Sequential Brands Group, Inc.
Q2 2017 Earnings Call Transcript

Published: 29 Jul 2017

[Operator:]

Thank you, and good morning. Before we begin, I'd 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 the 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 that statement was made. Other than as required by the 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 Karen Murray, CEO of Sequential Brands Group. Karen, you may begin when you're ready.

[Karen Murray:]

Thank you. And good morning to everyone joining us for our second quarter 2017 earnings conference call. As many of you read in today's press release this morning, we announced that Gary Klein is stepping down as CFO at the end of August. I want to personally thank Gary for his work during his almost five years at the company. Beginning in September, our President, Andrew Cooper, will assume the position of Interim Chief Financial Officer, along with his current duties, as we initiate a search to identify a permanent replacement. With that, let me turn the call over to Gary.

[Gary Klein:]

Thank you, Karen, and good morning, everyone. I joined Sequential almost five years ago, and I'm proud of the platform that the company has built. Today, Sequential has 18 great brands and a strong management team in place to lead the next phase of growth. Turning to the numbers. Total revenue for the second quarter 2017 was $42.1 million, representing an increase of 23% from prior year's revenue of $34.2 million. On a GAAP basis, net income for the second quarter 2017 was $2.5 million or $0.04 per diluted share compared to a net loss the prior year period of $100,000 or $0.00 per diluted share. Non-GAAP net income was $7.8 million or $0.12 per diluted share for the second quarter this year compared to $3.6 million or $0.06 per diluted share last year. Adjusted EBITDA increased 43% to $24.7 million for the second quarter this year compared to $17.3 million in the prior year's quarter. Our adjusted EBITDA margin for Q2 was 59%, an improvement over the prior year's margin of 51%, driven by GAIAM and the overall expense control. For the six months that ended June 30, 2017, total revenue increased 20% to $81.5 million compared to $68.2 million the prior year period. On a GAAP basis, net income for the six months ended June 30, 2017, was $1.4 million or $0.02 per diluted share compared to the last year's net loss of $1.1 million or $0.02 per diluted share. Non-GAAP net income was $13.6 million or $0.21 per diluted share compared to $6.2 million or $0.10 per diluted share in the prior year period. And adjusted EBITDA for the six-month period increased to $47.7 million versus $34 million last year. We also ended the second quarter of 2017 with approximately $21.3 million of cash, including restricted cash. Our cash flow from operating activities for the first half of 2017, as reflected on a GAAP cash flow statement, increased to $16 million versus $11.6 million in the prior year. The year-on-year increase was impacted by changes in balance sheet items, which reduced cash by $4.4 million in the first half of this year as compared to only $300,000 the prior year period. The changes in balance sheet items include a net decrease of deferred revenue of $4.3 million for the first half of 2017 as compared to $800,000 in the period for 2016. The net decrease in deferred revenue represents the recognition of revenue for payments received in earlier period. Changes in balance sheet items will fluctuate from period to period depending on our company's organic growth and acquisition-related strategies. On previous call, we highlighted that given the period's variability in those items; we've also focused on adjusted free cash flow, which focuses on the cash flow profile of the underlying licensing business. Adjusted free cash flow is calculated as adjusted EBITDA less cash interest, cash taxes and capital expenditures and excludes both changes in balance sheet items and acquisition related and other costs not core to the licensing business. For the first half of 2017, our adjusted free cash flow increased from $12.4 million to $20.1 million. For the year, we expect it to increase from $34 million to a range of $41 million to $45 million. As we previously mentioned, we're focused on strengthening our balance sheet and are currently in a process of working with our lending partners on various refinancing opportunities for early 2018. And finally, as seen in today's press release, we are reiterating our guidance for the full-year 2017 of $170 million to $175 million in revenue and $98 million to $102 million for adjusted EBITDA. We continue to expect low-to-mid single-digit organic growth for 2017. The company's GAAP net income is now expected to be $13.6 million to $16.2 million due to the company's $1.9 million realized loss on the sale of available for sale securities starting this year's second quarter. The company's contractual minimum guarantees for 2017 are approximately $120 million. With that, I'll turn the call over to our CEO, Karen Murray.

[Karen Murray:]

Thank you, Gary. As I mentioned, when I joined Sequential three months ago, we are focused on three main areas

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Camilo Lyon with Canaccord Genuity. Please proceed with your question.

