Greetings and welcome to the Inter Parfums Q1 2020 Conference Call. At this time, all participants are in a listen-only mode. A question- and- answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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 Q1 conference call. It is obviously not business as usual. What has happened since our last conference call on March 3rd has been unlike anything any of us have ever experienced or even imagined. We see no need for me to read out the Q1 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. Jean 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 31st, 2019, the quarterly report on Form 10-Q for the Q1 ended March 31st, 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, Inter Parfums 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 Q1 gross margin of 61.5% of net sales was just 10 basis points off of last year's Q1. 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 Q1. 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 Q1 was based on our originally projected annual sales of $742 million. As we discussed on our last conference call, our sales in January and February, with the exception of China, were pretty good. 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. For the Q1, promotion and advertising included in SG&A expenses approximated 19.7% of net sales, compared to 15.4% in last year's Q1. In a typical year, we budget around 21% of net sales for advertising and promotion, with the Q4 accounting for the largest percentage.
This is not a typical year, with new product launches postponed, you can expect a decline for advertising and promotion in dollars as well 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 Q1 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 Q1 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 Q2 sales as compared to last year's Q2.
We have been able to rein in some advertising and promotion expenses. Of course, travel and non-essential expenses have been severely cut. 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 Q1. Our effective tax rate was 29% and 27.4% for the current and prior year's Q1, with the European rate dropping 1 percentage point and the U.S. rate increasing from 12.1- 20.9. In last year's Q1, 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. 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 31st 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. 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 Q1 with working capital of $386 million, including approximately $204 million in cash equivalents, and short-term investments, with a working capital ratio of over 3.7 to one, 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. Jean?
Yes. Thank you, Russ, and good morning, everyone. While 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-third of our expenses are variable, and our near-term fixed expense should come in at under $25 million per quarter.
We have always maintained an exceptionally strong balance sheet, so we don't need to raise money, nor hire more people at present, nor in the future to grow our business. While we have instituted a hiring freeze, we have not furloughed, nor discharged our employees. Although we have not cut any salaries, we have notified our staff that we will eliminate 2020 bonuses. Moving on to our markets. As noted in the Q1, 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 Q1. In North America and Western Europe, where shelter in place and store closing were implemented later in the period, Q1 net sales declined only 1% in North America and 11% in Western Europe.
Towards the end of March and into April 2020, northern part of Asia have 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 although brand sales at retail were poor in January and February, come March, brand sales at retail were revived due in great part to e-commerce sales, and this trend appear to be continuing. However, to date, Japan, Australia, and markets in Southeast Asia are still in the containment 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. Things are moving in the right direction, also in the Middle East, with shopping malls beginning to reopen. However, business in the U.K., very important market for us, Russia, and travel retail are at a standstill. As Russ noted earlier, Q2 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 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 are looking beyond 2020. Our business development team has able to devote more time to exploring brand acquisition, but so far, nothing firm to report. 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. 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. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Joseph Altobello with Raymond James. Please state your question.
Thanks. Hey, guys. Good morning.
Hi, Joe.
Hi. Just wanted to start, in terms of Asia in particular, in Northern Asia, where you're starting to see markets open up, you mentioned Korea, China, for example, curious what trends you're seeing in April, in brick-and-mortar retail, in these two markets. Is traffic starting to come back? Is it up year-over-year, or is it just up sequentially from where it was in February, let's call it?
Okay. This is something that I follow carefully. The traffic in brick-and-mortar stores are down this year compared to last year. Even in the month of April, the traffic is down. I expect for something like 50%. Our business was up because of e-com, the part of e-com in China, for instance, for fragrance, is today much bigger than the brick-and-mortar stores. We will see. I think we'll continue to see sales up in e-commerce, which will balance the fact that the traffic and the sales at brick-and-mortar stores are down.
Exactly. That's very helpful, Jean. Thank you.
