Apex Global Brands Inc
Q3 2018 Earnings Call Transcript

Published: 6 Dec 2017

[Operator:]

Greetings, and welcome to the Cherokee Global Brands Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded. And it is now my pleasure to introduce your host, Ms. Patricia Nir, Investor Relation. Thank you, you may begin.

[Patricia Nir:]

Thank you. Speaking today will be the company's Chief Executive Officer, Henry Stupp; and Chief Financial Officer, Jason Boling. You can find accompanying slides for today's call on Cherokee's Investor Relations website. Before I hand the call over to management, please note that on this call certain information presented contains forward-looking statements including the financial forecast for fiscal year 2018 and 2019. Forward-looking statements are neither a prediction nor a guarantee of future results or circumstances, and are based on currently available market, operating, financial, and competitive information and assumptions. Our actual results could differ in a material manner from those expected in such forward-looking statements for any reasons including those listed in the company's SEC filings and those identified in the presentation materials accompanying this call. The company assumes no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results. Further, this conference call includes a discussion of non-GAAP financial measures as defined in Regulation-G, the most directly comparable GAAP financial measures, and information reconciling these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP are included in the earnings release, which is posted on the company's website at www.cherokeeglobalbrands.com. And with that, I'll hand the call over to Cherokee's Chief Executive Officer, Henry Stupp.

[Henry Stupp:]

Thank you, Patricia and good morning everyone. It is a pleasure speaking with you today and share the details and the meaningful progress we've made across key business and financial objectives. I'll start today's call with the review of these developments with the focus on the actions to enhance our liquidity, ensure our financial discipline and position the company for the full financial performance. Jason will then discuss our third quarter results in greater detail as well as discuss our outlook for fiscal 2018 and early thoughts in fiscal 2019. Then recap our quarterly brand highlights including retail and wholesale partner updates. Starting with our business and financial highlights. Most notably as announced last month, we successfully amended our existing loan agreement with Cerberus. The amended revises the financial covenants materially and the way that it allows us to focus on growing the business for the long-term. We secured the financing portion of the senior secured credit facility; the amount for the $11.5 million through the participation interest of certain of our shareholders with funding expected to close tomorrow December 7. On funding, we will eliminate further liquidity call which could have resulted in the issuance so that as much as $5.5 million in additional common stock and we'll cancel the previously announced special meeting shareholders. Our amended agreement with Cerberus enhances our ability to focus on the future sustainable and profitable growth of our four brand including Cherokee, Tony Hawk, Hi-Tec and Magnum. I'd like to take this opportunity to thank Cerberus and our shareholders for working collaboratively with us throughout the process. Based on this new banking arrangement, the company anticipates moving our debt from current to long-term at year end. In addition we've taken several actions to strengthen our quarter business fundamentals and focus mainly on our high growth brand opportunities. In October, we announced the appointment of Mark Conway, who joins Cherokee Global Brands with the powerful global retail, marketing and sales expertise. In this newly created role of Chief Branding Revenue Officer, in his capacity Mark is responsible for all the new business developments, strategic brand planning, e-commerce and marketing and with the conjunction of our sales and marketing teams manage business development in oversight of Cherokee Global Brands licensee partnerships worldwide. I would also like to reiterate that we've strengthened our financial and accounting capabilities and team leadership. In October, we're pleased to appoint John McClain, a former C-level executive for several publicly traded and apparel enterprises as Chairman of Audit Committee. Deloitte & Touche has been an exceptional partner and are pleased with the collaboration of the shift transition to our new audit firm. Our team is focused on identifying opportunities to enhance our operating and financial performance. As part of this effort, we are conducting a strategic review of our current operations with a particular emphasis on reducing expenses and growing cash flow. We'll continue to evaluate ways in which we can further reduce expenses through global efficiencies as well as review our product development and marketing initiatives to ensure strategic alignment across all high growth brands. The company is not solely focused on expense reduction, rather the recent hiring of our Chief Branding Revenue Officer combined with new compelling structured marketing initiatives will further enhance our retail placement, sell-through and visibility of our brands in the market. We will continue to strengthen our brands and the value proposition associated with our new unique 363 platform that emphasize this product development, marketing and brand expansion and consumer insights. In fact as Jason will detail our financial guidance for next year and contemplate some meaningful reduction in ongoing operating expenses. We expect our cost structure to drive improved profitability and cash flow. As a result, we're comfortable with our financial position and confident in our ability to meet our existing obligations. Our debt to EBITDA ratio should improve during fiscal 2019. And as you'll hear me discuss in greater detail momentarily, we continue to execute our strategic vision for Cherokee global brands, an [intuition] [ph] to servicing mew and existing licensees, we've executed several new license agreements to expand the reach of Cherokee, Tony Hawk, Hi-Tec and Magnum into new markets and categories. These new license agreements are expected to generate new royalty streams beginning fiscal 2019. So while it has been a tough year and many of the challenges we have faced are self inflicted. The Hi-Tec acquisition was undoubtedly more cost and time intensive than we originally forecasted. With the integration behind us and the strong team in place, we're committed to getting back on track and position the organization for future profitable growth. I'm confident that we have the resources, the leadership platform and portfolio to do so. And with that, I'll hand the call over to Jason to review our third quarter results and our outlook for fiscal 2018 and 2019.

