Lenox Group Inc. Q2 2008 Earnings Call Transcript

Lenox Group Inc. (LNX)

Q2 2008 Earnings Call

August 7, 2008 9:00 am ET

Executives

Marc Pfefferle - Interim Chief Executive Officer

Fred Spivak - Chief Operating Officer and CFO

Lou Fantin - General Council

Bret Rattray - Chief Marketing Officer

Presentation

Operator

Welcome to the Lenox Group Inc. second quarter earnings release conference call. (Operator Instructions) As reminder, any comments that are made today about the company’s outlook or future performance are forward looking statements. As such they are subject to uncertainties and risks and actual results may differ materially from those contained of the outlook.

Please refer to the company’s SEC filings including its Form 10-K to the complete reports of the risks and factors at work in the company’s business and the industry. No recording, reproduction, transmission or distribution of today’s call is permitted, without Lenox’s consent.

I would now like to turn the conference over to Marc Pfefferle, Lenox Group Interim Chief Executive Officer. 

Marc Pfefferle

I have with me Fred Spivak the company’s Chief Operating Officer and CFO, I also have Lou Fantin the Company’s General Council and Bret Rattray the Company’s Chief Marketing Officer. The purpose of the call is to review our Second Quarter Earnings Results. As we have discussed before we will not be providing any earnings guidance for the foreseeable future but we will be providing an update on key business trends and market conditions.

Mr. Spivak will now address the highlights of our second quarter financial performance that was disclosed in our press release.

Fred Spivak

Net sales for the second quarter 2008 totaled $76.2 million as compared to $93 million for the comparable prior year period. The net loss for the second quarter of 2008 was impacted by significant one time non-cash charges relating to deferred income tax expense as well as trademark and asset impairment charges. As a result, the net loss for the second quarter was $50.7 million compared to a net loss of $11.3 million in the comparable prior year period.

It is important to note that the company’s business is highly seasonal and historically does operate at a net loss in the first half of the year. Due to the magnitude of the one time and special charges incurred in 2007 and 2008 the company believes EBITDA adjusted for these one time and special items is useful information for investors. This method should not be considered as an alternative to our reported results which are in accordance with GAAP.

EBITDA adjusted for these one time and special items resulted in a gain of approximately $1 million in the second quarter 2008 versus approximately $1.3 million in the second quarter 2007. Moreover, this adjusted EBITDA improved by approximately $5.7 million for the first half of 2008 in which the company recorded an adjusted EBITDA loss of $4.3 million versus an adjusted EBITDA loss of approximately $10 million in the first half of 2007.

The current difficult economic and retail environment is having a particularly negative effect on highly discretionary purchases such as table top and collectible products that are sold by our company. Although the reduction in net sales was across all channels it was more significant in the wholesale division including gift and specialty stores during the quarter.

Sales in the retail segment have also been impacted by an average of four fewer company operated stores in the second quarter of 2008. In the direct channels sales were also impacted by a planned decline in the direct mail business as a result of a decision to reduce promotional activity for programs having poor response rates.

Gross profit dollars for the quarter were down as a result of lower sales but the gross profit as a percentage of net sales improved to 51% from 47% in the second quarter of 2007. This was the result of higher margin product mix as well as improvement in overseas sourcing and Kinston, North Carolina operations.

SG&A expenses were 15.6% or $7.8 million lower in the second quarter of 2008 compared to the same period last year. Although part of this is reflective of lower sales a great portion of the reduction is reflective of the cost containment programs instituted by the company which included consolidation of operations and headcount reductions.

As the result of declining revenues the company performed an impairment analysis of its intangible assets as of June 28. Based on this analysis the company recorded a non-cash impairment charge of $14.2 million in the second quarter relating to Department 56 in Gorham Trademarks. The company also completed an evaluation of an existing Federal and State net deferred tax assets and determined that a $27.5 million non-cash expense should be recorded based on SFAS 109.

The company had borrowings and its revolving credit in the amount of $69.9 million at the end of June. Letters of credit outstanding were $8.3 million. Availability under the credit facility was $17.3 million. The company’s business is seasonal; accordingly a significant portion of availability was used in the first half of the year while availability will increase in the second half. The company was in compliance with all bank covenants at June 28, 2008.

Due in part to the negative impact of current economic and retail market conditions the company does not expect to remain in compliance with its financial covenants at the end of the third quarter 2008. The company’s ability to continue with its current capital and operating structure and to fund operations is contingent upon the company’s ability to negotiate a waiver with its lenders and/or restructure its outstanding indebtedness.

There is currently no assurance that such a waiver can be obtained or such restructuring can occur. However, the company is currently pursuing certain actions to strengthen its balance sheet and reduce indebtedness and has commenced discussions with its term debt and credit facility lenders to restructure its outstanding indebtedness.

With that I’ll turn the call back to Marc.

Marc Pfefferle

As you can see from our earnings release and Fred’s report we have so far as a result of significant expense savings and margin improvements been successful so far in mitigating the P&L impact of the significant sales decreases despite extremely challenging times. Consumers and the trade particularly in the gift and specialty channel have been reducing their purchases and that is making the fiscal year especially difficult.

