Since I've only written one article on Iconix Brand Group (NASDAQ:ICON) since the end of winter in late March, and that article was focused almost entirely on the recent buybacks of debt, I'll start with my analysis of the earnings report/call that was in May.
In sum, the company beat on EPS by 12 cents and missed on revenue by $1.16 million with revenue of $94.63M and EPS of 53 cents. Naturally much of the call was spent breaking down the increases and decreases in specific segments (women's and entertainment up, men's down, and home goods flat) and similar. But somewhat buried in the call were some important things that investors who didn't listen to the call probably missed, and that many investors who heard the call may not have fully registered. These include:
New approaches and initiatives
* For the first time, Iconix appointed a creative director for one of its brands, and on top of that, made the director a prominent TV star known for her fashion: Modern Family star Sarah Hyland. This approach has three benefits:
1) Stars many times set the trends for their demographic, so having a star who is very into fashion helping to direct the line makes it much more likely smart choices will be made. Right now, a considerable amount of women's fashion is still made by older men who aren't in the demographic and to a good degree are guessing. A person in the demographic and at the forefront of the demographic is much more likely to get it right.
2) Involving a star as creative director gets them much more personally invested in the brand and its success. When a company has a relationship with a star, the extent to which the star puts themselves out there for the company is often limited. The star appears in a photo shoot or commercial, collects their money and doesn't do much else, if anything else. If however, you're the creative director of a brand and line of clothing or shoes, your name and reputation are on the line. If it does great, you not only look good to your fans and the general public, but you'll also have opportunities in the fashion world long after your normally brief run on TV is over. You might even get your own line. If it tanks, you look bad and you won't have opportunities in the fashion world.
3) Fans of a star are much more likely to think the star is genuinely into and connected to the product line if she is the creative director of it, compared to if she's just a spokesperson doing an endorsement.
I expect Iconix will replicate this approach with more of its brands with positive results for sales and earnings.
* Iconix formed its first partnership with popular fashion-oriented content creator, StyleHaul, to produce a six episode digital docu series about the life of model and singer Pia Mia. It will in part look at her new role as the spokesperson and fashion director of Material Girl, an Iconix Brand created by Madonna. CEO John Haugh explained, "In every episode she will wear Material Girl pieces and links to buy the clothing will be provided."
Mia has 4.2 million followers on Instagram, and StyleHaul has a community of 500 million people with most of its focus on interactions between a select group of 6,000 fashion creators and their "loyal communities."
During the Q&A session, Chairman Peter Cuneo noted, "It's not just the increase in advertising dollars that we have budgeted in 2016 over 2015. It's how we're spending the money. And we actually think by shifting very heavily to social media from past years, we're actually going to get more bang for our buck. So even if our advertising spending were to be up some percentage, we actually think the effectiveness of our overall advertising would be much greater."
I agree that things like the Pia Mia series with a major fashion website with links to buy the items will be much bigger bang for the buck than offline advertising.
* In May, Iconix held its first ever Ecko "brand summit" with over 20 licensees from the U.S. and overseas, and its brand ambassadors Manny Santiago and Danny Garcia. Doing brand summits is a great idea for three reasons:
1) It gives Iconix a great opportunity to get feedback and new ideas for the brand. The licensees get feedback from customers, so Iconix getting this feedback helps.
2) Attendees share sales and marketing ideas specific to the brand with each other.
3) Licensees become more connected to Iconix by spending extended time with the company, and more invested in the brand via the trip and in part because of getting to interact with celebs. My father was CEO of a NASDAQ company that was acquired by a larger company. As part of the deal, he was required to be a board member of the larger company for several years even though he sort of didn't connect with the larger company.
The larger company used to have major musicians play at its annual gathering and hang out some with the board, upper management and key partners. As a result, every year he would tell friends, family and other people about the trip, and his involvement with the company became more a part of his identity. Overall, Haugh said the Ecko licensees "walked out very energized and believe that the brand is back to where it should be."
* Partly related, the men's segment is expected to rebound in the second half of the year and end the year flat for the whole year, which would be a significant improvement over being down 15% in the first quarter. Haugh noted, "We have had a lot of progress with Ed Hardy and you're going to see it in more ways and with more licenses and more presence than we've had in quite a long time."
In April, the company's new core Ecko licensee started "with a relatively seamless transition and we have already been seeing positive results from our new strategies," he said. The company's new Rocawear licensees will launch in the fall. The company has plans to develop the Starter Black Halo business, which it considers "an untapped jewel." An analyst on the call noted the profit margins in the men's segment were far higher in Q1 and asked why, and Jones said he'd get back to the analyst. So we don't know why the profit margins improved so much, but it looks like a positive.
