Sequential Brands Group, Inc.
Q3 2016 Earnings Call Transcript

Published: 7 Nov 2016

[Operator:]

Greetings and welcome to the Sequential Brands Group Third Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

[Unidentified Company Representative:]

Thank you and good morning. Before we begin I would like to bring to your attention that statements that are not historical facts contained in this conference call are forward-looking statements that involve a number of risks, uncertainties, and other factors, all of which are difficult or impossible to predict and many of which are beyond the control of the Company. This may cause the actual results, performance or achievements of the Company to materially differ from the results, performance or achievements expressed or implied by such forward-looking statements. We refer you to our public filings and a press release we issued this morning for a summary of such factors. The words believe, anticipate, expect, may, will, should, estimate, project, plan, confident, or similar expressions identify forward-looking statements. Listeners are cautioned to not place undue reliance on these forward-looking statements which may speak only as of the date the statement was made. Other than as required by law, we undertake no obligation to update or revise these forward-looking statements whether as a result of information, future events, or otherwise. Additionally, the terms adjusted EBITDA and non-GAAP net income are all non-GAAP metrics and reconciliation tables for each can be found in the press release distributed today in the Investor Relations portion of our website, www.sequentialbrandsgroup.com. I’ll now turn the conference call over to Gary Klein, Chief Financial Officer of Sequential Brands Group. Thank you Mr. Klein, you may begin when you're ready.

[Gary Klein:]

Good morning and thank you for joining Sequential's third quarter 2016 earnings conference call. Today, I will overview our third quarter results for 2016 and our outlook for the full year 2016 and 2017, and then turn the call over to our CEO, Yehuda Schmidman. Total revenue for the third quarter 2016 increased to $42 million compared to $23 million in the prior year’s comparable quarter. On a non-GAAP basis net income was $1.3 million for the third quarter of 2016 or $0.02 per diluted share compared to $2.7 million or $0.06 per diluted share in the prior-year period. On a non-GAAP basis, net income for the third quarter of 2016 was $7.5 million or $0.12 per diluted share compared to $5 million or $0.12 per diluted share in the prior-year quarter. Adjusted EBITDA for the third quarter of 2016 was $24.9 million compared to $15.7 million in the prior-year. Total revenue for the nine months that ended September 30, 2016 increased to $110.1 million compared to $56.8 million in the prior-year period. On a GAAP basis net income was $200,000 for the nine months that ended September 30, 2016 or $0.0 per diluted share compared to $2.8 million or $0.07 per diluted share in the prior year. On a non-GAAP basis net income was $13.7 million or $0.22 per diluted share compared to $9.6 million or $0.23 per diluted share in the prior-year period. Adjusted EBITDA was $58.9 million compared to $36.1 million in the prior year. We closed the quarter with approximately $29 million of cash-on-hand. This balance is net of $32 million of balance sheet cash used to finance the Gaiam acquisition that closed in the quarter. The company expects to end the year with approximately $640 million of net debt and no significant maturities over the next five years. For full year 2016, we are reiterating our revenue guidance of $155 million to $160 million and we now expect adjusted EBITDA to be in the range of $83 million to $88 million, which Yehuda will take you through in just a moment. For full year 2017, we are projecting a $175 million to $180 million in revenue, and adjusted EBITDA to be in the range of $100 million to $105 million. Our contractual guaranteed minimum royalties for 2017 are approximately $120 million or approximately two-thirds of our projected revenue. For full year 2017, we are projecting to generate close to $50 million of free cash flow and for the full year we expect to pay down $28 million of debt. We anticipate ending the year with approximately $600 million of net debt. Our three-year plan remains intact as outlined in details at our recent investor day including $6 billion in annual retail sales, $215 million in revenue, $175 million in adjusted EBITDA, and $120 million in free cash flow. This plan includes both continued organic growth and new brand acquisitions. With that, I would now like to turn the call over to Yehuda.

