Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2019

 

OR

 

☐ 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:  000-18926

 

CENTRIC BRANDS 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.)

 

 

350 5th Avenue, 6th Floor, New York, NY 10118

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code: (646) 582-6000

 

N/A

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

 

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock, par value $0.10 per share

 

CTRC

 

The Nasdaq Stock Market LLC (Nasdaq Capital Market)

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  ☒  Yes  ☐ No

 

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

 

Large accelerated filer ☐

 

Smaller reporting company ☒

Non-accelerated filer ☒

 

Emerging growth company ☐

Accelerated filer ☐

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

The number of shares of the registrant’s common stock outstanding as of May 20, 2019 was 58,542,641.

 

 

 

 

Table of Contents

CENTRIC BRANDS INC.

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

 

 

 

 

Item Number

 

Page

 

 

 

 

PART I FINANCIAL INFORMATION

 

 

 

 

Item 1. 

Financial Statements

 

 

Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018

3

 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended March 31, 2019 and 2018 

4

 

Condensed Consolidated Statements of Equity for the three months ended March 31, 2019 and 2018

5

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018

6

 

Notes to Condensed Consolidated Financial Statements

7

Item 2. 

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

29

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

43

Item 4. 

Controls and Procedures

43

 

 

 

 

PART II OTHER INFORMATION

 

 

 

 

Item 1. 

Legal Proceedings

44

Item 1A. 

Risk Factors

44

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

44

Item 5. 

Other Information

44

Item 6. 

Exhibits

45

 

 

 

 

Signature Page

46

 

 

 

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Table of Contents

PART I — FINANCIAL INFORMATION

Item 1.          Financial Statements

 

CENTRIC BRANDS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands)

 

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2019

 

2018

 

 

(unaudited)

 

(Note 1)

ASSETS

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

25,218

 

$

29,519

Accounts receivable, net

 

 

26,373

 

 

27,910

Sold receivables, net

 

 

13,516

 

 

33,825

Inventories

 

 

294,243

 

 

342,952

Prepaid expenses and other current assets

 

 

76,641

 

 

48,378

Total current assets

 

 

435,991

 

 

482,584

Property and equipment, net

 

 

92,763

 

 

93,044

Goodwill

 

 

376,132

 

 

376,132

Intangible assets, net

 

 

878,055

 

 

897,470

Operating lease right-of-use assets

 

 

209,715

 

 

 —

Other assets

 

 

9,320

 

 

9,725

Total assets

 

$

2,001,976

 

$

1,858,955

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

485,207

 

$

525,863

Current portion of operating lease liabilities

 

 

23,155

 

 

 —

Current portion of long-term debt

 

 

18,929

 

 

11,602

Revolving credit facilities

 

 

40,000

 

 

 —

Total current liabilities

 

 

567,291

 

 

537,465

Convertible notes

 

 

37,310

 

 

36,235

Long-term debt, net of current portion

 

 

1,195,904

 

 

1,195,297

Deferred income taxes, net

 

 

1,986

 

 

 —

Operating lease liabilities

 

 

193,782

 

 

 —

Other non-current liabilities

 

 

1,012

 

 

6,581

Total liabilities

 

 

1,997,285

 

 

1,775,578

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

Equity

 

 

 

 

 

 

Common stock, $0.10 par value: 100,000 shares authorized, 58,570 and 58,364 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively

 

 

5,857

 

 

5,836

Additional paid-in capital

 

 

221,522

 

 

218,240

Accumulated other comprehensive income

 

 

361

 

 

487

Accumulated deficit

 

 

(223,049)

 

 

(141,186)

Total equity

 

 

4,691

 

 

83,377

Total liabilities and equity

 

$

2,001,976

 

$

1,858,955

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

3

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CENTRIC BRANDS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE LOSS

(in thousands, except per share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2019

    

2018

Net sales

 

$

528,897

 

$

38,818

Cost of goods sold

 

 

409,951

 

 

22,563

Gross profit

 

 

118,946

 

 

16,255

Operating expenses

 

 

 

 

 

 

Selling, general and administrative

 

 

113,165

 

 

15,348

Depreciation and amortization

 

 

22,956

 

 

1,463

Other operating expense, net

 

 

17,098

 

 

 —

Total operating expenses

 

 

153,219

 

 

16,811

Operating loss

 

 

(34,273)

 

 

(556)

Other expense, net

 

 

 

 

 

 

Interest expense

 

 

46,013

 

 

2,215

Other (income) expense, net

 

 

(42)

 

 

(1)

Total other expense, net

 

 

45,971

 

 

2,214

Loss before income taxes

 

 

(80,244)

 

 

(2,770)

Income tax provision

 

 

1,619

 

 

1,315

Net loss

 

$

(81,863)

 

$

(4,085)

 

 

 

 

 

 

 

Net loss attributable to common stockholders

 

$

(81,863)

 

$

(5,847)

 

 

 

 

 

 

 

Net loss

 

$

(81,863)

 

$

(4,085)

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

(126)

 

 

763

Other comprehensive income (loss)

 

 

(126)

 

 

763

Comprehensive loss

 

$

(81,989)

 

$

(3,322)

 

 

 

 

 

 

 

Loss per common share - basic

 

 

 

 

 

 

Loss per common share - basic

 

$

(1.40)

 

$

(0.43)

 

 

 

 

 

 

 

Loss per common share - diluted

 

 

 

 

 

 

Loss per common share - diluted

 

$

(1.40)

 

$

(0.43)

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

 

 

 

 

Basic

 

 

58,548

 

 

13,550

Diluted

 

 

58,548

 

 

13,550

 

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

 

 

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CENTRIC BRANDS INC.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(in thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

Common Stock

 

Preferred Series A

 

Preferred Series A-1

 

Additional

 

Comprehensive

 

Accumulated

 

Total

 

    

Shares

    

Par Value

    

Shares

    

Par Value

    

Shares

    

Par Value

    

Paid-In Capital

    

Income (Loss)

    

Deficit

    

Equity

Balance, January 1, 2018, as previously reported

 

13,488

 

$

1,349

 

 

50

 

$

 5

 

 

 —

 

 

 —

 

$

61,314

 

$

271

 

$

(18,196)

 

$

44,743

Impact of change in accounting policy

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

775

 

 

775

Adjusted balance at January 1, 2018

 

13,488

 

$

1,349

 

 

50

 

$

 5

 

 

 —

 

 

 —

 

$

61,314

 

$

271

 

$

(17,421)

 

$

45,518

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of Series A-1 convertible preferred stock

