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Elizabeth Arden, Inc. (NASDAQ:RDEN)

F2Q09 Earnings Call

February 5, 2009 11:00 am ET

Executives

Allison Malkin – Integrated Corporate Relations

E. Scott Beattie – Chairman, Chief Executive Officer

Joel B. Ronkin – Executive Vice President of the North American Fragrance Unit

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

Marcey Becker – Senior Vice President of Finance

Analysts

Joseph Altobello - Oppenheimer & Co.

Arnold Ursaner - CJS Securities

Rommel Dionisio - Wedbush Morgan Securities Inc.

[Unidentified Analyst] – Suntrust Robinson Humphrey

Reza Vahabzadeh - Barclays Capital

Operator

Greetings and welcome to the Elizabeth Arden second quarter fiscal 2009 results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Miss Allison Malkin at Integrated Corporate Relations. Thank you. You may begin.

Allison Malkin

Thank you. Good morning. Thank you for joining us. 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 immediately. 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 provisions of the Securities Litigation Reform Act of 1995. Such information is subject to risks and uncertainties that could cause actual results to differ materially from the statements as described in the press release and in Elizabeth Arden’s most recent annual report on Form 10-K, filed with the SEC. We direct all listeners to that 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. Reconciliations 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 contained 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. Scott please go ahead.

E. Scott Beattie

Thank you operator and welcome everyone to our Q2 conference call. With me today is Joel Ronkin, our Executive Vice President of the North American Fragrance Unit; Steve Smith, our Executive Vice President and CFO; and Marcey Becker, our Senior Vice President of Finance.

I’d like to first outline the agenda for today’s call. First of all I’ll provide an overview of our corporate performance for the second quarter. In addition, I’ll review the specific performance of the International Business Unit which represents 32% of our revenues and the Elizabeth Arden Prestige Department Store Business Unit which represents 3.5% of our total business. I will also provide a summary of our key corporate initiatives and priorities for the remainder of fiscal ’09 and 2010.

Joel will provide a review of our North American Fragrance Business Unit performance, which represents 65% of our total business. This business unit includes our Department Store and Mass Fragrance Businesses in the United States as well as our Canadian and Puerto Rican businesses. Joel will discuss the key initiatives of this business unit including fragrance brand performance.

Steve will provide a detailed review of our key financial metrics and review our financial guidance. Hopefully this structure combined with the segment of reporting we have in our 10-Q will provide more clarity into our quarterly operating performance for investors.

But first of all I’ll talk about and a summary of our Q2 performance. Our Elizabeth Arden global brand performance – or excuse me our Elizabeth Arden department store performance in the United States was much below what our expected performance levels were. Our Skin Care and Color categories performed consistent with category which was approximately 8 to 9% decline, but our Fragrance business was much worse.

And the primary reasons for that were one, that retailers which sold our seasonal gift sets which have return privileges and have very strong value proposition for customers. Unfortunately, most of our department store customers did not replenish significant amounts of basic stock, which is much higher margin business for us. So as a result, we had committed to seasonal spend to support our business in that channel of distributions and we were negatively impacted by the de-leveraging of our cost structure and the fact that the basic stock replenishment was so poor in that channel of distribution.

In addition, we had no new fragrance launch during the Christmas season for the Elizabeth Arden brand. Instead we had planned a fragrance launch which is named Pretty for this spring. And that will help us during the third and fourth quarters of this year.

In terms of our international business our net sales were down 13.8% but ex currency were down 3.7%. The primary driver of that decline was our travel retail and distributor business which was down 33% and as investors will recall this is not only a growing traditionally been a growing component of our business but a very profitable contributor to EBITDA, both for our International Business Unit as well as our overall business.

What happened in travel retail and the distributor market were a couple of factors. One, there was a tremendous inventory de-stocking that occurred throughout our travel retail business as the traffic internationally declined and as a result of consumer confidence declines in overall economic weakness.

We also experienced for the first time both credit and currency issues for many of our distributors, particularly in emerging markets. They are also being impacted by the world credit crisis and their weak currency and the volatility or the rapid strengthening of the U.S. dollar during the fall created a lot of pressure on their ability to acquire additional volumes for the Christmas season and their profitability, when in fact we billed them in U.S. dollars. This also is a very profitable component of our international business.