[Yehuda Schmidman:]

Thank you, and good morning to everyone joining us on today's call. As evidenced by our third quarter results reported this morning with revenue up 83% year-over-year and year-to-date revenue up 94% year-over-year, we are pleased to report that our business activation team is executing and our portfolio brand health is solid. Highlights in the third quarter included growth from existing brands such Jessica Simpson, William Rast and Heelys; and revenue from recently acquired brands inclusive of Joe's Jeans, Martha Stewart, Chef Emeril and Gaiam. Consistent with this past quarter's performance and our year-to-date results, our revenue forecast for the balance of 2016 remains unchanged, as we continued to see high single digit organic growth from our brands for the full year. Our core business is strong and we expect continued high single digit organic growth for 2017. However, we are forecasting that SG&A expense will be higher for the full year 2016 and into 2017 attributable in part to higher than anticipated costs associated with the MSLO business integration. Specifically as part of our strategy to optimize our expense structure, during 2016 we anticipated offsetting a portion of the New York office space we inherited during the transaction. While we expect to achieve cost savings in the least, it has impacted the fourth quarter of 2016 and we are forecasting $4 million to $5 million of incremental expense next year until the cost saving task is complete. Of note, the current lease expires at the end of January 2018. In addition, we are augmenting our investment in operating resources in targeted areas of the Company. This will allow us to double down on macro opportunities we want to cease upon as we strive to achieve and ultimately exceed our long term goals just as we have in the past. Big picture next month we will mark the first anniversary of our acquisition of the MSLO business. Integrating this multifaceted media and merchandising business into our model was certainly a unique challenge, but overall we are pleased with the results of the integration process. We removed nearly $20 million of expense from the business. We successfully licensed the legacy publishing business to Meredith Corporation and transitioned it without interruption. We have made meaningful progress with each of the brand’s core retail partners, including Macy's and Home Depot to get them back to growth mode. We launched a direct retail partnership with Staples. We entered into the fast growing Meal-Kit market with Martha & Marley Spoon. We expanded the Martha Stewart brand to Hudson's Bay stores in Canada. We signed a new agreement to bring the Martha Stewart brand of home products to the rapidly emerging home furnishing market in Korea, and most important we are excited about additional future opportunities for the brand around the world including the possibility of establishing a new partnership with Alibaba following our trip to China in September. All in all the Martha acquisition was the first of its kind in our industry and a game changer for our company. As we think about the future of Sequential, our focus is on our three-year plan, which includes key areas of growth we see long term, including international expansion and e-commerce both of which we expect to exceed 15% of our overall sales by the end of 2018. On the international front in addition to what I already mentioned with the Martha Stewart brand, we recently announced the new long term agreement with GRN, a leading sports retailer in China with over 4000 stores across the country to bring the AND1 basketball brand to the region. GRN will develop and distribute a line of men's and boys’ basketball apparel, accessories and footwear. The collection will launch in 2017 across both traditional and digital retail channels. Stand alone AND1 retail stores as well as women's apparel and women's footwear are planned for 2018. We are also focused on digital, a key example of that is what I mentioned a moment ago regarding Martha and Marley Spoon, which is growing double digits every single month. In addition to all of our business initiatives we are also focused on long term opportunities to bring down our cost of capital now that both the MSLO integration is complete and our business has reached a new level of scale. Bottom line, our team is laser focused on our three-year plan, which includes continued organic growth, strategic acquisitions, and opportunistic improvements to our capital structure all to enhance value for all of our stakeholders. Thank you all for being a part of this journey with us and thank you for your continued support. We will now open the call to Q&A.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Erinn Murphy of Piper Jaffray.

[Erinn Murphy:]

Great thanks. Good morning. Yehuda, I was hoping you could elaborate a little bit more about the EBITDA guidance adjustment, I guess first, why wasn't this maybe brought up at the Analyst Day? And then second, as I was under the impression that the integration period with Martha was nearing completion, so maybe just kind of talk through the timeline and a little bit more about the nuance change there with the higher lease expense?

