Jason Boling - Chief Financial Officer and Principal Accounting Officer
Henry Stupp - Chief Executive Officer and Director
James Fronda - Sidoti & Company, LLC
Cherokee (CHKE) Q3 2014 Earnings Call December 12, 2013 4:30 PM ET
Greetings and welcome to the Cherokee Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kimberly Esterkin. Thank you, Ms. Esterkin, you may begin.
Thank you. Speaking today will be the company's Chief Executive Officer, Henry Stupp; and Chief Financial Officer, Jason Boling. You can also 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. Certain statements contained herein may contain forward-looking statements for purposes of the Safe Harbor provided by the Private Securities Litigation Reform Act of 1995. When used, the words anticipates, believes, expects, may, should and similar expressions are intended to identify such forward-looking statements.
Forward-looking statements included in this conference call can involve known and unknown risks and uncertainties that may cause the actual results, performance or achievements of the company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. A further list and description of these risks, uncertainties and other matters can be found in the company's annual report on Form 10-K/A for fiscal year 2013, and in its periodic reports on Forms 10-Q and 8-K.
Given these risks and uncertainties, you should not place undue reliance on forward-looking statements as a prediction of actual results. The company disclaims any intent or obligation to update any of the forward-looking statements contained herein to reflect future events and developments.
The most directly comparable GAAP financial measures and information reconciling 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.cherokeegroup.com.
And with that, I'll hand the call over to Cherokee's Chief Financial Officer, Jason Boling.
Good afternoon, everyone, and thank you for joining us today on our third quarter fiscal 2014 conference call. I will begin today's call by discussing our financial results for the quarter. I will then turn the call over to Henry Stupp, our Chief Executive Officer, to speak in further detail about our brands and our partners before we open up the call to your questions.
Turning to the third quarter results, revenue of $6.7 million was on par with Q3 fiscal 2013. We increased revenue due to the acquisitions of Liz Lange and Cherokee School Uniform brands, combined with organic revenue growth from several of our Cherokee licensees, particularly in South America and Asia. The revenue increases associated with the acquisitions and general health of our licensees offset significant revenue declines related to both Zellers Canada of approximately $525,000 and the negative impact related to our success with Target U.S., where we moved to the next lower tier of royalty rates.
In other words, even though Cherokee retail sales at Target U.S. once again grew for the quarter, there was, as expected, a negative revenue impact of approximately $400,000 as the royalty rate declined. Additionally, there was $122,000 negative impact attributable to foreign currency devaluations in several of our key markets including Japan, South Africa and India. We expect the revenue decreases experienced as a result of the secession of Zellers Canada operations will be offset by further expansion of Target Canada, which began in March 2013.
Selling, general and administrative expenses for the third quarter were $4.1 million or 61% of sales compared with $3.4 million or 51% of sales in the prior year period. This increase is related to personnel and development costs required for further -- to further maximize the 360-degree licensing model as we added to our infrastructure in anticipation of further growth in fiscal 2015, including the launch of Cherokee-branded adult products at target.com and the expansion of our brand portfolio in new territories.
For the 9-month period, sales increased to $22.2 million from $20.6 million, while non-GAAP SG&A increased to $12.8 million from $11.2 million, representing 58% and 55% of sales, respectively.
The increase in costs related to infrastructure was partially offset by decreases in costs relating to marketing and travel. We continue to prudently monitor all expenses while ensuring that we are establishing a framework for future success with all of our brands and all organic growth opportunities.
Net income for the third quarter was $1.6 million or $0.19 per diluted share compared with $2.1 million or $0.25 per diluted share in the prior year period.
For the 9 months ending November 2, 2013, and October 27, 2012, non-GAAP net income was $5.7 million and $5.8 million, respectively. Non-GAAP EPS for the same periods were $0.67 and $0.68, respectively.
Operating income for the quarter totaled $2.6 million versus $3.3 million in the same period last year. Operating margins for the quarter were 39% as compared to 49% in the prior year period.
For the quarter ended November 2, 2013, we recorded a tax provision of $900,000, which equates to an effective tax rate of 37.6% compared to $1.2 million or an effective tax rate of 36.4% recorded in the third quarter of last year.
Turning to our balance sheet and related metrics. Total cash and cash equivalents as of November 2, 2013, were $3.5 million, up from $2.4 million at February 2, 2013. Cash flow from operations totaled $6.5 million for the quarter versus $7.2 million for the prior year period. We remain in a strong financial position to explore additional brand acquisitions and share repurchases while meeting our existing cash requirements, which will primarily be for business operations, debt service and paying dividends as determined by our Board of Directors.