[Camilo Lyon:]

Hi, Karen. Hi, Gary. I wanted to get your thoughts on -- or just a little bit of color on how your -- how the quarter progressed, if we split it up between retail and your online partners? If there is a widening divergence of performance between your partners that you're selling online versus your retail -- traditional retail partners?

[Karen Murray:]

I'll take that, it's Karen. So I would say that, yes, more and more business is going towards digital. We're still underpenetrated in this area, but we have a big emphasis on growing this part of our business. We still have a lot of work to do. We are making tractions. But, yes, absolutely, there is more and more business going towards digital. We have a three-pronged approach in attacking this part of the business. We are absolutely focused on growth, on our retail partner side, such as macys.com, but our own sites as well. We're building a jessica.com business as well as third-party sites, such as Amazon. But it's an important and growing part of our business.

[Camilo Lyon:]

And how do you see the evolution of those strategic implementations to enable you to accelerate that piece of the online business, because seemingly that's where a lot of the traffic is going. So what is the roadmap there right now, Karen? Did you try and capture more of that traffic in hopes to drive more the sell-through via those channels -- through that channel route?

[Karen Murray:]

I think we again need to really focus on this area and make sure that we are exploring as much as businesses as we can in the digital area. We're looking to make some key hires. But at this point, we're already experiencing growth of our Marley Spoon initiative as well as our wine club in the Martha business, and continuing to figure out ways to drive traffic to our -- all of our .com sites.

[Camilo Lyon:]

Okay, great. And then just my final question. I know you talked about pruning in on the brands and focusing on extracting those from them through all channels. What are your thoughts, Karen, on pruning the portfolio? And I know maybe shedding some of the underperforming assets to increase your cash position and use that to pay down debt.

[Andrew Cooper:]

Hey, Camilo, this is Andrew Cooper, as well; I am here with Karen and Gary.

[Camilo Lyon:]

Hi.

[Andrew Cooper:]

I mean, really that's going to -- the message there is going to be consistent with what we said in the past. We are in some active discussions on some of our smaller noncore brands. We really feel like our core brands are the growth engine for this company and are going to create a lot of value going forward. So I think, if you see anything there, it's going to be incremental impact, but positive on the capital structure, but it will be really incremental focused on those noncore brands.

[Camilo Lyon:]

Could we see something announced this year from that perspective?

[Andrew Cooper:]

Yes. We always have active discussions, but it's premature to indicate that at this time.

[Camilo Lyon:]

Okay, understood. Thanks guys. Good luck.

[Karen Murray:]

Thank you.

[Operator:]

Thank you. Our next question comes from Eric Beder with FBR. Please proceed with your question.

[Eric Beder:]

Could we talk a little bit about a little more depth on what you believe in terms of expense controls are out there? And is there some kind of low-hanging fruit in terms of driving down expenses? It looks like you did a great job at that this quarter.

[Andrew Cooper:]

Thanks, Eric. It's Andrew, I'll take that. Really, the framework that we're using to think about expenses of this company are driving EBITDA margin. So as you saw in the release, Q2 has 59% EBITDA margin, first quarter was 58%, the full-year should be in that range. And that really reflects a significant improvement year-over-year. And for the most part, it's about being disciplined across all of our decisions. We've taken some costs out. We've talked about the space. There's really a broad-based effort to reduce expenses. But the way to think about that is, there also will be opportunities for significant growth, QVC and other areas, digital, where you might find opportunities to add some resources to the team. So ultimately, we're managing to a margin. We want to make sure we execute against that 58% to 59% EBITDA margin and continue to make good decisions every day as opposed to some sort of massive cost-cutting exercise.

[Eric Beder:]

Talking about QVC, how does the HSN acquisition add to that? Is that going to be another opportunity for you to analyze another contract? Or is that something that just comes will become naturally. How is that going to flow in there?

[Karen Murray:]

It's Karen. The acquisition of HSN can only be viewed as a positive for both them and for us. It's really a great opportunity for the QVC business. And I just think it will give us the opportunity to have more scale -- to build more scale. But we're looking at it as a very, very positive move.

[Eric Beder:]

Okay. And with QVC, do you believe there are opportunities to do things more than just Martha Stewart as this gets through and as this expands out?

[Karen Murray:]

QVC is just a little bit of the details around that launch. The first appearance is August 13, where we're breaking with the presale of Martha's book, which is a slow-cooker book. But there are nine additional appearances scheduled for the balance of 2017. And to your point of that new categories, we have many new categories launching in 2018. So for QVC for 2017, all appearances are included in our current full-year guidance, and the new categories are added for 2018.