[Yehuda Schmidman:]

Sure, good morning. So I think the – as you will recall when we completed the transaction with MSLO, which was done at the end of '15, we knew that this integration was going to be different, we knew it was a multifaceted complex organization that we had to integrate and we knew it would take up to nine months. This was the quarter where we actually completed that integration process and while we are thrilled with the outcome of that integration process overall, especially as it relates to all the brand’s elements and the brand activations, the one element that did not conclude which we thought would conclude differently was mitigating in part the commercial office lease which we inherited. It's a beautiful lease, it's a beautiful office space, it's just too large and we were in negotiations with several parties to offset some of that cost. So while that didn't come through and while it still can come through in the near term we felt that for the ’17 guidance, which we're initiating today it was important to assume that it would not conclude through the balance of the year. Now, what I would mention is, it is temporary. The lease expires in January of 2018 and in addition to that we think we are in sort of a great area of New York where it's an attractive space. And then we think we have strategic partners who are interested in taking some of the space. So here we are today and with the integration behind us and with us in our traditional format, this is the call where we would initiate our 17 full year numbers, we felt it was important to put that impact in there.

[Erinn Murphy:]

Okay. I guess – that’s helpful and then, but there is still an opportunity it sounds like that between now and the end of January 18 I guess when the lease expires you could potentially lease or carve out some of that space for other tenants, which would maybe change the structure of the SG&A, is that – are we – am I reading you correctly on that?

[Yehuda Schmidman:]

Correct, if we were able to offset it sooner that would inure to our benefit.

[Erinn Murphy:]

Okay, got it. And then I guess a couple of months ago, probably six months ago, there was a lot of conversation about some of the – kind of $100 million opportunities that a Martha Stewart brand heading into the holiday season and into next year in the domestic market with accounts like Macy's and other key partners of yours. Could you just maybe walk through what you're excited about for that brand and particularly into the holiday season and where we're at with kind of rolling out some of those opportunities?

[Yehuda Schmidman:]

Yes, absolutely. I mean nothing has changed in fact, if anything we have got more excited about the long term – short term, near term, long term opportunities with the Martha Stewart brand. You referenced one of our core partners and I will elaborate there in specific, which is namely Macy's. You may have seen that we recently launched a new concept of a Martha Stewart café, which started in a store in California that is about to roll out in a second store and possibly even more stores as we continue and that would be an example of a new category. We have an additional new category, which we plan to announce hopefully before I would say the next few weeks with Macy's as well; something for the holiday season, which we're real thrilled about and the core business, of course, is so important at Macy's and we feel we're on the right track with them back to growth mode. Same would go for the other core partners and that would include the Home Depot and others. And of course all that is in addition to the new business, which we've begun to setup and activate and that includes a new partnership in Korea, which we recently announced and sort of big movement that we've had with Alibaba in China.

[Erinn Murphy:]

Okay, and I have two more questions if I may, I guess one, and I may have missed this, but did you say kind of what brands over indexed in the quarter to that high single-digit organic growth? If you could just maybe elaborate on the better performers in the portfolio and then which ones were the laggards?

[Yehuda Schmidman:]

Yes, I mean in the quarter the standouts were Jessica Simpson, William Rast and Heelys. Of course there was incremental revenue from brands we did not own last year in the same quarter which would include Gaiam, Martha Stewart, and Joe’s Jeans in part, but really the standouts were Jessica Simpson in core categories; in Heelys, in the footwear specially internationally; and then in William Rast, which has expanded dramatically this past season across the country its new accounts.

[Erinn Murphy:]

Okay and then this is my last question, is there a way maybe over time you guys can help us think about the major brands in your portfolio; Jessica Simpson, Martha Stewart, AND1, Avia; and help us contextualize kind of a roadmap of when some of the licenses within them start to expire, so we can kind of think out over the next year or two of any of the major potential expiration periods for some of the category licenses or is there anything that we should be mindful of in the next year at least that affects your 2017 guidance?

[Yehuda Schmidman:]

Sure, sure. Now that's a great point and of course that is something we're very mindful of within the business and something we will work to elaborate on, but in general our contracts, we have over 150 license agreements, we feel really good about them. I think if you look at the revenue both for this year and for next year and how we think about organic growth we feel very strongly about what's happening in our underlying business and as relates to renewals we're always working on renewals as they come due and our typical terms as you know are three to five years.

[Erinn Murphy:]

All right, thank you. I will let someone else hop in.

[Yehuda Schmidman:]

Thank you.

[Operator:]

Our next question comes from Camilo Lyon of Canaccord Genuity.

[Camilo Lyon:]

Thanks, good morning guys.

[Yehuda Schmidman:]

Good morning.

