Xcel Brands - Q3 2022

Transcript

Operator (participant)

Good day, and welcome to Xcel Brands third quarter earnings conference call. Please be advised that reproduction of this call, in whole or in part, is not permitted without prior written authorization of Xcel Brands. As a reminder, this conference call is being recorded. I would now like to turn the call over to Andrew Berger of SM Berger & Company. Thank you. Andrew, you may now begin.

Andrew Berger (President)

Good morning, everyone, and thank you for joining us, and welcome to the Xcel Brands third quarter 2022 earnings call. We greatly appreciate your participation and interest. With us on the call today are Chairman and Chief Executive Officer Robert D'Loren, Chief Financial Officer James Haran, and Executive Vice President of Business Development and Treasury Seth Burroughs. By now, everyone should have had access to the earnings release for the third quarter ended September 30, 2022, which went out last evening. In addition, the company filed with the Securities and Exchange Commission its quarterly report on Form 10-Q yesterday, November 14. The release and the quarterly report are available on the company's website at www.xcelbrands.com. This call is being webcast, and a replay will be available on the company's investor relations website.

Before we begin, please keep in mind that this call will contain forward-looking statements. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from certain expectations discussed here today. These risk factors are explained in detail in the company's most recent annual report filed with the SEC. Xcel does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. The dynamic nature of the current macroeconomic and geopolitical environment means what is said on today's call could change materially at any time. Finally, please note that on today's call, management will refer to certain non-GAAP financial measures, including non-GAAP net income, non-GAAP diluted earnings per share, and adjusted EBITDA.

Our management uses these non-GAAP metrics as measures of operating performance to assist in comparing performance from period to period on a consistent basis and to identify business trends relating to the company's results of operations. Our management believes these financial performance measurements are also useful because these measures adjust for certain costs and other events that management believes are not representative of our core business operating results.

Thus, they provide supplemental information to assist the investors in evaluating the company's financial results. These non-GAAP measures should not be considered in isolation or as alternatives to net income, earnings per share, or any other measure of financial performance calculated and presented in accordance with GAAP. You may refer to the attachment to the company's earnings release or to part one, item two of the Form 10-Q for a reconciliation of non-GAAP measures. Now, I am pleased to introduce Robert D'Loren, Chairman and Chief Executive Officer. Bob, please go ahead.

Robert D'Loren (Chairman and CEO)

Thank you, Andrew. Good morning, everyone, and thank you for joining us. I'd like to start today's call with some brief opening remarks, followed by some operating highlights and insights. After that, our CFO, James Haran, will discuss our financial results in more detail. As we reported last quarter, we completed the sale of a 70% interest in our Isaac Mizrahi brand and entered into a newly formed business venture with WHP Global. We have made a lot of progress with the integration of the venture into WHP's operations and expect to make some announcements soon related to our progress with respect to new business developments. That said, the transaction has impacted our revenues and earnings for the third quarter and will continue to have an impact for the remainder of 2022.

In addition, near-term retail headwinds caused by a challenging retail and business environment have further impacted revenues and earnings during the year. As discussed on our last quarterly earnings call, we will carefully manage our business by controlling expenses. Despite near-term headwinds, we are pursuing initiatives that we expect to positively impact revenues and EBITDA going into 2023. These initiatives include our recent announcement of the appointment of Ken Downing as the creative director and live stream spokesperson for Halston. Ken's shows are doing well on HSN, and he's having a very positive impact on all creative aspects of the brand. I am extremely excited by how Ken is setting the stage for the go-forward for Halston under his creative direction.

I am also excited by the September 2022 appointment of Christian Siriano as the creative director of our C. Wonder brand, and we are on track for the brand to debut on HSN with Christian as the on-air host starting in the spring of 2023. We are seeing significant interest from potential licensees for the new C. Wonder by Christian Siriano brand across multiple categories. We are excited to be working with Christian and his significant social media following of nearly 5 million followers. During the current quarter, we also launched Q Optics, a multi-branded optical business on HSN and QVC. This business is conducted through a joint venture whereby we leverage inventory and systems of our partner without any material working capital investments. Overall, we expect these new developments to help create growth in our existing brands and expand our relationship with QVC and HSN.