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

4,588

 

 

459

 

 

13,305

 

 

 —

 

 

 —

 

 

13,764

Stock-based compensation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

637

 

 

 —

 

 

 —

 

 

637

Issuance of common stock, net of taxes withheld

 

111

 

 

11

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(64)

 

 

 —

 

 

 —

 

 

(53)

Foreign currency translation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

763

 

 

 —

 

 

763

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(4,085)

 

 

(4,085)

Balance, March 31, 2018

 

13,599

 

$

1,360

 

 

50

 

$

 5

 

 

4,588

 

$

459

 

$

75,192

 

$

1,034

 

$

(21,506)

 

$

56,544

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2019

 

58,364

 

$

5,836

 

 

 —

 

$

 —

 

 

 —

 

$

 —

 

$

218,240

 

 

487

 

$

(141,186)

 

$

83,377

Issuance of common stock, net of taxes withheld

 

206

 

 

21

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(114)

 

 

 —

 

 

 —

 

 

(93)

Stock-based compensation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

3,396

 

 

 —

 

 

 —

 

 

3,396

Foreign currency translation

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(126)

 

 

 —

 

 

(126)

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(81,863)

 

 

(81,863)

Balance, March 31, 2019

 

58,570

 

$

5,857

 

 

 —

 

$

 —

 

 

 —

 

$

 —

 

$

221,522

 

$

361

 

$

(223,049)

 

$

4,691

 

The accompanying notes are an integral part of these condensed consolidated financial statements

 

 

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CENTRIC BRANDS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

    

2019

    

2018

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

Loss from operations

 

$

(81,863)

 

$

(4,085)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

22,956

 

 

1,463

Amortization of deferred financing costs and discounts

 

 

4,392

 

 

289

Paid-in-kind interest

 

 

5,184

 

 

437

Stock-based compensation

 

 

3,396

 

 

637

Amortization of inventory step up

 

 

8,781

 

 

 —

Amortization of lease expense

 

 

5,993

 

 

 —

Other non-cash adjustments

 

 

1,263

 

 

98

Deferred income taxes, net

 

 

1,986

 

 

523

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable, net

 

 

(284,890)

 

 

(145)

Operating lease liability

 

 

(5,512)

 

 

 —

Inventories

 

 

40,234

 

 

(2,365)

Prepaid expenses and other assets

 

 

(29,212)

 

 

(628)

Accounts payable and accrued expenses

 

 

(36,476)

 

 

(416)

Other liabilities

 

 

(3,348)

 

 

317

Net cash used in operating activities

 

 

(347,116)

 

 

(3,875)

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

Collections of sold receivables

 

 

307,279

 

 

 —

Purchases of property and equipment

 

 

(3,899)

 

 

(439)

Net cash provided by (used in) investing activities

 

 

303,380

 

 

(439)

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

Repayment of long-term debt

 

 

 —

 

 

(938)

Proceeds from line of credit, net

 

 

39,685

 

 

1,379

Taxes paid in lieu of shares issued for stock-based compensation

 

 

(93)

 

 

(53)

Net cash provided by financing activities

 

 

39,592

 

 

388

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(157)

 

 

 7

 

 

 

 

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

 

(4,301)

 

 

(3,919)

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, at beginning of period

 

 

29,519

 

 

8,250

CASH AND CASH EQUIVALENTS, at end of period

 

$

25,218

 

$

4,331

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

 

Interest paid

 

$

34,170

 

$

3,021

Income taxes paid

 

$

 —

 

$

 6

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

 

 

 

 

 

 

Unpaid purchases of property and equipment

 

$

63

 

$

101

Beneficial interest obtained in exchange for securitized trade receivables

 

$

276,668

 

$

 —

Conversion of short-term convertible notes

 

$

 —

 

$

13,764

 

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

 

6

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CENTRIC BRANDS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands (unless otherwise indicated) except share and per share data)

(unaudited)

 

1.    Business Description and Basis of Presentation

Centric Brands Inc. (“Centric” or the “Company”) is a leading lifestyle brands collective, bringing together creative minds from the worlds of fashion and commerce, sourcing, technology, marketing, digital and entertainment. The Company designs, produces, merchandises, manages, and markets kidswear, accessories, and men’s and women’s apparel under owned, licensed and private label brands. The Company’s distinctive image has been developed across an expanding number of products, brands, sales channels and markets. Company owned brands include Hudson®, Robert Graham®, and SWIMS® (the “Owned Brands”). Additionally, the Company licenses brands or makes private label brands which are sold in various product categories primarily in North America. Licensed brands include Calvin Klein®, Tommy Hilfiger®, Nautica®, Under Armour®, BCBG®, Buffalo Jeans®, Joe’s Jeans®, and Michael Kors®. Centric and its subsidiaries are collectively referred to herein as the “Company,” “we,” “us,” “our,” and “ourselves,” unless the context indicates otherwise.

On October 29, 2018, the Company acquired from Global Brands Group Holding Limited’s (“GBG”) and GBG USA Inc., a wholly-owned subsidiary of GBG (“GBG USA”) a significant part of GBG’s North American business (“GBG Acquisition”), including the wholesale, retail and e-commerce operations comprising all of their North American kids business, all of their North American accessories business and a majority of their West Coast and Canadian fashion businesses (the “GBG Business”). Effective upon the consummation of the GBG Acquisition, the Company changed its name from Differential Brands Group Inc. to Centric Brands Inc. and changed its trading symbol on NASDAQ from DFBG to CTRC.

Prior to the GBG Acquisition, the Company organized its business into the following three reportable segments: Wholesale, Consumer Direct and Corporate and other. Subsequent to the GBG Acquisition, the Company implemented organizational changes that have impacted the manner in which it manages the Company. Accordingly, the Company realigned its business into the following three reportable segments: Kids, Accessories and Men’s & Women’s Apparel. See “Note 15 – Segment Information.”

The Company continues to be a “smaller reporting company,” as defined under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with the Company’s audited financial statements and footnotes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018 (“2018 10-K”) filed on May 16, 2019. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such rules and regulations.

The condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the Company’s consolidated financial position,  its results of operations and cash flows for the interim periods presented. The operating results for the three months ended March 31, 2019 are not necessarily indicative of the results to be expected for the full fiscal year 2019 or for any other interim period. The December 31, 2018 consolidated balance sheet is condensed from the audited financial statements as of that date. 

The condensed consolidated financial statements have been prepared in accordance with GAAP and include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make

7

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estimates and assumptions that affect the amounts reported in the financial statements.  Actual results may differ from those estimates.

