Interparfums Inc Q1 FY2020 Earnings Call

Greetings. And welcome to the Inter Parfums First Quarter 2020 Conference Call. A question-and-answer session will follow the formal presentation. Please note that this conference is being recorded. I will now turn the conference call over to Russell Greenberg, Executive Vice President and Chief Financial Officer of Inter Parfums. Thank you, Mr. Greenberg. You may begin.

Thank you, operator. Good morning and welcome to our 2020 first quarter conference call. It is obviously not business as usual. What has happened since our last conference call on March 3 has been unlike anything any of us have ever experienced or even imagined. We see no need for me to read out the first quarter comparisons that were in the release we issued yesterday afternoon. I will devote my discussion to explanations of those results and to the balance sheet and cash flow items. John will then bring you up-to-date on how our business is faring through the COVID-19 pandemic, where we see bright spots and opportunities, where we see weaknesses and key aspects of our plan of action. As usual, however, I must read the following. This conference call may contain forward-looking statements, which involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from projected results. These factors include, but are not limited to the risks and uncertainties discussed under the headings Forward-Looking Statements and Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2019, the quarterly report on Form 10-Q for the first quarter ended March 31, 2020, and other reports we file from time-to-time with the Securities and Exchange Commission. We do not intend to and undertake no duty to update the information discussed. One more recurring message, when we refer to our European-based operations, we are primarily talking about sales of Prestige Fragrance products conducted through our 73% owned French subsidiary, Interparfums SA. When we discuss U.S. based operations, we are primarily referring to sales of Prestige Fragrance products conducted through our wholly owned domestic subsidiaries. Our consolidated first quarter gross margin of 61.5% of net sales was just 10 basis points off of last year's first quarter. Once again, the strong U.S. dollar had a positive effect on our gross profit margin for European operations, which rose 70 basis points to 63.9%, as compared to 63.2% from last year's first quarter. For U.S. operations, gross profit margin was 52.6%, compared to 55.1%, with the decline related to product mix. In particular, Anna Sui product sales declined sharply in January and February, as China closed down. This brand is a bestseller in Asia overall and in China, in particular, and the gross margins on Anna Sui product sales are among the highest in our portfolio of brands. As I turn the discussion to expenses, please keep in mind that our entire operational budget for the first quarter was based on our originally projected annual sales of $742 million. And as we discussed on our last conference call, our sales in January and February with the exception of China were pretty good. But when sales practically ground to a halt in March, our advertising and promotion campaigns were underway and there was nothing we could do to recover those expenses. So, for the first quarter, promotion and advertising included in SG&A expenses approximated 19.7% of net sales, compared to 15.4% in last year's first quarter. In a typical year, we budgeted around 21% of net sales for advertising and promotion, with the fourth quarter accounting for the largest percentage. This is not a typical year and with new product launches postponed, you can expect a decline for advertising and promotion in dollars, as well as, as a percentage of net sales in future quarters this year. For European operations, SG&A expenses declined 6.4% and represented 50.1% and 42.5% of 2020 and 2019 first quarter sales, respectively. For U.S. operations, where sales dropped 10.9%, comparable quarter SG&A expenses decreased 8.8% and represented 45.8% and 44.7% of net sales in 2020 and 2019. The first quarter story is one of significant erosion from the positive leverage that we've seen over the last couple of years. As the loss of fixed cost absorption produced a steep decline in our operating income and margin. We are looking for an even greater decline in the second quarter sales as compared to last year's second quarter. We have been able to rein in some advertising and promotion expenses, and of course, travel and non-essential expenses have been severely cut but loss of fixed cost absorption is expected to continue. We are looking for some improvement as the year unfolds, but until we see firm product orders, it is impossible to quantify. You probably saw that below the operating income line was a $954,000 gain on foreign currency, as compared to a $151,000 loss in last year's first quarter. Also, our effective tax rate was 29% and 27.4% for the current and prior year's first quarter. With the European rate dropping 1 percentage point, and the U.S. rate increasing from 12.1% to 20.9%. In last year's first quarter, tax benefits from the exercise of stock options significantly lowered our U.S. tax rate. One of the points Jean made on our last conference call bears repeating. When the coronavirus was first identified, we were worried about the supply of certain components coming from China, but because of tariffs imposed last year, we had already identified alternative sourcing. At this point, we not only have alternative sources but the Chinese factories we buy from are pretty much operational. On a related subject, you will see that our inventories at March 31 are relatively unchanged from year-end where there was little if anything being reported about COVID-19. At year-end, our inventory levels were built to support 2020 new product launches. Well, with the exception of Coach Dreams, which debuted in January, most of our major launches have been pushed into 2021. As a result, even though we have worked closely with our vendors to push out inventory purchases where possible, we anticipate that inventory levels will increase in the coming quarters. If there ever was a time for a strong balance sheet, it is now. We closed the first quarter with working capital of $386 million, including approximately $204 million in cash, cash equivalents, and short-term investments. We have a working capital ratio of over 3.7 to 1 and only $9.8 million of long-term debt. We also have $47 million in untapped credit facilities. Finally, as previously reported, we temporarily suspended our quarterly cash dividend saving us approximately $10.4 million per quarter. Now, I will turn the call over to Jean for a closer look at how we are doing, what we are doing, and our expectations.