[Jason Boling:]

Thank you, Henry, and good morning everyone. I will begin with the detailed review of our fiscal 2018 third quarter and nine-month financial results. I will then elaborate on our outlook for the remainder of fiscal 2018 and our preliminary guidance for fiscal 2019 which we issued today. So let's start with the recap of our financial results. Consolidated GAAP revenues for the third quarter were $11 million, which were comprised of royalty revenues and indirect product sales. Royalty revenues were $7.9 million compared with $6.5 million in the prior year period. The year-over-year increase was primarily due to royalty reports from the Hi-Tec and Magnum brands of $3.2 million partially offset by a decrease in Cherokee brand royalties of $1.8 million. The anticipated decrease in Cherokee brand revenues reflects the ongoing transition to our wholesale licensing partners to many new brick and mortar and online retailers in the United States. Hi-Tec revenues for the third quarter were $6.4 million and are comprised of two components, indirect product sales and royalty revenue. Indirect product sales of $3.2 million which carry a cost of goods sold of $2.3 million and represent sales to certain distributors and government contracts and as I just mentioned royalty revenues were $3.2 million. We continue to and maybe completely transition out of our remaining indirect sales in early fiscal 2019. On a sequential basis, royalty revenues and gross profit from indirect sales for the Hi-Tec and Magnum brands increased by over 16% or $500,000 as we strengthen and expand our presence through new licensees and distribution channels, primarily in the U.K. and countries across Europe. For the nine-month period of fiscal 2018, GAAP consolidated revenues were $36.1 million, royalty revenues were $22.7 million compared with $25.6 million in the prior year period. GAAP, selling and general and administrative expenses for the third quarter were $10.4 million compared to $7.7 million in the prior year period. The year-over-year increase was primarily due to the operating expenses related to the Hi-Tec portfolio of brands and $2.2 million of integration related expenses that were incurred during the third quarter. For the nine-month period GAAP SG&A totaled $30.7 million compared to $20 million for the prior year period. The year-over-year increase was primarily due to the operating expenses related to the Hi-Tec portfolio of brands and $6.2 million of integration related expenses that were incurred during the nine-month period. Non-GAAP SG&A which excludes the aforementioned Hi-Tec integration fees and certain other accounting, legal and professional fees totaled $8.2 million for the third quarter and includes $4 million of SG&A related to Hi-Tec. This compares to $5.3 million in the prior year period. For the nine-month period, non-GAAP SG&A totaled $24.5 million and includes $12 million of SG&A related to Hi-Tec. This compares to $16.2 million in the prior year period. For the third quarter, GAAP operating loss was $1.7 million compared to $1.2 million loss in the prior year period. GAAP operating loss for the nine-month period totaled $4.7 million compared with operating income of $5.6 million in the prior year period. Non-GAAP operating income excluding the aforementioned costs, totaled $541,000 compared to $1.2 million in the prior year period. Non-GAAP