Furthermore, we continue to work on several other new initiatives with new talent and celebrities and hope to be able to announce them shortly. Our goal is to build a live stream shopping destination for interactive TV and our proprietary live stream platforms with over 10 million followers through the combined social media reach of our new creative talent, celebrities, brands, and product launches. We have also continued to see success in our Longaberger business, especially from our live stream shopping perspective as we regularly sell our products in our live stream shows. We have successfully positioned Xcel Brands as a leader in live stream and social commerce, and this has been at least partially responsible for our ability to attract top talent from our new brands and initiatives with QVC and HSN and our live stream platforms.

While the Isaac Mizrahi transaction is having a short-term impact on our financial results, we expect the new businesses I discussed and the new projects and opportunities that are currently either planned or being considered to more than offset the lost revenue and earnings in the coming year. From a financial perspective, we continue to maintain a strong debt-free balance sheet, and we believe having strong liquidity levels and greater access to capital is critically important in today's complex, challenging business environment. We expect to enhance our capital levels in the coming quarters with a new commercial bank working capital line. Also, Jim and I, together with our operating teams, are working hard on a plan for operating efficiency goals for 2023 to offset recent increased cost in operating the business, especially as it relates to logistics, warehouse, and duty costs.

We expect that our new warehouse operation in Mexico, coupled with other operating efficiencies that we plan to implement by year-end, can reduce operating costs by over $2.5 million over an annualized period. In closing, we are excited about the growth opportunities for our existing brands, including Halston and C. Wonder, with respect to announcements for the brands, as well as new business opportunities in our pipeline. We continue to explore new opportunities, including acquisition opportunities and strategic partnerships. We have and will continue to be disciplined in our operating costs, and we are optimistic that the company will return to profitability in 2023. Now, I'd like to turn the call over to Jim to discuss our results and financial highlights for the third quarter.

James Haran (CFO)

Thanks, Bob, and good morning, everyone. I will briefly discuss our financial results for the quarter and nine months ended September 30, 2022. Total revenue for the third quarter was $4.5 million, representing a decrease of approximately $6.8 million from the prior year quarter. For the current nine months, total revenue decreased approximately $8.1 million from the prior year period to $17.2 million. These revenue declines were driven by declines in both net licensing revenues and net sales. Net licensing revenue for the current quarter was approximately $2.2 million, representing a decrease of approximately $4.7 million or 68% as compared with the prior year quarter. This decrease in licensing revenue was primarily attributable to the May 31, 2022 sale of a majority interest in the Isaac Mizrahi brand.

Net licensing revenue for the current nine months decreased by approximately $8.1 million to $21.7 million or 27% as compared with the prior year period. This decrease in licensing revenue was primarily attributable to the sale of the Isaac Mizrahi brand, partially offset by licensing revenue generated from the Lori Goldstein brand during the entire nine months in 2022. Sales decreased by approximately $2.1 million in the current quarter and $4 million for the nine months ended September 30th, 2022, which is 47% and 32% lower, respectively, as compared with the prior year comparable periods.

These decreases were primarily attributable to declines in wholesale apparel revenue, which early in the year were driven by a combination of discounts on seasoned inventory and canceled orders caused by temporary closing of overseas factories, and more recently are being driven by reduced or paused orders from retailers due to industry-wide excess inventory levels. Gross profit margin from product sales increased slightly from 35% in the third quarter of 2021 to 37% in the current quarter. For the nine-month period, gross margin from product sales declined from 39% in the prior year to 32% in the current year. This decline for the nine-month period was primarily due to the selling off of seasoned apparel inventory early in the year and inventory write-downs related to canceled sales orders.

Our operating costs and expenses were $8.7 million for the current quarter, down $1 million from the $9.7 million in the prior year quarter. This decrease was primarily attributable to the costs associated with the Isaac Mizrahi brand. On a year-to-date basis, our operating costs were $30.2 million, up $2.6 million from $27.6 million in the prior year nine months. This increase was mainly driven by the combination of cash and non-cash expenses related to the Lori Goldstein brand, which we own for the entire months of the current year. Transaction expenses incurred in connection with the Isaac Mizrahi brand sale and investments in our new initiatives. These increases were partially offset by costs associated with the Isaac Mizrahi brand.