Yes. Thank you, Russ. And good morning, everyone. Well, I won't repeat most of the points we raised in our release and Form 10-Q filed yesterday. I do think that the exceptional performance of Coach Dreams and GUESS legacy products are worthy of a special mention. I also think that there is value in pointing out certain fundamentals of our business model, which distinguish Inter Parfums from some of its peers and immunize us against some of the harshest effects of this pandemic. Let's look at them. Firstly, we are not capital intensive. We don't own factories. We don't operate stores. Our 2020 CapEx budget is only $4 million. We have 400 full-time employees worldwide, not thousands, and approximately two-thirds of our expenses are variable and our near-term fixed expense should come in at under $25 million per quarter. So we have always maintained an exceptionally strong balance sheet. So we don't need to raise money, not hire more people at present nor in the future to grow our business. While we have instituted a hiring freeze, we have not furloughed or discharged our employees, and although we have not cut any salaries, we have notified our staff that we will eliminate 2020 bonuses. Moving on to our market, as noted in the first quarter, the impact of COVID-19 was most severe in the Middle East and Asia, where net sales declined for us 44% in the Middle East and 37% in Asia, respectively, for the first quarter. In North America and Western Europe, where shelter-in-place and store closings were implemented later in the period, first quarter net sales declined 21% in North America and 11% in Western Europe. Towards the end of March and into April 2020, the northern part of Asia has reopened, with China taking the lead and South Korea and Taiwan following. We've seen some business bounce back. As noted, one of our best selling brands in Asia is Anna Sui and overall brand sales at retail were poor in January and February, but come March brand sales at retail were revived, due in great part to e-commerce sales and these trends appear to be continuing. However, to date, Japan, Australia, and the markets in Southeast Asia are still in the continuum phase and most retail outlets remain closed. Our consolidated sales for the month of April were down significantly. Yes, there has been an improvement in China, but sales in Western Europe and North America, our two largest markets continue to feel the effects of the pandemic. Much of Western Europe has recently reopened like Germany, very recently, Austria and now Italy, with others planned for later this month, France opened some stores yesterday. Several U.S. states have also begun to restart with more coming on-board in the weeks and months ahead. So things are moving in the right direction, also in the Middle East with shopping malls beginning to reopen. However, business in the UK, a very important market for us, Russia and travel retail are at a standstill. So as Russ noted earlier, second quarter sales will be down significantly. With regard to retail, the reopening of brick-and-mortar stores has been gradual, the process is complex and the regulations differ by country and locality. In general, stores must effectively deal with a number of issues including signage, sanitation, staff training, monitoring, masks for staff and for the consumers, and limiting also the concentration of customers; some have imposed curbside pickup, which is not conducive to fragrance purchases. Even with economies opening, our expectations are restrained, and quite frankly, we expect near-term demand for fragrance to be considerably less than last year. Moreover, while online sales have increased since stores closing, our online sales primarily rely on third parties, like department stores, specialty stores, Amazon, or Alibaba, rather than our own e-commerce site. Nonetheless, we're looking beyond 2020. Our business development team has been able to devote more time to exploring brand acquisition but so far nothing firm to report. So before taking your questions, one thing is Russ and I want to extend our appreciation to all of our employees, as well as our suppliers, our distributors around the globe for their effort during this unprecedented period. So now, operator, you can open the floor for questions. Russ and I will be glad to answer.