A quarterly dividend payment of approximately $840,000 or $0.10 per share will be paid on or around December 16 to shareholders of record as of December 2, 2013, and reflects an annualized dividend yield of roughly 3.3%. In addition, during the quarter, our Board of Directors approved a new stock repurchase program authorizing Cherokee to repurchase up to 1 million shares of our common stock. This new share repurchase program reflects our board's confidence in our long-term business strategy and growth plan, and we believe represents an attractive investment opportunity for our shareholders.
Thank you, all, for your time. I will now turn the call over to Henry to speak in further detail about our partners and brands.
Thank you, Jason. We're pleased with the Cherokee Group's performance for the first 9 months of fiscal 2014, during which revenues increased roughly 8.2% over the prior year period. Working within a rather challenging domestic retail environment and the macroeconomic challenges faced by many of our partners, particularly in Europe and Japan, our brand portfolio has performed well and continues to see solid growth. As Jason mentioned, we continue to prudently manage our expenses in areas of product development, travel, marketing and G&A, all while actively supporting our 360-degree licensing model, our brands and partnerships to ensure that we realize future growth opportunities.
Now that we've had the Liz Lange Maternity brand under our belt for over 1 year, we're excited to provide you with an update on our many successes since our acquisition in September of 2012. Sales of the Liz Lange brand at Target have increased as our team in Minneapolis has worked even closer with the retailer than ever before, and we are now seeing the positive fruits of our labor. On a year-over-year basis, Liz Lange Maternity retail sales at Target for the third quarter are up over 5%. Over the last few months, we've also increased our online presence; and during the fourth quarter, we expect to see an increase in Liz Lange sales at both brick-and-mortar stores and on target.com.
Liz Lange is one America's best-selling maternity brands and we believe that there's still much room for growth internationally. We've seen increased interest across the globe. And with that said, we are proud to have just announced license agreement for the Liz Lange brand with Mahindra retail's Mom & Me Stores in India. This license agreement will be highly accretive to Cherokee, and we anticipate launching Liz Lange in Mom & Me stores during spring of 2014.
The introduction of Liz Lange to Mahindra is an important step towards our globalization of the brand, and we expect to secure additional international partnerships in the coming quarters.
With respect to Target U.S., not including the additional revenue recorded from the Cherokee School Uniforms business, we continue to see progress with the retailer during the third quarter despite challenges faced by U.S. retailers, particularly attributable to the negative impact associated with the government shutdown. Given same, sales of Cherokee branded products totaled approximately $280 million, an increase of $3.5 million or 1% over the same period last year. And despite overall softness reported by Target, we maintained our base.
On a year-to-date basis, domestic retail sales totaled $807 million, up 9% over the first 9 months of fiscal 2013. We have had a good start to the fourth quarter, and we feel that consumers are positively responding to the expanded Cherokee assortment in store and online.
Over the past few years, we have presented various new, exciting growth initiatives for the Cherokee brand to Target, and we continue to expand our multi-year strategic plan in collaboration with Target to introduce more innovative marketing tactics to the retail space. We will introduce new categories of products to their brick-and-mortar stores, specifically related to the newborn, accessory and footwear departments.
Cherokee footwear, in particular, continues to perform exceptionally well. And there's much growth to be had online as well. As we mentioned last quarter, we're excited for the launch of Cherokee adults in target.com beginning in spring of 2014. This launch is a strong testament to the success of the value proposition associated with Cherokee's 360-degree licensing model towards enhancing each of our retail partnerships.
We are also planning additional growth opportunities for Cherokee School Uniforms with Target, particularly related to the dotcom business. The Cherokee and Target teams are collaborating very closely on an expanded product assortment and marketing campaigns for Cherokee School Uniforms. You can expect to see the beginning of these efforts during the Back-To-School 2014 season.
Turning our attention to Canada. Target has been in Canadian market for approximately 6 months now. And as the retailer has publicly stated, they have experienced issues related to their launch in Canada. While it certainly takes time, Target is working to remedy problems with its position of in-stock goods and supply chain. And working directly with the Target Canada team, we remain confident in their ability to grow the Canadian Cherokee and Liz Lange brands. Cherokee remains one of Canada's top-selling children's brands and as we mentioned last quarter, the brand is already seeing solid growth at Canadian Target stores.
Liz Lange also saw growth in Canada in the third quarter, where we feel that Target will fast become the market leader in maternity wear in Canada. The retailer now operates 124 Canadian stores, and we're glad to be partnering with Target on their Canadian expansion. We are starting to see the positive impact of the refinements of their Canadian operations as we enter the fourth quarter.
