months ended May 30, 2014, we used $4,039,000 of cash flow from operations.  Cash flow from financing activities consisted of $6,068,000 of borrowings under our new revolving credit facility.  We made payments of $205,000 for taxes on restricted stock units.  We purchased $227,000 in restricted stock, repaid our promissory tax notes in the aggregate amount of $1,235,000 and made payments of $15,000 against our term loan.  We used $708,000 in investing activities, $290,000 for the purchase of property and equipment and $418,000 for a final working capital payment relating to our purchase of Hudson.  Our cash balance decreased to $424,000 as of May 31, 2014.

 

The agreements prior to September 30, 2013 were structured so that we had the ability to obtain cash by selling to CIT certain of our accounts receivable and advances for up to 50 percent of the value of certain eligible inventory.  The accounts receivables were sold for up to 85 percent of the face amount on either a recourse or non-recourse basis depending on the creditworthiness of the customer.  CIT permitted us to sell our accounts receivables at the maximum level of 85 percent and allowed advances of up to $6,000,000 for eligible inventory.  CIT had the ability, in its discretion at any time or from time to time, to adjust or revise any limits on the amount of loans or advances made to us pursuant to both of these agreements and to impose surcharges on our rates for certain of our customers.  In addition, cross guarantees were executed by and among us and all of our parent and subsidiaries to guarantee each entity’s obligations.  In connection with the agreements prior to September 30, 2013, certain assets were pledged to CIT, including our entire inventory, merchandise and/or goods, including raw materials through finished goods and receivables.  However, our trademarks were not encumbered under those agreements.

 

This accounts receivable agreement could be terminated by CIT upon 60 days’ written notice or immediately upon the occurrence of an event of default as defined in the agreement.  In June 2013, we entered into an amendment to the accounts receivable agreement that permitted us to terminate the accounts receivable agreement upon 30 days’ written notice prior to September 30, 2013, or thereafter upon 60 days’ written notice; provided, that the minimum factoring fees have been paid for the respective period, or if CIT fails to fund us for five consecutive days.  The inventory agreement could be terminated once all obligations were paid under both agreements or if an event of default occurred as defined in the agreement.  On September 30, 2013, we entered into an amended and restated factoring agreement with CIT that amended and restated our existing factoring agreement and replaced all prior agreements relating to factoring and inventory security.

 

Under the agreements that terminated on September 30, 2013, we paid to CIT a factoring rate of 0.55 percent for accounts for which CIT had the credit risk, subject to discretionary surcharges, up to $40,000,000 of invoices factored, 0.50 percent over $40,000,000 of invoices factored and 0.35 percent for accounts for which we had the credit risk.  The interest rate associated with borrowings under the inventory lines and factoring facility was 0.25 percent plus the Chase prime rate, which was 3.25 percent prior to September 30, 2013.  In the event we needed additional funds, we also had a letter of credit facility with CIT to allow us to open letters of credit for a fee of 0.25 percent of the letter of credit face value with international and domestic suppliers, subject to our overall availability.

 

Under the amended and restated factoring agreement entered into on September 30, 2013, we continue to sell or assign to CIT certain of our accounts receivable, including accounts arising from or related to sales of inventory and the rendition of services.  We pay a factoring rate of 0.50 percent for accounts for which CIT bears the credit risk, subject to discretionary surcharges and 0.35 percent for accounts for which we bear the credit risk, but in no event less than $3.50

 

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per invoice.  The interest rate associated with borrowings equals the interest rate then in effect for “Revolving A Loans” pursuant to the revolving credit agreement.  As of February 28, 2014, that interest rate was approximately 2.75 percent.  The amended and restated factoring agreement may be terminated by CIT upon 60 days’ written notice or immediately upon the occurrence of an event of default as defined in the agreement.  The accounts receivable agreement may be terminated by us upon 60 days’ written notice prior to September 30, 2018 or annually with 60 days’ written notice prior to September 30th of each year thereafter and remains effective until terminated.

 

As of May 31, 2014, our cash balance was $424,000 and our borrowing base cash availability with CIT was approximately $18,000,000.  This amount with CIT fluctuates on a daily basis based upon invoicing and collection related activity by CIT on our behalf.

 

As of May 31, 2014, our revolving credit facility had a balance of $23,741,000.

