Iconix Brand Group Inc. Q4 2008 Earnings Call Transcript

| About: Iconix Brand (ICON)

Iconix Brand Group Inc. (NASDAQ:ICON)

Q4 2008 Earnings Call

February 24, 2009 10:00 am ET


Warren Clamen - Chief Financial Officer

Neil Cole - Chief Executive Officer


Todd Slater - Lazard Capital Markets

Eric Beder - Brean Murray, Carret & Co.

Jim Chartier - Monness, Crespi, Hardt & Co.

Sean Naughton – Piper Jaffray


Good day, ladies and gentlemen and welcome to the Iconix Brand Group’s fourth quarter and full year 2008 earnings conference call. (Operator Instructions).

The Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. The 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 be materially different from the results, performance or achievements expressed or implied by such forward-looking statements. The words believe, anticipate, expect, confident, and similar expressions identify forward-looking statements. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made.

Your presenters for today’s conference call are Neil Cole, Chief Executive Officer, and Warren Clamen, Chief Financial Officer. I would now like to turn the presentation over to Mr. Warren Clamen.

Warren Clamen

Good morning everyone and welcome to the Iconix Brand Group fourth quarter and full year 2008 earnings conference call. Beginning with our results for our full year 2008, revenue increased 35% to approximately $216.8 million as compared to $160.0 million in the prior year.

EBITDA increased 17% to approximately $149.6 million as compared to approximately $127.6 million. And EBITDA margins were approximately 69% for the year.

Free cash flow increased 22% to $122.1 million as compared to approximately $99.9 million in the prior year. Net income increased 10% to approximately $70.2 million compared to approximately $63.8 million in the prior year.

Diluted GAAP earnings per share was $1.15 as compared to $1.04 in the prior year and includes $0.10 and $0.02 of non-cash-related compensation respectively. Free cash flow per diluted share was $1.99 in the year.

A review of our results for the fourth quarter ended December 31, 2008, revenue increased 14% to approximately $54.3 million in this quarter compared to approximately $47.4 million in the prior year quarter.

EBITDA decreased 10% to approximately $37.8 million as compared to approximately $42.4 million, however, our fourth quarter 2008 EBITDA results included a one-time pre-tax gain with an adjustment of approximately $7.1 million associated with the company’s Unzipped litigation. Therefore, excluding this gain, EBITDA for the fourth quarter 2008 actually increased $2.7 million, or 8%. EBITDA margins were approximately 70% for the quarter.

And free cash flow increased 18% to $31.0 million in the quarter as compared to $26.3 million in the prior-year quarter. Net income decreased 11% to approximately $17.1 million compared to approximately $19.2 million in the prior-year quarter, however, excluding the gain in 2007’s net income, fourth quarter 2008 net income actually increased quarter-over-quarter by approximately 4%.

Diluted GAAP earnings per share for the fourth quarter was $0.28 as compared to $0.31 in the prior-year quarter, however, again, the fourth quarter 2007 results included that gain related to the Unzipped litigation of $0.04 in EPS. Therefore, excluding the gain, diluted earnings per share for the fourth quarter actually increased $0.01 to $0.28 versus $0.27 in the 2007 fourth quarter.

The fourth quarter 2008 and 2007 included $0.03 and $0.005 of non-cash compensation expense respectively.

Free cash flow per diluted share for the fourth quarter 2008 was $0.51. EBITDA, free cash flow, and results excluding the Unzipped litigation are all non-GAAP metrics and reconciliation for each can be found in the press release sent earlier this morning or on our website, iconixbrand.com.

Free cash flow is an important metric to look at in determining our financial performance as our business model generates a significant amount of cash that is incremental to our reported net income. In 2008 the non-cash items totaled $52.0 million. The majority of this amount is the reoccurring annual cash benefit related to our non-cash taxes, our non-cash compensation and depreciation.

The company ended the year with approximately $67.0 million of cash on hand and as of today has cash on hand of approximately $79.0 million. We understand the importance of cash in the current environment and will continue to evaluate our options regarding our use of cash and make decisions based on what we believe is in the best interest of the company and our shareholders.