Sticking with our international progress. We have seen growth in China and Japan. Retails sales in local currency at our exclusive Chinese partner, RT-Mart, increased almost 12% over the third quarter of fiscal '13. And at Nishimatsuya in Japan, despite a nearly 23% reduction in the value of the yen, retail sales of Cherokee branded products in local currency were up 17%. For the 9-month period, retail sales at RT-Mart in China and Nishimatsuya in Japan grew 19% and 28%, respectively, in local currency over last year.
Nishimatsuya is truly an example of an exceptional partner and a model licensee with top-notch product and marketing. We are also pleased to announce that during the first half of calendar 2014, RT-Mart will be launching an updated, fully redesigned in-store experience to fully capitalize on the brand's growing presence in China.
We are also very enthused by our progress in Latin America. Tottus, our exclusive retailer in Peru, Chile and Colombia, continues to experience exceptional double-digit growth with retail sales in local currency up 75% and 64% year-to-date in Chile and Peru, respectively. Having recently signed a 6-year expansion of our partnership with Tottus at the beginning of the third quarter, we are very happy to see the Cherokee brand resonating amongst their customer base in one of the world's top growth regions.
Keeping within Latin America, for over 7 years Comercial Mexicana has been a very strong partner of the Cherokee Group. Year-to-date, retail sales in local currency at Comercial Mexicana have increased 16% beginning in the third quarter and into the fourth quarter. 17 additional Comercial Mexicana stores have been retrofitted with Cherokee's new shop-in-shop concept, a terrific showcase of our 360-degree licensing model brought to life. We're currently working on the rollout of additional Cherokee-branded locations, and we'll keep you updated on our progress.
Despite continued challenges impacting the European economy, we continue to work with Tesco towards planning sustainable long-term growth since our relaunch at the beginning of this fiscal year. Retail sales of Cherokee branded products for the third quarter at Tesco resulted in 187% increase in U.S. dollars on a year-over-year basis and at a higher royalty rate that befits our new working model. We know it takes time to revitalize the relationship, and we are not yet satisfied with the results of our progress at Tesco. We will continue to work closely with the Tesco team to develop and grow the Cherokee brand.
Today, we are also announcing a new license agreement with Apostrophy, a subsidiary of Connectin Asia, for the expansion of the Cherokee brand in department, specialty and freestanding stores in Thailand, Singapore, Malaysia, Vietnam and Myanmar. With approximately 1.5 months remaining in fiscal '14, we remain confident that our brand initiatives, marketing efforts, and increased support and collaboration with our key partners positions the Cherokee Group well for future growth. We are pleased with the positive impact of our acquisitions, and we tend to continue to pursue additional accretive acquisitions where we can capitalize on the strength of our 360-degree licensing model and global network of best-in-class partners.
Our deal pipeline is more active than ever before and we shall continue to aggressively pursue additional style-focused lifestyle brands so that we can continue to benefit and leverage the new model introduced a couple of years back. We remain encouraged by this performance of our brand as we head into the holiday season, and we look forward to sharing our success in next quarter's call.
With that, I would like to thank our partners, the entire Cherokee team and our Board of Directors for their continued support. Operator, we can now open up the call to questions.
[Operator Instructions] Our first question is from James Fronda of Sidoti & Company.
James Fronda - Sidoti & Company, LLC
Could you just disclose, I guess, what the year-over-year growth or decline was with Target for the quarter?
We had put that in our 10-Q. Let me just pull it up here. And the 10-Q hasn't gone out. It will be out very shortly. So Target in the U.S. increased -- or royalty revenues went down year-over-year. For the 9 months, plus 5% though, and that's due to the change in the deceleration of rates.
James Fronda - Sidoti & Company, LLC
Right, okay. All right. And I guess, Jason, just in terms of the SG&A line, do you think what you did for the quarter is what we're going to see as a run rate going forward even though the year-over-year is for fourth quarter much lower?
Yes. So we think that we've been seeing some declines. However, we still think it's about in that area. It's -- as we increase some personnel related to our 360 model and our future, we're also decreasing some expenses relating to some marketing and travel and things like that, so we're trying to offset all of that. And we think that this current is a reasonable amount.
James Fronda - Sidoti & Company, LLC
All right, okay. And I guess, how many stores are you in exactly with the Target Canada? And do you expect to be in all stores as they continue to expand or do you think they might decline at all?
