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Perry Ellis (NASDAQ:PERY)

F2Q10 Earnings Call

August 19, 2009 11:00 am ET

Executives

Francisco G. Hoffmann - Investor Relations and Strategy

George Feldenkreis - Chairman of the Board, Chief Executive Officer

Oscar Feldenkreis - Vice Chairman of the Board, President, Chief Operating Officer

Anita Britt - Chief Financial Officer

Analysts

Eric Beder - Brean Murray

Grant Jordan - Wells Fargo Securities

Ronald Bookbinder - Global Hunter Securities

Mickey Schlein - Ladenburg Thalmann & Co.

Robin Murchison - Suntrust

Paula Torch - Needham & Company

Andrew Berg - Post Advisory Group

Kelly Vichi - Eaton Vance

Operator

Good day, everyone and welcome to the Perry Ellis second quarter 2009 earnings conference call. As a reminder, today’s conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Francisco Hoffmann, Investor Relations and Strategy. Please go ahead, sir.

Francisco G. Hoffmann

Thank you, Operator. Good morning, ladies and gentlemen and welcome to the Perry Ellis International second quarter fiscal 2010 conference call. You should have received a copy of the press release that went out this morning, including the income statement and balance sheet. If you have not received a copy of this release, it can be found on our website at www.pery.com.

Before we begin, I would like to remind you that some of the comments made on the call, either as part of the prepared remarks or in response to your questions, may contain forward-looking statements as are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such information is subject to risks and uncertainties as described in the press release and in the document that we have filed with the SEC.

Joining us today for the call from Perry Ellis International are George Feldenkreis, Chairman and CEO; Oscar Feldenkreis, Vice Chairman, President, and COO; and

Anita Britt, Chief Financial Officer.

I would like now to turn the call to Mr. George Feldenkreis, Chairman and CEO. George.

George Feldenkreis

Good morning. We have finished a more difficult quarter with an EBITDA slightly better than last year and better than what we projected at the beginning of the year. We believe that focused management and a strong effort by all of our associates in the worst retail market in recent memory have allowed us to complete the second quarter that was better than projected and have positioned us as a profitable company at the half-year mark.

During this quarter, our revenues impacted by some of the retailers that went out of business, like Mervyn’s, [Golchaks], and Goody’s, which reduced our private label business with mass marketers. We continue to experience a drop in revenues and profit from the exiting of the PING license without the offsetting income of our new color wear agreement that will come in next year.

Perry Ellis suffered a drop in sales as department stores went into inventory reduction mode and substantially reduced their product placement. And unseasonably cold weather contributed to a drop in swimwear shipments compared to last year. Our sales decreased by $34.5 million but we also managed to reduce our SG&A by $13 million, representing a 21% drop versus Q2 of last year.

At the same time, some of our businesses like Golf, Hispanic lifestyle brands, and denim showed increased revenues and they will continue to do so in the foreseeable future. As important, we exited some businesses that we did not want to continue and thus we have been able to focus on the potential growth of business units that are being brought back toward profitability.

We are glad to confirm that some of the divisions that were not profitable last year are doing better than projected a few months ago and we expect most of them to be profitable next year.

Royalty income was flat for the quarter, which was a good development. In the last two years, we have signed a number of new partners who have helped us to broaden our licensing base. We have been able to maintain the royalty income despite the fact that many of the licensees have been unable to report additional sales over the contract minimums because of the economic slowdown. We are very confident that as retail sales improve, our license and income will resume its growth.

We have also expanded our licensee marketing group and as a consequence, there are several new initiatives being discussed in Asia and Europe as well as in the United States.

On the international side, our Original Penguin sales in the U.K. and Europe continue to grow this year, while our Farah brand business has suffered. However, as a whole, our U.K. operations show positive operating income for the first six months and we feel strongly that it will continue to do better in the second half of the year compared to last year.

In Canada, our joint venture profits were negatively affected by the devaluation of the Canadian dollar -- or by the re-valuation of the Canadian dollar. We have made the necessary adjustment and we are projecting to finish the year with a better profit than last year.

Revenues for our direct-to-consumer business decreased during Q2. Our retail outlet experienced a 10% drop in sales for the quarter. However, we have been able to negotiate some rent reduction and have streamlined operations to reduce expenses. Again, we feel that the next half of the year will be much better than last year’s second half, both in terms of revenues and profits.

We continue to invest in e-commerce and web-related initiatives, including social networks. On the M&A side, we continue to look at many opportunities which are opening up. We have been very cautious in the last few years and we will continue to be so if no acquisitions become available.

