Xcel Brands, Inc. (XELB) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Xcel Brands Second Quarter Fiscal Year 2019 Financial Results Conference Call and Webcast. [Operator Instructions] Please be advised that reproduction of this call, in whole or in part, is not permitted without prior written authorization of Xcel Brands. And as a reminder, this conference call is being recorded. I would now like to turn the conference call over to Mr. Andrew Berger of SM Berger & Company. Mr. Berger, the floor is yours, sir.

Good morning, everyone, and thank you for joining us. We appreciate your participation and interest. With us on the call today are Chairman and Chief Executive Officer, Robert D'Loren; Chief Financial Officer, Jim Haran; and Executive Vice President of Business Development and Treasury, Seth Burroughs. By now, everyone should have had the access to the earnings release for the second quarter ended June 30, 2019, which went out earlier today. And in addition, the company plans to file with the Securities and Exchange Commission its quarterly report on Form 10-Q by August 14, 2019. The release and quarterly report will be available on the company's website at www.xcelbrands.com. This call is being webcast, and a replay will be available on the company's Investor Relations website. Before we begin, please keep in mind that this call will contain forward-looking statements. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from certain expectations discussed here today. These risk factors are explained in detail in the company's SEC filings. Xcel does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Finally, please note that on today's call, management will refer to certain non-GAAP financial measures, such as non-GAAP net income, non-GAAP diluted earnings per share and adjusted EBITDA. Our management uses these non-GAAP metrics as measures of operating performance to assist in comparing performance from period to period on a consistent basis and to identify business trends related to the company's results of operations. Our management believes these financial performance measurements are also useful because these measures adjust for certain costs and other events that management believes are not representative of our core business operating results. And thus, they provide supplemental information to assist investors in evaluating the company's financial results. These non-GAAP measures should not be considered in isolation or as alternatives to net income, earnings per share or any other measure of financial performance calculated and presented in accordance with GAAP. You may refer to the attachment to the company's earnings release or to Part 1, Item 2 of the Form 10-Q for a reconciliation of non-GAAP measures. Now I'm pleased to introduce Robert D'Loren, Chairman and Chief Executive Officer. Bob, please go ahead.

Thank you, Andrew. Good morning, everyone, and thank you for joining us. I'll start with our financial and operating highlights and then provide some thoughts on the rest of the year. After that, our CFO, Jim Haran, will discuss our financial results in more detail, and then we will conclude by opening the call for Q&A. Now let's get started with financial highlights. We showed an 8% increase in total revenue in the second quarter of 2019 as compared with the same period in 2018. And on a year-to-date basis, we delivered a 13% increase in total revenue from last year. This was primarily the result of continued growth in our apparel and jewelry wholesale and e-commerce businesses. Our GAAP bottom line earnings increased significantly from last year. And while our non-GAAP earnings decreased, this was in line with our expectations. Overall, we are pleased with the quarter and the first half results and believe we are well positioned for a strong second half for 2019. As previously reported, we have transitioned from a licensing company to a vertical consumer products, media and technology-based operating company. Our focus remains on expanding distribution of our brands across all channels. This includes interactive TV, wholesale, specialty collaborations and direct-to-consumer sales of our products. We are encouraged by our current top line revenue growth and continued to make strides in leveraging our technology platform to drive efficiency and more intelligent, data-driven decisions across all channels of distribution. Finally, we believe conditions are favorable for us to consider strategic acquisition opportunities, including branded operating companies. Now taking a closer look at our business by distribution channel. Our interactive television business is performing well, especially in our Isaac Mizrahi brand, which includes a successful 2019 collaboration with new balance on QVC. Our Judith Ripka brand continues to be playing on QVC and has launched on HSN. And although we continued to see some macro headwinds in the jewelry business in this channel, we have been able to manage our operating expenses in this business in line with our revenues. In our wholesale apparel business, we have been focused on building an outstanding design, merchandising and sourcing team that is able to embrace our integrated technology platform to make smarter and data-driven merchandising and design decisions across all channels of distribution. The new team is off to a good start, and I am very pleased with the direction of our products with the full 2019 collections being the first collection fully designed and developed under our new team and the platform. We have received positive feedback from the industry on the new collections, which has enabled us to open new accounts starting in fall 2019, and we are optimistic about sales for Q3 and Q4 and future growth as we look towards 2020. We've been focused on the pending tariff discussions in Washington and for full 2019 preemptively sourced the majority of our product outside of China as well as reserving an allowance for potential tariffs. While the industry as a whole faces increased margin compression, if the entire extent of the tariffs are implemented, we believe that through advanced planning, we are well positioned to manage these events. I should note that there is no tariff impact on our jewelry business, which is primarily produced in Thailand and Italy. Finally, our Judith Ripka e-commerce business continues to show strong growth. We've recently launched two new collections that are doing well and plan to launch five additional new collections over the next three quarters. We have fully implemented our integrated technology platform in our jewelry business to advance the vision of leveraging technology to drive efficiency and smarter decision-making. All of our jewelry designs are now being done in 3D design software, which drives efficiencies in our design and sourcing processes with less room for error. We also used the 3D images to conduct consumer insight testing and utilize the results to adjust design then pre-market with final images to get a read on demand before we place a production order. The process enables us to design and source more efficiently, ensures demand for products we are bringing to market and drives our buying decisions in order to minimize inventory risk. This is extremely exciting, and we hope to have this fully operational in apparel in 2020. Finally, in our specialty retail business, we are participating in targets recently announced retrospective, celebrating 20 years of design partnerships, which includes apparel collections from our Isaac Mizrahi brand. The collection will feature reproductions of original Isaac designs and will be featured this fall at Target stores nationwide on September 14, following an extensive marketing campaign and launch event during the upcoming New York Fashion week. We have additional collaborations for this fall that we are excited to announce shortly, and combined with the release of Isaac Mizrahi's best-selling Memoir and an award-winning documentary on Halston have already generated millions of media impressions for our brand in 2019. In conclusion, through our overall and old channel approach, we have positioned ourselves to establish our presence in all forms of distribution so that we can reach our customers everywhere they shop. Now with the operational transition of our business complete and a strong balance sheet, we believe more than ever, we are well positioned for both organic growth as well as growth through potential acquisitions. Now, I'd like to turn the call over to Jim to review our financial results for the quarter. Jim?

