Xcel Brands, Inc. (XELB) Q2 2022 Earnings Report, Transcript and Summary

Welcome to Xcel Brands Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that reproduction of this call in whole or in part is not prohibited without prior written authorization of Xcel Brands. And as a reminder, this conference call is being recorded. I would now like to turn the call over to Andrew Berger of SM Berger & Co. Thank you. Andrew, you may now begin.

Good morning, everyone, and thank you for joining us, and welcome to the Xcel Brands Second Quarter 2022 Earnings Call. We appreciate your participation and interest and hope that all of you are safe and well. 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 access to the earnings release for the second quarter ended June 30, 2022, which went out a short while ago. And in addition, the company will file with the Securities and Exchange Commission its quarterly report on Form 10-Q today. The release and the quarterly report will be available on the company's website at www.xcelbrands.com. During the second quarter, the company announced that it closed on the sale of a 70% interest in its Isaac Mizrahi brand. The company filed a Form 8-K report relating to the transaction, and it, too, is 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 most recent annual report filed with the SEC. Xcel Brands 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. The dynamic nature of the current macroeconomic and geopolitical environment means what is said on this call could change materially at any time. 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 relating to the company's results of operations. Our management believes that use of financial performance measures 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 to Part 1, Item 2 of the Form 10-Q for a reconciliation of non-GAAP measures. And 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 will start today's call with a review of the transformation of our business through the sale of the 70% interest in the Isaac Mizrahi brand and joint venture agreement with WHP Global, our operating role going forward and our plans to use proceeds from the sale. I will then cover some operating highlights for the second quarter, and then our CFO, Jim Haran, will discuss our financial results for the second quarter in more detail. I'm pleased to share with you that on May 26, we successfully completed the sale of the 70% interest in our Isaac Mizrahi brand and entered into a newly formed joint venture agreement with WHP Global, a private equity-backed brand management and licensing company. The transaction resulted in $46.2 million of cash proceeds at closing, which combined with our 30% retained interest in the venture and a $2 million earnout, valued the Isaac Mizrahi brand at $68 million. This is significantly higher than the value of the brand when we acquired it in 2011. By retaining ownership in the brand, we remain committed to participating in the future growth of this iconic brand. Under our agreement with WHP, we will continue to oversee and manage the Isaac Mizrahi business on QVC, and we have entered into a license agreement with the venture to continue to develop a women's apparel business under the Isaac Mizrahi brand in the United States and Canada. In this connection, we have been working with WHP to develop a new strategic plan to grow the women's apparel business which we hope to be able to announce soon. We are excited to partner with WHP for the next phase of growth for the Isaac Mizrahi brand, including a launch of a direct-to-consumer website as well as international opportunities that leverage WHP's global footprint and expertise. Overall, we believe this was a transformational transaction for Xcel in that it allowed us to realize substantial value from the growth created by us in the Isaac Mizrahi brand, while at the same time, retaining a material interest in its future growth. As I stated on our Q1 earnings call, we have worked hard over the past 12 years to position Xcel as a design production and live stream media platform focused on driving growth and creating long-term value for consumer brands. We have also developed an innovative proprietary live streaming platform based upon reimagining, shopping, entertainment and social media is one thing and have become a leader in this rapidly emerging marketplace. We are pleased both with the success we have been able to achieve under our brands on direct response television as well as our ability to materially increase the long-term value of our brands as evidenced by the second quarter Isaac Mizrahi transaction. From a financial perspective, the transaction significantly enhanced our balance sheet. Concurrent with this transaction, we repaid 100% of our outstanding debt under