Yes. So we are all in 124 stores, and we expect to be in every store that's available.
[Operator Instructions] The next question comes from Pankaj Chandak of B. Riley & Co.
So I think in your commentary, you alluded to some investments related to Target adult products. So I think, can you give us some color, what do you expect in terms of progress for the next fiscal year? When do you see that relationship going into action?
Well, the investment was related to the launch of the Target adult program, which will happen at the beginning of next year with target.com, and it will expand throughout the year. We're anticipating adding more styles as each season progresses during the year next year. Even though we've added additional infrastructure to support that launch, it's also bears noting that there was an amendment to our license agreement, resetting the royalty rate at 2% on all Target adult sales. So we have to spend the money now to ensure a proper launch and proper success, and we put in place the necessary infrastructure to ensure a very positive go forward with Target.
Excellent. So I would think you're working with the Target's technology team to sort of build at integration points and whatnot, right? So it's a joint effort to make that infrastructure investment?
Not a joint effort because a lot of the infrastructure has been built up over the last 2 years. We do have to have people working directly on the sales and factory supply chain requirements in order to deal with target.com. So it was incremental additions to the infrastructure that was already put in place. But we got one shot to do this right, and we're going to do it right. So we've made the necessary investments for the long term.
Understood. And it is nice to see Liz Lange and School Uniforms showing good results. Can you give us a sense, is that fully penetrated with -- of all the Target stores or -- and were you fully stocked up for school uniform for this Back-To-School season?
Yes. We took over Cherokee Uniform business at the beginning of the year. We were a little behind in making sure that we -- for our product to-date from the transition from the former company to us. We had very good Back-To-School season. We've worked really closely with Target for planning next year where we can have much more of a direct impact, particularly, how we're going to be framing the department in store, and we are in all stores. However, there's a couple, I think it's about 300 designated Cherokee Uniform shops as part of Target that -- those are stores that have a framed Cherokee Uniform department over and above the regular children's wear area. And then on target.com, we see a lot of growth potential. We have competition that sells uniforms, particularly through dotcom, and we've been working very aggressively to try and expand our relationship to grow there. With respect to Liz Lange, again, we're in all stores. We have a big opportunity to grow the Liz Lange brand in dotcom. And with respect to Canada, the early leads are outperforming estimates in Canada and I had a meeting up there a few weeks ago, and we can anticipate an increase in our presence in the Canadian stores. And I really do believe that Liz Lange in Canada will be the market leader. We don't have the same amount of competition in Canada as we have in the U.S., and the results are there. So we're very excited about Liz Lange.
Understood. And in Canada, Target Canada, can you talk about what's the productivity there, how the stores are maturing as you're going into the stores and what should we expect for next year?
Well, it's been a little difficult to get the same kind of reads in Canada as we're able to pull in the United States as they are opening up stores mid-month, mid-quarter. So we have been monitoring the sales and we're seeing good growth as the stores get more penetrated, as they adjust their supply chain, and refine the merchandise assortment. So we are bullish on Canada. We entered fourth quarter very strong, and we were delighted to see the start of the fourth quarter results because they have now 124 fully operational stores, and we saw a nice shift there. So going into next year, again, we're bullish. We think that whatever issues Target has are short-term issues, not long-term issues. They will be a very strong player in Canada, and we're proud to be there.
Excellent. And I think the last question for me, you have a lot of international initiatives in place. So could you sort of help us prioritize maybe 3 or 4, the top ones that you think are materially important over the next -- like small to mid-term, next 2 to 3 years?
Yes, well there's a couple of things that bear noting. We're showing sales for the quarter roughly on par with last year. And what's important to note is that when you examine the de-escalation of the Target royalty rate as we started the quarter, plus the loss of Zellers Canada and the impact of currency, we started off the quarter with effectively greater than $1 million in loss of revenue that we've made up. And we've made it up through the growth of our international partnerships, primarily in the third quarter. And what that means is South America has been particularly strong for us with an excellent partner in Colombia, Chile and Peru, that's seen incredible growth, and that's a growing economic region. So we've worked really closely with them to come up with a good, long-term strategic plan. We're also seeing a lot of opportunity in Asia. Nishimatsuya, despite a 27% decrease in local currency, decrease in currency, we saw an increase in sales, and they've been exceptional in terms of execution in product, marketing and in store. And then also in China, the brand is starting to resonate more and more as each season progresses with the Chinese consumers and the recent launch of the Cherokee brand on Tmall. So we're very pleased with Asia as well.
[Operator Instructions] We have no further questions in queue at this time. Ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.