operating income for the nine-month period totaled $1.4 million compared with $9.4 million in the prior year period. GAAP net loss for the quarter was $2.5 million or $0.18 per share compared to GAAP net loss of $873,000 or $0.10 per share in the prior year period. For the nine-month period GAAP net loss totaled $10.4 million or $0.79 per diluted share. This compares to GAAP net income of $3.2 million or $0.37 per diluted share in the prior year period. Excluding the aforementioned integration accounting, legal and other professional fees, non-GAAP net loss totaled $740,000 or $0.05 per diluted share. This compares to non-GAAP net income of nearly $700,000 or $0.08 per diluted share in the prior year period. For the nine-month period, non-GAAP net loss totaled $2.2 million or $0.17 per diluted share, this compares to non-GAAP net income of $5.6 million or $0.64 per diluted share in the prior year period. Adjusted EBITDA was $928,000 compared to $1.6 million in the prior year period. For the nine-month period, we recorded an adjusted EBITDA of $2.8 million compared to adjusted EBITDA of $10.5 million in the prior year period. We recorded tax benefit of $889,000 in the third quarter and this compares to a tax benefit of $489,000 in the prior year period. At October 28, 2017, our cash and cash equivalents were $4.6 million. As Henry mentioned, we are comfortable with our balance sheet and expect our continued focus on reducing operating expenses and generating increased cash flow will contribute to a further strengthening of our balance sheet in the coming quarters. With that, I'll turn my attention to our outlook for fiscal 2018 and 2019. As noted in today's press release, we are updating our outlook for fiscal 2018 as follows. We now expect gross profit to be in the range of $34 million to $37 million. Adjusted EBITDA is now expected to be in the range of $6 million to $9 million. Our updated guidance accounts for our year-to-date performance specifically the retail headwinds we encountered as we transitioned our namesake Cherokee brand to new licensing partners. We continue to build our base of both domestic and international through further product expansion with new licenses, territory expansion as Henry will discuss shortly. Tony Hawk licensing revenue in Canada while growing with the year-over-year increase of 20% is still behind our original projections. Furthermore, the bankruptcy of Sears Canada combined with the overall retail environment impacted our forecast revenue. Hi-Tec's transition from its legacy operating model to our new licensing model is also affected. And finally foot-walk shops and the transition of the business model is driving slower franchise shop openings as well as the closing of underperforming franchise locations. As noted in today's press release we are initiating guidance for the fiscal year 2019 ending February 2, 2019. We currently expect gross profit to be in the range of $34 million to $39 million adjusted EBITDA is anticipated to be in the range of $7 million to $11 million. In summary, despite some of the integration challenges we've faced this year, we believe we now have the proper people, processes and infrastructure in place, our brand portfolio is strong and we're operating with increased financial discipline and productivity. Thank you for your time. I will now turn the call back over to Henry.

[Henry Stupp:]