If you want, I can add, because I'm following this on a weekly basis. I get reports. China is a big animal that everybody is looking at. As you know, for us, Korea is a very important market, and because there is no travel, all the very strong duty-free business that we had in Korea, especially serving Chinese customer traveling, is absolutely down to zero. When is it going to reopen? This is a big question mark. What else can I tell you? Japan stores are closed. That's all I can tell you for now for Asia. If you have other questions, I can give you more precise indications by countries in Europe, et cetera. If you need, I'm available.
No, absolutely. That's helpful. I just wanted to follow up with that. You mentioned travel retail, obviously, significantly impacted for the foreseeable future, and 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 travel retail. At the end of the year, I expect this business to present maybe 5%-7% of our business, where last year it was, I will say almost 20%, Russ, last year, travel retail?
Between 15% and 20%, absolutely.
15%. This is really where we're going to feel the most painful effect because all airport operators of duty frees are closed. We think the traffic is going to be way down. There is also a problem of exposure, receivables with operators that have not paid bills yet, so you don't want to give more credit. Really, the travel retail for Inter Parfums will be the most affected part of the business. The other territories, Europe, U.S., will start recouping. We think, in our projections, we have starting the month of June, July, and August. As Russ said, we have maintained a good amount of inventory, a higher amount of inventory that we need for the sales that we'll have this year. In case the market rebounded faster than we expect, we will have immediately the inventory to respond.
In terms of e-com as a percentage of revenue?
Russ, you want to answer on e-com?
Yeah. E-com, 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-com section. We get some indications, but we don't know precisely how much of their business is actually done through e-com. 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-com?
Yes.
Right?
If you put together the macy's.com, the sephora.com, ulta.com, all these third parties e-com, for us, it's less than 5% of our business today.
Less than five. Okay. Thank you, guys. Appreciate it.
Pleasure.
Thank you. Our next question comes from Linda Bolton Weiser with D.A. Davidson. Please state your question.
Hi, how are you?
Very good. You, Linda?
Good. Thank you. 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? Can you comment on how permanent those reductions would be? The bonus reduction would come back later, but can you just comment on if any of this would be more permanent?
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 or depreciation on tooling for molds that we create for bottles, caps, and collars, and things of that sort. Most of what we're talking about with respect to this $25 million is in the SG&A. Where we came up with the number is really we're 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. The less than $25 million is a short-term number of what we're expecting over at least the next two, three quarters as we move through this pandemic.
You commented on a down 50% number for retail store traffic. Would it be safe to say that the Q2 revenue is going to be down at least 50%? 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 Q2?
Jean mentioned the 50%, and Jean, correct me if I'm wrong, because I don't want to put words in your mouth. I think you were talking about the brick-and-mortar retail in China.
Absolutely.
Right?
Brick-and-mortar retail in China, where when the stores are open, it was down 50%. Let's not forget that in the month of April, all the stores besides China, all the stores worldwide were closed.
Yeah.
We're not talking about 50%, we're talking about 100%. We decided not to give guidance. Let's realize that in the U.S., for instance, we didn't sell any products in the month of April. This is because all the stores, all our customers were closed. Again, this was in our projections. When we redid our projections in March for the rest of the year, we didn't expect sales in April. It's going to be a little bit better in May. Already, we think that June will be, of course, better. It's going to be a very unusual quarter.
Yeah, we can't make any projections.
No.
The visibility really isn't there. Not only do we not know when different states within the U.S. might open, but certain other countries around the world. You also don't know what the acceptance rate of these stores opening is going to be. That's the reason we don't have the ability, we don't have the visibility to actually put out any projections. Honestly, in the Q2, we expect that to be the worst quarter, clearly, without a doubt.
Thank you. That's helpful. 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? What kind of condition would you want to see the business in to bring back the dividend?