* Iconix is continuing its push in entertainment with the launch of a new Peanuts TV series and an upcoming partnership for creating new Strawberry Shortcake content. Haugh reported the brand scores for Peanuts "are higher than a bunch of very, very popular brands that are out there right now with big movie franchises behind them…. So we think that Peanuts has a lot of opportunity..."
Cuneo said typically franchise movies are done about every three years and the company is seriously considering another one. I was partly surprised by the new Peanuts series because a news report last November said Schulz's widow was opposed to more animations. The new series demonstrates she's not, which is pretty significant. I've read she's interested in quality standards, but I think Iconix is also, so that shouldn't be an issue. She said she was very happy with the quality.
Plus, her son and grandson scored a major hit with it (and the grandson had a limited career beforehand) and said they loved doing the film. If one of them wants to continue, it's pretty unusual for a mother/grandmother to squash her kid's or grandkid's career plans and dreams. Nine months ago before the movie launched, I would have put the chances of a sequel at 10%.
Now knowing that the son and grandson enjoyed doing the movie, it was a hit with the public, the widow liked it and the widow has already agree to a new TV series, I put the chances at 90%. So the probability of strong future box office revenues and subsequent merchandise sales is far higher now than late 2015.
* The company has revamped its pay practices to be focused on performance-based compensation rather than the discretionary bonuses of the past. Discretionary bonuses aren't as effective as performance-based bonuses because managers often feel compelled to give discretionary bonuses due to their personal relationship with the person, and to avoid upsetting the person.
For a manager to not give a discretionary bonus, he or she needs to tell the employee that in essence the manager's subjective opinion is that the employee doesn't deserve the bonus. As a result, employees normally get between most of the bonus and all of the bonus. Employees realize this, so the bonuses give little incentive for strong performance.
The great thing about retail is that performance-based bonuses are usually very effective because they can easily be tied to revenues. If team members achieve higher targets of revenues, they get bonuses. If they don't achieve them, they don't get the money. This results in both increased effort (e.g. making extra phone calls to partners) and creativity (e.g. thinking up new ideas during their off hours).
The company mentioned another important detail about compensation that I will analyze in part two of this series in which I focus on the upcoming earnings report and upcoming guidance.
Acquisition options are available
Considerable emphasis was put on organic growth through various initiatives combined with strategic acquisitions. In passing during the Q&A, CFO David Jones said, "And we've got some options on acquisitions, both domestically and internationally." While some investors are gun-shy about acquisitions at present and I was somewhat gun-shy on the idea in late 2015, I've come around to the idea for two reasons:
A) Iconix has fixed costs such as management, rent, etc., so any time it can add a good brand at a good price, it gets economies of scale because the fixed costs don't go up, and the majority of the revenues go to the bottom line and to free cash flow. Iconix's profit margins are fairly close to 50%. But when any new brand is added, I estimate the margins on it will be 60% to 70% because operating that brand won't add to rent, upper management salaries and other fixed costs.
B) It also can gain by leveraging its huge number of relationships with wholesalers and retail chains. If it buys a quality brand that doesn't have strong distribution, and it signs deals with wholesalers or major retail chains to carry the brand, there are instant gains. I favor international acquisitions over domestic ones because the company has a stockpile of cash overseas it can't use to pay off debt or to increase domestic marketing. But that will have to be based on whether the international options are good or not.
In a nutshell, if the annual profits from a new brand are greater than the cost of the capital associated with it (e.g. paying down the debt associated with it over time), then it's likely a smart move to acquire the brand, of course depending on some other factors. But whether some investors might dislike the idea of an acquisition is not one of those factors. The long-term role of the board and management is to maximize profits in the long term, not please all investors. Certainly, they have to communicate with investors through earnings calls, press releases and investor days. And of course they shouldn't do a bone-headed acquisition. But if they have a good opportunity, I think they have the right to take it and most likely will take it.
The fact they haven't acquired anything in the six weeks since Jones said there were already options available indicates they're evaluating opportunities carefully and not acquiring just to acquire.
Sharing long-term growth plans at investor day
There is a major investor day coming this summer. During the opening remarks of the earnings call, Haugh said, "My strategic review and analysis of the business is ongoing. And we are currently in the process of developing a long-term growth plan that will detail where we see the largest opportunities for our company and our shareholders." He later said, "We've got everybody engaged in a project right now to really craft this go-forward strategy," which the company plans to share at the end of the summer with an Investor Day.
I think there is good potential that the unveiling of the long-term growth plan and accompanying details will be a moderate catalyst. Management said it's very comfortable that $160 million a year in free cash flow per year is a dependable "base" this year and going forward, which conveys that it expects $160 million in FCF at minimum and is aiming for higher.