Thank you. Ladies and gentlemen, at this time, we will conduct our question-and-answer session. Our first question comes from Joe Altobello with Raymond James. Please state your question.

Hi. I wanted to ask about Asia, specifically Northern Asia, where markets are starting to open up. You mentioned Korea and China. What trends are you observing in brick-and-mortar retail in these two markets for April? Is traffic beginning to return? Is it up compared to last year or just higher than in February?

I closely monitor this situation. Traffic in physical stores has decreased this year compared to last year, and even in April, it remains lower. I anticipate a drop of around 60%. However, our business has benefited from e-commerce, particularly in China, where the fragrance segment online has surpassed physical retail. I believe we will continue to see growth in e-commerce that will offset the decline in traffic and sales at physical stores.

Exactly. That's very helpful. Thank you.

If you'd like, I can provide more details since I'm tracking this weekly and receive reports. China is a major concern for everyone. Korea is also a significant market. Due to travel restrictions, our robust duty-free business in Korea, which primarily serves Chinese customers, has completely halted. The reopening timeline remains uncertain. Additionally, stores in Japan are closed. That’s the current situation in Asia. If you have more specific questions, I can offer detailed information by country in Europe or elsewhere. Just let me know, and I'm here to help.

No. Absolutely. That's helpful. I just wanted to follow-up with that, you mentioned, travel retail, obviously, significantly impacted for the foreseeable future. I'm seeing a little bit of an uptick or significant uptick in e-commerce. If you could size for us last year how big travel retail was from a sales and earnings perspective? And how big e-commerce was for you guys?

Let's talk about the duty-free business. I have to tell you that we have reduced drastically our projections for the travel retail. At the end of the year, I expect this business to represent maybe 5% to 7% of our business, where last year it was, I would say, almost 20%, Russell last year in travel retail.

Yes. It's between 15% and 20%, absolutely.

This is where we are likely to feel the most significant impact because all duty-free airport operations are closed. We anticipate a substantial decline in traffic and there is also an issue with unpaid receivables from operators, which means we are hesitant to extend them more credit. Consequently, travel retail for Inter Parfums is possibly the most impacted segment of our business. We believe that recovery in other regions, such as Europe and the U.S., will begin in June, July, and August. As Russ mentioned, we have maintained a larger inventory than necessary for this year's sales, ensuring that if the market rebounds faster than expected, we can respond immediately with our existing inventory.

And in terms of e-comm as a percentage of revenue?

Russ, do you want to answer on the e-comm?

Yes. E-comm, Joe, as I usually say, is a little bit more difficult to quantify because of the fact that many of our brick-and-mortar customers also have an e-comm section and where we get some indications, but we don't know precisely how much of their business is actually done through e-comm. In China and in Asia, it's a little bit different because, Jean, I think, what is it close to 70% of the sales in China are through e-comm?

Yes. Yes, where if you put together the macys.com, sephora.com, ulta.com, all these third-parties e-comm for us. It's less than 5% of our business today.

Thank you. Our next question comes from Linda Bolton-Weiser with DA Davidson. Please state your question.

So in terms of your comment about fixed costs being less than $25 million per quarter, is that on the SG&A line alone or is that including some costs that are in COGS as well? And can you comment on how permanent those reductions would be? I mean, obviously, the bonus reduction would come back later. But can you just comment on sort of if any of this would be more permanent?

Well, the first of all, there is a little bit in COGS, but it's almost inconsequential. The only thing that's in COGS that is a fixed expense is your amortization and depreciation on tooling for the molds that we create for bottles, caps, and collars and things of that sort. So most of what we're talking about with respect to this $25 million is in the SG&A. And where we came up with the number is really we are looking at it as to what we expect in the near term. What we've done with respect to the fixed costs. As Jean mentioned, we did not furlough any employees. We only have 400 people. It took us a long time to build the team that we have. The last thing we really want to do is to lose some of the great talent that we have. Once this pandemic is over, we really do expect things to get somewhat back to normal and we would want to have this great team that we have. So it's a less than $25 million is a short-term number of what we're expecting over at least the next two or three quarters as we move through this pandemic.

