A.K.A. Brands Holding Corp. Q2 FY2024 Earnings Call

Greetings, and welcome to a.k.a. Brands Holding Corp. Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, K.C. White. Thank you, you may begin.

Good afternoon. Thank you for joining a.k.a. Brands' second quarter fiscal 2024 conference call to discuss the results released this afternoon, which can be found on our website at ir.aka-brands.com. With me on the call today is Ciaran Long, Interim Chief Executive Officer and Chief Financial Officer. Before we get started, I'd like to remind you of the company's Safe Harbor language. Management may make forward-looking statements, which refer to expectations, projections, and other characterizations of future events including guidance and underlying assumptions. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those expressed. For a further discussion of risks related to our business, please see our filings with the SEC. Please note, we assume no obligation to update any forward-looking statements. This call will contain non-GAAP financial measures such as adjusted EBITDA and adjusted EBITDA margin. Reconciliations of these non-GAAP measures to the most comparable GAAP measures are included in the release furnished to the SEC and available on our website. With that, I'll turn the call over to Ciaran.

Thanks, K.C. Good afternoon, everyone, and thanks for joining our second quarter earnings call. Before I review a few key highlights from the quarter, I would like to again take a moment to thank our team for their continued commitment to building on our portfolio of next-generation brands for the next generation of consumers. This was another quarter in which the team's agility and flexibility in executing our strategic priorities while keeping our customers at the center of every decision we make enabled us to deliver strong top line and operating results that exceeded our expectations. I continue to be very confident in our team's ability to execute and in the many profitable future growth opportunities we see for a.k.a. Brands to expand our brand portfolio reach and total addressable market. Before I go through the results in more detail, let me share a few highlights from the second quarter. Net sales far exceeded the high end of our guidance as we achieved year-over-year growth of more than 9%. Momentum in our US business meaningfully accelerated with year-over-year net sales growth of more than 19%. We delivered a strong gross margin of 57.7%, up 80 basis points from the prior year, which, combined with marketing expense leverage of 120 basis points, contributed to adjusted EBITDA of $8 million, a year-over-year increase of 44%, exceeding the high end of our guidance. Despite a late in the quarter build of inventory as we chased into demand, we generated $3.5 million of operating cash flow. We registered another strong quarter of active customer growth, up 11.7% on a trailing 12-month basis. We ended the quarter with net debt down 13% from the prior year and down 20% on a two-year stack. In addition to planned new Princess Polly store openings in Scottsdale, Fashion Square and Ann Street in Boston, and the Fashion Valley Mall in San Diego, we signed two new leases for additional locations in Irvine and Santa Clara, California, which we expect will bring the Princess Polly physical presence to six locations by year-end, with more expected to come in 2025 and beyond. Petal & Pup's expanded omni-channel presence has exceeded expectations, setting the stage for continued growth and brand expansion. Leveraging the successful experience of Petal & Pup, our streetwear brand, Minimal, launched a small test on Nordstrom.com. Lastly, Culture Kings US delivered another strong quarter of double-digit net sales growth on top of strong results last year. Turning now to more details on the second quarter, we generated $149 million of net sales, a 10% constant currency increase over last year, far exceeding our expectations. The momentum in the U.S. business accelerated, with net sales growing 19.3% over the prior year period, reaching $95 million and accounting for 64% of net sales for the quarter, up from 54% last year. We remain very pleased by the accelerated strength we are seeing in the U.S. region, which remains our fastest-growing and most profitable growth region. Our success remains broad-based, with strong product acceptance across our brands, coupled with growing brand awareness and attracting many new customers. Our Australia and New Zealand region results sequentially improved, ending the period with a net sales year-over-year contraction of only 5%. With a combination of reduced inventories in the region and our shift to a test-and-repeat merchandising strategy, we expect to experience second-half year-over-year gross margin expansion. Our operating performance well exceeded the high end of our expectations as we registered adjusted EBITDA of $8 million, a year-over-year increase of 44%. Looking at our first-half performance, our momentum is accelerating, and our results are being fueled by the transformational work we started in 2023. We registered first-half year-over-year net sales growth of 3.6% with strong flow-through, resulting in EBITDA growth of 15%. Although there is much work ahead of us, with our strong first-half results, I'm even more confident in the opportunity we see in the U.S. to expand our brand portfolio and total addressable market. We are committed to our strategic priorities as we continue to build on our portfolio of next-generation brands for the next generation of consumers. Just as in our first-quarter call, I will take a moment to reiterate our strategic operating framework for 2024, including our three key strategic priorities. Priority