Wilhelmina International, Inc. - Quarter Report: 2015 September (Form 10-Q)

Note 4.  Foreign Currency Translation

The functional currency of the wholly owned subsidiary, London, is the Pound Sterling. Its assets and liabilities are translated into U.S. dollars at the exchange rates in effect at each balance sheet date, revenues and expenses are translated at average monthly exchange rates and resulting translation gains or losses are accumulated in other comprehensive income as a separate component of shareholders’ equity.

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

The following is a discussion of the interim unaudited consolidated financial condition and results of operations for the Company and its subsidiaries for the three and nine months ended September 30, 2015 and 2014.  It should be read in conjunction with the financial statements of the Company, the notes thereto and other financial information included elsewhere in this report, and the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as amended.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain “forward-looking” statements as such term is defined in Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995 and information relating to the Company and its subsidiaries that are based on the beliefs of the Company’s management as well as information currently available to the Company’s management.  When used in this report, the words “anticipate,” “believe,” “estimate,” “expect” and “intend” and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements.  Such statements reflect the current risks, uncertainties and assumptions related to certain factors including, without limitation, competitive factors, general economic conditions, the interest rate environment, governmental regulation and supervision, seasonality, changes in industry practices, one-time events and other factors described herein and in other filings made by the Company with the SEC.  Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended.  The Company does not undertake any obligation to publicly update these forward-looking statements.  As a result, you should not place undue reliance on these forward-looking statements.

OVERVIEW

The Company’s primary business is fashion model management, which is headquartered in New York City. The Company’s predecessor was founded in 1967 by Wilhelmina Cooper, a renowned fashion model, and is one of the oldest, best known and largest fashion model management companies in the world. Since its founding, it has grown to include operations located in Los Angeles, Miami and London, as well as a growing network of licensees comprising leading modeling agencies in various local markets across the U.S., as well as in Thailand, Dubai, Vancouver and Tokyo. The Company provides traditional, full-service fashion model and talent management services, specializing in the representation and management of models, entertainers, artists, athletes and other talent to various customers and clients, including retailers, designers, advertising agencies and catalog companies.

The business of talent management firms, such as Wilhelmina, depends heavily on the state of the advertising industry, as demand for talent is driven by Internet, print and TV advertising campaigns for consumer goods and retail clients.

Wilhelmina believes it has strong brand recognition which enables it to attract and retain top agents and talent to service a broad universe of clients. In order to take advantage of these opportunities and support its continued growth, the Company will need to continue to successfully allocate resources and staffing in a way that enhances its ability to respond to these new opportunities. The Company continues to focus on cutting costs, recruiting top agents when available and scouting and developing new talent.

Although Wilhelmina has a large and diverse client base, it is not immune to global economic conditions. Wilhelmina closely monitors economic conditions, client spending and other factors and continually looks for ways to reduce costs, manage working capital and conserve cash. There can be no assurance as to the effects on Wilhelmina of future economic circumstances, client spending patterns, client credit worthiness and other developments and whether, or to what extent, Wilhelmina’s efforts to respond to them will be effective.

Trends and Opportunities

The Company expects that the combination of Wilhelmina’s main operating base in New York City, the industry’s capital, with the depth and breadth of its talent pool and client roster and its diversification across various talent management segments, together with its geographical reach should make Wilhelmina’s operations more resilient to industry changes and economic swings than those of many of the smaller firms operating in the industry. Similarly, in the segments where the Company competes with other leading full service agencies, Wilhelmina competed successfully during the third quarter of 2015.

With 2015 total advertising expenditures on major media (newspapers, magazines, television, cinema, outdoor and Internet) expecting to exceed approximately $189 billion, North America is by far the world’s largest advertising market. For the fashion talent management industry, including Wilhelmina, advertising expenditures on magazines, television, Internet and outdoor are of particular relevance. 

Strategy

Management’s strategy is to increase value to shareholders through the following initiatives:

Due to the increasing ubiquity of the Internet as a standard business tool, the Company has increasingly sought to harness the opportunities of the Internet and other digital media to improve its communications with clients and to facilitate the effective exchange of fashion model and talent information. The Company continues to make significant investments in technology (including developing in-house art and social media departments) in pursuit of gains in efficiency and better communications with customers. At the same time, the Internet presents challenges for the Company, including (i) the cannibalization of traditional print advertising business and (ii) pricing pressures with respect to photo shoots and client engagements.