 

2.    Summary of Significant Accounting Policies

Information regarding significant accounting policies is contained in “Note 2 - Summary of Significant Accounting Policies” of the consolidated financial statements in the 2018 10-K.

Revenue Recognition

The Company adopted Accounting Standards Codification (“ASC 606”), Revenue from Contracts with Customers, with a date of initial application of January 1, 2018. As a result, the Company has changed its accounting policy for revenue recognition as described below. The Company applied ASC 606 using the modified retrospective approach – i.e. by recognizing the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of equity at January 1, 2018. The details of the significant changes and quantitative impact of the changes are set out below. The Company applied the modified retrospective approach only to contracts that were not complete as of the date of the initial application, January 1, 2018.

Effective January 1, 2018, wholesale revenues are recorded when a contract with the customer is agreed to by both parties and product has been transferred, which generally occurs at the point of shipment from the Company’s warehouse, and recorded at the transaction price based on the amount the Company expects to receive. Collection is probable as the majority of shipments occur to reputable credit worthy businesses and through factored relationships which guarantee payment. Estimated reductions to revenue for customer allowances are recorded based upon history as a percentage of sales and current outstanding chargebacks. The Company may allow for returns based upon pre-approval or in the case of damaged goods. Such returns are estimated based on historical experience and also specific claims filed by the customer. Beginning January 1, 2018, a refund liability is included in accounts payable and accrued expenses within the accompanying condensed consolidated balance sheet, which was previously recorded net of accounts receivable. Also, effective January 1, 2018, the Company records a return asset receivable in prepaid expenses and other current assets within the accompanying condensed consolidated balance sheet. Prior to January 1, 2018, inventory expected to be returned was recorded within inventories. The return asset receivable is evaluated for impairment each period. The Company recorded a decrease of $0.6 million to opening accumulated deficit as of January 1, 2018 to record the return asset receivable and related impairment charge.

Retail store revenue is recognized at the time the customer takes possession of the related merchandise. Revenue for ecommerce sales of products ordered through the Company’s retail internet sites are recognized at the point of shipment to the customer. Prior to January 1, 2018, revenue for ecommerce sales was recorded at the point of delivery to the customer. The Company recorded an immaterial adjustment to increase the opening accumulated deficit as of January 1, 2018, to reflect the impact on ecommerce shipments from adopting ASC 606. Ecommerce revenue was reduced by an estimate for returns based on the historical rate of return as a percent of sales. Retail store revenue and ecommerce revenue exclude sales taxes collected from the customer.

Revenue from licensing arrangements is recognized based on actual sales when the Company expects royalties to exceed the minimum guarantee. For licensing arrangements in which the Company does not expect royalties to exceed the minimum guarantee, an estimate of the transaction price is recognized on a straight-line basis over the term of the contract. A contract asset is recorded for revenue recognized in advance of the contract payment terms, which is included in other assets within the accompanying condensed consolidated balance sheet. Nonrefundable upfront fees are recorded as a contract liability and revenue is recognized straight-line over the term of the contract. Contract liabilities are included in other liabilities within the accompanying condensed consolidated balance sheet. Prior to January 1, 2018, revenue from licensing arrangements was recognized when earned in accordance with the terms of the underlying agreements and deemed collectible, generally based upon the higher of (a) the contractually guaranteed minimum royalty or (b) actual net sales data received from licensees. The Company recorded an adjustment to increase the opening accumulated deficit as of January 1, 2018, by $1.3 million, to reflect the impact on licensing revenue from adopting ASC 606.

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Amounts related to shipping and handling that are billed to customers are considered to be activities to fulfill a promise to transfer the goods and are reflected in net sales, and the related costs are reflected in cost of goods sold within the accompanying condensed consolidated statements of operations and comprehensive loss. This accounting treatment is consistent with the Company’s treatment of shipping and handling revenue prior to January 1, 2018.

The adoption of ASC 606 had no net impact on the Company's condensed consolidated statement of cash flows for the year ended December 31, 2018.

Concentration of Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents, accounts receivable and factored accounts receivable. The Company maintains cash and cash equivalents with various financial institutions. The policy is designed to limit exposure to any one institution. Periodic evaluations are performed of the relative credit rating of those financial institutions that are considered in the Company’s investment strategy. The vast majority of trade receivables from sales to customers are subsequently sold to a financial institution pursuant to a trade receivables securitization facility. The sale of trade receivables are made on a recourse basis however are guaranteed through credit insurance purchased from an unrelated financial institution. When insured, the Company is not at risk if a customer fails to pay. For trade receivables not sold to a financial institution, the Company generally does not require collateral. As of March 31, 2019, the net deferred purchase price of trade receivables sold pursuant to the RPA (as defined below) totaled $13.5 million. The RPA was not in place as of March 31, 2018.  See “Note 4 –Accounts Receivables.”

The Company provides an allowance for estimated losses to be incurred in the collection of accounts receivable based upon the aging of outstanding balances and other account monitoring analysis. The net carrying value approximates the fair value for these assets. Such losses have historically been within management’s expectations. Uncollectible accounts are written off once collection efforts are deemed by management to have been exhausted.

For the three months ended March 31, 2019 and 2018, sales to customers or customer groups representing 10 percent or greater of net sales for such period are as follows:

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

2019

    

2018

 

Customer A

 

15

%  

 —

%

Customer B

 

13

%  

 —

%

 

Financial Accounting Standards Recently Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASC Topic 842, Leases (“ASC 842”), a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of ROU assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by lessees for those leases classified as operating. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

The Company adopted ASC 842 as of January 1, 2019, using the modified retrospective approach. The Company elected the ‘comparatives under ASC 840 option’ as a transitional practical expedient, which allows the Company to initially apply the new lease requirements at the effective date and recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. It also allows the Company to report comparative periods in the financial statements under previous GAAP under ASC 840, Leases (“ASC 840”). The Company also elected the ‘package of practical expedients’ permitted under the transition guidance, which allowed the Company to (i) carry forward the historical lease classification, (ii) forgo reassessment of whether any expired or existing contracts contain leases, and (iii) forgo reassessment of whether any previously unamortized initial direct costs continue to meet the definition of initial direct costs under ASC 842. However, any initial direct costs after the effective date will be included within the ROU asset under ASC 842. The Company did not elect the ‘hindsight’ practical expedient to reassess the lease term for existing leases.

