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Elizabeth Arden, Inc. (NASDAQ:RDEN)

F1Q09 Earnings Call

November 6, 2008 10:00 am ET

Executives

Allison Malkin - Integrated Corporate Relations

E. Scott Beattie - Chairman of the Board, President, Chief Executive Officer

Joel B. Ronkin - Executive Vice President, General Manager - North America Fragrances

Stephen J. Smith - Chief Financial Officer, Executive Vice President

Marcey Becker - Senior Vice President of Finance

Analysts

William Chappell - SunTrust Robinson Humphrey

Jason Gere - Wachovia Securities

Joseph Altobello - CIBC World Markets

Arnold Ursaner - CJS Securities

Alice Longley - Buckingham Research

[Analyst for Reza Vahasita] - Barclays Capital

Operator

Welcome to the Elizabeth Arden first quarter fiscal 2009 results conference call. At this time all participants are in a listen-only mode. A question and answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Allison Malkin of ICR.

Allison Malkin

Before we begin if you have not received a copy of Elizabeth Arden’s press release, please call 203-682-8200 and we’ll send one out to you. Also, please note that this call is being broadcast live over the Internet and you can access the call at www.elizabetharden.com.

Before we begin I’d like to remind you that some of the comments made on this call as either prepared remarks or in response to your questions may contain forward-looking statements that are made pursuant to the Safe Harbor provision of the Securities Litigation Reform Act of 1995. Such information is subject to risks and uncertainties that could cause actual results differ materially from the statements as described in the press release and on Elizabeth Arden’s most recent annual report on Form 10K filed with the SEC. We direct all listeners to t hat report.

Also, some of the information that may be contained in our earnings releases or comments made on this or other calls may constitute non-GAAP financial information under the SEC’s Regulation G. Reconciliation of such information to the most comparable financial measure prepared in accordance with Generally Accepted Accounting Principles may be found on our website at www.elizabetharden.com.

The information in this call is accurate only as of the date discussed and investors should not assume that the statements made in this call remain operative at a later time. Finally Elizabeth Arden undertakes no obligation to update any information discussed on this call.

I would now like to turn the call over to Scott Beattie, Chairman and CEO of Elizabeth Arden.

E. Scott Beattie

Welcome everyone to our first quarter conference call. Joining me today is Joel Ronkin, our Executive Vice President of our North American Fragrance unit, Steve Smith, our Executive Vice President and Chief Financial Officer, and Marcey Becker, our Senior Vice President of Finance.

In terms of the outline of today’s agenda, I will provide a brief summary of Q1 performance and specifically the performance of the international business and the global performance of the Elizabeth Arden brand. I’ll also provide a summary of our supply chain re-engineering initiatives as well as our JDE implementation. Finally I’ll provide an overview of the Q2 outlook and remainder of 2009 fiscal year outlook.

Joel will provide a review of our total North American Fragrance unit including a performance summary of our new fragrance launches, the integration and performance of the Liz Claiborne beauty business, and a review of second quarter and the holiday season for his business which just to remind everyone consists of our North American department store fragrance business, our mass retail fragrance business in North America, and the Canadian and Puerto Rican affiliates. The Q2 is a particularly important quarter for Joel’s business and particularly the mass business which is obviously our biggest component of our overall business.

Steve Smith will provide a financial overview of our Q1 performance and provide a summary of that quite dramatic impact currency fluctuations had on our quarterly performance and the impact for the remainder of the year of corporate currency and overall review of the remainder of the year. Steve will also provide a detailed review of our capital and liquidity position given that this is top of mind for many investors. He will also provide an insight into how we are managing during this difficult financial period and how we’re managing our financial affairs including credit and collections, capital expenditures, etc. during this period.

In terms of the first quarter performance our North American business was up 9% and that was really led by two components, primarily by the US department store component which was up 45%. Obviously this was a function of the Liz Claiborne deal. As you recall during our previous conference call the Liz Claiborne department store business unit was combined with our business unit to increase that efficiency and productivity of our combined business. Our mass business in the first quarter was down 4.6% which Joel will go into more detail on in a second.

In terms of our international business it was essentially flat. The international in total I think was up 1%. Europe was down a little and the rest of the world was up a little but primarily flat. The specific weakness was in the UK and Australia but it was primarily driven by a very strong first half last year and more difficult comps year-over-year which I’ll talk about in a second.

In our previous conference call our outlook predicted continued weakness in North America with a reduction in the decline of the department store business primarily as a result of the Liz Claiborne acquisition. But we did expect the continued weakness in the US consumer and overall performance through the first half of the fiscal year. While our concerns during the spring and our most recent call in August were validated despite very strong product launches, some certain product launches particularly in our fragrance unit did substantially better than we anticipated.

Our retailers in North America experienced a dramatic falloff in traffic particularly from mid-September forward. As a result of this reduction in store retail performance, many of our retailers are being very cautious with regard to basic stock inventory replenishment builds for Christmas. They are obviously taking all of our promotional programs, our gift sets, because those provide tremendous value to the consumer and they do have return privileges if they don’t sell through. But in terms of the basic stock, I think generally across all of our department store type retailers globally they’re being very cautious in terms of basic stock replenishment.

On the other hand, our mass based retailers have generally fairly well with regard to consumer traffic and same-store sales comps. This morning you saw the Wal-Mart numbers come in quite strong vis-à-vis expectations and we have very strong programs for the holiday season for our mass retailers as well as the rest of our retailers. Joel will describe in more detail the mass phase retail programs for the Q2 quarter.