The rest of the international business performed reasonably well. And for the first half our total international business was down 7.7%, ex currency down just 1.6%. This unit had minimal contribution from the Liz Claiborne acquisition and will benefit during the third and fourth quarter as we start to roll out the [GC] Couture brand and some of the other launches throughout our international platform.

As a result of the general weakness of our business during the second quarter and the additional Liz Claiborne inventory that we acquired, not only in June but the commitments that we acquired through their supply chain for the fall season, we carried excess inventory at the end of December. At the end of December inventory levels were $390 million versus last year $340 million. All of this excess inventory is in fact access fragrance inventory that is being reprogrammed into retail.

We have a very active program of reducing receipts of inventory over the next six months as well as reprogramming both promotional and basic stock inventories to the existing retail channels. This program combined with dramatically reducing receipts of new inventory will substantially reduce our inventory levels from now until June.

This leads me into a discussion of our key corporate initiatives. Our first priority is our global reengineering initiative which began in November ’07. The objective of this reengineering initiative was to improve the performance of our indirect overhead and improve the supply chain and sales ops planning business processes globally. This will help improve gross margins on our global business as well as reduce inventory investment per dollar sales.

Weak demand during the first half of the year, particularly in the second quarter has hidden many of the significant progress we have made during the last year on these initiatives. We’ve seen substantial improvement in cost of goods as a result of our strategic purchasing initiatives in combining the purchasing power of the Liz Claiborne volume of business. We’ve seen a significant improvement in the simplification of our business; fewer SKUs, fewer customizations on fragrance SKUs and much more streamlined promotional and gift set programs.

We’ve also seen improved demand planning in S&OP processes which help improve fill rates and service levels to our customers. We’ve also seen a significant improvement in our organizational effectiveness. And we are well positioned for the remainder of this fiscal year and as we go into 2010 in our supply chains and S&OP processes.

A second priority is the migration towards the shared services model for financial accounting, order to cash processing, and accounts payable. These business processes are currently imbedded in business units around the world and in three separate locations in the United States. By July 1 in time for the initial J.D. Edwards implementation of our financial accounting modules, 12 to 13 locations around the world will be consolidated into three locations in terms of the business processes; Geneva, Roanoke and Stamford.

This will create centers of excellence in terms of business transaction processing and will leverage the implementation of our J.D. Edwards technology platform. This [prizes] the J.D. Edwards project as I mentioned with first implementation July 1 and the second implementation of our order to cash processes in February ‘010 are both on schedule and on budget.

Our third priority is improvement of our overall financial performance and returns on invested capital. Our global finance organization has been reorganized and divided into two separate units. Steve Smith our CFO will lead the compliance tax and financial accounting and control functions as well as our shared services model.

[Miten Dishpati] joined us after 25 years with Procter and Gamble is our new Senior Vice President of Business Finance. He will lead our global business, financial planning team which will support our supply chains, logistics and brand marketing groups and will provide a process of building a three year financial plan to drive and improve financial performance of our overall business.

In addition to Miten, [Udo Shinancs] has joined us also from P&G after 20 years in Europe as our Senior International Business Finance executive. Udo will act as Miten’s counterpart in the international business.

These initiatives will drive improvement in profitability across our brand portfolio, our geographies and our channels of distribution. And of particular focus will be over the next few years on driving holistic improvement in our gross margin. This dedicated resource to forward planning will drive improved organic sales growth, gross margin growth in a very difficult economic environment.

Steve’s organization will drive greater efficiency in direct overheads in order to drive profit [grewt] to additional leverage of our overhead structure. The global organization has been put in place and is engaged in detraction in terms of improved financial planning is very good.

The one last point I would like to make today and given this economic environment is the strength of our business model. As many of you know, we outsource our logistics, manufacturing, information technology and R&D functions, with the exception of managing our own logistics facility here in North America. But this helps us to manage the fixed costs de-leveraging that is incurring as a result of declining sales throughout the world.

It allows us to manage our fixed costs investment and capital cost investment across our infrastructure and our capacity. We have a key opportunity to drive fragrance volume inventories down to generate improved return on invested capital and that’s our key priority between now and the end of the year.

On that note I’d like to hand it over to Joel Ronkin.

Joel B. Ronkin

Thank you Scott. I’m going to comment on the performance of the North American Fragrances Group for the quarter and particular the holiday season, discuss our new launches and comment on the outlook for the remainder of fiscal 2009. And what we’re seeing out there from a retail standpoint.