our loan agreement with First Eagle and significantly increased our cash and working capital positions. For the first time since we started the company in 2011, we are now a debt-free company, which provides us with significant flexibility to pursue opportunities that accelerate growth. As I discussed, when we announced the transaction, selling the majority of the Isaac Mizrahi brand will impact our revenues and earnings for the remainder of 2022. This, combined with recent headwinds caused by continued supply chain issues, high inflation, order cancellations as retailers manage inventory and added costs for new initiatives that I will discuss more fully, has resulted in the 2022 year, not shaping up as we had initially expected. I should note that the challenges in the retail environment came suddenly, and the market remains extremely fluid. That said, having strong liquidity levels and greater access to capital is critically important in today's business environment. We expect to enhance our capital levels in the coming quarters with a new commercial bank working capital line and have maintained our relationship with First Eagle for future acquisition financing. We will move quickly but prudently to put this capital to work and are exploring several strategic investments that we believe will continue to enhance our competitive position and provide earnings growth while maintaining a strong balance sheet. In the current economic environment, we believe there will be attractive acquisition opportunities as our industry deals with the slowdown we've seen at retail in the past and approaching quarters. We are also working on multiple new projects within our existing businesses, the first of which we recently announced with the appointment of Ken Downing as the Creative Director and live stream spokesperson for Halston. We have several new launches planned for Halston in Spring '23, including a distribution arrangement in the U.K. We also recently launched a multi-branded optical business on HSN, which will be filed with the launch on QVC soon, all through a joint venture whereby Xcel has been able to leverage inventory and systems and manufacturing partner without any material capital investments. We are extremely excited by these new developments, which will help create growth in our existing brands and expand our relationship with QVC and HSN and expect more announcements soon. Also, we executed a distribution agreement for our C. Wonder brand in the U.K. Finally, we recently executed an agreement with a warehouse facility in Mexico that will give us a significant competitive advantage and improve margins through Section 321A tariff savings and established a new domestic distribution center in Ohio to better serve our long Longaberger customers. From a high-level perspective, while the Isaac Mizrahi transaction had a short-term impact on revenue and earnings, we expect to quickly replace these based upon the pipeline of new projects and new opportunities that are currently either planned or being considered. We are very pleased with the transaction as a step towards strengthening our balance sheet and positioning Xcel as the leading platform for brands, primarily driven by live stream shopping. In closing, we believe our financial flexibility, strong liquidity, rich asset values and access to capital will drive our current businesses and fund new opportunities. This is even more important as companies in our industry are dealing with continued margin pressure and order cancellations due to logistics, raw material cost and macro and geopolitical concerns. As a result, we believe that the growth investments we are pursuing, combined with our strong balance sheet, will position us well to grow our business through economic headwinds that have been suddenly thrust upon us. As of today's call, our wholly owned brands include Halston and Lori Goldstein, Judith Ripka and C. Wonder, and we share ownership in Longaberger and now in Isaac Mizrahi. I continue to believe that our asset values far exceed our stock price and market cap. The Isaac Mizrahi transaction supports this hypothesis. We have proven our platform success at creating long-term value and our brands have developed a reputation in the industry as a leading platform for brands driven by live stream shopping. And we'll continue to build our existing brands, enter into partnerships and acquire new brands and businesses with the goal of enhancing shareholder value for our stakeholders. The platform we have created is supported by the strongest pipeline of new opportunities in our history, and I am excited by the direction we are headed. Now I'd like to turn the call over to Jim to discuss the Isaac Mizrahi transaction in more detail and our results for the second quarter. Jim?

