Welcome to Movado Group’s second quarter earnings conference call. (Operator Instructions) I would now like to introduce Ms. Leigh Parrish of FD. Please go ahead.
Good morning everyone and thank you for joining us today. With me on the call is Efraim Grinberg, Chairman, President and CEO; Rick Cote, Chief Operating Officer and Sallie DeMarsilis, Chief Financial Officer. Before we begin I would like to note that this conference call contains forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
Factors which could cause actual results to be materially different from any future results expressed or implied are discussed in our filings with the SEC. Such forward-looking statements include statements regarding Movado Group’s performance for fiscal 2010 and beyond. However, the failure to update this information should not be taken as Movado’s acceptance of these estimates on a continuing basis. Movado Group may also choose to discontinue presenting future estimates at any time.
Let me now outline the order of speakers and topics for today’s conference call. Efraim will begin with the highlights of the second quarter, Sallie will review the financial details and Rick will then provide you with an update on our operating in initiatives along with the company’s financial outlook. The Company would then be glad to answer any questions you might have.
I would now like to turn the call over to Efraim.
Thank you. Good morning everyone. Since early last year we have discussed the challenges of the global economy and the significant impact on the retail environment, consumer spending and more specifically on the watch and jewelry industry. We are neither expecting nor are we planning our business around any type of fast recovery in the world economy. We are beginning to see some stability in the market, particularly in the U.S., although it should come as no surprise that the European market which began to experience the economic downturn later than the U.S. was somewhat more challenging in the second quarter.
With all this in mind I am pleased with our results during the second quarter and our ability to return to profitability earlier than anticipated. We have maintained a disciplined approach to managing our business including stringent expense management coupled with a keen focus on our capital position. At the same time we continue to provide products at a variety of price points and offer compelling marketing and advertising campaigns that differentiate our brands in the marketplace. We believe we are doing the right things to position Movado Group in a challenging environment.
Further, we are beginning to see more consistent orders from many of our retail customers in the U.S. after significant de-stocking late last year and earlier this year. We have also had a number of important retailers go out of business. Collectively, our strategic initiatives and our team’s steadfast execution have enabled us to efficiently address the current sales environment while helping us to achieve better than expected results during the quarter.
Although we recognize consumers are maintaining a conservative posture on spending, we are encouraged by some bright spots we are seeing as we have introduced new products and more acceptable price points within each of our brands. Within our Movado brand we have been encouraged by the enthusiastic response and strong sell through we have received for our new Sub Sea Collection priced from $795-995, the Movado sweet spot.
This month we are also introducing a new collection of watches designed by the artist Kenny Scharf. This series of watches has already been featured in leading fashion publications in September. The collection, which is made up of six different designs will predominately be sold in our Movado Boutiques.
In addition we are also launching a new Pinnacle Collection for Movado. The Movado Master features an automatic movement, a natural rubber strap and a sapphire bezel. The collection ranges in price from $3,000 to $5,000. The Movado Master will be heavily advertised this fall. Overall we believe the Movado brand has maintained a leadership position in its category and we are pleased with the exciting opportunities to build on the aspirational nature of the brand.
Turning to our boutiques, as you may recall we implemented the unified Movado brand strategy early in 2008 and we leveraged the strength of the Movado brand across all distribution channels. This included enhancing the performance of our boutiques as we plan to dedicate increased space to watches and to offer more unique and exclusive products while being more selective in our jewelry assortment.
Our boutiques provide us an exclusive and proprietary opportunity to feature Movado jewelry and we believe this really sets our store apart. With that in mind we will launch several new Movado jewelry collections in our Boutiques this fall supported by a strong advertising program this holiday season. We remain confident our boutiques will continue to play an important role in the future of the Movado brand in both jewelry and watches.
In February we established a new subsidiary in China, first to distribute the Movado brand in China and also to provide a platform for the distribution of our other brands in this fast growing market. We are very pleased with our recent performance of Movado in this high potential market place and we will begin launching our licensed brands in China this fall.