We’ve experienced this is past cycles in the early 90s and again in the early this decade, and what we have found is that shoppers tend to trade down during the Christmas season and are clearly more value based purchasers of product and also are selecting more value based retailers. They tend to purchase later in the Christmas season postponing purchases and they tend to be attracted to more lower price points where they can buy a larger group of gifts but at a lower price point. This typically drives more of our fragrance customers particularly into our mass retail channel of distribution.

In terms of our international performance, as you might recall last year we had a very strong international performance during Q1 and Q2 driven by most markets and also by the positive impact of currency.

During our Q1 this year most businesses performed generally well with regard to their constant currency budgets with the exception of Australia and the UK that had very strong mass [inaudible] fragrance businesses last year in both the first and second quarter. We had difficulty aniversarying those businesses this year. As you recall last year first quarter Australia was up almost 45% and the UK was up double digits as well. Most of the weakness in international was driven by this not annivesarying this additional volume year-over-year and the impact that currency had, which Steve will talk in more detail in a second.

In terms of global brand highlights, the EA brand was down 4.7%. Again this was driven by currency but also weakness in the EA fragrance category which was down 15%. The total skin and color component of the Elizabeth Arden brand was up 4.4% globally and Prevage led that by being up 3.7%. The fragrance business is down really in anticipation of our new fragrance launch in Q3 which we’re very excited about.

Elizabeth Arden Pretty is the name of the product. This launch has been presented to the trade on a global basis and we anticipate it being a fantastic success. It’s been very well received by both beauty editors and retailers and I believe as well as our brand marketing and sales people around the world that this will be a very strong global launch and a global fragrance and will provide a fourth pillar to our Elizabeth Arden fragrance business in addition to Red Door, Fifth Avenue and Green Tea.

The recently re-launched Prevage body product has really provided a lift to the overall Prevage franchise. Although it was just recently shipped to trade, it is contributing to the positive improvement at retail that we’ve seen in October for the Prevage business and that launch will continue to roll out internationally during the third and fourth quarters of this year. It will provide strength in our second half of the year.

In terms of the J.D. Edwards and re-engineering projects just briefly, each project is running on schedule and within our budget. The supply chain re-engineering has contributed to improved inventory position that we’re experiencing and operating cash flow despite a very unpredictable environment and the related difficulties that come in accurately predicting retail replenishment and supply chain requirements. Our supply chain people have done extremely well both to implement new business processes and at the same time adapt to a very unusual environment from a replenishment point of view.

In terms of our outlook for the second quarter and beyond, as Joel will discuss in more detail Q2 is really driven by our mass retailers in North America. The fragrance department store business should benefit from the efficiencies of the combined Liz Claiborne business as we did in the first quarter despite the category weakness in this channel.

In terms of international, Europe and Australia will continue to be weak because of what I described earlier but the rest of the world is essentially performing as we expect to offset some of this weakness. Our guidance specifically decouples the impact of economic weakness from currency weakness and our assumptions on currency to provide the visibility to everyone on the business. Steve will provide sort of a more detailed review of the impact of currency on the first half performance and then into the second half.

The second half of the year will benefit very strongly from the innovation that I’ve described, the Arden fragrance Pretty will launch in the third quarter. The Prevage body product will roll out during the third and fourth quarters to international. The Liz Claiborne brands will be moving more into international distribution during the third and fourth quarter and be launched in our travel retail business. The integration expenses related to the Liz Claiborne transaction and some of the transitional expenses will be completed during the second half. It won’t be incurred during the second half of the year.

One final contributor, as you recall last year Q1 and Q2 were very strong for our business and particularly in our international business. We really started to see the consumer slowdown during our third quarter last year and as a result we saw very weak replenishment during the third quarter which resulted in quite a step-down year-over-year.

Obviously this year there have been less aggressive inventory builds during the first two quarters and we anticipate as we go into the third quarter this year that we’ll have more normalized replenishment and won’t have the dramatic slowdown. That impact has been somewhat normalized hopefully by the performance of the first and second quarter of this year.

On that note I will hand it over to Joel Ronkin who will talk about the North American fragrance business.

Joel B. Ronkin

As usual I’m going to give an overview of the performance in North American fragrances group overall, I’ll discuss our new launches, I’ll also comment on our outlook for the second quarter of this fiscal year, and I’ll also give everyone an update on what we’re seeing from a retail standpoint. We have an interesting perspective on that because of our multichannel approach.

The North American fragrances group comprised about 60% to 65% of our overall net sales. As Scott mentioned it includes our department store fragrance business in the US, our mass business in the US, our ecommerce business which I’ll get into in a few minutes, as well as our businesses in Canada and Puerto Rico.

For the first quarter we were up 9% in net sales which was in line with our expectations. Primarily this was driven as a result of the Liz Claiborne fragrances being added to our department store business. It didn’t have a big impact from the sales in our mass business because you may recall that we already had been the distributor of these fragrances into the mass market.

Excluding the charges related to the integration of the Liz Claiborne business and some other one-time charges, our profits for North American Fragrances was up an even more significant 55% year-over-year. This was largely the result of the fact that we are now a brand owner rather than a distributor on those Claiborne brands in our mass channel.

As Scott mentioned before, our mass business was slightly down year-over-year for the first quarter consistent with retail trends. However our market share has remained strong and in fact slightly increased this calendar year.