Thanks, Bob, and good morning, everyone. I will briefly discuss our financial results for the quarter and six months ended June 30, 2022. Total revenue for the second quarter of 2022 was $8.5 million, representing a decrease of approximately $2.3 million or 21% from the prior year quarter. For the current six months, total revenue decreased approximately $1.4 million from the prior year period to $17.2 million. Wholesale apparel revenues were down on a year-to-year basis compared with the prior year and was partially offset by higher licensing revenues for the current six-month period. Net wholesale and direct-to-consumer sales decreased by approximately $1.2 million in the current quarter and $2 million for the six months ended June 30, 2022, which is approximately 27% and 24% lower, respectively, as compared with the prior year comparable period. These decreases were primarily attributable to declines in wholesale apparel revenue during the first half of the year, mainly driven by the temporary closing of overseas factories and cancellation of orders from our retail customers based on industry headwinds. Net licensing revenues for the current quarter were approximately $5.2 million, representing a decrease of approximately $1 million or 17% as compared with the prior year quarter. This decrease in licensing revenue was primarily attributable to the May 31, 2022, sale of the majority interest in the Isaac Mizrahi brand. Net licensing revenue for the current six months increased by approximately $0.6 million to $11.2 million or 6% as compared with the prior period, primarily attributable to our ownership of the Lori Goldstein brand during the entire six months in 2022 and partially offset by the sale of Isaac brand in the current year. Gross profit margin from - approximately - has declined approximately 33% in the second quarter 2021 to approximately 22% in the current quarter. And from 39% in the prior year six-month period to 30% in the current six months. These declines were primarily due to the selling off of seasoned apparel inventory and inventory write-downs relating to canceled sales orders as well as increased logistics and global supply chain costs. Relocating our product distribution in Mexico that Bob mentioned in his opening remarks, will have a positive impact on our cost of goods going forward. Our operating expenses were $11.3 million for the current quarter, up $1.9 million from $9.4 million in the prior year quarter. Approximately half of this increase was attributable to expenses related to the sale of the Isaac Mizrahi brand that are onetime costs and would not be expected to continue. Although we experienced various cost increases from multiple service providers and vendors due to the current inflationary economic environment, most notably in the area of shipping, warehousing and logistics costs, we have managed to control overall expenses. Separately, we have incurred costs associated with several new initiatives we are working on, including design and product development and warehouse set forth. The investment in these new initiatives is part of the company's plan to replace the revenue from the Mizrahi brand. And again, we continue to pursue ways to cut operating costs. In the other income category, we recognized a $20.6 million gain in the current quarter and six-month period related to the previously mentioned cost of sales of the Isaac Mizrahi brand. Interest and finance expense for the current quarter was $2.8 million compared with $1.4 million in the prior year quarter. On a year-to-date basis, interest and finance expense was $3.5 million for the current year period versus $1.7 million in the prior year period. This trend on a quarter and year-to-date basis is primarily driven by the fact that in the current year, we recognized a higher gross on distinguishment of debt as a result of the May 2022 repayment of all of our outstanding term loan debt, which included a $1.4 million early repayment premium. The fact that we have fully paid off all of our outstanding term loan debt and thus no longer had any interest and principal payments due will benefit both our cash flow as well as our income statement in subsequent quarters. Overall, our net income, excluding noncontrolling interest for the second quarter of 2022 was approximately $9.5 million or $0.48 per share compared with a net loss of $1.6 million or minus $0.08 per share in the second quarter of 2021. On a non-GAAP basis, we had a net loss for the current quarter of $3.6 million or minus $0.18 per share, compared with $0.1 million or minus $0.01 per share in the second quarter of 2021. Adjusted EBITDA was negative $2.8 million for the current quarter compared with $0.9 million in the prior year quarter. The decrease in EBITDA was primarily attributable to lower revenues previously mentioned. As a reminder, non-GAAP net income, non-GAAP diluted EPS and adjusted EBITDA are non-GAAP unaudited terms. Our earnings press release and our Form 10-Q present a reconciliation of these items with the most directly comparable GAAP measures. Turning now to our balance sheet. As of June 30, 2022, the company had unrestricted cash and cash equivalents of approximately $11 million and positive net working capital of $17 million, excluding the current portion of our lease obligations and contingent obligations payable in shares of stock. It should be noted that our cash balance is at its low level at the end of each quarter. Our current cash balance is approximately $15 million compared with $11 million at June 30, 2022. And as discussed, we have fully paid off all outstanding term loan debt, which will eliminate approximately $4.5 million in annual debt service payments. And with that, I would like to turn the call back over to Bob. Bob?