 

For the remainder of fiscal 2014, our primary capital needs are for: (i) operating expenses; (ii) payments, including interest, required to be made under our amended and restated factoring facility, revolving credit agreement, term loan credit agreement and convertible notes; (iii) working capital necessary to fund inventory purchases; (iv) capital expenditures to support additional retail store openings and integration costs with Hudson; (v) financing extensions of trade credit to our customers; (vi) payment for the fixed amount paid to Mr. Dahan pursuant to our agreement with him; and (vii) payments for transaction expenses associated with the acquisition of Hudson.  We anticipate funding our operations through working capital generated by the following: (i) cash flow from sales of our products from the combined companies; (ii) managing our operating expenses and inventory levels; (iii) maximizing trade payables with our domestic and international suppliers; (iv) increasing collection efforts on existing accounts receivables; and (v) utilizing our revolving credit agreement with CIT, which includes the amended and restated factoring facility.

 

Based on our cash on hand, cash flow from operations and the expected borrowing availability under the revolving credit agreement with CIT, we believe that we have the working capital resources necessary to meet our projected operational needs for fiscal 2014.  However, if we require more capital for growth or experience operating losses, we believe that it will be necessary to obtain additional working capital through additional credit arrangements.  However, there can be no assurance that other financings will be available if needed.  Our inability to fulfill any interim working capital requirements would force us to constrict our operations.

 

We believe that the rate of inflation over the past few years has not had a significant adverse impact on our net sales or income from continuing operations.

 

Financing Arrangements Related to the Acquisition of Hudson

 

As discussed above, in connection with the acquisition of Hudson we entered into a revolving credit agreement with CIT and a term loan credit agreement with Garrison.  We also issued approximately $32,445,000 in convertible notes (face amount) and promissory notes, bearing no interest, for approximately $1,235,000 in aggregate principal amount to certain option holders of Hudson that we subsequently paid on April 1, 2014.

 

The convertible notes were issued with different interest rates and conversion features for Hudson’s management stockholders and Fireman Capital CPF Hudson Co-Invest LP, or Fireman, respectively.  Interest on the convertible notes is paid in a combination of cash and additional paid-in-kind notes, or PIK notes.  Convertible notes in an aggregate principal amount of approximately $22,885,000 (face amount) were issued to Hudson’s management stockholders, are structurally and contractually subordinated to our senior debt and mature on March 31, 2019.  All of the notes are expressly junior and subordinated in right of payment to all amounts due and owing upon any indebtedness outstanding under the revolving credit facility and the term loan facility (as discussed below).

 

The management notes accrue interest quarterly on the outstanding principal amount (i) from September 30, 2013 until the earlier to occur of the date of conversion of the notes or November 30, 2014 at a rate of 10 percent per annum, which is payable 7.68 percent in cash and 2.32 percent in PIK notes, (ii) from December 1, 2014 until the earlier to occur of the date of conversion of the notes or September 30, 2016 at a rate of 10 percent per annum payable in cash, and (iii) from October 1, 2016 until the earlier to occur of the date of conversion of the notes or the date such principal amount is

 

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paid in full at a rate of 10.928 percent per annum payable in cash.  Payment of interest at the cash pay rate under clause (ii) or (iii), as applicable, for any payment date will be subject to satisfaction of certain financial conditions for us.  The management notes become convertible by each of the holders beginning on September 30, 2015 until maturity on March 31, 2019 into shares of our common stock, cash, or a combination of cash and common stock, at our election, upon conversion by the holder or for cash at maturity.

 

The approximately $9,560,000 (face amount) in aggregate principal amount of convertible notes issued to Fireman are structurally and contractually subordinated to our senior debt and mature on March 31, 2019.  The Fireman note accrues interest quarterly on the outstanding principal amount (i) from September 30, 2013 until the earlier to occur of the date of conversion of the notes or November 30, 2014 at a rate of 6.5 percent per annum, which is payable 3 percent in cash and 3.5 percent in PIK notes, (ii) from December 1, 2014 until the earlier to occur of the date of conversion of the notes or September 30, 2016 at a rate of 6.5 percent per annum payable in cash, and (iii) from October 1, 2016 until the earlier to occur of the date of conversion of the notes or the date such principal amount is paid in full at a rate of 7 percent per annum payable in cash. Payment of interest at the cash pay rate under clause (ii) or (iii), as applicable, for any payment date will be subject to satisfaction of certain financial conditions for us.  The Fireman note becomes convertible by the holder on October 14, 2014 until maturity on March 31, 2019 into shares of common stock, cash, or a combination of cash and common stock, at our election, upon conversion by the holder or for cash at maturity.