Many of our brands are performing very, very well including our new launches in that channel. Curve for Men and White Diamonds which is a ladies brand continue to rank as the number one men’s and women’s fragrances in the mass channel. They have been for many years. In addition we own or distribute six of the top 10 and five of the top 10 women’s and men’s Prestige fragrances in the US mass retail channel respectively.

The addition of the Liz Claiborne business has had a big impact to our business in particular to our department store business where our net sales have almost doubled for the quarter. We had mentioned in the last call how we thought this would give us some great synergies and be able to provide better service to our retailers. We are seeing that and we are really pleased to date with the performance of this business unit.

We successfully completed the integration of the Claiborne business by the end of august with all inventory transferred, all order management fulfilled from our Roanoke facility, and our department store sales forces were combined. What we did is we took the best people from the Claiborne and Arden sales forces and put them together. Overall the size of the sales force really did not increase.

We also brought in Art Spiro who was the President of Liz Claiborne’s fragrance business as well as his marketing team to continue to lead the development of the Claiborne brands globally. We’re pleased that are retailers have been extremely supportive of our efforts as we’ve been integrating these businesses and have worked through all the transition issues with us. I would be remiss if I didn’t compliment our field sales team in managing this transition at the busiest time of the year, which included an unprecedented number of launches while integrating the Claiborne and Arden brands together.

I mentioned earlier I was going to talk about ecommerce which we’ve really not gotten into in specifics before but is really a great story. We’ve really only been at this for a little more than a year and our sales are just up a tremendous amount; 300% year-over-year. Each month’s comps are getting better. It’s largely driven by the success of our Prevage franchise and we think Prevage body will also add to that.

Not only do we sell products on the site but we also use it almost as a test lab to find a great way to communicate with our consumers, test merchandising concepts, promotional concepts and have really been pleased with the overall performance of that business. As the years go by we really think this is an opportunity to ultimately become about 105 of our business.

As far as our new launches, we are pleased with the performance of our new brands. Viva La Juicy, the second fragrance in the Juicy line, has resonated tremendously with retailers and consumers. We’re pleased to report it’s the number one fragrance bar launch this year at Prestige and it significantly exceeded the retailers’ expectations and frankly our expectations of it. We’re supporting this brand with national print advertising, selling assistants in the stores, and authentically Juicy promotional material.

Mariah Carey’s Luscious Pink has also launched in the last few months and is exceeding retailer expectations to date. We expect this brand will be a real solid performer for us over the holiday season as we continue to ramp up our advertising activities. Hopefully you’ll be seeing some of the activities that Mariah has done herself in the last few weeks to promote the brand including on Good Morning America. We’re also in the process of launching a new print campaign and a new commercial which will begin airing the day after Thanksgiving. So we have an awful lot of activities behind that brand.

On the men’s fragrance side we have Rocawear 99 which launched on counter in mid-September. It’s quickly established itself as a major brand ranking in the top 15 in October in all of Prestige. It has an innovative edgy vibe which is consistent with the positioning of the fashion label which was started by JV. Anecdotally we’re also seeing the brand gain some traction. At retailers we have begun rolling out our advertising campaign over the last three or four weeks. We included a radio commercial which you will hear featuring JV’s voice.

In men’s and ladies’ fragrances we’re trying to capitalize on the success of the Usher launches last year by launching a limited edition men’s and ladies’ fragrance called Usher UR. It’s just hitting counters now so it’s a little bit early to make any comments on the performance. We met with Usher this week and he was quick to tell us how much he’s doing to promote both the fragrance brand as well as his music, and he’s really excited about it as are we.

In addition to these major launches we’re launching a new Britney Spears fragrance called Hidden Fantasy which ships in early December. This launch is more focused on specialty and international retailers. We probably had lower expectations when we initially came out with this brand than what we’re seeing now, and the reaction from the trade has been great. Overall the Britney brands continue to be significant contributors to our portfolio. The Britney Spears Believe is one of our best performing new brands in international as well as in mass retail and Fantasy and Curious, her two original fragrances, continue to be top 20 brands overall at mass.

We’re continuing to support all these brands with TV and print advertising at holiday. Globally the sales of Britney’s fragrances were slightly down for the quarter yet sales in mass and international were up and were only down in Prestige department stores in the US. That’s because last year we had a department store launch Believe and we have no department store launch this year.

As is always the case talking about the holiday season, it’s our key selling season for Elizabeth Taylor’s White Diamonds. We like to say that the holiday season is Taylor Time. It’s always a number one brand at mass as well as a top 10 Prestige fragrance set and we expect that to be the case this year. It’s truly one of the pillars of our business and you’ll continue to see that same television commercial you’ve been seeing for years as well as an innovative online TV ad focused on the core over-35 female audience.

Turning to the holiday season overall, we are really well positioned with our new launches as well as our classic brands. Our relationships with our retailers continue to be strong and to date our sell-in of holiday sets has achieved our expectations. That being said, as Scott alluded to, we did see a retail sales slowdown a bit in September and October. Remember we’re category manager for a number of our retailers so we have access to not just our sales but other sales of Prestige fragrances and it’s been pretty consistent to see a slowdown in the last few weeks of September and the beginning of October.

In addition we’re noticing that some of our department store accounts seem to be replenishing inventory at a slower rate than retail sales. Retail sales are not off as far as the replenishment rate is off. That indicates obviously that they’re taking a cautious approach to inventory. If anything, they’re erring on the side of buying more promotional sets rather than basic at this point to give more value to the consumer.