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For the accounting policy practical expedients, the Company elected the short-term lease exemption, under which any lease less than 12 months is excluded from recognition on the balance sheet. The Company elected not to recognize ROU assets and lease liabilities for short term leases which have a lease term of 12 months or less and do not include an option to purchase the underlying asset that the Company is reasonably certain to exercise. Additionally, the Company elected the non-separation of lease and non-lease components, and as a result, the Company does not need to account for lease components (e.g., fixed payments including rent) separately from the non-lease components (e.g., common-area maintenance costs) for all leases.

The adoption of ASC 842 resulted in the recognition of ROU assets of $214.0 million with corresponding lease liabilities of $220.7 million. As a result of adopting the standard, $6.7 million of pre-existing liabilities for deferred rent, unfavorable leases and various lease incentives were reclassified as a component of the ROU assets.

There was no adjustment to the opening balance of retained earnings upon adoption of ASC 842 given the nature of the impacts and the other transition practical expedients elected by the Company. Adoption of ASC 842 impacted the Company’s results on January 1, 2019, as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustments due

 

 

 

    

December 31, 2018

    

to ASC 842

    

January 1, 2019

Operating lease right-of-use assets  (1) (2) (4)

 

$

 —

 

$

214,000

 

$

214,000

 

 

 

 

 

 

 

 

 

 

Current portion of operating lease liabilities (3)

 

 

 —

 

 

20,883

 

 

20,883

Accounts payable and accrued expenses (1)

 

 

525,863

 

 

(367)

 

 

525,496

Operating lease liabilities (3)

 

 

 —

 

 

199,857

 

 

199,857

Other non-current liabilities (4)

 

 

6,581

 

 

(6,373)

 

 

208

Total

 

$

532,444

 

$

214,000

 

$

746,444


(1)

Represents the reclassification of deferred rent, unfavorable leases and lease incentives to operating lease right-of-use assets. 

(2)

Represents capitalization of operating lease assets.

(3)

Represents recognition of operating lease liabilities.

(4)

Represents reclassification of deferred rent, unfavorable leases and lease incentives to operating lease right-of-use assets.

 

The standard did not materially impact the Company’s consolidated net earnings and had no material impact on the condensed consolidated statement of cash flows. For further information regarding leases, see “Note 10 - Leases.”

Leases

In general, leases are evaluated and classified as either operating or finance leases. The Company has finance leases, however, finance leases are not material to the Company’s condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive loss or condensed consolidated statement of cash flows.

The Company’s operating leases are included in operating lease right-of-use (“ROU”)  assets, accounts payable and accrued expenses, and non-current lease liabilities on the condensed consolidated balance sheets. Operating lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses its estimated incremental borrowing rate based on information available at the date of adoption in calculating the present value of its existing lease payments. The incremental borrowing rate is determined using the U.S. Treasury rate adjusted to account for the Company’s credit rating and the collateralized nature of operating leases. The operating lease asset also includes any lease payments made and unamortized lease incentives. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line method over the term of the lease.

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Recently Issued Financial Accounting Standards

In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments — Credit Losses — Measurement of Credit Losses on Financial Instruments, an accounting standards update that introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. This includes accounts receivable, trade receivables, loans, held-to-maturity debt securities, net investments in leases and certain off-balance sheet credit exposures.  The guidance also modifies the impairment model for available-for-sale debt securities. The update is effective for fiscal years beginning after December 15, 2019 and interim periods within that reporting period.  The Company is currently assessing the potential effects this update may have on its condensed consolidated financial statements and related disclosures.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairments by eliminating step two from the goodwill impairment test. Under this guidance, if the carrying amount of a reporting unit exceeds its estimated fair value, an impairment charge shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. This standard is effective beginning in the first quarter of 2020, with early adoption permitted. The Company is currently assessing the impact of the new guidance.

 

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This new guidance removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. This new guidance is effective for the Company beginning on January 1, 2020, with early adoption permitted. Certain disclosures in the new guidance will need to be applied on a retrospective basis and others on a prospective basis. The Company is currently assessing the impact of the new guidance.

 

 

3.    GBG Acquisition

On October 29, 2018, the Company completed the GBG Acquisition. To finance the acquisition, the Company entered into the Credit Agreements (as defined below). The First Lien Credit Agreement (as defined below) provides for a senior secured asset based revolving credit facility with commitments in an aggregate principal amount of $150.0 million and a senior secured term loan credit facility in an aggregate principal amount of $645.0 million. The Second Lien Credit Agreement (as defined below) provides for a second lien term loan facility in an aggregate principal amount of $668.0 million. See “Note 8 – Debt” for a discussion of the terms of the Credit Agreements.

The GBG Acquisition qualified as a business combination and was accounted for under the acquisition method of accounting. Business acquisitions are accounted for under the acquisition 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 or whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

 

The purchase price allocation is subject to adjustment until the Company has completed its analysis within the measurement period. The purchase price allocation is preliminary and the finalization of the Company's purchase price allocation may result in changes in the valuation of assets acquired and liabilities assumed. The Company will finalize the purchase price allocation as soon as practicable, but not to exceed one year following October 29, 2018.

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The following table summarizes the allocation of the preliminary purchase price as of October 29, 2018 (in thousands):

 

 

 

 

 

 

Purchase

 

 

Price Allocation

Assets acquired and liabilities assumed:

    

 

  

Accounts receivable

 

$

65,106

Inventories

 

 

371,605

Prepaid expenses and other current assets

 

 

56,380

Property and equipment

 

 

86,971

Other assets

 

 

41

Accounts payable and accrued expenses

 

 

(589,849)

 

 

 

 

Intangible assets and liabilities acquired:

 

 

 

Goodwill

 

 

367,725

Leasehold interests

 

 

(2,310)

Customer relationships

 

 

824,000

Preliminary Purchase Price

 

$

1,179,669

 

The purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed in the GBG Acquisition based on their estimated fair values as of the acquisition date. The fair values of assets acquired and liabilities assumed represent management’s estimate of fair value based on information obtained from various sources, including management’s historical experience. As a result of the fair value assessment, inventory acquired was stepped up to fair value by the amount of $32.4 million. During the three months ended March 31, 2019, we recognized $8.8 million within cost of goods sold related to the stepped up fair value of inventory acquired. The estimated fair value of the acquired tangible and intangible assets and liabilities assumed were determined using multiple valuation approaches depending on the type of tangible or intangible asset acquired, including but not limited to the income approach, the excess earnings method, the with versus without method,  net realizable value method and the relief from royalty method approach.