As Scott mentioned the North American Fragrances Group comprised about 65% of our overall net sales. It includes the department store fragrance business in the U.S. By that I mean the part of the U.S. department store business where we sell our non-Arden branded fragrances; our mass business; our e-commerce business and our businesses in Canada and Puerto Rico.

For the second quarter our net sales and operating profits for North American Fragrance Group were down approximately 10% compared with the second quarter of fiscal 2008. Fiscal year-to-date results are a bit better with sales slightly down at 3% with operating profits up 4% on higher gross margins.

Turning to mass, net sales in our mass business were down approximately 14% in the second quarter primarily due to credit constraints largely at our smaller retail and distributor accounts, as well as reduced replenishment at mass fine retailers in the quarter. In addition, replenishment orders were generally below our expectations and did not keep pace with our sale through results as retailers carefully managed inventory levels and generally replenished at rates below our retail sell through.

The decline in operating profits for the mass business was somewhat less than the sales decline. While the sales decline was 14% the operating profit decline was 8% and this was largely due to the Liz Claiborne licensing deal providing better gross margins. Comparing the first half of this year to the first half of last year, I’m pleased that our operating profit in the mass business improved slightly despite an 11% reduction net sales, quite an accomplishment due to circumstances.

In turning to retail sales, retail sales of fragrances in mass channels declined approximately 7% overall for the calendar year and 9% for this past quarter, which is pretty consistent with our outlook. As we have stated before, the trend of chains rug and clubs outpacing mass volume retailers continued in the fourth quarter – their fourth quarter. But we did see importantly a strengthening in retail sales at our mass volume retailers at the very end of December.

Retail sales of our brand exceeded category trends and our market share in mass channel increased in the fourth quarter and was modestly up for the calendar year as well. Our market share of the top ranked brands in mass continues to be strong, as we either own or distribute six of the top ten women’s brands and five of the top ten men’s brands as far as Prestige fragrances. And of course we have the number one men’s and women’s brands, Curve and White Diamonds.

Moving over to our department store fragrance business, the business continues to benefit from the Liz Claiborne transaction. For the second quarter as compared to last year, net sales increased by 60% and operating profit improved from a loss to a modest operating profit.

Fiscal year-to-date shipments to department stores have doubled and our operating profit has increased by almost 50%. We’re really pleased with this performance overall. Keep in mind that over the last six months we had to complete the blending of the Claiborne-Arden sales-forces which cut the total number of salespeople between the two organizations in half from a year ago.

We have also successfully launched four major new brands with considerable support in spend behind those launches, as well as a few smaller brands. And we also consolidated our logistics and supply chain operations, all of this in obviously a very challenging economic environment.

Retail sales of fragrances in department stores declined by about 6% in the calendar year and the December trend was a negative 8% as compared with the prior year, which was actually helped a bit by all the markdowns. Of course as a result of the Liz Claiborne transaction our market share in fragrances expanded considerably, increasing from 2.8% in calendar 2007 to 6.1% for calendar 2008, assuming we owned the Claiborne brands for the entire year.

Overall sell through percentages for our holiday promotional sets at department stores were comparable to last year that as I mentioned we saw more markdowns. Mass as well commenting on promotional sets sell through was very similar. And of course there were no markdowns there.

I will now spend some time discussing the performance of our brands. We’re most pleased with the performance of our new brand, Viva La Juicy, the second fragrance in the G. C. Couture line. This brand was the number one fragrance brand launch at U.S. department stores for the fall season, outselling all other new brands in December and significantly exceeding retailer expectations.

Now moving into the spring season we’re continuing to support this brand at point of sale. We’ll do that with samples, testers, call up advertising and selling assistance. And we’re also continuing to focus support on the original Juicy brand. On the men’s brand, Rocawear 9IX launched on counter in mid-September and gained a lot of momentum particularly in November and December. It was our best selling men’s brand at department store fragrance counters, ranking #12 in December and was the number six launch among all men’s brands for the year which is right in line with our ranking goals.

Our new brands are also performing well in the mass channel. M by Mariah Carey, which we launched in department stores last year, and was new to mass retailers this season was the number one ladies launch for the year, with retail sales 30% greater than last year’s number one mass launch which was [inaudible] With Love Hilary Duff. Usher He was the number two men’s launch in the mass channel, achieving a #12 ranking for the calendar year despite being on the shelves for only a few months.