Gain on sale of Complex Media
On April 18, reports in the media surfaced that Verizon (NYSE:VZ) was buying Complex Media, a non-core business that Iconix owns a stake in. You can read initial details here.
Before the call, investors were uncertain if the company would only break-even or gain on the sale. On the call, management said its stake has definitely gained in value over the money it invested. I will give my analysis of the sale and what I expect the gain on the sale to be in part two of this series. But a key detail that was revealed on the call is that the company is not yet including the gains on the sale in its earning guidance, so that gain will be added to earnings in the near future.
Shorts and the courts
On May 18, the Supreme Court made a ruling that should give Iconix and other companies more protection from people and/or institutions who collude to drive stock prices down. Short selling is still legal, and I think that it should be. But organizing a group of people to deliberately drive the stock price down is illegal and this should help deter that. It's especially good, as the article says, for small-cap companies like Iconix that don't have a large budget to sue federally.
This is also particularly good for Iconix because a sizable number of the biggest short sellers and financial institutions that short sell are located in New York, and Iconix is also, so ICON can now prosecute them in NY state courts.
That said, it may be the case that now that Iconix has top-level management, its earnings have stabilized, it has many initiatives under way and it just had an earnings beat, the shorts may have much better targets to go after. Iconix was highly vulnerable last year, and when the big shorts see blood in the water, they often swoop in because they know they can take advantage of the fear. So while this law should help protect Iconix going forward, it may not be needed by Iconix much now. It would have been nice to have it in place a year ago.
Cuneo buys $400,000 of stock
"Research shows that insider purchases tend to outperform broader market gauges by a wide margin, which is why insider trading indicators continue to receive strong attention from the investment community. Indeed, insider buying is relatively straightforward to interpret, considering there's only one prime objective for purchasing shares. ... Academic research has shown that certain insider purchases historically outperformed the market by an average of seven percentage points per year. This effect is more pronounced in small-cap stocks."
Cuneo has more information about Iconix than anyone including Haugh, who has been at the company less time. Plus, Cuneo has successfully turned around seven different companies so I'm sure he knows when a company he's running is clearly on its way to a successful turnaround. He wouldn't invest $400,000 of his own money into the stock if he wasn't confident it's going to higher. Cuneo already owned over $2 million in stock. If he was unsure of whether the company would do well, he'd either sell some of the $2 million, or at the very least not add to it.
Iconix buys back some debt
As I mentioned, Iconix bought back some of its debt from bondholders. For the details, go here. One thing I'll add is on the question of when bondholders will sell their shares; I'm fairly sure they're not going to sell them for lower prices than they think they're worth. The Iconix filing says that some bondholders indicated that they wanted the right to sell them quickly if they so desired. But if bondholders for example basically agreed to pay between a range of $7.60 and $8.10 per share, they're not going to sell them for lower than the bottom end of the range.
Based on 1) the fact the deal has a bunch of factors in place that control the final transfer price and that they seemed to say that one of the factors is based on min/max levels of the publicly-traded share price, and 2) based on common sense, I'm somewhat sure both the bondholders and Iconix set it up in such a way that there is a maximum level and a minimum level the bondholders will pay for the shares. I don't think either side would have agreed to an open-ended thing where they might end up with a significantly unreasonable price.
Also, the bondholders owned the bonds of the company because they had confidence it was going to do well and not default on its debt. Owning bonds is at least somewhat different than stock, but in both cases, people are forecasting the company is going to do well.
Even if by some strange chance 1/4 of them decide to sell in the first week at low prices, that's 2 million shares divided by five days equals 400,000 a day. That's only about 45% of the average daily volume of the stock and won't have a big impact. Shorts still have about 13 million shares they've borrowed that they're going to have to buy to cover at some point, and that's far more than what the bondholders have. If you don't have time to read the whole debt buyback article, on the whole, I believe it's a moderate net positive.
Shorts are down, and days to cover is up
The number of shares shorted has gone down significantly from 17.54 million in late January to a little under 13 million in June. At the same time, the "days to cover" has gone up because average daily volume is much lower. Days to cover is the number of days it would take short sellers to exit their positions. The higher the number of days, the higher the probability of a short squeeze.
Currently, the days to cover is 14.62, which is more than double the 6.48 it was in mid-March and almost quadruple the 3.74 days it was in late December.
The days to cover is higher than any time in the nine months from July 31st, 2015, to April 28, 2016. So the potential of a short squeeze is higher now than most of the past year.
The next article
In the second article in this two-part series, I'll examine the impact of the items above on total earnings and free cash flow for the year, what to expect on the next earnings call and a list of four catalysts to expect in the next several months.
Disclosure: I am/we are long ICON.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.