[Camilo Lyon:]

So, I wanted to dig in a little deeper on the China partnership with GRN and AND1. That seems like a great opportunity although it's a pretty entrenched market from a category perspective; you got Nike, the Under Armour, we've got the domestic brands with Li-Ning and others as well going after that share. Can you just help me understand how you think about the growth opportunity for AND1 in China and maybe dig a little deeper into how you build out the brand there given the competitive landscape?

[Yehuda Schmidman:]

Yes, absolutely. So we're really excited about this one and definitely have high expectations than high hopes for it. First, the partner that we are working with, GRN, is just absolutely outstanding. They've got thousands and thousands of stores across the region in China. This will be a big new brand initiative for them. To your point there are other great examples of western brands in the athletic space that have been successful and continue to be successful in China. The entry therefore of AND1 with this partner who does not have those brands directly will give them a big opportunity to compete at great price levels. What I would also add though, Camilo, is that in addition to this specific deal and a specific partnership of GRN with AND1, what I would add is that through this process and we have been investing in the region into China and it’s a big focal point for the Company, but in addition to this specific partnership we believe this will dovetail into other new partnerships in China for our other athletic brands and our greater portfolio. So I would just add that to the equation as well.

[Camilo Lyon:]

Is this where the bulk of the incremental investments are slated to go into the Chinese market and how you can penetrate your brands into those different tiered cities, is that how we should think about this incremental spend outside of obvious component of the real estate piece?

[Yehuda Schmidman:]

Yes, it's a big part of it. I think when we think about investing in the business obviously revenue activation above and beyond where we are today is a big sort of focus for us. That will come we think not only from the core business, but of course from two big initiatives in the Company, one of which is international growth and the other which is digital commerce, those investments will span both of those areas. In our three-year plan, we believe that each of international and digital can achieve 15% of our sales, but frankly we can even do a lot better. So I think obviously we will always look to be disciplined in how we invest our dollars and how we invest our capital, but to the extent we feel we can unpack even greater opportunities on the revenue side especially in those areas in international, in China, in particular of course, then we're going to look to do those.

[Camilo Lyon:]

Okay. And just remind us where each of those components are digital and international today?

[Camilo Lyon:]

Each of those segments today are south of 10%.

[Camilo Lyon:]

And then just switching topics a little bit, so, you've got exposure to a couple of different trends in the marketplace with your different brands obviously on the athletic and athleisure side with AND1 and now Gaiam too on the mass market side and you've also got Joe's Jeans on the denim side, higher-end fashion. Could you just talk a little bit about what you're seeing from a trend perspective, is one flexing more than the other relative to the consumer that they are addressing?

[Yehuda Schmidman:]

Yes, it is interesting because where we have this sort of portfolio across those various areas and others of course, gives us some sort of a sense of perspective. We're definitely hearing what people are hearing around athleisure, but what I would say is within the brands we own, we're really more focused on the wellness aspect of it, so if you think of Gaiam and the opportunity that we see which is largely on the apparel side, right. So the Gaiam hardlines are well established in 38,000 points of sale. But now with the expansion of the apparel, a trend or the sort of long term sustainable sort of need that we see in that market is really around health and wellness, which we think is really important. At the same time again while there is talk of certainly athleisure having been tapered and denim being even stronger, we are seeing the benefits of that in Joe’s Jeans. Joe’s Jeans has been strong for us. We have owned it less than a year, but have been very pleased with it as an addition to our portfolio, and I think you will see growth ahead for that brand and that is certainly factored into our 2017 plan.

[Camilo Lyon:]

Okay, great. Thanks Yehuda. Good luck.

[Yehuda Schmidman:]

Thank you.

[Operator:]

Our next question comes from Eric Beder of Wunderlich Securities.

[Eric Beder:]

Good morning.

[Yehuda Schmidman:]

Good morning.

[Eric Beder:]

Okay, first of all, just a housekeeping question, the 2017 guidance assumes no more acquisition, no more incremental acquisitions?

[Yehuda Schmidman:]

Correct.

[Eric Beder:]

Okay, on the acquisition front what are you seeing in terms of the volume of opportunities and pricing and in terms of the financing, you mentioned lowering financing cost, what do you think that entails and on the flip side, and on the flip side if you decide to buy acquisitions, how confident are you to have the financing to do such things?