In January 2015, the Company purchased 100% of the outstanding shares of Union Models Management Ltd. in London and renamed it Wilhelmina London Limited (“London”). The strategic acquisition of London establishes a footprint for the Company and the brand in Western Europe. It will also serve as a base of operations to service the Company’s European clients, and as a new talent development office for European models and artists.

The key financial indicators that the Company reviews to monitor the business are revenues, model costs, operating expenses and cash flows.

The Company analyzes revenue by reviewing the mix of revenues generated by the different “boards” (each a specific division of the fashion model management operations which specializes by the type of model it represents (Women, Men, Select, Media, Runway, Curve, Lifestyle, Kids, etc.)) of the business, revenues by geographic locations and revenues from significant clients. Wilhelmina has three primary sources of revenue: revenues from principal relationships whereby the gross amount billed to the client is recorded as revenue, when the revenues are earned and collectability is reasonably assured; revenues from agent relationships whereby the commissions paid by models as a percentage of their gross earnings are recorded as revenue when earned and collectability is reasonably assured; and separate service charges, paid by clients in addition to the booking fees, which are calculated as a percentage of the models’ booking fees and are recorded as revenues when earned and collectability is reasonably assured. See Critical Accounting Policies - Revenue Recognition is an important business metric that ultimately drive revenues, profits and cash flows.

Because Wilhelmina provides professional services, salary and service costs represent the largest part of the Company’s operating expenses. Salary and service costs are comprised of payroll and related costs and T&E (travel, meals and entertainment) to deliver the Company’s services and to enable new business development activities. 

 Analysis of Consolidated Statements of Operations

Revenues

Generally, the Company’s revenues fluctuate in response to its clients’ willingness to spend on advertising and the Company’s ability to have the desired talent available.

The increase in revenues for the three and nine months ended September 30, 2015 of 8.9% and 11.5% when compared to the three and nine months ended September 30, 2014 were driven by an expanded developed talent pool and our customers’ increased interest in booking the Company's talent. The Company’s expanded talent pool continues to be driven by an emphasis on scouting and relationships with mother agencies around the world.

All boards of the core modeling business experienced positive growth during the three months and nine months ended September 30, 2015 when compared to the corresponding period of the prior year.

License Fees and Other Income

License fees and other income include management and administrative services from an unconsolidated affiliate and franchise revenues from independently owned model agencies that use the Wilhelmina trademark name and various services provided by the Company. License fees remained materially unchanged when compared to the corresponding period of the prior year.

Gross Profit Margin

Fluctuations in gross profit margin, between periods, are predominantly due to the following:

 Gross profit margin as a percentage of revenue in the three and nine months ended September 30, 2015, when compared to the three and nine months ended September 30, 2014, remained relatively unchanged. All of the components of gross margin increased proportionally with the increase in revenue.

Salaries and Service Costs

Salaries and service costs consist of payroll and related costs and T&E (travel, meals and entertainment) costs required to deliver the Company’s services to its customers and talent. 

Office and General Expenses

Office and general expenses consist of office and equipment rents, advertising and promotion, insurance expenses, administration and technology cost.  These costs are less directly linked to changes in the Company’s revenues than are salaries and service costs. 

During the three and nine months ended September 30, 2015, office and general expenses decreased by 0.6% and increased by 3.4%, when compared to the three and nine months ended September 30, 2014 respectively. When removing the London Office and General Expenses, the 2015 over 2014 decreased by 2.6% and increased by 1.6% for the three and nine months reflecting managements’ effort to control over expenses during a period of Company growth.

Amortization and Depreciation

Depreciation and amortization expense is incurred with respect to certain assets, including computer hardware, software, office equipment, furniture, and other intangibles.  During the three and nine months ended September 30, 2015, depreciation and amortization expense totaled $112 and $365 (of which $47 and $182 relates to amortization of intangibles acquired in connection with the Wilhelmina Acquisition), compared to $114 and $484 of depreciation and amortization expense during the three and nine months ended September 30, 2014 (of which $44 and $289 relates to amortization of intangibles acquired in connection with the Wilhelmina Acquisition).  Certain intangible assets were fully amortized as of Aug 31, 2015, therefore amortization expense decreased from $68 to $47, decrease of 29.8% from second quarter to third quarter for the three months ended September 30, 2015.

Fixed asset purchases (mostly related to technology) totaled approximately $612 and $389 during the nine months ended September 30, 2015 and September 30, 2014, respectively.