number one: retain existing and attract new customers. Over the last 12 months, we added 420,000 new customers, which included the addition of 180,000 new customers during the second quarter, resulting in our active customers for the quarter increasing by nearly 12% over the prior year. Our level of product newness has never been higher. Our assortments are resonating strongly, enabling a greater level of full-price selling, which fuels expanded gross margin results. Marketing efforts are yielding strong returns on investments, positioning us well for continued active customer growth across our brand portfolio. Priority number two: we remain committed to showing up for our customers wherever they choose to shop with us. Alongside enhancing our online channels, we continue to test and expand our omni-channel strategies, including experiential stores, wholesale, and marketplaces. I'm pleased to report that we are seeing success across all channels of distribution, which signals that our brands are meaningfully underpenetrated in the U.S. market. As our awareness increases, we continue to expand our total addressable market. Priority number three is to streamline our operations to deliver financial benefits. The strong second-quarter flow-through in which our net sales growth of 9.5% contributed to adjusted EBITDA growth of 44% as compared to the same period in the prior year showcases our ability to drive outsized profitability. This is a direct result of the transformational work we started in 2023, as well as the instilled culture to always look for ways to improve overall efficiencies, share best practices, and leverage the AKA platform to drive additional improvements in our results. Now let me share some highlights from our brands. Our largest brand, Princess Polly, which focuses on trend-based fashion targeting Gen Z and millennial women, posted another strong quarter of growth with particular strength in dresses. Approximately 35% of the brand's new styles were made with lower environmental impact materials, which is up from 30% a year ago. Shifting to physical stores, we believe stores serve as a powerful customer acquisition tool and provide customers with unique brand experiences, creating a halo effect that expands our digital reach. The LA store continues to perform strongly. We're excited for the five new Princess Polly store openings expected to occur in the second half of 2024, with two scheduled in the third quarter and three in the fourth quarter, all in time for the holiday season. The team remains focused on developing immersive brand experiences, engaging influencers, and college ambassadors. Petal & Pup's second-quarter performance was outstanding, particularly across the brand's omni-channel efforts. Petal & Pup is now being offered on major online platforms, and the brand saw a significant uptick in new customers in the second quarter. We remain pleased with Petal's launch into modern romance and wedding collections, with many styles selling out swiftly. Culture Kings US delivered another quarter of strong double-digit net sales growth. Culture Kings is disrupting the streetwear market with an immersive experience across channels. We continue to see strong sales performance, particularly in our flagship Las Vegas location. Minimal's spring collection achieved record-breaking seasonal sales, successfully expanding its wholesale strategy. I'm optimistic about our streetwear brand's long-term growth potential in the US and globally. For the second quarter, net sales increased 9.5% to $149 million, driven by strength in our US business. While we saw softer sales in Australia and New Zealand compared to the last year, we observed meaningful sequential improvements as brands gained ground in the US. Total orders for the second quarter increased 16.4% compared to last year. Our trailing 12-month active customer count rose to 4 million, a 12% increase year-over-year. Gross margin expanded 80 basis points to 57.7% driven by lower airfreight costs and strong full-price selling. We're committed to managing our inventory effectively and optimizing our operational efficiency. We delivered adjusted EBITDA of $8 million compared to $5.6 million in the same period last year, ahead of expectations. Adjusted EBITDA margin for the second quarter of 2024 increased 130 basis points to 5.4% compared to 4.1% in the same period last year. We ended the quarter with $25.5 million in cash and cash equivalents, debt totaling $106.9 million, and inventory levels flat with the previous year. In the second quarter, we repurchased shares for a total cost of approximately $100,000. Now turning to our outlook for 2024. Given the strength in our first half results, we are adjusting our outlook to expect $560 million to $565 million in net sales for the full year. For 2024, we expect gross margin between 56% and 57%. We anticipate selling expenses to be approximately 27% of net sales and marketing expenses around 12.5%. For the year, we expect adjusted EBITDA of $20 million to $22 million. In summary, we've delivered a very strong quarter with double-digit constant currency top-line growth leading to EBITDA growth of 44% year-over-year. The transformational work we initiated in 2023, combined with our culture of innovation, is driving meaningful improvements across the business. We remain committed to building our portfolio of next-generation brands while focusing on executing our strategic priorities. We'll continue to look for opportunities to expand our total addressable market. I appreciate your engagement with a.k.a. Brands. We feel we made significant progress in executing against our strategies and demonstrating the opportunities to scale profitably. Thank you for your time.

