Interparfums, Inc.

Greetings and welcome to the Interparfums second quarter 2022 conference call and webcast. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If you'd like to ask a question, press star 1 on your telephone keypad. If anyone should require operator assistance during this conference, press star 0 on your telephone keypad. Please note that this conference is being recorded. Also, 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 Interparfums' annual report on Form 10-K for the year ended December 31, 2021. and other reports Interparfum files from time to time with the Securities and Exchange Commission. Interparfum does not intend to and undertakes no duty to update the information discussed. I will now turn the call over to Jean Madard, Chairman and CEO of Interparfum. Mr. Madard, you may begin.

Good morning, everyone, and thank you for participating in today's call. In the past, our CFO, Russ Greenberg, started the ball rolling, but today I will take the lead because this is Russ' final conference call for Interparfums. And on behalf of our entire staff and our board of directors, I want to say thank you to Russ for 30 years of loyal and dedicated service. As you know, it has been announced that Russ will be retiring next month. He has earned and well deserves to devote more time to his family and the activities he most enjoys. As we announced in June, Michel Atwood will officially take over the CFO reins on September 6. Michel and Interparfums are not strangers. We have worked with him in various capacities at various companies in the past. He was most recently at Estée Lauder, as Vice President Finance and Strategy, providing strategy and oversight for the fragrance category, where he led a team of finance professionals across the globe as a key member of ELC Senior Finance Leadership Team. Michel also spent more than 20 years at Procter & Gamble, where his final title was Divisional CFO of Global Prestige Fragrance, leading a team of 90 people and ultimately, spearheading the divestiture of that division to Coty. Also, we have included Michel in our proxy material to fill the board, a seat Ross is vacating at our annual meeting of shareholders on September 9, 2022. So again, thank you, Ross, for all this time with us. For anyone new to Interparfums, keep in mind that when we refer to our European-based operations, We are talking about our 73% owned French subsidiary called Interparfums SA, while our US-based operations refer to our only owned domestic subsidiaries. In both sides of the Atlantic, our business is primarily prestige, fragrance, and related products. First, I want to address our 2022 guidance, which we raised last month to approximately $1 billion in net sales and diluted EPS of $3.25. If you know Interparfums for any length of time, you know that we are traditionally cautious. While we are halfway through the third quarter, historically our strongest quarter, and business is solid, our visibility is clouded by the unpredictability of international turmoil. Eastern Europe, China and Taiwan are among the most newsworthy today. But tomorrow, who knows where the crisis will be. While we try to factor into our guidance the implications of regional resurgence in COVID-19 and currency fluctuations, forecasting is imperfect and we prefer to adjust guidance after we book the orders. Moving on. The fragrance industry has been on an upward trajectory around the world and so has our business. Year-to-date, North America, our largest market, achieved sales growth of 8% despite the IT problems by our US distribution subsidiary for European-based products and the strength of the dollar. compared to the Euro. For the first half, Western Europe and Asia Pacific, our second and third largest markets, grew sales by 40 and 39% respectively. Our sales in the Middle East increased by 31% and in Central and South America, sales rose 35%. Understandably, our sales in Eastern Europe declined thus far this year by 14%. Fortunately, who are continuing to see a renaissance in travel retail. I do a great deal of travel, and what I see are packed flies and eager shoppers at duty-free and in-flight stores. Fragrances launched in the first quarter continue to roll out in the second, notably Kate Spade Sparkle, Mont Blanc Legend Red, Coach Wild Rose, and Guess Wombo. Incremental sales of Ferragamo, Ungaro and MCM products also factored into our top-line growth. And we have been enjoying a big success with our debut duo for Moncler. In our sales release last month, we talked about how the strength of the dollar masked our progress for European-based products in the second quarter. Six-month figures are just as confounding. Take our three largest brands. Montblanc's first half sales were 25% ahead of last year in euro, but only 14% in dollars. Jimmy Choo's first half sales rose 16% in euro and under 6% in dollars. Coach sales were up 29% in euro, but just 17% in dollars. Our fourth largest brand, Guess, experienced first half sales Sales growth of 37%. With the EFFECT collection last year and WOMO this year, guest fragrance and grooming products have captured market share among men. Some good things are happening with our midsize brands too. Take Abercrombie & Fitch. First half sales are 50% ahead of last year with a large infusion of sales coming from Europe. Still a very small part of our business, travel amenities are starting to percolate. We are looking to double those sales this year. The Atlantis in Dubai, which may be the most deluxe hotel I've ever encountered, recently has selected Graf as its travel amenities partner. Ferragamo accessories can be found in many hotels, such as Longano and Kempinski, and just opened Turkish Airlines. Lanvin continues to be a supplier of the Sofitel chain. We are very pleased to welcome Donna Karan and DKNY to our portfolio. We have assembled a team of real pros for these brands and acquired inventory from the former licensee who will also be producing legacy scents for us through year-end. So we are fully prepared to build upon the appeal of these names. We have many new product launches in the pipeline for the coming year, but I could describe most of them as brand extensions rather than new pillars. Fortunately, we do not need major launches for our business to continue to grow. Some of our best sellers have been around for years, even decades. We have also decided to hold off on major product launches for Ferragamo, Donacaran, DKNY and Ungaro until 2024 rather than next year. But new flankers and extensions are in the works for all of them. We will be able to disclose more about our 2023 plans on our next conference call. And yes, we are still on the lookout for new names. We have two types of targets, those with established businesses and fragments often for aspirational brands with great potential. We are now on the A-list of fragrance partners for brands that fit one of those profiles. However, there is no shortage of eager competitors. Interparfums is on the cusp of an anticipated growth surge. I sometimes feel like the CEO of a 40-year-old startup. To prepare for this expected growth, we see ahead. We have taken on more space at our New York City headquarters. and of course we are established in Florence, Paris and Geneva. Our New Jersey distribution warehouse is undergoing refurbishment and also our inventory management and enterprise resource planning ERP systems overall. The ERP implementation is moving forward and we are getting closer to the finish line. It is an ambitious move encompassing a cloud-based system using third-party programs to assist in inventory and warehouse management, scanning systems, and related functions. We expect the transition to fully complete by year-end. On a somewhat related topic, you may have seen the July 10 issue of the Wall Street Journal in which I was quoted about our move away from sourcing in China for our U.S. operations. One of the lessons learned in the aftermath of COVID was that even though made-in-China components are cheaper, getting them where they were needed became an impossible task. We decided that shifting operations back to the U.S. from China and, for that matter, other countries where in the past cheap labor and access to factory capacity outweighed cost of shipping products across the ocean. Even now that Shanghai has reopened and shipping rates have come down, we are still reducing our dependence on China because the logistics is far too often impossible. We have engaged US suppliers and nearly 70% of the parts are being produced by US companies. Our plan is to have nearly all filling and assembly operations in the US and in Europe by 2024, and that is company-wide. While China is becoming less important to us as a supplier, it is becoming increasingly important as a market. Chinese shoppers are big spenders and fine fragrance market penetration has been growing, but it is still in its infancy. We have stepped up our advertising, engaged key opinion leaders, celebrities of all sorts, including up-and-coming K-pop groups which are extraordinarily popular in China. Lanvin, Ferragamo and of course Anasui occupy much of that effort. We are learning to adapt to inflation where moderate and regular price increases are becoming the norm. That means becoming more proficient at projecting costs and adapting our pricing two years into the future. At the start of 2022, we raised prices on average 5%, and another price increase of between 3% and 6%, depending upon the region, is coming this fall. Now, I will turn the call over to Russ for some of the financial review.