As I mentioned before, Curve and White Diamonds continue to rank as the number one men’s and women’s fragrances in the mass channel respectively for calendar 2008. White Diamonds also fared well in Prestige distribution maintaining its very high ranking in unit sell through. The holiday gift sets for this brand continued to be very popular, with sell through percentages at Macy’s in excess of 90%. White Diamonds as it has for many years also continues to be the number one ranked brand at J.C. Penney.

Turning now to the Britney brands, they continue to be significant contributors to our global portfolio. Overall our sales of Britney brands are down as we planned as we didn’t have a launch in department stores this year like we did last year with Believe. We are pleased, however, that retail sales of Britney brands have exceeded our projections over the last few months. We’re hoping that this is a continuing trend over the next six months to a year as she has taken a more active role out in her own career the last few months.

The brands continue to perform well in mass retail with Vanishing and Curious ranks in the top 15. And in December we launched a new brand for Britney Spears called Hidden Fantasy into specialty and international retail stores. To date this brand is performing well.

Despite the tough economic environment one of the bright spots for our business has been the performance of our e-commerce business which we touched on last call. For calendar 2008 e-commerce shipments were up 192%, visits up 78% and conversions which is all important to us up 53%. While this business has been a modest contributor to our operating profits so far, we do expect growth in both North America and abroad in the years ahead.

Looking forward, our largest prestige retailer as I’m sure most of you know Macy’s recently announced it is reorganizing its business, including centralizing buying and planning functions. Macy’s represents about half of our prestige department stores sales and we’re now in the process of evaluating our current structure to determine how to effectively and efficiently respond. We do have some recent experience in reorganizing our department stores sales force after the Claiborne transaction.

That being said, we got a note that most of our department stores sales force is focused on shelf route to consumers rather than selling into retailers. And the number of doors we will service for Macy’s is not being changed. As previously mentioned, we just doubled the volume of our department store business as part of the Claiborne transaction without increasing overall headcount.

As far as our outlook given the weak economic indicators we believe that conditions in retail markets will continue to be difficult for the rest of this fiscal year. Our guidance assumes that retail trends for department stores and mass are consistent with the trends we saw in the second quarter. Now so far in 2009, retail trans and mass have been somewhat better than the performance in second quarter though we caution is still very early.

As consumers become more value oriented, we definitely feel we’re well positioned. And given the tough circumstances, we’re also closely monitoring all expenditures and making sure that we focus our spend on our best brands and channels for distribution.

And with that, I will turn it over to Steve Smith our Chief Financial Officer.

Stephen J. Smith

Thank you Joel. I would first like to discuss our second quarter results, provide some comments on our balance sheet and then provide comments on our outlook for the remainder of fiscal 2009. In the second quarter and first six months we incurred non-recurring expenses of approximately

$5 million and $23 million respectively related to the Liz Claiborne fragrance licensing agreement, consistent with previous guidance. This is in our reported results.

Of this amount, $3.5 million and $19 million respectively relate to adjusting the carrying value of this inventory to that of a brand owner from that of a distributor. I would like to emphasize that this is a non-cash charge. The remainder relates to $1.3 million or $4.4 million for the first six months of transition related expenses for supply chain and logistic support and earlier in the year sales support as well. These expenses are consistent with our prior expectations. The transition is essentially complete, on time and on budget, and will no longer be incurring any additional Claiborne related expenses.

Adjusted for these charges, our second quarter margin was 41.9% or a 40 basis point decrease versus the prior year. Our gross margins were adversely affected by lower sales volumes and a higher margin travel retail and European channels and a higher proportion and promotional set sales versus basic stock replenishment orders. Excluding Liz Claiborne and restructuring and reengineering related charges, SG&A expenses as a percentage of net sales was 31.9% as compared to 28.3% for the prior year.

Foreign currency accounts for 50 basis points of the increase. Royalties increased by 120 basis points due to the Claiborne licensing agreement. And other direct expenses to support our brands increased by 230 basis points. These increases were offset by lower general and administrative expenses. Our overhead costs have been tightly controlled since last year when we announced the zero overhead growth initiative as part of our global reengineering initiative.

Furthermore, in the fall we froze hiring; placed additional restrictions on discretionary expenditure outlook. For example, we believe our investment in video conferencing in our key locations in the last year is leading to a permanent reduction in certain travel related expenses. Our emphasis continues to be on directing spend and investments to those initiatives, brands and markets that will provide the greatest returns.