Although we, like many other companies, have experienced cost increases from our service providers and vendors due to the current inflationary economic environment, most notably in the area of shipping, warehousing, and logistics costs, we have generally managed to control our overall expenses and continue to pursue ways to cut operating costs. In the other income category, we recognized a $0.3 million equity method loss in both the current quarter and year-to-date period, in accordance with the distribution provisions governing the business venture for the Isaac Mizrahi brand. The recorded loss includes $0.7 million of amortization of intangibles. Also, in this category, the current nine months includes the $20.6 million gain from the second quarter partial sale of the Isaac Mizrahi brand.

Interest and finance expenses for the current quarter were essentially zero compared with the $ half a million in the third quarter of 2021. This decrease was due to the full repayment of all of our outstanding debt in the second quarter of 2022. Overall, we had a net loss excluding non-controlling interest for the third quarter of 2022 of approximately $4 million or -$0.21 per share, compared with a net loss of $1.1 million or -$0.06 per share in the prior year quarter. On a non-GAAP basis, we had a net loss for the current quarter of $3.3 million or -$0.17 per share, compared with essentially breakeven net income in the third quarter of 2021.

Adjusted EBITDA was -$2.9 million for the current quarter, compared with $1 million in the prior year quarter. The decrease in EBITDA was primarily attributable to lower revenues previously mentioned. As a reminder, non-GAAP net income, non-GAAP diluted EPS, and adjusted EBITDA are non-GAAP unaudited terms. Our earnings press release and Form 10-Q present a reconciliation of these items with the most directly comparable GAAP measures. Turning now to our balance sheet. As of September 30, 2022, the company had unrestricted cash of approximately $8.4 million and positive net working capital of $13.7 million, excluding the current portion of our lease obligations and contingent obligations payable in shares of stock.

Although the sale of the Isaac Mizrahi business had an impact on our revenues and earnings for the last 2 quarters and will continue to have an impact for the remainder of 2022, the new initiatives Bob alluded to earlier will begin contributing to earnings shortly. In addition to these initiatives, the company has plans in the works that will reduce operating costs in several areas, maintaining operating efficiency and quality. The combination of new revenue sources and operating costs is expected to turn the company back to profitability in the second half of 2023 and beyond. With that, I would like to turn the call back over to Bob. Bob?

Robert D'Loren (Chairman and CEO)

Thank you, Jim. This concludes our prepared remarks. Operator?

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile this Q&A roster. Your first question comes from the line of Anthony Lebiedzinski with Sidoti & Company.

Anthony Lebiedzinski (Senior Equity Research Analyst)

Good morning, gentlemen. Thank you for taking the question. First, just some questions about the third quarter. Just curious where, as far as the 3Q performance, were there any notable changes to the business as the quarter progressed, or was it fairly consistent month to month?

Robert D'Loren (Chairman and CEO)

I would say, Anthony, it's Bob, that the quarter was exactly as we thought it would turn out. There were some canceled sales in our wholesale business, which we did anticipate coming into the current inventory situation that exists with most retailers. For the most part, the quarter shaped up exactly the way we thought it would. When we sold the Isaac Mizrahi brand or the 70% interest in Isaac Mizrahi, we anticipated losses until we brought online the five or six new initiatives that we have in the pipeline, three of which, of course, we have announced. The first launch of the new initiatives will be Q Optics, which has already launched on both networks. C. Wonder launches in March 2023.

That will be followed by the whole new Halston, Ken Downing line. Ken has been very busy working with the creative teams involved with Halston. He's had some very successful shows at HSN. We expect that we'll be making more announcements over the next 90-120 days that will fill out the roster that we were planning to bring into the business in 2023.

Anthony Lebiedzinski (Senior Equity Research Analyst)

Got it. Okay. Yeah, thanks for that, Bob. As far as the, you know, the gross margin percentage, it was good to see that being up versus last year and certainly up versus the second quarter. What would you attribute that to?

