RGBD Regional Brands Inc (PK)

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Regional Brands Inc. (formerly 4net Software, Inc.) (“Regional Brands,” the “Company,” “we,” “our” and “us”) was incorporated under the laws of the State of Delaware in 1986. Regional Brands is a holding company formed to acquire substantial ownership in regional companies with strong brand recognition, stable revenues and profitability. Regional Brands has been pursuing a business strategy whereby it seeks to engage in an acquisition, merger or other business combination transaction with undervalued businesses (each, a “Target Company”) with a history of operating revenues in markets that provide opportunities for growth. On November 1, 2016, the Company's majority-owned subsidiary acquired substantially all of the assets (the “Acquisition”) of B.R. Johnson, Inc. (“BRJ Inc.”), a seller and distributor of windows, doors and related hardware as well as specialty products for use in commercial and residential buildings. After the acquisition of the business of BRJ Inc. by our majority-owned subsidiary, B.R. Johnson, LLC (“BRJ LLC”), we are currently focused on considering opportunities for growth of BRJ LLC through utilizing its balance sheet to provide capital for additional acquisitions of companies that would be complementary to BRJ LLC. Additionally, we may seek to acquire Target Companies that satisfy the following criteria: (1) established businesses with viable services or products; (2) an experienced and qualified management team; (3) opportunities for growth and/or expansion into other markets; (4) are accretive to earnings; (5) offer the opportunity to achieve and/or enhance profitability; and (6) increase shareholder value.

Basis of Presentation - The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly, these statements do not include all of the information and footnotes required by U.S. GAAP. In the opinion of management, the accompanying condensed consolidated balance sheets and related condensed consolidated statements of income and cash flows include all adjustments, consisting only of normal recurring items necessary for their fair presentation in accordance with U.S. GAAP. Interim results are not necessarily indicative of results expected for a full year. For further information regarding the Company’s accounting policies, please refer to the audited consolidated financial statements and footnotes for the year ended December 31, 2017 included in the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2018.

Principles of Consolidation   - The consolidated financial statements include the accounts of Regional Brands Inc. and its majority-owned subsidiary, BRJ LLC. All intercompany balances and transactions have been eliminated in consolidation. The Company has a controlling interest in its subsidiary, BRJ LLC. BRJ LLC has preferred and common membership interests that are not controlled by the Company. Earnings and losses of BRJ LLC are attributed to the noncontrolling interests and distributions are made in accordance with the B.R. Johnson LLC Limited Liability Company Agreement.

Use of Estimates - The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates and be based on events different from those assumptions. Future events and their effects cannot be predicted with certainty; estimating, therefore, requires the exercise of judgment. Thus, accounting estimates change as new events occur, as more experience is acquired or as additional information is obtained. We believe the most significant estimates and judgments are associated with revenue recognition for our customer contracts in process, including estimating costs and the recognition of unapproved change orders and claims.

Concentration of Credit Risk – Amounts due from a single customer represented 15.4% of Accounts Receivable at September 30, 2018.

Inventories - Inventory is comprised of purchased materials and other materials that have been assigned to a job deemed to be work-in-process. As of September 30, 2018 and December 31, 2017, the work-in-process inventory was $911,625 and $ 676,153, respectively and is included in inventories in the accompanying consolidated balance sheet. We maintain an inventory allowance for slow-moving and unused inventories based on the historical trend and estimates. The allowance was approximately $72,000 and $66,000 at September 30, 2018 and December 31, 2017, respectively.

Common Shares Issued and Earnings Per Share - Common shares issued are recorded based on the value of the shares issued or consideration received, including cash, services rendered or other non-monetary assets, whichever is more readily determinable. The Company presents basic and diluted earnings per share. Basic earnings per share reflect the actual weighted average number of shares issued and outstanding during the period. Diluted earnings per share is computed including the number of additional shares that would have been outstanding if dilutive potential shares had been issued, such as those issuable upon exercise of outstanding stock options or conversion of convertible securities. In a loss period, the calculation for basic and diluted loss per share is considered to be the same, as the impact of the issuance of any potential common shares would be anti-dilutive. During the three and nine months ended September 30, 2018, since the exercise prices of the outstanding stock options were above the average market price of our common stock during the period, the outstanding stock options were considered anti-dilutive. In calculating income per common share, income attributable to common shareholders is reduced by distributions made to certain noncontrolling interests in the Company’s consolidated subsidiary. A reconciliation of income attributable to common shareholders to the amounts used to calculate income per common share - basic and diluted is included on the face of the consolidated statements of income.