Honestly, it's a very good question, because I ask myself this question because as you know, me and Philippe, my partner, we receive 45%-50% of the dividend. When do we think that it will be time to go back to dividend? It's important to have better visibility for 2021. When I think the company will have a better feeling of how 2021 is going to be, when we're going to be back to normal comparison of sales, normal type of profit, we'll definitely go back to the dividend. Again, the dividend was not too much a cash flow thing because we have, I think, $200 million. We think that it was better to hold it. Again, if we are too conservative, if the business come back faster than what we think, it's very easy to reactivate the dividend. Russ, you want to comment on that?
Yeah. The only thing I would add is that when the board met to discuss, a lot of it really went around the cash flow issue. Right? As soon as we have things get back somewhat where we have the visibility we need and our projections show that we have a positive cash flow, I think the company will revisit the dividend.
Okay. Thanks very much, and good luck with everything.
Thank you, Linda.
Thank you. You too, Linda.
Thank you. Our next question comes from Wendy Nicholson with Citigroup. Please state your question.
Hi. Good morning. A couple 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.
Okay. Second thing.
Totally neutral.
Yesterday. Totally neutral. Okay. On their call yesterday, Coty talked about some customers, and they didn't call out which customers, which class of trade, but some customers in the beauty space are having trouble paying their bills, and so receivables have gone up for the quarter. I'm wondering if you have any issues. I know you said you don't have any liquidity issues, Russ, are you having any challenges on the receivable side?
We are working very closely with pretty much all of our customers because everybody is trying to push things out as much as they can due to their own cash flow issues. The only area though where we have seen a little bit of a collection issue, as Jean mentioned, is in the travel retail. Some of the duty-free operators and the airlines are suffering significantly. Their doors are completely closed. We're getting some pushback on some collection efforts. Honestly, for the most part, we are working very closely with all of our customers. Some of them are on payment plans. There are a couple of retailers that, of course, are sketchy with respect to the possibility of bankruptcy. None of the major customers that we deal with have filed bankruptcy at this time.
Got it. Okay.
I would like to add, if I may.
Yeah.
I would like to add that either from our operations in Paris or in New York, most, 99% of our receivables are covered by insurance. Like Russ has said, we see maybe some weakness with one or two travel retail operator, but the risk is in hundreds of thousands maximum.
Yeah, absolutely.
We have absolutely not increased our reserves for bad debt or things like that. That's true that all our teams in Europe, in the U.S., in Asia, are helping finance department to collect. I think they are doing quite well because the collection rate is actually a little bit better than expected. Let's put it this way.
Got it. That's great. My last question, 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 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.
Yeah. Thank you. It's a very good question, because this is also something where the whole company spends a tremendous amount of time. 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. The product that I'm producing today, it will be the same in six months, in one year, and it is the same than the one I produced three years ago. Yes, we have definitely a little bit more inventory than we would like. 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 inventory than that is necessitated by the situation. Russ, you want to add something?
Yeah. 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 cost. Remember, our margins are extremely high. The idea would be to at least recoup the cost of the product. Inventory obsolescence is not something that's very significant in our business.
Got it. Thank you so much.
Yeah, I will continue. In Paris and in New York, we have been able to push out millions of dollars of deliveries of components. Yes, today, I think at the end of March, our inventory level was the same as it was at December 31st. It's going to increase a little bit more in the Q2 just because we don't have the sales that we expected. Let's not forget that we place our purchase orders of components six to seven months in advance of delivery. Of course, today we have too much. We think that at the end of Q3, and definitely at the end of Q4, we will be back to something that is very acceptable.
Got it. Thank you.
Thanks, Wendy.
Our next question comes from Steph Wissink with Jefferies. Please state your question.
Hi. Good morning, everyone. I just have a few follow-ups.
The first, maybe, Russ, this is for you, is on, apologies about the background, license minimums, if you have any sort of agreements that would strike some sort of minimum guarantee.
