Inter Parfums, Inc. (IPAR) Q3 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Inter Parfums Inc. Third Quarter 2012 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Russell Greenberg, Executive Vice President and CFO. Thank you. Mr. Greenberg, you may begin.

Thank you. Good morning, and welcome to our 2012 third quarter conference call. Following the financial review, I will turn the call over to Jean Madar, our Chairman and CEO, who will share some business highlights and then we will take your questions. Before proceeding further, I want to remind listeners that 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 and the 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. When we refer to our European-based operations, we are primarily talking about sales of Prestige Fragrances conducted through our 73%-owned French subsidiary, Inter Parfums SA. This business includes distribution companies owned or controlled by our French subsidiary such as InterParfums Luxury Brands, which took over U.S. distribution of our European-based Prestige Fragrances in 2011. It also includes our distribution subsidiaries in Germany, Italy, the United Kingdom and Spain. When we discuss our United States operations, we are generally referring to sales of specialty retail and mass-market products. Specialty retail products are typically sold at namesake stores domestically, and in department and specialty stores in the United States and internationally under license agreements with the brand owners. Moving on to our third quarter. Net sales decreased 3.2% to $166.3 million from $171.7 million. At comparable foreign currency exchange rates, net sales actually rose 2%. European-based operations generated sales of $148.6 million, down 4% from $154.7 million, and sales by U.S.-based operations were $17.7 million, up 4% from $17 million. Gross margin was 60.8% compared to 62.5%. SG&A expense as a percentage of sales was 47.5% compared to 50% in 2011. Operating margin was 13.3% of net sales compared to 12.6% of net sales in 2011. Net income attributable to Inter Parfums was $10 million compared to $10.4 million. And basic and diluted earnings per share came out to $0.33 per share compared to $0.34. Thus, for the 9 months of 2012, net sales reached $477.2 million or 12% ahead of the $426.1 million reported in the same period of 2011. At comparable foreign currency exchange rates, net sales rose 16.9%. Net income attributable to Inter Parfums increased 11.8% to $31.5 million or $1.03 per basic and diluted share, from $28.2 million or $0.92 per basic and diluted share in 2011. We are on track to achieve our 2012 guidance, which anticipates net sales of approximately $632 million, net income attributable to Inter Parfums of approximately $35.9 million, or $1.17 per diluted share. This guidance, of course, assumes that the dollar remains at current levels. And keep in mind that on November 21, we will announce our formal guidance for 2013. We already covered the subject of third quarter sales by brand and region in our October 23 sales release, and some of these points were also referenced in yesterday's news release. So let's move on from there. Gross margin was off slightly, despite the margin gains associated with the stronger dollar versus the euro. These gains were entirely offset by changes in product mix including a larger proportion of value sets and also because of some discounted sales of certain slow-moving product lines in our third quarter. The decline in SG&A expense as a percentage of net sales for the third quarter is due in great part to a reduction in promotional and advertising expenses included in SG&A, both in dollars and as a percentage of net sales. In the current third quarter, promotion and advertising included in SG&A expenses declined to $31.2 million or 18.8% of net sales. That compares to $37.2 million or 21.6% of net sales in last year's third quarter. As most of you know, in 2011, our promotion and advertising budget was heavily weighted in the second half, corresponding with the advertising campaign rolled out for the launch of Burberry Body. This year, our advertising and promotional budget has been more evenly distributed throughout the year. However, for the first 9 months of 2012, our promotion and advertising is actually running slightly ahead of last year at $88.3 million versus $78 million for the same period in 2011. For the current third quarter, royalty expense included in SG&A aggregated $14.7 million or 8.8% of net sales as compared to $14.3 million or 8.3% of net sales for the same period in 2011. Also, as mentioned in our release, foreign currency losses aggregated $1.4 million for the current third quarter compared to a gain of $1.2 million in the corresponding period of the prior year. We have a very strong balance sheet and excellent liquidity. At the close of the third quarter, cash and cash equivalents aggregated $26 million. And working capital aggregated $241 million, for a working capital ratio of 2.8:1. We also had no long-term debt. Through the first 9 months, Inter Parfums generated cash flow from operations in excess of $22 million. Before passing the call on to Jean, I just want to mention our transition agreement with Burberry, which runs through March 31, 2013, under which we will continue to operate certain aspects of the Burberry fragrance and beauty business. The transition agreement confirms that the exit payment of EUR 181 million or approximately $230 million at current exchange rates, that was EUR 181 million, which translates to $230 million at current exchange rates, excluding receivables, inventory and other tangible assets, will be made by December 31, 2012. Jean, please continue.