We are also seeing many times for the first time some smaller retailers having credit issues requiring us to be more careful with our shipments to these accounts. This has really been the first time we’ve seen that and that’s included in our guidance.

As customers reduce holiday spend and become more value focused and as mass retailers aggressively seek to gain market share, we think we’re very well positioned in the mass retail market to benefit from this change in behavior as well as to take advantage of the strong value we have in our holiday sets at department stores.

We have fantastic launches of new brands in all channels and a number of our key retailers as Scott alluded to have worked with us to implement some really aggressive merchandising initiatives that grow the fragrance category, including new fixturing you’ll see, better awareness of the category, improved locations for our holiday sets and dedicated in-store signage. In an ordinary circumstance we would probably be extremely excited about our holiday season but because some of our retailers are experiencing declines in retail sales across many categories, we’re a bit more cautious.

Obviously holiday sell-through does affect our retail results particularly in Prestige department stores where we allow for returns of holiday promotions. We do think it’s almost impossible at this point to predict overall consumer takeaway for this most important next six to eight weeks. We do believe that our multichannel business model coupled with our strong brand portfolio will help us fare better than most though in this tough economic climate.

With that I’ll turn it over to Steve Smith, our Chief Financial Officer.

Stephen J. Smith

I will provide an overview of our first quarter results and then I will give a brief update on our re-engineering projects. Finally I will provide comments on our outlook for the remainder of fiscal 2009.

Adjusting for Liz Claiborne related expenses gross margin was 43.2%, 410 basis points higher versus the prior year. This increase is substantially related to some 85% of our sales now coming from our own brands as compared to 73% in the prior year. This was partially offset by an increase in freight costs which was 50 basis points and gift with purchase costs as a percentage of sales. That was 60 basis points.

Excluding charges, SG&A expenses as a percentage of net sales was 37.1% versus 33.8% for the prior year. Our advertising and sales promotion expenses increased 18% and this accounts for 44% of the increase. The remainder is primarily related to the royalties owed to Liz Claiborne related to our licensing agreement and the balance primarily relates to the negative impact of foreign currency. Excluding the effects of currency and some additional bad debt reserves we took given the credit markets, in dollars we continued to manage our G&A overhead expenses flat to the prior year.

Cash flow from operations was the use of $94.5 million which is a $22 million improvement over the prior year. Inventory ended the quarter at $459 million, $9 million higher than the prior year in spite of the approximately $45 million of net incremental inventory purchased in June as part of the Claiborne transaction. DSOs at 90 days were three days higher than the prior year. We did not acquire any receivables from Claiborne as part of the licensing agreement and have been building them up. The DSOs are two days better than what our expectations were for the quarter.

The credit facility had a balance as of September 30 of $229.5 million compared to $223 million in the prior year. In July we completed an amendment to the current credit facility to accommodate the incremental working capital for the Claiborne fragrances.

As part of that amendment we increased the size of the facility from $250 million to $325 million and there was no change to the current pricing of LIBOR + 125 basis points or prime. The maturity date remains at December 31, 2012. Our bank certificate is led by J.P. Morgan Chase and Bank of America is the co-manager. Over 80% of the facility is with these two lead banks and then HSBC and Wachovia Wells Fargo. As such we had ample liquidity to manage through our peak season. Borrowings under the credit facility peaked as we expected in October at roughly $276 million, well below the $325 million credit line.

Regarding our customers we are closely monitoring our credit risk with all of our customers. This includes managing cash collections in concert with shipments to certain customers to minimize spikes in credit exposures. We have little to no exposure to many retailers which have recently filed Chapter 11 such as Mervyns or Valu City or Goody’s as was the case last year. Our largest customers are no currently experiencing liquidity or credit issues. We did record some additional bad debt reserves in Q1 and we believe we have adequately reserved our receivables based on current facts.

I’d like to spend a few minutes providing an update on our global efficiency re-engineering project. The restructuring costs and charges that we outlined when we announced the plan in May of $12 million to $14 million are still on track and as planned. We have begun to implement the JDE financial system platform and that continues to progress according to plan. The annualized savings of $10 million to $12 million through fiscal 2009 are also on track but we are starting to see some affects of cost pressures and currency movements.

As far as the capital expenditures, we continue to expect capital expenditures for the implementation of J.D. Edwards to be $25 million of which $14 million is scheduled for this year. The remainder of fiscal 2009 we will be scrutinizing all other capital expenditures and will be looking to defer many of those related to our international business.

I’d like to take a few minutes to explain our guidance and the impact of foreign currency. We hedge a portion of our Euro and Pound Sterling net sales as we have a partial natural hedge due to the translation of local currency denominated SG&A expenses. However we have also been impacted from the revaluation of our international affiliate balance sheets on their foreign denominated positions from their functional currency.

Given the extreme volatility over the last few months we incurred losses to the revaluation of aspects of the working capital components of our balance sheet. In the first quarter the total net adverse currency impact to our earnings was $3 million and for Q2 end of October rates the total net adverse impact to our earnings is estimated at approximately $4.2 million which is $0.18 a share for the first half of our fiscal year.

The full year adverse impact to earnings is $0.08 a share as it actually results in a gain in the second half because there is a net gain from our hedging program and the natural hedges assuming end of October rates for the remainder of the year. Using these rates there would be little additional impact to the balance sheet revaluations.