 

Each of the notes are convertible, in whole but not in part, at a conversion price of $1.78 per share, subject to certain adjustments, into approximately 18,200,000 shares of our common stock.  The Fireman note may be converted at its sole election and the management notes may be converted at either a majority of the holders’ election or individually, depending on the holder.  If we elect to pay cash with respect to a conversion of the notes, the amount of cash to be paid per share will be equal to (a) the number of shares of common stock issuable upon such conversion multiplied by (b) the average of the closing prices for the common stock over the 20 trading day period immediately preceding the notice of conversion.  We will have the right to prepay all or any portion of the principal amount of the notes at any time by paying 103 percent of the principal amount of the portion of any management note subject to prepayment or 100 percent of the principal amount of the portion of the Fireman note subject to prepayment.

 

In connection with the quarterly interest payments on January 1, 2014 and April 1, 2014, we issued a total of approximately $218,000 and $215,000, respectively, in the aggregate principal amount of convertible notes as PIK notes to the holders of the convertible notes.

 

Revolving Credit Agreement

 

The revolving credit agreement with CIT provides us with a revolving credit facility up to $50,000,000 comprised of a revolving A-1 commitment of up to $1,000,000 and a revolving A commitment of up to $50,000,000 minus the revolving A-1 commitment.  Our actual maximum credit availability under the revolving facility varies from time to time and is determined by calculating a borrowing base, which is based on the value of the eligible accounts and eligible inventory minus reserves imposed by CIT.  The revolving facility also provides for swingline loans, up to a $5,000,000 sublimit, and letters of credit, up to a $1,000,000 sublimit.  Proceeds from advances under the revolving facility may be used for working capital needs and general corporate purposes and were initially used to pay a portion of the consideration for the acquisition and fees and expenses associated with the acquisition and to repay our existing factor loans.

 

All unpaid loans under the revolving facility mature on September 30, 2018.  We have the right at any time and from time to time to terminate the commitments under the revolving facility by paying in full or prepay any borrowings, in whole or in part, without terminating or reducing the commitment.  If we terminate the revolving facility in full prior to the second anniversary of the date, we are required to pay a prepayment fee of 1 percent or 0.5 percent of the commitments terminated, depending on when we make the prepayment.

 

The revolving facility is guaranteed by us and all of our subsidiaries, and secured by liens on substantially all assets owned by us, including a first-priority lien on certain property, including principally trade accounts, inventory, certain related assets and proceeds of the foregoing, subject to permitted liens and exceptions, and a second-priority lien on all other assets, including intellectual property owned by us, which secures the term loan facility on a first-priority basis.

 

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Advances under the revolving facility are in the form of either base rate loans or LIBOR rate loans.  The interest rate for base rate loans under the revolving A commitment fluctuates and is equal to (x) the Alternate Base Rate, which is the greatest of (a) the JPMorgan Chase Bank prime rate; (b) the Federal funds rate plus 0.50 percent; and (c) the 90 day LIBO Rate, which is the rate per annum equal to the 90-Day LIBO Rate published in the New York City edition of the Wall Street Journal under “Money Rates,”  plus 1 percent, in each case, plus (y) 1.5 percent.  The interest rate for LIBOR rate loans under the revolving A commitment is equal to the 90-Day LIBO Rate per annum plus 2.5 percent.  The interest rate for base rate loans and LIBOR rate loans under the revolving A-1 commitment is equal to (i) the Alternate Base Rate plus 2.5 percent and (ii) the 90-Day LIBO Rate plus 3.5 percent, respectively.  Interest on the revolving facility is payable on the first day of each calendar month and the maturity date.  Among other fees, we pay a commitment fee of 0.25 percent per annum (due quarterly) on the average daily amount of the unused revolving commitment under the revolving facility.  We also pay fees with respect to any letters of credit.

 

The revolving facility contains usual and customary negative covenants for transactions of this type, including, but not limited to, restrictions on our ability and our subsidiaries’ ability to create or incur indebtedness; create liens; consolidate, merge, liquidate or dissolve; sell, lease or otherwise transfer any of its assets; substantially change the nature of its business; make investments or acquisitions; pay dividends; enter into transactions with affiliates; amend material documents, prepay certain indebtedness and make capital expenditures.  The negative covenants are subject to certain exceptions as specified in the revolving credit agreement.

 

In addition, the revolving credit agreement requires us to (a) maintain (i) at all times, availability under the revolving facility of not less than $5,000,000, and (ii) at all times, the sum of availability under the revolving facility plus up to $2,500,000 of unrestricted cash of not less than $7,500,000; and (b) maintain a minimum fixed charge coverage ratio calculated for each four fiscal quarter period at levels set forth in the revolving facility.

 

As of May 31, 2014, we were in compliance with the covenants under the revolving credit agreement.