[Andrew Cooper:]

Just in terms of other brands, I mean, the strengthening -- the strength of the relationship that we're developing with QVC is a great one. We're focused on Martha. That's where the opportunity is that's baked into our numbers and hopefully that can lead to additional opportunities in the future. It's a very close relationship with QVC.

[Eric Beder:]

Great. And finally, you talked a little about that at last quarter with China. What should we think about in terms of the international opportunities for the brand going forward and where do you think that can go?

[Karen Murray:]

I think there are opportunities across the board with international, in general, for all of our brands. We -- again, this is an area where we are underpenetrated pretty much across the board internationally. Heelys continues to be the strongest performer we have, more than 85 countries. We have presence with Martha in South Korea. But I would tell you that we're engaging with both Macy's and Alibaba to really grow our business in China. So it's absolute emphasis for the Martha brand today.

[Eric Beder:]

Great. Thank you. Good luck.

[Karen Murray:]

Thank you.

[Operator:]

Thank you. Our next question comes from Dave King of Roth Capital. Please proceed with your question.

[Dave King:]

I guess, first off, can you talk about where the organic growth came in for the quarter? And then more importantly, which brands are the ones that sort of outperformed that? And then were there any brands that were underperforming that, any bigger brands, I guess, is a better question in terms of ones that were underperforming that, bigger ones than ones you might look to divest at this point. And then similarly, if you look at GMRs of the year, the $120 million, what -- which brands are the biggest chunks of that? Thanks.

[Andrew Cooper:]

Okay, it was a multipart question. So we might split this one up. But generally speaking, there was broad-based -- there was a broad-based growth, which is really positive. Jessica Simpson in the quarter, Ellen Tracy, our active brands of AND1. Heelys, of course, has continued to be a strong performer. So there was, generally speaking, relatively broad-based growth. And where you saw the weakness was really just in some of those noncore brands that are smaller, and probably some of the same ones we're having active discussion about divestiture. So that's the first part of the question. The second part, was it reflecting the GMR's?

[Dave King:]

Yes, the second part was the $120 million GMR, which brands are the biggest chunk for that?

[Gary Klein:]

Hey, Dave, it's Gary. So I would say like it's broad across the brand. I can't tell you which one exactly is the highest of all of them. I'd say, in general, the company is supportive of the top-line revenue, two-third of it is secured by the guarantees. There could be -- and most brands follow that. There could be a couple of outliers, but -- maybe offline, I can look into that and get back to you, but I can't tell you which ones are overly on the GMR's at this point.

[Dave King:]

No problem. And then in terms of -- another one for Gary, in terms of the total GMR's you have remaining on outstanding, I think the last quarter in the Q was like $430 million or something like that. I guess where did that stand at the end of the quarter? And then forgive me, Gary, if you already gave this in the prepared remarks, where was your debt balance at the end of the quarter?

[Gary Klein:]

So the debt balance, I believe, was right about $648 million gross. Net -- we said about $21 million of cash. So that covers that. I'm sorry, what was the other question?

[Dave King:]

Total GMR's remaining --

[Gary Klein:]

So we are -- again, I really get back to January, it was actually higher than the $430 million that you just mentioned. So we did add some new categories, including the deal with Gannett that added toward guaranteed minutes going forward.

[Dave King:]

Great to hear. And then I guess last one for me. All right. In terms of the free cash flow guidance that you outlined, the $41 million to $45 million, do you have -- what, do you expect that to be on a GAAP basis. And then in terms of refinancing, is the thought still to look to reduce the interest rate primarily? Or is the plan also do try to bring down that balance to some extent as well. I guess, what are the current thoughts because it sounds, Karen, like the plan is still to try to be somewhat acquisitive to the extent you're afraid to do so with the debt facility. Thank you

[Gary Klein:]

Hey, Dave, it's Gary. So I'll start with cash flow. So again, we're focusing on what we call the adjusted free cash flow just to get it lined up better with our licensing business, which we said is approximately $40 million to $44 million. And that's where we're focused. So if you look at where we are year-to-date, $16 million on the GAAP statement. So -- and we've said that $4 million of it is reduced because of the change in balance sheet items because of deferred revenue, I mean that we collected it in 2016 and that's why we're a little bit lower this year. And the thought [ph] for us to completely estimate that because as we get to the end of this year, we're going to do the same thing. We're going to try to collect minimums that are going to be recognized in 2018, we'll try to collect them this year. So that's why it's a little bit harder for us to give the exact GAAP number, other things slide into it such as collections of AR and payments on AP. So again -- and we feel good about the number of $40 million to $44 million on the adjusted free cash flow. And again, the GAAP, it will be in that range on how well we do with collecting minimums early and collecting on AR.