Fair Value of Financial Instruments - Financial instruments include cash, accounts receivable, accounts payable, accrued expenses, and line of credit. Fair values were assumed to approximate carrying values for these financial instruments because of their immediate or short-term maturity and the fair value of the line of credit approximates the carrying value as the stated interest rate approximates market rates currently available to the Company.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Fair Value Measurement Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). These tiers include:

The Company’s valuation techniques used to measure the fair value of money market funds, certificate of deposits, and certain marketable equity securities were derived from quoted prices in active markets for identical assets or liabilities.

In accordance with the fair value accounting requirements, companies may choose to measure eligible financial instruments and certain other items at fair value. The Company has not elected the fair value option for any eligible financial instruments.

Our short-term investments consist of investments in marketable equity related securities and money market funds. All of these marketable securities are accounted for as available-for-sale securities, which are carried at fair value using quoted market prices in active markets for each marketable security. Prior to 2018, any unrealized gains or losses on these securities were recognized through other comprehensive income (loss).  Beginning on January 1, 2018 with the adoption of Accounting Standards Update ("ASU") 2016-01, all of our marketable equity securities and money market funds will continue to be carried at fair value as noted above, with any unrealized gains or losses on the securities recognized as a component of other income included on our Condensed Consolidated Statements of Income. As a result of the adoption of ASU 2016-01, the accumulated deficit for the year ended December 31, 2017 was increased by $1,504 and the net income for the nine months ended September 30, 2017 was decreased by $1,576.

The tables below present the Company's assets and liabilities measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 aggregated by the level in the fair value hierarchy within which those measurements fall.

Recent Accounting Pronouncements - In May 2014, the FASB issued ASU 2014-9 “Revenue from Contracts with Customers”. The new guidance requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Subsequently, the FASB has issued the following standards related to ASU 2014-09: ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations” (“ASU 2016-08”); ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” (“ASU 2016-10”); and ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” (“ASU 2016-12”). The Company adopted ASU 2016-08, ASU 2016-10 and ASU 2016-12 with ASU 2014-09 (collectively, the “new revenue standards”) effective January 1, 2018 utilizing the modified retrospective approach and applied the guidance to those contracts which were not completed as of that date. The adoption of Topic 606 did not impact the timing of revenue recognition in our Consolidated Financial Statements for the current or prior interim or annual periods. Accordingly, no adjustments have been made to opening retained earnings or prior period results. See Note 2, “Revenue Recognition,” for further information.

In February 2016, the FASB issued an accounting standard update ASU 2016-02, “Leases" to replace existing lease accounting guidance. This pronouncement is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet for most leases. Expenses associated with leases will continue to be recognized in a manner similar to current accounting guidance. This pronouncement is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted. The adoption is required to be applied on a modified retrospective basis for each prior reporting period presented. The Company has not yet determined the effect that the adoption of this pronouncement may have on its financial position and/or results of operations.

In August 2016, the FASB issued Accounting Standards Update 2016-15, “Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments”. The standard makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The new standard requires adoption on a retrospective basis unless it is impracticable to apply, in which case the Company would be required to apply the amendments prospectively as of the earliest date practicable. The Company has adopted this standard effective January 1, 2018. Adoption of this standard did not impact our Consolidated Financial Statements for the current or prior periods presented.

In May 2017, the FASB issued Accounting Standards Update 2017-09, “Compensation – Stock Compensation (Topic 718) – Scope of Modification Accounting”, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The standard is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The standard is to be applied on a prospective basis to an award modified on or after the adoption date. The Company has adopted this standard effective January 1, 2018. Adoption of this standard did not impact our Consolidated Financial Statements.