These economic impacts are compounding the impacts that consumer lifestyle changes have had on our fine tabletop and collectibles businesses and we project further sales declines versus LY in Q3 and Q4. While we are continuing to reduce operating expenses we will not be able to do so at a pace of reductions that will offset the projected sales decline.

In the case of fine tabletop we have retail data from NPD to benchmark ourselves against. Over the last 12 rolling months industry sales are down double digits in fine dinnerware, beverage ware, fine flatware, while casual dinnerware is down mid single digits. Our performance varies by category and is impacted by our decision not to significantly increase promotional activity to drive unprofitable sales at the expense of margin which we believe others have done and this is a shortsighted strategy.

In the case of our fine casual offering which are a success story we are showing double digit increases versus a decline in the category as a whole in the mid single digits and are on our way to capturing the number one share position. In the case of find china we are trending several percentage points worse than the category as a whole. We believe this is due in part to the dilutive effective of a large number of newly introduced designer collections.

In the case of fine beverage ware we are slightly better than the category as a whole and have not chosen again to significantly reduce our margins to chase sales as some others have done in this market. In the case of fine flatware we are several points better than the category as a whole while still negative and we have picked up two share points on the market leader but we are still seeing high single digit declines.

These numbers are trailing 12 month numbers so they reflect the last year. We believe that these declines have been significantly accentuated by the current economic conditions and will continue until those conditions improve at which such time we would expect to see some significant improvement in all of our businesses.

Although current economic and market conditions are impacting our results we believe we have put in place the correct two fold strategy. First, to maximize operational efficiency and cost reduction through streamlining and process improvement and second, to innovate and create new products and expand our valuable Lenox brand into new product categories and channels through licensing and direct extensions to generate future sales growth. These improvements have obviously been muted by the economic conditions we face.

We have already accomplished a great deal on the cost reduction front. The company’s SG&A excluding special charges was reduced from $235.6 million in fiscal ’06 to $178.5 million in fiscal ’07. Moreover, during the past 18 months we reduced headcount 22% in the non-manufacturing area from 1,140 to 894 full time employees and 9% in the manufacturing and overseas sourcing area from 444 to 405 full time employees.

There’s an ongoing evaluation of resource needs as we head into the second half of the fiscal year. In addition to these larger cost cutting initiatives we are paying attention to the small items which can add up and make a difference. Essentially we are promoting a cost conscious culture amongst employees and outside vendors. Every employee is expected to save wherever and whenever they can in eliminating low value activities where possible, cutting back on travel or simply turning out the lights at the end of a meeting or a day’s work.

Improvements in our operations and processes especially at our Kinston, North Carolina factory and in our overseas sourcing operations have already produced better gross margins despite significant Asian inflationary pressures. There is still work to be done in these areas where continuous improvement will ensure that we live up to the high quality image of our brands and maintain competitive pricing and improved margins. We want it all in this area, quality, competitive pricing and high gross margins.

We are also focused on improving or forecasting process, most importantly our IT systems to support our business units. There has been much progress in both of these areas but much more work needs to be done.

The second part of our strategy is the most exciting, innovating and creating new products to excite end customers and the trade which is the DNA of our company. Over the past 18 months we have changed the way young consumers look at fine china with the introduction of Simply Fine under the Lenox brand. Simply Fine’s four piece place settings of durable, youthful and fresh designs and shapes of bone china have been extremely well received in the bridal market and is expected to be an important contributor to future growth.

Lenox has also made significant progress in the casual market with the introduction of such patters as Orchard in Bloom and Aspen Ridge. The quality casual market is a growth area for the Lenox brand as consumers migrate to more casual entertaining. Lenox is a trusted iconic brand which represents quality and good taste. We believe that this brand has great potential to expand horizontally across many different home décor and giftware categories.

We have a focused initiative underway to license out the Lenox brand in new product categories and in addition to pursue other categories directly where Lenox will bring a new and innovative perspective and add value and excitement to the end consumer. Some of these programs area already well underway.

The Lenox brand also intends to expand distribution in select foreign markets where there is demand for well known American brands. To date we have achieved reasonable success in foreign markets with limited resources. We believe that a reallocation of resources to grow in international markets will produce incremental sales and profit growth for the future.

Over the past 18 months we have dedicated resources to reinvent the Dansk brand and are optimistic about its prospects in the upstairs tabletop market. The new Dansk contemporary tabletop products have been well placed in all the important department store channels plus Bed Bath & Beyond and is gaining traction in the home specialty and club store channels. Dansk also continues to do well in Asian markets and has the potential for international growth.

The Dansk brand has a rich heritage of elegant and unique contemporary designs. We have returned Dansk to its heritage and will build the Dansk business on this strength rather than pursue the failed strategy of placing Dansk in the lower priced housewares market.

In conclusion there is no doubt that we are sailing into headwind with current economic and market conditions. In these tough times it behooves us to keep focused on our strategy of cost reductions and operational and process improvements while at the same time act to strengthen our balance sheet and reduce indebtedness. We also believe that it’s important to continue to create innovative products so that we can ride the competitive advantage that they provide out of the recession.

You will continue to see us interpret product categories in new ways to build retail sales and maintain the relevancy of our brand. That concludes my formal comments and I will turn it back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) At this time I show no questions in the queue. Ladies and gentlemen this concludes the Lenox Group Inc. second quarter earnings release conference call. We would like to thank you for your participation.

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