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Elizabeth Arden, Inc. (NASDAQ:RDEN)

Q4 2009 Earnings Call

August 13, 2009 4:30 pm ET

Executives

Scott Beattie – President & CEO

Joel Ronkin – EVP & GM North America Fragrances

Steve Smith – EVP & CFO

Allison Malkin - IR

Analysts

Arnold Ursaner - CJS Securities

William Chappell - SunTrust Robinson Humphrey

Joseph Altobello – Oppenheimer

Jason Gere – RBC Capital Markets

Rommel Dionisio - Wedbush Morgan Securities

Operator

Greetings and welcome to the Elizabeth Arden fourth quarter fiscal 2009 results conference call. (Operator instructions) It is now my pleasure to introduce your host, Allison Malkin of ICR for Elizabeth Arden. Ms. Allison Malkin, you may now begin.

Allison Malkin

Good afternoon. Thank you for joining us. 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.

If any non-GAAP financial information is provided on this call, a reconciliation of the non-GAAP information to the most comparable GAAP financial measure is available in our press release.

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

Scott Beattie

Thank you very much. Welcome everyone to our fiscal year end 2009 conference call. Joining me here today is Joel Ronkin, our Executive VP of North American Fragrances; Steve Smith, our Executive VP and Chief Financial Officer; and Marcey Becker, our Senior Vice President, Finance.

Before we begin I’d just like to outline our agenda for today, first of all I will provide an overview of the Q4 performance and overall fiscal 2009 operating performance. I’ll specifically review our international business which is approximately a third of our total business and our US Elizabeth Arden department store business which is approximately 3% of our business.

Joel will provide a review of the remaining two thirds of our business which is the North American fragrance business. I’ll also provide a summary of the key corporate initiatives and priorities as we begin fiscal 2010. Joel will speak secondly and then he will provide an overview of our North American fragrance.

This business just to remind everyone includes our US department store fragrance business, our US mass business, Canada and Puerto Rico, and our online business. Joel will provide an overview of both the North American business conditions both for the fourth quarter as we enter into 2010 fiscal year as well as brand performance and brand launches into 2010.

Steve will provide a detailed review of our key financial metrics including a status on the JD Edwards implementation and some key metrics on our global efficiency reengineering initiative. So in terms of a summary of the fourth quarter and for fiscal 2009 first of all I’d like to just talk about the Arden Prestige business, our US department store business.

This business had a very difficult year particularly in the second quarter as we saw tremendous deleveraging of fragrance inventory particularly for the year the brand was down 24% but for the latest fourth quarter it actually exceeded our expectation and was only down 5%. And that was driven by the success of the Pretty Fragrance launch and our new Elizabeth Arden mineral makeup launch both of which were very successful this spring.

Retail sales year to date, the calendar year to date, as tracked by MPD, we’re down 4% versus the category being down 8%. So in terms of performance in the second half of this, from January through June, we’re seeing improved performance and that has a lot to do with the improvement in innovation.

July sales are actually up year over year for the first time in over a year so that shows some solid improvement in trends. As I said earlier most of the decline for the Elizabeth Arden brand for the year occurred in the second quarter and it was really a result of deleveraging inventory particularly fragrance inventory.

Our international business which again is about a third of our total business was down 8.6% for the year ex FX, it was down 3%. This business is primarily driven by the Elizabeth Arden brand which represents approximately 70% of the total sales of international and its profitability is significantly driven by the performance of the distributor and travel retail component of the business and that was extremely soft for the second half of the year.

The Elizabeth Arden brand represents about 70% of the overall DMTR business. In total globally the Elizabeth Arden brand was down approximately 10% ex currency and again that was driven primarily by the weakness in the US during the second quarter and by the deterioration of the travel retail business during the third and fourth quarter.

Asia Pacific including South Africa, Australia, New Zealand, Korea, Greater China, the brand was up in almost all the markets and that was driven by the success of skincare and color. The rest of the world, primarily Europe, the Middle East, and the rest of the distributor markets in South America etc., was basically flat ex currency which was much better than the category.

Our expectations for the Elizabeth Arden brand for 2010 is for the brand to grow in the low to mid single-digits driven by the skincare growth in Asia Pacific and the rollout of the Pretty fragrance globally. Longer-term our goal is to double the size of the Arden brand.

The Arden brand is one of the most widely recognized and respected beauty brands in the world and 2010 will be the 100th anniversary for the Elizabeth Arden brand. And we have exciting PR events, innovation and promotions to celebrate this brand’s heritage.

These programs will cross over both fiscal 2010 and 2011 and will provide exciting new energy behind the brand and will stimulate global growth. The strategy to accelerate the growth of the Elizabeth Arden brand is to focus on core skincare and particularly the core skincare and related color brand franchises.