Yes. Many of our licenses do have certain minimum guarantees. However, the good news is that we have been working with each and every one of our licensees, pretty much from the day this pandemic first came into existence. In many cases, we have already received modifications of the license agreement. Our goal is basically to modify these agreements where we pay based upon actual sales. In most cases, so far where we have negotiated, we've been able to work with our partners, and alleviate the strain 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've been working on quite a few different things prior to the pandemic coming out. I think the fact is that right now everybody is in basically survival mode. This pandemic has affected just about every single industry. Certainly, any of the companies that would be potential licensors are also severely affected. Everybody kind of is in their survival mode, doing what they need to do to run their business, to maintain their businesses, to prepare themselves for the post-pandemic opportunities. I think that many of the things that we were working on will resurface once things get a little bit back to normal. We really haven't been pursuing anything brand new during this pandemic. I think our efforts have really been concentrated on business at hand. Jean, do you want to add anything?
No. I think that just before the pandemic, we were pursuing a couple of interesting brands that we would like to add to our portfolio. Conversations were moving in the right direction. Again, the last two months, I don't think it's the time to go back to this conversation. People are busy protecting their business, their people.
Yeah.
Definitely, in the next weeks or months, we will go back to the table and talk to different very interesting brands that we can add to the stable.
Great. 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.
Definitely.
Is that correct?
Definitely. Yeah.
And-
Three times bigger, something like that.
Has that been the case even pre-crisis, or is that what you're seeing currently-
Yeah.
In this month?
It started really, for us, it started really almost a year and a half ago, when we developed these programs with Tmall and JD.com. We have a very strong distribution in China. Again, some of our brands like Anna Sui, Lanvin, even Coach, are well-recognized in China. That's why we are able to have such a nice e-com business.
Great. Thank you very much.
Thank you.
Thank you. Our next question comes from Hamed Khorsand with BWS Financial. Please state your question.
Hi. First off, does the push-out in product releases to 2021 delay your plans for any previously planned releases in 2021?
Russ?
We work with each of the brands. We work with a calendar of product launches. I think the answer would be yes. If we launched a master new fragrance family in 2020, we would have gone with a flanker for that family in 2021. If we've moved the launch out, the idea would be you're going to launch your new pillar in 2021. It would be silly to launch a flanker simultaneously with it. Theoretically, your calendar moves out by the six-month delay or seven-month delay. It's just as if 2020 didn't exist. That's kind of how we're really approaching it. It's a rebuilding stage based upon something that came to us so unexpectedly.
Okay. How is channel inventory ahead of the planned reopening? Do you think there will be a significant delay as far as the restocking is concerned?
I'm sorry, I didn't hear the beginning of the sentence, of the question.
About how is the-
What?
channel inventory?
Yeah. The question is, with respect to channel inventory, when do we think that we're going to start seeing restocking? I think we're also in a situation that many of these retail locations closed rather suddenly. There is an existing inventory that is in the channel. I think it's really going to depend on how acceptable the experience is for the customer to come back to the retail channels, and to see where the demand is. At that point, then you'll get to restocking. Right now, I think that there's plenty of product in the channels. It's just that the stores are closed, and there's nothing being sold.
Okay. Then last question-
If I may. I totally agree with you, Russ, because the stores closed very abruptly, and there was inventory in the stores. We monitor very carefully the inventory at the wholesale level, at our distributors and agents. There, the inventory is not high. That's one of the reasons also that we are able to collect our receivable so well. They are not overstocked. I don't say that they will reorder immediately after the store open, but it means that a month or two after the stores open, we will see reorders from our distributors.
Okay. Are you planning any changes to your go-to-market strategy? Are you going to spend more time for the online sales instead of retail?
Russ?
It's interesting. It's a good question. We are experimenting with a lot of different online opportunities. Simultaneously, we're working probably with three or four different online venues, if you will, to see how we can increase our presence with respect to e-commerce. That is a platform, that is a strategy that the company is pursuing, we are still at the very early stages.
Okay, great. Thank you.
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. 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 parties may disconnect. Have a good day.