In June 2018, the FASB issued ASU No.2018-07, "Compensation - Stock Compensation (Topic 718) Improvements to Nonemployee Share-Based Payment Accounting." The FASB issued this update as part of its Simplification Initiative. The amendments in this update expand the scope of Topic 718 to include share-based payments for acquiring goods and services from nonemployees.  An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option model and the attribution of cost.  The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor's own operations by issuing share-based payment awards. The amendments for this update are effective for public companies for fiscal years beginning after December 15, 2018. Early adoption is permitted but no earlier than the adoption date of Topic 606. An entity should only remeasure liability-classified awards that have not been settled by the date of adoptions and equity classified awards for which a measurement date has not been established through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption.  Upon transition, the entity is required to measure these nonemployee awards at fair value as of the adoption date.  The Company believes the adoption of this standard on our consolidated financial statements and related disclosures will not be material.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. This final rule is effective on November 5, 2018. The Company is in the process of evaluating the impact of the final rule on its consolidated financial statements.

NOTE 2. REVENUE RECOGNITION

Effective January 1, 2018, we recognize revenue in accordance with ASC Topic 606 when the following criteria are met: 1) Contract with the customer has been identified; 2) Performance obligations in the contract have been identified; 3) Transaction price has been determined; 4) The transaction price has been allocated to the performance obligations; and 5) Revenue is recognized when (or as) performance obligations are satisfied.

A portion of our revenue is derived from long-term contracts and is recognized using the percentage of completion (“POC”) method, primarily based on the percentage that actual costs-to-date bear to total estimated costs to complete each contract. We utilize the cost-to-cost approach to estimate POC as we believe this method is less subjective than relying on assessments of physical progress. Under the cost-to-cost approach, the use of estimated costs to complete each contract is a significant variable in the process of determining recognized revenue and is a significant factor in the accounting for contracts. Significant estimates that impact the cost to complete each contract are costs of materials, components, equipment, labor and subcontracts; labor productivity; schedule durations, including subcontractor or supplier progress; liquidated damages; contract disputes, including claims; achievement of contractual performance requirements; and contingency, among others. This business is related to the distribution and installation of commercial windows and specialty products which are supported by specific written contracts which include contract price, scope, payments terms and are signed by both parties. Our contract price is fixed for the scope of work specified and we generally have no variable consideration. We frequently negotiate change orders for additional work to be performed which typically relate to the initial performance obligation. Our customer payment terms are typical for our industry. For most contracts under the POC method, progress payments, less retainage, are made shortly after the contractor receives payment from the owner. For the remainder of our business, standard terms are that amounts are due 30 days after invoice date. For this business, we have determined that we have one performance obligation due to the high degree of inter-dependability and highly integrated nature of the work. Performance obligations for the remainder of our business are generally supported by written contracts or purchase orders which require the delivery of goods or services and the revenue is recognized upon shipment of those goods or performance of the services. The majority of our performance obligations are typically completed within one year.

Revisions in estimated profits for contracts accounted for under the POC method are made in the period   in which circumstances requiring the revision become known. During the three and nine months ended September 30, 2018, the effect of changes in estimates of contract profit decreased gross profit by approximately $200,000 and $230,000, respectively, decreased net income by approximately $148,000 and $170,000, respectively, and decreased income per common share (net of income taxes) by $0.12 and $0.13, respectively. During the three and nine months ended September 30, 2017, the effect of changes in estimates of contract profits increased (decreased) net income by approximately $80,000 and $(62,000), respectively, and increased (decreased ) income per common share (net of income taxes) by $0.06 and $(0.05), respectively.

The following table presents our revenues disaggregated by contracts accounted for using the percentage of completion method. Sales and usage taxes are excluded from revenues:

Remaining performance obligations represent the transaction price of firm orders for which work has not been performed. As of September 30, 2018, the aggregate amounts of the transaction prices allocated to the remaining performance obligations, for contracts to be recognized using the percentage of completion method, were $14.6 million.

We have elected the practical expedients for not adjusting the promised amount of consideration for the effects of financing components when, at contract inception, the period between the transfer of good or service and when the customer pays is expected to be less than one year and for recognizing incremental costs of obtaining a contract as incurred as they would otherwise have been amortized over one year or less.

We have made an accounting policy election to treat any common carrier shipping and handling activities as a fulfillment cost, rather than a separate obligation or promised service.