Good morning, everyone, and thank you, Jean, for your kind words. Over the past three decades, I have been part of a winning team that has made Interparfum a rapidly growing, highly respected global fragrance enterprise. I know that I am leaving the company in excellent hands. Let's move on to business. Foreign currency exchange rates have had a significant impact on our 2022 reported results. The US dollar relative to the euro hasn't been this strong for about five years. And as you must know by now, a strong US dollar has a negative impact on our sales. However, a strong dollar increases gross margin because almost 50% of net sales of our European operations are denominated in US dollars, while almost all of its costs are incurred in euro. For European-based operations, overall gross profit margin was about the same, just under 70% in the second quarter of both 2022 and 2021. The gross margin benefit from currency fluctuation and price increases was offset by increased transportation and component costs. In addition, our U.S. sales of European-based products were hampered in the early part of the second quarter by shipping related issues following a change in the distribution software by our logistics partner. I will also remind you that we generate higher margins for sales by our own distribution subsidiaries versus gross margins that are generated on sales to unaffiliated distributors. For United States operations, gross profit margin was 100 basis points ahead of the second quarter of 2021, with the improvement due to the 69% increase in net sales, which enabled us to better absorb fixed costs such as depreciation and point-of-sale expenses. On a consolidated basis, SG&A expense for the second quarter rose 24% and represented 44% of net sales, while in last year's second quarter, they were 42% of net sales. For European operations, SG&A expenses represented 47 and 44% of net sales in 2022 and 2021 second quarters, respectively. For U.S. operations, SG&A expenses represented 38 and 36% of second quarter net sales, in the 2022 and 2021 periods, respectively. You will recall that throughout 2021, net sales blasted through expectations, and we tried to play catch up on advertising and promotion. As we have been reporting, we are spending more than last year on A&P, both in dollars and as a percentage of net sales. Thus far this year, we've invested slightly more than $80 million or nearly 16% of net sales on A&P as compared to $55 million or 14% of net sales at mid-year 2021. Based upon our $1 billion sales guidance, you can expect another $120 million of such expenditures to meet our A&P target of 21% of net sales. Once again, usually the fourth quarter is when we activate the big A&P spend to both drive holiday sales and to keep the momentum going in the first quarter of the following year. Just a point that we made in the first conference call that still applies. While second quarter A&P expenditures were up 38% and represented 19% of net sales, This is still below pre-pandemic levels. In both the second quarters of 2019 and 2018, promotion and advertising represented 22% of net sales. Our second quarter operating margin last year was an exceptional 21.5%, and this year it came in at 18.6%. Going back to pre-pandemic levels, our 2019 second quarter operating margin was 13 and a half, and in 2018 it was 12.6%. Our consolidated effective tax rate was 24% for the first half of 2022, and that compares to 30% for the same period last year. You may recall that in 2021, our tax bill included a settlement with the French tax authorities, which along with a higher French corporate tax rate accounted for the 20% decline in our overall tax rate. From a cash flow perspective, mid-year inventory levels increased 41% to $266 million from 2021 year end. We closed the quarter with working capital of $445 million, including approximately $196 million in cash, cash equivalents, and short-term investments. And our working capital ratio was 2.9 to 1. The $117 million of long-term debt relates primarily to the acquisition of the new headquarters for Interperform SA, which today is fully operational and absolutely fabulous. Now, operator, please open the line for questions.