Corporate Overhead

Corporate overhead expenses include public company costs, director and executive officer compensation, directors’ and officers’ insurance, legal, audit and professional fees, corporate office rent and travel.  The decline in corporate overhead of 43.0% and 26.0% for the three and nine months ended September 30, 2015, when compared to the three and nine months ended September 30, 2014 reflects a general decline in corporate salaries as well as public company costs. 

Operating Margin

Operating margins improved for the three and nine months ended September 30, 2015 to 5.9% and 4.5% from 4.1% and 3.8% when compared to the corresponding periods of the prior year due to a decline in operating costs relative to revenues for the three an d nine months ended September 30, 2015 to 23.6% and 24.4% from 24.8% and 25.1%. The resulting operating income for the three and nine months ended September 30, 2015 increased by 54.9% and 32.3% from the corresponding periods of the prior year.

Asset Impairment Charge

Each reporting period, the Company assesses whether events or circumstances have occurred which indicate that the carrying amount of an intangible asset exceeds its fair value.  If the carrying amount of the intangible asset exceeds its fair value, an asset impairment charge will be recognized in an amount equal to that excess. No asset impairment charges were incurred during the three and nine months ended September 30, 2015 and September 30, 2014.

Foreign Exchange

The Company realized $21and $119 (including $14 from the acquisition of London) of foreign currency exchange loss during the three and nine months ended September 30, 2015. Fluctuations in currencies from Latin America and the Euro caused $21 and $105 of the loss.

Interest Expense

There was no interest expense for the three and nine months ended September 30, 2015, compared to a small interest expense the three and nine months ended September 30, 2014, both associated with a decline in the average borrowings under the Third Credit Agreement Amendment to zero.

Income Taxes

Generally, the Company’s combined effective tax rate is high because it operates in states that have high income tax rates.  As of December 31, 2014, the Company has a federal income tax loss carryforward of $1,239, which begins expiring in 2025.  The Company anticipates the remaining net operating loss will be used in 2015.  The Company also operates in international jurisdictions.  Accordingly, the Company pays tax in those international jurisdictions, creating foreign tax credits which are used to offset federal income taxes payable.

Liquidity and Capital Resources

The Company’s cash balance decreased to $2,102 at September 30, 2015, from $5,869 at December 31, 2014. For the nine months ended September 30, 2015, cash balances decreased as a result of cash flows used by operations of approximately $2,338, investing activities used $978, including $282 to purchase the stock of Wilhelmina London and approximately $696 of capital expenditures. Cash flows from operating activities include the use of cash due to an increase in accounts receivables as well as a decrease in accounts payable and accrued expenses. The increase in accounts receivable is driven by increased revenues and an increase in the average number of days it takes to collect from its customers. The Company has increased its collection resources and is actively working to improve the average collection days. The increase in revenues usually negatively impact cash flows as typically, the collection of customer receivables averages greater than 60 days, while the Company incurs significant operating expenses with shorter payment terms.

Amegy Credit Agreement

On November 10, 2015, the Company executed and closed the Fourth Amendment to Credit Agreement (the “Fourth Credit Agreement Amendment”) with Amegy National Bank National Association (“Amegy”) effective October 24, 2015. The Fourth Credit Agreement Amendment includes a $7,000 facility under which there is an extension of the revolving line of credit along with a term loan.

Under the terms of the Fourth Credit Agreement, the total availability is $7,000 subject to a borrowing base derived from 80% of eligible accounts receivable (as defined) and the Company’s minimum net worth covenant of $20,000 in the form of: (1) revolving credit facility of $4,000 (2) term loan of $3,000. The revolving line of credit is due on October 24, 2016 with interest paid monthly at prime plus 0.50%. The term loan is payable in 60 monthly payments, interest only at 4.25% for the 12 months followed by 47 equal monthly payments of principal and interest computed based on a 60 month amortization schedule and a final payment of principal and interest due on October 24, 2019. The Company’s obligation to repay the loans is evidenced by promissory notes. The revolving facility contains the ability to issue up to $500 of standby letters of credit. Outstanding letters of credit reduce the Company’s availability under the facility.

As of November 16, 2015, the Company had no outstanding borrowings under the revolving credit facility.

Off-Balance Sheet Arrangements

As of March 31, 2014, the Company was responsible for $222 of restricted cash that served as collateral for an irrevocable standby letter of credit. In September 2014, the Company issued a replacement letter of credit and recovered the restricted cash of $222. This replacement letter of credit is secured by available and unused borrowing capacity under the Company’s existing line of credit with Amegy Bank. The letter of credit serves as additional security under the lease extension relating to the Company’s office space in New York City that expires February 2021.