The amount of goodwill represents the excess of the GBG Acquisition purchase price over the net identifiable assets acquired and liabilities assumed. Goodwill primarily represents, among other factors, the value of synergies expected to be realized by integration with the Company and expected positive cash flow and return on capital projections from the integration. Goodwill arising from the acquisition of the GBG Business was determined as the excess of the purchase price over the net acquisition date fair values of the acquired assets and the liabilities assumed, and is not deductible for income tax purposes subject to certain tax elections that are currently being considered.

The Company has determined the useful life of the acquired customer relationships are finite and will be amortized over their useful lives. However, the assets will be tested for impairment if events or changes in circumstances indicate that the assets might be impaired.

GBG USA, through various affiliates and third parties, currently provides a number of critical services to us, such as information technology services, financial systems, shared real estate and logistics support through a transition services agreement.

Unaudited pro forma financial information

The following table presents our unaudited pro forma results for the three months ended March 31, 2018, as if the GBG Acquisition had occurred on January 1, 2018. The unaudited pro forma financial information presented includes the effects of adjustments related to the amortization of acquired tangible and intangible assets, and excludes other non-

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recurring transaction costs directly associated with the acquisition such as legal and other professional service fees. Statutory rates were used to calculate income taxes.

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

2018

 

 

 

(in thousands)

 

Net sales

 

$

599,121

 

Cost of goods sold

 

 

449,026

 

Gross margin

 

 

150,095

 

Gross margin % of net sales

 

 

25.1

%

Operating expenses

 

 

 

 

Selling, general and administrative

 

 

135,288

 

Depreciation and amortization

 

 

23,434

 

Total operating expenses

 

 

158,722

 

Operating loss

 

 

(8,627)

 

Interest expense

 

 

38,113

 

Gain on contingent consideration

 

 

(17,676)

 

Loss before income taxes

 

 

(29,064)

 

Income tax provision

 

 

1,316

 

Net loss

 

$

(30,380)

 

 

The unaudited pro forma financial information as presented above is for information purposes only and is not necessarily indicative of the actual results that would have been achieved had the GBG Acquisition occurred at the beginning of the earliest period presented or the results that may be achieved in future periods.

 

4.    Accounts Receivables

PNC Receivables Facility

In October 2018, in connection with the GBG Acquisition, the Company entered into a three-year trade receivables securitization facility (the PNC Receivables Facility) pursuant to (i) a Purchase and Sale Agreement, among certain subsidiaries of the Company, as “Originators,” and Spring Funding, LLC (“Spring”), a wholly owned, bankruptcy-remote special purpose subsidiary of the Company, as “Buyer” (the “PSA”) and (ii) a Receivables Purchase Agreement among Spring, as “Seller”, the Company, as initial “Servicer”, certain purchasers party thereto (the “Purchasers”), PNC Bank, National Association, as Administrative Agent, and PNC Capital Markets LLC, as Structuring Agent (the “RPA”). Other subsidiaries of the Company may later enter into the PNC Receivables Facility. At the end of the initial three year term, the Purchasers may elect to renew their commitments under the RPA.

Under the terms of the PSA, the Originators sell or contribute certain of their trade accounts receivable, related collections and security interests (the “Receivables”) to Spring on a revolving basis. Under the terms of the RPA, Spring sells to the Purchasers an undivided ownership interest in the Receivables for up to $450.0 million in cash proceeds. The proceeds from the Purchasers’ investment are used to finance Spring’s purchase of the Receivables from the Originators. Spring may also use the proceeds from a subordinated loan made by the Originators to Spring to finance purchases of the Receivables from the Originators. Rather than remitting to the Purchasers the amount received upon payment of the Receivables, Spring reinvests such Receivables payments to purchase additional Receivables from the Originators through the term of the agreement, subject to the Originators generating sufficient eligible Receivables to sell to Spring in replacement of collected balances. Advances under the RPA will accrue interest based on a variable rate plus a margin.

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Accounts receivables consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

    

March 31, 2019

    

December 31, 2018

Insured receivables sold

    

$

347,316

    

$

380,595

Uninsured receivables sold

 

 

31,982

 

 

43,630

Total receivables sold

 

 

379,298

 

 

424,225

Purchase price of sold receivables

 

 

(341,100)

 

 

(364,900)

Allowances and bad debt

 

 

(24,682)

 

 

(25,500)

Sold receivables, net

 

 

13,516

 

 

33,825

 

 

 

 

 

 

 

Accounts receivable, net

 

$

26,373

 

$

27,910

 

On April 25, 2019, the Company amended the PNC Receivables Facility to, among other things, increase the aggregate commitments under the it; see “Note 16 – Subsequent Events” below for additional information.

 

 

5.    Inventories

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

 

 

 

 

 

 

 

 

    

March 31, 2019

    

December 31, 2018

Finished goods

    

$

262,929

    

$

315,484

Raw materials and work in progress

 

 

31,314

 

 

27,468

Total inventories

 

$

294,243

 

$

342,952

 

 

6.    Intangible Assets and Goodwill

Company’s intangible assets as of March 31, 2019 are comprised of trade names, customer relationships and non-compete agreements. Intangible assets are recorded at cost, less accumulated amortization. Amortization of intangible assets with finite lives is provided for over their estimated useful lives on a straight-line basis. The life of the trade names are indefinite.

Amortization expense related to the intangible assets amounted to approximately $19.5 million and $0.8 million for the three months ended March 31, 2019 and 2018, respectively.

There were no impairment charges recorded related to intangible assets or goodwill during the three months ended March 31, 2019 and 2018.

 

7.    Commitments and Contingencies

Litigation

In the ordinary course of business, the Company is subject to periodic claims, investigations and lawsuits. Although the Company cannot predict with certainty the ultimate resolution of claims, investigations and lawsuits, asserted against the Company, it does not believe that any currently pending legal proceeding or proceedings to which it is a party could have a material adverse effect on its business, financial condition or results of operations.