Thank you, Russ, and good morning, everyone. Thank you for your participation on today's conference call. Last month, we announced the 20-year worldwide license agreement with Karl Lagerfeld to create, produce and distribute perfumes under the Karl Lagerfeld brand. We are replacing Coty as the brand segment's licensee. And as you will read in our 10-Q, which we have just filed, we paid the license entry fee of around EUR 10 million or approximately $12.5 million. And in addition, we have made an advance royalty payments to Lagerfeld of approximately EUR 10 million, which is $12.5 million, which will be credited against future royalty payments. So we are on the same page with the Karl Lagerfeld team when it comes to brand positioning. In fact, I saw an interview in one of the [indiscernible] of the CEO of Karl Lagerfeld and he said of Inter Parfums, something along the lines of love at first sight when they met with us. We feel exactly the same way. Karl Lagerfeld is a fabulous addition to our luxury fashion brand portfolio. And we will give the brand a fresh start and we're not going to be marketing the brand's existing fragrances. The launch of the new fragrance under the Karl Lagerfeld brand is scheduled for 2014, second half 2014. So this was about the latest announcement that we made. Regarding Burberry, of course, we'll discuss Burberry. I would like to say that we had a great run with Burberry and we are very enthusiastic about the new chapter in our corporate life without Burberry. We have every confidence that, over time, we will be able to rebuild lost sales by growing our current ones and by adding new ones, as I just mentioned, Karl Lagerfeld, will be an important addition for replacement of the Burberry business. And as I said on the second quarter call, we have had some very interesting growth with many of our brands. For example, Lanvin fragrances has grown at a compounded annual growth rate of 22% from 2004 to 2011, so that's 7 years at 22%. As for the first 9 months of this year, the sales were up 13% in local currency. Also, yesterday's [ph] Montblanc fragrances are up 73% for the first 9 months, confirming the continued success of Legend, our first men's scent, introduced last year. And the Jimmy Choo fragrance sales, based upon the signature scent that was launched in 2011, were up 43% in the first 9 months of this year. Regarding the other brands in our portfolio the release of Boucheron fragrance and the first initiative with Jaipur Bracelet, a new product, has given us sales of EUR 13 million. And this gives us a high degree of confidence in the future of this brand. And as we previously announced, we have a big line up of product launches in the works for 2013, almost all our brands will have a new fragrance next year. Also, we are, of course, pursuing other designers and brand owners and while we are hopeful, we cannot assure you that in the agreements with design [indiscernible] we are absolutely working on it. Similarly, we are working on a number of new names for our U.S.-based operations. From it's early days as a developer and supplier of fragrance and other personal care products to GAP and Banana Republic stores in North America, we then have added names and global distributions to its resume. Many of the brands for whom we trade product have now international appeal. For example, Anna Sui is huge in Asia, while bebe is a highly sought after brand in South and Central America. Iconic American names like GAP and Banana Republic have a big following overseas, and we are selling these products to department stores, perfumery, specialty stores, travel retail, overseas under a license royalty arrangement with the brand owners. We have some notable and continuing strengths: A very strong financial position, which will get even stronger by year-end with the payment that Burberry agreement [ph] ; the first-class reputation in our industry as a brand leader [ph] , as a worldwide distribution network; a scalable business model; a balanced and growing portfolio brand, which will be growing in the future; plus a very creative and talented staff in Paris and in the U.S. So before I take your questions, since this is our last conference call for this year, Russ and I want to wish you a very best for the holiday season and the coming year. One last point, Russ and maybe myself, will be presenting at the California Women's [ph] Conference on December 11, which this year will be held in New York. This ends our prepared remarks. So operator, you can open the floor for questions.

[Operator Instructions] Our first question comes from the line of Neely Tamminga of Piper Jaffray.

I want to just ask a very high-level question, Jean and Russ, in terms of kind of this post Burberry sort of outlook for the next couple of years. Is the strategy here to kind of redeploy into one big whale of a license or is the strategy kind of shifting towards collecting some very up-and-coming potential fish, per se? We're just trying to get a better sense as to what some of the next steps possibly can be from that perspective.

Thank you for this interesting question. I'm going to try to answer. Russ, will have maybe something to add. What I would like to say is we signed with Karl Lagerfeld just now. But even if we had Burberry, we will have signed with Karl Lagerfeld also. We think it's an extremely important addition and we had this opportunity. So of course, the first idea [ph] is going to be to replace the Burberry business. And it could be made with 5 different new names or one big one. But I think, it's going to be, as usual, very opportunistic and be very close to what the market has to offer us. And I will not tell you that I want to concentrate only on one big brand [ph] . Definitely, we want to use the money to deploy and to begin the business and grow the business. Lagerfeld, which has a huge potential, was not very expensive. As I mentioned before, the cash outlay was $20 million, but the real cost is really at $10 million because the other $10 million we had earned from the royalty. And in 2014, we'll be able to launch a whole new line of Karl Lagerfeld product. Karl Lagerfeld has an unbelievable name recognition in China, in Japan, in Europe, East Europe or West Europe and of course, the U.S. So we have here a name that can give us some interesting results in 2013, 2014. Russ, you want add something?