Cash flow use and operations for the first half of the year was $2.1 million, $14 million less than the prior year. Our original target for operating cash flow for the full fiscal year was $50 to $60 million and we are still comfortable with that range.

This will be achieved primarily by reducing inventories in the second half of the year. We will be very strict with respect to purchases of inventory from all suppliers. Inventory ended the quarter at $390 million, up from $341 million in the same period last year. While we ended the December quarter with inventory ahead of plans due to reduced sales, the extra inventory is excesses; it’s not obsolete. It’s primarily fragrance related and will be used in the second half of our year, allowing us to reduce purchases significantly.

Our DSO’s were 77 days, a 16 day reduction from the same period in the prior year. As a result, our net trade cycle is only five days higher than last year. CapEx for the first six months was $12.8 million. Our original CapEx budget for the full year was approximately $46 million, of which $14.5 million was for J.D. Edwards and related IT investments and some product tester units in our international markets. In total, we expect to defer a minimum of $10 million of our planned capital expenditure budget for fiscal ’09 and now expect total CapEx to be somewhere between $30 and $35 million.

The credit facility had a balance as of the end of December of $145.7 million compared to

$226 million at the end of September. The credit facility peaked in mid-October at $276 million. We are past our peak borrowings and expect to continue to reduce the operating line over the next several months. It is important to note that while the credit facility is classified as short term debt, because it is revolving in nature it does not expire until December 31, 2012. We finished January with approximately $65 million of availability on the credit facility.

With respect to covenant compliance, the only financial maintenance covenant we have is a fixed charge coverage ratio of 1.1 to 1, and it only applies when our average availability is less then

$35 million during this time of the year, or $25 million between June and November.

In July we completed an amendment to the current credit facility and we increased the size of the facility from $250 million to $325 million with the ability to increase it by another $50 million without consent of all the banks. There was no change to the current pricing of Libor plus 100 to 175 or prime. The only other debt outstanding is our senior subordinated notes which are at 7.75% which do not return until January of 2014. These bonds have no maintenance covenants to strip as they are in current space only.

One last point regarding our balance sheet is as Scott mentioned, we decided to hold shipments back from certain customers due to credit issues to protect our balance sheet, and we believe we are adequately reserved for exposures based on current facts and circumstances. Our total reserves, allowances and other customer related deductions are 25% of our gross receivables, up from 17% in the same period last year.

Our bad debt reserves are proportionately 31% higher than the same period last year, based on net customer balances owed. We have not experienced any significant individual customer write-offs consistent with our historical experience in previous economic downturns.

I’d like to spend a few minutes discussing the impact foreign currency fluctuations have had on our results. Much of our international revenues and profits are in foreign currencies, primarily the euro; pound sterling; Canadian dollar; and the South African rand; Australian and New Zealand dollar as well. Therefore, weak U.S. dollar is positive to sales and earnings and a strong dollar is unfavorable. We typically have a natural hedge for a portion of our revenues since foreign denominated SG&A expenses are also translated at current rates.

However, given the extreme volatility of currencies and the flight to safer currencies, including the U.S. dollar and Swiss franc, the currencies in which our expenses are denominated have been negatively impacted. The recent volatility of foreign currencies came at a time when our working capital was at its peak, and as a result we have been adversely impacted by the revaluation of our international affiliate balance sheets. And that was $1.7 million for the quarter.

The foreign currency gains we had previously expected for the second half of the year have in large part dissipated due to the continued and current weakness of the aforementioned currencies and the continued strength of the Swiss franc.

Regarding our guidance for the second half of the fiscal year, we currently expect net sales to decline by 1 to 3% on a reported basis, with similar declines for the third and fourth fiscal quarters versus the prior year periods. Gross margins are anticipated to be in the 46% range, reflecting higher basic stock orders due to innovation pipeline and our second half business being more skewed to Skin Color basic stock sales. The adjusted tax rate is approximately 27%.

Our earnings for Q3 and Q4 are expected to reflect the spend for the global launch of the new Elizabeth Arden fragrance Pretty and advertising support for the Liz Claiborne brands in Q3 and additional cost savings to be incurred primarily in Q4. In addition, the comparison of operating income in the third quarter this year to the third quarter of the prior year is distorted by the reversal and associated credit for incentive compensation, which was reversed out in the third quarter last year but in the December quarter of this fiscal year.