Thank you, Bob, and good morning, everybody. I will briefly discuss financial results for the quarter ended June 30, 2019. Please note that our financial results are described more fully in our quarterly report on Form 10-Q, which will be filed with the SEC by August 14 of this year. In the second quarter of 2019, our net revenues increased to $9.1 million, an increase of $0.6 million or 8% over the prior year quarter, primarily driven by sales from the apparel and jewelry wholesale and e-commerce operations, which was partially offset by lower licensing royalties attributable to a transitioning a component of our licensing business to a wholesale model. Our gross profit decreased by $0.9 million to $7.4 million, primarily attributable to a decrease in net licensing revenue as a percentage of our overall revenues. Operating costs and expenses were flat year-over-year, coming in at approximately $7 million for the current and prior year quarter. Net income was approximately $1.9 million for the current quarter or $0.10 per diluted share compared with a net loss of $0.1 million or $0.01 diluted share for the prior year quarter. This included a $2.9 million gain on the reduction of a contingent obligation related to the acquisition of the C. Wonder brand. After adjusting for certain cash and noncash items, non-GAAP net income for the first quarter was approximately $1 million and non-GAAP earnings per share was $0.05 per diluted share. This compares with $1.7 million or $0.09 per diluted share in the prior year quarter. Adjusted EBITDA for the current quarter was $1.6 million compared to approximately $2.2 million in the prior year quarter. Now moving to our six-month results. In the first six months of 2019, net revenue was $19.4 million, an increase of $2.1 million or 13% over the prior year 6-month period. This was primarily driven by sales from the apparel and jewelry wholesale and e-commerce operations, which, again, was partially offset by a decrease in net licensing revenue due to the transition of a portion of our licensing business to a wholesale model. Gross profit decreased by $1 million to $15.8 million from the prior year. This was primarily attributable to a decrease in net licensing revenues. Although our gross profit has decreased compared to last year, our product sales and related margin contributions have increased, and we expect these to continue to grow into the second half of the year. Our operating expenses increased by approximately $0.4 million, compared with the prior year period. This was primarily due to $0.8 million in increased noncash amortization expense related to our trademarks, which was largely offset by a decrease in compensation costs, which was a result of capital expense management, while we continue to invest in certain segments of that business as well as our integrated technology platform. Total interest and finance expense for the current six months increased by $0.28 million from the prior year period, primarily attributable to a loss on the extinguishable debt as well as the refinancing of our bank term debt in conjunction with our recent acquisition of the Halston and Halston Heritage brands. Net income was approximately $2 million for the six months or $0.11 per diluted share compared with net income of $0.4 million or $0.02 per diluted share for the prior year period. This included the aforementioned gain on the reduction of contingent obligations related to the C. Wonder as well as a decrease in our provision for income taxes. After adjusting for certain cash and noncash items, non-GAAP net income for the current six months was approximately $2.5 million and non-GAAP earnings per share was 13% per diluted share, which compares with $3.4 million or $0.18 per diluted share in the same period last year. Adjusted EBITDA for the current six months was $3.7 million. This compares to approximately $4.4 million in the prior year period. Turning now to our cash position; as of June 30, 2019, the company had unrestricted cash and cash equivalents of approximately $6.3 million compared with total cash of approximately $8.8 million at December 31, 2018. This $2.5 million net decrease was primarily attributable to $1.6 million of cash used in the acquisition of the Halston and Halston Heritage trademarks and capital expenditures related to investments in our integrated technology platform. Looking at our debt; at June 30, 2019, total liabilities were approximately $47.4 million, which includes $21.7 million term debt, $0.9 million of contingent obligations, $12.3 million of operating lease liability and $9.3 million of net deferred cash liability. The contingent obligation of $0.9 million is associated with the Halston and Halston Heritage acquisitions and is payable in cash or common stock at the company's option. In conclusion, and to reiterate hearing Bob's comments, our first half results were well within our expectations. The growth of our e-commerce business and transitioning certain components of our licensing business to a wholesale model resulted in higher revenues, but lower non-GAAP earnings for the first half of this year. However, based on continued growth in both our e-commerce and wholesale businesses, we expect to see continued revenue and operating result growth into the second half of this year. And with that, I would like to turn the call back over to Bob. Bob?