Thank you, Jason. As I read it too earlier it's been a productive few months for Cherokee Global Brands as we continue to grow off the global relevance in reach of our core brands. We are working toward a future with Cherokee Global Brand is more diversified than ever before across brands, geographies, categories and channel partners. With more than 50% of our licensing revenue and gross profit generated outside the United States with best-in-class licensees, franchisees, retail partners and distributors. I'll now share some brand updates with you. I will start with our namesake Cherokee brand, which still delivered royalty revenue of $2.6 million in the quarter. A decrease of $1.5 million in the prior year period largely due to the transition from our legacy licensee. Most notably I'm pleased to share that we recently reached an agreement for the Pan-European distribution of the Cherokee brand. And Cherokee apparel and accessories for men, women and children will be offered in over 10,000 doors in approximately 30 countries. While Cherokee maintain strong brand awareness starting late summer and the early fall 2018. We're working with strong and progressive retail partner to expand the presence of our Cherokee brand [value] [ph]. Through this new licensing partnership, we will explore further distribution to alternative channels that are less penetrated globally in particular in the United States today. Through this new multi-year contract, we will diversify our revenues into new channels and begin to recognize meaningful revenue in fiscal 2019 with multi-million dollar purchase orders already secured. Diversified revenue streams to non-traditional retail channels including grocery, uniform, [indiscernible] plus the continued expansion of our e-commerce business will balance and grow revenue base into the future. Outside of Europe, we continue to see strong interest and demand for Cherokee brands and apparel and accessories. Latin America, Africa and India all posted year-over-year increases in revenue in the quarter up to double-digit growth in certain cases. Turning our attention to North America, we continue to make progress in the multi-category launch in the Cherokee brand in the United States. While partners has been slower than we had originally hoped and with selective of headwind spacing, broader retail in fashion segue. We continued to build on the depth and breadth of our product assortment and retail outreach. While in Europe, Cherokee brand is expected to be offered in over 4,500 retail doors increased placement through the back-to-school period was strong and we're pleased with the interest and demand [indiscernible] for a holiday in calendar spring 2018 programs. Building upon our successful relationship with our best-in-class U.S. licensees, we've expanded their license to Canada where we will begin expanding the distribution of the Cherokee brands starting spring of 2018. Today's retail and consumer environment necessitates that we continue to evolve our playbook and retail customers through the channels and mediums that they rely on the most. While growing our presence through digital and social media, emphasizing the story-telling nature of the Cherokee brand and our focus on families and communities for a partnership with saving the children. Through this partnership, a percentage of every sale in Cherokee branded products beginning in fiscal 2019 will directly support the families of saving children service. Cherokee customers are looking for opportunities to connect with us and beloved American brand and while giving back to the communities and organizations that they care about most. We look forward to meeting this head on and expect a partnership will be an important initiative to building and growing, our consumer engagement in the U.S. in future years. I'll now turn to our Tony Hawk brand which delivered revenue of $1.4 million in the quarter, up 10% over the prior year period. Once again performance was driven by strong increases in both domestic and international markets. As global demand and enthusiasm let's keep building culture continues to build. Domestically in ordination with our new licensees, we continue to build traction with new accounts for Tony Hawk. Performance at retail has been encouraging and we saw strong interest demand at the retail level for this holiday season and increased interest as we head into spring of 2018. We're excited to continue to expand the reach among specialty, regional department stores and mass market retailers with the brand and historically under represented as well as grow our online presence for amazon.com and walmart.com. At the end of the third quarter Hawk product was distributing approximately 1,500 doors in the United States and over the next year we would expect to grow or reach over 3,000 points of distribution in addition to our growing e-commerce presence. As with Cherokee, our expanded distribution for Tony Hawk offers most comprehensive assortment of men's and boys' apparel, footwear and accessories available in the United States. And we are in discussion to add new licensees for additional product categories including essentials in both domestic and international