transcript of Q2 2007 conference call
Fair Disclosure Wire
OPERATOR: Welcome to the Innovo Group 2007 second quarter earnings conference call. My name is Michelle, and I will be your coordinator for today. At this time, all participants are in a listen-only mode.
We will be facilitating a question-and-answer session toward the end of today's conferences. (OPERATOR INSTRUCTIONS) . As a reminder, this conference is being recorded for replay purposes. And I would now like to turn the presentation over to your host for today's call, Mr.
Dustine Huffine, General Counsel. Please DUSTINE HUFFINE, GENERAL COUNSEL, INNOVO GROUP: Thank you, Michelle.
I'm Dustine Huffine, General Counsel for the Company. Good afternoon, everyone. Present on our call is Marc Crossman, our President and CEO.
Before we begin, let me review the Company's Safe Harbor language.
During the course of this call, I'll remind you that the statements made today may contain forward-looking statements. Statements of the Company's or management's intentions, hopes, beliefs, expectations, or predictions of the future are forward-looking statements. These statements include but are not limited to Joe's position in the premium denim market, our ability to produce products at competitive prices, estimations of retailers' future intentions to purchase our products and our ability to achieve and or maintain profitability in sales growth in the future. These statements are subject to risks and uncertainties that could cause our actual results to be materially different. Your caution is not to place undue reliance on forward-looking statements, which speak only as of the date they're made.
I'll also refer you to our reports that are filed with the SEC, including our 10-K for our year ending November 25, 2006 filed on February 8, 2007, our 2007 first quarter 10-K, filed April 10, 2007 and our second quarter 10-Q filed today. Those documents include information that could cause actual results to differ materially from those contained in any projections which may be made during the course of this call. And by making these forward-looking statements, we undertake no obligation to update them for revisions or changes after the date of the earnings call. Finally, a copy of this-- our earnings release and a recording of this call will be available on our Web site and a telephone replay will be available for one week from today.
Now I'll turn the call over to Marc.
MARC CROSSMAN, PRESIDENT, CEO, INNOVO GROUP: Thanks, Dustine, and thank you everyone, for joining us today on the call to review our second quarter results for 2007. The second quarter can be summarized by two primary themes. One, our return to profitability one quarter ahead of schedule, and two, achieving gross margins above 45% two quarters ahead of schedule. Needless to say, we're extremely pleased to announce these results, as we believe they beat everyone's expectations. For the second quarter, overall net sales were $15.2 million, a 55% increase over the prior year's net sales of $9.8 million. We reported operating income of $657,000 during the quarter compared to an operating loss of $2.3 million a year ago. Setting aside the $1.5 million non-cash charge as a part of our settlement with Beyond Blue, our operating income would have been $2.1 million for the quarter. These improved results were largely due to us, one, growing our Joe Jeans revenues by 71%, two, improving our gross profits by 100% over the prior-year period, which in turn boosted our Joe's gross margins from 42% a year ago to 48% this quarter; and three, with the exception of the settlement charge, maintaining our SG&A at roughly $5.1 million for the period.
And now I want to expand on the very segments of our business regarding our second quarter results. As we have seen in recent quarters, the primary reason for our Q2 growth continues to be our women's department store business growing over 60%. More specifically, our quick response core basic program helped drive a 90% increase in our Nordstrom's business, where we are now the number one resource in the savvy department and nearly 150% increase in our Bloomingdale's business. More impressively, the core program drove a 7 fold increase in our Saks business, as evidenced by the fact that our door count only grew 68% year-over-year from 32 to all 54 doors.
As we reported on our first quarter call, we shipped our first six-door test in Neiman Marcus late February and they immediately reordered and rolled out an additional eight doors in Q2.
We are pleased to report that we'll be rolling out the all Neiman Marcus doors in the third quarter due to the success of those tests.
Our women's specialty store business continues to maintain the solid consistency that we have expected, as we have a stable 800 plus door count during the quarter. Compared to Q2 of '06, sales grew 46% during the period. This was driven primarily by 146% increase in our Anthropology business, as we are their number one denim brand. We also saw a 122% increase in our Barney's business, an increase in our Jasmine Solo, Bergdorf Goodman and Lisa Klein businesses, as well as others. The mix between our women's department store and specialty store sales were 46% department store and 54% specialty store.
During the second quarter, our men's gross sales was approximately $1.2 million, which is extremely encouraging as we continue to strategically grow this segment. Our men's business continues to have an approximate sales mix of 49% department store and 51% specialty.