Thank you. And at this time, we'll be conducting our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press the star key followed by the number 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 Linda Bolton-Weiser with DA Davidson. Please go ahead.

Thanks. Well, Russ, a fond farewell to you, and congratulations on everything you've done, and good luck in the future. Thank you.

Thank you, Linda.

We'll miss you. So just to start out, in the quarter, I guess the thing that was most different from our expectations was the gross margin, and I guess it would benefit from the weaker euro. but yet it was down year over year and down sequentially. So can you just explain a little bit more? I know you started to give some color, but can you just, if there's any way you can quantify certain impacts, that would be helpful. And then kind of what do you expect maybe gross margin in the second half roughly? Thanks.

No problem. You know, it's really quite a little bit of an anomaly because if you look at the the details between both European operations and U.S. operations, the gross margin actually went up. In the European operations, it went from 66.8% to 66.9%. And in the U.S. operations, it went from 53.3% to 54.3%. And I'm talking here for the three months end of June. You have almost the same effect for the six months as well. The reason the consolidated gross margin appears to have declined is really the mix between the U.S. operations and European operations. For the six months, we have a 72% increase in sales for U.S. operations compared to a 9% increase for European operations. Of course, that 9% is significant. is low because of the exchange rates, but it's the overall mix in U.S. dollars of a higher U.S. business that has created this anomaly of appearing as if gross margins actually decline. Overall, as we would normally expect, the foreign currency exchange rates together with some price increases clearly mitigated the incremental costs on components and transportation in both European and the United States operations. So overall, we were actually very pleased to see continued expansion. Going on into the future, one of the things that also, as I mentioned in my remarks, that helps our gross margin is when we can increase sales from our U.S., distribution subsidiaries as we continue to ship more wholesale product through our own distribution subsidiaries in the US as opposed to third-party distributors we should see continued expansion within the gross margin okay thank you that's very helpful and then just that issue that you've talked about with the software changeover

Just so I understand, is that in your own captive distributor organization, that issue, or is it an outside party? And then is that all cleared up now, or are all the impacts behind you, or will there still be some impacts going forward?