July retail sales came in lower than analysts expected. There is an issue about sales [inaudible] being moved from July to August in some states. But I would also submit that probably the number of units sold in July was the same or higher than last year, but the average price per unit was lower so naturally sales appear lower.

I am glad to report that some retailers are reporting strong sales in the first couple of weeks of August. We believe that the 140 million Americans who are working and receiving their regular incomes are returning to a normal life, quote-unquote. Although they might be more cautious on how they spend their money, while at the same time increase their savings just in case.

We would also like to bring to the attention of our stockholders that the department store channel represent 24% of our business. The other 76% is with other channels of distribution.

There is no question that the consumer is asking for better value. In that sense, we feel very confident because we have always maintained a competitive advantage in value due to our great sourcing capabilities. Our own network of offices in Asia and lower overhead in comparison to other companies, as evidenced by our strong business relationship with the mass market retailer.

We are very confident that in the current client of value brands and value products, we will remain a top player because of our proven ability to sort, design, and deliver at very competitive price points.

As we look into the future, we feel that the next six months are definitely going to do better than the same period last year.

Although many retailers are still projecting lower revenues for the next 12 months and trying to achieve more sales velocity from smaller inventory levels, we feel that the strength of our product line, as well as our plan to improve those businesses that have not been performing well will result in better profits for Q3 and Q4 than last year.

The reorganization has been a painful process. Our headcount has been reduced in the last 12 months by 181 people, or over 9% of our U.S. workforce. However, the result of our efforts will be evident in the next fiscal year with a leaner and more streamlined operation.

We continue to make improvement in sourcing, production and speed to market initiatives. We have succeeded in implementing processes to improve managerial oversight in some areas like charge-backs, which have already resulted in much lower customer deduction due to operational issues.

At the same time, we continue to come up with the products, new ideas, and new marketing programs to continue to grow our organic opportunities and take market share from weaker or disappearing competitors.

We feel very good about what has been accomplished in the first half of the year and we are very optimistic about the immediate and long-term future of our company.

Oscar, please.

Oscar Feldenkreis

Thank you. Good morning. As we finish the first half of fiscal 2010 and the effects of the so-called great recession begin to subside, the actions that Perry Ellis International took last year at the beginning of the crisis, trimming our cost structure, strengthening our balance sheet and aligning our management team to address the opportunities in the marketplace are paying off and have put us in a great position for the second half of this year and beyond. Anita will walk you through the details of our second quarter results and I will address our prospects for the second half of this year and the great opportunities that lay ahead for our company.

Our core business, men’s wholesale apparel, keeps picking up momentum and several of our new initiatives have primed for explosive growth. We have become the leader of the golf apparel lifestyle at all channels of distribution and golf remains a major growth opportunity for us. Our partnership with Calloway has opened up new retailers in the golf category, such as Bloomingdales, Lord & Taylor, Belts, and Dillards, all of them are committed to carry the Calloway brand for spring 2010. Our collection will include tops, bottoms, and sweaters, as well as outerwear, hats, and signature belts for both men and ladies.

Meanwhile, our legacy golf brands, PGA Tour, Grand Slam, Champions Tour, and Links Edition keep gaining market share and door penetration for fall of ’09. Our products will be available in 3,431 doors across all distribution channels, up from 2,951 doors, representing a 16% increase over last year. Our design and stores planning capabilities allow us to distribute from Macy’s, Dillards, and Belts to Kohl’s and J.C. Penny, to regional retailers such as Bells and Stage Doors.

Our Hispanic brands keep delivering strong results compared to fall of 2008. We have expanded our door penetrations for Cuba Vera, Havanerra, and Centro brands from 730 doors to nearly 1,100 doors for fall of ’09. This is a 50% increase from last year’s level. The Hispanic lifestyle is one of our core expansion drivers in the second half of this year and beyond as we remain the authentic Hispanic apparel company in the U.S. I would also like to note that our Cuba Vera retail door in the airport is performing extremely well.

Another proof of our success business model was the relaunch of our John Henry brand this spring. Last year the brand was distributed at 177 Mervyn doors. As the retailer went into liquidation, we successfully repositioned John Henry as an updated sportswear collection in over 906 doors at other mid-tier retailers. This increased door penetration is driving double-digit growth compared to last year’s results and increasing our presence in retailers, such as Sears, Bells, Stage Doors, and Bosco’s, and the military.

Our swimwear platform has proven to be one of the greatest acquisitions in Perry Ellis history. While our first half results were affected by unseasonably cold weather, it could not attain the performance we expected. We are very excited about several trends that favor the Perry Ellis International in the swimwear market. Today retailers are partnering with strong financial companies that have the infrastructure to service their needs. In today’s day and age, a company in our industry cannot succeed without a clear understanding of the geographic markets, sizing needs, and the ability to plan receipts and flow according to the season needs.