Given our current view on the impacts of the current economic environment, we have adjusted our guidance for the earnings for the first half to $1.18 to $1.28 and for the full year from $1.50 to $1.75. These are exclusive of the aforementioned currency impacts. Our guidance does not assume any improving economy.

When we provided guidance in August, there were some uncertainties in our plan that we needed to work through including the Claiborne integration and our innovation calendar. We now have more visibility as the Claiborne transition is essentially complete and we have firmed up our calendar for the remainder of the year.

Additionally there were one-time product changes in our mass business which normalize out in the second half. To the extent customer takeaway is reduced and/or retailer attitudes towards inventory levels change, we could see a further impact to this guidance. As a reminder last year sales and earnings were impacted by our international markets being over-inventoried coming out of Christmas last year and by losses in our hedges as the dollar weakened in the first half of calendar 2008.

With that I’ll turn it back to Scott.

E. Scott Beattie

Operator, we’re available to answer any questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from William Chappell - SunTrust Robinson Humphrey.

William Chappell - SunTrust Robinson Humphrey

It sounds like a change in the guidance is primarily inventory destock related but can maybe you give some color on how sales trended throughout the quarter? Did you see a slowdown in consumer foot traffic or consumer takeaway or was it pretty steady throughout the quarter?

E. Scott Beattie

In terms of the guidance, there are two elements of it. What we’ve tried to do is isolate the reduction in consumer demand from the currency impact. I think Steve walked through that and the press release sort of identifies the two components. So the currency impact particularly for the first half of the year has a pretty significant impact on earnings as Steve just mentioned; almost $0.18 a share.

In terms of the consumer trends right now, as most of our other personal care companies and beauty companies have identified, we really saw a dramatic reduction in traffic at retail starting in about mid--September through the end of October. Obviously as Joel I think went into detail, all of our retailers committed and took their promotional programs, their gift sets, into their inventory as a result of the fact that they’re great value to consumers and the department stores have some return privileges so obviously there’s very little risk on that inventory.

But they have been cautious in terms of replenishing basic stock. What we’ve done through our planning group is to really stay on top of retails by brand, by store and really focus on making sure that we’ve got adequate basic stock inventory in our department store piece.

In the mass piece it’s less of an issue. As I mentioned in my remarks, the mass retailers particularly the Wal-Marts and the Targets and others are very aggressive in this kind of economic downturn and have very aggressive programs of promoting their businesses for holiday season across multiple categories. We’ve seen them maintain budget levels of inventory build-up both on value sets as well as basic stock.

One other point I’d like to emphasize that Joel mentioned is a little over 80% of our total business in the second quarter comes from our US mass business. It’s a significant contributor to our business. That’s the area that continues to hold up in terms of traffic and retail takeaway.

William Chappell - SunTrust Robinson Humphrey

With the change in consumer sentiment, does that change your outlook in terms of brand support or maybe pushing out some new launches till things stabilize to get maybe a better bang for your buck?

E. Scott Beattie

No, it hasn’t. That’s a good point but as you know many of those launches have been scheduled with our retailers and commitments to media support and promotional PR support well in advance of the fall season, and frankly again as Joel went through the launches in our fragrance side which are primary launches that we have this fall are doing very well. They’re ranking very well. Clearly even though they are holding strong rankings, it will be less than you would in a strong economic environment.

Where we might be more cautious is just in terms of some of the additional support that we can provide as more discretionary in terms of the brand. We’re watching that very closely with the consumer takeaway.

The other option that we have as well as we roll some of these brands out internationally if it continues to be an extremely weak economic environment, we have the ability to stage the rollout internationally over a longer period of time.

Operator

Our next question comes from Jason Gere - Wachovia Securities.

Jason Gere - Wachovia Securities

If you look at the guidance, second quarter comes down pretty significantly but the second half remains pretty much unchanged I think from where you were back in August. I know you’ve talked about the new launches and the new EA fragrance, but just talk about maybe in this type of macro environment where people are certainly cautious, can you talk about your level of confidence in the back half guidance?

Stephen J. Smith

Right now we’re confident with the second half guidance. A lot of it’s going to depend upon consumer takeaway at Christmas and retailer attitudes towards inventory levels in the second half. As we said in our remarks, given our overall business strategy and multichannel strategy we think we’re better positioned than a lot of our competitors. We have a lot of innovation that’s scheduled to go out in the second half.

There are particular things that impacted our results in the first half of this year versus last year in terms of one-time events that we knew about that will normalize itself out in the second half of the year. If you’ll recall, last year we were over-inventoried in international coming into the second half of the year so we think that this year that will normalize out.

In addition to that, last year there were some one-time product changes with some of our mass customers that impact year-on-year comparisons for the first half but normalize out in the second half.

Jason Gere - Wachovia Securities

I think in the last quarter you were talking about EBITDA margins maybe up 40 to 90 basis points. Given all the moving parts here, and I think you said some of the cost savings from the J.D. Edwards, there might be some partial offsets because of costs or fx. Could you just give a little bit of an update where you see EBITDA for the year and is there any ability to take some other cost savings than just lower overhead and bring that forward?

Stephen J. Smith

We’re always looking at opportunities to look for cost savings in our infrastructure. We’re currently looking at cost savings from bringing in the Claiborne business and some of the manufacturing that they had done previously on their own. Now that is part of the Arden business.

