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PARL > SEC Filings for PARL > Form 10-Q on 15-Aug-2005All Recent SEC Filings

Show all filings for PARLUX FRAGRANCES INC

Form 10-Q for PARLUX FRAGRANCES INC


15-Aug-2005

Quarterly Report

Management's Discussion and Analysis of Financial Condition and Results of Operations

We may periodically release forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, including those in this Form 10-Q, involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or our achievements, or our industry, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These risks and uncertainties include, among others, future trends in sales, our ability to introduce new products in a cost-effective manner, and collectability of trade receivables from related parties. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date thereof. We undertake no obligation to publicly release the result of any revisions to those forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Recent Developments

On July 22, 2005, we finalized an agreement with SGII, Ltd. (an unrelated Florida limited partnership), to purchase certain real property in Sunrise, Florida (approximately ten miles from our current office and distribution center location in Fort Lauderdale), for $14 million. The property, which would be used as our corporate headquarters and distribution center, includes approximately 15 acres of land and a 150,000 square foot distribution center, with existing office space of 15,000 square feet. The purchase price will also include certain office furniture and warehouse packing and conveyor systems.

At signing, we paid a deposit of $1 million, refundable only if the current tenant does not vacate the premises by November 30, 2005, or the seller does not comply with certain covenants. We anticipate closing on the purchase during December 2005, which would allow us to consolidate our present three South Florida warehouse locations.

On July 11, 2005, the Company announced that it had retained Citigroup Global Markets Inc. and Oppenheimer and Co. as financial advisors to explore strategic alternatives to enhance shareholder value, including the possible sale of the Company. The Company does not expect to disclose developments unless and until its Board of Directors has approved a definite transaction, and there can be no assurance that this process will result in any specific transaction.

During May 2005, we entered into exclusive worldwide license agreements with Paris Hilton Entertainment, Inc. to develop, manufacture and market a line of cosmetics and a line of handbags, purses, wallets, and other small leather goods under the Paris Hilton name. The initial term of the agreements continue through January 10, 2011, and are renewable for an additional five-year period. The Company currently manufactures and distributes Paris Hilton fragrances, and in January 2005, signed an exclusive license agreement for watches.

During April 2005, we entered into a worldwide license agreement with Gund Inc. to develop, manufacture and distribute children's fragrances and related products under the "babyGund" trademark. The initial term of the agreement continues through June 30, 2010, and is renewable for an additional two years if certain sales levels are met.

Under all of these license agreements, we must pay a fixed royalty percentage and spend minimum amounts for advertising based on sales volume.

No other material change in our contractual obligations, outside the ordinary course of business, has occurred during the periods covered by this report.

The following is management's discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying condensed consolidated financial statements and notes. This discussion and analysis should be read in conjunction with such condensed consolidated financial statements and notes.


Critical Accounting Policies and Estimates

In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial position in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company has included in its Annual Report on Form 10-K for the year ended March 31, 2005 a discussion of the Company's most critical accounting policies, which are those that are most important to the portrayal of the Company's financial condition and results of operations and require management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has not made any changes in these critical accounting policies, nor has it made any material change in any of the critical accounting estimates underlying these accounting policies, since the Form 10-K filing, discussed above.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, (SFAS 123(R)). This Statement requires companies to expense the estimated fair value of stock options and similar equity instruments issued to employees. Currently, companies are required to calculate the estimated fair value of these share-based payments and can elect to either include the estimated cost in earnings or disclose the pro forma effect in the footnotes to their financial statements. We have chosen to disclose the pro forma effect. The fair value concepts were not changed significantly in SFAS 123(R); however, in adopting this standard, companies must choose among alternative valuation models and amortization assumptions. The valuation model and amortization assumption we have used continues to be available, but we have not yet completed our assessment of the alternatives. The new standard will be effective for us beginning with the quarter ending June 30, 2006. Transition options allow companies to choose whether to adopt prospectively, restate results to the beginning of the year, or to restate prior periods with the amounts that have been included in the footnotes. We have not yet concluded on which transition option we will select. See note B to the accompanying condensed consolidated financial statements for the pro forma effect for the three months ended June 30, 2005 and 2004, using our existing valuation and amortization assumptions.

Significant Trends

Over the last few years, a significant number of new prestige fragrance products have been introduced on a worldwide basis. The beauty industry in general is highly competitive and consumer preferences change rapidly. The initial appeal of these new fragrances, launched for the most part in U.S. department stores, has fueled the growth of our industry. Department stores continue to lose sales to the mass market as a product matures. To counter the effect of lower department store sales, companies are required to introduce new products more quickly, which requires additional spending for development and advertising and promotional expenses. In addition, a number of the new launches are with celebrities (either entertainers or athletes) which require substantial royalty commitments and whose careers and/or appeal could change drastically, either positively or negatively, based on a single event. We believe this pattern will continue. If one or more of our new product introductions would be unsuccessful, or the appeal of the celebrity would diminish, it could result in a reduction in profitability and operating cash flows.