During the fourth quarter we repurchased 265,404 shares at a weighted average stock price of $6.85, totaling approximately $1.8 million. We will continue to consider stock repurchases as a potential use of our cash and will balance this initiative with a need to preserve cash to the opportunistic with acquisitions and for other corporate purposes.

Total debt at the end of the year was $668.0 million and the earliest maturity of any of our debt is approximately 3 years from now in 2012. Our pro forma net debt to EBITDA is below 4x and we are comfortable with these levels given the controlled risk profile of our model and our strong free cash flows. Unlike many companies in the retail and consumer product industry, we have downside protection for our minimum guaranteed revenue and our tierability structures.

As we have stated before, as of January 1, 2009, we had over $500.0 million in aggregate guaranteed minimums from our existing contracts, excluding any renewals. In addition, some of our large direct-to-retail contracts have a royalty rate that steps down as the retailer hits certain revenue thresholds, which insulates us in a weakened economy as the lost sales are typically valued at the lower royalty rate. In addition, the tierability structure incentivizes the retailer to grow the business because the higher sales levels, they pay a lower rate.

The company’s weighted average interest rate on all its debt declined in 2008 to approximately 4.7% from 5.9% in 2007 and we have locked in our rate of approximately 3.7% for the first quarter of 2009. The company has only one financial covenant in its senior term facility. This covenant is a net debt to EBITDA calculation and the company is currently below the level required to be compliant for 2009.

Giving us additional comfort is that the Walmart brands, our largest growth brands, are currently in the term facility and will positively impact that ratio in 2009.

I will now turn the call over to the Iconix Chairman and CEO, Neil Cole.

Neil Cole

Good morning everyone. As 2008 unfolded it became more and more evident that we were heading into one of the most challenging economic times of our generation. Although macroeconomic factors tested our ability to grow, both organically and through acquisitions, our business remained strong and 2008 was a very successful year for Iconix.

In 2008 we delivered 35% revenue growth, 10% earnings growth, and generated approximately $122.0 million of free cash flow, which translates to $1.99 per share.

We executed new direct-to-retail partnerships for Danskin Now and Starter with Walmart, Mudd with Coles, Cannon with Sears Holdings, and we renewed Mossimo at Target.

We initiated two international joint ventures with strong partners to expand our business to China and Latin America and in a difficult acquisition environment we acquired the Waverly brand at attractive economics with cash from our balance sheet.

These economic times have enabled us to demonstrate many of the advantages inherent to our licensing model that differentiates us from the traditional operating model. We believe we have the most relevant model in the market today, making it possible for leading retailers to offer national brands at affordable prices supported by innovative marketing campaigns.

I would now like to give you a quick update of each of our brands. Our direct-to-retail brands, which are brands that we have licensed directly to retailers are becoming a much larger percent of our royalty revenue stream. In 2008 they accounted for approximately 25% of our revenue and we expect this increase to well over 50% in 2009. Today we have 13 direct-to-retail partnerships, 11 in the United States and 2 international. These partnerships align us with top retailers that have strong credit, that have capital to contribute to marketing and in-house fixtures, and provide our brands with some of the best placements within the stores and in their newspaper circulars.

The advantage to the retailer is that receive the opportunity to offer their customers exclusive national brands at private label economics. We anticipate that the significant growth in this segment will be primarily driven by our three brands at Walmart: OP, Starter, and Danskin Now, which are projected this year to more than double retail sales.

The OP launch is on track. Product will be rolling out from all doors this spring and OP will be taking over the vast majority of Walmart swim business this year. OP product is also being sold in Walmart Canada and will be launching in Walmart Mexico next week.

The expanded relaunch of Danskin Now is off to a strong start with Danskin Now taking over the hot spot in Walmart stores this past January.

The new Starter product has also began to arrive in stores. Our latest campaign featuring Tony Romo and we expect to keep the excitement going with additional high-profile athletes to promote the Starter brand.