Thank you, Jim. Ladies and gentlemen, this concludes our prepared remarks. Operator?

[Operator Instructions] The first question we have will come from Michael Kawamoto of D.A. Davidson.

First, just on the wholesale business, was that about in line with your expectations for the quarter? Or were retailers still working through some old inventory from you guys?

No. I would say, sales -- wholesale sales were about where we thought they would be based on book. We did have some orders that shipped early July. They pushed over from what we thought would be June shipment. So overall, based on the book of business that we had, we came in about where we thought we would be. But as I said, we just had some of the June shipments shipped out in July and didn't make it into the quarter. And there is some inventory that we are working through with the retailers, but it didn't impact the performance of the spring goods when you average, of course, the markdowns on the old inventory that came from our licensee, there was an impact. But the performance of the goods shift for spring was much better than what our licensee was doing.

Got it. And then how should we be thinking about, I guess, the back half order book for that business in the mid-2020? Can you ballpark kind of the opportunity you see there? Do you still expect pretty rapid acceleration of growth there?

We do. And our current book of business based on orders that we've taken is a little ahead of expectations. So we're very optimistic about Q3 and Q4.

And if I could just add, the 2019, our book of business grows top-heavy toward the back of the year. So in addition to our optimism with where we expect to be, we knew all along that this was going to be a second half, the performance for the company.

Yes. When you say ahead of expectations, do you mean consensus expectations or your internal expectations?

Both, actually. We worked out, yes.

Okay, got it. And then you talked about opening some new accounts for the wholesale business. Can you talk about maybe who those are, if you can? And those -- and your expectations for those accounts?

Sure. We -- prior to last year under the license agreement that we had, we were signed to an exclusive with the Hudson's Bay Company and with Dillard's. So we were precluded from opening new accounts and better distribution. And this year, part of the new effort here is we hired a sales team that has now broadened distribution. So we're now selling the digital players like Stitch Fix and Fab Fit. We've also opened some accounts with Macy's and some of the off-price players. So that was the plan, and we've been able to accomplish that. We've opened a private-label business with Saks. And we have plans going into next year to open some business with Walmart with one of our brands.

And then Michael, I would add, our performance in the second half of the year, for the most part, excludes these new accounts. So these new accounts should impact our book of business starting in 2020.

And you mentioned Walmart, what they have -- was it 4,000 stores. That would, I imagine, adds up pretty sizable opportunity for you guys?

It could be. Generally, what we're seeing is Walmart is using their .com as a testing ground. And if a brand gets traction there, then it could expand into bricks. So we're working on actually two programs with them. One is some business with one of their brands, and one is with one of our brands.

Got it. That's super encouraging. And then just lastly, within the next 1.5 years, it looks like, I think your QVC agreements begin to expire. As you renegotiate those, are you going to shift back to the traditional wholesale model as well?

So the QVC agreements are -- there are evergreen provisions where they renew. And as our brands become more mature there, they transition from a guaranteed royalty model to actual royalty models. So Isaac Mizrahi, for example, has been off the GMRs for at least five years, and we're now generating actual royalties that far exceed what the initial minimums were. Halston is coming off the GMRs next year. We are evaluating the possibility of converting that to a wholesale model. We think that would make sense for us now with platform built and my confidence in the new team, in design, development, and sourcing, all driven by the technologies that we've implemented. I'm very optimistic and confident that we could flip that to a wholesale model. So we are exploring that.

Got it. And then I guess, just lastly, my last, last question, you mentioned the possibility of doing a deal a couple of times. Can you just talk about what the environment looks like right now? And maybe how big you can go?

So as you know, Michael, these are challenging times for most companies in the industry, both on the wholesale side and on the retail side, there's an enormous amount of disruption. And we're seeing a lot of opportunities with those branded companies, licensed trademarks and with operating companies. Multiples are beginning to make more sense to us. There is capital available in the markets for these types of transactions. In Q1, we looked at two potential acquisitions, we actually conducted detailed due diligence and decided that neither one of those acquisitions were suitable for us, given the risk that was in the companies, but we continue to look. And given where the balance sheet is at the moment, we think this is a good time for us to consider some strategic acquisitions that give us distribution in channels where we currently don't have a great deal of penetration like off-price clubs and in some of the other better retailers.

Got it. Thanks so much for your time guys, and good luck for the rest of the year.

Thanks, Michael.

Well, at this time, we're showing no further questions. We are going to conclude today's conference call. And we thank you, management team, for your time. And we also thank you all for attending. At this time, you may disconnect your lines. Thank you. Take care. And have a great day, everyone.

Thanks you.