The growth of our men's business is the result of several factors, first, Nordstrom's; this continues to be our largest and fastest-growing account and a great partner for Joe's, as they have committed to expanding the brand in their stores. Accordingly, we will be participating in the Nordstrom's Anniversary Sale. Second, Bloomingdales. We are currently in 12 doors and will be rolling out to 17 doors in the third quarter. Saks Fifth Avenue, we launched a six-store test in April and will be rolling additional doors in fall.
And lastly our specialty store business, we opened another 22 doors during the quarter, increasing our total door count to 175.
Regarding our international business, sales during the quarter were $812,000, an 8% improvement over prior-year sales of $607,000, but in our opinion far below the true potential of the brand internationally. I'll have more to say about this shortly.
Turning to Joe's gross margins, for the second quarter we experienced gross margins of 48% compared to 42% gross margins during the year-ago period. We had originally projected a 45% target exit margin for 2007 and are a full two quarters ahead of plan. These improved margins can be attributable to lower unit production costs per garment, a clear benefit from our strategy to source outside the U.S.
Our SG&A during the second quarter of 2007 was $6.6 million.
Setting aside the settlement charge of Beyond Blue, our SG&A would have been $5.1 million, roughly in line with last quarter and where we had projected our SG&A to be. Growing sales, increasing gross margins and keeping expenses in check led to our return to profitability with net income of $422,000 for the second quarter.
What is even more encouraging is that if we back out the one-time settlement charge during the quarter, our operating income would have been $2.1 million. Needless to say, we are extremely pleased with the quarter's results and are glad to have surpassed expectations on many levels.
Now I'll talk about where we see the direction of the Company going forward. We've announced certain initiatives in past conference calls that we have been focusing on to improve our results. These include growing our women's department store sales, expanding our men's line, and realigning our international presence. I'll discuss these initiatives in a little more detail now. First, as we have continued to grow our women's department store sales, we will continue to see improved quarter-over-quarter growth through 2007, as a result of door increases and better penetration within key accounts. Going into 2008, we believe our growth will be dependent on a few key factors.
A, the continued progression and evolution of our core basic replenishment program, B, Neiman's Marcus' new door rollout and expansion of their business, and C, increased depth of presentation and best performing department specialty stores by layering the collection and additional fashion basics into their assortments.
Second, the Joe's Men's collection continues to show tremendous opportunity at retail. As we indicated on the first quarter conference call, we are truly excited about the assortments we have been developing to expand the category for our fall deliveries.
Accordingly, we expect our retail partners to take a more aggressive approach to rolling out the men's line for fall and holiday. To update you on our men's replenishment program, Nordstrom's, Bloomingdale's, Saks and Macy's will all be layering on styles to build stronger presentations in their key bodies. As evidenced from the success of our women's replenishment program, we are confident we will experience strong end-season sales growth with the addition of this program.
Third, our international business admittedly is one area in which there is still a lot of work to do. However, we truly believe there is tremendous upside potential for the Joe's brand and we are committed to growing this segment into a larger percentage of our overall mix. Two major steps we have taken to that end is signing a $20 million distribution deal in Japan and bringing our European business in-house, which we are announcing for the first time today.
We're opening our own office in Paris and plan to use a combination of agents and distributors throughout Europe. Servicing this business out of Paris will not only give us a better measure of control over our European distribution, but also should result in better margins.
Just last week, we attended the "Bread and Butter Show" in Barcelona, where we met with new agents and distributors. We received a tremendous response to our spring collection and many of the European trend forecasters felt like we looked new and showed great trend leadership.
Finally, before I open it up to Q&A, I want to say a few things about our acquisition of the Joe's brand. We recently filed our proxy and will be holding our shareholder meeting on August 14th. This process has taken a bit longer than initially anticipated, but as we recently announced we were able to rework the structure of the acquisition to better align our interests towards the continued profitability of the Company. Operator, we're now ready to take questions.
OPERATOR: Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Ronald Bookbinder of Sterne, Agee. Please proceed.
RONALD BOOKBINDER, ANALYST, STERNE AGEE: Good afternoon and congratulations on a terrific quarter.
MARC CROSSMAN: Thank you.
RONALD BOOKBINDER: First off, on the gross margin. You're lowering your cost by sourcing internationally. How much more upside do you see in that going forward?