All I can say is we do have some costs in our model that are discretionary in nature and as we go through the course of the year, if we have the opportunity to cut back on those costs, we will. We haven’t committed all of our spend for the second half of the year yet and we’ll see how Christmas plays out and then make decisions on second half spend once we have a better visibility on Christmas takeaway.

Going back to my prior comments, again I want to reiterate that our guidance does not assume an improving economy.

E. Scott Beattie

The other thing is we have incurred a significant amount of conditional costs in the first half related to the Claiborne integration which will be eliminated. We also have much better visibility in the rollout of the Liz Claiborne fragrances internationally and we’ve got a more detailed plan that we did last summer. We’re a bit more confident in terms of particularly the rollout of Juicy Couture and the Usher brand internationally.

There are two other major drivers in the second half in addition to what Steve mentioned was the Pretty fragrance during the fall we presented to our international trade and that’s tracking a little bit better than what we had hoped in terms of commitments and sell-in as well as the Prevage body is performing better than what we expected in terms of launch. That really has a big impact as we roll into the second half.

The last component that I really emphasize that Steve discussed is if you look back last year, the first half of the year we had an extremely strong fragrance business in international performance. As you’ll recall during the third quarter we had quite a dramatic falloff in revenue and earnings vis-à-vis what we had expected and much of that was a result of some of our international customers taking more inventory than they could sell through and then the replenishment orders in third quarter diminished more than we had expected.

As both Steve and I have mentioned, that normalization that’s occurred during this first half of this year will mitigate some of the steep drop-off in replenishment in the third quarter of next year. Just that normalization process will have an impact as well as some of the other re-engineering and efficiencies that we’ve got as a result of our corporate initiatives as well as the integration of the Liz Claiborne business into our business.

Jason Gere - Wachovia Securities

As you talk about international, can you just give us an update maybe on travel retail what you’ve seen over the last month or so and your expectations as you build into that kind of normalization of the international?

E. Scott Beattie

The travel retail business performed well in the first quarter. They’ve seen some falloff in Europe particularly in travel retail with the decline in some of the flight schedules but still are anticipating quite a strong performance this quarter. Part of that is that we’re expanding some of our locations around the world both in our travel retail unit as well as in our distributor markets particularly in Southeast Asia and the Middle East, so that’s helping drive some additional performance over and above the weakness that we’re seeing in the more mature markets.

I’d anticipate in the mature markets the travel retail performance declining and we’ve taken that into account but we’ve got offsets to that in some of the other markets around the world.

Operator

Our next question comes from Joseph Altobello - CIBC World Markets.

Joseph Altobello - CIBC World Markets

I just wondered about something you mentioned earlier Joel about visibility into the December quarter. Tell me if I’ve got this right, but it seems like the risk is really not to December but more to the March quarter because at this point your quarter’s probably locked and loaded to some extent and if you do see some weakness in terms of sell-through, it’s not going to be felt until January or February when you get reorders or some of the retailers put back the promotional items. Is that the case?

Joel B. Ronkin

I think that’s a little bit of an overstatement. In terms of sell-through that does impact our Q2 results because we have certain expectations of sell-through and if sell-through excess is less than we anticipate that impacts our Q2 results. We basically true up our accruals on that. In addition we’re still expecting some replenishment orders for this quarter that if they don’t come in as expected, now we have taken a cautious view on that given what we’ve seen, that could potentially impact Q2.

I think the biggest factor you need to consider about Q2 is as Scott alluded to that I think it’s 84% of our sales during Q2 for North American Fragrances is out of our mass business and that has been a lot more predictable. Some of our biggest accounts are definitely taking positions to actually try to win share in this top time. You’ve seen some of that in recent reports on different accounts of retail sales. We’re certainly going to benefit from that having average market shares of Prestige fragrances of about 60%.

Joseph Altobello - CIBC World Markets

In terms of the North American business being up 9% and you mentioned it in your release and on the call, but that was mostly if not all Liz. Is the incremental impact to Liz in the quarter about $15 million, because I had something much bigger in my model?

Marcey Becker

You have to remember we were distributing the brands last year as well to match.

Joseph Altobello - CIBC World Markets

Exactly, but in terms of the incremental impact the call it $125 million of revenue you pick up on a department store side, it was only $15 million in the quarter?

Stephen J. Smith

It was about $25 million.

Joseph Altobello - CIBC World Markets

In terms of the “at risk” retailers you’ve got out there, how much of a percentage of sales is that for you guys?

Stephen J. Smith

Very small.

Joseph Altobello - CIBC World Markets

Less than 10%?

Stephen J. Smith

Well less than 10%.

Operator

Our next question comes from Arnold Ursaner - CJS Securities.

Arnold Ursaner - CJS Securities

My first question relates to timing. A lot of times Scott you have a shift between September and October when retailers may take shipments. Did we have any unusual shifts of timing this year at all one way or the other?

Joel B. Ronkin

No. Actually this year we didn’t have that. It used to happen more when we had an October/November quarter end. It’s been as predicted the takeaway.

Stephen J. Smith

We did have some expense shift from first quarter into the second quarter.

Arnold Ursaner - CJS Securities

Thinking about your SG&A line and the cost of advertising and timing of advertising, obviously it appears as if many of the retailers are going to have a much earlier promotional activity this year. Would you expect that to impact the timing of when you would do some of your advertising and again what are you seeing in the trends of what television or radio advertising costs?