Robert D'Loren (Chairman and CEO)

I would say, the sourcing team did a very good job here, and we did manage inventory very, very tight. I think that's a good piece of it. Going forward into 2023, we will bring the warehouse in Mexico online. That's going to help significantly with cost, both from a logistics perspective as well as a duty perspective. We're excited to get that warehouse up and running.

Anthony Lebiedzinski (Senior Equity Research Analyst)

Okay. What's the timing of the Mexico warehouse opening?

Robert D'Loren (Chairman and CEO)

We are testing new shipments this month. We're fully integrated into the warehouse. We are moving goods from our 3PL in Los Angeles to the 3PL in Mexico. By year-end, we should be fully operational there.

Anthony Lebiedzinski (Senior Equity Research Analyst)

Got it. Okay. That's good to hear. Right now you're sort of midway through the fourth quarter. You know, can you share with us just kind of, you know, broadly speaking, you know, what are you seeing so far from a, you know, demand perspective for apparel, jewelry, trends? Any sort of comments also on Longaberger, what you're seeing there?

Robert D'Loren (Chairman and CEO)

Yeah. I'll answer the apparel question first. Most retailers are backed up with inventory. I think many retailers and a lot of wholesalers, because of the supply chain problems that we've all been experiencing since the beginning of COVID, got a little ahead of inventory because it was difficult to buy it in 2020 and 2021. Now most retailers are over-inventoried, and we're starting to see that in headlines as recent as today in The Wall Street Journal, that retailers are discounting significantly to move that inventory. I do believe that it will take a good part of Q1 and Q2 for all of that inventory to flush itself out and for everyone to get back to normal operating levels with inventory.

We expect that wholesale demand will be a little soft in the department store channels in Q1 and Q2, and then we'll see that return to more normal levels of buying in Q3 and Q4. Our interactive television business is less sensitive to that. There are buy commitments in place with HSN on the new programs that we're launching, and we're on track with that business.

Anthony Lebiedzinski (Senior Equity Research Analyst)

Got it. Okay. Then that business a year ago was certainly hurt severely by the QVC warehouse fire. I guess you have, in theory, an easier comparison, right?

Robert D'Loren (Chairman and CEO)

Yes. I don't think most people fully understand the implications of that fire and the impact on QVC and Qurate in general. They didn't really have the capacity in their other warehouses. It's not so easy to just switch to a 3PL. It doesn't happen overnight. I do think QVC did an amazing job of navigating through a very difficult situation.

Anthony Lebiedzinski (Senior Equity Research Analyst)

Got it. Okay. Well, thanks, and best of luck for the holiday season.

Robert D'Loren (Chairman and CEO)

Thank you, Anthony.

Operator (participant)

Your next question comes from the line of Debra Fiakas with Crystal Equity Research.

Debra Fiakis (Founder and Managing Director)

Good morning, and thank you for taking my questions. I was hoping to return to the gross margin discussion. Just one additional, just a follow-up. Would we perhaps see an impact in the December quarter from your Mexico operations and the benefits thereof, or would it perhaps really not be visible until the first quarter in 2023?

Robert D'Loren (Chairman and CEO)

You won't see it, Debra, until first quarter. When we brought those goods into the U.S., into the L.A. 3PL, we paid the duty. We're moving goods down to Mexico now, really just to run tests and just be sure by January everything's running efficiently. Go forward next year, goods will arrive in the port in L.A. and will be trucked from L.A., bonded to Mexico, and then shipped direct to consumer, for the duty savings.

Debra Fiakis (Founder and Managing Director)

Thank you. Another question. I appreciate you perhaps don't want to provide, you know, dollar figures or numerical figures, but I was hoping you might provide a little bit more color on the launch of the optical product. At least perhaps tell us whether or not it's tracking your expectations and your plans in the early days of the introduction.

Robert D'Loren (Chairman and CEO)

I would say on both networks, they were soft launches and there were a lot of back-end pieces to it that had to be debugged, so to speak. It's operating efficiently heading into the new year. I do believe QVC will begin, and HSN will begin to market more aggressively the program. The program really brings to QVC and HSN eyewear brands that they previously did not offer their customer base. We are very optimistic that over the coming years, this will develop into a strong business for us.