This spring we began the rebranding of ESQ to ESQ by Movado. The initial results appear to be promising and can help to provide an entry level product for our retailers with a strong association to the Movado brand. This fall we will begin a comprehensive online and print marketing program to communicate the ESQ by Movado initiative.
Our licensed brand category has also been affected during the first half by the economic environment especially by the impact of the consumer in Latin America and Europe. However, we have introduced sharper price points in each of our brands and believe this will have a positive impact along with exciting new product introductions. We are already beginning to see positive results as we address consumer needs for an improved value proposition.
The luxury segment remains weak across the board. We are now positioning our luxury brands Ebel and Concord for recovery in 2010 with focused product introductions and innovative marketing programs beginning next spring. We have our two most challenging quarters behind us and I am satisfied with our execution and performance despite the headwinds we faced in the global environment. We are operating as a much more efficient organization and giving close attention to consumers as we see a new economy emerging where they are looking for excellent value.
As such, we are adapting our new products to address their needs by delivering value across our strong portfolio of brands from the high end of the luxury market to the more affordable fashion watch category. As a result, we believe we are well positioned to capture growth and market share. Before I turn the call over to Sallie I would like to remember David Taylor, a long-time shareholder and supporter of our company who recently passed away. David was a frequent participant on these calls and will be missed.
Now let me turn the call over to Sallie.
Thank you Efraim. Good morning everyone. On a GAAP basis we reported a second quarter net income of $500,000 or $0.02 per diluted share compared to net income of $8.1 million or $0.32 per diluted share in the prior year. Sales for the second quarter were $89.7 million, down from last year by $40 million or 30.8%. Net sales for this year included $1 million of excess discontinued inventory.
Including the sales of discontinued products, sales declined by 31.6%. The balance [inaudible] as it relates to sales and gross margin excludes the excess discontinued product sales reported in the second quarter of fiscal 2010. Year-ago sales and gross margin results do not include any such sales.
For the second quarter sales in our wholesale segment were $68.6 million or 35.9% of prior year sales of $107 million. Sales were below prior year in all categories, most significantly in the luxury and accessible luxury categories. The U.S. wholesale was below prior year by $15.9 million or 33%. The decrease was primarily driven by the luxury and accessible luxury categories.
Sales in the licensed brand category were flat to last year. The international wholesale business was down by $22.6 million or 38.3% year-over-year. Lower sales were recorded in all categories as compared to last year. The retail business posted an 11.2% sales decrease over last year. The company outlet store sales were below prior year by 6.3% and sales in the Movado Boutiques decreased by 19.7%. At July 31, the company operated 27 Movado Boutiques and 31 outlet stores.
Gross profit in the second quarter was $52.6 million versus $83.2 million last year. Gross margin for the quarter was 59.3% as compared to 64.1% last year. The overall decrease in gross margin was primarily driven by promotional activity in our retail business and the overall mix of the business.
Results for the second quarter of the current year include a $1.3 million charge for one-time costs incurred in connection with the repayment of $25 million that was outstanding under our former note agreement and other costs related to the refinancing of our revolving credit facility. The results of the second quarter of the prior year included a $2.2 million charge or $0.06 per diluted share related to severance associated with our previously announced expense reduction programs.
The balance of my comments as they relate to the quarter will exclude these charges for comparison purposes. Operating expenses for the quarter were $49.5 million below prior year by $29.3 million or 29%. The decrease was primarily the result of initiatives to streamline operations and reduce expenses which included lower marketing expenses of $7.5 million and lower expenses across all other operating expense categories of $12.8 million.
The operating income for the quarter was $3.1 million compared to operating income of $13.3 million last year. Income tax expense of $1 million reflects a 42.8% tax rate in the second quarter compared to income tax expense of $3.2 million or a 24.6% tax rate reported last year. The tax rate in the current period included adjustments of $200,000. The effective tax rate excluding these adjustments was 24.5%.