Effect of Inflation

Inflation has not been a material factor affecting the Company’s business.  General operating expenses, such as salaries, employee benefits, insurance and occupancy costs, are subject to normal inflationary pressures.

Critical Accounting Policies

Revenue Recognition

In compliance with generally accepted accounting principles (GAAP) when reporting revenue gross as a principal versus net as an agent, the Company assesses whether it, the model or the talent is the primary obligor.  The Company evaluates the terms of its model, talent and client agreements as part of this assessment.  In addition, the Company gives appropriate consideration to other key indicators such as latitude in establishing price, discretion in model or talent selection and credit risk the Company undertakes.  The Company operates broadly as a modeling agency and in those relationships with models and talents where the key indicators suggest the Company acts as a principal, the Company records the gross amount billed to the client as revenue when earned and collectability is reasonably assured and the related costs incurred to the model or talent as model or talent costs.  In other model and talent relationships, where the Company believes the key indicators suggest it acts as an agent on behalf of the model or talent, the Company records revenue net of pass-through model or talent cost.

The Company also recognizes management fees as revenues for providing services to other modeling agencies as well as consulting income in connection with services provided to a television production network according to the terms of the contract.  The Company recognizes royalty income when earned based on terms of the contractual agreement.  Revenues received in advance are deferred and amortized using the straight-line method over periods pursuant to the related contract.

The Company also records fees from licensees when the revenues are earned and collectability is reasonably assured.

Advances to models for the cost of producing initial portfolios and other out-of-pocket costs are expensed to model costs as incurred.  Any repayments of such costs are credited to model costs in the period received.

Goodwill and Intangible Assets

Goodwill and intangible assets consist primarily of goodwill and buyer relationships resulting from a business acquisition.  Goodwill and intangible assets with indefinite lives are no longer subject to amortization, but rather to an annual assessment of impairment by applying a fair-value based test.

Management’s assessments of the recoverability and impairment tests of goodwill and intangible assets involve critical accounting estimates.  These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation.  Factors that management must estimate include, among others, the economic life of the asset, sales volume, prices, inflation, cost of capital, marketing spending, tax rates and capital spending.  These factors are even more difficult to predict when global financial markets are highly volatile.  When performing impairment tests, the Company estimates the fair values of the assets using management’s best assumptions, which it believes would be consistent with what a hypothetical marketplace participant would use.  Estimates and assumptions used in these tests are evaluated and updated as appropriate.  The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus the accounting estimates may change from period to period.  If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted.

Basis of Presentation

The financial statements include the consolidated accounts of Wilhelmina International and its wholly owned subsidiaries.  All significant inter-company accounts and transactions have been eliminated in consolidation.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are accounted for at fair value, do not bear interest and are short-term in nature.  The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability to collect on accounts receivable.  Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to the valuation allowance.  Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.  The Company generally does not require collateral.

Income Taxes

Income taxes are accounted for under the asset and liability method.  Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards.  Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  The Company continually assesses the need for a tax valuation allowance based on all available information.  As of September 30, 2015, and as a result of this assessment, the Company believes that its deferred tax assets are more likely than not to be realized.  In addition, the Company continuously evaluates its tax contingencies.

Accounting for uncertainty in income taxes recognized in an enterprise’s financial statements requires a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  Also, consideration should be given to de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  There was no change to the net amount of assets and liabilities recognized in the consolidated balance sheets as a result of the Company’s tax positions.

Item 3.            Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4.            Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, the Company’s principal executive officer and principal financial officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act).  Based on their evaluation of the Company’s disclosure controls and procedures, the Company’s principal executive officer and principal financial officer, with the participation of management, have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2015 to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is (a) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) accumulated and communicated to management, including the Company’s principal executive officer and principal financial officer, as appropriate to allow for timely decisions regarding required disclosure.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.  In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.  Given these and other inherent limitations of control systems, there is only reasonable assurance that the Company’s controls will succeed in achieving their stated goals under all potential future conditions.  The Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2015.

Changes in Internal Control Over Financial Reporting

As of the end of the period covered by this report, there were no changes in the Company’s internal controls over financial reporting, or in other factors that could significantly affect these controls, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1.            Legal Proceedings.