 

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8.    Debt

The five-year payment schedule of the Company’s debt as of March 31, 2019 is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payment Due by Period

 

Original

 

 

 

 

 

Remainder of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issue (Discount)

 

Carrying

 

    

2019

    

2020

    

2021

    

2022

    

2023

    

Thereafter

    

Total

    

Premium and Costs, Net

    

Value

Revolving facility

 

$

40,000

 

$

 

$

 

$

 

$

 

$

 

$

40,000

 

$

 —

 

$

40,000

1L Term Loan

 

 

9,674

 

 

32,250

 

 

32,250

 

 

32,250

 

 

536,963

 

 

 

 

643,387

 

 

(17,168)

 

 

626,219

2L Term Loan

 

 

 —

 

 

 

 

 

 

 

 

 

 

677,888

 

 

677,888

 

 

(89,274)

 

 

588,614

Convertible notes

 

 

 

 

 

 

18,128

 

 

 

 

 

 

25,000

 

 

43,128

 

 

(5,818)

 

 

37,310

Total

 

$

49,674

 

$

32,250

 

$

50,378

 

$

32,250

 

$

536,963

 

$

702,888

 

$

1,404,403

 

$

(112,260)

 

$

1,292,143

 

New Term Loans

On October 29, 2018 (the “GBG Closing Date”), the Company and certain of its subsidiaries entered into a (i) first lien credit agreement with Ares Capital Corporation (“Ares”), as administrative agent, ACF FinCo I LP, as collateral agent, and certain other lenders party thereto (the “First Lien Credit Agreement”) and (ii) second lien credit agreement with U.S. Bank National Association, as administrative agent and collateral agent, and certain lenders party thereto (the “Second Lien Credit Agreement”, and together with the First Lien Credit Agreement, the “Credit Agreements”).

The First Lien Credit Agreement provides for a senior secured asset based revolving credit facility with commitments in an aggregate principal amount of $150.0 million, which matures on April 29, 2023 (the “New Revolving Facility”) and a senior secured term loan credit facility in an aggregate principal amount of $645.0 million, which matures on October 29, 2023 (the “First Lien Term Loan Facility”, and together with the New Revolving Facility, are collectively referred to herein as “First Lien Facilities”). The Second Lien Credit Agreement provides for a second lien term loan facility in an aggregate principal amount of $668.0 million, which matures on October 29, 2024 (the “Second Lien Term Loan Facility”, and together with the First Lien Term Loan Facility are collectively referred to herein as the “Term Loan Facilities”). The obligations under the Credit Agreements are guaranteed by certain domestic subsidiaries of the Company and are secured by substantially all assets of the Company and its domestic subsidiaries. Cumulative paid-in-kind interest (“PIK”) under the Credit Agreements totaled $9.9 million as of March 31, 2019.

The Credit Agreements contain customary representations and warranties, events of default and covenants, including, among other things and subject to certain exceptions, covenants that restrict the ability of the Company and its subsidiaries to incur additional indebtedness, create or permit liens on assets, engage in mergers or consolidations, dispose of assets, make prepayments of certain indebtedness, pay certain dividends and other restricted payments, make investments, and engage in transactions with affiliates. The Term Loan Facilities require the Company to comply with financial maintenance covenants to be tested quarterly (beginning with the fiscal quarter ending March 31, 2019), consisting of a maximum net first lien leverage ratio, a maximum net total leverage ratio and a minimum fixed charge coverage ratio. As of March 31, 2019, the Company was in compliance with these covenants.

The Company incurred debt issuance costs totaling $51.5 million related to the Term Loan Facilities. In accordance with ASU No. 2015-15, the debt issuance costs have been deferred and are presented as a contra-liability, offsetting the outstanding balance of the Term Loan Facilities, and are amortized using the effective interest method over the remaining life of the Term Loan Facilities.

The Company used the proceeds from the Credit Agreements to consummate the GBG Acquisition and repay existing debt.

On April 17, 2019, the Company amended its Credit Facilities to, among other things, increase the amount of indebtedness permitted under the First Lien Credit Agreement, increase the size of the New Revolving Facility and amend the Company's consolidated fixed charge ratio covenant; see “Note 16-Subsequent Events” for additional information.

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New Revolving Facility

In addition to the First Lien Term Loan, the First Lien Credit Agreement provides for a senior secured asset based revolving credit facility with commitments in an aggregate principal amount of $150.0 million, which matures on April 29, 2023 (the “New Revolving Facility”). The amount available to be drawn under the New Revolving Facility is based on the borrowing base values attributed to eligible inventory. There are no scheduled periodic payments under the New Revolving Facility. The obligations under the Credit Agreements, including the New Revolving Facility, are guaranteed by certain domestic subsidiaries of the Company (the “Guarantors”) and are secured by substantially all assets of the Company and its domestic subsidiaries. The availability under the New Revolving Facility as of March 31, 2019 was $110.0 million. Borrowings under the New Revolving Facility as of March 31, 2019 were $40.0 million.

The annual interest rates for the New Revolving Facility is the lender’s alternate base rate (“ABR”)  (with a 1.00% floor) plus 4.50% for base rate loans and adjusted LIBOR (with a 0.00% floor) plus 5.50% for LIBOR rate loans. The New Revolving Facility includes mandatory prepayments customary for credit facilities of this nature. Subject to certain exceptions, permanent reductions of the commitments under the New Revolving Facility are subject to a prepayment premium of (i) 3.00% during the first year after the GBG Closing Date, (ii) 2.00% during the second year after the GBG Closing Date and (iii) 1.00% during the third year after the GBG Closing Date, plus, if applicable, customary “breakage” costs with respect to LIBOR rate loans.

The New Revolving Facility, contains customary representations and warranties, events of default and covenants, including, among other things and subject to certain exceptions, covenants that restrict the ability of the Company and its subsidiaries to incur additional indebtedness, create or permit liens on assets, engage in mergers or consolidations, dispose of assets, make prepayments of certain indebtedness, pay certain dividends and other restricted payments, make investments, and engage in transactions with affiliates. The Credit Agreements, inclusive of the provisions of the New Revolving Facility, require the Company to comply with financial maintenance covenants to be tested quarterly (beginning with the fiscal quarter ending March 31, 2019), consisting of a maximum net first lien leverage ratio, a maximum net total leverage ratio and a minimum fixed charge coverage ratio. As of March 31, 2019, the Company was in compliance with these covenants.

The Company incurred debt issuance costs totaling $6.8 million related to the New Revolving Facility. The debt issuance costs have been deferred and are presented in Other Assets and are amortized using the effective interest method over the life of the New Revolving Facility.

On April 17, 2019, the Company amended its New Revolving Facility to, among other things, increase the aggregate commitments thereunder; see “Note 16—Subsequent Events” for additional information.

The PNC Receivables Facility

On October 29, 2018, the Company entered into the PNC Receivables Facility. Other subsidiaries of the Company may later enter into the PNC Receivables Facility. At the end of the initial three year term, the Purchasers may elect to renew their commitments under the RPA.