Debra Fiakis (Founder and Managing Director)

Thank you. I also wanted to ask about the two newest additions to your roster of personalities and designers. I mean, he's just jumped right in. Will we see the same thing with Christian Siriano, or will we have to wait until spring of 2023 before we see him on air?

Robert D'Loren (Chairman and CEO)

Christian's first show is scheduled for March of 2023. We expect goods to land in the warehouse early January. First show will be toward the end of March. Is it possible that we may do some type of marketing before? Absolutely. I think Christian will become very visible as the face and the creative director of C. Wonder when we start the new year.

Debra Fiakis (Founder and Managing Director)

Very good. This last question has to do with. It's more of a shopping question, really. You've talked about putting together a multi-brand site, and I just wanted to know, you know, technically speaking, or just a description of how shoppers will navigate or if they can navigate between the QVC platform and HSN to Xcel Brands' site where you're going to allow direct-to-consumer sales to take place. How would they interact? How's the interaction going to be crafted?

Robert D'Loren (Chairman and CEO)

Well, first and foremost, there are collection differences, generally speaking. You know, if you look at our Judith Ripka brand, we have a significant presence on QVC. With Judith, the product is not the same as the Judith Ripka brand, which is sold through direct-to-consumer channels, wholesale channels, as well as live streaming. It's going to be a similar strategy. There will be some overlap in product. We don't view this any different than say, Michael Kors being available on michaelkors.com and being available in virtually every department store in America.

Debra Fiakis (Founder and Managing Director)

Okay. Thank you very much. That was all very helpful.

Robert D'Loren (Chairman and CEO)

Thank you.

Operator (participant)

Again, if you wish to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment. Your next question comes from the line of Marc Lunder with Lunder Capital.

Marc Lunder (Managing Member)

Good morning. Thanks for taking the question. Where sales have always been a kind of a next year type situation, can you talk a little bit and give some more specifics about what you're gonna do to kind of bridge us to there as far as compensation and SG&A, reducing those, both of those?

Robert D'Loren (Chairman and CEO)

Sure. We have a plan in place, Marc, to reduce overhead by $2.5 million, maybe more, by year-end. There will be some announcements soon about more specifically how we're going to do that. We believe those reductions in cost will right size the business. You know, the challenge for us, Marc, is we built a significant platform for our wholesale apparel and jewelry business and literally launched that in December of 2019. Then we were hit with COVID in March of 2020. It has been challenging, at best, to navigate through having onboarded all of those people, launching a business, making supply commitments to various retailers to only have to deal with COVID.

We have been working on right-sizing the overhead so that now in 2023, when we think things really get back to normal, we can return the company to growth and profitability.

Marc Lunder (Managing Member)

What kind of growth you're looking to do? I mean, we've. It's been a number of years where we've been looking for growth and profitability. I'm just wondering if you have some measurable objectives that you guys are shooting for that investors can say, "Okay, they're meeting their objectives or they're not.

Robert D'Loren (Chairman and CEO)

We do. There is analyst guidance out there. We think they're looking at the business appropriately in terms of how we believe the business will grow. A lot of that growth will come from us returning back to our core business and interactive TV with both HSN and QVC. QVC is doing a great job navigating through this and some of the micro challenges they had with their warehouse fire. We would anticipate that going into the second half of the year, QVC will have worked through their inventory issues, and certainly work through their warehousing issues. With all the new launches that we anticipate, we think we'll come out of all the effects of COVID nicely and continue to grow the company.

Marc Lunder (Managing Member)

Thank you.

Robert D'Loren (Chairman and CEO)

Thank you, Marc.

Operator (participant)

At this time, there are no further questions. I'll turn the call back to the speakers for any closing remarks.

Robert D'Loren (Chairman and CEO)

Ladies and gentlemen, thank you for your time this morning. We greatly appreciate your continued interest and support in Xcel Brands. As always and more than ever, stay fit, eat well and be healthy.

Operator (participant)

This concludes today's conference call. Thank you for participating. You may disconnect at this time.