One of our largest retail customers, for example, has reduced its swimwear vendor structure from 99 to 40, and will exit their private label programs for 2010. As one of the strongest 40 vendors remaining, we are capturing more open-to-buy dollars and expanding our door penetration.

Swimwear as a lifestyle is becoming a larger emphasis for retailers as they realize the untapped potential in the cover-ups business. Items such as dresses and shorts, drivers of the cover-up segment are hard to source for old line swim companies that lack the sourcing expertise. As a result, we believe our cover-up business represents and has the potential to be as much as 20% of our swimwear assortment mix today.

As for Nike Swim, we are very excited about the introduction of new product lines for men and women across all distribution channels with an extremely positive result from the early testing. Our Jansen brand continues to penetrate the department store channel and gain market share with door increases of over 21% from the prior swim season, reaching 1,100 doors.

The Perry Ellis sportswear collection is going through a transitional period. After 12 months of strong door penetration across multiple department store retailers, we realized that we were in many underperforming doors impacting our profitability because of higher markdowns. We have decided to retrench and exit 127 unprofitable doors this coming fall season. We will continue to evaluate our performance in each of the 852 department store doors where our Perry Ellis collection will be available this fall. We expected this proposition to be much more profitable than last year. Further, we are extremely excited about reintroducing Perry Ellis at Lord & Taylor this coming fall season.

As George previously discussed, our licensees continued to perform in the department store channel and our belt business, which is in-house, continued to capture market share. As we realign our management team for the new challenges presented by the overall weakness at the department store and returned the design line to its true heritage, Perry Ellis remains one of the premier brands for the consumer with the right lifestyle, fashion price for today’s economy.

After exiting over $14 million in private label men’s pants programs in the mass channel during the first half of this year, our bottoms division is returning to its profitable growth path, primarily through our denim platform, new short programs, and a return to a more normal replenishment business.

Denim continues to perform above average at all distribution channels. We recently launched a new premium denim product under the Exist brand in all Kohl’s doors with great results and strong sell-throughs this quarter.

We feel that denim is a key growth initiatives for today and the future. As we evolve our denim business by leveraging our strong portfolio of brands. For spring 2010, we will be delivering multiple bottoms initiatives under several of our brands across all distribution channels, creating additional revenues for Q4 and growing our market share.

Finally, as the consumers are returning to more predictable purchasing patterns, our retail partners have resumed more normal pants replenishment cycles, which represents a significant part of our bottoms business.

Turning to our contemporary brands, C&C of California and Lundry by Shelley Siegel, we are very pleased by their prospects for the second half of this year as we continue to make strong improvements. First, we are very excited with the return of Clare Stanfield, one of the original Cs of the founding team to C&C of California. In her new role as creative director, Clare is bringing back the authenticity and mystique that years of mis-management by the previous owner had taken away from the brand. After only two months, Clare’s vision is already delivering results with outstanding reviews from our holiday line. With Laundry by Shelly Siegel, we are very encouraged by the performance of the contemporary dress category, which continues to be trending ahead of the rest of the women’s department. Laundry will be available in 180 luxury doors during this fall. Thanks to the addition of Niemann Marcus and he expansion in a number of doors at Macy’s and Lord & Taylor.

Another exciting initiative at Laundry is the introduction of LBD, a diffusion line catering to a younger consumer that wants fashion at value. LBD will start shipping to department store channels in spring 2010.

Finally, we are encouraged by the market share gains and new programs launched for our under-performing businesses -- Contemporary, Original Penguin, and Action Sports. We aligned the management structure of these businesses to improve market focus, adjust their cost structure to improve profitability and return design back to their heritage to bring back the authenticity. All in all, we are confident that we have taken all necessary actions to bring these businesses back to profitability in the very near future.

What doesn’t kill you makes you stronger, goes the popular saying. The toughest 12 months in the history of Perry Ellis International certainly didn’t kill us but rather made us hungry, more agile, and certainly a stronger company than ever before. We are excited about our growth opportunities for the second half of this year and we are laser focused on the executing upon them.

We want to thank again our fellow shareholders for their loyalty and patience and with that, I would like to turn over the call to Anita Britt who will discuss our financials.

Anita Britt

Thank you, Oscar and good morning, all. To further discuss our performance for the quarter, our second quarter fiscal 2010 revenues totaled $159 million as compared to $194 million, a decrease of $35 million or 17.8% compared to last year. Oscar spoke to the quarter as well as the future opportunities and outlook. To reiterate our strategy, we remain acutely focused on exiting businesses that are neither margin enhancers nor profitability drivers.