When we started our own U.S. distribution, we partnered with a third party in both sales and inventory management. Today, the sales are 100% controlled by Interparfum, but we still use this third party for inventory and inventory management. So it's this third party that changed the software within their distribution center that impacted their ability to ship some of our products, mostly in the first quarter with a little bit of carryover into the second quarter. From what I understand, this issue has been rectified. and we should not see additional impact from the software changeover by our logistics partner going on into the third or fourth quarter of 2022. Okay, great.

And just a little kind of housekeeping. The DKNY, when that comes in in the third quarter, is that going to be in the Europe or the U.S. division?

DKNY is in the U.S. operations. And we manufacture product all over the world for our U.S. operations. But all of the DKNY will be through U.S., so all the profits will be 100% to the bottom line of Interparfums, Inc. There won't be any minority interest share as a result.

Okay. And is there any way to quantify how much the – Ferragamo and Ongaro contributed in the quarter to sales. Was it about $10 million or a little bit more than that?

You asked the same question at the end of Q1. Let me just quickly see if I can give you... It was a little bit above $10 million.

You can check.

Yes. Yeah, it was closer to, yeah, closer to 12, almost 13 million.

For three months.

Yeah, just for the three months.

Right. Okay, thank you so much. I'll pass it on. Thanks.

Thank you. Thank you, Linda.

Thank you. Our next question comes from Steph Wissink with Jefferies. Please go ahead.

Thank you. Good morning, everyone. And I will echo Linda's comments, Russ. We're going to miss you. Thank you for everything you've done for us. I have a question for you on pricing. I think you mentioned you've already taken a mid-single digit price and another possibly low to mid-single digit price to come. Share with us a little bit about the timing and what you're anticipating in terms of any change in demand, if you've seen any change in demand. And then is that pricing fully covering your cost based on your current cost structure? And would it also cover your cost based on Jean, what you mentioned in terms of relocating your infrastructure into the U.S. from China.

So the first price increase has been in effect and everybody has accepted, integrated worldwide. We told all our customers that they are going to see another price increase towards the end of the year. We don't know If it's going to be between 3% to, let's say, 6%, certain markets have different retail prices than others. Honestly, there are so many companies doing price increase, so there is no resistance. There is not the same resistance than before. So, I was checking yesterday the margins in the last 30 days, for instance, because the price increase has been on for a while now, and we see a nice impact, a positive impact in our margin. So I don't want to say that we absolutely need a price increase at the end of the year, but I think that it was reasonable to give a long lead time to all our retailers and our distributors, so there is no surprise. As of now, our cost of goods is very acceptable, our margin is acceptable, but again, because of lack of visibility, we don't know, and I prefer to announce a price increase coming at the end of the year. If we don't need it, I will delay. If we see that the margins are maintained, if we see that our suppliers stay at the same kind of pricing, if we see that we don't need, we will delay. But I think it was important to give this information to our customers. Ross, you want to add something?

Yeah, the only thing I would add is clearly we've been able to absorb through this price increase the incremental cost. Today we're starting to see a little bit of lowering, and especially in the transportation side of the business. Transportation costs are just starting to come down a little bit, so we're kind of hopeful that that might continue. But clearly we've been able to absorb all of the incremental inflationary pressures that we've seen with the price increase that was instituted earlier in the year.

Very helpful. And, John, one for you on your comments regarding the renaissance of travel retail. I'm wondering if you have any data that you can share with respect to summer seasonal demand within travel retail. Sure. Any sort of improvement?

Difficult to quantify, but the field that I can tell you is that we've seen orders, plenty, plenty of orders from duty-free operators in Europe, in the U.S., and DKNY had quite a good exposure with travel retail, and we we were talking to all the operators that are carrying DKNY, and they gave us some very optimistic projections. That's why I said at the beginning of my comments, we cannot change too frequently our guidance, and some people are going to say, oh, but with almost $500 million... In the first six months, of course, they're going to be able to do the $1 billion. It's not that obvious. A lot of things could happen, but we take each good news at the time, and definitely travel retail is going into the right direction. Let's not forget that we have not seen orders for years. It's quite refreshing. And the airports, as I said, are packed full. It's almost impossible to book tickets. So there is a strong activity, and this is going to help us, especially in the third and fourth quarter.