Our three pillars are Ceramide, INRERVENE, and PREVAGE. We’re particularly focusing on our skincare franchises in Asia Pacific where we are experiencing double-digit growth and we’re focusing on our core fragrance franchises Red Door, Green Tea, 5th Avenue and Pretty by allocating more of our fuel spend against those brands on a global basis.

Before I discuss the 2010 corporate initiatives and outlook I’d like to spend a moment just to provide a high level review of the entire business performance for 2009, what worked for us, what didn’t, and I think the discussion of this will help in understanding the variables that will drive operating performance during 2010 fiscal year and beyond.

What worked for us well in 2009 fiscal year was we had a very strong innovation calendar. All of our innovation [inaudible] exceeded our expectations in terms of ranking and launch performance. As a result of that we saw improved North American market share both in department stores and mass retail which Joel will discuss in more detail in a second, despite the deleveraging of inventory with most of our retailers in both channels in addition to door closings particularly in the department store channel.

The international business performed reasonably well, again driven by the Asia Pacific business despite the dramatic effect with FX and the decline of the travel retail business. The international platform as I’ve discussed many times in the past is very sensitive to operating leverage as we operate in over 60 countries and its still a relatively small portion in terms of dollars, size and scale as a business.

When the travel retail business declines that has a dramatic effect on profitability and we’ve had both that as well as negative FX implications. In terms of our reengineering project we were very pleased with the performance of our initiatives to reduce inventory, improve customer fill rates and service levels, we were able to improve cost structure both in terms of the operating costs of our supply chain and logistics organization, as well as our cost of goods and related drivers in gross margin.

Unfortunately many of these cost reductions weren’t fully realized in the third and fourth quarter of 2009 as we were net liquidators of inventory during that period. We expect as we move into fiscal 2010 to see improvement in gross margin driven primarily by improvements in supply chain, logistics, and cost of goods.

We successfully implemented our shared service organization remodeling which Steve will talk to in more detail in a second. This positioned us very well in terms of driving down indirect overhead costs as well as improving the efficiency of how we process transactions and our financial accounting systems.

We also successfully implemented our JD Edwards financial modules as of July 1 and in fact we’ve just recently closed our July month end successfully on budget and on time. And in terms of our indirect overhead we were able to actually reduce our indirect overheads year over year which don’t show up obviously in our financial results as a result of us having our, the Liz Claiborne loyalty expense imbedded in our overhead cost this year.

Issues as we look forward into 2010, the key variable that’s going to drive performance for our business as we move forward is the impact of replenishment basic stock inventory particularly for our fragrance business in mass retail. The deleveraging of existing brand inventory is still occurring and its very difficult for us to put any kind of estimate into when that replenishment will normalize.

There is a significant gap between retail sell through and replenishment currently so we’re seeing net declines in inventory and as that corrects itself and normalizes particularly in our travel retail business, our mass business and our distributor business, that will drive improved EBITDA margins and profitability.

As we move forward our 2010 guidance reflects continued contribution from our reengineering initiatives and improvements, they will be the main contributors to gross margin improvement between 200 and 250 basis points. We have a very strong pipeline of new innovation including a new Juicy Couture fragrance, Halston fragrance, [inaudible], Britney Spears Circus, and several new skincare and color initiatives.

These all require spend and investment to launch and we’re very excited about the contribution that these brands will make during fiscal 2010. We have projected no improved inventory replenishment in existing brands despite improved retail performance in some of our business units and as I mentioned a second ago, as new replenishment more closely matches retail sell through we’ll not only see an improvement in margins but we’ll see an improvement in EBITDA performance.

Our operating priorities for 2010 are one to drive continued organic growth in the Elizabeth Arden brands, and to continue to improve market share in our North American fragrance unit. To focus future growth on our European fragrance business. This market provides exciting opportunity for us. It’s a $10 billion fragrance market which is growing at approximately 7% a year.

Our market shares are very small there and we see an opportunity to more then double the size of our business in Europe over the next several years. This combined with the Elizabeth Arden brand development and the expansion of our PREVAGE business will provide continued organic growth for our business in the next several years.

I’d like to now turn it over to Joel Ronkin to talk about the North American fragrance business.

Joel Ronkin

Thank you Scott, I’m going to comment on the performance of the North American fragrances group for the quarter and the year, current retail sales trends, the key initiatives for the group and also give some perspective on our outlook for fiscal 2010 as it relates to the North American fragrances group.

As Scott mentioned its about two thirds of the sales of the business and an even greater percentage of our profits. Overall the business performed as expected for the fourth quarter and we were overall pleased that the net sales decline was very minor for the fiscal year, 4% and we were able to offset the impact from the difficult economic and retail environment as well as the retailer de-stocking that Scott mentioned through very strong innovation as well as sales resulting from our Liz Claiborne fragrance license.