E. Scott Beattie

Most of our national advertising has been locked in and we have a pretty good model in terms of when to run that in terms of the impact that it has with shoppers; obviously in and around the Thanksgiving shopping period and then we have specific times by brand that we either run cable or print and the timing of that varies by brand and so on. But we’re pretty good at matching up the timing and the medium itself with the brand and execution particularly on some of our more mature brands like Elizabeth Taylor and Arden and so on.

We are also spending a significant amount in our SG&A this year in in-store execution. We’re trying to win at retail both in the department stores and in some of the mid-tier stores. I think that’s very important when you have more heads in consumer and lower traffic patterns, many of our products will win the sale by having better people and more focused energy at point of sale. We work closely with our retailers to do that and that’s one of the advantages of merging the Liz Claiborne and Elizabeth Arden department store fragrance sales units together.

As Joel mentioned our indirect overhead structure stayed the same even though we’ve almost doubled the size of the business, but it’s enabled us to have much higher market share in the fragrance door and it’s enabled us to dedicate more in-store resources to sell more fragrances in those doors and be more effective. I think that will have a big impact this year at Christmas.

Arnold Ursaner - CJS Securities

A final question and maybe it’s better to be off line with Marcie, but to be clear to try to get more normalized numbers should we be using a 28% tax rate pro forma and should we assume roughly $3.5 million of the write-offs or noncash expenses occurred in the SG&A line? Is that the right way to think of that?

Stephen J. Smith

Yes.

Operator

Our next question comes from Alice Longley - Buckingham Research.

Alice Longley - Buckingham Research

A question on the mass business. Was I right in hearing your shipments were down 4.6% in the quarter?

Stephen J. Smith

Yes.

Alice Longley - Buckingham Research

Do you think that was about the same as the sell-through of your brands in the quarter?

Stephen J. Smith

Yes. It was very consistent.

Alice Longley - Buckingham Research

Was there a slowdown in mass in September and October or was that just in department stores?

Stephen J. Smith

We actually did see a little bit of a slowdown in September versus what prior trends had been for a few months. October we really don’t have a good enough look at. We’ve seen some mixed results in October and we don’t have the final numbers yet.

Alice Longley - Buckingham Research

When we look at the second quarter, I guess you’re expecting more of a consumer shift to mass which makes some sense and you’ve got strong products going in. Does that number improve from the first quarter into the second quarter from down 4.6 to a better comparison in the second quarter?

Stephen J. Smith

Hopefully. Because much of it is sell-in that we’ve done, it’s not that precise that the takeaway is perfectly matched with the sell-in. But we’re hoping it gets a bit better.

E. Scott Beattie

The one thing that works in your favor is the mass fragrance category is really concentrated over the holiday season from say a week before Thanksgiving right through to the first week of January. So the mass category for fragrance, particularly in the large accounts, doesn’t really have a strong first quarter retail takeaway. It’s really focused on the sets that are being shipped in and then the build-up of the basic stock that’s focused on sell-through from Thanksgiving through Christmas time.

Joel B. Ronkin

The other thing if you’ll recall is we didn’t have a great Q2 in mass retail last year particularly because of a couple of our largest mass volume retailers having issues in general at that time particularly with space issues in our category. That’s really going to reverse itself this year, number one. And number two, I think I mentioned earlier we have some really innovative programs at improved locations this Christmas that really if it was an ordinary Christmas and ordinary economic climate, we’d feel really strong about our results. And that’s got to help retail sales this quarter but to put a number on it would be very tough.

Alice Longley - Buckingham Research

But you’ve got a model so it sounds like I should assume that shipments into mass in the second quarter are down but less than that 4.6%. Is that correct?

Stephen J. Smith

It’s down slightly. Close to flat.

Alice Longley - Buckingham Research

On the department store arena with your shipments being boosted by Claiborne, can I assume that your shipments excluding Claiborne were down in the first quarter?

Stephen J. Smith

Yes.

Alice Longley - Buckingham Research

Can you give me some feeling for how much they were down?

E. Scott Beattie

In the Arden business we were sort of down with the category which is sort of 5% to 6% I think and in the fragrance side I think it was very similar. The category in fragrance is down pretty significantly in the first quarter but we also as Joel mentioned had a number of launches, not just with the Claiborne brands but with our own brands like Rocawear and Mariah Carey and so on. So it’s kind of apples and oranges on a comp basis but I can tell you the fragrance category in department stores was down double digits.

Alice Longley - Buckingham Research

Was it down by 15% or over 20%?

E. Scott Beattie

I think it was around 15%.

Alice Longley - Buckingham Research

Were your shipments also down 15% excluding Claiborne?

E. Scott Beattie

No. Given the launch schedule that we had it kind of offset some of that.

Stephen J. Smith

Remember we not only had an anniversarying of the Mariah launch but we also had Rocawear which is helping us as well.

Alice Longley - Buckingham Research

So you were down more like 5%?

Stephen J. Smith

That sounds about right.

Operator

Our next question comes from [Analyst for Reza Vahasita] - Barclays Capital.

[Analyst for Reza Vahasita] - Barclays Capital

If I could just take care of a couple housekeeping items. The $15 million charge was all noncash for inventory. The transition expense, was that also noncash or does that relate more to J.D. Edwards?

Stephen J. Smith

No. The transition expenses were not noncash. They did involve cash. It relates to the Claiborne transaction and it was about $3.5 million.

E. Scott Beattie

The vast majority of that expense is related to the fact that we agreed during that transition to support the costs of their warehouse and many of their people to support fulfillment. As we transferred inventory from that warehouse during the quarter into our warehouse and we started taking over fulfillment, then that cost wound down. But as Steve said that was all cash charge and after the end of the second quarter that will be eliminated.