NOTE 3. CONTRACT ASSETS AND LIABILITIES

Cost of revenue for our long-term contracts includes direct contract costs, such as materials and labor, and indirect costs that are attributable to contract activity. The timing of when we bill our customers is generally dependent upon advance billing terms, milestone billings based on the completion of certain phases of the work, or when services are provided. Projects with costs and estimated earnings recognized to date in excess of cumulative billings is reported on the accompanying balance sheet as an asset as costs and estimated earnings in excess of billings. Projects with cumulative billings in excess of costs and estimated earnings recognized to date is reported on the accompanying balance sheet as a liability as billings in excess of costs and estimated earnings. The following is information with respect to uncompleted contracts:

The Company had unbilled revenues of $1,097,565 and $1,043,082 at the end of September 30, 2018 and December 31, 2017, respectively, which are included in Costs and estimated earnings in excess of billings on the balance sheet.

NOTE 4. DEBT

In November 2016, BRJ LLC entered into a credit agreement with KeyBank, N.A. Under the credit agreement, BRJ LLC may borrow up to an aggregate amount of $6,000,000 (the “Credit Facility”) under revolving loans and letters of credit, with a sublimit of $500,000 for letters of credit. The Credit Facility is payable upon demand of KeyBank, N.A., or the lenders, or upon acceleration as a result of an event of default. At the closing of the Acquisition, approximately $1,900,000 was drawn under the Credit Facility to pay a portion of the purchase price and costs associated with the Acquisition, with the balance being available for general working capital of BRJ LLC.

Interest under the Credit Facility is payable monthly and accrues pursuant to the “base rate” of interest, which is equal to the highest of (a) KeyBank, N.A.’s prime rate, (b) one-half of one percent (0.50%) in excess of the Federal Funds Effective Rate of the Federal Reserve Bank of New York, and (c) one hundred (100) basis points in excess of the London Interbank Offered Rate for loans in Eurodollars with an interest period of one month, plus any applicable margin. The credit agreement also requires the payment of certain fees, including, but not limited to, letter of credit fees.

The Credit Facility is secured by substantially all of BRJ LLC’s assets. The Credit Facility contains customary financial and other covenant requirements, including, but not limited to, a covenant to not permit BRJ LLC’s consolidated fixed charge coverage ratio to exceed 1.15 to 1.00. The Credit Facility also contains customary events of default. For the nine months ended September 30, 2018, the Company was in compliance with these covenants.

The effective interest rate on borrowings under the Credit Facility at September 30, 2018 was 4.69%. The aggregate borrowings outstanding under the Credit Facility at September 30, 2018 were $2,846,334. In addition, the bank has issued a letter of credit on behalf of the Company in the amount of $250,000 that expires on December 1, 2018.

NOTE 5. STOCKHOLDERS’ EQUITY

The Company’s authorized capital consists of 3,000,000 shares of common stock, par value $0.00001 per share, and 50,000 shares of preferred stock, par value $0.01 per share.

On March 2, 2017, the Company filed a certificate of amendment (the “Amendment”) to the Company’s Certificate of Incorporation with the Delaware Secretary of State to reduce the number of shares of Common Stock the Company is authorized to issue from 50,000,000 to 3,000,000 shares and to reduce the number of shares of Preferred Stock the Company is authorized to issue from 5,000,000 to 50,000 shares. The Amendment was approved by the Board of Directors of the Company and the holders of a majority of the issued and outstanding shares of Common Stock by written consent in lieu of a meeting.

The Company recorded stock compensation expense for options vesting during the three month periods ended September 30, 2018 and 2017 of $13,878 and $15,181, respectively, and during the nine month periods ended September 30, 2018 and 2017 of $41,798 and $46,181, respectively.

On June 15, 2017, the Company’s stockholders approved and adopted the Company’s Amended and Restated 2016 Equity Incentive Plan (the “Amended and Restated Equity Incentive Plan”). The amendment modified the Company’s 2016 Equity Incentive Plan to, among other things, (1) provide the Board of Directors with the authority to grant awards in the form of restricted stock and restricted stock units, (2) set the maximum number of shares available for issuance under the Amended and Restated Equity Incentive Plan at 130,000 shares of the Company’s common stock, par value $0.00001 per share, and (3) adopt certain other technical amendments.