Thank you, Jim. This concludes our prepared remarks. Operator?

Thank you. [Operator Instructions] Our first question is from Anthony Lebiedzinski with Sidoti & Company. Please proceed.

Good morning. Thank you for taking the questions. So I know you guys talked about the strong pipeline of new products. Can you give us perhaps any additional color on those? And as far as the other project that you announced as far as Halston and C. Wonder, maybe if you could just help us to think about how should we think about the impact on your revenue and earnings going forward and stuff in some of these new projects?

Sounds good. So a majority of the new projects that are in the pipeline for launching are both with QVC and HSN. First is the optical joint venture that we call Q-Optics, that we have launched with both HSN, and I believe by the end of this week, we will be fully launched with QVC. And then with the announcement of Ken Downing for the Creative Director for Halston, we are working with HSN to significantly increase the business there with Ken as a spokesperson as well as a distribution deal in the U.K. for a new premium line of Halston that we are going to launch for spring of '23. That will be also distributed to premium retailers here in the U.S., Bloomingdale, Saks, Nordstrom, Neiman's, that level of distribution. And of course, we will continue to build the Halston business in the better tiers of distribution like Macy's and some of the off-price retailers. There are also three additional new initiatives that are in the pipeline with HSN and with QVC, one of which we hope to be announcing in the next few weeks. And that will be a significant increase in business for our C. Wonder brand. So that's a majority of the pipeline transactions. No significant capital being deployed for any of these other than startup cost for product development, additional staff to oversee these businesses before the launch as well as some freelance employees that we brought in to get the old product that we are working on, developed and launched on time.

Got it. Thanks for that. And just a follow-up, is there any way to quantify these start-up costs and some of these freelance workers as far as the magnitude of that? Is any sort of color on that?

Sure. And generally, they are onetime cost and to launch a brand for a new season, including start-up costs for product development, freelance employees that we need in terms of extra hand to take on the additional workload. It's about $300,000 per initiative. And of course, all of that hits the P&L, we can't capitalize that. But those are onetime costs. We are also incurring some additional cost setting up warehouse operations in Mexico and the new 3PL that we set up in Ohio for our Longaberger business. The Longaberger business has outgrown the 3PL that we're in. They just cannot process orders fast enough if we run a big event and we moved into a state-of-the-art 3PL there. And most of those costs are technology-related for the setup cost.

Got it. Okay. And then to follow up on that, as far as the new Mexico facility and the new Ohio facility, what is the timing as to when you expect to complete that by?

Mexico will be operational by year-end. We will be shipping one of the new launches from that facility in late December and then take it forward from there. The duty savings is anywhere from 17% to 36% on apparel, depending upon the material in the goods. So it's a very significant advantage for us. And if you're not familiar with Section 321A, the trade rules, there is the concept of the de minimis amount to qualify for the duty savings. And so long as the shipment to direct to the consumer is under $800, it is duty-free. So it is a program that many companies, particularly direct-to-consumer companies are taking advantage of and for our HSN and QVC business, given that 100% of their orders are direct-to-consumer. It's a way that we can be much more competitive on retail prices and margins both for QVC, HSN and for Xcel.

Got it. Thanks for the additional color. So as you look at your current brand portfolio, where do you think you have the most opportunity to expand?

I think Halston has significant upside for us, just given its current distribution. We believe that the new distribution program that we've started in the U.K. will be a meaningful business for us. Immediate distribution is going to be 300 independent boutiques and better department stores there. We are in a discussion to do something similar in Mexico with distribution in Liverpool and above. So we see significant upside with Halston also now with Ken being on board, we think we have an authentic voice there that can drive business at HSN. And also with the duty-free status coming out of the warehouse, I think our retails will be in line perfectly to drive business at HSN. Also the C. Wonder program has tremendous upside. We will be reporting, over the next few weeks, what this program will be. It's a significant piece of business for us over the next three years, and we are very, very excited about this.

Got it. Okay. And the last question for me. So as you look to enter these new projects, what is your willingness to perhaps go back into a debt position? Or should we assume that for now, you want to maintain a debt-free balance sheet?

We would prefer to have a debt-free balance sheet as it relates to any term debt. We will - or I should say we are in the process of securing a working capital line. Given the planned increase in the amount of inventory that we will be carrying for these various QVC and HSN programs as well as the launch of Halston and premium, it's much more efficient for us to have a line of credit secured by AR and inventory.

Got it. Okay. That makes a lot of sense. Okay. Well, thank you, very much and best of luck.

Thank you, Anthony.

Our next question is from Debra Fiakas with Crystal Equity Research. Please proceed.

Thank you. And thank you for taking my questions. The first one is more or less a housekeeping question related to your sale of the Mizrahi brand. Of course, you retained a significant portion of that, 30% of it, and it's obvious how that looks on the balance sheet. But I wondered - and maybe this is a question for Jim. How would we expect that 30% interest to be reflected in your income statement, your P&L?