Under the terms of the PSA, the Originators sell or contribute certain of their trade accounts receivable, related collections and security interests to Spring on a revolving basis. Under the terms of the RPA, Spring sells to the Purchasers an undivided ownership interest in the Receivables for up to $450.0 million in cash proceeds. The proceeds from the Purchasers’ investment are used to finance Spring’s purchase of the Receivables from the Originators. Spring may also use the proceeds from a subordinated loan made by the Originators to Spring to finance purchases of the Receivables from the Originators. Rather than remitting to the Purchasers the amount received upon payment of the Receivables, Spring reinvests such Receivables payments to purchase additional Receivables from the Originators through the term of the agreement, subject to the Originators generating sufficient eligible Receivables to sell to Spring in replacement of collected balances. Advances under the RPA will accrue interest based on a variable rate plus a margin.

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In connection with the PNC Receivables Facility, the Company incurred $2.4 million in deferred financing fees, including $1.6 million related to securitization closing fees, $0.5 million in legal fees, and $0.3 million in other fees. These deferred financing fees are included in other assets in the condensed consolidated balance sheet as of March 31, 2019.

On April 25, 2019, the Company amended its PNC Receivables Facility to, among other things, increase the aggregate commitments under the PNC Receivables Facility; see “Note 16—Subsequent Events” for additional information.

Convertible Notes

2024 Convertible Notes

On October 29, 2018, the Company issued convertible promissory notes (the “2024 Convertible Notes”) in an aggregate principal amount of $25.0 million to funds managed by GSO Capital Partners LP  (“GSO”) and funds managed by Blackstone Tactical Opportunities Advisors L.L.C. (collectively, the “GSO/BTO Affiliates”).  The 2024 Convertible Notes are convertible at the holder’s option beginning on or after October 29, 2019 until the earlier of (i) repayment in full of all principal and interest outstanding under the Second Lien Credit Agreement and (ii) October 29, 2024 (such earlier date, the “2024 Convertible Note Maturity Date”), into shares of the Company’s common stock at a conversion price of $8.00 per share, subject to customary adjustments as described in agreement. The 2024 Convertible Notes shall not initially bear interest.  From and after April 29, 2019, the 2024 Convertible Notes shall bear interest at the rate of 12.0% per annum multiplied by the principal amount as of the previous interest payment date.  From and after October 29, 2019, the 2024 Convertible Notes shall bear interest at the rate of 16.0% per annum multiplied by the principal amount as of the previous interest payment date.  Interest payments are due each January 31, April 30, July 31, and October 31.  To the extent that the Company is unable to pay cash interest on the 2024 Convertible Notes on each interest payment date because of restrictions in the Credit Agreements or other debt agreements of the Company, an amount equal to the unpaid interest then due shall be added to the principal amount of this Note (such additional amount, the “PIK Principal”), without any action by the Company or a holder of a 2024 Convertible Note.

The Company may, at any time and at its sole option, elect to prepay the entirety of aggregate then-outstanding PIK Principal, plus any accrued and unpaid interest on such PIK Principal, at any time (an “Optional PIK Prepayment”).  Optional PIK Prepayments may be paid in cash.

From and after the GBG Closing Date until October 29, 2019, upon consummation of any sales of common stock by the Company for cash, the Company may, on at least ten (10) days’ prior written notice to the holder of a 2024 Convertible Note, prepay such 2024 Convertible Note in whole but not in part solely with the net proceeds of such sale of common stock in an amount equal to the greater of (i) the principal amount, together with accrued interest through and including the date of prepayment, or (ii) the value equal to (a) the number of shares of common stock that would be received upon conversion of the 2024 Convertible Note on the repayment date multiplied by the market value of the common stock as of such date, plus (b) any accrued but unpaid interest that has not been added to the principal amount of the 2024 Convertible Note on the date of such prepayment (such greater amount, the “Prepayment Amount”).  Also, the 2024 Convertible Notes shall be prepayable in whole but not in part at the Prepayment Amount: (i) from October 29, 2019 through October 29, 2021 only upon a change in control or a liquidation of the Company, or (ii) from October 29, 2021 until the 2024 Convertible Note Maturity Date, in each case on at least ten (10) day’s prior written notice to the holder.

Also, on the GBG Closing Date, the Company and the Guarantors entered into a Subordinated Convertible Promissory Notes Guaranty Agreement pursuant to which those subsidiaries agreed to guarantee the obligations due under the 2024 Convertible Notes.

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The following table is a summary of the recorded value of the 2024 Convertible Notes as of March 31, 2019 and December 31, 2018 (in thousands):

 

 

 

 

 

 

 

 

 

    

March 31, 2019

   

December 31, 2018

Convertible note - face value

 

$

25,000

 

$

25,000

Less: Original issue discount

 

 

(4,522)

 

 

(4,522)

Short-term convertible note recorded value on issue date

 

 

20,478

 

 

20,478

PIK interest issued

 

 

 —

 

 

 —

Accumulated accretion of original issue debt discount

 

 

1,321

 

 

534

Convertible note value

 

$

21,799

 

$

21,012

 

Modified Convertible Notes

On January 18, 2016, in partial satisfaction of certain outstanding convertible notes, the Company issued an aggregate principal amount of approximately $16.5 million of modified convertible notes (the “Modified Convertible Notes”).

The Modified Convertible Notes are structurally and contractually subordinated to our senior debt and will mature on July 28, 2021. The Modified Convertible Notes accrue interest quarterly on the outstanding principal amount at a rate of 6.5% per annum (which increased to 7% as of October 1, 2016, with respect to the Modified Convertible Notes issued to Fireman Capital CPF Hudson Co-Invest LP (“Fireman) only), which is payable 50% in cash and 50% in additional paid-in-kind notes. However, the Company may elect to pay 100% of such interest in cash at its sole discretion. The Modified Convertible Notes are convertible at the option of the holders into either shares of the Company’s common stock, cash, or a combination thereof, at the Company’s election.

If the Company elects to issue only shares of common stock upon conversion of the Modified Convertible Notes, each of the Modified Convertible Notes would be convertible, in whole but not in part into a number of shares of the Company’s common stock equal to the “conversion amount” divided by the “market price”. The “conversion amount” is (a) the product of (i) the “market price”, multiplied by (ii) the quotient of (A) the principal amount, divided by (B) the conversion price, minus (b) the aggregate optional prepayment amounts paid to the holder. The “market price” is the average of the closing prices for our common stock over the 20-trading-day period immediately preceding the notice of conversion.  If the Company elects to pay cash with respect to a conversion of the Modified Convertible Notes, the amount of cash to be paid per share will be equal to the conversion amount. The Company will have the right to prepay all or any portion of the principal amount of the Modified Convertible Notes at any time so long as the Company makes a pro rata prepayment on all of the Modified Convertible Notes.