On an adjusted basis, second quarter net income was $1.4 million or $0.06 per diluted share compared to net income of $9.8 million or $0.39 per diluted share in the prior year.
Now looking at our year-to-date results, on a GAAP basis for the six month period we reported a net loss of $8.4 million or $0.34 per diluted share compared to net income of $9.4 million or $0.36 per diluted share in the prior year. Sales for the six month period were $157.3 million. The net sales for this year included $5.3 million in excess and discontinued inventory. Excluding the sales of discontinued products, net sales decreased by 34.2%.
Once again let me remind you the balance of my remarks as they relate to sales and gross margins will exclude the excess discontinued product sales reported this year. Sales in our wholesale segment were $116.2 million or 39.6% from the prior year sales of $192.3 million. Sales were below prior year in all categories, most significantly in the luxury and accessible luxury categories.
The U.S. wholesale business was below prior year by $34.6 million or 40.6%. The international wholesale business was down by $41.5 million or 38.8% year-over-year. Net sales in the retail segment were $35.9 million or below prior year by 7.5%. Gross profit for the six months was $90.4 million versus $147.5 million last year. Gross margin for the six months was 59.5% as compared to 63.8% last year. The decrease in gross margin was primarily driven by promotional activity in our retail business and the overall mix of business.
As previously discussed, year-to-date sales included a $1.3 million charge related to the repayment and refinancing of our revolving credit facility and the results for the six months of the prior year include a $2.2 million charge or $0.06 per diluted share related to our previously announced expense reduction programs. The balance of my comments for the six month period will exclude these charges for comparative purposes.
Operating expenses for the six months were $97.7 million below prior year by $34.9 million or 26.3%. The decrease was primarily the result of initiatives to streamline operations and reduce expenses which included lower marketing expenses of $13.7 million and lower expenses across all other operating expense categories of $21.2 million.
Income taxes were provided at a 16.9% effective tax rate versus a 25.4% rate for the prior year. The tax rate for the six month period included adjustments of $400,000. The effective tax rate excluding these adjustments was 24.5%. On an adjusted basis for the six months period, net loss was $7.2 million or $0.29 per diluted share compared to net income of $11 million or $0.42 per diluted share in the prior year.
Now taking a quick look at our balance sheet our cash at July 31, 2009 was $47.5 million compared to $84.5 million last year. Our debt has been reduced to $40 million at the end of the current period. Accounts receivable of $76.7 million are below prior year by $19.7 million. The lower receivables year-over-year were primarily due to the decline in our sales.
Inventory of $248.2 million increased from $238.7 million last year. Due to the lead times required when purchasing inventory orders were placed well in advance of the downturn of the economy. The decrease in sales volume causes these receipts to remain in inventory.
Lastly, capital expenditures for the six months were $2.9 million and depreciation expense was $9 million which includes depreciation for our new ERT system.
Now let me turn the call over to Rick.
Thank you Sallie. Good morning everyone. The aggressive actions we took last year to enhance our operational efficiencies are continuing to translate into tangible improvement in our financial results. As a reminder, throughout the year we are focused on improving our cost structure, preserving cash, maintaining a strong balance sheet and funding our business appropriate for future growth.
First, let me update you on the progress we have continued to make against the cost savings initiatives we began implementing last year. Through continued execution of our expense management program we have successfully reduced operating expenses by $37.1 million or 27% from the first half of last year. As Efraim mentioned, this was achieved while supporting our brands’ strong advertising and marketing programs. As a result of our efforts, we remain on track to reach our goal of annualized savings between $50-60 million most of which we expect to realize this year.
Second, capital expenditure reductions. As we have continued to focus on preserving capital we have only budgeted spending this year for those projects being deemed absolutely necessary. As a result, we continue to expect CapEx in fiscal 2010 to be no more than $10 million versus $23 million last year.