As a result, while many of our businesses performed very well, we saw offsetting revenue decreases driven by the planned exit of mass merchant private label business, the exit of the Perry dress shirt business, Dockers Outerwear, and selected specialty store accounts, bankruptcy filings by a number of our previous customers, such as Mervyn’s, Goodies and [Galchaks]; the transitioning from a licensing arrangement with PING Golf to Calloway Golf; door count reduction for Perry Ellis collection by exiting unprofitable retail store locations that Oscar spoke to. These collective businesses impacted the quarter by approximately $28 million, or 80% of the decrease.

In addition, our international revenues were also negatively impacted by foreign currency translation, which approximated $2.1 million for the quarter. The remaining decrease in the quarter revenue was driven principally by private label programs. The continued execution of this strategy will carry into the third quarter as well.

Royalty income held fairly even for the quarter at $6.2 million. We experienced sales increases from the addition of the new licensing agreement for Perry dress shirts, which was offset by the exit of our Hart Marks license.

In addition, Perry Ellis International licenses, notably in Latin America as well as Japan, experienced growth in royalty revenue. Overall we are extremely pleased with our product placement and positioning with our licensees, and continue to focus on new regions and product category expansions. We believe that as the global economy recovers, more opportunities will arise.

Gross margin for the quarter was 30.9% as compared to 32.1% for the prior year. Sales allowances and charge-backs for the quarter decreased by approximately 200 basis points as a percentage of sales year over year. We were especially pleased with the progress we have made with improving our shipping accuracy and compliance requirements with our vendors which have reduced our overall operational charges.

Margins for our direct-to-consumer businesses in retail an e-commerce were fairly even with the prior year and improved over Q1. We were encouraged by our international businesses in both Canada and the U.K., both of which experienced margin expansion. Offsetting this improvement was the continuation of the strategy to exit and transition certain businesses in order to focus on margin enhancing business platforms. Therefore, margins were impacted by the exit and inventory liquidation of the licensed PING and Dockers Outerwear businesses.

In addition, a higher level of promotional activity in our private label swim and bottoms businesses also impacted margins for the quarter.

Our operating expenses for the quarter totaled $51 million compared to $64 million, reflecting a $13 million reduction, or 20%. The reduction approximated $11 million as adjusted for non-recurring expenses identified in the prior year. These reductions came in a number of numerous categories.

In our distribution costs, we realized a 7% improvement in our cost per unit. In advertising, as we focused on measuring marketing opportunities, investing on projects that produce a sales lift and a return to the company.

Through our focus on SKU profitability and our effort to control sample costs, third party sales commissions decreased as we exited certain specialty stores during the prior year, as well as measure control in travel and entertainment. Overall, we are extremely pleased with the expense reduction and continued to remain diligent in ensuring that expenses are held in check.

We have delivered $19 million in expense savings for the year and see additional savings to be realized. We estimate that there is an additional $5 million to $10 million in savings for the second half of the year, year over year.

Depreciation and amortization declined slightly for the quarter, totaling $3.4 million. So our earnings before interest, taxes, depreciation and amortization, or EBITDA for the quarter, totaled $1.5 million ahead of analyst consensus.

We continue to forecast an effective tax rate approximating 12.5% for fiscal 2010 and this compares to a tax benefit of 23% for the full year in fiscal 2009. Again, as I spoke to on last quarter’s call, our mix of international businesses including licensing income, is a key driver in that tax rate.

Fully diluted shares totaled $12.7 million as compared to $14.8 million in prior year. During the quarter, we did not repurchase any stock.

Turning to the balance sheet, our disciplined management of working capital was evident in our balance sheet for the quarter. Our accounts receivable decreased by 12.6% over prior year, consistent with our first half sales change, and our days outstanding continue to approximate 64 days and are very well managed.

Inventories decreased by 22% over prior year to just over $103 million. Inventory turnover increased to 4.5 times as compared to 4.3 times for prior year. We remain focused on increasing inventory turnover and are very pleased with the integrity, as well as the aging of our goods. And as discussed in our last call, we continue to review each of our businesses and establish target turnovers based on each business model. We continue to see opportunities for further expansion in our turnover ratio.

Our liquidity position is outstanding. We ended the quarter with $29.5 million of cash on our balance sheet. After fully paying down $38 million in borrowings under our facility at the end of Q1, and have full availability on our revolving credit facility of $125 million as of the end of the quarter.