[Andrew Cooper:]

Okay. And on the capital structure, we've talked about that a lot in the past and from a timing perspective, just 1 comment there. Of course, we have the make whole in our current arrangement that goes through September 30th and then we've prepayment penalties that drop down. So by the first quarter of 2018, we're in a better position to working with our current lenders and on refinancing alternatives and executing something in early 2018. So we still have that same time line in mind, and are working behind scenes on preparing the company to pursue those alternatives. As far as the ultimate objectives of it, we really want to identify -- we really want to optimize our capital structure. And as we get towards concluding that process, we'll determine exactly what it's going to take in order to get to that optimal level and reduce our interest rate. So that could go in a couple of different directions in terms of total leverage, but we'll keep everyone posted as we progress through that over the next six months.

[Dave King:]

Okay, great. that's great color. Thanks for taking all my questions and good luck for the next year.

[Gary Klein:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of John Kernan with Cowen and Company. Please proceed with your question.

[Krista Zuber:]

Good morning. This is Krista Zuber on John's behalf. Thank you for taking our questions. First, can you kind of help us understand what the ending cash balance will look at the end of fiscal 2017? And kind of your desire to pay down debt over and above this planned refi for the beginning of 2018? Just trying to get a sense of where you think the leverage ratio will be moving over the next couple of years in the optimal mix of debt equity?

[Gary Klein:]

Gary here. So the plan today on the debt pay down is to strictly pay down just the $28 million for this year. And as far as the ending cash balance, again, so we're not -- it goes exactly what I was saying with Dave, we don't want to project that out right now that goes right into the GAAP version of the cash flow because again towards the end of the year we're going to try to collect some of the -- some revenues for next year that will be recognized next year. We'll try to collect some of them this year. And depending on how well we do with that will affect the ending balance. And, again, how well we're able to control the AR and AP, we'll do our best job and we have done a great job to-date, but again, it's harder to predict, so that's why, again, we're really just focused on giving that adjusted free cash flow number that sounds how we -- which really lines up with what is up from $100 million of EBITDA this year, what is going to be the cash flow off of that, and that we've said is about $40 million to $44 million.

[Krista Zuber:]

Okay, thanks. And kind of how do you see the organic growth run rate over the next couple of years? Should it be in line with the low-to-mid-single or with all the new additions that you've made, could we see something that's sort of accelerating beyond the current plan?

[Andrew Cooper:]

Yes. It's is a good question. We -- we're for 2017; we're still focused on driving low-to-mid single-digit growth. And really it's -- that's a solid accomplishment for the company as we're dealing with the current retail environment. What allows us to do that is our strong stable of brands. That's what differentiates us and really allows us to continue to diversify away from traditional brick-and-mortar retail. As you look out over the next couple of years, I think, responsibly and realistically, you have to anticipate that there's going to continue to be a transition in the marketplace. Our challenge and opportunity is to take as much -- to transition as much of our business into those new channels as possible, continue to develop opportunities like QVC, like Gannett, where we're are finding ways to generate revenue and organic growth outside of traditional brick-and-mortar retail. So we haven't issued guidance for the future at this point. We're currently looking at low to single -- low-to-mid single-digit organic growth for this year. And as we get later in this year, we'll give you a projection for the next year.

[Krista Zuber:]

Okay, great. And then the final question just, Andrew, when you look at the targets that were kind of set forth at the prior Investor Day, just kind of getting your sense of your level of comfort with those numbers.

[Andrew Cooper:]

Can you --

[Gary Klein:]

I guess, you're alluding to the three-year plan, correct?

[Krista Zuber:]

Correct -- sorry, Gary.

[Gary Klein:]

Yes, I think that the company's strategy has changed over the past year. I think it's a bit -- we're much more focused on the organic business. And that three-year plan did assume a heavy amount of acquisition now. It could still happen, right? We're going to work on the balance sheet this year, and our acquisition strategy could change over the next couple of years. But I think, again, at this point, the company is much more focused on growing the company organically.

[Krista Zuber:]

Okay, great. Thank you so much.

[Operator:]

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