We will now conduct a question-and-answer session. One moment while we pull for the first question. The first question comes from Randy Konik with Jefferies. Please proceed.

Yeah, thanks a lot, and good evening. You guys are seeing a lot of success with the multi-channel approach you've been undertaking, whether it's stores, wholesale, and obviously DTC with e-comm. If you think about over the next few years, how do you think about the optimal channels mix in the business?

Thanks, Randy. I appreciate the question. We are seeing great success. We're happy with the progress and results from the transformation work we've started over the last couple of years, with overall sales up 9.5% and the U.S. up 19%. We really look for opportunities in channels that elevate our brands and meet our expectations for economics. Our learnings from tests over the past months show tremendous opportunities across our brands, with Culture Kings and Poly’s stores ahead of expectations on sales and profits. We think long term that we will remain predominantly a direct-to-consumer business, but see opportunities for all brands to expand in omni-channel strategies for further growth.

That’s super helpful. My last question is regarding the fashion landscape. Are you observing a shift in consumer behavior that is benefiting your business?

Yes. Thanks, Randy. We're fortunate to have great brands that customers love. Most of our products are proprietary and exclusive. Our test and repeat model allows us to stay close to trends that resonate. Our active customers have increased by 12% year-over-year, totaling nearly 420,000 customers. We’re seeing success across the board, especially with dresses at Princess Polly and Petal & Pup. We're optimistic about our ability to leverage the test and repeat model while staying customer-focused.

Good afternoon. Congratulations on the upside for the quarter.

Thanks, Eric.

I want to talk about Culture Kings. We are entering the period now where you're going to shift that business over to the test and repeat mode. How should we view those opportunities going forward?

Yes, sure. We’re happy with Culture Kings’ progress. It continues to be up double-digits in the US. Transitioning first-party brands to test and repeat presents an excellent opportunity. We expect to see margin expansion in the back half of the year while managing the promotional activity from last year. We're excited about the potential of this model.

Great. What’s the outlook for the new Princess Polly stores based on the performance of the Century City store?

We’re excited to expand Princess Polly stores further. The LA store has performed well, benefiting overall growth. We'll utilize the learnings gained from the LA store to enhance merchandising in new stores while maintaining a compelling online experience. There’s enormous opportunity for growth in direct-to-consumer and omni-channel aspects.

Congrats on the strong performance. Can you elaborate on the drivers of this quarter's performance?

Certainly, we’re delighted with the quarter’s results. The direct-to-consumer channel had the largest impact. Princess Polly showed notable growth, as did Petal & Pup with their omni-channel initiatives. The robust US performance at 19% growth is particularly encouraging.

Can you discuss any upcoming debt maturities and your plans?

Our debt matures in September 2026. Last year, we paid down $50 million of debt, and we expect to continue paying down more in the latter half of the year. We want to maintain a low leverage ratio while continuing to see our EBITDA grow faster than sales.

Good afternoon. Can you talk about the challenges in Australia and when you expect growth there?

We are making progress in Australia. The sequential improvements we observed are promising. Culture Kings is transitioning to the test and repeat model, and we anticipate it will yield significant benefits in margin expansion moving forward.

What is your strategy for Princess Polly's future store openings?

Princess Polly has vast growth opportunities in the US. We're excited about the expansion and are working hard to ensure we select ideal locations based on customer data and feedback. Our direct-to-consumer path looks promising.

How will you manage potential tariffs affecting your suppliers in China?

Thank you for your question. We're focusing on diversifying our supply chain and testing strategies to manage potential impacts effectively. We'll provide updates in future calls. Thank you all for your engagement with a.k.a. Brands. We feel we've made significant progress on executing our strategies and demonstrating opportunities for profitable growth. Thank you for your time.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.