Yes. Just to go back -- I think, to summarize what Jean is saying really is we're going to be opportunistic. It's very difficult to sit here and determine what might come across our desks in the future. It could very well be in the form of, as you coined the phrase, a whale, it's very possible. Or it could be a series of smaller types of acquisitions, similar to what the company has done in the past. The real key here is what opportunities are going to come across our desk.

And I do want to follow up, and I really should have led with this for you guys, I mean, it is a fantastic get, from our perspective, on the Karl Lagerfeld license. So I do want to congratulate you there. I think what you guys have proven over more than a decade is the ability to identify those next great global brands. And I think that that's completely right on point with your expertise. I guess the other way to ask this is, are there existing relationships you have in your portfolio that you think are -- I mean, with the growth rates that you kind of listed off here today on some of these names, I mean can some of these brands be the next Burberry in terms of sheer size to your P&L? We're just kind of conceptualize -- and conceptualize that a little bit.

I think that there are at least 3 or 4 brands within the portfolio that clearly have the potential to be EUR 100 million brands or $130 million, $120 million, $130 million plus. I think the one interesting thing with respect to the portfolio is it's certainly moving towards a much more balanced portfolio of brands. But what we are really looking for are brands that can reach at least that EUR 100 million mark. Maybe it might take 3 years, 4 years or 5 years, but that is part of the business plan that we're putting together when we evaluate new potential licenses.

Our next question comes from the line of Joe Altobello of Oppenheimer.

First question, I wanted to kind of delve into the transition agreement with Burberry for 1Q. It sounds like it's not quite business as usual, you're only going to be taking on certain aspects of -- I think, with that certain aspects of that license, what's the potential sales contribution in 1Q from that brand? And what's the profitability look like? Is it more or less than what you guys are seeing right now?

What was the first part of your question, I'm sorry?

The sales contribution you might see from Burberry, because it's obviously not quite business as usual.

Yes. It's not business as usual. I believe we've even stated that there's even a cap in connection with sales during that quarter. But it's not going to be anything that is materially different from what you would ordinarily expect in the first quarter, all right, for a brand that is not going to see a new launch, all right. Because we're certainly not going to launch and come out with an advertising program for a new product in the very last quarter. As far as ...

This transition really came -- Burberry came to us and asked us to continue for 3 months, because they are not ready, they are not ready [indiscernible]to take the business over. So we are going to continue to invest [ph] and we will keep the margin. And like Russ said, it's one quarter, so we say that we will not do more -- in one quarter, [indiscernible] of Burberry.

Yes. I think that the profitability would be -- is similar to what would be in the ordinary course of business. The key here is what's the purpose of the transition agreement? The main purpose is to effectuate a smooth transition of this business in the most orderly possible way and hand it over to Burberry. We want to make it favorable for us and for them. This opportunity, we're using it to bring inventory levels down. We've agreed, as a matter of fact, we've disclosed that we expect inventory levels by the transition to be under EUR 15 million, right?

[indiscernible] inventory we have left at the end of March, either Burberry will buy it or we will sell it in a sell off period. So the goal is to -- is really to protect the brand and don't forget, we've been doing these brands for almost 20 years. So it's important for us not to lose any market share and momentum during this transition. And that's why we have agreed to help Burberry in this [ph] transition.

Okay. Got it. And then secondly, you did allude to, both on the call and on the release, the margin impact you're seeing from the sales from slow moving goods at a discount. It feels like it's a little more than normal, I guess, since you called it out. But where are you seeing that and which channels and which products are slow moving? And is that continuing into fourth quarter?

I don't really feel it will effect the fourth quarter at nearly as much. But as always, not every product we launch is a home run. We've had some issues in connection with the Burberry Sport line, all right. And here, it's a matter of just moving through some of the inventory issues that we have. I've always said that you're never going to see any significant losses in connection with the sell off of any finished good product that we have. Because we can always, at least, recoup cost, and in this case, it's even much more than cost. But every once in a while, we do have to watch and we do have to work through inventories that may be a little bit of the slow-moving items.

And I think, there was [indiscernible] some slow-moving products. But so soon, the third quarter, don't forget, we ship a lot of our gift sets for Christmas and these gift sets, which represent at least 30% to 40% of our sales of the third quarter, typically, has a higher cost of goods than the regular product. So I don't know what was the gross margin in the third quarter of last year [indiscernible] it's 2% [indiscernible], absolutely in line with that perspective [ph] .