For the fiscal year we are also pleased that we expanded our gross margins by a significant 560 basis points to improve sales mix from 38.5% to 44.1%. As far as overall retail trends, the department store fragrance category was down about 10% on a calendar basis according to MPD last year.

Our share however was up from 2% to 5% due to the successful brand launches that Scott mentioned. Overall in the department store channel we nearly doubled both sales and operating profit during this fiscal year despite a difficult economic environment and we are now one of the top suppliers of fragrances to department store fragrance counters.

Scott touched a little bit on our Juicy Couture brands and overall the Juicy Couture franchises continued to be a stellar performer for us in department stores. In fact Viva la Juicy we’re pleased to announce was the number one fragrance launched in US department stores last year and in fact just last week the Juicy franchise overall was the number one ranked group of brands at Macy’s.

Now turning to our big mass business we continue to see inventory de-stocking as Scott mentioned taking place at really all of our key retailers throughout the fourth quarter. Now while this de-stocking has impacted our shipments to mass customers we’re not seeing the same with retail sales, in fact, retail sales for the category have been flat and perhaps more importantly retail sales of the brands we supply have been up 8% over the same period this year.

So like I said flat sales for the category were up 8% and sales overall as far as shipments of our product in are down. Now what this has resulted in is significant increases in our market share. Our market share is actually gone up from a very high 60% to 65% so we’re gaining share and this should bode well in the future as this inventory de-stocking phenomenon goes away.

So as a result of this inventory de-stocking and credit constraints at some of our smaller accounts our net sales for the fiscal year came in as we expected down about 10% to 12%. We have however increased our gross margin substantially from around 35% to 40% in the mass channel.

As far as our Canada business our net sales were up 15% for the quarter on a local currency basis and that was really driven by the successful of Always by Alfred Sung and Elizabeth Arden Pretty. We have a new management team in Canada and they’re making very good progress on improving our retail sales trends in our key retailers and particularly Shoppers Drug Mart.

As far as our e-commerce business we have improved significantly that business this year. Sales were up 164% for the quarter and 85% for the fiscal year. This is business is showing some great momentum and is really being driven by increases in site traffic as well as much better conversion rates.

Actually site traffic is up about 50% and conversion rates about 45% during the fiscal year. Maybe even more importantly we’re really finding the site to be a great way for us to communicate with our consumers, we can advertise our brands, we test products, we also test merchandising initiatives.

And what we’re doing now is we’re in the process of leveraging this online expertise and bringing content to our global business and our global markets. And before I get into the new launches, and a calendar of launches that we think is really going to lead to great growth for our franchise, I want to just spend a few minutes talking about our merchandising initiatives that we’re undertaking in our mass channel with some of our key mass retail partners.

I mentioned on the last call that a number of the largest mass volume retailers and chain drug customers are seeing in this environment as their consumer traffic grows in their stores, a great opportunity to take market share and they want to improve the fragrance shopping experience and they see that it’s a way for them to gain share during this time.

So we have seen this as a great opportunity for us as a category leader in prestige fragrances to partner with them in this effort and so what we’re doing is we’re in the process of redesigning the category and you’ll see improvements as you go into the stores over the next group of months and the rest of the year in merchandising, fixturing, signage and of course all important open shelf.

Now to fuel this effort we’ve really devoted more resources to our mass group. We’ve recently hired a new head of our Target business and will have an office in Minneapolis. This is similar to the focused approach we’ve undertaken with our Wal-Mart business in Bentonville, which has been successful for us.

We’ve also reorganized our chain drug sales team and added a very experienced sales person to head our CVS business. In addition the redesigning of the entire fragrance category at Wal-Mart is well underway. You may have heard Wal-Mart discussed publicly that it is in the process of converting about 200 to 300 stores to an improved format for the overall store. They call it project impact.

In our case the impact of the project impact means the fragrance is moving to a different aisle. Typically it upgrades the appearance always in the signage of the category and unlocks the cabinets. They plan to roll out project impact to about 500 to 700 doors per year for the next three to five years. And as Wal-Mart has stated publicly the increase in retail sales that they’re seeing in their stores from this project impact is considerable.

So as this occurs obviously this benefits us with such a high market share at Wal-Mart in prestige fragrances. We believe, there’s much upside to these efforts for both our sales and our retail partners but of course its going to take some time to rollout these improvements as this is across many, many doors in these big retailers.

Now turning to innovation we have just a number of very exciting launches planned for the fall season. As previously mentioned Juicy Couture and Viva la Juicy have been very successful for us. With sales for the whole house of Juicy up about 40% in retails sales year to date in the US.

Its also performing very well in the Juicy franchise internationally. We see strong growth in the UK and really have top rankings at [Dugloss] in Italy and in Germany. In fact we’re planning for the Juicy brands to grow a bit more than 10% this fiscal year which will primarily be driven by the launch of Couture Couture, which will be the third women’s fragrance in the Juicy house.