MARC CROSSMAN: I think there actually is -- I don't want to get too far off our guidance that we've given in the past of 45% exiting the year, but that said, the cat's a little bit out of the bag. Right now we're still doing about half our production in the U.S., and half out of Mexico. When we look at 2008, what we're doing now is we're going to more aggressively move offshore or move out of the U.S. , and you're going to see a bigger proportion made out of Mexico. You're also going to see some of our fashion basics and our fashion styles coming out of Morocco and in addition to that we got another $2.55 negotiated off our pricing here. So I think what you're going to see is the mix is going to actually change more dramatically. And if we're at this, call it, 45 to 48% level with a 50/50 mix, you can imagine what will happen if we get to an 80/20 or 90/10 mix. Mexico versus the U. S. So I think they are-- could be potentially a lot more RONALD BOOKBINDER: Moving some production to the Morocco, wouldn't Morocco be significantly cheaper than even Mexico because of duty?
MARC CROSSMAN: It would be cheaper because of the duty, but it's such a strong Euro, when we pay in Euro, so they pretty much net each other out. Yes, Morocco is a little bit cheaper, but, again, you have the 40 days' boat time, their number of, I don't want to call them draw backs but their trade-offs between the two. So really what we're looking to Morocco for is not a big part of our production, but definitely to be online for a lot of the fashion styles that we're not doing down in Mexico.
RONALD BOOKBINDER: But wouldn't there be more basics coming from Morocco such that the lead times wouldn't affect delivery or timing in the market?
MARC CROSSMAN: You would think that would be the case but we're actually doing the opposite because we have a couple styles here on our core basics. So, just to set it up, our core basics were originally done here in the U.S., and what we're doing is moving as many of those down to Mexico as we can because the pricing out of Mexico on our core basics is actually better than Morocco. And, again, each one is negotiated wash by wash, so we're looking at it a little differently now, but some of our core basics in the past have been running at 43 to 50% starting margins and then you have dilution on top of that. If we go down to Mexico, we can get 65% starting margins on those jeans. So, again, it's a little case by case, but really where we want to use Morocco is on the fashion side. And, again with the 270-day design calendar, you can pretty much manufacture wherever you want to manufacture, but for us, being in Mexico, being able to send our QCs, both out sewing, wash, finishing QCs down to Mexico and it's a short plane flight is really for us a lot easier. And in addition to that, the same goes for their team, any time we have issues up here, they can fly right up and we can be meeting face to face that next day.
RONALD BOOKBINDER: On Japan, you have $20 million in a contract. When do you start delivering on those jeans?
MARC CROSSMAN: Well, we've already started delivering the $20 million contract spread over three years and the minimums are -- they scale up, I think it's 5.5 in the first year, 6.5 in the second, and 8 in the third. But we've already been -- already started delivering on that contract.
RONALD BOOKBINDER: On the Paris office, are you working with a partner over there or is this just totally on Joe's and what sort of cost are we looking at?
MARC CROSSMAN: It's going to be totally Joe's. We tried this with Japan, had a partner over there, our own subsidiary. This is going to be -- again, I'm taking you back a number of years on our Joe's Jeans or pants subsidiary. This going to be 100% us. This has been in development for quite a while. We're just now talking about it. But we for probably the last six months have had the guy that's going to run the Paris office who is making around $200,000 a year; he's been on our payroll. So we're not looking at this massive payroll increase, we'll rent an office, we'll have a third party distribution, much like we have with Pixie or here. So we're going to try to variablize as many of those costs as possible, but we're going to own it ourselves. And there you get a real pickup because you don't have the country of origin label on the jeans coming out of Mexico, and if we ship direct Mexico to ourselves, we're going to save over $6 a garment on the duties alone. In addition to that, once the goods are landed in Europe, we'll be able to sell in Euro instead of in U.S. dollars. So we'll get two really, really big pickups that will more than pay for any office space, etc. In addition to that, we'll be able to use agents and agents work on a 15% margin instead of distributors that work on anywhere from 55 to 60 points. So for us it makes absolute sense for us to open our own office in Paris and service that business.
RONALD BOOKBINDER: What is the price point in Europe for a pair of Joe's?
MARC CROSSMAN: What we've wanted to do in the past, we've be in excess of 240 Euro. We really-- in the past we are pricing ourselves way out of the market. We had jeans at 400 Euro. Now I think what we want to do is have a core basic program running between 185 and 195 Euro. I think at that price point, we'll be able to generate tremendous volume.
RONALD BOOKBINDER: The raise that you had recently to support the inventory growth, what kind of shape is the inventory in?