The Mossimo business was down versus the prior year, however, we believe Target’s renewal of the contract for the fourth time, through January 31, 2012, with no changes to any terms, speaks to the importance of the Mossimo brand to the Target consumer.

At Cole’s our Candie’s business was impacted by the general environment and our lean inventory management. However, Cole’s has remained committed to the brand and has invested alongside Iconix for in-store fixturing programs and innovative marketing campaigns.

Also, later this week we will be announcing a mega-star as new Candie’s spokesperson which should create quite a buzz for the brand.

In December we signed our second direct-to-retail agreement with Cole’s for our Mudd brand. Although Mud struggled in 2008 as many key retailers focused on their exclusive brands, this new partnership with Cole’s will stabilize the brand and enable growth for 2010 and beyond.

2009 will be a transition year for Mudd and the new exclusive Cole’s product launching in July will be there for minimal retail sales associated with Mudd brands in the first half.

Joe Boxer was one of the best performing direct-to-retail brands in 2008 with double-digit sales growth as K-Mart introduced new categories and expanded into Sears. The Sears rollout continues to be slower than expected but we believe in the new merchant team at Sears and their ability to move forward with the brand.

Looking at our traditional wholesale brands, Rocawear sales were relatively flat in 2008, even as the urban market consolidated and several independent retailers shut down. Jay-Z’s commitment to the brand and participation in the marketing campaign has given a boost to the brand and today Rocawear is one of the top brands in America.

Our Rampage business was down this year but we think that our new core licensee and new distribution channels and the new campaign featuring Brazilian supermodel, Gisele, will re-energize the brand.

London Fog has been a great growth story for us as we continue to transition the brand to a life-style brand adding new categories including luggage, handbags, and footwear. We are still looking to expand into additional categories including sportswear.

Badgley Mischka had a tough year with the luxury markets suffering more than most. We have transitioned the new core dress category to a new company and are excited that Mark Badgley and James Mischka are among the new owners.

Bongo is performing as expected and we realize it is in a generally challenged retail position and we are exploring a number of options for the brand.

As for our home brand, this was our first full year in the home business and we are pleased at our many accomplishments, including our ability to achieve our revenue targets. We introduced Royal Velvet as an exclusive brand in Bed Bath & Beyond and supported the launch with an exciting an innovative campaign featuring Brook Shields and her family.

We signed a direct-to-retail deal for the Cannon brand with Sears Holdings, positioning the brand to take over a significant portion of the Sears/K-Mart home business as the Martha Stewart brand exits the store by the end of 2009.

We are repositioning the Fieldcrest brand at Target and working on a new distribution strategy to expand the Charisma brand. As for Waverly, we are working to reinvigorate the brand and will be launching a new campaign in the next couple of months.

We have also been able to leverage our home platform this year and are launching new home products at some of our other brands, including Mossimio at Target and OP at Walmart.

As we look into the future we are excited about our growth prospects, both domestically and internationally. Our global expansion plans are progressing and over the past year we entered two international joint venture agreements, one in China and one in Latin America. We believe by having locally-based partners in these regions we will be more successful in monetizing our brands.

Our joint venture in Latin America is with the FALO Group which has extensive expertise and relationships throughout Latin America and is also the owner of Duty Free America, the largest duty-free retail operator in the Americas. We believe that in partnering with the FALO Group we will accelerate the growth of our brands throughout the territory and maximize the revenue from our existing licenses in the region. Unlike our China joint venture, this business will be run as a traditional licensing model.

We have also begun to make progress in Iconix China and in December signed our first deal for Rampage with the Mecox Lane Group, a multi-channel retailer in China. Mecox Lane has already begun rolling out Rampage stores and expects to have over 50 stores open by the end of 2009.

We continue to work on finding partners for our other brands in China and have an imminent that is in the contract stage for another brand.

Moving on to acquisitions, while 2008 was a difficult year for acquisitions as the credit market shut down and sellers were still valuing their businesses at the prior-year level, we believe in 2009 opportunities will present themselves in this industry as the industry consolidates and sellers begin to appreciate the new reality.

