Usually, the juicy, salacious stuff comes to the fore during recession or crisis, when past misconduct can no longer be concealed. Recently, between Valeant Pharmaceuticals, and Volkswagen, there are plenty of good fraud stories to go around. Yesterday, sigh, Iconix Brand Group (ICON) revealed that its accounting statements, since 2013, were presented with smoke and mirrors. The revelation comes after the former CEO, and founder, Neil Cole (Kenneth Cole’s brother) left abruptly in August to “pursue other interests”. Perhaps there is a good backlog of dodgy accounting, and insider shenanigans to expose after the 6-year recovery since the financial crisis. The story of Iconix is a fascinating one, and rhymes with other high profile deceptions over the years, such as, Valeant, Enron, and WorldCom; beware of acquisitive growth that looks too good to be true! Iconix corporate history prior to 2005 is unclear. A stock traded since an IPO in 1990, and the company bought its first brand, Candies, in 1993. Neil Cole is credited with the current formation of the Iconix corporate structure over the past 10-years. The company business model:
1) raise capital through a combination of debt & equity
2) use proceeds to purchase distressed or bankrupt brands
3) “fix” the brands that struggled/failed previously through involvement in the design/marketing process
4) either just before or after step 3 – Iconix signs agreements with retailers on a royalty structure and guaranteed minimum payments
5) collect royalties and payments from the retailer without the need to manage retail markups and inventory
The above model worked well enough for several years, with ICON stock peaking in 2014 at $44, a market capitalization over $2 billion. For companies that grow through acquisition, more deals, and low scrutiny, are often required to sustain the semblance of a sound business model. The organic growth rate of the acquired businesses are generally negative; reclamation projects of failing brands may be cheap, but generally quite difficult to turn into growth vehicles. Some of the brands owned and managed by Iconix include (partial list): Candies, Rocawear, Pony, Badgley Mischka, London Fog, Ocean Pacific, Ed Hardy, Danskin, and Sharper Image. Prior to August, it was already a tough year for Iconix. The stock got cut in half as business trends slowed and retailer results came under pressure. The Iconix timeline in bullet point form:
- August 6th 2015 – Neil Cole resigns as Chairman of the Board, and CEO, of the company he founded. After leading the company, for 10-years, Neil agrees to be a “special advisor” for 7-weeks.
- Peter Cuneo, Iconix board member, agrees to be Interim CEO. His recent experience includes investing in comic book characters with his sons (from the press release): Mr. Cuneo is currently the Managing Principal of Cuneo & Company, LLC, a private investment and management company, in which his sons, Gavin and Colin are partners. Cuneo & Co. is focused on making investments in private companies within the consumer, retail and entertainment oriented industries. Some current investments include: Valiant Entertainment Inc. (comic book character based entertainment), Herotainment, LLC (online gaming based children’s entertainment), West World Media Inc. (entertainment exhibition data aggregation), and RangeWorks, LLC (multimedia producer of western American entertainment) among others. In recent years, Mr. Cuneo has also served as senior advisor to a large distressed and special situations hedge fund co-investing in select private companies in the consumer and media sectors.
- August 10th 2015 – 2Q15 earnings conference call takes place in which Iconix lowers its financial projections for the year. Sales cut from a midpoint of $500m to a midpoint of $417m. 60% of the newly reduced sales estimate comes from guaranteed minimum payments.
- An SEC staff review on past securities filings remains ongoing.
- The board of directors forms a special committee of independent directors to review accounting treatment for joint ventures.
- When asked for color about Neil Cole’s resignation on the conference call, Peter Cuneo responds that Neil resigned to pursue other business opportunities and there is nothing more to add.
- November 5th 2015 – Special committee determines that 3-years worth of financial statements will need to be restated based on expense classifications
- Preliminary third quarter results are a bomb, well below the prior expectations, based on write-down of account receivables, tax adjustments, severance, costs related to the SEC audit, and continued slowdown at retail.
- Updated guidance for sales of $370-$380 million, 25% below sales expectations in the spring.
- Earnings expectations are reduced dramatically to $1.35-$1.40 on the year from $2.00-$2.15 prior.
- As of the most recently reported quarter, ICON has $1.5 billion in debt relative to EBITDA that will perhaps amount to $150m.
- ICON stock price tumbles 51% in the after-hours from $16.14 to $7.87 on heavy volume.
Not a great fact pattern. Maintaining noncollectable A/R on the books is a material misstatement of financial results and capital structure of the firm. The negative spiral of operating trends, high debt load, management transition, and misleading accounting practices over the past 3-years will put Iconix in extreme distress. Lawsuits are coming, and Iconix stock will be questioned as a going concern. Of the eight Wall Street firms covering ICON, four recommend buying the stock, four holding, no sells (although downgrades suspected). Look for the apparel licensing space to come under scrutiny/pressure; peers include Sequential Brands (SQBG) and Cherokee Inc (CHKE).