 

Term Loan Credit Agreement

 

The term loan credit agreement entered into with Garrison provided for term loans of up to $60,000,000 and was fully funded to us as of September 30, 2013.  The term loan proceeds were used to finance a portion of the consideration for the acquisition and to pay fees and expenses associated with the acquisition.

 

The term loan matures on September 30, 2018.  We are allowed to prepay the term loan at any time, in whole or in part, subject to the payment of a prepayment fee if we prepay prior to September 30, 2016.  The prepayment fee is three percent if we prepay prior to September 30, 2014 and reduced by one percent per year until September 30, 2016.  In addition, we are required to make prepayments out of extraordinary receipts, of a certain percentage of the excess cash flow and certain net proceeds of certain asset sales or equity issuances, in each case (other than a prepayment in connection with excess cash flow), subject to the payment of the prepayment fee as set forth above.

 

The term loan facility is guaranteed by us and all of our subsidiaries, and is secured by liens on substantially all assets owned by us, including a first-priority lien on intellectual property owned by us and a second-priority lien on the revolving credit priority collateral.

 

The interest rate for the term loan fluctuates and is equal to the rate per annum equal to the British Banker Association Interest Settlement Rate for deposits in Dollars with a term of three months, as appears on the Bloomberg BBAM Screen, plus 10.75 percent.  Interest is payable on the first day of each calendar month and the maturity date.

 

The term loan credit agreement contains usual and customary negative covenants for transactions of this type, including, but not limited to, restrictions on our ability and our subsidiaries’ ability to create or incur indebtedness; create liens; consolidate, merge, liquidate or dissolve; sell, lease or otherwise transfer any of its assets; substantially change the nature of its business; make investments or acquisitions; pay dividends; enter into transactions with affiliates; amend material documents, prepay certain indebtedness and make capital expenditures.  The negative covenants are subject to certain exceptions as specified in the term loan credit agreement.

 

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In addition, the term loan credit agreement also requires us to maintain (a) (i) at all times, availability under the revolving credit facility of not less than $5,000,000, and (ii) at all times as tested on each date that a borrowing certificate is delivered, the sum of availability under the revolving credit facility plus up to $2,500,000 of unrestricted cash of not less than $7,500,000; (b) a minimum fixed charge coverage ratio; (c) a minimum EBITDA; and (d) a leverage ratio not more than the maximum leverage coverage ratio as set forth in the term loan credit agreement.

 

As of May 31, 2014, we were in compliance with the covenants under the term loan credit agreement.

 

Off Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements.

 

Management’s Discussion of Critical Accounting Policies

 

We believe that the accounting policies discussed below are important to an understanding of our financial statements because they require management to exercise judgment and estimate the effects of uncertain matters in the preparation and reporting of financial results. Accordingly, we caution that these policies and the judgments and estimates they involve are subject to revision and adjustment in the future. While they involve less judgment, management believes that the other accounting policies discussed in “Notes to Consolidated Financial Statements - Note 2 — Summary of Significant Accounting Policies” included in our Annual Report on Form 10-K for the year ended November 30, 2013 previously filed with the SEC are also important to an understanding of our financial statements. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

Wholesale revenues are recorded on the accrual basis of accounting when title transfers to the customer, which is typically at the shipping point.  We record estimated reductions to revenue for customer programs, including co-op advertising, other advertising programs or allowances, based upon a percentage of sales.  We also allow for returns based upon pre-approval or in the case of damaged goods. Such returns are estimated based on historical experience and an allowance is provided at the time of sale.

 

Retail store revenue is recognized net of estimated returns at the time of sale to consumers.  E-commerce sales of products ordered through our retail internet site known as www.joesjeans.com are recognized upon estimated delivery and receipt of the shipment by the customers. E-commerce revenue is also reduced by an estimate of returns. Retail store revenue and E-commerce revenue exclude sales taxes.  Revenue from licensing arrangements are recognized when earned in accordance with the terms of the underlying agreements, generally based upon the higher of (a) contractually guaranteed minimum royalty levels; and (b) estimates of sales and royalty data received from our licensees.  Payments received in consideration of the grant of a license or advanced royalty payments are recognized ratably as revenue over the term of the license agreement.  The revenue recognized ratably over the term of the license agreement will not exceed royalty payments received.  The unrecognized portion of the upfront payments are included in deferred royalties and accrued expenses depending on the long or short term nature of the payments to be recognized.  As of May 31, 2014, we have recognized all of the advanced payments under our licensing agreements as income.