For the first half, the company generated $78.5 million in cash from operations and this compared to $16.4 million for the prior year period, a great improvement. Capital expenditures for the quarter totaled $1.5 million, bringing our first half spend to $2.5 million.

As we look toward the second half of the year, retailers were cautious with fall purchases and remain disciplined with focus on tighter inventories to ensure improved sell-throughs. Given an increased level of visibility with regard to sales trends for the balance of the year, we felt it was appropriate to offer additional color on our expectations.

We believe that the top line revenues in the second half will reflect a reduction of low double-digits in the third quarter. And just as a reminder, our strategy of exiting and transitioning from some of the businesses that we discussed in the first half will continue through Q3 and be completed and anniversaried in that quarter.

As the industry moves into the fourth quarter, we see a greater opportunity to drive our sales trend as the economy cycles a disastrous prior year period, ridden with bankruptcies, liquidation of excess inventory levels, and huge uncertainty. We also expect to continue our favorable performance as Oscar spoke to in our golf and Hispanic business platform and believe we are well-positioned to improve our trend within our women’s and original penguin contemporary businesses as well seize on new opportunity businesses, such as Calloway Golf.

We believe that fourth quarter provides us with an inflection point where we will report increased net sales of low single digits and expansion in gross margins year over year. We remain intrinsically focused on our balance sheet and maintaining exceptional liquidity to continue to provide financial strength for the near future as well as forward opportunities.

With that, we will now open up the call to questions and we ask that you limit your questions to one at a time so everybody’s questions can be addressed. I will now turn it over to the Operator.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Eric Beder with Brean Murray.

Eric Beder - Brean Murray

I just have a little bit about inventories and about other pieces. Inventories were down about 22%. What should we be thinking about in terms of inventory levels for the rest of the year? And when you look out in terms of the opportunity with the contemporary businesses, Original Penguin, and C&C and Laundry, do you still believe they are as strong as they were when you initially made these acquisitions of these companies? And either way, what do you think about the longer term prospects of that area?

Oscar Feldenkreis

I am going to allow Anita to answer the first piece of your question and then I will answer the [question about] the future.

Anita Britt

Eric, as we look at inventory on a go-forward basis, again we’re focused on turnover by business platform, so we believe that there is continued expansion to increase the turnover. If you look at the progress that we made, it’s basically been an incremental 0.1% improvement each quarter, so we do believe that we can drive the turnover closer to a five time turnover in the future and as far as a reduction year over year, we do believe that we will continue to track inventories down in the double-digits on a go-forward basis.

Oscar Feldenkreis

As to the contemporary brands, Eric, we are very excited. I think bringing back Clare to C&C was a great move and we are very happy to have her back. The reception of the line the little that she was able to impact for holiday but of course the more impactful will be in the spring line, I think has been very, very positive. Retailers also have begun to look at us differently now that we have her back and we are very excited about that. I think also we are much more focused. We walked the -- we got out of a lot of the other businesses that we started with and men’s side, lounge wear, and all different types of categories that we really should have never been into and we are much more focused today on rebuilding C&C, bringing it back to its heritage.

On the Laundry side, it continues to perform really well. We have great positioning in the stores. The stores are very excited about our designs and our capabilities on sourcing and what we are able to bring to the market. We have been getting a lot of requests as well to add sportswear product but of course, we don’t want to jump into sportswear at this time until we are sure that we have really built the foundation necessary, bringing back the brand to its heritage on the dress side, and we continue to look for ways to grow our businesses, both on the department store side and better specialty store side.

On Original Penguin, the exiting of the ladies business has made us much stronger. We are very focused on the men’s side. We have gotten back into our -- some of the doors that we were exited from. We walked away from Nordstrom’s for a while. We’re back in Nordstrom’s, so we are very excited about the potential and plus as my father mentioned, the European business is very, very strong. Our retail stores in Coven Garden that we opened last year in November is performing extremely well and we continue to look for additional opportunities. We will be opening a pop-up store in Soho in the fourth quarter of this year with Original Penguin and C&C combined together, which we are very excited about that also.

So all in all, we are very excited with contemporary but we continue to make improvements on it.

Eric Beder - Brean Murray

Great, congrats on the quarter.

Operator

And we’ll take our next question from Grant Jordan with Wells Fargo Securities.

Grant Jordan - Wells Fargo Securities

Great. Thanks for taking the question. George, I guess this question is for you -- it seems like your comments are a bit more optimistic than maybe we’ve heard from some other retailers and apparel suppliers. Do you think that’s driven more by Perry’s ability to take market share in this environment or just more by your outlook on the overall economy?