As such, our expectations for the third quarter are for a loss of $0.30 to $0.35 a share versus a loss of $0.10 a share the prior year. Finally I’d now like to provide an update on the global efficiency and engineering project. The restructuring costs and charges that we outlined on our previous calls of $12 to $14 million are still on track and as planned. We also continue to see positive results in the supply chain initiatives to reduce costs of working capital.

Savings of $10 to $12 million are still anticipated to be realized, but obviously with the significant changes in volumes in our business the timing of the full benefit of their savings continue to be pushed out.

And with that I’ll turn it back to Scott.

E. Scott Beattie

Thank you Steve. Operator, we’re now in a position to answer any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Joseph Altobello - Oppenheimer & Co.

Joseph Altobello - Oppenheimer & Co.

First question, I just wanted to go back to something you mentioned earlier on the call. In terms of retail sales I think you said that in the quarter that overall retail sales of fragrances were down 9%. This is probably a difficult question but how much of that 9% decline do you think was the difficult consumer environment and how much of that was attributable to some soft line retailers and apparel retailers heavily discounting in the quarter to that gift-giving consumer who’s indifferent between fragrance and a sweater for example?

E. Scott Beattie

I think Joe in terms of the fragrance numbers it’s difficult to kind of separate out those two factors. I clearly as I mentioned in the Arden business, as well as Joel in the overall department store fragrance, the replenishment of basic stock was well below what we had expected. And what the department store retailers did was they brought in the gift sets and promotional type items that offered the best value to customers and also had return privileges. So they essentially had very minimal inventory risk on those items and were very conservative on bringing in basic stock replenishment, which happens to be the higher margined component of the business for us.

And this applied not only to our businesses but to all of our competitors as well. And the likely reason for that was that the basic stock isn’t discounted to your point, and with the rest of the store on discount they felt probably that – I don’t mean to speak for them, but my inference is that they felt that discounting was better applied to the already discounted gift set programs that were shipped in. So that was more the reaction in the beauty category than in the United States.

Joseph Altobello - Oppenheimer & Co.

So the fact that trends improved somewhat I guess in January seems to indicate that at least some portion of the weakness in the holiday season, for example, was because of that gift giver not buying fragrance because like you said they’re not discounted.

E. Scott Beattie

Well, I think part of what Joel described in terms of the replenishment in January being modestly better than what we had expected against trend was the fact that there was already a de-leveraging of inventory during the second quarter of basic stock. What we typically see in January-February is when you like last year for example we had quite a good strong second quarter, but as we went into the third quarter there was a lot of overhanging of basic stock inventory. So our third quarter replenishment was quite poor.

This year the second quarter replenishment of basic stock is very poor, and so inventory levels were modest to low. And as a result, we’re seeing a little bit better replenishment in January-February. But as Joel said it’s still a very difficult retail environment and we’re very cautious about those kinds of improvements.

Joseph Altobello - Oppenheimer & Co.

So sell-through hasn’t necessarily improved. It’s more the sell-in.

E. Scott Beattie

No, actually sell-through has improved as well. But sometimes you have to have to have the product on the shelf to sell.

Joseph Altobello - Oppenheimer & Co.

And then secondly in terms of gross margins you mentioned Scott obviously doing a lot of things internally to get those higher. Where can you go given that you are improving things in terms of processes? And you’re also now including the Liz brands which I imagine would have a higher gross margin. So what’s the sort of I don’t know aspirational goal on that margin line?

E. Scott Beattie

I’d prefer not to kind of give that aspirational goal now. We’re working through this with a number of initiatives and it’s really a function of what our blended business is globally. When I talked about a holistic gross margin improvement, gross margin for us improves everything from reduce dilution between gross to net sales to improvement in logistics costs; and improvement in supply chain costs; and improvement in costs of goods by leveraging some of our strategic buying initiatives.

There’s a dozen separate initiatives that are driving improvement in gross margin. And until we kind of roll that up into our plan for 2010, I’d rather not sort of get into that detail. But I can tell you that as Steve mentioned we are getting very strong traction in these initiatives. It’s not showing up yet in our P&L because it’s imbedded in the value of the inventory that we’re carrying, our access inventory. But as that gets liquidated we’ll start to see an improvement in our gross margins and our overall operating performance.

Joseph Altobello - Oppenheimer & Co.

But it’s fair to say that it’s in the hundreds of basis points?

E. Scott Beattie

I would say that’s fair.