Results of Operations

Comparison of the three-month period ended June 30, 2005 with the three-month period ended June 30, 2004.

During the quarter ended June 30, 2005, net sales increased 47% to $33,817,329 as compared to $22,961,203 for the same period for the prior year. The increase is mainly attributable to (1) the continuation of the worldwide launch of Paris Hilton fragrances for women and men, which commenced shipping in October 2004 and April 2005, respectively, generating $9,328,436 in gross sales during the current quarter; (2) the initial shipment of GUESS? women's fragrance to certain U.S. department stores during June 2005, which resulted in $1,066,436 in gross sales; (3) the introduction of "360 White" for men and women under the Perry Ellis line of fragrances which resulted in a 10% increase in total sales of Perry Ellis fragrance brands, from $19,288,625 to $21,447,031; and (4) $738,728 in gross sales of XOXO brand products, which license was acquired during January 2005. The increase was partially offset by a $2,249,763 reduction in gross sales of Ocean Pacific ("OP") brand products, as no major launches were introduced during the current period pending strategic direction from OP's new owner, Warnaco, who acquired the OP brand during 2005.


Net sales to unrelated customers increased 113% to $19,402,059, compared to $9,105,652 for the same period in the prior year, mainly as a result of the Paris Hilton and GUESS? brand sales discussed above, offset by the reduction in OP brand sales. Sales to related parties (See Note F to the condensed consolidated financial statements for further discussion of related parties) increased 4% to $14,415,270 compared to $13,855,551 for the same period in the prior year mainly as a result of $2,255,195 of Paris Hilton brand sales offset by a reduction of $1,454,111 in OP brand sales. We expect that sales increases for the rest of the fiscal year ending March 31, 2006 to unrelated customers will continue to outpace those of related customers with the continued roll out of our Paris Hilton fragrance products, and the launch of the GUESS? fragrance which will initially be sold mainly to unrelated customers.

Our gross margins may not be comparable to other entities that include all of the costs related to their distribution network in costs of goods sold as compared to our allocating only a portion of these distribution costs to costs of goods sold and including the remaining unallocated amounts as selling and distribution expenses.

Our overall cost of goods sold decreased as a percentage of net sales to 43% for the quarter ended June 30, 2005 compared to 51% for the prior year comparable period. Cost of goods sold as a percentage of net sales to unrelated customers and related parties approximated 41% and 44%, respectively, for the current period, as compared to 53% and 50%, respectively, for the same period in the prior year. The significant improvement in cost of goods is due primarily to the shipment of Paris Hilton and GUESS? to unrelated parties, including U.S. department stores, where margins are significantly higher. As noted below, these improved margins were partially offset by increased in-store advertising and promotional spending, both of which we expect to continue during the launch period. In addition, the prior year quarter included a higher percentage of value sets being sold. Value sets, which include multiple products, have a higher cost of goods compared to basic stock items.

Operating expenses increased by 71% compared to the same period in the prior year from $7,774,982 to $13,325,692, increasing as a percentage of net sales from 34% to 39%. However, individual components of our operating expenses experienced more significant changes as we invested in support of our new product launches. Advertising and promotional expenses more than doubled to $7,417,042, compared to $3,405,295 in the prior year period, increasing as a percentage of net sales from 15% to 22%. The current year period includes approximately $4,300,000 of promotional costs for the continued roll out of Paris Hilton fragrances for women and men. Selling and distribution costs increased 33% to $2,256,101 compared to $1,692,625 in the prior year period, but remained relatively constant at 7% of net sales. The increase was mainly attributable to additional costs for temporary warehouse storage space to handle the increased order flow and inventory requirements, coupled with an increase in domestic sales headcount and travel expenses to support the increased sales in this distribution channel. General and administrative expenses increased 3% compared to prior year, from $1,566,221 to $1,617,124, while decreasing as a percentage of net sales from 7% to 5% resulting from the relatively fixed nature of these costs and our expense controls. Depreciation and amortization nearly doubled during the current period from $249,049 to $488,909. Amortization of intangibles of approximately $263,000 relating to the January 2005 XOXO license acquisition (See Note D to the condensed consolidated financial statements for further discussion) were offset by a reduction in depreciation for certain fully depreciated equipment. Royalties increased by 79% in the current period, increasing from 4% to 5% of net sales due to minimum royalty requirements under the XOXO license.

As a result of the above factors, operating income increased to $6,098,155 or 18% of net sales for the current period, compared to $3,495,755 or 15% of net sales for the same period in the prior year. Net interest income was $49,626 in the current period as compared to $36,248 for the same period in the prior year. The increase reflects increased cash on deposit as compared to the prior year.

Income before taxes for the current period was $6,147,781 compared to $3,532,003 in the same period for the prior year. Giving effect to the tax provision, which reflects an effective rate of 38%, we earned net income of $3,811,623 or 11% of net sales for the current period compared to $2,189,842 or 10% of net sales in the comparable period of the prior year.