This can be recorded under the equity method, so it would be a separate line item. We'll record the income that will flow through us from the JV. We have - essentially, we'll be broken to two pieces. I don't want to go too technical, but it's going to be - it will be sort of the core cash operating component that is in conjunction with the distributions for the two members. And there's noncash expense of the amortizing part of the intangibles that they acquired, which we did in prior, which with the Isaac Mizrahi brand as an indefinite-lived asset.

Okay. Very good. And when can shareholders expect to see that begin?

It was a breakeven this quarter. We only had the brand for a month. So we didn't record anything. You'll start to see that on the P&L starting in the third quarter.

Okay. Excellent. Thank you. And then, of course, in regard to the new license that you have for the Mizrahi brand, where you're going to create women's apparel, are there limitations on that on that license? Is it sports only? Or can we see a broad array of women's apparel?

So I'll take that, Debra, it will be a very broad offering. It's all-classifications under apparel. And we expect to be making an announcement about that launch very soon.

Okay. Are you expecting - this sort of queues into what was asked by the previous person regarding the C. Wonder brand. Are you expecting that to take place, the C. Wonder activity to take place at a faster pace than maybe we would see the new Mizrahi items?

Yes. The C. Wonder product development has been in place over the last three months. It is a Spring '23 launch. Isaac would be before Fall '23.

In '23?

Yes.

Okay. Okay. And this is more of a global question. You mentioned in your opening remarks, Bob, about unexpected inflation and it's in the headlines every day. But last Friday, the University of Michigan gave out some preliminary numbers related to consumer sentiment. And of course, this is just a survey of economists, but they indicated that consumer sentiment had spiked up to 55.1%, which is a big number off of a low that was set in June. And I just wondered, how can shareholders make sense out of these big headlines vis-à-vis how - what you're experiencing at Xcel Brands, what do you see in terms of the pace of your orders and maybe the order size, average order sizes or ticket averages if that's the way you look at it?

So this year was challenging for us because of supply chain issues. We - in our apparel business, most of our goods are sourced out of China. And as you know, there were shutdowns in many of the provinces in China that caused 45- to 60-day delays in deliveries. And while we try to hold as many of those orders as we could, as retailers began to pull back on inventory levels where they could, cancel orders they did. And that has had a very significant impact on the wholesale business for us this year. And of course, we're managing through the various different stages of goods where we could cancel orders that were at factories we did. But in certain cases, there are manufacturing inputs, ready goods, trims, buttons that were ordered. We will do our very best to repurpose those goods and where we could cancel orders and negotiate fairly with our factories, we did. And that's been the biggest challenge. And then, of course, while container costs and logistics costs are improving, they are still significantly more than they were pre-COVID. And when we saw two-and-half years ago, the de minimis change from $200 to $800 under Section 321A, we started doing research and diligence on identifying a warehouse there because this is a significant advantage where you're shipping direct-to-consumer.

Right. I appreciate you bringing that up just now because that actually has to do with my next question. It seems like you're bringing consumers quite a bit of value by making that adjustment in your upstream distribution chain. What other means do you use to bring value to consumers or to attract them? I just wondered if you could maybe give us a little color on your pricing strategies. Do you feel like, at this juncture, you have to engage in sales to keep customers coming to you and loyal to you? If you could just give us a little bit of color in regard to your policies on pricing.

So pricing is important regardless of tier distribution. People like to believe that they purchase something at a fair price. And there is some art and engineering to building a product, whatever it is, at a price point that is going to work with the consumer, particularly at each tier of distribution. And we do believe that tomorrow's winners may not necessarily be branded companies the way apparel companies emerged say, 20, 30 years ago with brands like Calvin and Tommy. Today, it's going to be platform companies that have fast production, have duty-free capability, have the ability to reach consumers directly and build audience and followers or I should say, highly engaged followers. And we believe that the best way to do that is through live streaming. The consumer is bored with static images. And we feel that we are very well positioned to be one of the leading platform companies doing what we do.

All right. Thank you. I'll get back in the queue in favor of the next questioner.

Thank you, Debra.

We have no more questions at this time. I would like to turn the conference back over to Mr. D'Loren for closing remarks.

Thank you, operator. Ladies and gentlemen, thank you all for your time this morning. We greatly appreciate your continued interest and support in Xcel Brands. As always, stay fit, eat well and be healthy.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.