MARC CROSSMAN: It's in good shape. When we look at the raise that we did, the inventory, we took back and we alluded to this on our first quarter call. We've been paying for the fabric, but putting it on our manufacturer's book. So from a cash flow standpoint, not a whole lot changed there. You just now see that inventory on our books because we're staging it in L.A. and it was about $3 million worth of inventory, that we were paying for it anyway. So that addresses the inventory build issue. If you pull that $3 million out and look at it apples to apples, our inventory really only grew like maybe $0.5 million, looking at the finished goods side of things. So we didn't have a real big increase in inventory, even though it looked like it.
Our real primary need for the cash was just the tremendous growth that we've seen. And yes, we need to buy inventory, but also run the business. When we looked at our business plan at the beginning of the year and we told people mid-teens growth, we thought we would do mid-teens growth and we looked at the financing of the Company based on that and what we have seen is we've done a lot better than that.
Now because we have to prepay all of our fabric and we don't have the terms with the vendors that we necessarily need right now, and our bank lines are a lot smaller than they need to be right now, we were capital constrained. That said, I think we're going to start putting some quarters, back to back quarters together that look good, that are profitable, and I think we'll be able to open up our bank lines and finance the business using just our asset-based lines, which a normal company does that's healthy. And I think we're getting to that point.
RONALD BOOKBINDER: But with this raise, you are going to be able to deliver the goods on time for the department stores in Q3, correct?
MARC CROSSMAN: Yes. 100%. This is really -- the best way to put it is we stretched our vendors during the first and second quarters. While we were seeing that growth, we clearly didn't want to be raising money at $0.50 again, so we just really worked hard with our vendors to allow us to stretch them and this is really a little bit of catch-up capital is probably the best way to put it.
RONALD BOOKBINDER: Nice. Okay, well. Let other people ask questions.
Congratulations once again on a terrific quarter and a nice turnaround in the business.
MARC CROSSMAN: Thanks, Ron. I appreciate that.
OPERATOR: (OPERATOR INSTRUCTIONS) Your next question comes from the line of Thomas Duffy, Private Investor. Please proceed.
THOMAS DUFFY, ANALYST, PRIVATE INVESTOR: Thanks for taking the call.
Again, congratulations on the quarter and this remarkable turnaround here. Just wanted to make sure I heard something correctly in your opening remarks. Are you now saying that in Nordstrom's and some of your other key accounts, you're actually out selling True Religion and Seven and those names?
MARC CROSSMAN: No. We weren't -- we weren't saying that we're out selling or speaking to any of our vendors. Nordstrom's, within the savvy department, we're their number one vendor. That was the only comment I made. I'm not -- I don't want to say anything about our competitors where we sit relative to them. We just know that in the savvy department in Nordstrom's, we're their number one vendor. I guess that would put us at the biggest within savvy. Keep in mind that TBD, that's where Seven and Citizens and some of the other really big guys sit, which is a completely different department and clearly we're not as big as those guys.
THOMAS DUFFY: Okay. I know that you have a great relationship with Anthropology in your women's business. Do you think it's possible that you might be able to get the men's brand into the Urban Outfitters stores?
MARC CROSSMAN: I don't think that's where we want to be. It's a little too edgy or urban is the right way to look at it. I don't think that's an account where we'd want to have the men's business.
THOMAS DUFFY: Okay. Can you comment a little bit about the handbag, the branding opportunities and maybe what the Coatry Show was like and have you lined up any stores for shipment in the coming quarters?
MARC CROSSMAN: In terms of the handbag license, at the outset, we rushed to put a line together for the spring of this year. The sales were minimal; it was more of a splash that said, hey, we're in the market. The real big show for us and where we're going to have the full line -- again, when we did the first line, I think we launched with 14 pieces, somewhere in that range. So it wasn't a big 60-piece collection. This coatry is when we're going to have the full 60-plus piece collection put together, so I would say there'll be more to come on that. We'll talk about it in the third quarter call, but that will be the true test of how the handbags are going to launch and what they're going to look like.
THOMAS DUFFY: The handbag, are they going to be marketed under Joe's, or are they going to be marketed under Joe deHann bags, or how is that going to work?
MARC CROSSMAN: Yes, they're going to be under Joe's. It's going to be under the Joe's brand, not Joe's Jeans, just regular Joe's, and each one in essence is going to be branded using the JD logo.
THOMAS DUFFY: Are you able to offer any kind of guidance for Q3 or full year at this point?