Operator

Your next question comes from Arnold Ursaner - CJS Securities.

Arnold Ursaner - CJS Securities

I guess I want to focus most of my questions related to the inventory numbers. In terms of the $390 million, how much of that might you view as basic stock or would you call basic stock? Why don’t we start with that question. And more specifically how much of that is directly tied to Liz?

E. Scott Beattie

We have about $20 million of the $390 in access promotional items. And I’m talking finished goods here. And that would be gift sets. And they’re primarily fragrance gift sets. About half of those have been reprogrammed to sell into during the spring season. And the other half have been reprogrammed to sell into other retail channels. So it’s – we’ve got a fairly clear program there in gift sets.

And then as Joel mentioned, our gift sets sell through on the fragrance side. We’re really quite comparable to what it was last year and we normally have some residual sets left over that we then sell during the third quarter. And so that’s tracking as we expect.

There’s not an issue. The vast majority of the overhang in inventory is in basic stock fragrance inventory. And as you know Arnie that fragrance it doesn’t have – you know the shelf life is very long. The fragrance packaging and so on is very consistent. There’s very little risk of obsolescence. We had more inventory than we needed given the weak takeaway in the second quarter. So what essentially is in place is we’re stopping the in flows as new receipts of inventory and we’re just deleting the excess basic stock fragrance down to normal replenishment across our business over the next six months.

And we’ve got a good plan in place. Our supply chain and business finance group combined with our sales units have assigned to our sales and ops planning process a very clear budget and how we’re going to bleed that inventory down. And we’ll see that happen from now until the end of June.

Arnold Ursaner - CJS Securities

As a follow up to that, you mentioned you plan to reduce the receipts of new inventory. But if it’s your own brand – I guess I’m trying to get a feel for the inventory of your own branded and Liz products versus the distribution products you have for others where they’re I guess a different supplier. And you tell them please stop the shipments. Can you give us a feel for that?

E. Scott Beattie

The majority of it because our mix right now in fragrance is about 80% owned and 20% distributed, the majority of the access is obviously in owned. And that’s just a matter of stopping the in-flows of componentry and new bulk materials and so on and just building out your existing inventory. And as I said bleed that through normal replenishment channels.

On our distributed side of our business, our partners also recognize the weakness in the retail environment and we’ve adjusted some of our purchasing budgets on those businesses down as well. So it’s multi-faceted.

Arnold Ursaner - CJS Securities

If I can, two very quick financial questions. You mentioned that you expected currency previously to be a positive contributor and now you thought it would be neutral. Can you quantify how much that has changed in your thinking numerically?

Marcey Becker

I think as we said in the press release I think we in the second half of the prior release expected the second half of the fiscal year to have a benefit of currency and now it’s neutral to take a loss of $0.01. And that’s primarily because of the currencies, the euro, the pound and other currencies appreciating. But with the Swiss franc and the dollar are depreciating and the Swiss franc and the dollar not doing so to the same extent. So you have you’re giving up the gains in the second half that we had previously forecasted versus where rates are now.

Arnold Ursaner - CJS Securities

And you also said in your prepared remarks you saw the $10 to $12 million savings as being pushed out. Can you highlight or comment further on pushed out from where, you know from which point to what other point?

E. Scott Beattie

Steve’s comment there, Arnie, was exact – consistent with what I said. The savings as we mentioned almost a year ago will first be seen in cash flow and then in P&L, mainly because they become imbedded in the cost of goods and right now they’re imbedded in inventory. Those savings have been tracked and realized but it’s in the value of the inventory. So as a result of carrying more inventory than we budgeted, the savings won’t be accrued until we sell that overhang of inventory through.

Operator

Your next question comes from Rommel Dionisio - Wedbush Morgan Securities Inc.

Rommel Dionisio - Wedbush Morgan Securities Inc.

Scott, on the international travel retail front do you sense that the inventory de-stocking that took place in the quarter and obviously is sort of finished now, or do you get that the sense that it might continue a little bit into the first part of the calendar year?

E. Scott Beattie

I think it varies by region of the world. The Asia-Pacific tenor seems to be stronger from a travel retail point of view than North America and Europe are. I think it reflects the overall traffic patterns in those travel retail locations. But also the quality of the retail outlets in those locations. But within that business unit it’s much more – we’ve been much more impacted by the distributor part of our business from a sales and profitability point of view. We use distributors and as I mentioned in many emerging markets including Latin America, South America, Eastern Europe, Asia, Africa, etc.