 

Accounts Receivable, Due To Factor and Allowance for Customer Credits and Doubtful Allowances

 

We evaluate our ability to collect on accounts receivable and charge-backs (disputes from the customer) based upon a combination of factors.  Whether a receivable is past due is based on how recently payments have been received and in certain circumstances where we are aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filings, substantial downgrading of credit sources).  A specific reserve for bad debts is taken against amounts due to reduce the net recognized receivable to the amount reasonably expected to be collected.  Amounts are charged off against the reserve once it is established that amounts are not likely to be collected.  We recognize reserves for charge-backs based on our historical collection experience.

 

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The balance in the allowance for customer credits and doubtful accounts as of May 31, 2014 and November 30, 2013 was $1,005,000 and $775,000, respectively, for non-factored accounts receivables.

 

Inventory

 

We continually evaluate the composition of our inventories, assessing slow-turning, ongoing product as well as product from prior seasons.  Market value of distressed inventory is valued based on historical sales trends on our individual product lines, the impact of market trends and economic conditions, and the value of current orders relating to the future sales of this type of inventory.  Significant changes in market values could cause us to record additional inventory markdowns.

 

Valuation of Goodwill, Intangible and Other Long Lived Assets

 

We assess the impairment of identifiable intangibles, long-lived assets and goodwill annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review other than on an annual basis include the following:

 

·                  A significant underperformance relative to expected historical or projected future operating results;

·                  A significant change in the manner of the use of the acquired asset or the strategy for the overall business; or

·                  A significant negative industry or economic trend.

 

When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the aforementioned factors and the carrying value exceeds the estimated undiscounted cash flows expected to be generated by the asset, impairment is measured based on a projected discounted cash flow method using a discount rate determined by management.  These cash flows are calculated by netting future estimated sales against associated merchandise costs and other related expenses such as payroll, occupancy and marketing.  An asset is considered to be impaired if we determine that the carrying value may not be recoverable based upon our assessment of the asset’s ability to continue to generate income from operations and positive cash flow in future periods or if significant changes our strategic business objectives and utilization of the assets occurred.  If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the estimated fair value, which is determined based on discounted future cash flows. The impairment loss calculations require management to apply judgment in estimating future cash flows and the discount rates that reflect the risk inherent in future cash flows.  Future expected cash flows for store assets are based on management’s estimates of future cash flows over the remaining lease period or expected life, if shorter. We consider historical trends, expected future business trends and other factors when estimating each store’s future cash flow. We also consider factors such as: the local environment for each store location, including mall traffic and competition; our ability to successfully implement strategic initiatives; and the ability to control variable costs such as cost of sales and payroll, and in some cases, renegotiate lease costs.

 

In the third quarter of fiscal 2011, we recorded store impairment charges of $1,144,000 related to two of our full price retail stores.  Based on the operating performance of these stores, we believed that we could not recover the carrying value of property and equipment located at these stores.

 

Business acquisitions are accounted for under the purchase method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed.  Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill.  Purchased intangible assets with finite lives are amortized over their estimated useful lives.  Goodwill and intangible assets with indefinite lives are not amortized but are tested at least annually for impairment.

 

In fiscal 2007, we acquired through merger JD Holdings, which included all of the goodwill and intangible assets goodwill related to the Joe’s®, Joe’s Jeans™ and JD® logo and marks. To date, we have not recognized any impairment related to the goodwill or intangible assets of our Joe’s® brand. We have assigned an indefinite life to these intangible assets, and therefore, no amortization expenses have been recognized. However, we test the assets for impairment annually in accordance with our critical accounting policies.

 

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On September 30, 2013, we acquired Hudson, which included all of the goodwill and intangible assets goodwill related to the Hudson® logos and marks. To date, we have not recognized any impairment related to the goodwill or intangible assets of our Hudson® brand. We have assigned an indefinite life to these intangible assets and therefore, no amortization expenses are expected to be recognized. However, we will test the assets for impairment annually in accordance with our critical accounting policies.

 

We evaluate goodwill and other indefinite lived intangible assets at least annually using a two-step process.  The first step is to determine the fair value of each reporting unit and compare this value to its carrying value.  If the fair value exceeds the carrying value, no further work is required and no impairment loss would be recognized.  The second step is performed if the carrying value exceeds the fair value of the assets.  The implied fair value of the reporting unit’s goodwill or indefinite lived intangible assets must be determined and compared to the carrying value of the goodwill or indefinite lived intangible assets.

 

Our annual impairment testing date is September 30 of each year.  For fiscal 2013, we determined that there was no impairment of our goodwill or indefinite lived intangible assets.