We are currently looking at a couple of exciting medium- to large-sized deals that we believe could be financed through both traditional and alternative structures, however, we remain extremely diligent and will only execute a transaction that we believe is in the long-term interest of our company and our shareholders.

Now I would like to take you through our 2009 outlook. We are reaffirming our full year 2009 EPS guidance of diluted EPS between $1.20 and $1.30, excluding the change in convertible debt accounting and between $1.06 and $1.16 including the non-cash interest related to the new debt accounting rules.

We are now projecting revenue to be in the range of $210.0 million to $220.0 million. This guidance relates to the existing portfolio of brands only and assumes no acquisitions.

We expect to continue to generate strong cash flow and are forecasting free cash flow to be approximately $120.0 million this year, which translates into a free cash flow per share of approximately $1.95.

While we have several exciting growth initiatives for 2009, including the large rollout of our OP, Danskin Now, and Starter brands at Walmart, we have updated our revenue projection to reflect current economic and sales trends and the negative short-term impact that the Mudd transition will have on 2009 as it will be taken out of the market for six months before re-launching at Cole’s in the second half of the year.

That being said, we remain committed to delivering earnings growth to our shareholders and are managing the business accordingly. Our business is highly scalable and we have been taking a very close look at all of our expenses and are adjusting our overhead structure based on the current economic conditions and our top-line projections.

At the same time, we will not lose sight of our long-term goals and will remain focused on keeping our brands fresh and relevant through innovative and exciting marketing and advertising.

In closing, while we cannot predict what will happen in this economy, we are confident that we have the right business model to deliver continued earnings growth. We believe that we are aligned with the retailers best positioned to thrive in this current market. We have strong cash flow supported by predictable revenues with minimum guarantees that do not have any material contracts up for renewal until the end of 2010.

We are pleased to have delivered such strong results to our shareholders for 2008 and look forward to continued success in 2009 and beyond.

With that I would like to thank you all for listening this morning and turn it over to a Q&A.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Todd Slater - Lazard Capital Markets.

Todd Slater - Lazard Capital Markets

Currently you’re trading at 6x GAAP EPS, 4x cash EPS, about the lowest valuation in the group even though you have one of the best models in the group, so I guess the Street is saying if Mudd is vulnerable, perhaps all the guaranteed minimum income is in jeopardy. I think this is an erroneous conclusion but I’m just wondering if you could just address these concerns.

Neil Cole

It’s tough to address the Street and the stock price hopefully will take care of itself in the long run, but I think we have addressed it over the last three years. I mean, the company has gone from $60.0 million royalty up to $217.0 million worth of royalty and we have partnerships with the best, we think, retailers in America, or the world, that are going to do well in this environment and we have three and we have three deals with Walmart and we have three deals with Target, we have two deals with Cole’s. Some of the best retailers, the best credits and our business continues to grow and prosper.

Obviously you get frustrated when you look at the stock but with what’s going on the world today, we just have to stay focused and we have to continue to execute. And yes, some of the plans where we thought they were going to bring in $20.0 million might bring in $18.0 million or $19.0 million in this economy and sales have been off as retailers are managing inventories tightly, but we just have to stay focused and we will come out incredibly strong on the other end as we continue to perform.

Todd Slater - Lazard Capital Markets

Help us understand Mudd. Mudd is kind of going from a wholesale type of structure to a direct-to-retail short-term negative implication concerning that transition. Does Mudd get back to or grow above the revenue levels with Cole’s that had it as a wholesale business?

Neil Cole

Yes, that’s the way. It will get there probably in 2011, 2010 it will probably get back to where it was and we think in 2011 and 2012 it will prosper.

Cole’s is an amazing retailer, we have had great success with them with Candies’s, they’re turning a large percent of their business over to us and have signed nice guarantees and we’re pretty excited about what they will do with Mudd in the years to come.