Our next question comes from the line of Eric Hollowaty of Stephens Inc.

A while back, you referenced a travel amenities business that could serve maybe as a longer term growth platform to leverage some of your existing brands. I'm just wondering whether if there was any update on that, that you could give us?

Yes. Last time we mentioned the growth of this new segment, I would say -- or not segment, but new area of business. And we have signed with a chain, the new hotel [ph] chain, a hotel called Sofitel. We will be supplying them shampoos, lotions under the Lanvin trademark. We have started already delivering to certain hotels in the world. Russ, you have more details of how many are in the agreement and how many...

I know that there's 120 -- it's a 120-hotel chain. The exact number of rooms, I don't have that information off the top of my head. But we can certainly provide that to you eventually.

But it is the first -- this is the first. We have a -- it is a contract that we are signing with them for 3 years. And we've got to see some -- we're going to see really in the fourth quarter, and of course next year, the positive impact on sales and margin and profit.

That's great. How should we think about the margin profile of that business? Is that better, worse, comparable to...

It's similar and in line with our specialty retail business, which typically generates somewhere around the 50% gross margin. But keep in mind that there is no advertising, there is no selling expenses, there is no extra marketing or merchandising type of expenses associated with sales of these products. Once you sign the contract with the customer, you're basically going to achieve your margin.

Our next question comes from the line of Linda Bolton-Weiser from Caris & Company.

So just in terms of your deployment of the proceeds from the Burberry license. Obviously, you're going to be opportunistic and look for the best things to do as you always have, but you can't control the timing of that. Is there a point where you say, "Okay, time has gone on, we have this cash sitting here, and we've done the deals that we can do" And therefore, you would consider like a special dividend or something like that. What timing are you giving yourself to make that conclusion? Like, are you going to give yourselves all of 2013? And if you come to the end of 2013 and there is still a bunch of cash sitting there, would you do it then? Or what's kind of your thinking on the timeframe?

Currently, as we say, the objective is to attempt to deploy as much of the cash, if not all of it, as possible. I think, as we move into 2013 and maybe, as we get 6, 7 months down the road, we're going to have to look at where we stand, what potential deals are we working on? How close do we think we are? What are the potential sizes? I mean, nobody wants to sit on that much cash at one time. We've always talked about other potential uses and those are still up in the air. No decision has been made whether or not there's going to be any sort of a special dividend, whether or not we can do stock buyback. I mean, all of that is up in the air, it's open for discussion, but we really want to use the time or the initial time is the opportunity to deploy it because we do believe that, that is the most accretive use of the funds. So I would say, as we move into the middle, maybe, between the second and the third quarter of 2013, we will be taking a little bit of a harder look of the situation and the macro situation as to where we fail [ph] .

And to add to what Russ said, it depends also on the size of the target, the size of the next [indiscernible]. That's why we think if we are looking at a $400 million acquisition, then we have $200 million of cash, we can go [ph] , $200 million. But if we are looking at $50 million or $100 million acquisition, we would use the cash and we could also do a special dividend if we think that we don't need to keep the cash in the company. So I think [indiscernible] we are in a good position. And interestingly enough, because of course, a lot of people know that we have this money, we are now looking at [indiscernible].

[Operator Instructions] Our next question comes from the line of Rommel Dionisio of Wedbush Securities.

Over the last couple of years, you guys have brought some of the distribution in certain European markets, some in the United States, in-house. But I just wondered if that was something that you're continuing to evaluate for other markets other than the ones that you've already done?

Yes. That's an interesting question. When we first started looking at the potentials of vertical expansion, we selected the 4 countries in Europe that's around France because of the proximity to France, the ease to oversee the distribution within those territories out of our home office in Paris. The United States was much more of an opportunity, taking advantage of an opportunity at a particular point in time. In many of the other countries around the world, we are working with some of the most well known and largest distributors in those countries that -- it doesn't necessarily make sense, at least at this point in time, to look at further vertical expansion from a distribution network. We will continue to look at it and evaluate it but currently, I really don't see expansion going beyond the 6 countries that we currently have our own distribution network.

That doesn't mean that we are not present in the other countries, we have -- but we think that having distributors, with big sale stock in Russia or in the Middle East, carrying also other brands than the brands we have, it's better than adding our own little or small subsidiary in Dubai or in Moscow.

Exactly.

There are no further questions at this time. I would like to turn the call back over to management for any closing comments.

Thank you. And thanks, everybody, for your participation on this conference call. As always, whether you're on the call live or listening, if anybody should have any additional questions, as usual, I am available by phone. Thank you once again and have a great day.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.