George Feldenkreis

My outlook on our business specifically, number one that men’s had not suffered as much as women’s and 90% of our business is men’s. That is number one. Number two, inventories have been very depleted at retail. They are going to find themselves in a situation where some of them, if sales just improve a little bit, are going to really be out of inventory and they are going to be chasing inventory.

So for us as a vendor, we are relatively optimistic that we look to a strong Q3 and Q4. We might have to increase inventories to be able to deliver product toward the fourth quarter of the year, as sales at retail improve and my thinking all along has been that sales have not dropped as much as advertised. There has been a drop in the average retail price of product. That was very evident last year when we had promotions at the end of the year. And the promotional activity still is there in many, many channels of distribution, not in all of them. But the reality is that when you see T.J. Maxx and Ross and the [inaudible] having record sales at this particular time, there is something that the consumer is switching their allegiance about what to buy but not that the number of units that are being sold that the consumer is consuming, let’s say, are smaller than before.

So it would depend on our ability to bring great product and take market share for other players and there has definitely been a contracting of apparel companies. Some of the ones who are public like [inaudible] -- I mean like [Heimrech’s], sorry -- that has finally gone out of business and now have no restructuring situation. And other retailers but there has been a big drop in smaller private companies who had some market share who are really disappearing from the market.

Grant Jordan - Wells Fargo Securities

Great. Well, thank you. The color is very helpful.

Operator

We’ll take our next question from Ronald Bookbinder with Global Hunter.

Ronald Bookbinder - Global Hunter Securities

First of all, congratulations on some really strong cost control and it’s great to see that and I’d be looking for that to continue the rest of the year, far above what you had planned for. But looking at that third quarter gross margin, there seems to be a lot of moving parts. We still have some goods to clear from the discontinued lines but your inventory looks in great shape and you are going to be anniversarying some allowances last year. How should we look at the gross margin in Q3, just sort of -- any sort of direction on that?

Laura Sen

What I would say, Ron, is you should expect an expansion in the third quarter gross margin versus our first half of this year. Our commentary in terms of some of the businesses that we are continuing to exit will have an impact on the margin year over year so we do still expect gross margins to be impacted for that but we do expect that Q3, you will start to see some expansion versus what we have shown in the first half of this year.

And then in terms of Q4, you should expect to see gross margins return to more normalized levels and again, versus LY, there’s a huge comparison there in terms of all of the liquidation of goods from Q4 last year, all the promotional environment. So we do expect Q4 margins to get back to a more normalized or historical level that the company has experienced.

And again, just looking forward, our strategy has been to focus on businesses that are margin enhancers in terms of the gross margin so that’s how you should think about margins on a go-forward basis.

Ronald Bookbinder - Global Hunter Securities

Okay, and more of a broad-based question, would the problems at CIT and the domino effect it could have on the other factoring companies and the customers, how could that -- does that create a nice opportunities for the Perry Ellis company? And what do you see the fallout being?

George Feldenkreis

Well, the CIT is a big problem for smaller companies. It is a problem for the industry. I wish that they stay in business and it’s important for the industry that it stays in business but we only factor a very small amount of our business and mostly on the specialty store side. On the big customers, we only factor when they approve a factoring, like some of the companies that have credit issues. I mean, 80% of our business has nothing to do with that and we could go “bare” without any factoring, so it won't affect us directly. We would probably have to stop shipping to some of the smaller stores, the specialty store business, which would be very highly impacted if Wells Fargo or other factors don’t take over that function that CIT is providing now if something happened to CIT. But we are not -- we don’t really have any liability on that.

Ronald Bookbinder - Global Hunter Securities

But could there be upside as other suppliers are hurt that do have exposure that we could step in?

George Feldenkreis

I think from that standpoint, there would be an upside because a lot of companies, smaller private companies, or maybe some actually the smaller public companies will have to -- would really have to go out of business if nobody picks up that business because they depend on CIT.

Remember there are two sides to factor -- one is the insurance itself, which is what we use, and the other one is the borrowing and a lot of companies depend on CIT for the borrowings not only to finance the receivables but to finance the inventory plus letters of credit to vendors. So if they cannot open the LCs to vendor, they cannot really stay in business.

So it is very worrisome for small companies and on that side, it might offer an upside for us but really it’s not something that I want to come to.

Ronald Bookbinder - Global Hunter Securities

Okay. Thank you and continued success.

Operator

We’ll take our next question from Mickey Schlein with Ladenburg.

Mickey Schlein - Ladenburg Thalmann & Co.

Good morning. I wanted to follow-up on the gross margin question. If I am interpreting your comments correctly, it sounds like the expansion that we can expect in the second half of the year may come from lower markdowns as a result of those decisions you’ve made to exit certain businesses and your product mix.