[Yehuda Schmidman:]

Thanks, all good questions. Let me try to start and Eric if I miss anything just please remind me, first and foremost in terms of the acquisition environment what I would say is especially with sort of this backdrop of having tumultuous retail environment characteristics out there, we are seeing a continued large pipeline of opportunities. We're seeing it in the fashion space, in the active space and the home space. We are evaluating opportunities. Obviously this year we did complete the Gaiam acquisition, and most importantly I think Eric if you look at our three-year plan as you know, continued acquisition is a core part of our strategy. A second part of that three-year planned strategy is to bring down the cost of capital and thereby increase free cash flow. This is a company that we're still in our young phase of growth, right. We only started a few years ago and so we built the capital structure based on being nimble and quick, I mean using that leverage capacity lever to acquire great brands, but now that we have scale, we believe there could be as much as 200 to 300 basis points of reduction potential that we think we can achieve in the three-year plan to bring down that cost of capital even further and thereby increase free cash flow. So that is a part of the plan. And then finally I think you referenced the ability to conclude deals and how they will be financed. And I think what you have seen by not just our track record, but also completing the Gaiam acquisition not long ago just a few months ago, I think what you've seen is that we've got these really strong stakeholder partners in the business that include GSO, Blackstone, Bank of America, Tengram and Carlyle who give us an ability to be creative around financing. And then of course each acquisition that we add, we believe gives us additional capacity if we do our job right.

[Eric Beder:]

Are you just seeing multiples kind of normalize for acquisitions now? I know the Gaiam transaction was more of what historically we've seen in the licensing space?

[Yehuda Schmidman:]

Yes, the Gaiam, you're right, I mean the Gaiam transaction definitely had attractive metrics to it. That was a big factor to our desire to conclude it, but I would say overall I wouldn't want to over promise it, I think we are seeing a steady market and looking of course at a range of valuations.

[Eric Beder:]

Okay, congrats. Good luck for the holiday season

[Yehuda Schmidman:]

Thank you.

[Operator:]

Our next question comes from Steve Marotta of CL King and Associates.

[Steve Marotta:]

Good Morning Yehuda and Gary, a couple of quick questions. The primary delta on the 2017 revenue guidance increase is that wholly Gaiam or is there another component to that?

[Yehuda Schmidman:]

Good morning Steve. The revenue increase for ’17 includes both a full year of Gaiam where we had about half a year this year, and then in addition it includes high-single digit organic growth.

[Steve Marotta:]

Okay. Specifically you basically raised it from the last time you commented from $172 million to $177 million, now $175 million to $180 million, that delta is wholly Gaiam I assume?

[Yehuda Schmidman:]

Yes, so I think if you think about this year '16, we're at 155 to 160 and that includes half a year of Gaiam, which is roughly $11 million. So we take out that $11 million and then look at the organic apples-to-apples and then add the total full year Gaiam you'll get to the calculation.

[Steve Marotta:]

The lease which expires in '18 and this is outside whether or not there is some offset to that between now and then. What are your thoughts beyond '18 from a space standpoint and could there an uptick in lease expenditures post '18?

[Yehuda Schmidman:]

And so we are certainly not looking for an uptick, I think the question is what are the variable options around getting the costs lower? Today in the space that we inherit again a wonderful, beautiful facility, which is simply too large. It is over 150,000 square feet and so we knew that it is too large, but of course we also believe that we can mitigate it. So I think when you think about ’18 there are number of options to impact in a positive way, the overall cost of our headquarter space.

[Steve Marotta:]

Okay, and the last question is your current mix cost of debt is roughly 7.5% to 8% that's correct, right?

[Yehuda Schmidman:]

Yes.

[Steve Marotta:]

And then from a timing standpoint of when that could be lowered, is this something that you think could happen in two months or 10 to 12 months?

[Yehuda Schmidman:]

So we did not model it into our '17 numbers that we put out there today. I think the way to think about that is that it would not be immediate, but it would certainly being built into the three-year plan.

[Steve Marotta:]

Okay, I got it. Thank you very much.

[Yehuda Schmidman:]

Thank you Steve.

[Operator:]

Our next question comes for Dave King of ROTH Capital Partners.

[Dave King:]

Good morning guys.