In many of these markets and emerging markets their currencies have been very dramatically weakened, vis a vie the U.S. dollar. We sell in U.S. dollars to them and as a result when we – during our peak period, many of them had bought their inventory and were holding a U.S. dollar receivable that was much more expensive and really ate into their profitability as distributors. So as a result, that combined with the credit crisis has spread around the world and without insuring consumer take away, they became very cautious in terms of taking additional volumes of inventory during December particularly.

So we saw dramatic fall off in that distributor market. I suspect that that will get normalized as the currencies become a little bit more stable and certainly in the second half you don’t have the peak purchasing like you would during the holiday season.

Rommel Dionisio - Wedbush Morgan Securities Inc.

Obviously la Juicy had a great launch and given the new business for it should we expect a normal pattern for taking that to mass? You know normally you’ll get a product that was launched in the holiday after mass by sometime this summer or something. Is that what we should expect to see or might you keep it in prestige another season, into the holiday season or what? Could you maybe just share your plans with that?

E. Scott Beattie

As we always do we never comment on those kind of strategies but I wouldn’t – every brand is different so I wouldn’t expect that it would just be a normal process of cascading our brand.

Operator

Your next question comes from [Unidentified Analyst] – Suntrust Robinson Humphrey.

Unidentified Analyst – Suntrust Robinson Humphrey

With the current state of the economy do you guys plan to postpone or push back your launches until you see improvement in the consumer retail environment?

E. Scott Beattie

We’ve sort of gone through all of our innovation calendar for the remainder of this year and as we move into the fall, many of which were programs we’re presenting to retailers and we’re making judgments on that both by channel and distribution, by brand and by the geography. It’s hard to generalize across the – you know all of our brands and all of our markets and all of our channels for distribution because they’re behaving quite differently.

I can tell you that we are very much focused on maximizing the return on investing capital of this new innovation. And in those markets where the launch or those channels of distribution or those brands where the launch or new innovation is marginal we’re pulling it back or eliminating it and focusing as much of our internal resources on our best brand portfolios, our best channels of distribution and our best markets around the world.

Unidentified Analyst – Suntrust Robinson Humphrey

So you guys won’t be delaying or pushing back the launch of the Pretty fragrance at all?

E. Scott Beattie

No. I mean the Pretty fragrance has been tremendously received around the world by our retailers. They continue to be very aggressive at supporting it. And we’re very excited about that launch.

Operator

Your last question comes from Reza Vahabzadeh - Barclays Capital.

Reza Vahabzadeh - Barclays Capital

I had a question on how you’re thinking about any free cash flow you might be generating in the balance of this fiscal year and frankly the balance of this calendar year, whether it’s going to be largely applied against debt reduction or have you thought about share repurchases? And would you consider small bulk on acquisitions?

E. Scott Beattie

The first priority is as we stated is to liquidate the additional overhang in inventory between now and June or as we move into the busy season next fall. And that will be our top priority, turning that into cash. And obviously as we turn that into cash it’ll be paying down our operating line of credit.

Now our operating line of credit currently is costing us in and around 2% interest rate. So it creates an opportunity for us then to redeploy that, both in terms of selective brand acquisitions, selective share repurchases and potentially selective bond repurchases. But right currently we’re focused on turning that inventory into cash. And then as we do that we’ll revisit each of those alternatives.

Reza Vahabzadeh - Barclays Capital

The limitation on bond repurchases as it would be considered under the R&P basket would be what $25 million these days?

Marcey Becker

For purposes of the credit facility or the bond indenture?

Reza Vahabzadeh - Barclays Capital

The bond indenture.

Marcey Becker

The bond indenture that restricted payments basket is around $70 million.

Reza Vahabzadeh - Barclays Capital

And the credit agreement?

Marcey Becker

The credit agreement allows us to repurchase bonds as long as their availability’s above certain thresholds. I think in season it’s $25 million, out of season it’s $35 million.

Reza Vahabzadeh - Barclays Capital

So you guys cover everyone on that front?

Marcey Becker

Yes.

Operator

Thank you. I will now turn the conference back over to management for final remarks.

E. Scott Beattie

Thank you very much everyone for joining us today for our second quarter conference call.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you all for your participation.

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Source: Elizabeth Arden, Inc. F2Q09 (Qtr End 12/31/2008) Earnings Call Transcript
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