markets. Speaking of international markets aforementioned category continues to be quite strong. Walmart Canada is proving a strong partner and operator and partner for the Tony Hawk brand, we're coming to hear was a very strong back-to-school season. In fact retail sales of Hawk branded products in the quarter were up 22% over the prior year period of Walmart Canada. In Europe, we're excited to launch a Tony Hawk pro-program, collection of men's and boy's apparel, footwear and accessories aimed at the upper tier of retail distribution. And in Asia we're finalizing discussions with partners in both China and Japan and expect to announce developments on our go-to-market strategy which will be a combination of shop and shops and freestanding stores in the very near future. Turning to flip flop shops were sales of $390,000 increased 10% over the prior year period. The year-over-year increase reflects strength in same-store sales which grew 5% over the prior year period; undoubtedly mall-based retail continues to film of ways and first half of the year we closed 7 under performing locations to make way for more profitable formats. We feel good about the health of the portfolio and our ability to open new stores headed into the fourth quarter and even more aggressive during fiscal 2019. After a disappointing fiscal 2018 we are focused on our store model and confident in our ability to increase store openings through a combination of shop and shops, freestanding stores, our new floating retail concept and by partnering with new master franchisees in new territories. For example, we recently signed a master franchise agreement with the development of over 33 freestanding flip flop shops in India. We expect the first store to open in spring of 2018 with the remaining stores to be open over the course of the next 10 years. In addition, we are finalizing a master franchise agreement for Spain and Portugal, the details of which will be announced shortly. I will now turn over to our Hi-Tec brand which report a gross profit of $4.9 million in the quarter, led by the strong performance of our Hi-Tec Magnum and intersect their brands. Gross profits consisted of $3.2 million in revenue for licensees and additional 845,000 in gross profit form indirect product sales. As we posted one year anniversary of our Hi-Tec acquisition, we are pleased with the growth in direction of the Hi-Tec brand portfolio. So with Hi-Tec we acquired a portfolio of high equity brands that are well positioned to capture growing consumer demand and enthusiasm prior to across over footwear and apparel and accessories. While the integration proved more cost save and time intensive than we expected. We now believe that these challenges are behind us. We have new financial leadership into tours and place and expect more normalized operating expenses in this business moving forward. In addition, we anticipate transitioning mainly indirectly sales to allow us to focus solely in a royalty model for all Hi-Tec sales in early fiscal 2019. In Europe, our core licensees are now distributing products in over 90 countries and building strong momentum on the heals of very successful fall launch of men's and women's Hi-Tec apparel and accessories. And we are in the midst of expanding the product offering in the U.S. and Canada with the plan and launch of men's and women's apparel and accessories slated for late summer, early fall 2018. We expect the product will launch in leading department stores, specialty stores, outer retailers and expanded e-commerce during the summer of 2018. Retailer reaction for the product expansion of apparel and accessories has been strong; performance of the footwear business continues to grow with their existing partners while we penetrate new distribution channels. We continue to see strong sales of interceptive brand footwear at Walmart which are more than 50% year-over-year and we are excited to build upon this momentum in the quarters ahead. Including the expansion of new interceptive product categories such as cold weather accessories and essentials including socks. And lastly we're pleased to add new multi-year government contracts for our brand Magnum footwear that will contribute additional revenue in fiscal 2019. In summary, despite the challenges we face this year. We are pleased with the progress that we have made over the past few months, through the actions taken, we have meaningfully improved our financial liquidity, short up our financial controls and position the company for future profitable growth. We have a clear vision for our future and are squarely focused on our high growth brand opportunities. As we look ahead we will continue to scale our portfolio brands from category, channel and geographic diversification. We'll maintain discipline around operating efficiency and productivity as well as leveraging our free cash flow to accelerate the repayment of long-term debt. We appreciate your support and confidence in Cherokee Global Brands and we look forward to keeping you abreast of our progress. With that, we will open up the call for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Dave King with ROTH Capital. Please proceed with your question.