[Yehuda Schmidman:]

Good morning.

[Yehuda Schmidman:]

I guess first of all on the $6 million to $8 million or so of incremental annual spend on macro opportunities, can you talk a bit about what those opportunities might be and then do you think these are items that will require kind of spending on an ongoing basis as we look forward and then what sort of impact should that have on sort of the long term kind of EBITDA margin potential of the business?

[Yehuda Schmidman:]

Sure, sure. So let me if I could start with last part of your question. We are absolutely in belief that the three-year plan which gets us to 70% EBITDA margins is achievable and that is still the goal. That plan of course does include two factors. It does include continued organic growth and acquisitions as you know, stand alone acquisitions we anticipate would come in at higher EBITDA margins, call it 75% to 80% standalone; but nevertheless, overall we believe we'll get to those margins. At the same time, the margins next year are obviously not at that point. And so I think to the first part of your question, those incremental investments that we see today are really about getting to that plan and beating that plan specifically around things that we're seeing more and more almost daily in terms of international market opportunities, more and more daily in terms of digital opportunities whether that be with Amazon or Alibaba. So, I think in our view when you think about an overall retail environment that in general sometimes feels like it's going the other way, our view is that people are looking for answers and looking for great branded content and we want to solidify our position right now when the time is there to seize upon those opportunities. To the extent they're not there over time, we can always pivot back and pull back SG&A as needed.

[Dave King:]

Okay. And so it sounds like some of this is also for existing brands that you don't think you necessarily would need to do that incremental spend on anything you acquire in terms of how to think about it or is it just sort of a reallocation of how you spend on some of those new brands? I guess what I'm trying to ask is obviously a lot of this digital kind of investment, content investment which I think is prudent, but if that's the case, how much better you're going to have to do with some of this other anything you acquire? How do you have the confidence that you could still get at the 75% to 80% incremental margins on the new stuff?

[Yehuda Schmidman:]

Yes, I think I understand the question, but I guess what would I way is the confidence comes in that, these are variable expenses that we could pull back as needed, right. So you think about a new business that we're launching in Korea with Martha Stewart, you think about a new business that we're launching with AND1 in China, you think about other opportunities that we have not yet been able to speak about but we will of course in normal course with our other brands. Ultimately there is a leverage of the platform and you've seen that consistently over our four years of growth I believe. But specifically right now, this is the moment in time to really accelerate the international and eCommerce, which will especially drive towards our three-year plan and beyond.

[Dave King:]

Okay, that helps. So thanks for the color there. Then switching gears a bit, the debt balance I think it was more than expected following the Gaiam transaction, what was the free cash flow generation in the quarter and then were you able to pay down any debt and if so, how much?

[Gary Klein:]

Hi, Dave. It is Gary. So, what I would tell you for the full year this year we're probably going to generate close to $35 million of free cash flow. We do pay down every quarter going forward for the balance of this year $5 million and then we step it up to a little over $7 million per quarter next year. So when you think about next year, free cash flow is looking approximately $50 million and we'll pay down $28 million of debt. So by the end of next year, we'll probably have net debt of approximately $600 million.

[Dave King:]

Okay. And then what would get you to maybe accelerate that pay down to meet more of the free cash flow generation that you're planning for 2017 or conversely what is sort of the plan in terms of the incremental or the free cash flow generation of above that required pay down? What are the plans for other kind of spending? I assume some of the things Yehuda talked about, but maybe we can just talk a little bit about that? Thank you.

[Gary Klein:]

Yes, sure. Yes, absolutely it's a great question, I think one of the, of course, benefits of this business model as a whole is that it has this high free cash flow generation. Another benefit specific to our business is that we're really not an effective taxpayer because of the NOLs and other tax benefits we have, we're not a taxpayer next year and not for the foreseeable future. So, it is a wonderful element to have. I think the optionality around what could happen with that capital is of course something we'll continue to look at both as a management team and as a Board of Directors as it happens. I think if you look historically at what we've done, we've typically used that capital either to reinvest in new brands and/or pay down debt in large part.

[Yehuda Schmidman:]

I'd just add, Dave, that this was the first time in Gaiam where we actually used some balance sheet cash to acquire a brand. So, it's something that was a positive.