I also wanted to understand whether the gross margin expansion has anything to do with renegotiated contracts with your customers regarding gross profit targets in those contracts, and/or new sourcing initiatives where perhaps you are finding lower cost suppliers in the world that will help you defend your margin.

George Feldenkreis

Well, we are projecting smaller markdowns for Q3 and Q4. As a matter of fact, in Q4 we are projecting a much lower markdown than last year. So there is a margin improvement from that side and on the sourcing side, we are getting lower prices and those will be -- those are really orders placed like in November, December, January and that’s the merchandise that is arriving now is the one being impacted by lower prices. So we do look forward to an improvement from cost of goods on Q3 and especially on Q4.

Anita Britt

I think the other thing too, Mickey, that we talked about is we are doing a better job in terms of just managing our operational allowances as well, which is a reduction from gross to net, so that will continue to benefit us and just to follow-up on George’s comment too, to the extent that we are managing our inventories better, the retailers are managing their inventories better. We would expect better sell-throughs as well, so the give back in terms of margin support would also be a positive for us on a go-forward basis.

Mickey Schlein - Ladenburg Thalmann & Co.

Thanks, Anita.

Operator

We’ll take our next question from Robin Murchison with Suntrust.

Robin Murchison - Suntrust

Good morning, and a sincere congratulations. I’ve got several questions here, if you would, but they are related, except for the tax rate -- and actually, Anita, I’ll start with that. The tax rate for next year, given the fact that international will continue to be an ongoing part of your business and a growth part of your business, should we be -- it seems to me we ought to be using something less than 35% for next year.

Anita Britt

Again, Robin, I would expect it to be north of where we are forecasting our effective tax rate this year and that it would return to a more -- a higher tax rate. In terms of where we’d actually forecast that, we have not given any guidance on that so I can't give you any deliberate color on that at this point but I would be using something north of 12.5%.

Robin Murchison - Suntrust

Okay. All right, well, we can revisit that later. Last year was effectively 23% and two years prior to that, you were at 35%.

And then just secondly, and these two are related -- I wanted to know just if you could discuss, and maybe this is for you, George, what’s going on with product costs from overseas? We obviously continue to believe and experience that they are down but wondering how sort of sustainable, what your thoughts are about that as we sort of look later into the year and maybe into next year, when we might begin to see some creep-up.

And then secondly, had your distribution channel, had your retailers and distribution -- those in your distribution channel requested lower opening price points in key brands, perhaps such as Perry and Penguin, or any of them? Are you seeing -- so therefore when we look at the balance of the year, particularly fourth quarter, maybe the product that you are selling in has lower opening price points which enables the retailers and that distribution channel to be more effective in offering product to their core customers. Thank you.

Oscar Feldenkreis

On the sourcing side, where we constantly look for ways to improve costing, it also is something that we have to take note of that as you know last year there were many, many factories that have closed down and those factories are not reopening, so of course there’s a smaller group of factories that today are actually manufacturing product and we are seeing some improvement on the fabric side because of course the oil prices have come down substantially over LY but at the end of the day, I don’t think that the cost of manufacturing has really come down to a very -- to a big aggressive level.

The other areas, we continue to look for new places to manufacture product. On the pricing question, you know, we continue to evaluate the value of our product that we are offering to the stores and making sure that the price is correct from inception, which has also -- which would also reduce you actual markdowns and make it much more easier for the product to sell at regular price from the inception, which is really what I see as the future, as more and more retailers reduce the levels of inventory that they have all carried. They are trying to ensure that the initial sell-through of the product are at the best and highest possible price, rather than have to constantly promote themselves through this environment.

So there is definitely a correction in the market going on on the pricing but as well as not inhibiting the DNA or the value of the brand. So we are not taking a product and bringing it down to become much more valuable just because the market has changed -- we have to ensure that we still stay within the brand.

Robin Murchison - Suntrust

Right. We were hearing from some retailers that in the second half product costs, their product costs, the retailers product costs, down 4% to 6% and then in the first half next year, maybe down around 10% and then one would assume that that all sort plays out and evens out as you get to second half next year, so that’s -- I appreciate the color. Thank you very much.

Oscar Feldenkreis

You’re welcome.

Operator

We’ll take our next question from Paula Torch with Needham & Company.

Paula Torch - Needham & Company

Good morning. Thank you for taking my question. I was wondering if you could give us a little bit more color on your LBD, the new younger line that you are going to come out with for under laundry. I was wondering where your target age would be of that customer. Would it predominantly be a dress business or if you can give us anymore color on the merchandise mix there, that would be helpful. Thank you.