Third, we are continuing to focus on cash flow management as well as reducing inventory levels to align with current sales trends. We remain committed to curtailing orders while being very selective and strategic with the new products we are bringing to the market place. We continue to believe the benefits of these actions coupled with retailers replenishing ahead of the holiday season will begin to be seen in our inventory levels and cash flow during the second half of this year. Importantly, we expect to return to being free cash flow positive this year.
Now I would like to turn to our financial outlook for fiscal 2010. While our visibility has improved since early this year, the economic environment remains extremely challenging. As I mentioned earlier, we are gaining traction with our cost reduction initiatives which have helped to mitigate the effects of the difficult consumer landscape.
We continue to expect a high single digit sales decline for the year and to maintain current adjusted gross margin levels of approximately 60%. With these factors in mind and as you may have seen in our press release this morning we reiterated we estimate fiscal 2010 fully diluted earnings per share to be approximately $0.50. I would like to note that this includes a $0.04 one-time charge reported in the second quarter. This guidance continues to be predicated on the improvement in sales trends during the second half of fiscal 2010 as retailers purchase inventory in preparation for the holiday season.
With that I would now like to open up the call to your questions.
(Operator Instructions) The first question comes from the line of Jeff Blaeser - Morgan Joseph & Co., Inc.
Jeff Blaeser - Morgan Joseph & Co., Inc.
A quick question on the G&A line in terms of the variability of it. If we were to see an uptick in sales next year or the year after, what kind of trends would we expect to see in the SG&A line or do you expect that to remain relatively steady in dollars?
Our focus is obviously with the initiatives that we took last year and at the end of last year as well to really reset our business and clearly SG&A is an important part of that. We certainly would expect that marketing expenses would continue to be variable as a percent of sales but again this year we are looking at about a 13.5% spending and that is probably a good level going forward. The changes we have made we do expect to be permanent and then obviously we would look at the changes taking place which are more customary with inflationary increase to see salary increases and those types of things. We are not looking at rebuilding back to where we were. This is a new platform for us going forward.
Jeff Blaeser - Morgan Joseph & Co., Inc.
On the inventory side, do you expect to be able to sell that through? Any other liquidation expected going forward or is it kind of a work in progress depending upon the environment?
I think it is going to be all of those. Clearly the key factor is as sales pick up in the second half of the year we would expect that would obviously come out of our existing inventory both from a standpoint of what we have and what we have built. We do expect to see a sizeable improvement in the second half of the year to the extent of excess liquidation sales to the extent we are able to do some of those that makes some sense. That is going to be minor. Again we would disclose that as that takes place.
The next question comes from the line of Jennifer Bennett – JMP Securities.
Jennifer Bennett – JMP Securities
Could you offer a little bit more color around the trends you are seeing with regard to retailer orders for the holiday season? Could you talk about those trends by market, the U.S. and internationally? You mentioned early on that you are seeing more weakness in Europe and I was just curious what your outlook for that is.
It is a little early to see really definitive trends. Most of our holiday sales will come in the latter part of the third quarter and beginning of the fourth quarter. We have seen inventories at retail drop over the first half of the year quite significantly. Our sales because of that have been lower than the sales trends at retail. We have seen Europe, as I said earlier, in the second quarter begin to become a little bit more challenging but we are seeing some bright spots as well in the marketplace like Germany that are beginning to recover earlier than others.
Jennifer Bennett – JMP Securities
Could you talk about the new distribution center in China and what exactly that means from the cost savings and a broader distribution standpoint?
The operation in China is we have gone from a distributor model where we were using a third party for selling our product into China to having our own full fledged subsidiary where we are actually able to sell directly to retail customers and collect cash and all that kind of stuff. It is much more from a marketing and business operation standpoint than it is from a distribution savings standpoint. So when you look at that it means we have the full margin of our sales to retail customers and we are able to manage our marketing expenses more directly. Obviously, as we have said many times, China certainly is a growth market for us and many others. This gives us the opportunity of being able to control our own destiny as we continue to invest in that important market.