 

Additional Merger Consideration

 

In connection with the merger with JD Holdings, we agreed to pay to Mr. Dahan the following contingent consideration in the applicable fiscal year for 120 months following October 25, 2007:

 

·                  No contingent consideration if the gross profit is less than $11,250,000 in the applicable fiscal year;

·                  11.33% of the gross profit from $11,251,000 to $22,500,000;

·                  3% of the gross profit from $22,501,000 to $31,500,000;

·                  2% of the gross profit from $31,501,000 to $40,500,000; and

·                  1% of the gross profit above $40,501,000.

 

The additional merger consideration, or contingent consideration, was paid in advance on a monthly basis based upon estimates of gross profits after the assumption that the payments were likely to be paid. At the end of each quarter, any overpayments were offset against future payments and any significant underpayments were made.

 

Under the Financial Accounting Standards Board (FASB) Accounting Standards Codification, or ASC, accounting for consideration transferred to settle a contingency based on earnings or other performance measures, certain criteria is used to determine whether contingent consideration based on earnings or other performance measures should be accounted for as (1) adjustment of the purchase price of the acquired enterprise or (2) compensation for services, use of property or profit sharing.  The determination of how to account for the contingent consideration is a matter of judgment that depends on the relevant facts and circumstances.  The advanced contingent consideration payments are accounted for as operating expense.

 

On February 18, 2013, we entered into a new agreement with Mr. Dahan that provided certainty of payments to him by removing the contingencies related to the contingent consideration payments described above.  This agreement fixed the overall amount to be paid by us for the remaining months of year six through year 10 with payments being made over an accelerated time period until November 2015 instead of October 2017.  Under the agreement, the total aggregate amount Mr. Dahan will receive is $9,168,000.  We will take a one-time charge as an expense for the full amount in the quarterly period ending February 28, 2013.  In addition, Mr. Dahan agreed to a restrictive covenant relating to non-competition and non-solicitation until November 30, 2016 in addition to the restrictive covenant in the original merger agreement.

 

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Income Taxes

 

As part of the process of preparing our consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which we operate. The process involves estimating actual current tax expense along with assessing temporary differences resulting from differing treatment of items for book and tax purposes. These timing differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. Management records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Management has considered future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. Increases in the valuation allowance result in additional expense to be reflected within the tax provision in the consolidated statement of income. Reserves are also estimated for ongoing audits regarding federal and state issues that are currently unresolved. We routinely monitor the potential impact of these situations.

 

Contingencies

 

We record an estimated loss from a loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. Accounting for contingencies such as legal and income tax matters requires management to use judgment. Many of these legal and tax contingencies can take years to be resolved. Generally, as the time period increases over which the uncertainties are resolved, the likelihood of changes to the estimate of the ultimate outcome increases. Management believes that the accruals for these matters are adequate. Should events or circumstances change, we could have to record additional accruals.

 

Stock Based Compensation

 

We account for stock-based compensation in accordance with the ASC standards. We elected the modified prospective method where prior periods are not revised for comparative purposes. Under the fair value recognition provisions, stock based compensation is measured at grant date based upon the fair value of the award and expense is recognized on a straight-line basis over the vesting period. We use the Black-Scholes option pricing model to determine the fair value of stock options, which requires management to use estimates and assumptions. The determination of the fair value of stock based option awards on the date of grant is based upon the exercise price as well as assumptions regarding subjective variables. These variables include our expected life of the option, expected stock price volatility over the term of the award, determination of a risk free interest rate and an estimated dividend yield. We estimate the expected life of the option by calculating the average term based upon historical experience. We estimate the expected stock price volatility by using implied volatility in market traded stock over the same period as the vesting period. We base the risk-free interest rate on zero coupon yields implied from U.S. Treasury issues with remaining terms similar to the term on the options. We do not expect to pay dividends in the foreseeable future and therefore use an expected dividend yield of zero. If factors change or we employ different assumptions for estimating fair value of the stock option, our estimates may be different than future estimates or actual values realized upon the exercise, expiration, early termination or forfeiture of those awards in the future. At this time, we believe that our current method for accounting for stock based compensation is reasonable. Furthermore, an entity may elect either an accelerated recognition method or a straight-line recognition method for awards subject to graded vesting based on a service condition, regardless of how the fair value of the award is measured. For all stock based compensation awards that contain graded vesting based on service conditions, we have elected to apply a straight-line recognition method to account for these awards. However, guidance is relatively new and the application of these principles over time may be subject to further interpretation or refinement. See “Notes to Unaudited Condensed Consolidated Financial Statements - Note 8 — Stockholders’ Equity” for additional discussion.