Todd Slater - Lazard Capital Markets

If you are looking for roughly flat revenue expectations this year, if you take out the Walmart gain then I guess you’re expecting, maybe it looks like $25.0 million to $30.0 million decline everywhere else. Could you just walk us through where these declines are coming from and make us comfortable with the rest of the non-Walmart businesses?

Neil Cole

It’s a little bit across the board. One of the places where we’re definitely losing business is Rocawear. Rocawear today is performing double-digit increases at Macy’s and Dillards and other places, however, we are losing independents. We have lost Demo, we are losing Up Against The Wall, and we are losing a lot of the independent business, which is probably going to take that business down about 10% going forward.

Pretty much across the board, we’re thinking that each business is going to be challenged with what’s happening with the consumer, especially in the first half of the year when we’re projecting somewhere 5% to 10% down on each brand. Hopefully we’re going to get some surprises. I mean, there’s a bright spot with Cannon, as it’s performing really well with K-Mart and that could be a growth business.

But we are planning conservatively and I felt that if we didn’t and didn’t adjust the overhead accordingly, then we wouldn’t show earnings growth and we’re committed, as we have the last four or five years, to try to continue to grow earnings and not be erroneously wait for the business to come back, we’re going to just look at current trends and go forward and adjust the business accordingly.

Todd Slater - Lazard Capital Markets

If the revenues, so in looking at that model, how is that you’re still comfortable with the earnings $120.0 million , $130.0 million What are the areas of offset?

Neil Cole

We basically looked at every part of the business and adjusted accordingly. We have taken down expenses roughly about $16.0 million. We were planning to increase advertising substantially over last year and we decided to keep it flat. We think with the help we’re getting from our retail partners, it will be sufficient, spending somewhere around $21.0 million in advertising, supplemented, as I said, by what we get from Walmart and Cole’s and our partners.

Headcount, we’ve taken down. We’ve reduced somewhere around $5.0 million, $6.0 million in salary and stock incentives. Also tightened up every aspect of the business whether it be rent and other. And we were going to build a big, new showroom, we stopped and we’re not building. We’re just being very careful.

We’ve also lowered our interest expense, about $4.0 million. That’s one of the good things happening in the world today, as far as where LIBOR is. So a combination across the board. We think we have adjust the overhead so that we can continue to grow earnings with a decrease in top line. Or top line projection, not a decrease for the year.


Your next question comes from Eric Beder - Brean Murray, Carret & Co.

Eric Beder - Brean Murray, Carret & Co.

Could you talk a little bit about the Walmart expansion internationally? You said Mexico and Canada with OP. Where do you think that can go and do you think the other brands also can expand internationally at Walmart?

Neil Cole

We’re pretty excited about that opportunity. It will take a couple of years to develop. We went down to Bentonville a few weeks ago and met with the international team, and we really believe we can go around the world and the first—we’re working hard in Canada and Mexico but we believe that pretty much everywhere Walmart is, in South America, either in Russia, India, China. The Walmart international business is a big growth play for them and almost equals the sales of Walmart America. So we put it as a big growth initiative for us over the next five years, especially as Walmart U.S.A. is performing, although the international division is run independently, it does give more respect to look at their parallel offerings and we think what John and Dottie, the team that they are leveraging in New York, they are going to hopefully bring the international people in to look at all the ideas they’re developing.

So we do think it’s an opportunity, it won’t happen quick. It will be incremental over the next few years.

Eric Beder - Brean Murray, Carret & Co.

You sometimes talk about how, what percentage of the guaranteed revenue is based into your numbers right now in terms of 2009. So how much of the $210.0 million or $220.0 million is guaranteed?

Warren Clamen

About 70% is guaranteed, of the number.


Your next question comes from Jim Chartier - Monness, Crespi, Hardt & Co.

Jim Chartier - Monness, Crespi, Hardt & Co.

Can you just talk about the early reef from Walmart, how that business is performing?

Neil Cole

We have to be somewhat careful because Walmart is a little proprietary, but we had in January, during wellness month, Danskin Now was the hot spot. And we really got off to an amazing start with Danskin Now and it really looked amazing and the sales were great. Starter and OP are really starting to roll out now. The inventory is starting to come in now and we are expecting big business of the next 10 months.