Helpful as always. Thank you.

Thank you.

Thank you. Our next question comes from Hamed Korsan with BWS Financial. Please go ahead.

Hi. Good luck, Russ, on your retirement. Congrats. I just wanted to start off with the euro weakening against the dollar. Does that accelerate or make you rethink about your capital structure as far as the debt in euros and paying that off quickly or maybe even a getting more Euro-based debt?

You know, the debt that we have in our book was really to buy the headquarters. We are paying it over 10 years. We swapped the rate to a fixed rate. I think we're paying, what, 1% for us?

Yeah, there's actually a maximum cap of 2% on the debt that was swapped.

But right now the cost is 1%, so it's very reasonable. And it's our French company who has the debt and their income is in euros, so I will leave the debt in euros. No changes for us on this one.

And then the other question was, are you seeing any changes in ordering habits at retailers in Europe and European region, just given the inflationary pressures there?

Not really. We have not seen any negative impact in terms of orders coming from Europe. We saw some slowdown. At certain retailers coming from the US, we know that certain retailers have heavy inventory. But again, this doesn't have any impact on our projections. But when it comes to fragrance, I will say that the level of inventory worldwide for retailers is at a very acceptable level.

Okay. And then my last question was going to be, how are you planning on for 2023 releases, and is the macro environment having any impact as to what your schedule would look like?

Thank you. It's a great question. We have a lot of plans for 2023, even though there will be no blockbuster in 2020. Each brand is going to have flankers and complements. And honestly, with the strength of the business, we do not need to play all our cards in 2023. We will keep some of the cards for 2024. optimistic for 2023 again by spending the amount of advertising and marketing that we are doing close to 20% so we are back to this kind of high level numbers this is a guarantee for our future sales so we are confident for we are very confident for 2023 that's why we delayed some important launches because we don't think we need them that early.

Okay, thank you.

Our next question comes from Linda Bolton-Weiser with DA Davidson. Please go ahead.

Yes, hi. I just wanted to follow up and to gain a better understanding of that change from China to U.S. and Europe production. Can you just explain? I knew you were always getting components from China, but I was never aware that you were actually doing some filling in China.

Thank you for this question.

When the U.S.

put sanctions against China with a tariff of 25% increase, we decided to switch a lot of production, for instance, of Anasui production, we're talking filling in China. And in the last, yes, 18 months, almost 24 months, we were doing the filling of Anasui in China, which is something I've decided to change. So Anasui will not be filled anymore in China. We are stopping with that. We are buying a lot of components in China. We will be buying much less components from China. We think we're better off. We're better off. It's not at all a statement against China. On the contrary, I think that we have to source components closer to where the finished product is sold. We have seen, for instance, products traveling, components traveling all around the world from China, then to be partly transformed in Europe, then come to the U.S., then shipped back to China. It's totally insane. And it's a decision that we've made. And, of course... We were a little forced to do it when you look at the cost of the transportation. And also, when you look at the delays, delays in port, delays in manufacturing, delays in shipping, it was almost impossible to forecast production, etc. So we feel more secure by producing closer to where we sell.

Okay. And can you tell us, are you still shipping some to Russia?

For Russia, we do not ship any products from the U.S. The rules are very clear. We have stopped shipping day one any products that are made in the U.S. We do not ship them to Russia. So we stopped almost six months ago. We stopped all our business with Rochard. But our subsidiary in France and in Italy will follow different types of rules. As long as the product retails for less than 300 euros or dollars, they have a right to ship. So the French subsidiary and the Italian subsidiary could legally ship to Russia. Of course, the business is down because there is less demand, I would say. But for us, we estimate that it's a loss of $20 to $30 million, the fact that we are shipping less from Europe and zero from the U.S. But again, these numbers are already included in our guidance.

Thank you very much.

Thank you. And there are no further questions at this time. I'll hand the floor back to management for closing remarks.

Thank you. And thank you for tuning in to our conference call. I hope some of you will be able to attend our annual meeting at 10 a.m. on Friday, September 9th. at our headquarters in New York. If you have any further questions, please, as usual, contact me by email. Stay well and stay safe. Thank you again.

Thank you, everyone. Thank you for attending this conference.

Thank you, and that concludes today's conference. All parties may disconnect. Have a great day.