 

Recent Accounting Pronouncements

 

In February 2013, the Financial Accounting Standards Board, or FASB, issued a standard that revised the disclosure requirements for items reclassified out of accumulated other comprehensive income and requires entities to present information about significant items reclassified out of accumulated other comprehensive income by component either (1) on the face of the statement where net income is presented or (2) as a separate disclosure in the notes to the financial statements. This guidance is effective for annual reporting periods beginning after December 15, 2012. We adopted this guidance effective for our first quarter of fiscal 2014.  The adoption of this guidance did not have a material effect on our financial statements.

 

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In March 2013, the FASB issued a standard which requires the release of our cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. This guidance is effective for annual reporting periods beginning after December 15, 2013.  The adoption of this amendment will not have a material effect on our financial statements.

 

In July 2013, the FASB issued a standard clarify the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists as of the reporting date. This guidance is effective for annual reporting periods beginning after December 15, 2013. The adoption of this amendment will not have a material effect on our financial statements.

 

In April 2014, the FASB issued authoritative guidance which raises the threshold for disposals to qualify as discontinued operations. Under this new guidance, a discontinued operation is (1) a component of an entity or group of components that have been disposed of or are classified as held for sale and represent a strategic shift that has or will have a major effect on an entity’s operations and financial results, or (2) an acquired business that is classified as held for sale on the acquisition date. This guidance also requires expanded or new disclosures for discontinued operations, individually material disposals that do not meet the definition of a discontinued operation, an entity’s continuing involvement with a discontinued operation following disposal and retained equity method investments in a discontinued operation. This guidance is effective for fiscal periods beginning after December 15, 2014. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

 

In May 2014, the FASB issued a comprehensive new revenue recognition standard which will supersede previous existing revenue recognition guidance. The standard creates a five-step model for revenue recognition that requires companies to exercise judgment when considering contract terms and relevant facts and circumstances. The five-step model includes (1) identifying the contract, (2) identifying the separate performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations and (5) recognizing revenue when each performance obligation has been satisfied. The standard also requires expanded disclosures surrounding revenue recognition. The standard is effective for fiscal periods beginning after December 15, 2016 and allows for either full retrospective or modified retrospective adoption. We are currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

Item 3.                                                         Quantitative and Qualitative Disclosure About Market Risk.

 

Not applicable until fiscal year ended November 30, 2014.

 

Item 4.                                                         Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

As of May 31, 2014, the end of the period covered by this periodic report, our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(b) and 15d-15(b) under the Exchange Act.

 

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.  In addition, disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive and principal financial officers or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosures.  Management recognizes that a control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within the company have been detected.  Therefore, assessing the costs and benefits of such controls and procedures necessarily involves the exercise of judgment by management.  Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.

 

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As of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control Over Financial Reporting

 

We made no change in our internal control over financial reporting during the second quarter of the fiscal year covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II — OTHER INFORMATION

 

Item 1.                                                         Legal Proceedings.

 

We are a party to lawsuits and other contingencies in the ordinary course of our business.  We do not believe that we are a party to any material pending legal proceedings or that it is probable that the outcome of any individual action would have an adverse effect in the aggregate on our financial condition.  We do not believe that it is likely that an adverse outcome of individually insignificant actions in the aggregate would be sufficient enough, in number or in magnitude, to have a material adverse effect in the aggregate on our financial condition.

 

Item 1A.                                                Risk Factors.

 

In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed under “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended November 30, 2013 as filed with the SEC.  These risks could materially and adversely affect our business, financial condition and results of operations.  The risks described in our Form 10-K are not the only risks we face.  Our operations could also be affected by additional factors that are not presently known to us or by factors that we currently consider immaterial to our business.

 

Item 2.                                                         Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3.                                                         Defaults upon Senior Securities.

 

None.

 

Item 4.                                                         Mine Safety Disclosure.

 

Not Applicable.

 

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Item 5.                                                         Other Information.

 

(a)                                 Subsequent Actions Concerning the Board of Directors and Board Committees.

 

We recently became aware of an issue relating to our compliance with NASDAQ Marketplace Rule 5605, or Rule 5605, which imposes certain conditions on listed companies, including: (i) a majority of the board of directors must be independent; (ii) the audit committee must have a minimum of three members, all of whom must be independent and also meet the specific audit committee standards required by the SEC; and (iii) independent directors must exercise oversight of the director nomination process.