NOTE 6. RELATED PARTY TRANSACTIONS

On April 8, 2016, the Company entered into a Management Services Agreement (the “MSA”) with Ancora Advisors, LLC, whereby Ancora Advisors, LLC agreed to provide specified services to the Company in exchange for a quarterly management fee in an amount equal to 0.14323% of the Company’s stockholders’ equity (excluding cash and cash equivalents) as shown on the Company’s balance sheet as of the end of each fiscal quarter of the Company. The MSA provides that the management fee with respect to each fiscal quarter of the Company is to be paid no later than 10 days following the issuance of the Company’s financial statements for such fiscal quarter, and in any event no later than 60 days following the end of each fiscal quarter. For the nine months ended September 30, 2018 and 2017, Ancora Advisors, LLC agreed to waive payment of the management fee, but reserves the right to institute payment of the management fee at its discretion.

On November 1, 2016, in connection with the Acquisition, BRJ LLC entered into a Management Services Agreement (the “BRJ MSA”) with Lorraine Capital, LLC (“Lorraine”), a member of BRJ LLC, whereby Lorraine agreed to provide specified management, financial and reporting services to us in exchange for an annual management fee in an amount equal to the greater of (i) $75,000 or (ii) five percent (5%) of the annual EBITDA (as defined in the BRJ MSA) of BRJ LLC, payable quarterly in arrears and subject to certain adjustments and offsets set forth in the BRJ MSA. The BRJ MSA may be terminated by BRJ LLC, Lorraine or Regional Brands at any time upon 60 days’ prior written notice and also terminates upon the consummation of a sale of BRJ LLC. For the nine months ended September 30, 2018 and 2017, amounts included in expense for fees payable to Lorraine under the BRJ MSA were $55,000 and $79,000, respectively, and fees payable were approximate $0 and $36,000 at September 30, 2018 and December 31, 2017, respectively.

BRJ LLC has a relationship with a union qualified commercial window subcontractor, Airways Door Service, Inc. (“ADSI”), which is advantageous to us in situations that require union installation and repair services. Individuals affiliated with Lorraine Capital, LLC acquired 57% of ADSI’s common stock; the remaining common stock is owned by three of BRJ LLC’s employees. BRJ LLC paid ADSI approximately $1,370,000 and $1,298,000 for its services during the nine months ended September 30, 2018 and 2017, respectively. In addition, we provide ADSI services utilizing an agreed-upon fee schedule. These services include accounting, warehousing, equipment use, employee benefit administration, risk management coordination and clerical functions. The fee for these services was $45,000 and $35,000 during the nine months ended September 30, 2018 and 2017, respectively.

NOTE 7. INCOME TAX

We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that may be in effect when the differences are expected to reverse.  The Company periodically evaluates the likelihood of realization of deferred tax assets, and provides for a valuation allowance when necessary. The Company currently maintains a full valuation allowance on the deferred tax assets associated with certain pre-acquisition losses that are subject to limitations under Internal Revenue Code Section 382.

On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Act”) was passed into law. The Act reduced the US federal corporate income tax rate from a top marginal rate of 35% in 2017 and prior years to 21% in 2018. The Company’s marginal tax rate in 2017 and prior years was 34%.

The Company had an effective income tax rate of 14.8% and 21.6% for the three and nine months ended September 30, 2018, respectively, and (86.5)% and 9.3% for the three and nine months ended September 30, 2017, respectively. The effective income tax rate for the three months ended September 30, 2018 is lower than the 2018 federal statutory rate of 21% due primarily to adjustments resulting from the filing of the 2017 federal income tax return. The effective income tax rate for the nine months ended September 30, 2018 approximates the 2018 federal statutory rate of 21%. The effective income tax rate for the three and nine months ended September 30, 2017 differs from the 2017 federal statutory rate of 34% primarily due to the reversal of a portion of the deferred tax valuation allowance during the three months ended September 30, 2017.

NOTE 8. BUSINESS ACQUISITIONS

Effective June 1, 2018, the Company acquired certain assets of R&D Fabricators, Inc. (R&D) for a purchase price of approximately $203,000. R&D is engaged in the business of the fabrication of aluminum curtain walls, store fronts, doors and frames.  The fair value of assets acquired include $120,000 of equipment and $51,000 of acquired backlog, resulting in goodwill of approximately $32,000. The operating results of R&D are included in the accompanying statement of income from the date of acquisition. In light of the size and value of the acquisition and its relative significance to the Company, pro forma disclosures of revenue and earnings are not included herein.

During the nine months ended September 30, 2017, a payment of $1,107,872 was made to the seller in the BRJ Inc. acquisition to satisfy our working capital liability.