MARC CROSSMAN: This is a turnaround year for us. It's been tough for us to look at what we're going to in terms of guidance. We are very lose on where we're going to come out in our gross margins, just saying that we're going to be at 45, hopefully, by end of the year, saying we're going to grow mid-teens. Clearly, the mid-teen's growth for the full year, we're not going to have down quarters in the third and fourth quarters, so mid-teens is completely out of the question, it's going to be higher than that for the full year. Put it in another perspective, we went into the year thinking we were going to do $54 million in revenue and we're going to come out substantially higher than that. We're really excited about that business, we've talked about the core SG&A before variable expenses being somewhere around 3.5 to $4 million and we're right in that range. I think this quarter our core SG&A was about $3.8.
OPERATOR: (Inaudible - technical difficulty) MARC CROSSMAN: Operator.
OPERATOR: Yes, sir, I'm sorry about that.
MARC CROSSMAN: Should I just continue?
OPERATOR: Yes, sir.
THOMAS DUFFY: I have one last thing. Are you still considering the name change and ticker symbol change?
MARC CROSSMAN: 100%. It's in the proxy. Changed the Company to, obviously, Joe's Jeans and then the new ticker symbol, I believe, is going to be JOEZ. They didn't have an S so we went with JOEZ.
THOMAS DUFFY: Okay. Thanks a lot, great quarter again.
MARC CROSSMAN: Thank you very much.
OPERATOR: (OPERATOR INSTRUCTIONS) We will now turn the call back over to Marc Crossman for closing remarks.
MARC CROSSMAN: I think there was one more question on that.
OPERATOR: Okay. Actually, we do have a question from the line of Tory Malazzo. Please proceed.
TORY MALAZZO, ANALYST, STONE RIVER CAPITAL: Hey guys, Stone River Capital, thanks for taking my question. Can you talk a little bit about the dilution from the recent offerings and if there are any lockups on those shares?
MARC CROSSMAN: There aren't any lockups on the shares. We did the deal with Barry Sternlicht and Maddy B and then also, Bill Swedeler.
That group was the same group that invested in the original pipe back in December or the pipe we did in December. So when we look at their share count, they're not going to be a filing entity, both of them.
They're going to hold, right now roughly about 20% of our stock outstanding. I think the first deal is like 6.8 million shares, this deal was 1.2 million shares. They're committed. I talk to them on a very regular basis, they want to be very involved and helpful with the Company, so as we look at that, there really isn't a need for a lockup, because by the time they start to try to sell, hopefully the stock will be a lot higher. There is a six-month lockup on the warrants, but that's just the warrants side of things. In terms of -- what was the other part of the question about the dilution?
TORY MALAZZO: That fairly sums it up. In general, do you expect to use equity to raise cash in the future or -- it sounds like you're looking at expanding your bank lines going forward?
MARC CROSSMAN: Yes, I think the real lay-up is our bank lines. We're probably borrowing against 20, 30% of our inventory and it should be 50. We don't have a separate ledger debt line to bring in inventory, fabric under so we're having to pay for it before it even hits the water, which is really extending our days out on our inventory. I think there are a number of things we can do, we just haven't been in a position as a company, having lost money, to open up our bank lines and finance it like any other business would finance their business.
That said, I have -- I obviously have a slug of option, and so the dilution hurt me just as bad as if not more than anyone else and we are aware of that and we don't want to come out and continue to dilute the investors and to the extent that we continue to fund our growth through our bank lines, we will do that, and that will be the number one priority. We're not just going to keep coming back and raising capital.
Also, if you do the math on the quarters and you look at where our business is going, you look at the profitability of the margins, and you extrapolate out, even take the second quarter and extrapolate that out to 2008, without even assuming we'd grow the business, this is going to be a cash flow positive company. So it's -- I think we kind of look at how everything's aligned and we'd like to not be back in the market raising capital. I can't say anything for 100% sure; we're going to do our best to avoid that at all costs.
TORY MALAZZO: Great. Well, thanks again and definitely impressive results.
MARC CROSSMAN: Thank you. I appreciate that.
TORY MALAZZO: Yes.
OPERATOR: As there are no further questions at this time, I will now turn it back to Mr. Crossman for closing remarks.
MARC CROSSMAN: Okay. I appreciate everyone being on the call and hopefully we'll have more good results to announce after the third quarter. If anybody needs to reach us, you can either call ICR or Dustine Huffine, and we'll try to answer your questions. Thank you very much.
OPERATOR: Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.