 

On February 8, 2013, Mr. Marc Crossman and Mr. Samuel J. Furrow entered into a personal business arrangement by which Mr. Crossman allowed certain of his shares of his Joe’s Jeans common stock to be pledged as additional collateral for a loan from a third-party lender to Mr. Furrow.  While the fact that Mr. Crossman’s shares had been pledged was previously disclosed, the details of the pledge arrangement were inadvertently miscommunicated to us.

 

NASDAQ listing standards require that a majority of the Board of Directors and all members of the audit committee be “independent”.  The independence criteria defines an “independent” director, in part, as a person other than an Executive Officer or employee of the Company or other individual having a relationship which in the opinion of the Joe’s Jeans Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

 

Although the miscommunication was unintentional, upon recently learning of the pledge arrangement from Mr. Furrow and Mr. Crossman, steps were promptly taken to assure compliance with the NASDAQ listing standards.  As a result, on July 9, 2014, effective immediately, Mr. Furrow stepped down from the audit and nominating and governance committees, but will remain as a director and Chairman of the Board and will not be designated as an independent director.  Also, Mr. Crossman resigned from the Board of Directors, on July 9, 2014, effective immediately, but will remain as our President and Chief Executive Officer.  After Mr. Crossman’s resignation from the Board of Directors, the Board is comprised of seven directors, four independent directors and three non-independent directors.  Further, on July 9, 2014, the Board approved the appointment of Ms. Joanne Calabrese to the audit committee and appointed her as chair of the nominating and governance committee.  At the same meeting, the Board appointed Mr. Kent Savage to the nominating and governance committee.

 

As a result of the actions taken by the Board of Directors, we believe that we are in compliance with Rule 5605 because currently (i) a majority of the Board is comprised of independent directors, (ii) the audit committee is comprised of at least three members that are independent directors and financially literate and (iii) the nominating and governance committee (which oversees the director nomination process) is comprised entirely of independent directors.

 

(b)                                 There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors, including adoption of procedures by which our stockholders may recommend nominees to the our board of directors.

 

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Item 6.                                                         Exhibits.

 

Exhibits (listed according to the number assigned in the table in Item 601 of Regulation S-K):

 

Exhibit
No.

 

Description

 

Document if Incorporated
by Reference

 

 

 

 

 

31.1

 

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended

 

Filed herewith

 

 

 

 

 

31.2

 

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended

 

Filed herewith

 

 

 

 

 

32

 

Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Filed herewith

 

 

 

 

 

101

 

The following materials from Joe’s Jeans Inc.’s Quarterly Report on Form 10-Q for the quarter ended May 31, 2014, formatted in XBRL (eXtensible Business Reporting Language); (i) Condensed Consolidated Statements of Net (Loss) Income and Comprehensive (Loss) Income for the three and six months ended May 31, 2014 and 2013, (ii) Condensed Consolidated Balance Sheets at May 31, 2014 and November 30, 2013, (iii) Condensed Consolidated Statements of Cash Flows for the three and six months ended May 31, 2014 and 2013, (iv) Condensed Consolidated Statements Stockholders’ Equity as of May 31, 2014 and 2013 and (v) Notes to the Unaudited Condensed Consolidated Financial Statements.

 

Filed herewith

 

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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.

 

 

JOE’S JEANS INC.

 

 

July 10, 2014

/s/ Marc B. Crossman

 

Marc B. Crossman

 

Chief Executive Officer (Principal Executive Officer) and President

 

 

 

 

July 10, 2014

/s/ Hamish Sandhu

 

Hamish Sandhu

 

Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit
No.

 

Description

 

Document if Incorporated
by Reference

 

 

 

 

 

31.1

 

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended

 

Filed herewith

 

 

 

 

 

31.2

 

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended

 

Filed herewith

 

 

 

 

 

32

 

Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Filed herewith

 

 

 

 

 

101

 

The following materials from Joe’s Jeans Inc.’s Quarterly Report on Form 10-Q for the quarter ended May 31, 2014, formatted in XBRL (eXtensible Business Reporting Language); (i) Condensed Consolidated Statements of Net (Loss) Income and Comprehensive (Loss) Income for the three and six months ended May 31, 2014 and 2013, (ii) Condensed Consolidated Balance Sheets at May 31, 2014 and November 30, 2013, (iii) Condensed Consolidated Statements of Cash Flows for the three and six months ended May 31, 2014 and 2013, (iv) Condensed Consolidated Statements Stockholders’ Equity as of May 31, 2014 and 2013 and (v) Notes to the Unaudited Condensed Consolidated Financial Statements.

 

Filed herewith

 

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