This will be a very similar introduction to the way we introduced Juicy Couture a few years ago when that was the initial launch brand as it will be a tiered launch that will start exclusively in Bloomingdale’s, in fact it just shipped in two weeks ago, and will then be followed by Nordstrom’s and some other specialty retailers in early fall and later in November to other department stores.

Really, really excited about this brand. We’re really planning for it to do big things and to be actually the number one launch of the season and luckily so our retailer partners. Now later this month we’re also launching a new fragrance for Mariah Carey, called Forever Mariah Carey. That will capitalize on her popularity and the success of her two fragrances that she’s previously launched both M and Luscious Pink.

We’re also pleased that Mariah will be featured in the Macy’s commercial this fall and as always she’ll be very active in supporting her newest brand. I’d like to talk about the Britney brand because we also discuss during our calls, it continues to be a strong performer in the mass and mid tier channels here in the US and even stronger abroad.

In fact sales in Britney brands globally rose 13% in the fourth quarter compared to the prior year. And actually for the fiscal year more then half of the sales of Britney brands were outside of North America which is really attributed to her global popularity. Now to capitalize on this popularity as well as the success of her recent circus theme concert tour, we are launching a new brand and not surprisingly its called Circus Fantasy.

And its going to be launched globally this fall and really has been just tremendous response from our retailers throughout the world. In addition to these women’s fragrance launches we’ve discussed we’re also launching Usher VIP in prestige department stores this fall. This will be the first time we’ve had television advertising for the Usher brand house and we’re able to put together a very compelling ad which I think you’ll agree will capture the celebrity and excitement of Usher.

Like Mariah we’re pleased that Usher is also going to be featured in the Macy’s fall TV campaign. Now last fall we successfully launched Rocawear 9IX, which became the number four ranked men’s launched brand of the season, and later this month we’ll also launch Rocawear [X] which is a brand that will celebrate the 10 year anniversary of the designer fashion brand started by JZ.

In addition to launching these large brands we also are launching a couple of other brands that will fall more into niche categories. We’ll launch Halston Man and Woman, brands which will evoke the popularity of the original Halston fragrances and this will be launched exclusively in Neiman Marcus.

Now we just launched Halston Man and Woman in Harrods in London and according to Harrods it was their number one launch since 2007. Obviously we hope to have the same success here in the States. We’ll also launch the Nanette by Nanette Lepore leveraging the popularity of the designer and the success of her previous fragrances in specialty retailers.

In terms of 2010 and looking forward as Scott mentioned our guidance does not reflect any improvement in inventory replenishment trends. And now although the gap between retail sales and replenishment continues to be significant and inventory levels are actually below February levels now it is really difficult to predict when and by how much inventory rebuilds will occur.

If you listened to the news over the last day or two and other press releases from Macy’s, Wal-Mart and Kohl’s, they’ve all announced earnings this week. What’s notable is that each has reported improved earnings through reductions in inventory and operating costs despite relatively soft sales.

This is a trend that we are seeing across our business as well. Obviously as inventory replenishment trends increase to more normalized levels, particularly as it occurs during the fall season, this would have a significant positive impact on our operating results. Now as far as the holiday season, and everyone always asks how do we look going into the season, we’re pleased that the planning for mass retailers is almost done and we’re looking at relatively flat sell in compared to last year despite the decline in economic conditions and of course there are some variances between accounts.

Retailers have reacted very well to the value that we offer to consumers and we’ve very fortunate that our brands and the promotional programs we presented have resonated well. As far as the prestige channel typically they plan later in the season for holiday promotions but we’ve gotten off to a very strong reception to our new brands and the associated promotions.

And we continue to finalize our orders for the season. Finally I just want to really stress that we see a great opportunity to grow our business as both the economy improves and also as this gap that Scott and I have discussed between retail sales and replenishment narrows. When we take that and couple it with the mass retail initiatives I mentioned and all of the great new launches that we have we can significantly improve the overall corporate sales and profitability of the business due to the very size of the North American fragrances group.

So with that I’d like to turn it over to Steve Smith, our CFO.

Steve Smith

Thank you Joel, I will provide some comments on our full year results, working capital and balance sheet as well as some insights into fiscal 2010. After adjusting for the non cash Liz Claiborne related expenses incurred in the first half of fiscal 2009 we finished the year with gross margins of 42.7%, which is a 70 basis point improvement over last year.

As Joel mentioned we had robust margin improvement in our North American fragrance business but this was offset primarily by unfavorable foreign currency translation, lower net sales in our higher margin European and travel retail markets, and a higher proportion of promotional sales which increased the sales dilution and further compressed margins.