And then, you commented on, like a down 50% number for retail store traffic. So would it be safe to say that the second quarter revenue is going to be down at least 50%? I mean, when you take into account all the travel retail decline and everything, is that kind of the magnitude that you're looking at maybe for the second quarter?

As Jean mentioned, the 50% figure refers to the brick-and-mortar retail in China.

Absolutely.

Right.

Brick and mortar in China was down 50% when the stores reopened. However, it's important to note that in April, all stores worldwide, except for those in China, were closed. So, instead of a 50% decline, we experienced a complete halt in sales. We have chosen not to provide guidance at this time. In the U.S., for example, there were no product sales during April because all our customers' stores were shut down. This scenario was anticipated when we adjusted our projections in March. We did not expect sales in April, but we believe subsequent months will show improvement, with some recovery expected in May and even better results anticipated in June. This upcoming quarter is going to be quite unusual.

Yes. And we can't make any projections, because the visibility really isn't there. Not only do we not know when different states within the United States might open, but certain countries around or other countries around the world. And then you also don't know what the acceptance rate of these stores opening is going to be. And that's the reason we don't have the ability, we don't have the visibility to actually put out any projections. But, honestly, in the second quarter, we expect that to be the worst quarter clearly without a doubt.

Thank you. That's helpful. And then, can I just ask you in terms of the cutting of the dividend, what KPIs or metrics or financial numbers or what would trigger your thoughts to bring back the dividend? Like, what kind of conditions would you want to see the business in to bring back the dividend?

That's a great question, and I often ask myself the same thing. My partner Philippe and I receive 45% to 50% of the dividend. We're considering when it will be appropriate to reinstate the dividend, and it's crucial to have better visibility for 2021. Once we have a clearer understanding of how 2021 will unfold, particularly with normalized sales and profit comparisons, we will definitely consider returning to dividends. It's worth noting that the decision was not purely cash flow driven; we had around $200 million, but we felt it was better to hold off for now. If our approach turns out to be too conservative and business rebounds more quickly than anticipated, we can easily reinstate the dividend. Russ, would you like to add anything?

Yes. I would like to add that during the Board meeting, a significant focus was on the cash flow issue. Once we achieve the necessary visibility and our projections indicate positive cash flow, the company will reconsider the dividend.

Thank you. Our next question comes from Wendy Nicholson with Citigroup. Please state your question.

Hi. Good morning. A couple of questions. First, just following up the online business because it's all going through third parties and you don't have to manage any of the fulfillment yourself. Is it fair to say that the margin of online sales is neutral to traditional brick-and-mortar sales, no advantage or disadvantage for you, is that right?

Absolutely, absolutely.

Okay. Second thing, yesterday –

Totally neutral.

On their call yesterday, Coty mentioned that some customers in the beauty sector were facing difficulties in settling their bills, leading to an increase in receivables for the quarter. I'm curious if you're experiencing any similar issues. I know you mentioned there are no liquidity problems, but Russ, are you encountering any challenges regarding receivables?

We are closely collaborating with nearly all of our customers, as everyone is trying to extend their timelines due to cash flow challenges. However, we have observed some collection issues in the travel retail sector. Some duty-free operators in the airlines are facing significant difficulties, as they are completely shut down, and we're experiencing some pushback regarding collections. Overall, we are maintaining strong relationships with our customers, with some on payment plans. There are a few retailers that appear to be at risk of bankruptcy, but none of our major customers have filed for bankruptcy at this time.

Got it. Okay.

And I'd like to add, if I may –

Yes.

I would like to mention that whether from our operations in Paris or New York, nearly all of our receivables, about 99%, are insured. As Russ mentioned, we do see some potential weakness with one or two travel retail operators, but the risk involved is limited to a few hundred thousand at most. We have not increased our reserves for bad debt or similar issues. However, our teams across Europe, the U.S., and Asia are collaborating with the finance department on collections, and I believe we are performing quite well, as the collection rate is slightly better than expected.