[Dave King:]

Yes, absolutely. Thanks for the color guys, and good luck for the rest of the year.

[Yehuda Schmidman:]

Thank you Dave.

[Operator:]

Our next question comes from John Kernan of Cowen and company.

[John Kernan:]

Good morning Gary and Yehuda.

[Yehuda Schmidman:]

Good morning.

[John Kernan:]

Just to go back to the EBITDA margin point, what's ultimately the driver of margins getting better here? Obviously it's been under pressure the past three quarters and there's going to be some more pressure next quarter. Is it really just lower OpEx or your cost getting more fixed as you gain scale? And how does the competitive environment in the industry and your ability to attract talent and invest in a lot of your brands affect the improvement in long-term EBITDA margins?

[Gary Klein:]

So, I guess what I would say is really critical to having context around the year-to-date margins within Sequential 2016 is of course the context that this year included the integration process, which was underway for pretty much all three quarters of this year. So, it is a little bit tough to use those three quarters as sort of a standalone comparison. Having said that, I think if you look over our history, which is short but yet is there call it about four years, there has been margin improvement overall. And really more importantly when you think about the cost structure going forward I guess to the root of your question, think about yes, there's a portion of our SG&A that is relatively fixed that relates to corporate overhead. But after that, largely our investments are variable and those investments relate to talent and overhead, people in addition to investments into our brands and into sort of new development. So, I think how we get to 70% is really in our minds very clear. It's both leveraging the scale of the platform. The ability to have this great platform is wonderful. I think what we're providing to our customers is very unique and very different. Leveraging that to the benefit of adding additional brands is a big value point for us. And then in addition to that, the idea of seizing on opportunities like building a business like AND1 in China or possibly taking a brand like Gaiam to China next, all of that is part of the game plan.

[John Kernan:]

Okay, that is helpful. And then just a follow-up, obviously really encouraging to see the free cash flow inflecting here into next year, I think Gary, you guided to $50 million next year, which is a big improvement. Can you just talk about the drivers of that as margins come under a little bit of pressure? Is it really just the receivables growth and the balance sheet growth coming down?

[Yehuda Schmidman:]

Obviously the biggest driver is EBITDA growth. That's the biggest driver of our free cash flow generation. But from there, obviously we're paying down debt which will lower our interest over time. Again as we move forward, we're still not going to be a cash taxpayer for the most part of next year. So, those are the main drivers and again as we continue to drive that EBITDA, our free cash flow will increase over time.

[John Kernan:]

And just finally, can you just talk about the competitive environment for deals and one of the four strategies to drive high single-digit organic growth that you laid out was new category growth. So, what other categories are you looking at with acquisitions and even with organic growth? You're already in quite a few including athletic and media and just wondering what other categories you think are out there that are attractive to you?

[Gary Klein:]

It's of course a broad question and a good question, but we think about that in a number of ways. First just on the organic side let me tackle that piece. Category growth is really important. You saw a number of new categories come online this year whether that was the Jessica Simpson Active clothing, then the Active Sneaker addition, you saw it with Martha Stewart where we added the meal-kit business, completely new category. We actually have another new category for the Martha Stewart brand which has been signed, but has not been announced yet, that will be announced closer to launch timing. So, all the new categories are really important. On the acquisitions perspective – from that perspective, categories are important as well and I think you were alluding to this very, very specifically. And if you think about today where we're focused in fashion and in active and in home, over time there could be other pillars. Having said that, I would say today our pipeline is really in those three spaces and I would say that the competitive environment is definitely there. We have competition, there's no question, but I would say our unique advantage is that what we deliver to our customers to enable us to grow these businesses is unique, and so I think we have an advantage in that we know how to activate businesses. I think we've got really the best business activation team out there and that ability to find that revenue or that value-add of new IP assets gives us an ability ultimately to win.

[John Kernan:]

That’s helpful, thanks guys, best of luck.

[Gary Klein:]

Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back to Mr. Yehuda Schmidman for closing remarks.

[Yehuda Schmidman:]

Great. Thank you. We appreciate everybody joining this morning. We are as you've heard laser focused really on our three-year plan, and of course as we finish of this year and head into next year we appreciate all your support. We are excited about what we have here at this company and we thank you for your time.

[Operator:]

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.