[Dave King:]

Thanks. Good morning guys. My first half in terms of the guidance particularly for fiscal 2019, can you talk a bit about what that assumes for each of the different, I guess the key brands and then specifically how much gross profit should we be anticipating for the Hi-Tec business?

[Henry Stupp:]

Well, as we mentioned with respect to the gross profit we intend to see transition from the indirect sales to a pure royalty models as we move into fiscal 2019. So the revenue number will be a combination of either royalty plus gross profit of pure royalties as we move into fiscal 2019. In terms of the breakdown, we have not provided the details by brand.

[Dave King:]

Okay, but I guess, I'm trying to get a sense on this, Hi-Tec I think out originally there it would be, I want to say we were expecting some $20 million or something of both profit out of that and it seems that's been trending sort of lower than that, is that should we expect that business to start to recover next year, I guess I'm just trying to get a sense of just what the major contributors are going to be as we think about, as we think about the year ahead given sort of the challenges that are happening at domestic retail obviously for the Cherokee business and some of that, I just want a better sense?

[Henry Stupp:]

I believe approach for assuming our guidance for next year was to take a conservative approach based on some of the challenges that we face this year. So we will update as we proceed through the year, but our focus right now is increasing profitability based on income and guidance that were provided today and we adjusted our operational mindset in order to ensure that we will be [indiscernible] some of the integration challenges that we face this year. And so at this stage we are taking a cautious approach with our guidance and we will build on that, we do believe that we have identified the way to put new brands for the future, retail reaction has been very strong for the agreement product offering. Our team including myself [indiscernible] retailers are very positive with the product presentations and our licensees have made, we've began to secure orders for this product expansion, but we are -- as I said taking a very conservative approach with our guidance as we go into next year.

[Dave King:]

Okay. Fair enough, Henry. And then we think about expenses seems like those completing to come in a bit higher than anticipated, can you talk about what's your guidance in delta and then speaking specifically on the core expense side. It looks like Hi-Tec for example is really just breaking even I guess where specifically are the cost really outsized how much success do you think you have in bringing those down, understanding that you are just going through the strategic review process now that any early thoughts are, where you can get that down, I think that will be helpful? Thanks.

[Henry Stupp:]

Sure, we took a review of the process, so while we were integrating on-boarding new licensees we were maintaining infrastructure related to product development marketing now that we are one year into the Hi-Tec business a lot of the licensees are picking up part of with the operating cost that we had related to marketing such as ratios, sponsorships, we're collaborating with them. We've also eliminated certain activities, extensive activities as we moved into next year in order to focus on like is more relevant for the future business model. So the combination of a focus on product demand with some of the responsibilities being shouldered by our licensees allow us to plan a reduction in product development and sampling cost as we head into next year on Hi-Tec separately a more conservative modern approach to marketing as allowed us to focus our expenses related to sponsorships tradeshows and such. So, we are basically looking at growing top-line revenue and at the same time reducing cost and consolidating some of the teams between, our teams state side and our teams in Europe where gets a little bit of overlap.

[Dave King:]

Okay. That's really good color. Thank you. And then just lastly, Jason do you have with the free cash flow generation was in the quarter and I guess just bigger picture in terms of the ability to generate cash flows when you move forward, is there anything you could view on the working capital front, maybe the break that helps drive that this spring receivables down or should we just be assuming that the most the cash generations to come from EBITDA? Thanks.

[Jason Boling:]

Yes, I mean most of the cash generating comes from EBITDA. I think, we - the adjusted EBITDA was $928,000 and that's going to be the most direct relation to free cash flow for us.

[Dave King:]

Okay and then in terms of that some of the receivables that you've taken on is part of Hi-Tec acquisition is that a part in terms of you, as you transition out of this indirect business what sort of impact that should have?

[Jason Boling:]

Yes. So, if once the 10-Q comes out you'll actually be able to see that over the past year receivables have actually decreased, because we've been collecting a lot of the older receivables and then we are collecting more timely certain of the indirect sales and things like that. As far as the direct effect the interesting part is the growth receivables that we have for indirect sales will come down, but the net affect should be relatively the same going forward.

[Dave King:]

Okay.

[Jason Boling:]

You also, if you look at the 10-Q when it comes out, you'll see the payables have gone down significantly as well, as we've been getting out of certain areas on certain lines of business.

[Dave King:]

Okay. Okay. That helps. Thanks for taking my questions and good luck.

[Jason Boling:]

All right. Thank you.

[Operator:]

Thank you. There are no further questions at this time. And this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.