But those businesses are growing and developing.

Jim Chartier - Monness, Crespi, Hardt & Co.

In terms of the seasonality of the business this year, are you projecting any major differences between first half and second half of the year for revenues?

Neil Cole

We are. We definitely believe the second half will be a lot stronger. As the Walmart business builds, especially with Starter and OP. The first quarter will definitely push back. And along with the combination of what’s happening with Mudd. That’s a brand that’s going to be all second-half loaded with the Cole’s launch.

So between those and how we retailers are playing inventories, we definitely see the first half a little weaker on the revenue side compared to Q3 and Q4.

Jim Chartier - Monness, Crespi, Hardt & Co.

Warren, what else is included in net other expenses other than interest? And it looked at little bit higher than I was looking at. Were there any one-time items in there?

Warren Clamen

The equity pick up on the China joint ventures, which as small, less than $1.0 million. That’s really the only thing. It’s just interest income, interest expense, and the equity pick up of the joint ventures.

Jim Chartier - Monness, Crespi, Hardt & Co.

So was the equity pick up an expense or a benefit?

Warren Clamen

It was an expense. A small expense. I think it was about $500,000.


Your next question comes from Sean Naughton – Piper Jaffray.

Sean Naughton – Piper Jaffray

When you were talking about SG&A before, is it possible for you to have SG&A in a dollar terms flat with last year? Is that what you are aiming for?

Neil Cole

No, actually we’re aiming to reduce it compared to last year.

Sean Naughton – Piper Jaffray

Did you say down $16.0 million?

Warren Clamen

Overall expenses will be down $16.0 million. We are projecting 70% EBITDA margins and Neil had said part of the $16.0 million was a pick up in interest also, which is below the EBITDA. So we are projecting that we are going to maintain our 70% EBITDA margins and we will claw back through SG&A but also through a pick up of interest since the rates are lower.

Sean Naughton – Piper Jaffray

And on the retail you have a good view into the consumer obviously. Have you noticed within some of your brands at retail, have the price points been changing there or have they been relatively consistent on your brands?

Neil Cole

I think the price points are generally coming down a little bit and people are getting a little more competitive in the market and obviously retailers are being more promotional. So we are seeing sometimes the same amount of units going out the door but still being down a couple of points. So I do think there will be pricing pressure on a lot of our brands, pretty much on all brands over the next few months.

Sean Naughton – Piper Jaffray

Given kind of the new run rate we are experiencing here, kind of with the consumer spending globally on discretionary apparel and home items, and you’ve had a lot of acquisitions over the last few years, is there anything in terms of your intangibles that, have you tested those recently and are there any write downs that potentially may be coming.

Warren Clamen

Intangibles, we have tested them recently and there are no write downs coming.

Sean Naughton – Piper Jaffray

So that’s the annual test and so you’ve done that and so we should be okay for 2009? Or are you testing them more frequently?

Warren Clamen

No, that’s the annual test and we should be okay. We test them on an annual basis.

Neil Cole

One of the benefits of our model is we have guaranteed royalties for pretty much all of our brands so it gives good comfort that they are all performing.

Sean Naughton – Piper Jaffray

On the term loan facility, can you remind us or give us a number on how much of the free cash flow from 2008 is actually needs to go to that particular facility?

Warren Clamen

50% of the free cash flow generated by the term facility brands is required to be paid down once a year and the payment will be probably in March. It’s going to be around $38.0 million, approximately.

Sean Naughton – Piper Jaffray

Was that taken out of the $67.0 million in the cash number that you gave earlier?

Warren Clamen

No. That’s still in there. It’s going to be taken out in Q1 or Q2, when it’s paid.

Neil Cole

But it also will have built up. Today it’s $78.0 million and it goes up substantially every quarter because we are generating at the rate of $120.0 million per year.


There are no further questions in the queue.

Neil Cole

Thank you for listening. Management will be around this afternoon to answer any individual questions.


This concludes today’s conference call.

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