As we were primarily liquidating excess inventory during the back half of the year we also didn’t realize the benefits from our global efficiency reengineering initiative. In fiscal 2010 we expect a 200 to 250 basis point improvement in gross margins coming from improved sales dilution and our reengineering initiatives related to product costs, sourcing and logistics, and savings associated with lower inventory levels.

Excluding the charges related to our reengineering initiative SG&A expense as a percentage of net sales for the year increased 340 basis points to 36.4%. Liz Claiborne royalties which is how we finance the license agreement were approximately half of the increase and other direct expenses to support our brands accounted for the remainder.

Our indirect overhead expenses were proactively managed throughout the year and are down in absolute dollars by over $10 million. Despite the unfavorable impact of sales deleveraging these expenses are flat as a percentage of sales. As innovation is the lifeblood of our business we will continue to support those brands and markets which are performing well and the exciting innovation pipeline that Joel and Scott discussed.

As such we expect total SG&A for fiscal 2010 to increase as a percentage of net sales. I would also like to mention a number of back office initiatives our organization has been involved with this past year. While these things don’t always show up in the numbers, and it is not a complete list, we believe it demonstrates the outstanding capabilities of our organization and team as we transform our infrastructure and build a scalable more efficient organization.

The first phase of our oracle financial accounting system namely accounts payable and general ledger went live last month on time and on budget, and our first financial close on the new system has just been completed without any delay in our information delivery or compromise of controls.

This implementation is intended to simplify and centralize our key transaction processes and accommodate the anticipated growth of our business. The second phase, order to cash processing is scheduled for a February, 2010 go live date with many activities around organization transformation and consolidation already accomplished.

We migrated to a shared services model through our primary global transaction processing functions such as accounts payable, general ledger, order to cash and payroll, again on time and on budget and we are rapidly consolidating our processing locations from 14 between the Americas, Europe and part of Asia to three.

Our North American consolidation is substantially complete. Internationally where we have our shared services center in Geneva, our organization has been transformed, the center is up and running and the consolidation of the various activities in each of our locations is underway.

As a result we incurred approximately $7 million of charges related to our reengineering initiative this year and almost $8 million since the project was announced in May of 2008. We expect the substantial majority of the remaining costs to be incurred in fiscal 2010 and the total cost of the project to be within the $12 to $14 million range previously communicated.

Finally we integrated the Liz Claiborne suite of brands into our back office infrastructure with no additional headcount and without any disruption in service capability to the business and our customers. We have emerged from the credit crisis of the last year with a stronger balance sheet and did not have any significant write-offs as a result of the credit crisis.

Our receivables DSO improved by four days to 64 days from last year and we showed year on year improvement both in North America and in international. As a result of this performance and tight inventory management and despite the reduction in sales, we were able to meet our free cash flow targets in fiscal 2009.

We finished the year with operating cash flow of $37 million. This was accomplished by reducing our inventories by $90 million surpassing our own goal. We were successful at proactively rebalancing our inventory requirements and will continue to reduce inventory levels into next year as inventory is again expected to be a positive contributor to working capital.

Operating cash flow is planned to get back to fiscal 2008 levels, $50 to $60 million driven by improved earnings along with the continued reduction of inventory. We also expect our peak credit line balance to lower next year by approximately $40 to $50 million as compared to fiscal 2009 which peaked at $270 million.

CapEx for the year was $26 million which was down significantly from our original guidance again as we proactively managed our spend down. In total we expect total CapEx for fiscal 2010 of approximately $30 to $35 million of which $13 million is for the oracle financial system implementation and IT related expenditures.

The credit facility had a balance as of the end of June of $115 million compared to $128 million at the end of March and we had $48 million of availability at the end of June. 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.

The only other debt outstanding is our senior subordinated notes which do not mature until January, 2014. These bonds have no maintenance covenants. Our credit rating is currently on negative watch by one of the rating agencies that rate our bonds. The ratings on our bonds have no implications to our current borrowing costs or covenant compliance as there is nothing in our bank agreement or long-term bonds or any other agreement that is tied to our credit ratings.

As we stated in our press release our guidance is based on a full year effective tax rate of 30%. In addition given the additional CapEx we had this year we expect full year depreciation and amortization to approximate $29 million, an increase of $3 million as compared to fiscal 2009 primarily related to our investments in the oracle financial systems and store fixture updates.

Regarding currency it is expected to be a headwind for Q1 of about 3% impact to net sales but reverse itself in the back half of the fiscal year based on current rates. And with that I’ll turn it back to Scott.

Scott Beattie

Thanks very much, we’re available to answer any questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Arnold Ursaner - CJS Securities

Arnold Ursaner - CJS Securities

The performance you had on reducing inventories was extremely impressive, more than $30 million even greater than you had hoped to achieve and yet you accomplished it at a time when your customers were reducing their inventories, can you give us a little more color as to how you accomplished this, is this reducing inventories coming into you, how did you do it.