[Analyst for Reza Vahasita] - Barclays Capital

And the inventory write-downs are also going to roll off after the second quarter?

Stephen J. Smith

Yes.

[Analyst for Reza Vahasita] - Barclays Capital

It sounds like you’re fairly comfortable with retailers but can you give us a sense of magnitude in terms of allowances for bad debt and maybe how that’s changed?

Stephen J. Smith

Generally our experience with bad debt is rather minimal. We increased the reserves probably by about 25% in the quarter but it’s off a very small base. It’s roughly $1 million to $1.5 million of additional reserves we took in the quarter.

[Analyst for Reza Vahasita] - Barclays Capital

And you feel mostly comfortable with the majority of your accounts?

Stephen J. Smith

Yes. Based upon current facts as we see them, we’re comfortable with the current receivables. A lot of it’s going to depend upon how Christmas plays out for those retailers.

E. Scott Beattie

Just to give you a perspective, many of our accounts we’ve been dealing with since the beginning of the company almost 16 years ago, both small and large. As I think Steve mentioned, our largest accounts the Wal-Marts, the Targets, the Walgreens, the CVS’, the [Booths], the Macy’s, they’re well capitalized and we’re comfortable with them.

We’re very diligent. We’ve always been very diligent in managing our credit exposure across the whole profile of accounts both domestically and internationally. Typically in a difficult environment and we’ve gone through these obviously before in the early part of this decade and then again in the early part of the ‘90s, ’92, ’93, ’94, most of our accounts who do get in some kind of difficulty tend to just spread out their payments and they pay you as they pay the product through. So rather than bad debt we can typically get more delayed payments as opposed to bankruptcies.

Obviously this is kind of unprecedented times so our diligence in reviewing these sorts of things is probably at a higher level than normal.

Stephen J. Smith

The other thing I should also mention is when we talk about bad debt we truly mean bad debt. There are other allowances that we give back to the trade off of deductions that they take which are a normal part of business disputes you get into, charge backs and that is separate and apart from those numbers that I gave.

[Analyst for Reza Vahasita] - Barclays Capital

Could you just tell me if you purchased any stock during the quarter and maybe what your outlook for share repurchases is versus other uses of free cash flow?

E. Scott Beattie

We did not purchase any stock this quarter and we haven’t for several quarters because we’ve been in a blackout period most of last fiscal quarter with the negotiation of the Liz Claiborne transaction.

Moving forward, again I would summarize our perspective and our Board’s perspective in being cautious in terms of our capital structure. We’re in a very strong position from a capital point of view. We’ve got as Steve went through a very strong banking group, we’ve expanded that facility, we have almost $70 million of availability under that facility, and we’ve passed our peak borrowing period for this season so that will be paid down over the next several months. The bank facility is at attractive rates at 1.50 over LIBOR and the facility isn’t renewed until 2012. Our high yield bonds again have limited covenants and are not refinanced till 2014.

So in this kind of a credit crisis we’re very cautious about shrinking our capital base whether it’s buying back bonds or buying back stock. That doesn’t mean we won’t opportunistically but we’re being very cautious in that regard.

The other consideration is that there is and will continue to be opportunities for us to acquire businesses particularly smaller brands that become available and we want to keep as much of our capital available to us to take advantage of those opportunities.

Operator

Our next question comes from Jason Gere - Wachovia Securities.

Jason Gere - Wachovia Securities

Thinking about the new product pipeline you have out there, can you just talk about the SKU management, discontinuation of older brands, and maybe just higher sales allowances that might be associated just given the soft economy right now?

E. Scott Beattie

In terms of the management of SKUs and what we would call the tail of some of the older SKUs or brands, as part of the supply chain re-engineering process there’s been specific business processes put in that focus on eliminating unproductive SKUs in a normal course. Steve accrues for obsolete inventory as part of our normal course of business. We have the opportunity because of our business model and some of our customer relationships to sell and still profitably sell inventory that we want to discontinue.

In fact some of our distribution partners take advantage of us to sell products like that because we have an established customer base that will buy closeout product and returns and so on. I think we’ll just become much more diligent as a result of the re-engineering we’re doing in our supply chain to manage our SKUs.

In addition to that I would say we’re very much focused on coming out of the second quarter with reduced inventory levels. We don’t see a dramatic improvement or any improvement in consumer environment as we move into Q3 and Q4. So we’re going to be very cautious on our inventory as well.

Jason Gere - Wachovia Securities

Do you expect free cash flow to be positive this year and should we be using 29 million as the shares outstanding for the full year?

Marcey Becker

Yes, and $29.2 million I think is the number we’re using.

Jason Gere - Wachovia Securities

And on the free cash flow, mildly positive?

E. Scott Beattie

We’ve estimated operating cash flow between $50 million and $60 million. Now we’ve got capital expenditures this year in the J.D. Edwards project and so on. As Steve mentioned earlier we’re being very cautious in discretionary capital expenditures in businesses that are not showing substantial growth. So we will have a positive free cash flow.

Operator

We have run out of time for questions. I’d like to hand it back over to management for closing comments.

E. Scott Beattie

Thank you everyone for joining us today in our first quarter conference call.

Operator

Ladies and Gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.

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Source: Elizabeth Arden, Inc. F1Q09 (Quarter End 9/30/08) Earnings Call Transcript
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