Liquidity and Capital Resources

Working capital increased to $61,213,924 as of June 30, 2005, compared to $60,570,303 at March 31, 2005, primarily as a result of the current period's net income offset by the purchase of treasury stock discussed below.

During the three months ended June 30, 2005, net cash used in operating activities was $2,119,947 compared to $2,387,446 provided by operating activities during the prior year comparable period. The decrease was mainly attributable to the increase in trade receivables from unrelated customers and inventory to support the Paris Hilton and GUESS brands.


Net cash provided by investing activities decreased from $4,549,268 to a use of ($12,932) in the current period, due to the release of approximately $4,162,669 in restricted cash resulting from our full pay down on our line of credit in the prior period, collection of $501,174 of notes receivable from unrelated parties in accordance with their terms, during the prior period, and a lesser amount of equipment was purchased during the current period.

Net cash used in financing activities was $3,874,982 compared to $37,052 in the prior year comparable period. The increase was attributable to the purchase of $3,877,795 in treasury stock during the current period.

As of June 30, 2005 and 2004, our ratios of the number of days sales in accounts receivable and inventory, on an annualized basis, were as follows:

June 30,
2005 2004
Trade accounts receivable:
                     Unrelated (1)                   62       39
                     Related                         74       92
                     Total                           67       71
                     Inventories                     97      132


-------

(1)

Calculated on gross trade receivables excluding allowances for doubtful accounts, sales returns and advertising allowances of approximately $2,990,000 and $2,011,000 in 2005 and 2004, respectively.

The increase in the number of days from 2004 to 2005 for unrelated customers is mainly attributable to the increase in sales to international distributors whose terms, for the most part, range from 60 to 90 days. Based on current circumstances, we anticipate the number of days for the unrelated customer group to range between 60 to 70 days.

During prior periods, the number of days sales in trade receivables from related parties have exceeded those of unrelated customers, due mainly to the seasonal cash flow of Perfumania, Inc. ("Perfumania") (See Note F to the accompanying condensed consolidated financial statements for further discussion of our relationship with Perfumania). There has been a significant improvement in the days outstanding as a result of Perfumania's increased borrowing capability and improved profitability as indicated in published information.

Due to the lead time for certain of our raw materials and components inventory (up to 120 days), we are required to maintain a three to six month supply of some items in order to ensure production schedules. In addition, when we launch a new brand or Stock Keeping Unit, we often produce a six to nine-month supply to ensure adequate inventories if the new products exceed our forecasted expectations. We believe that the gross margins on our products outweigh the additional carrying costs. The improvement in turnover from 2004 to 2005, and the decrease in number of days, is attributable to the 47% increase in sales for the comparable three-month period, which resulted in a 23% increase in cost of goods sold, while inventories only increased by 10% during the current three-month period.

As of December 31, 2002, we had repurchased, under all phases of our common stock buy-back program, a total of 8,017,131 shares at a cost of $22,116,995. On February 6, 2003, we received approval from our lender to purchase an additional 2,500,000 shares not to exceed $7,500,000, which was ratified on February 14, 2003, by our Board of Directors (the "Board"). As of March 31, 2004, we had repurchased, in the open market, an additional 2,162,564 shares at a cost of $7,109,305 under this approval.

On August 6, 2004, the Board approved the repurchase of an additional 1,000,000 shares of our common stock, subject to certain limitations, including approval from our lender, which was subsequently received, for up to $8,000,000, on August 16, 2004. As of June 30, 2005, we have repurchased, in the open market, 384,102 shares at a cost of $5,302,560, including 217,272 shares at a cost of $3,877,795 during the period April 1, 2005 through June 30, 2005.


On July 20, 2001, we entered into a Loan and Security Agreement (the "Loan Agreement") with GMAC Commercial Credit LLC ("GMACCC"). On January 4, 2005, the Loan Agreement was extended through July 20, 2006. Under the Loan Agreement, we are able to borrow, depending upon the availability of a borrowing base, on a revolving basis, up to $20,000,000 at an interest rate of LIBOR plus 3.75% or the Bank of New York's prime rate, at our option.

At June 30, 2005, based on the borrowing base at that date, the credit line amounted to $20,000,000, none of which was utilized.

Substantially all of our domestic assets collateralize this borrowing. The Loan Agreement contains customary events of default and covenants which prohibit, among other things, incurring additional indebtedness in excess of a specified amount, paying dividends, creating liens, and engaging in mergers and acquisitions without the prior consent of GMACCC. The Loan Agreement also contains certain financial covenants relating to net worth, interest coverage and other financial ratios, which we were in compliance with.

As of June 30, 2005, we did not have any "off-balance sheet" arrangements as that term is defined in Regulation S-K item 303(a)4, nor do we have any material commitments for capital expenditures other than for the purchase of real property discussed in "Recent Developments".

Management believes that funds from operations and our existing financing will be sufficient to meet our current operating needs. However, if we would expand operations through acquisitions, new licensing arrangements or both, we may need to obtain financing. There is no assurance that we could obtain such financing or what the terms of such financing, if available, would be.

Item 3.

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