Scott Beattie

Your point is absolutely right, it’s a fantastic accomplishment and it was really multifunctional. Obviously our supply chain initiatives in our supply chain organization were the leaders in terms of implementing very disciplined sales and operations planning with our sales organizations so that we aligned replenishment with our inventory requirements.

But also our marketing teams worked very effectively at reprogramming inventory both finished goods inventory and promotional inventory into programs into the spring. Our contract fillers and suppliers worked with us very effectively at delaying inbound raw materials and commitments to inventory as we carried a lot of extra finished goods after the Christmas season.

So its was, and our international team also worked very effectively at rationalizing some of the inventory balances that they carry in the various locations around the world. In addition to that we’re implementing a turn key manufacturing model whereby our contract fillers will actually draw down and own the raw materials inventory and we will just be delivered finished goods.

So as we move ahead we will actually own the raw material and component inventory and that will as Steve mentioned be a contributor to reducing inventories as we go into 2010. So this will have the single biggest impact on driving improved return on invested capital but it will also help drive down operating expenses and improve gross margins by reducing freight costs, reducing storage costs related to inventory, and so on.

And we see a reduction in inventory year over year for each of the next several quarters. So it’s a very positive improvement to our business model and its something people that have followed us know we’ve been working on for the last year and a half. We would have actually had even more improvements in the second half of the year if we hadn’t carried such a legacy of excess inventory through the Christmas season and as you say had such weak replenishment from our retail partners.

Arnold Ursaner - CJS Securities

In Q3 the gap between your sales and replenishment was 13%, and you give so much information I’m not sure I got it right, your sales were up 8 but your shipments were down, give us your best sense of what the gap was in Q4 between replenishment and sales.

Joel Ronkin

Actually the reason we haven’t given a number is because it is so different across the board. Sales continue to be down but it depends retailer to retailer. Sales are up overall out of our key retailers 8%, there’s some non-planner brand accounts that we don’t include in those numbers and sales in general are down but we don’t have as solid numbers as we did in Q3 on an overall basis and its all over the board but in general, the gap is about the same as it was if not a little more than it was in Q3.

Scott Beattie

One of the other metrics that is interesting is that we saw supply on hand for our retail customers and when we looked across and this is just the North America customers they actually have less inventory today then they had in February and February is traditionally a very low period of the year for inventory.

So we’re really seeing significant de-stocking of particularly fragrance inventory in the mass retail channel. And as both Joel and I mentioned its very difficult right now to be able to project in our forward guidance when or if, not so much if, when and how much that replenishment will be. Its probably sensible if the economy continues to stabilize and has slight improvements that there would be a pick up in inventory in the Christmas season.

But right now its very difficult to project it so we haven’t included that in our guidance. When that comes and the magnitude of that improvement will have a significant impact on our EBITDA margins.

Arnold Ursaner - CJS Securities

But the way you positioned it you’ve given that arguably a very conservative view and then hope to see positive trends from there which would lead to upside.

Scott Beattie

That’s right, that’s what we believe and we’ve done that because unfortunately last year we had a number of adjustments to our guidance which we don’t like to do and as I stated on our conference call last quarter that the lack of financial visibility moving forward was frustrating to us and so what we’ve tried to do is take out some of those risks in our forward guidance and as I say, as we start to get that replenishment back and it will come because the reason we went into such detail in terms of market shares, in terms of retail performance of our new innovation, in terms of the performance of our brands, is that we want everyone to understand that we’ve got very good trends in our business.

And our business model is very strong. The part that we can’t control obviously is the deleveraging of inventory that’s occurring globally and eventually that will be fixed as long as the brands are strong and the retail sell through is strong.

Arnold Ursaner - CJS Securities

I think you told us you would let us know in the beginning of the year what your projected cost savings would be from the enterprise system. I think you’ve been holding off trying to quantify it. Now that we’re at this point, would you take a stab at trying to quantify it.

Scott Beattie

I don’t think so. I don’t want to be evasive but the fact of the matter is that the reengineering initiative and the IT implementation of JD Edwards, both of those are really, the order of magnitude of contribution is really a function of the scalability of the business and we talked about last two quarters we’ve been net liquidators of inventory despite the fact that we’ve gotten very strong traction in many of the initiatives driving improved supply chain, cost of goods, logistics, freight, the planning processes, better fill rates, all of the underlying drivers of improved supply chain performance.

But it doesn’t really show up in the earnings because you’re selling down existing inventory. It shows up in the cash flows and again, I think that Steve mentioned we’re seeing quite a significant improvement in cash flow performance from 2009 to 2010 and we expect that to occur in 2011 and 2012 as well.

Operator

Your next question comes from the line of William Chappell - SunTrust Robinson Humphrey

William Chappell - SunTrust Robinson Humphrey

I was just wondering if you could provide an outlook on travel retail for fiscal year 2010.