Got it. That's great. My last question, and thank you so much for letting me ask a couple, is on the push out of your new products, which makes total sense, the new launches. I guess the question is, is there inventory sitting there? Do you have bottles of perfume that you thought you'd be shipping that now you're not, is there any risk of sort of inventory obsolescence or any consideration there in terms of impact of those delayed launches? Thanks.

Yes. Thank you. It's a very good question because this is also something where the whole company spent a tremendous amount of time. So number one, the good news is that with fragrance, with perfume, we don't have issues with seasons, with size, with colors, as opposed to garments for instance. So the product that I'm producing today, it will be the same six months and one year and it is the same than the one I produced three years ago. So, yes, we have definitely a little bit more inventory than we would like. But, again, as we review on a monthly or quarterly our inventory, we have not increased at all the reserve for obsolescence due to having more inventories than that is necessitated by the situation. Russ, you want to add something?

Yes. The only thing I would say, just on your last comment is that in our industry because of the fact that you don't really have an issue with respect to longevity, it's very rare to actually have a write-down with respect to finished product. Even if you discontinue something, you can always find a market where you're going to sell it, where you can at least recoup your costs. Remember, our margins are extremely high. So the idea would be to at least recoup the cost of the product. So inventory obsolescence is not something that's very significant in our business.

Got it. Thank you so much.

We have successfully managed to deliver millions of dollars' worth of components in Paris and New York. As of the end of March, our inventory level remains consistent with December 31, but we anticipate a slight increase in the second quarter due to lower than expected sales. It's important to remember that we place our orders for components six to seven months ahead of delivery. Therefore, it is understandable that our inventory appears high at the moment. However, we expect to return to a more acceptable inventory level by the end of the third and fourth quarters.

Our next question comes from Steph Wissink with Jefferies. Please state your question.

Hi, good morning, everyone. I just have a few follow-up questions. First, Russ, this is for you. Can you clarify the minimum license agreement and whether there is a minimum guarantee associated with it?

Yes. Many of our licenses include minimum guarantees. However, we have been collaborating with all of our licensees since the pandemic began. In many instances, we have already made adjustments to the license agreements. Our aim is to modify these agreements so that payments are based on actual sales. So far, in most of our negotiations, we have successfully worked with our partners to ease the burden of the minimum guarantees.

Very helpful. Okay. Second question is just with respect to M&A, as you think about the post-crisis period, are you seeing anything even now around brands that might be loosened up in some portfolios that could be interesting for you to take on?

We have been working on several initiatives before the pandemic. Currently, everyone is essentially in survival mode. This pandemic has impacted nearly every industry, and potential licensors are also facing significant challenges. As a result, everyone is focused on maintaining their operations and preparing for opportunities that may arise after the pandemic. Many of the projects we were engaged in will likely come back into focus once things stabilize. During this period, we haven't pursued any new initiatives; our attention has been on current business matters. Jean, would you like to add anything?

Before the pandemic, we were actively looking to add a few compelling brands to our portfolio, and discussions were progressing positively. However, in the past couple of months, it hasn't been the right time to revisit those conversations as everyone is focused on protecting their businesses and their teams. Nonetheless, in the coming weeks or months, we plan to reengage and discuss opportunities with various interesting brands that we can potentially include in our portfolio.

Great. And then just a final housekeeping, I think, I wrote this down but right, Jean, but you said, your e-commerce business in China is bigger than bricks-and-mortar? Is that correct?

Yes, it's three times larger.

And has that been the case even pre-crisis or is that what you're seeing currently in this month?

Yes, it began nearly a year and a half ago when we initiated these programs with Tmall and JD. We have a strong distribution network in China. Several of our brands, such as Anna Sui, Lanvin, and Coach, are well-known in China, which has contributed to the success of our e-commerce business.

Thank you. Ladies and gentlemen, there are no further questions at this time. I'll turn it back to management for closing remarks.

Great. Thank you. And thank you all for joining in today's conference call. As usual, if you have further questions, please contact me by email and I will do my best to get back to you. Please be safe and stay healthy, and have a great day. Bye.

This concludes today's conference. All participants can disconnect. Have a good day.