The next question comes from the line of Josh Pechter – Cacti Partners.
Josh Pechter – Cacti Partners
Can you help me with an inventory question? I was looking at your annual report and inventory is held on your balance sheet at cost?
Yes, our inventory is at our cost.
Josh Pechter – Cacti Partners
Whatever dollars of inventory you show or is what you physically have in [Paramus] or around the world, right? It is not what is held at retail in any capacity? You have been paid for everything that is on the shelves.
And/or it is in receivables except for our owned outlet stores and boutique stores. That is also recorded in costs but obviously that is our inventory as well. So it is inventory we have produced and is still in our possession and we haven’t sold to a third party. On the wholesale side that would be retailers and on our own boutique side it would be to final consumers.
Josh Pechter – Cacti Partners
So how much inventory is typically held at retail outside of boutiques and outlets? Is there usually a year of inventory held out in the retail channel?
The turn in this industry varies from the high end to the licensed brand. Some brands turn below one at retail and other brand turn above 2, 3 or 4 times. It really varies. The fashion category and the license category turns a lot faster than as the price points move up the spectrum.
Obviously one of the things we have been impacted by as we have said many times is the significant level of de-stocking or the inventory decline at retail have been far greater than their sell through declines. That is where we would expect in the second half to get some pick up as people have to get their inventory to a more reasonable level even though it is at a reset perhaps lower sales level than it has been historically.
Josh Pechter – Cacti Partners
You would expect as we work through Q3 and Q4 that the $200 million or so you have got will be sent out into the channel? It is not like you have two years of inventory and we may have to go through a devaluation of that inventory. You are not anticipating that are you?
First of all, no. There are two things I will reply to that. First, clearly we do expect inventories to decline because sales will obviously be picked up versus where they were on a very low basis last year. That is number one. Number two, the product that we have has long life and if you go back and look historically that is one of the things that doesn’t really doesn’t take place for us specifically or pretty much in the category of any write offs or devaluations of inventory because [it will be done]. That is why we use our outlets quite a bit. The outlets to the extent we do have product we are discontinuing it allows us to sell through our outlets in a very controlled, organized and very profitable manner. So we do not see that is usually not an item that takes place in this industry.
Josh Pechter – Cacti Partners
One last question for my friend David Taylor who I do miss on the call after almost a decade of listening to him. Can you tell us anything about receivables? You have had a lot of bankruptcies in the industry. A lot of players that held your watches are gone. You have done a remarkable job of getting way ahead of what very few left in the industry would have seen as such a rapid downturn. You cut costs. You cut doors. It has been an amazing display of what management should do ahead of what has turned out to be a remarkably bad period. Is there any concern on your part? I know you are paid very quickly. Is there any receivable out there that could really sting you or come out of nowhere or you got into bed with someone that just didn’t turn out to be a good client?
We try to be very careful in terms of our credit valuation and how we extend credit. Obviously it has been more challenging over the past several years but I think our finance team has done a pretty good job on monitoring the situation with the higher credit risk customers and mitigating the impact to the company. Obviously we have taken some small hits over the last two years.
I think it is important if you go back to our conference calls I would say probably eight now we have talked every single time, and this is before the recession started, that we were concerned and were being very cautious with credit. We were willing to have lower sales to be sure we were doing it with the most credit worthy customers. As a lot of those companies have gone out of business that are important customers of our historically the impact we have had was quite insignificant. So we continue to have that prudent approach in issuing credit in who we do business with.
Josh Pechter – Cacti Partners
We have always been tough on you guys on all types of things. You have done a remarkable job of getting ahead of this. I don’t care if you make $0.01. It is a great display of really running a company well. I give you a tremendous amount of praise.
Thank you. We always try to position our company for the future. If there are no more questions I would like to thank everyone for participating today and hope that everybody has a very nice holiday weekend and enjoys the holiday weekend. Thank you.
Thank you. This concludes today’s conference call. You may now disconnect.
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