Scott Beattie

I just had a conference with our executive yesterday who happens to be in South Africa right now and just to get a real updated version because the dynamics of that market can change very quickly. We’ve actually seen slightly improved replenishment in travel retail over the last month or two and that’s really a function of the strong travel and traffic globally during the summer season.

So we did see an improvement in June and July in replenishment. The question is, the real difficult question is that the number of travelers actually is still declining although its not declining at the rate it was in February, March and April. Its still declining and we’re somewhat concerned that the inventory that they built for the summer holiday season will sort of hang over into the fall season and it will effect some replenishment then.

I don’t think it will be dramatic but it will certainly potentially slow the rebuild of that business unit so right now we’re pretty cautious in terms of the return to the previous volumes and inventory replenishment in that channel. In terms of the distribution markets where we use distributors around the world, I do think that that’s improving.

We’re seeing improvement in foreign currencies, we’re seeing improvement in the credit environment, we’re seeing more stabilized demand in many of the distributor markets around the world, so that business I think is gradually getting better.

William Chappell - SunTrust Robinson Humphrey

And if you could just provide how much of the FX will benefit second or third quarter.

Marcey Becker

As we said in our press release it’s a headwind in Q1 and its for the back, I guess last three quarters its about 1.5% positive.

Operator

Your next question comes from the line of Joseph Altobello – Oppenheimer

Joseph Altobello – Oppenheimer

I just wanted to dive into the 2% to 3.5% sales guidance growth for fiscal 2010 if you look at fiscal 2009 obviously your sales were down and you’re talking about continue de-stock, could you just give us a sense of where that growth is coming from and how much you expect the category to grow.

Scott Beattie

The growth is coming from our North American fragrance business, the business that Joel runs and as he went through I think earlier it’s a combination of the new product launches, fragrance launches he has this fall as well as the continued positive performance of his mass business. We’re seeing improvement in our international business particularly driven by Asia Pacific.

That whole region, the travel business in that region, Australia, New Zealand, South Korea, China, Taiwan, Hong Kong, South Africa, even smaller distributor markets like India and Southeast Asia are all performing significantly better than the rest of the world. So we’re seeing a lot of the growth coming from that market.

Joseph Altobello – Oppenheimer

So it over the overall category though you continue to expect to gain share next year.

Scott Beattie

In which category, the global beauty category—

Joseph Altobello – Oppenheimer

No, prestige fragrance.

Scott Beattie

Well within North American fragrance definitely will grow market share, what we’re seeing is continued movement of department store shoppers into the mass channel and obviously with our market shares in between, in approximately 65% in that channel we get a disproportionate of the incremental volume.

Joseph Altobello – Oppenheimer

And then in terms of the retail inventory levels that you’re seeing now, obviously you talked about it being relatively low or very low in fact, you have been in this business a long time, have the retail inventory levels ever gotten this low in the past.

Scott Beattie

Well with certain customers I don’t think so, but I think just as we’ve had an incredible focus on inventory so have our suppliers, so have our retailers, this isn’t a phenomenon to our industry. I think if you look at any industry, any part of the global economy what we’re seeing is tremendous deleveraging of inventory and just noticed yesterday on one of the web news pages, it’s the tenth straight month of wholesale inventories declining.

And its been a significant amount so I think it’s a phenomenon that started through the credit crisis, people were turning more of their balance sheets into cash and creating more liquidity and they’re just continuing to drive it down to drive improved operating earnings anticipating a very slow anemic consumer recovery.

So we’re all sort of positioning ourselves for that environment.

Joseph Altobello – Oppenheimer

And then on the SG&A side you talked about the sales being up in fiscal 2010, the gross margin being up 200 plus bps and SG&A up as a percentage of sales, can you just go over sort of the drivers again of what’s driving the SG&A spending increase. It sounds like its going to be up absolutely in dollars.

Scott Beattie

Yes it’s a bit of a phenomenon, its unique to this year. We’ve got improved gross margin that’s being driven by improved dilution and improved supply chain and initiatives and all the cost structure savings we’ve talked about. The same time, the mix between just normal replenishment of existing brand inventory particularly in channels of distribution like mass and travel retail, the high profit generating units, has declined.

So where we haven’t anticipated a recovery in that business so the SG&A line as a proportion of our revenue projections is higher because we’ve got a strong pipeline of new innovation without having the normal replenishment sort of cycle that we’ve described.

So that’s why SG&A is a higher percentage of net sales or in absolute dollars is an increase because of that new innovation pipeline combined with the fact that not getting the replenishment on our existing brands which have a proportionately less amount of dollars support behind them, dilutes down your EBITDA margin. I hope that’s clear. Its kind of a complicated thing to describe.

But that’s really what’s driving that phenomenon.