Oscar Feldenkreis

Yes, it would be a dress business. The customer base would be like a 22- to about a 35-year old customer. It’s a little bit more sexier, much more -- a little bit more fashionable. It’s going to be geared more for department stores. It’s more value oriented than where we have been before under Laundry. We will continue to stay focused on Laundry in the price points that it is and offer a new dress line under LBD.

Paula Torch - Needham & Company

And if I could just follow-up on that, who do you think would be some of your competitors there?

Oscar Feldenkreis

Probably lines like Jessica Simpson, Maggie London, that type of dresswear, dresses.

Paula Torch - Needham & Company

Great. Thank you and good luck.

Operator

We’ll take our next question from Andrew Berg with Post Advisory Group.

Andrew Berg - Post Advisory Group

Anita, when you talked about gross margin improvement as you get into the fourth quarter, obviously last year was a tough quarter. If you went back two or three years ago, you put up some margins. I think we are in sort of the low 30s. If you go a couple of years beyond that, it was more in the upper 20s. So when we think about getting back to more normalized levels, are we talking high 20s gross or low 30s kind of gross? Actually --

Anita Britt

Andrew, we’re actually talking to closer to mid-30s, in all fairness. Again, historically I think the mix probably impacted some of what you are looking at but if you look at what the company’s historically put up, it’s been north of 30 so it’s been the 30% to 35% type range. And again, when we are anniversarying 29% in Q4, that I think was an anomaly in terms of again a lot of the things that we talked about that impacted the fourth quarter of last year. So it should be closer to that mid-30s type of range.

Andrew Berg - Post Advisory Group

Okay, very good. Thank you.

Operator

We’ll take our next question from Kelly [Vichi] with Eaton Vance.

Kelly Vichi - Eaton Vance

Thanks. Most of my questions were already answered but just real quick, Anita, if you could just flesh out a little bit more, the $5 million to $10 million of additional cost-cutting expense reductions for the second half of the year, where that’s coming from?

Anita Britt

In all fairness, it’s going to mirror what I’ve talked about in Q2 and in the first half of the year, so it’s a combination of the restructuring efforts that we went through in Q4 of last year, so reduced headcount; it’s more focused advertising spend, it is more disciplined SKU generation and sample cost control. It’s lower commissions on the specialty store business and than again, focused control on TNE, so it’s a combination of all those things and to the extent that we can continue to drive those improvements year over year, it’s a very focused approach across that George talked about, the company and the entire management team.

George Feldenkreis

And that of course refers to last year, saving versus last year, not continue saving against this year, Q2 or Q1.

Kelly Vichi - Eaton Vance

Right. Okay, great. And then just really quick, I know that Grant picked up on this as well but just to go back, George, to your early remarks that retailers had very strong results on the first couple of weeks of August. Was that sequentially or year over year? And do you believe that those results in the first half of August were above the retailers plans?

George Feldenkreis

Oscar is in --

Oscar Feldenkreis

I would say that retailers are sequential and it’s improving, as well as I think they are running ahead of plan now for the month of August. As a matter of fact, we are getting calls to -- for inventory.

Kelly Vichi - Eaton Vance

Okay, great so your inventory levels versus POS and inventory levels at retail, it’s kind of reaching more of an equilibrium right now?

Oscar Feldenkreis

Yes.

Kelly Vichi - Eaton Vance

That we are back to open-to-buy dollars have opened up a little bit?

Oscar Feldenkreis

Yes.

Kelly Vichi - Eaton Vance

Okay, terrific.

Oscar Feldenkreis

Remember Father’s Day on the men’s side was very strong, so inventory levels have been very, very, very well-managed at retail and they continue to manage those -- the inventory levels and as we saw that with some of the momentums, and some of the new sell-throughs that I understand on the fall season early reads have been very strong. And we are only -- this is only really only two weeks. It should not -- you know, hopefully it’s a trend that will continue but I feel very strong that retailers are very happy with what they have currently today.

Kelly Vichi - Eaton Vance

Okay, great. Thanks.

Operator

It appears we have no further questions at this time. I would like to turn it back over to our speakers.

George Feldenkreis

I want to thank all of you for your confidence in the company. We are committed to continue to do -- to grow Perry Ellis and grow it not only in revenues but in profit and I think that the worst is behind us and we are again on a path that will bring us to higher growth and income levels. Thank you very much.

Operator

That concludes today’s conference. Thank you for your participation.

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Source: Perry Ellis F2Q10 (Qtr End 8/1/09) Earnings Call Transcript
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