On :

In July 2015, an action was commenced in New York State Supreme Court (New York County) against Wilhelmina Models, Inc. by a model previously under contract to Wilhelmina, Kimberly Forbes, claiming  that Wilhelmina had authorized the re-use of certain of her photos, allegedly without her authorization, without paying her; asserting that the IRS had asserted claims against her arising out of an IRS Form 1099 issued by Wilhelmina with respect to payments she had not received; and seeking  an unspecified amount in compensatory damages and $1,000,000 in exemplary damages.   When the model informally brought the matter to its attention prior to commencing litigation, Wilhelmina acknowledged owing her compensation she had not received because of her change of address, and offered to pay her in full and reimburse her for related costs (although the exact amount has not been calculated, it is not a material amount).  Despite that fact, this action was thereafter commenced.  The parties have agreed to a settlement in principle with Forbes, subject to execution of settlement documents, by Wilhelmina’s payment of $15,000 to Forbes.

Shanklin:

On October 24, 2013, a purported class action lawsuit brought by former Wilhelmina model Alex Shanklin and others (the “Shanklin Litigation”), naming the Company’s subsidiaries Wilhelmina International, Ltd. and Wilhelmina Models, Inc. (the “Wilhelmina Subsidiary Parties”), was initiated in New York State Supreme Court (New York County) by the same lead counsel who represented plaintiffs in the prior, now-dismissed action brought by Louisa Raske (the “Raske Litigation”). The claims in the Shanklin Litigation initially included breach of contract and unjust enrichment and are alleged to arise out of matters relating to those involved in the Raske Litigation, such as the handling and reporting of funds on behalf of models and the use of model images.  Other parties named as defendants in the Shanklin Litigation include other model management companies, advertising firms, and certain advertisers.  On January 6, 2014, the Wilhelmina Subsidiary Parties moved to dismiss the Amended Complaint in the Shanklin Litigation for failure to state a claim upon which relief can be granted and other grounds, and other defendants also filed motions to dismiss.  On August 11, 2014, the court denied the motion to dismiss as to Wilhelmina and other of the model management defendants.  Further, on March 3, 2014, the judge assigned to the Shanklin Litigation wrote the Office of the New York Attorney General bringing the case to its attention, generally describing the claims asserted therein against the model management defendants, and stating that the case “may involve matters in the public interest.”  The judge’s letter also enclosed a copy of his decision in the Raske Litigation, which dismissed that case. Plaintiffs have retained substitute counsel, who has filed a Second Amended Complaint.  Plaintiffs’ Second Amended Complaint asserts causes of action for alleged breaches of the plaintiffs' management contracts with the defendants, conversion, breach of the duty of good faith and fair dealing, and unjust enrichment.  The Second Amended Complaint also alleges that the plaintiff models were at all relevant times employees, and not independent contractors, of Wilhelmina and the other model management defendants, and that defendants violated the New York Labor Law in several respects, including, among other things, by allegedly failing to pay the models the minimum wages and overtime pay required thereunder, not maintaining accurate payroll records, and not providing plaintiffs with full explanations of how their wages and deductions therefrom were computed.  The Second Amended Complaint seeks certification of the action as a class action, damages in an amount to be determined at trial, plus interest, costs, attorneys’ fees, and such other relief as the court deems proper. On October 6, 2015, the Company filed a motion to dismiss as to most of the claims in the Second Amended Complaint.  The motion to dismiss will be fully briefed by December 2015.  The Company believes the claims asserted in the Second Amended Complaint are without merit, and intends to continue to vigorously defend itself.

Patterson:

The lawsuit previously commenced by Sean Patterson, the former president of Wilhelmina International, Ltd., against the Company, Wilhelmina International, Ltd., and Mark Schwarz, previously reported, was settled pursuant to an agreement dated as of August 21, 2015, which includes a confidentiality provision regarding its terms.

In addition to the legal proceedings disclosed herein, the Company is also engaged in various legal proceedings that are routine in nature and incidental to its business. None of these routine proceedings, either individually or in the aggregate, are believed, in the Company's opinion, to have a material adverse effect on its consolidated financial position or its results of operations.

In addition to the legal proceedings disclosed herein, the Company is also engaged in various legal proceedings that are routine in nature and incidental to its business.  None of these routine proceedings, either individually or in the aggregate, are believed, in the Company's opinion, to have a material adverse effect on its consolidated financial position or its results of operations.

Item 1.A.        Risk Factors.

Not applicable.

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

None.

Item 3.            Defaults Upon Senior Securities.

None.

Item 4.            Mine Safety Disclosures.

Not applicable.

Item 5.            Other Information.

None.

Item 6.            Exhibits.

The following is a list of exhibits filed as part of this Form 10-Q:

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* Filed herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBIT INDEX

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* Filed herewith

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