Joseph Altobello – Oppenheimer

I’ll probably have to follow-up with you later because I don’t understand why it would be up in absolute dollars given what’s going on in every other company that I follow is trying to cut SG&A but we can follow-up offline.

Operator

Your next question comes from the line of Jason Gere – RBC Capital Markets

Jason Gere – RBC Capital Markets

I guess just following up on Joe’s question just on SG&A, can you say that there’s a certain degree of sales growth you can get to start getting operating leverage. I think you were saying international maybe was a little bit more than on the domestic side.

Scott Beattie

We have strong operating leverage in our domestic business, its really the international platform which is about a third of our business and that business is really very sensitive to both Forex and volume in terms of its operating leverage.

Jason Gere – RBC Capital Markets

Can you maybe just talk more theoretically, in the fragrance category in general there’s a proliferation of brands out there, how do you think about SKU rationalization with some of the tail brands that you have whether owned or maybe you’re licensing them out, how do you think about that when your goal is to obviously drive new innovation, are those the brands that you have to kind of step up some allowances or promotions, are those brands that you want to kind of get rid of over time because they kind of weigh on the EBITDA trends.

Joel Ronkin

We’ve been fairly successful at winning more then our share of battles in terms of [planogram] changes and that doesn’t mean its unlimited in all of our brands always remain in every planogram but we’re gaining a lot more SKUs then we’re losing and we have a lot more important brands that we’re either gaining or maintaining then the ones we’re losing.

So in general if a SKU gets delisted that was something we owned or distribute for another manufacturer it hasn’t been material to our results. And we’ve had situations I think I mentioned this a few calls ago where we’ve actually, because we wanted to create more of a friendly in store environment and have testers and have great visuals, we’ve actually decreased the planogram space and the number of SKUs in a planogram to allow for this visual imagery.

And sales have actually gone up even with less SKUs and so like I mentioned before our market shares are improving despite the proliferation of brands and we sometimes have our own brands, we sometimes introduce other manufacturers brands but in general, we’re winning more than losing in terms of the planogram battles and that’s largely due to the quality of the innovation.

That we’re either innovating or our partners are innovating and there’s just a, especially in the mass retail environment, the number of brands that are now being available to sell in that channel are just really growing and growing and its becoming easier for us to find the top brands to distribute in that channel.

Jason Gere – RBC Capital Markets

And as you talk about the de-stocking of fragrance inventory in the mass channel and I just want to make sure, is this really across the board or is this really driven by some more of the smaller players with liquidity issues as opposed to your largest player out there and I was just wondering on that context, if you can kind of shape up how project impact, with Wal-Mart how that kind of ties into your 2% to 3.5% sales growth. What type of contribution you’re looking for that to deliver for 2010.

Scott Beattie

I’ll let Joel deal with project impact at Wal-Mart but just in terms of deleveraging of inventory this isn’t unique to the fragrance category per say, you look at Wal-Mart’s numbers today. They had I think 1% growth in revenues and 4% decline in inventories and when you net out the food business which is a very fast turning business, the likelihood is that the majority of the much higher decline in inventory is in some of the other categories.

It’s a general process across all categories of mass and prestige retailers to drive inventory down so its not a fragrance based issue.

Joel Ronkin

In terms of project impact, we can’t get into specifics about its impact on the fragrance category but what we can tell you is that we have planned for the project impact doors that are expected to open throughout the year and the sales increases that we have seen on the project impact doors that have converted already, those increases have been planned into our guidance so obviously as more and more doors open and as replenishment of regular inventory at other Wal-Mart doors improves, that should be a positive contributor for us.

Jason Gere – RBC Capital Markets

And then I guess I would just assume that fiscal 2011 obviously would be a much stronger contribution given the challenges that are going out with Wal-Mart and everybody else.

Scott Beattie

Yes.

Operator

Your next question comes from the line of Rommel Dionisio - Wedbush Morgan Securities

Rommel Dionisio - Wedbush Morgan Securities

I wonder if you could just give us a little bit more color in terms of why you saw such impressive market share gains in mass, up 8% in the category, could you just give us a little color what happened in the quarter, was there a promotion or any of your shelf space, some new products you brought to the channel that really were big hits.

Scott Beattie

First of all that market share increase is for the year not the quarter but I think Joel sort of addressed all the drivers of that. We’ve had improvement selection of product both of our own innovation, our own brands plus the brands that we distribute on behalf of some of the other manufacturers. We’ve seen improved traffic in the mass outlets, so people are trading down into the mass channel of distribution.

Just about all of our retailers have improved traffic and we’ve got a larger share of the overall planogram space as a result of having a strong offering of brands. So all those are contributing to the improvement in market share.

Rommel Dionisio - Wedbush Morgan Securities

So you haven’t run any unusual promotions or price cuts or anything like that.

Scott Beattie

Not at all.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Scott Beattie

Thank you very much everyone for joining us today.

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