The following table is a summary of the recorded value of the Modified Convertible Notes as of March 31, 2019 and December 31, 2018 (in thousands). The value of the Modified Convertible Notes reflects the present value of the contractual cash flows from the Modified Convertible Notes and resulted in an original issue discount of $4.7 million that was recorded on January 28, 2016, the issuance date.

 

 

 

 

 

 

 

 

    

March 31, 2019

    

December 31, 2018

Modified convertible notes - face value

    

$

16,473

    

$

16,473

Less: original issue discount

 

 

(4,673)

 

 

(4,673)

Modified convertible notes recorded value on issue date

 

 

11,800

 

 

11,800

PIK interest issued

 

 

1,655

 

 

1,505

Accumulated accretion of original issue debt discount

 

 

2,056

 

 

1,918

Modified convertible notes value

 

$

15,511

 

$

15,223

 

Short-Term Convertible Note

In connection with the acquisition of SWIMS® on July 18, 2016, the Company entered into certain financing arrangements with Tengram Partners Fund II, L.P. (“Tengram II”), a related party, including a convertible note issued to Tengram II on July 18, 2016 (the “SWIMS Convertible Note”). The SWIMS Convertible Note accrued interest at a rate

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of 3.75% per annum, compounding on the first day of each month starting August 1, 2016, and was convertible, at Tengram II’s option or on the revised maturity date of January 18, 2018, which had an original maturity date of January 18, 2017, if not already repaid in cash on or prior to that date, into newly issued shares of our Series A-1 Preferred Stock at a conversion price of $3.00 per share.

On January 18, 2018, the SWIMS Convertible Note matured and automatically converted into newly issued shares of the Company’s Series A-1 Preferred Stock, at a conversion price of $3.00 per share. The outstanding balance of the SWIMS Convertible Note, together with any accrued and unpaid interest thereon, converted into 4,587,964 shares of Series A-1 Preferred Stock. Upon the issuance of such shares of Series A-1 Preferred Stock by the Company to Tengram II, the SWIMS Convertible Note was settled in its entirety. The Series A-1 Preferred Stock was convertible into shares of the Company’s common stock, par value $0.10 per share, at an initial price of $3.00 per share (subject to adjustment), was entitled to dividends at a rate of 10% per annum payable quarterly in arrears, was senior to the common stock upon liquidation and had voting rights on an as-converted basis alongside its common stock. 

On October 29, 2018, the 4,587,964 shares of the Company’s Series A-1 Preferred Stock converted into 4,951,177 newly issued shares of common stock in accordance with the terms of the Series A-1 Preferred Stock.

Total Interest Expense

The following table is a summary of total interest expense recognized (in thousands):

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 

 

    

2019

    

2018

Contractual coupon interest

 

$

36,047

 

$

1,926

Non-cash interest expense (including amortization of discounts and deferred financing costs)

 

 

9,966

 

 

289

Total interest expense

 

$

46,013

 

$

2,215

 

 

9.    Fair Value Measurement of Financial Instruments

The Company’s assets measured at fair value on a nonrecurring basis include long-lived assets. The Company reviews the carrying amounts of such assets when events indicate that their carrying amounts may not be recoverable. Any resulting asset impairment would require that the asset be recorded at its fair value. The resulting fair value measurements of the assets are considered to be Level 3 inputs. There were no impairments of long-lived assets during the three months ended March 31, 2019 and 2018.

The carrying value of the 2024 Convertible Notes and the Modified Convertible Notes at March 31, 2019 was $37.3 million which approximates their fair value at March 31, 2019. The Company estimates the fair value of the 2024 Convertible Notes and the Modified Convertible Notes using commonly accepted valuation methodologies and unobservable inputs based on the low volume of similar market activity (Level 3). The Company carries the 2024 Convertible Notes and the Modified Convertible Notes at face value less unamortized debt discount and issuance costs on its condensed consolidated balance sheets. For further information on the 2024 Convertible Notes and the Modified Convertible Notes, see “Note 8—Debt.”

 

10.    Leases

The Company adopted ASC 842 on January 1, 2019.  Because the Company adopted ASC 842 using the transition method that allowed the Company to initially apply ASC 842 as of January 1, 2019 and recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption, prior year financial statements were not recast under the new standard and, therefore, those prior year amounts are not presented below.

The Company has commitments under operating leases for retail stores, corporate offices, administrative offices and showrooms expiring on various dates through January 2029. The Company leases certain equipment under finance lease agreements expiring on various dates through January 2022. As of March 31, 2019, the Company’s finance leases

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were not material to the condensed consolidated balance sheets, condensed consolidated statements of operations or statement of cash flows.

Lease agreements for office and showroom facilities expire on various dates through December 2028, and are generally non-cancelable. Initial lease terms for retail store leases generally range from three to ten years with an option to extend or renew the leases for 1 to 10 years. In most instances, at the commencement of the lease, the Company has determined that it is not reasonably certain to exercise either of these options; accordingly, these options are generally not considered in determining the initial lease term.

Some of these leases require the Company to make periodic payments for property taxes, utilities and common area operating expenses. Most of the retail store leases are “net” leases, which require us to pay all of the cost of insurance, taxes, maintenance and utilities. The Company’s lease agreements generally do not contain any material residual value guarantees or material restrictive covenants.

Certain retail store leases provide for rents based upon the minimum annual rental amount and a percentage of annual sales volume 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 from the possession date.

The components of lease cost for the quarter ended March 31, 2019 are as follows (in thousands):

 

 

 

 

 

 

    

Three months ended 

 

 

March 31, 2019

Lease cost

 

 

  

Operating lease cost

 

$

10,694

Short-term lease cost

 

 

2,132

Variable lease cost (1) 

 

 

3,435

Total lease cost

 

$

16,261


(1)

Variable components of the lease payments such as utilities, taxes and insurance, parking and maintenance costs.

Minimum rental payments under operating leases are recognized on a straight-line basis over the term of the lease including any periods of free rent.

Amounts reported in the condensed consolidated balance sheet for the quarter ended March 31, 2019 are as follows (in thousands):

 

 

 

 

 

 

 

    

Three months ended,

 

 

 

March 31, 2019

 

Operating Leases:

 

 

  

 

Operating lease right-of-use assets

 

$

209,715

 

Operating lease liabilities

 

 

193,782